Free allocation in the EU ETS

The EU ETS is the cornerstone of the EU's climate policy. In 2025, it contributed to reducing ETS-covered emissions by more than half compared to their 2005 level, remaining well on track to meet its target of cutting greenhouse gas (GHG) emissions by 62 % in 2030. The EU ETS upholds the 'polluter pays' principle, requiring participants to pay for their carbon footprint. To comply with their emission obligations, participants must obtain emission allowances (certified rights to emit). Since 2013, auctioning has been the default method of allocating these allowances under the EU ETS. Through auctions, participants can buy the allowances they need for compliance.¹ Auctioning is an important source of income, as Member States collect revenues from ETS auctions that they can later invest in climate and energy-related activities. Between 2013 and 2025, the EU ETS generated more than €258 billion in auction revenues.

Eligibility for free allocation and exposure to the risk of carbon leakage

In principle, all industrial installations covered by the EU ETS, except those producing electricity only (with the exception of electricity produced from waste gases) and municipal waste incinerators, are eligible for free allocation². To receive free allocation, installations must apply to their national competent authorities before the relevant deadline and be included in the national implementation measures list (NIMs)³. The NIMs are lists prepared by Member States detailing the preliminary amount of free allowances allocated to each installation and submitted to the Commission.

The EU ETS Directive establishes different levels of exposure to carbon leakage for the industrial sectors and subsectors it covers. These levels of exposure are important as they determine the level of free allocation to which a sector or subsector is entitled to receive. Article 10b of the EU ETS Directive establishes the conditions for a sector and subsector to be considered at risk of carbon leakage.

The sectors exposed to carbon leakage during the 2021-2030 period are those included in Commission Delegated Decision (EU) 2019/708 establishing the carbon leakage list (CLL), based on emissions and trade intensity indicators. These sectors are entitled to receive free allowances equal to 100 % of the relevant benchmark level. The benchmark level is based on the average GHG emissions intensity (in terms of CO₂ equivalent emitted, per tonne of product produced or per terajoule) of the 10 % most efficient sub-installations covered by a given benchmark. All sub-installations producing benchmarked products are assigned to the corresponding product benchmark and depicted in a benchmark curve. Examples of product benchmarks include refinery products, ammonia, soda ash and hydrogen (see Figure 1 for the hydrogen benchmark curve).

Source: European Commission, Update of benchmark values for the years 2021-2025 of phase 4 of the EU ETS, 2021.

For each benchmark, only the 10 % most GHG-efficient sub-installations in a benchmark curve receive their full allocation free of charge, while the rest must purchase additional allowances to cover part of their emissions. The further a sub-installation is from the benchmark value representing the 10 % most efficient installations in terms of GHG emission intensity, the more allowances it will need to purchase to cover its emissions. In the example shown in Figure 1, only the five most efficient sub-installations covered by the hydrogen product benchmark in 2016-2017 would receive their full allocation free of charge during the 2021-2025 period, to comply with their emissions-related obligations.

Through the benchmarking approach to free allocation, the EU ETS aims to reward sub-installations with the best average GHG emissions performance within each benchmark. The EU ETS covers 52 product benchmarks and two fallback benchmarks:

Regulation (EU) 2023/956 establishing the CBAM introduced a new category – 'CBAM sectors' – covering the goods listed in Annex I to the regulation. A first list of sectors with goods under CBAM include aluminium, hydrogen, fertilisers, iron and steel, and cement.⁵ Within this new category, a distinction is made between sectors and subsectors exposed to a high risk of carbon leakage that are covered by the CBAM and those that are not. For CBAM sectors, free allocation is gradually phased out through the application of a 'CBAM factor', which annually adjusts the level of free allocation in parallel with the gradual introduction (phase-in) of the CBAM.The CBAM factor will cease to apply from 2034, when free allocation for CBAM for these goods will end entirely.

This is not the case for non-CBAM sectors. While both CBAM and non-CBAM sectors are listed in the carbon leakage list (CLL), the CBAM factor does not apply to non-CBAM sectors. Furthermore, the amount of free allocation for non-CBAM sectors is determined for each product benchmark by the value set out in Commission Implementing Regulation (EU) 2021/447 setting the revised benchmark values for free allocation of emission allowances. The current benchmark values apply for the 2021-2025 period, and the Commission is required to update them for the 2026-2030 period.⁶ The Commission updated the benchmark list on 29 June 2026 (see Section on 'Updated benchmark values' below). For non-CBAM sectors, there is no announced free allocation phase-out deadline.⁷

Some sectors exposed to the risk of carbon leakage will continue to receive a reduced level of free allocation until 2030, after which free allocation will be fully eliminated. These are the sectors that are excluded from the carbon leakage list because they are considered to have a lower exposure to carbon leakage based on their emissions or trade intensity indicators.⁸ Examples of such sectors are 'mining of lignite', 'extraction of natural gas' and 'casting of light metals'. For sectors exposed to a lower risk of carbon leakage, free allocation is set at 30 % until 2026 and is to be gradually phased out by 2030. In addition, ETS installations providing heat to district heating systems may still continue receiving free allocation until 2030.

Certain Member States can also provide free allocation to electricity-generating installations to support investment in the modernisation of their energy sectors. Out of 10 eligible Member States, only Bulgaria, Hungary and Romania make use of this provision, which will end on 31 December 2030.

The concept of dynamic allocation was introduced in the EU ETS with the adoption of Commission Implementing Regulation (EU) 2019/1842 as regards adjustments to free allocation of emission allowances due to activity level changes. Dynamic allocation means that free allowances allocated to an installation receiving free allocation may be corrected later if its average activity level changes significantly, compared to a historical activity level initially used to determine its volume of free allocation.

A 15 % increase or decrease in production triggers the adjustment; this increase or decrease is determined by calculating a rolling two-year (arithmetic mean) average activity level for each sub-installation.⁹ Since 2021, dynamic allocation has replaced the older approach for the adjustment of free allocation volumes as a result of significant capacity changes. Dynamic allocation aims to better align free allocation with actual production volumes.

Conditionalities for free allocation

Conditionality refers to the requirements that eligible installations receiving free allocation have to meet in order to avoid a reduction in their level of free allocations. The concept of conditionality for free allocation was introduced in the 2023 revision of the EU ETS Directive and comprises three non-cumulative types:

Updated benchmark values

Under Article 10a (2) of the EU ETS Directive, the European Commission is required to propose an updated list of benchmark values for the 2026-2030 period. The Commission had first planned the publication of the benchmark regulation for April 2026. However, the draft was sent for public consultation in May 2026, which lasted four weeks. It was then voted upon by Member States on 15 June in the Climate Change Committee. The vote was positive, with 17 Member States voting in favour, 5 against, and 5 abstaining. The updated benchmark values were then formally adopted and published in the EU Official Journal on 29 June. Industrial facilities will be required to surrender their emission allowances to the relevant authorities in September.

With the updated benchmark values, free allocation would decrease by more than 16 % on average in 2026 compared with 2021. While the heat and fuel fallback benchmarks would record some of the largest reductions (34 % each), other product benchmarks would increase.¹² They would benefit from the inclusion of indirect GHG emissions from electricity use, alongside direct emissions, in the calculation of the average GHG emission intensities of the 10 % best-performing installations for each benchmark in 2021-2022¹³.The new approach is expected to have a financial impact of around €4 billion more in free allocation.

Source: Compiled by the author on the basis of information extracted from Commission Implementing Regulation (EU) 2021/447 determining the benchmark values for 2021-2025, and Commission Implementing Regulation (EU) 2026/1412 determining the revised benchmark values the adopted for 2026-2030. Graphics by Samy Chahri, EPRS, 2026.

Revision of the EU ETS Directive

Following the adoption of Regulation (EU) 2026/667 as regards the setting of a Union intermediate climate target for 2040 and the adoption of amending Regulation (EU) 2021/1119 (the European Climate Law), the EU ETS is set to undergo a comprehensive and mandatory assessment. The Commission has announced that it would submit a proposal by July 2026. The EU target for a potential agreement between the European Parliament and the Council to revise the EU ETS Directive is Q1 2027.

In its proposal, the Commission will have to integrate the elements related to the EU ETS outlined in Recital 13 of the revised European Climate Law. As regards free allocation, the Commission should consider a slower phase-out pathway from 2028 onwards. In addition, the upcoming revision of the EU ETS Directive needs to address a number of issues, including the risk of carbon leakage in sectors not covered by the CBAM. The Commission's tender specifications regarding support for the review of the EU ETS and the market stability reserve, and the questionnaire released during the 2025 public consultation on the revision of the EU ETS Directive, offer clues about the Commission proposal's potential focus areas.

Among others, the Commission proposal could assess whether free allocation is an effective measure to achieve emissions reductions; whether the existing benchmark value system is the most effective approach; and whether free allocation would continue to offer protection against carbon leakage risk post-2030. The existing CLL, adopted in 2019, is only valid for the 2021-2030 period and would likely be updated ahead of 2030. Consequently, the Commission might assess whether different levels of exposure to carbon leakage in the CLL would increase the effectiveness of free allocation. The Commission impact assessment accompanying its proposal to revise the EU ETS Directive in 2021 already looked at the 'tiered approach', concentrating free allowances on sectors with the highest exposure to carbon leakage as a potential option for a more targeted approach to free allocation.¹⁴

In addition, the Commission may be considering introducing stricter conditionality requirements linked to investment supporting decarbonisation, among other options. The Commissioner for Climate, Net Zero and Clean Growth, Wopke Hoekstra, has confirmed that the upcoming revision of the EU ETS should condition free allocation on investment in the EU in support of decarbonisation objectives. This would add a further layer of conditionality to the existing requirements for granting free allocation to industry.

On 11 May 2026, when announcing the launch of the public consultation on revising the benchmark values for free allocation, the Commission stated that it will propose introducing sector-specific fallback benchmarks as part of the upcoming EU ETS revision. The revised methodology, if adopted in parallel to the revision of the EU ETS Directive, should be implemented as early as possible. On 19 June, the European Council conclusions on competitiveness and global challenges confirmed that the Commission will present a separate proposal alongside the revision of the EU ETS Directive.

Member States' and stakeholders' views

Already ahead of the draft publication of the updated benchmark values applicable for the 2026-2030 period, some Member States had been actively advocating for a relaxation of the current benchmark rules. In April 2026, the Czech Prime Minister called for additional free allocation, conditional on decarbonisation plans, for businesses in the most affected sectors and regions.Two days later, the Spanish Minister of Industry and Tourism sent a letter to the Commissioner for Climate, Net Zero and Clean Growth, expressing concerns about the update of the benchmark values and the lack of transparency. According to the minister, the update of the fuel and heat benchmark values should better reflect the diversity of industrial processes, for example, by introducing an unbundling mechanism with separate reference levels based on temperature ranges.¹⁵

The Italian Ministers of the Environment and Energy Security and of Enterprises and Made in Italy asked the European Commission to temporarily freeze the 2021-2025 benchmark values until the overall revision of the EU ETS Directive has taken place. Ahead of the Competitiveness Council of 28 May, Czechia, Greece, Poland and Romania made the same request. Later, government representatives from Estonia, France, Germany and Spain signed a non-paper expressing their concerns about the update of the heat and fuel fallback benchmarks. They called for a targeted legislative proposal to be adopted before January 2027, separate from the revision of the EU ETS Directive, and for retroactive application of the new benchmarks from January 2026. They argued that the proposed revision of the benchmark values could inadequately increase the carbon cost borne by industries in a context of extraordinary energy prices and global competition.

Along the same lines, in February 2026, energy-intensive industries submitted a letter asking for the suspension of further ETS benchmark reductions and the adoption of measures to avoid triggering the CSCF. They argued that, if triggered, the CSCF would further reduce free allocation for all sectors. In April, another letter, co-signed by energy-intensive companies, asked that, instead of tightening the fall-back benchmarks, they be kept at the 2021-2025 level or be subject only to the minimum annual benchmark reduction of 0.3 % for the same period, as defined in Article 10a of the EU ETS Directive. Business Europe has demanded, among other things, the extension of the carbon leakage list and the removal of the existing conditionalities for free allocation in the upcoming revision of the EU ETS Directive. On the other hand, NGOs such as Sandbag believe that increasing the volume of free allocation is not only unnecessary, but it would also undermine the EU's ability to reduce dependency on fossil fuels. Carbon Market Watch argues that free allocation continues to undermine investment incentives for zero-carbon solutions. Think tanks such as EPICO call for a more strategic approach to allocation while providing greater flexibility.