On 30th January the EU Commission adopted the most recent draft of the delegated act amending the free allocation regulation to the EU ETS. If Parliament and Council do not object within the 2-month scrutiny period, the regulation will adjust free allocations from this year (the new timetable sets a 30 June deadline for 2024 free allowances to be issued by member states).

The alignment of the free allocation regulation with the Carbon Border Adjustment Mechanism (CBAM) is the most significant change. The CBAM, introduced under the EU “Fit for 55” package, is a new tool to combat carbon leakage by introducing a carbon import tax from 2026 which will enable a gradual phase out of free allocations to the cement, iron and steel, aluminium, fertiliser and electricity sector by 2034.

Sectors not on the carbon leakage list, currently receiving a free allocation up to a maximum of 30% will have their free allocation phased out from 2026 to zero by 2030.

The Commission also proposed changes to expand several process benchmarks and include a wider scope of technologies. In a new requirement, operators in all sectors will now also have to set comprehensive sustainability targets and efficiency upgrade requirements – so called ‘conditionalities’ - as prerequisite to receiving 100% of their free allocation (see below for more details).

Installation level changes to free allocations:

• Historical Activity Levels (HAL): Activity Adjustments will be calculated on the basis of median values of the HAL reference period (arithmetic average previously), to avoid the impact of ‘economic crises’ skewing data. Operators HAL will be made publicly available.
• Benchmarks: Further product- and process-benchmark specific revisions can be found in the Annex of the regulation.
• Operational changes: A merger or split of installations will trigger an adjustment in free allocation.
• Closures: If an installation ceases to operate the FA will be reduced retrospectively for the calendar year.

Sector specific changes to free allocations:

• Changes in CBAM sectors: EU producers of goods that are subject to the CBAM, will be required to submit more meticulous monitoring methodology plans.
• Iron and steel: For the purpose of production of primary steel, the consolidated iron ore products and the sintered ore benchmark will be opened to alternative products and will be kept technology neutral.
• Cement: The benchmark will be expanded for production of “alternative hydraulic binders, as substitute for white and grey cement clinker”.
• Heat: Across sectors, operators who electrify their processes and invest in heat-capturing technology will receive free allocations for that heat in addition to allocations for fossil fuel emissions. This also means, the fuel benchmark will be limited to combustion processes where non-measurable heat is the primary purpose.
• Exchangeability between fuel and electricity: Electrified processes covered by the EU ETS will be eligible for free allocation in the same way as processes with high direct emissions.
• Electricity: Operators with onsite generation previously referred to as electricity generators will be removed from the category from Jan 2026 and assessed for their cogeneration in the same way as industrial installations, to receive FA for heat production and district heating.
• Producers in manufacturing sectors will have to document energy exported to non-EU ETS installations, free allocation will be adjusted on the basis of data submitted.
• Hydrogen: From 2026 hydrogen production, will be eligible for free allowances under the EU ETS Hydrogen benchmark (where Hydrogen is produced for the purpose of ammonia it will fall under the ammonia benchmark).
• Aviation: In December 2022 the EU announced that all free allocations to the Aviation sector would be reduced by 25% in 2024, 50% in 2025 before being phased out 100% in 2026.
• District Heating: Operators of district heating installations may seek a 30% increase in free allocation for the period 2026-2030 by submitting a CNP (see below) and demonstrating further requirements.
   

Conditionality:

• Climate-Neutrality-Plans (CNP): The 20% worst performers within a product benchmark, will be required to draft and submit CNP by 30 May 2024 to receive their full preliminary free allocation on June 30th, and review their performance every 5 years after 2025 (date subject to Member State and sub-installations contributing less than 20% to overall FA, will be exempt).
• Energy Efficiency Improvements (EEI): Recommendations made in energy audit reports must be implemented in order to avoid a 20% reduction of FA – previously at company level and henceforth at installation level.
• Loss in free allocation: Reductions from the CNP and EEI will be non-cumulative. The 20% reduction may be recovered by the operator if implementation of recommendations can be confirmed by a verifier in annual activity level reports.
   

Conclusion

The amended free allocation regulation will result in the gradual removal of free allowances (for those not on the carbon leakage list) by the end of Phase 4 (2030) and by 2034 for sectors at risk of carbon leakage (following the introduction of CBAM). EU ETS Operators will therefore face a choice to either budget for the purchase of increased EU Allowances volumes (at prices >€100 if the forecasts are to be believed), explore ways to decarbonise or take advantage of currently favourable EUA prices (2 year low, around €60) and hedge future needs.

If technology and/or capital availability for low carbon projects is limited, then operators should now look to put in place a risk management strategy to manage rising compliance needs and hedge future EU Allowance prices in an increasingly volatile carbon market.

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CFP Energy (formerly CF Partners) have been a pioneer in carbon markets for over 15 years, particularly the EU Emissions Trading Scheme (EU ETS) and more recently the UK ETS which started in May 2021. We operate one of the largest trading desks in the carbon compliance markets and have won a number of awards for our services. We specialise in working with ETS operators to help them understand the carbon market, develop a compliance strategy and execute trades effectively.