EU Emissions Trading System

Several myths or misunderstandings about the role and functioning of the EU ETS abound in discussions about this central EU climate policy. This mythbuster addresses some of those questions.

EU Emissions Trading System

Several myths or misunderstandings about the role and functioning of the EU ETS abound in discussions about this central EU climate policy.

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Mythbuster Q&A on the EU ETS

In fact, the one-off cancellation and the Market Stability Reserve do not affect the 2030 climate ambition. The climate target is set by the total cap to EU emissions under the EU ETS by 2030.

This cap declines annually according to the linear reduction target (LRF), which ensures that ETS sectors achieve the 2030 target.

The one-off cancellation and the Market Stability Reserve affects the budget of allowances available during the trading period (i.e. the trajectory until 2030) without impacting the 2030 target (i.e. the end point of the trajectory.

Therefore, both measures artificially increase the carbon costs for the same level of 2030 ambition, since they reduce the volume of available emissions during the trading period.

According to analysis by market analysts[1], the one off cancellation would bring the EU carbon price within the range 80-100€/t compared to scenarios around 50€/t without it.


The faster decarbonisation of the power sector compared to energy intensive industries is linked to structural differences in technologies, market functioning and the regulatory framework.

Firstly, the development and uptake of renewables has been massively supported by state aid. According to the report on energy prices, costs and subsidies published DG ENER, in the period 2008-2018 renewable schemes benefited from around € 600 billion, which tremendously accelerated the roll out of such technologies.

In addition, the power sector is not exposed to international competition, hence it is able to pass on carbon costs without risk of losing market shares. Due to the marginal pricing system, carbon costs are passed on also by electricity that does not embed emissions.

The abatement costs of low carbon technologies in energy intensive industries are much higher than the costs of the coal-to-gas switch in the power sector (100-150€/t vs. 30€/t); hence, reducing emissions firstly in the power sector in the last year is fully in line with the cost-efficient nature of a cap-and-trade system.

Furthermore, energy intensive industries are exposed to international competition with the concrete risk of losing market share to imports in case they pass through carbon costs.

Free allocation is a tool to avoid this risk materialising, while preserving an incentive to improve carbon intensity, since free allowances are capped at the level of the best 10% installations.

Deeper emission reductions in energy intensive sectors is only possible with the roll out, at industrial scale, of breakthrough technologies.

Yet, this relies on supportive regulatory framework and market conditions, including funding support, access to competitive and abundant low carbon energy sources and creation of led markets.

Phasing out free allocation abruptly would actually be counterproductive for the low carbon transition of the sector, since it would expose EU steel producers and downstream sectors to the full ETS compliance costs, undermining their financial ability to invest in low carbon technologies.

In order to be WTO compatible, the CBA needs not to discriminate between EU production and imports. This can be achieved also when the CBA complements existing carbon leakage measures such as free allocation.

In this case, the border measure would be applied only to imports’ embedded emissions that are above the level of the free allocation’s benchmark granted to EU industry.

While remaining WTO compliant, the CBA complementing free allocation mitigates the impact of the border measure on trade flows and facilitates international trade relations. 

Even with a complementary CBAM, EU installations still have an incentive to improve their performance, since they would save on their ETS compliance costs and have a better competitive position.

The European steel industry is, indeed, exposed to structural overcapacities in third countries which result often in unfair trade practises such as dumping.

Yet, this situation makes the relevance of unilateral carbon costs even more important than in other sectors. The rapid growth of the carbon price, which increased from single digit value to above 50€/t in around three years exposes EU steel producers to exponentially increasing costs.

As an order of magnitude, a primary steel maker emitting around 2t CO2/t and having a free allocation shortage of 20% needs to purchase around 0.4t CO2/t of steel. With the increased carbon price, this shortage passed from around 5€/t to almost 20€/t of steel and is expected to increase even further in the near future.

Therefore, unilateral EU carbon costs have become an essential issue for the competitiveness and future sustainability of the sector.

Some overallocation was experienced in the second trading period (2008-2012), when the sector was hit by the economic crisis and the ex-ante nature of the ETS did not allow adjustments in allocation.

Yet, the economic crisis had a massive negative impact on the sector, which lost around 30,000 jobs. Most importantly, with the proper accounting of the emissions embedded in the waste gases that steel sites transfer to power plants, the sector has registered an annual shortage in the balance of direct emissions/free allocation since the beginning of phase 3 (2013).

Furthermore, if one takes into account not only direct emissions and free allocation, but also indirect carbon costs and financial compensation for such costs, the EU steel industry is exposed to massive unilateral carbon costs; in the period 2008-2020 around 250 Mt of direct and indirect emissions equivalent were not covered by carbon leakage measures (free allocation and indirect costs compensation).

The claim that the steel industry has been able, or is able, to pass through carbon costs, including the opportunity costs of free allocation is at odds with the everyday-reality.

Steel is a sector which is highly exposed to an uneven international playing field and suffers from unfair practises, such as dumping and global overcapacity.

Allegations surrounding windfall profits are based on misinterpretation and misreading of a very limited literature on this subject.

The main background studies (CE Delft 2010 and 2015) suffer from a number of methodological flaws due to implausible data proxies: among others, one report used Japanese production costs as proxies of EU prices and the other compared the evolution of EU and USA steel prices in an econometric model without considering major variables like iron ore and scrap prices.

Another report by McKinsey is based on interviews with market experts but dates back to 2006, when international competition was completely different and much more limited than the current situation.

Vivid Economics (2014) is the only study that links the cost pass through with the loss of market share; assuming a high cost pass through rate of around 80%, they find that the steel sector would lose between 21% and 22% of its market share with a carbon price of 30€/t CO2. Hence, in fact it confirms the high carbon leakage risk of the sector.

Published: 12 May 2021. Most recent update: 17 May 2021.

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