Free Allocation vs. CBAM: Why the Chemicals Push Triggers the Next CBAM Debate When a core principle comes under pressure

When a core principle comes under pressure

Federal Environment Minister Carsten Schneider is pushing in Brussels to grant the chemical industry more free ETS allowances in the short term, with “more realistic standards” for the benchmarks. For those responsible for CBAM, this may at first glance sound like internal ETS politics that concerns them little. That would be a fallacy. The tension becoming visible here is structural. CBAM was designed as an instrument that is meant to gradually replace the rationale for free allowances. If a major industrial sector now again demands more free allocation, the question inevitably arises as to whether Europe is in fact running two carbon-leakage protection mechanisms in parallel. CBAM at the border and free allocation within the ETS. This is not only politically sensitive, but also raises WTO-law questions that are already being openly discussed in Brussels.

Political background

The German chemical industry in particular, with companies such as BASF, is lobbying strongly for relief from the European CO2 levy. They fear excessively high additional costs and see this as a major threat to production in Europe. Indeed, this is an industry that generates high CO2 emissions and is correspondingly in CBAM’s focus. For example, the European Commission already spoke at the beginning of last year-when discussing an expansion of the mechanism to additional industrial sectors-among other things about organic chemicals. Germany’s Environment Minister Carsten Schneider now appears to be yielding to industry pressure. He is advocating an expansion of free CO2 allowances for the sector.

The allocation of free allowances

In recent years, the relocation of industry due to excessively high CO2 prices has been prevented through the allocation of free allowances. This is based on the so-called ETS benchmarks. A benchmark sets an amount of CO2 emissions per tonne of product. Companies then receive their allowances free of charge in this amount for the quantities they produce. However, this free allocation of allowances is now to be replaced by CBAM. Because such protection is no longer needed by industry-at least for the European market-if everyone there is subject to the same CO2 price. That is why a CBAM factor was introduced, which over the coming years will lead to a gradual phase-down of free allowances. It must be kept in mind, however, that the export side is currently not resolved by CBAM. In foreign markets, companies that produce in Europe face a competitive disadvantage as long as there is no export adjustment.

What this means for CBAM sectors

Context is crucial: For the current CBAM sectors, the phase-out of free allocation by 2034 is politically predetermined. Schneider’s push targets sectors that are not yet covered by CBAM but likewise claim carbon-leakage protection. Different options are now available. On the one hand, ETS benchmarks for the chemical industry could be adjusted. If these were increased, European producers would automatically benefit from a higher free allocation of allowances. They would feel cost relief both on the European market and on third-country markets. Another path could also be to include the chemical industry within CBAM’s scope. We fundamentally want to replace free allocation. CBAM is intended to be our protection instrument against carbon leakage. An extension to the chemical industry therefore appears only logical. At the same time, however, it must be borne in mind that competitive disadvantages on export markets would continue to exist as long as CBAM does not provide relief for exports. It is also interesting what the Commission is thinking in parallel. Models that link the allocation of free allowances to transformation and efficiency investments. Even if this formally remains true to the ETS design, such dependencies-as experience shows-shape expectations regarding corporate evidence, data quality, and auditability along the entire value chain.

Consistent action required

Carsten Schneider’s push is unsettling the debate and creating uncertainty for companies already affected by the CBAM mechanism. Coherent political action would be desirable. Certainly, CBAM does not meet with approval everywhere in industry. At the same time, it is an instrument that also protects European industry. It would therefore be desirable for the European Commission to stick with a model of protection against carbon leakage. Parallel instruments should not be pursued. These raise questions of equal treatment where industrial value chains overlap and where the measures intersect. Political capital should therefore be better spent on completing CBAM and shaping it in a way that provides efficient protection for exports. It should function similarly to VAT. Then it can also be further expanded and protect industry and the environment alike.

Outlook

Will we see a model of “free allocation in exchange for proof of investment,” or rather a political extension? If top politicians in several countries discuss ETS interventions, the likelihood increases that CBAM details such as scope, anti-circumvention measures, and double compensation will move back to the very top of the agenda. Any debate about “protection gaps” makes a CBAM expansion more likely in the medium term.

Support

If you would like to assess how you can set up your current CBAM processes or data structures in a scalable way, feel free to email me at helge@kolum.earth. We support you in organizing your CBAM compliance so that it remains resilient even in the event of political course changes.