The changes to free allocation are significant for the next phase of the EU ETS. Conditionality, which previously only applied to the worst-performing installations, will now be broadly applicable and have specific ‘made in Europe’ specifications. Fallback benchmarks are adjusted for the near-term to increase allocation between 2026-2030, and the minimum and maximum benchmark reduction values are established for 2031-2035. CBAM phase-in/free allocation phase-out factors have been adjusted to provide a longer time horizon and new rules are in place that would smooth the transition of new sectors into the CBAM regulation.
A standalone benchmark proposal was put forward alongside the broader EU ETS review, aimed at addressing industry concerns around fallback benchmarks for the 2026-2030 period. The text indicates that, rather than applying sector-specific heat and fuel benchmarks, the current heat and fuel benchmarks will be retroactively amended to the maximum level possible without triggering the Cross Sectoral Correction Factor (CSCF).
Essentially, this means that installations using either heat or fuel benchmarks will see their allocation increase uniformly to the extent that there is space remaining under the industry cap. Notably, the Commission explicitly excludes oil and gas installations from this increase in free allocation.
Timing-wise, the adjustment is expected to take place for the 2027 distribution of free allocation, but to apply retroactively to 2026.
Next FA period (2031-2035)
The EU ETS Directive proposal includes the new free allocation benchmark rates to be applied from 2031-2035. These new minimum/maximum bounds are set at 0.3% per year and 2% per year respectively, equating to a 7.5% or a 50% reduction compared to 2008 benchmarks.
Additionally, there is language signaling that the EU will consider UK installations as a part of the next benchmarking process, “Information submitted by a third country for installations in its territory in accordance with an agreement concluded pursuant to Article 25 may also be taken into account.” For those eyeing the EU-UK linking negotiations, this can be taken as an extremely positive signal.
CBAM and free allocation phase-out
The CBAM phase-out trajectory, initially set in the previous EU ETS reform has been reworked, to continue to provide free allocation beyond the previous 2034 end-date.
The new trajectory is much more lenient, with an end-date of 2038, and residual free allocation remaining at 15% for several years prior. This is visualized in Figure 1 below.
The new rules also establish rules for new CBAM goods or sectors, allowing for full allocation if acceded to the CBAM scope mid-allocation period, and a gradual phase-out along the existing CBAM trajectory upon entry into the subsequent allocation period. This is displayed in Figure 1 below, with scope expansion displayed for either a 2026-2030 entry and for a 2031-2035 entry.
For an overview of the different possible CBAM/FA phase-out trajectories, see below.
New CBAM/FA phase-out trajectory
Conditionality
Finally, earlier language on conditionality by which allocation could be withheld from worst-performing installations has been removed. Instead, it has been replaced with industry wide conditionality.
The new rules will be applicable from 2031 and will require that installations receiving free allocation submit ‘Invest in EU decarbonisation plans’ through which they detail the investments for which allocation revenue will be used. Allocation is then made conditional upon 1) handing in the report, 2) proving that the investments in decarbonization have been made, and 3) maintaining production in Europe. A total of 80% of allocation will be distributed upon the first step, 20% upon the second step, and 100% of allocation must be returned if production is relocated outside of the EU.
Conclusion
Overall, the free allocation rules outlined in both the proposed EU ETS Directive and the benchmark proposal are more generous in terms of the volume of free allocation to be distributed, but significantly more stringent in how conditionality will be applied. While the administrative complexity of the ‘Invest in EU decarbonisation’ plan will be steep, the intention of the European Commission is clear – they want industry to remain in Europe but only if it decarbonises.
EU ETS Weekly price drivers
A weekly cap of what moved EUA prices and a clear view of the week ahead. We set out the drivers, their directional impact, and what matters next.
