EPICO has published a new Policy Report with Frontier Economics on the reform of free allocation under the EU Emissions Trading System (ETS). The report develops the first systematic typology and evaluation framework for the different forms of conditionality that could govern free allocation in the future — from access requirements to performance-based models to investment obligations.
As the European Commission moves forward with the ETS reform, it faces a decision that will shape the link between carbon leakage protection, industrial competitiveness, and investment incentives for years to come. At the heart of the debate is a question that has so far lacked a clear structure: under what conditions should companies continue to receive free allowances, and what role should free allocation play going forward? Should it remain focused on preventing carbon leakage, or should it increasingly become a lever for steering industrial decarbonization investment? Brussels is clearly moving toward stronger conditionality, but a consistent framework for classifying and designing these conditions has so far been missing.
To fill that gap, the report assesses the main forms of conditionality against four criteria:
- Effectiveness in carbon leakage protection
- Investment and decarbonization incentives
- Administrative feasibility
- Integrity of the emissions trading system
Building on this framework, the study also provides a systematic classification of current reform proposals from Germany, the Netherlands, and the EPP, offering policymakers a clear map of where these proposals sit and what trade-offs they imply.
Based on this analysis, the report puts forward four core recommendations:
- Free allocation should primarily prevent carbon leakage. Additional industrial policy goals should be pursued through dedicated instruments such as the Innovation Fund, Carbon Contracts for Difference, or an Industrial Decarbonisation Bank, funded through ETS revenues.
- Access to basic carbon leakage protection should be simple, proportionate, and predictable. Tools like climate neutrality plans or energy audits can play a useful role, but should not complicate access to this baseline protection.
- Performance-based conditionality is best suited to any additional support granted. It can reward investment and protect first movers without undermining basic carbon leakage protection.
- Rigid "use-of-value" requirements should be avoided. Prescribing how companies must spend the economic value of their free allowances adds bureaucracy, weakens carbon leakage protection, and risks locking companies into investments that are not yet economically viable under current market conditions.