UK Government Guidance on Claiming Compensation for Indirect Costs

Government updates support for energy intensive businesses facing carbon costs

The UK government has published revised guidance for businesses claiming compensation for indirect carbon costs. These costs arise from the UK Emissions Trading Scheme and the Carbon Price Support mechanism. For manufacturers with high electricity use, the support helps offset price increases passed through supply chains.

The compensation scheme targets sectors at risk of carbon leakage. This happens when production moves to countries with lower environmental standards. Steel, cement, chemicals, paper, and aluminium producers face particular pressure. Their electricity bills include embedded carbon costs that competitors in other markets may not pay.

Businesses must meet specific eligibility tests. However, the updated guidance clarifies how to calculate claims and what evidence to provide. For many energy intensive manufacturers, this compensation makes a material difference to operating costs.

How the compensation scheme works in practice

Companies must satisfy two main requirements. First, they need to operate in designated energy intensive sectors. The government uses Standard Industrial Classification codes to define which activities qualify. Second, businesses must pass the 5% filter test.

This test compares indirect carbon costs to gross value added. Specifically, the costs must equal at least 5% of GVA. Calculations use a mean average across five years of financial accounts. This approach smooths out unusual trading periods and gives a fairer picture of normal operations.

Businesses running both eligible and non-eligible activities can still claim. Compensation applies only to the portion of energy use attributable to qualifying production. You need to apportion costs accurately between different parts of your operation.

The scheme caps compensation at the lower of two figures. You receive either 75% of total indirect emissions costs or 1.5% of gross value added. Whichever is smaller determines your maximum claim. The government calculates emissions using CO₂ factors from the Digest of UK Energy Statistics. The current price stands at £40.06 per tonne of CO₂ per megawatt hour.

For most eligible businesses, compensation covers between 15% and 30% of total energy expenditure. This percentage varies by sector and individual energy intensity. Renewable generation you produce yourself attracts no compensation. If you use biomass co-firing, you receive compensation only on the fossil fuel element.

Dual benefits for qualifying manufacturers

Energy intensive businesses may access a second support mechanism alongside ETS compensation. The Energy Intensive Industries Exemption Scheme reduces other policy costs in electricity bills. Qualifying companies receive a full exemption from charges that fund Contracts for Difference and the Renewables Obligation.

This exemption also covers small scale Feed-in Tariff costs and GB Capacity Market charges. From 2025, network charge compensation payments will begin. Together, these exemptions significantly reduce the non-commodity elements of electricity bills. For large users, these charges normally represent a substantial portion of total costs.

The Department for Business and Trade administers both schemes. Businesses often qualify for support under both programmes. Therefore, it makes sense to review eligibility for each when assessing your position. The application processes run separately but cover related territory.

Five essential facts about the updated guidance

• Businesses must demonstrate indirect carbon costs equal at least 5% of gross value added, calculated as a mean average over five years of financial accounts.
• Compensation is capped at the lower of 75% of indirect emissions costs or 1.5% of gross value added, using a CO₂ price of £40.06 per tonne.
• Energy intensive manufacturers can typically claim compensation covering 15% to 30% of total electricity bills, depending on their specific circumstances.
• Recipients must complete a Department for Business and Trade questionnaire outlining their decarbonization plans, though non-completion will not trigger clawback in the first year.
• Eligible businesses may also qualify for the Energy Intensive Industries Exemption Scheme, which provides 100% relief on several renewable energy policy costs.

Balancing competitiveness with emissions reduction

Research from the London School of Economics examined how compensation affects business behaviour. The findings show compensated firms in electro intensive sectors increased production by 16% to 30% after receiving support. This suggests the scheme successfully prevents production moving overseas.

Nevertheless, the research also identified a trade off. Companies receiving compensation show weaker incentives to improve energy efficiency. Compensated businesses increased electricity consumption and carbon emissions by 22% to 24% compared to non-compensated firms. This happened despite their higher production volumes.

For manufacturers, this creates a strategic question. Compensation provides short term cost relief and protects market position. Meanwhile, investing in efficiency reduces long term exposure to rising carbon prices. The optimal approach depends on your sector, capital availability, and competitive dynamics.

Government policy aims to maintain UK industrial capacity during the transition to net zero. However, businesses relying solely on compensation without improving efficiency may face greater challenges as carbon prices rise further. The questionnaire on decarbonization pathways reflects this tension. Regulators want to understand how recipients plan to reduce emissions over time.

Preparing your claim and planning ahead

The updated guidance includes worked examples showing how to calculate eligibility and compensation amounts. These examples cover common scenarios and help businesses understand the methodology. If your energy costs have risen sharply, reviewing your potential eligibility makes commercial sense.

Start by gathering five years of financial accounts. You need accurate figures for gross value added and electricity consumption. Next, identify which of your activities use Standard Industrial Classification codes that qualify. If you run mixed operations, you need clear records separating eligible from non-eligible energy use.

Calculate your indirect carbon costs using the specified CO₂ emission factors. Apply the 5% filter test to determine whether you meet the threshold. If you qualify, work through the compensation formula to estimate your potential claim value. The government guidance provides the detailed methodology.

Consider your decarbonization strategy alongside the compensation claim. The Department for Business and Trade wants to see credible plans for reducing emissions. While you will not face clawback for incomplete questionnaires initially, demonstrating a clear pathway strengthens your position. Moreover, efficiency improvements reduce your baseline costs regardless of compensation.

Many energy intensive manufacturers face significant capital investment decisions. New equipment often delivers both production benefits and lower energy consumption. Carbon reporting and reduction programmes help you quantify potential savings and structure business cases for investment. Understanding your emissions profile also supports more accurate compensation claims.

Supply chain pressures affect eligibility too. If your customers increasingly require environmental credentials, investing in efficiency may open new commercial opportunities. Public sector suppliers already face carbon reduction requirements under Procurement Policy Note 06/21. Private sector buyers are following suit. Therefore, treating emissions reduction as purely a compliance cost may miss wider strategic implications.

Where to find detailed guidance and support

The Department for Business and Trade publishes the official compensation scheme guidance on GOV.UK. This includes eligibility criteria, calculation methodologies, and application procedures. The UK Emissions Trading Scheme compensation guidance provides comprehensive technical detail for preparing claims.

Information about the Energy Intensive Industries Exemption Scheme appears separately on the government’s guidance pages. This covers the application process for policy cost exemptions. Businesses should review both sets of guidance to understand their full entitlement.

The Digest of UK Energy Statistics contains the CO₂ emission factors used in calculations. The Department for Energy Security and Net Zero publishes this annually. Using the correct factors ensures your claim calculations match the government’s methodology.

For businesses reviewing their broader sustainability position, regulatory compliance support helps navigate overlapping requirements. Carbon pricing mechanisms interact with reporting obligations, supply chain expectations, and tender criteria. Understanding how these elements connect supports better strategic planning.