EU steelmakers' €25.73bn in free allowances fails to spur decarbonisation
Steel industry received billions while contributing little to climate goals
EU steelmakers received €25.73 billion in free emissions allowances between 2021 and 2025. During the same period, they committed just €3.2 billion of their own money to reducing carbon emissions. This stark imbalance shows that subsidies alone cannot drive industrial decarbonisation.
The numbers reveal a fundamental flaw in how the EU Emissions Trading System has approached heavy industry. For more than a decade, steel producers benefited from generous free allowances designed to prevent carbon leakage. However, emissions from the sector barely moved. Steel output remained carbon intensive while competitors investing in cleaner production methods found themselves at a disadvantage.
The EU is now dismantling this failed approach. Free allowances will disappear entirely by 2035, replaced by the Carbon Border Adjustment Mechanism. This transition marks a significant shift from subsidy to accountability. Steelmakers will soon face the full cost of their emissions, fundamentally changing the economics of production.
How the free allocation system was meant to work
The EU Emissions Trading System operates on a cap-and-trade principle. Regulators set a declining cap on total emissions and issue allowances that companies can trade. Industries at risk of carbon leakage received free allowances to prevent them relocating outside the EU.
Steel qualified as high risk because production is energy intensive and internationally competitive. Between 2008 and 2019, the sector received 95% of its required allowances without charge. That amounted to roughly 2.3 billion emission permits over 12 years.
The policy assumed free allocation would buy time for industrial transformation. Plants would continue operating in Europe while developing cleaner production methods. In practice, emissions stagnated from 2012 onwards. The sector made no meaningful progress toward the 2050 climate neutrality target.
Research confirms the EU ETS has been unsuccessful in steel over the last decade. Free allowances failed to create sufficient incentive for the shift to low-carbon technologies. Instead, the system rewarded continued operation of polluting facilities.
Windfall profits undermined the policy intent
Free allocation created substantial windfall profits for steel producers. Studies estimate these profits across 15 industrial sectors reached between €26 billion and €46 billion from 2008 to 2019. Iron and steel production accounted for a significant concentration of this total.
These windfalls occurred because companies could pass the opportunity cost of free allowances to customers. Even though they received permits without charge, steelmakers priced products as if they had purchased allowances at market rates. Consequently, polluting installations thrived financially while undermining competitors investing in lower-carbon techniques.
The European Court of Auditors noted that free allocation covered over 90% of industrial emissions. However, the system failed to differentiate effectively between genuine carbon leakage risks. This blanket approach weakened decarbonisation incentives across the board.
Meanwhile, the power sector received almost no free allowances during the same period. Emissions from power generation dropped 22% between 2012 and 2018. Industrial emissions managed only a 1% reduction. The correlation between free allocation and stagnant emissions is difficult to ignore.
Phase-out begins in 2026 with annual reductions
The EU has now acknowledged this approach failed. From 2026, free allocation for CBAM-covered goods including steel will reduce by 10% annually. By 2035, it will reach zero.
The Carbon Border Adjustment Mechanism replaces free allowances as the primary defence against carbon leakage. From 2026, importers must purchase CBAM certificates for the emissions embedded in steel and other covered products. This levels the playing field between EU producers and international competitors.
During the transition period from 2026 to 2034, producers will need CBAM certificates for emissions exceeding their reduced free allowance benchmarks. As free allocation diminishes each year, more emissions fall within the scope of carbon pricing. By 2034, total free allocation reaches zero for CBAM-covered sectors.
The revised ETS also introduces new subsidies for hydrogen-based direct reduction technology from 2026 to 2033. This targets green steel production specifically. Additionally, new benchmark definitions for sintered ore, hot metal, and hydrogen enable free allocation for pellet and DRI production. These outputs previously faced full EU Allowance costs.
Carbon costs will rise significantly for conventional production
S&P Global Energy has calculated the financial impact of removing free allowances. Blast furnace-based steel production faces additional costs of approximately €144.72 per metric tonne of finished steel. Electric arc furnace carbon steel sees smaller but still significant increases of around €18.93 per tonne.
These cost increases make emission intensity central to competitiveness. Producers using carbon-intensive methods will carry substantially higher operating costs than those adopting cleaner technologies. Market advantage shifts decisively toward decarbonisation.
For UK steelmakers competing in European markets, this changes strategic planning considerably. Companies relying on traditional blast furnace methods will face mounting pressure on margins. Those investing in electric arc furnaces or hydrogen reduction gain comparative advantage as the transition progresses.
The phase-out also affects procurement decisions. Manufacturers buying steel as a raw material should anticipate price variations linked to production methods. Suppliers with lower emission intensity will become more competitive. This may influence which steelmakers secure long-term contracts.
Multiple factors explain why subsidies failed to drive change
The failure of free allowances stems from structural design flaws rather than implementation issues. Subsidies alone cannot drive industrial transformation without accompanying requirements.
The IPCC emphasises that incentives are insufficient for steel decarbonisation. Clear regulation and comprehensive policy packages are necessary. Free allocation provided financial support but imposed no obligations to reduce emissions. Companies could pocket windfall profits while continuing business as usual.
Furthermore, the system created perverse incentives based on historical output. Allocations rewarded past production levels, keeping older and more polluting plants active. Closing inefficient facilities meant losing valuable free allowances. This actively discouraged the retirement of carbon-intensive assets.
Steelmakers investing in low-carbon techniques found themselves disadvantaged. They received fewer allowances while facing higher upfront costs for new technology. Meanwhile, competitors operating polluting installations collected substantial free permits and passed opportunity costs to customers. The policy effectively penalised innovation.
The ability to pass costs through to consumers weakened emission reduction incentives further. Producers faced no financial penalty for high emissions as long as they received sufficient free allowances. This undermined the fundamental price signal that carbon trading is meant to create.
What UK businesses need to understand about the transition
Several key facts define the current situation and near-term changes:
- EU steelmakers received €25.73 billion in free emissions allowances between 2021 and 2025 while investing only €3.2 billion of their own capital in decarbonisation.
- Free allocation for steel and other CBAM-covered sectors reduces by 10% annually from 2026, reaching zero by 2035.
- Blast furnace steel production will face additional costs of approximately €144.72 per tonne as free allowances disappear.
- The Carbon Border Adjustment Mechanism requires importers to purchase certificates for embedded emissions from 2026 onwards.
- New ETS benchmarks from 2026 support hydrogen-based production methods through targeted free allocation for green steel technologies.
- Industrial ETS emissions dropped only 1% between 2012 and 2018, compared to a 22% reduction in the power sector that received minimal free allowances.
Commercial implications extend beyond steel producers
This transition affects businesses across multiple sectors. Manufacturers using steel as an input material will see price impacts driven by supplier emission intensity. Consequently, procurement strategies should account for carbon costs in supplier selection.
Companies tendering for public sector contracts already face carbon reporting requirements under PPN 06/21. As steel prices increasingly reflect emission intensity, supply chain carbon footprints become more material to tender competitiveness. Choosing lower-carbon suppliers may offer both environmental and commercial advantages.
The phase-out also creates risks around long-term supply agreements. Contracts with fixed pricing may not adequately reflect rising carbon costs for conventional steel production. Buyers should consider how agreements account for the 10% annual reduction in free allowances through 2035.
For businesses operating in sectors covered by the ETS, the steel experience offers important lessons. Free allocation without decarbonisation obligations does not drive emissions reduction. Future policy will likely attach stronger conditions to any continued free allowances in other industries.
The shift toward CBAM also affects international trade relationships. Importers of steel from outside the EU must now account for embedded emissions and purchase corresponding certificates. This changes the economics of global sourcing decisions. Suppliers in countries with carbon pricing equivalent to the EU ETS may gain advantage over those without comparable systems.
Expert consensus points toward conditional support
Policy analysts now argue that free allocation should continue only when linked to measurable decarbonisation progress. Bruegel recommends maintaining support for carbon-intensive industries exclusively in exchange for actual investment in emissions reduction.
This represents a fundamental change in approach. Rather than providing blanket subsidies to prevent carbon leakage, policy would make support conditional on transformation. Companies failing to reduce emissions would lose eligibility for free allowances regardless of carbon leakage risk.
Additional recommendations include aligning member state revenue expenditure with genuine decarbonisation initiatives. Currently, countries receive revenue from auctioning ETS allowances but face limited requirements on how they spend it. Directing this money toward industrial decarbonisation could accelerate the transition.
Expanding the EU's share of auction revenues could fund broader investment in industrial competitiveness. This would create a direct link between carbon pricing revenue and support for clean technology deployment. However, it requires coordination across member states with different industrial priorities.
The European Court of Auditors has also called for better differentiation of carbon leakage risk. Not all industries face equal threat of relocation. Targeting free allocation more precisely could maintain protection where genuinely needed while strengthening incentives elsewhere.
Our analysis of what businesses should consider
The steel sector experience demonstrates that subsidies without accountability cannot drive industrial transformation. Companies across all sectors should expect future climate policy to impose stronger conditions on any financial support.
For manufacturers, this transition creates both risks and opportunities. Businesses can gain competitive advantage by reducing supply chain emissions ahead of regulatory requirements. As carbon costs rise for conventional production methods, early movers toward lower-carbon alternatives may secure better pricing and supply reliability.
Procurement teams should begin assessing supplier emission intensity now rather than waiting for the full phase-out in 2035. The 10% annual reduction in free allowances creates predictable cost increases each year. Building these projections into commercial planning helps avoid surprises.
Companies should also review their own eligibility for any remaining free allowances under the revised ETS. Understanding how benchmarks apply to your operations and what conditions attach to allocation will be increasingly important. Additionally, those investing in decarbonisation may access targeted support for specific technologies like hydrogen production.
Our compliance support service helps businesses navigate carbon reporting requirements and understand exposure to changing ETS rules. We also work with manufacturers on sustainable procurement strategies that account for supply chain emission intensity.
The message from the steel sector is clear. Waiting for subsidies to drive transformation does not work. Businesses that act proactively to reduce emissions will be better positioned as carbon costs rise and free allocation disappears. This is now a commercial imperative, not just an environmental consideration.
Where to find authoritative guidance on ETS and CBAM
The European Commission's EU ETS page provides comprehensive information on how the trading system operates and current rule changes. For specific detail on free allocation phase-out, the CBAM information portal explains transition timelines and certificate requirements.
UK businesses exporting to the EU should consult Department for Energy Security and Net Zero guidance on how Brexit affects participation in carbon markets. The department also publishes updates on UK carbon pricing and any future border adjustment mechanisms.
For sector-specific analysis, the Carbon Market Watch steel decarbonisation report examines why free allocation failed in detail. Their research provides useful context for understanding the policy shift toward conditional support and accountability mechanisms.