The European Union’s shift from free emissions allowances to the Carbon Border Adjustment Mechanism (CBAM) could weaken the competitiveness of European steelmakers in international markets, according to research published by Swedish research institute SNS. The study reports that replacing free allocation under the EU Emissions Trading System (ETS) with CBAM could reduce industrial output while improving carbon leakage prevention only to a limited extent.
Economists Christoph Böhringer and Knut Einar Rosendahl compared the economic effects of alternative climate policy arrangements. Their findings challenge the assumption that carbon costs applied to imports would provide energy-intensive industries with protection equivalent to the existing free allowance system.
The results are linked to the EU plan to phase out free ETS allowances for CBAM-covered industries by 2034. While CBAM applies carbon-related costs to covered goods entering the EU, the study says it does not provide equivalent compensation to EU manufacturers exporting to markets where competitors may face lower carbon costs.
CBAM versus free allocation effects on Swedish production
Under current ETS rules, free allowances provide partial compensation for carbon costs incurred by European industrial installations. The SNS study says this helps firms compete in domestic and international markets. Under CBAM, it reports that the mechanism instead targets carbon costs associated with covered imports.
The SNS simulations estimate that Swedish energy-intensive industrial production would decline by 1.3% under a fully implemented CBAM. In the same model comparison, production would contract by 0.6% under free allocation, relative to a hypothetical scenario without climate policy.
The study reports stronger effects for iron and steel. It estimates Swedish steel output would rise modestly under free allocation but fall by 1.7% under CBAM.
The researchers note that Sweden’s electricity supply is relatively low-carbon and its industrial production processes are comparatively clean. They state these characteristics would not necessarily offset the loss of free allowances when steelmakers compete in export markets.
Broader output changes across Europe
For the rest of Europe, the researchers estimate energy-intensive industrial output would contract by 2.6% under CBAM. Under free allocation, they estimate a contraction of 1.3%, using modelled comparisons between policy scenarios rather than forecasts of actual production volumes.
The study also distinguishes sector-level outcomes from economy-wide effects. It reports that replacing free allowances with CBAM could improve overall economic welfare even as production in energy-intensive sectors declines.
For Sweden, the estimated economic cost of climate policy falls from approximately 0.05% of real income under free allocation to almost zero under CBAM. For the rest of Europe, the cost decreases from 0.25% to 0.17%.
The researchers attribute these welfare changes largely to more favourable international terms of trade rather than increased industrial production. They add that lower aggregate climate-policy costs may still increase pressure on steelmakers, aluminium producers and other energy-intensive manufacturers competing against lower-cost international suppliers.
Carbon leakage results under alternative arrangements
The EU’s carbon border policy aims to prevent carbon leakage, defined as emissions reductions within the bloc being offset by increased production and emissions elsewhere. The SNS study estimates that replacing free allowances with CBAM reduces carbon leakage only slightly.
The model places the carbon leakage rate at 16.9% under free allocation and 16.0% under CBAM. Without either mechanism, it estimates leakage would reach 28.5%.
The difference between the two protective arrangements suggests that import carbon adjustments alone may not eliminate relocation of emissions-intensive industrial production. The study points to ongoing influences from energy prices, manufacturing costs and international trade patterns on where production takes place.
Treatment of indirect electricity emissions and export compensation
The researchers identify accounting for indirect emissions from electricity consumption as one potential adjustment area. They say extending CBAM accounting to cover electricity-related emissions for industrial products where these are not currently included could change relative positions among manufacturers using different electricity sources.
For Swedish energy-intensive industry, incorporating indirect electricity emissions into the model reduces the estimated production decline under CBAM from 1.3% to 1.0%. The study says this adjustment is relevant where electricity-related emissions differ significantly from those of competitors.
The study also examines export rebates or other compensation for carbon costs incurred by European manufacturers selling products outside the EU. In its simulations, combining CBAM with export compensation reduces the estimated carbon leakage rate to 10.6%.
The researchers note that introducing such measures would raise questions about international trade rules, restrictions on subsidies and how EU climate legislation is designed.
Implications for non-EU steel suppliers and downstream sectors
The transition has implications for steel producers supplying the EU from the Western Balkans, Türkiye and other neighbouring industrial economies. As free allowances are phased out, CBAM is expected to play an increasingly important role in determining carbon-related costs for covered steel imports.
The study says non-EU manufacturers’ verified emissions data, production efficiency and access to lower-carbon electricity are becoming important factors when supplying European customers. It also highlights a distinction between protecting the EU market against imports with higher embedded emissions and preserving European producers’ ability to compete internationally.
A mechanism affecting costs of goods entering the EU does not, according to the research, automatically compensate European manufacturers for carbon costs associated with exports to third-country markets. The issue extends to downstream steel and aluminium manufacturers whose competitiveness depends on input prices, electricity costs and emissions intensity of purchased materials.
Expanding product coverage toward 2034
The study reports that extending CBAM to additional downstream products could address some competitive distortions while adding further requirements related to embedded emissions, precursor materials and verification. It says interaction between product coverage, emissions accounting and withdrawal of free allowances will remain important as the EU moves toward its planned 2034 phase-out.
SNS research concludes that CBAM may improve economic efficiency of European carbon pricing and affect competitiveness of imports and domestic producers within the EU market without automatically reproducing export protection provided by free ETS allocation. For steelmakers and other energy-intensive manufacturers, it reports modelled outcomes focus on links between carbon pricing, production costs and access to international markets as EU industrial emissions rules change.