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Glossary · Energy industry & energy transition

Carbon Leakage

Carbon leakage EU Emissions Trading Industry Climate policy competitiveness greenhouse gas emissions

Carbon leakage (in German roughly "Verlagerung von CO₂-Emissionen", i.e. relocation of CO₂ emissions) refers to the shift of greenhouse gas emissions to other countries or regions. It occurs when climate protection rules, a carbon price or other climate policy requirements make production more expensive at a given location. Production, investment or market share then move to areas with less stringent requirements. In the statistics of the strictly regulated area, emissions fall. Worldwide, however, they may stay the same or even rise, for example if the relocated production is less efficient. The European Commission describes the term in a similar way: companies move their production to countries with laxer emission rules because of strict climate policy, which can increase global emissions.

Not every relocation of production is carbon leakage. One speaks of carbon leakage only if differing climate policy costs can be identified as the cause or as a substantial trigger. If a company relocates because of labour costs, proximity to sales markets, raw material prices or general location policy, this is initially not carbon leakage in the narrower sense. However, climate policy can be one part of a whole bundle of location costs.

Direct, indirect and investment-related leakage

Direct carbon leakage arises when a plant in the regulated area produces less or closes, and comparable production increases elsewhere without similar CO₂ costs. An example: a European steelworks loses market share to a producer outside the EU whose blast furnace does not pay a comparable carbon price. Emissions in Europe fall, but the steel demanded worldwide continues to be produced, just in a different place.

Indirect carbon leakage works through inputs and energy prices. Electricity generators in emissions trading pass on the costs of emission allowances to their customers via the electricity price. As a result, electricity-intensive businesses bear indirect CO₂ costs. This affects, for example, aluminium, chlor-alkali chemicals, electric steel or paper. However, the electricity price also consists of fuel costs, grid charges, levies, surcharges, procurement costs and market design effects. A high electricity price is therefore not automatically carbon leakage. Together with international competition, though, it can increase the risk.

A third variant is investment leakage. Here, no existing production is relocated. Instead, new capacity is not built in the regulated area in the first place. This is hard to detect statistically because no plant closes. It can nevertheless be significant for the transformation of industry, for example when new basic materials production, hydrogen plants or climate-friendly intermediate products are established where energy is cheaper or climate policy is less strict.

Distinction from imports, deindustrialisation and emissions statistics

Carbon leakage is not the same as rising imports. Imports can also grow because demand rises, foreign suppliers are more productive, exchange rates change or supply chains are reorganised. For carbon leakage, it must be examined whether CO₂ costs triggered a relevant shift and how this affects global emissions.

A general decline of industry, i.e. deindustrialisation, is likewise not automatically carbon leakage. The distinction is important because national emissions inventories are kept on the territorial principle: they record emissions where they occur. Emissions embedded in imported goods hardly appear in the importing country's inventory. Consumption-based accounts or a product carbon footprint can partly close this gap. However, they are methodologically more demanding.

Carbon leakage is also not synonymous with competitiveness. A company can be under competitive pressure without emissions being relocated. Particularly vulnerable are markets for globally traded basic materials with low transport costs, where CO₂ costs make up a noticeable share of production costs. Typical examples are steel, cement, chemicals, fertilisers, aluminium, glass and paper.

How the EU measures the risk

In the EU Emissions Trading System (EU ETS 1), the risk is formally defined. The Commission combines two measures: trade intensity, calculated as (imports + exports) / (imports + production), and emission intensity. Emission intensity comprises direct emissions plus electricity consumption times the emission factor of electricity, relative to gross value added. If the product of the two values exceeds 0.2, a sector is considered significantly at risk. For values between 0.15 and 0.2, a qualitative assessment follows. It takes into account, among other things, abatement potential, market characteristics and profit margins.

On this basis, the Commission sets the carbon leakage list for 2021 to 2030 in Delegated Decision (EU) 2019/708. It comprises 63 sectors and subsectors, which together cover about 94 percent of industrial emissions in the EU ETS. In the reasoning of the decision, the Commission notes that the sectors are exposed to differing degrees of risk. In its assessment, free allocation has so far prevented carbon leakage. This is the Commission's view, not an independent empirical finding.

Why the term matters for climate policy and the energy system

Carbon leakage shows whether territorial climate policy really works. If an economic area reduces its emissions only because imported goods from more emission-intensive plants replace its own production, the benefit for the climate is small. A high carbon price strengthens the incentive for decarbonisation. But it can burden manufacturers whose competitors do not bear comparable costs.

This also concerns the transformation of the energy system. Many industrial decarbonisation pathways rely on electrification, green hydrogen, renewable electricity, new process routes and flexible load. If fossil processes remain cheap abroad while new domestic plants bear high initial costs, an investment risk arises. Nevertheless, carbon leakage is not a blanket argument against carbon prices. Without a price signal, many companies lack the economic reason to reduce emissions systematically. What matters is the design of the instruments.

Instruments against carbon leakage

The central instrument in the EU ETS remains the free allocation of allowances. Its level is based on product benchmarks. These reflect the average emission intensity of the most efficient 10 percent of installations in a sector. The allocated quantity results from production volume times benchmark. Therefore, only very efficient installations receive enough allowances for their entire needs. The incentive for efficiency is thus preserved. Sectors on the carbon leakage list can in principle receive 100 percent of this benchmark quantity free of charge. For less exposed sectors, free allocation is 30 percent until 2026 and then phases out by 2030.

Free allocation has limits. It supports existing production but triggers investment in climate-neutral processes only to a limited extent. For this reason, carbon contracts for difference are used as a complement. They compensate the additional costs of climate-friendly processes for a certain period.

The carbon border adjustment mechanism CBAM addresses imports. It applies to cement, iron and steel, aluminium, fertilisers, hydrogen and electricity. Chemicals, glass and paper are currently not covered. After a transitional phase with reporting obligations only (October 2023 to the end of 2025), the definitive phase has been running since 1 January 2026. Anyone importing more than 50 tonnes of CBAM goods per year needs the status of authorised CBAM declarant. For electricity and hydrogen there is no quantity threshold. The first annual declaration for 2026 is due by 30 September 2027. CBAM certificates will be sold from February 2027, and their price follows the EU ETS 1. Importers can have a carbon price actually paid in the country of origin taken into account.

CBAM and free allocation are linked. The number of CBAM certificates to be surrendered is reduced to the extent that comparable EU products still receive free allowances. At the same time, free allocation for CBAM sectors decreases under Article 10a(1a) of the Emissions Trading Directive via the so-called CBAM factor. This stands at 97.5 percent in 2026, 51.5 percent in 2030 and 14 percent in 2033. From 2034, no factor is provided for, so allocation for these sectors ends. This is the position of the law in force in November 2026. A revision of emissions trading is currently under discussion.

For electricity-intensive industries, there is additionally electricity price compensation. It offsets part of the indirect CO₂ costs passed on via the electricity price. The basis is the EU state aid guidelines for 2021 to 2030. National programmes must be approved by the Commission. Member States should spend at most 25 percent of their ETS revenues on it; otherwise they must justify the excess. In Germany, the German Emissions Trading Authority (DEHSt) is responsible. For the settlement year 2023, 351 companies with 707 installations received a total of around 2.4 billion euros. Here too there is a tension: the relief is meant to prevent relocation but must not entirely remove the incentive for efficiency and climate-friendly electricity procurement.

Typical misunderstandings

  • Carbon leakage cannot be read from the national emissions inventory alone. Falling industrial emissions can be due to efficiency, fuel switching, the economic cycle, production decline or changed statistical delineations. Without data on production volumes, import flows and emission intensities, it remains unclear what actually happened.

  • Not every location disadvantage is carbon leakage. Sectors differ greatly: cement has high process emissions, aluminium is sensitive to electricity costs, and for steel, raw material pathways, plant age and hydrogen availability matter. The chemical industry depends on integrated sites, feedstock flows and process heat.

  • However, carbon leakage is also not a mere pretext of industry. In open markets with very different CO₂ costs, relocation can be real. The answer to this is good rule design, not ignoring the problem.

  • The term says nothing about whether a sector should remain in the country permanently. Questions about jobs, security of supply or strategic dependencies require their own criteria.

A term with a clear system boundary

Carbon leakage shows that climate policy operates within territorial jurisdictions, whereas goods markets and investment decisions are organised internationally. Those who use the term precisely ask about emission intensity, tradability, differences in CO₂ costs, pass-through of costs to customers, investment pathways and the rules of the respective instrument. The term loses sharpness when it is used for every cost burden or every structural change. It is not an objection to climate policy, but a condition for designing it effectively.

Sources

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Edited by eCMS on 11.11.2026 16:59

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