The European Union’s transition 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 finds that replacing free allocation under the EU Emissions Trading System (ETS) with CBAM could reduce industrial output while delivering only a limited improvement in carbon leakage prevention.
Economists Christoph Böhringer and Knut Einar Rosendahl, who conducted the research, compared the economic effects of alternative climate policy arrangements. Their findings challenge the assumption that charging carbon costs on imports will provide European energy-intensive industries with protection equivalent to the existing free allowance system.
The results are particularly relevant as the EU plans to phase out free ETS allowances for CBAM-covered industries by 2034. While CBAM imposes carbon-related costs on covered goods entering the European market, it does not provide equivalent compensation to EU manufacturers exporting to markets where competing producers may face lower carbon costs.
Steel output faces pressure under the CBAM model
Free ETS allowances currently provide partial compensation for carbon costs incurred by European industrial installations, helping them compete in domestic and international markets. Under CBAM, the mechanism instead focuses on the carbon costs associated with covered imports, leaving European exporters exposed to production costs that may not be matched by their international competitors.
The SNS simulations indicate that Swedish energy-intensive industrial production would decline by 1.3% under a fully implemented CBAM, compared with a 0.6% contraction under free allocation, measured against a hypothetical scenario without climate policy.
The projected difference is more pronounced in iron and steel. In the model, Swedish steel output would increase modestly under free allocation but fall by 1.7% under CBAM.
These results are notable given Sweden’s relatively low-carbon electricity supply and comparatively clean industrial production processes. The study indicates that these characteristics would not necessarily offset the loss of free allowances when steelmakers compete in export markets.
For the rest of Europe, the researchers estimate that energy-intensive industrial output would contract by 2.6% under CBAM, compared with 1.3% under free allocation. The figures represent modelled comparisons between policy scenarios, rather than forecasts of actual production volumes.
Overall economic welfare improves despite industrial losses
The study identifies a different outcome when assessing the broader economic effects of the transition. 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 would fall from approximately 0.05% of real income under free allocation to almost zero under CBAM. Across the rest of Europe, the corresponding cost would decrease from 0.25% to 0.17%.
According to the researchers, these improvements largely reflect more favourable international terms of trade rather than an expansion in industrial production.
The findings distinguish aggregate economic performance from the position of individual manufacturing sectors. A change that reduces the overall economic cost of climate policy may still increase pressure on steelmakers, aluminium producers and other energy-intensive manufacturers competing against lower-cost international suppliers.
Carbon leakage falls only marginally under CBAM
Preventing carbon leakage is a central objective of the EU’s carbon border policy. Carbon leakage occurs when emissions reductions achieved within the bloc are offset by increased production and emissions in countries with less stringent climate policies.
However, the SNS study estimates that the carbon leakage rate would decline only slightly when free allowances are replaced by CBAM. The model places the rate at 16.9% under free allocation and 16.0% under CBAM.
Without either mechanism, the estimated leakage rate would reach 28.5%.
The difference between the two protective arrangements suggests that import carbon adjustments alone may not eliminate the relocation of emissions-intensive industrial production. Differences in energy prices, manufacturing costs and international trade patterns continue to affect where production takes place.
For European policymakers, the results raise questions about whether CBAM, in its current design, can simultaneously maintain industrial competitiveness and achieve the intended reduction in carbon leakage.
Indirect electricity emissions could alter production outcomes
The researchers identify the treatment of indirect emissions from electricity consumption as one potential area for adjustment. Extending CBAM accounting to cover electricity-related emissions for industrial products where these are not currently included could change the relative position of manufacturers using different electricity sources.
For Swedish energy-intensive industry, incorporating indirect electricity emissions into the model would reduce the estimated production decline under CBAM from 1.3% to 1.0%.
The proposed adjustment is relevant to industrial producers whose electricity-related emissions differ significantly from those of competitors. Recognising indirect emissions could strengthen the position of manufacturers using lower-carbon electricity, depending on the final accounting methodology.
The study also examines the potential role of export rebates or other compensation for carbon costs incurred by European manufacturers selling products outside the EU.
In the simulations, combining CBAM with export compensation would reduce the estimated carbon leakage rate to 10.6%. Introducing such measures would, however, raise questions about international trade rules, restrictions on subsidies and the design of EU climate legislation.
Steel exporters face changing conditions in the European market
The transition also 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 will play an increasingly important role in determining the carbon-related costs of covered steel imports.
For non-EU manufacturers, verified emissions data, production efficiency and access to lower-carbon electricity are becoming important factors in their commercial position when supplying European customers.
The research nevertheless highlights a distinction between protecting the EU market against imports with higher embedded emissions and preserving the ability of European producers to compete internationally. A mechanism that affects the cost of goods entering the bloc does not, by itself, 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 the emissions intensity of purchased materials.
Downstream coverage adds to the regulatory challenge
Extending CBAM to additional downstream products could address some competitive distortions, but a broader scope would also introduce further requirements concerning embedded emissions, precursor materials and verification.
The interaction between product coverage, emissions accounting and the withdrawal of free allowances will therefore remain important as the EU moves towards the planned 2034 phase-out.
The SNS research indicates that CBAM may improve the economic efficiency of European carbon pricing and affect the competitiveness of imports and domestic producers within the EU market, without automatically reproducing the export protection provided by free ETS allocation.
For steelmakers and other energy-intensive manufacturers, the modelled outcomes centre on the relationship between carbon pricing, production costs and access to international markets as the EU changes its industrial emissions framework.
