In the current Carbon Border Adjustment Mechanism (CBAM) Regulation, indirect emissions are excluded from the aluminium, hydrogen and iron and steel sectors. This exclusion is concerning given that electricity-related emissions account for a significant share, if not the majority, of the carbon footprint of these sectors. This results in a major shortfall for the climate credibility of the mechanism, as carbon-intensive goods from those sectors will enter in the EU market with indirect emissions unaccounted for. 

The main reason for this pitfall is the functioning of the European electricity market paired with the carbon cost on electricity. This interaction creates a situation in which some EU electricity-intensive industries are exposed to the indirect carbon price on electricity, which makes them at risk of carbon leakage, therefore eligible to receive Indirect Cost Compensation (ICC). This compensation is provided by certain Member States to compensate such industries for the indirect carbon cost that is passed on their electricity bills, regardless from the emission intensity of the electricity consumed. This has major consequences for CBAM, because as long as ICCs are granted in their current form, applying CBAM to indirect emissions could result in double protection for EU industries. 

With this article, Bellona puts forward a proposal to include indirect emissions in the CBAM from its definitive phase, in parallel to revising how ICC is distributed within the EU. In particular: 

• Indirect emissions of all sectors should be covered by the CBAM starting in 2026, alongside a reform of the ICC scheme. 

• Emissions from electricity generation must be fully paid by EU’s industries with the CBAM protecting them from risk of carbon leakage. 

• ICC can remain a transitional tool to compensate EU’s energy-intensive industries for the share of renewables electricity consumed and subjected to carbon cost.  

The risks of a CBAM without indirect emissions 

Excluding emissions resulting from the production of electricity used to produce CBAM goods in the aluminium, iron and steel and hydrogen sectors means ignoring the lion’s share of the climate footprint of most energy-intensive products, fundamentally contradicting core principles of robust carbon accounting. The importance of including indirect emissions for the environmental effectiveness of the CBAM has been recognised in recital 19 of the Regulation; action on this front cannot be delayed and it matters for the following reasons: 

• Strengthening environmental integrity and aligning with the EU ETS: CBAM was designed to mirror the EU Emission Trading System (ETS), which covers both direct and indirect emissions. Excluding indirect emissions from CBAM creates a fundamental inconsistency between the two systems and weakens the EU’s overall carbon pricing framework. Sectors such as aluminium, hydrogen, and steel, where indirect emissions constitute a significant share, if not the majority, of the carbon footprint would remain unaccounted for, severely undermining the mechanism’s climate impact. Including these emissions is essential to ensure full carbon cost exposure, avoid loopholes, and reduce fossil fuel dependency across supply chains. 

• Ensuring fair competition and protecting low-carbon producers: Without indirect emissions in the CBAM, EU producers using clean electricity will face unfair competition from imported goods made with fossil-based power. The EU’s electricity grid is significantly cleaner than many global counterparts, but this advantage is ignored if only direct emissions are considered. As a result, EU industries are effectively penalised for investing in decarbonisation, while carbon-intensive imports remain not subject to carbon price. Including indirect emissions levels the playing field and recognises the climate efforts of European producers. 

• Driving global climate action and investment signals: Excluding indirect emissions removes a major incentive for international producers to decarbonise their electricity use. By covering these emissions, CBAM can meet its objective of “reducing global carbon emissions” and “creating incentives for the reduction of emissions by operators in third countries” as stated in article 1 of the Regulation. 

The EU Electricity Market and ICC 

In Europe, on the short-term market, electricity prices are set through a marginal pricing mechanism, where the final market price is determined by the last and most expensive producer needed to meet demand, usually a fossil-fuel-fired power plant.¹ This means that, regardless of the electricity’s source, the electricity price often has the associated carbon cost, which is not borne by the fossil power producer, but instead passed on to consumers. On the one hand, marginal pricing makes renewable energy more profitable because it allows low-cost renewables to be sold at the same price as higher-cost fossil generation, encouraging investment and deployment. Consequently, as more renewables enter the market, they also reduce the frequency with which fossil plants set the marginal price. On the other, it also imposes an indirect carbon cost on part of the renewable electricity purchased and consumed, despite its zero emissions. While this spillover effect is evident when purchasing electricity on the short-term market, the price of renewable electricity bought through over-the-counter contracts may also be indirectly influenced by the carbon cost. 

The spillover effect of the carbon cost on electricity prices has significant consequences for EU energy-intensive industries. Without measures to make up for this financial burden, these industries may face a competitive disadvantage compared to producers in third countries, increasing the risk of carbon leakage. To address this, the EU ETS Directive (art. 10) establishes ICC as a measure to compensate those industries that are “exposed to a genuine risk of carbon leakage” due to carbon cost passed on to electricity prices. Member States can decide to compensate industries spending up to 25% of revenues generated from the auctioning of ETS allowances. ICC is subjected to State aid rules and regulated by the “Guidelines on certain State aid measures in the context of the system for greenhouse gas emission allowance trading post-2021”.  

While ICC is an important instrument to protect energy-intensive industries from the risk of carbon leakage, its current design and implementation raise significant concerns. Most notably, the calculations at the basis of the compensation are based on the entire amount of electricity consumed, regardless of the carbon intensity of their energy mix. This means that even electricity generated from fossil fuels is subsidised, which directly contradicts the Polluter Pays Principle. For the EU ETS to function effectively, all carbon emissions must be fully priced, without loopholes or compensations that undermine its integrity. It is therefore essential that energy-intensive producers are fully exposed to the carbon cost of emissions from electricity generation, to drive genuine decarbonisation and uphold climate policy objectives. 

ICC and the CBAM 

The current distribution of ICC becomes even more problematic if we consider that CBAM has been conceived as an instrument to substitute current carbon leakage measures foreseen in the EU ETS Directive. The debate around ICC is becoming increasingly intertwined with the implementation of the CBAM. Some industry stakeholders argue that ICC remains essential to safeguard competitiveness and protect against carbon leakage risks, insisting on keeping current compensation scheme beyond 2030. Other actors call for an immediate phase-out of ICC to allow for the inclusion of indirect emissions in CBAM.  

Bellona Europa considers it crucial for emissions rising from electricity to be fully subjected to the carbon cost and regards ICC to be a transitional instrument that must be phased out eventually. An adjusted ICC only covering the renewable electricity consumed and subjected to carbon cost is the best temporary and alternative solution for the inclusion of indirect emissions in the CBAM. As the share of fossil-based electricity in setting the marginal price declines, the justification for ICC will diminish, and they should be progressively phased out. 

Furthermore, while Bellona’s suggested reform of ICC enables CBAM to fully cover indirect emissions across sectors, doubts may arise concerning equal treatment of goods on both sides of the border. This is because, while emissions would be priced in the same way, EU industries would receive compensation for the spillover effect of carbon costs on renewable electricity. While this spillover is quite unique to the European context, third countries could face similar unintended consequences as they adopt more ambitious climate policies, one of CBAM’s core objectives. In such cases, CBAM should remain flexible and allow non-EU producers to demonstrate that comparable carbon cost spillovers occur in their electricity markets and are not mitigated locally or nationally in the third country. When such proof is provided, a corresponding adjustment at the border should be possible to ensure fair and consistent treatment. 

Towards a fair and effective inclusion of indirect emissions in the CBAM  

For the inclusion of indirect emissions in the CBAM, Bellona Europa recommends the following steps to be carried out by the Commission in the months leading up to the instrument’s full phase in: 

• Reform the “Guidelines on certain State aid measures in the context of the system for greenhouse gas emission allowance trading post-2021” to ensure that ICC are only covering the renewable share of the electricity consumed and subjected to the carbon cost. 

• Extend the CBAM to cover indirect emissions in all covered sectors as a measure to protect EU industries from the risk of carbon leakage arising from the full exposure to the carbon cost of emitting electricity generation. This would ensure equal treatment of goods across the border. 

• If third countries producers are facing comparable carbon cost spillovers on renewable electricity without adequate domestic compensation, CBAM should provide a pathway for such producers to demonstrate their circumstances and receive an adequate adjustment at the border. 

The inclusion of indirect emissions in the CBAM as soon as possible is crucial not only for the climate credibility of the Mechanism and the EU as a whole, but also for carbon accounting and life-cycle assessment practices together with fairness for EU companies. Once the outlined adjustments are implemented, goods produced in the EU and in non-EU countries would be treated equally, with producers on both sides of the border facing the same carbon price. At the same time, European companies would be shielded from the unintended spillover effects of carbon costs on renewable electricity. With these conditions met and a strong carbon accounting methodology preventing circumventions’ risks, CBAM could start covering indirect emissions as of 2026, becoming a comprehensive measure against carbon leakage, covering both direct and indirect emissions across all covered sectors. This would allow the CBAM to fully deliver on its dual objective: ensuring a level playing field for EU industry and its external objective of encouraging higher climate ambition globally.