Climate policy ambitiousness has to be ratcheted up in the coming years in order to attain net-zero targets. This means increasing costs for industries and consumers and designing compensation measures becomes increasingly important. EU carbon trading has the indirect effect of increasing energy costs for energy-intensive industries. Since 2012, half of the European Economic Area countries have turned to specific CO2 compensation to counter such costs and, together with free allowances, avoid carbon leakage. Already amounting to millions of euros, such compensation is expected to increase substantially. However, the compensation mechanism has attracted surprisingly little research interest. Why do some countries establish such compensation, while others do not? And with what effects as to incentives and carbon leakage protection?

This report studies the differing choices of Norway and Sweden: two neighbouring countries with significant energy-intensive industries. Only Norway decided (in 2012) to establish a specific CO2 compensation mechanism. This report highlights two central explanations: first and foremost, there was a significant underlying, ‘structural’, difference as to the allocation of EU ETS free allowances, with Norwegian industry somewhat ‘under-allocated’ and Swedish industry considerably over-allocated, indicating different needs for compensation. Second, in Norway key industries mobilized significantly through contacts with prominent politicians and parliamentarians, but less such mobilization took place in Sweden. As to effects, the Norwegian compensation seems to have had the intended results as to carbon leakage protection. But existing evidence is surprisingly scarce, seen in light of considerable compensation handed out and projected increasing amounts.