Allocation and competitiveness in the EU emissions trading scheme: policy overview

The European emissions trading scheme (EU ETS) has an efficient and effective market design that risks being undermined by three interrelated problems: the approach to allocation; the absence of a credible commitment to post-2012 continuation; and concerns about its impact on the international competitiveness of key sectors. This special issue of Climate Policy explores these three factors in depth. This policy overview summarizes key insights from the individual studies in this issue, and draws overall policy conclusions about the next round of allocations and the design of the system for the longer term. • Allocations for 2008-2012. Allocations defined relative to projected 'business-as-usual' emissions should involve cutbacks for all sectors, in part to hedge against an unavoidable element of projection inflation. Additional cutbacks for the power sector could help to address distributional and legal (State aid) concerns. Benchmarking allocations, e.g. on best practice technologies, could offer important advantages: experience in different sectors and countries is needed, given their existing diversity. However, a common standard for new entrant reserves should be agreed across the EU, based on capacity or output, not on technology or fuel. Maximum use of allowed auctioning (10%) would improve efficiency, provide reassurance, and potentially help to stabilize the system through minimum-price auctions. These measures will not preclude most participating sectors from profiting from the EU ETS during phase II. Companies can choose to scale back these potential profits to protect market share against imports and/or use the revenues to support longer term decarbonization investments, whilst auction revenues can be used creatively to support broader investments towards a lowcarbon industrial sector in Europe. • Post-2012 design. Effective operation during phase II requires a concrete commitment to continue the EU ETS beyond 2012 with future design addressing concerns about distribution, potential perverse incentives, and industrial competitiveness. Declining free allocation combined with greater auctioning offers the simplest solution to distributional and incentive problems. For its unilateral implementation to be sustainable under higher carbon prices over longer periods, EU ETS post-2012 design must accommodate one of three main approaches for the most energy-intensive internationally traded sectors: international (sectoral) agreements, border-tax adjustments, or output-based (intensity) allocation. If significant free allocations continue, governments may also need to follow the example of monetary policy in establishing independent allocation authorities with some degree of EU coordination. Such reform for the post-2012 period would require the Directive to be fundamentally renegotiated in relation to allocation procedures. Such renegotiation is neither feasible nor necessary for phase II operation. Rather, phase II should be a period in which diverse national approaches build experience, whilst the profits potentially accruing to participating sectors can be used to protect market share and jump-start their investments for a globally carbonconstrained future.