Allocation of carbon emission certificates in the power sector: how generators profit from grandfathered rights

To meet its Kyoto requirements, the EU will establish an internal market for carbon dioxide allowances from 2005, the EU Emissions Trading Scheme (ETS). National governments are to allocate most of these allowances for free. The analysis shows that as a result of the free allocation, the net value of both a typical pulverised coal-fired (PC) power station and a more modern gas-fired combined cycle gas turbine (CCGT) will increase. The paper also analyses different distortions that can arise from allocation mechanisms that allow for updating of the baseline reference period. We also explore the interaction between the EU ETS with the Large Combustion Plant Directive, which limits SO₂ and NO_x emissions.