Historic versus output-based allocation of GHG tradable allowances: a comparison

Two ways of allocating greenhouse gas (GHG) allowances are compared: historic allocation (HA) based solely on past information, and output-based allocation (OBA) based on an allocation proportional to the current output level. The advantages and problems of each allocation method are considered and compared. It is essential to distinguish the sectors sheltered from international competition (e.g. power generation) from the exposed sectors. In the sheltered sectors, OBA entails a much higher overall cost because it provides too little incentive to reduce the production of the polluting goods. HA does not suffer from this drawback but its distributional impact is highly unfair. Hence in these sectors neither of these two ways of freely allocating allowances can be supported, and auctioning should be favoured. However, in the exposed sectors, OBA is an option worth considering because it reduces carbon leakage, although it also suffers from some drawbacks compared with auctioning.