Methods for Allocating Allowances Under the EU Emissions Trading Scheme

At the center of the EU's climate change policy is the EU Emissions Trading Scheme: an ambitious market-based approach to reducing GHG emissions within the EU. While commendable in theory, the practice of the EU ETS has exposed a number of issues regarding its compatibility with its own internal regime on subsidies (called state aid). Much of the academic literature to date has focused on the competitive disadvantages that can arise in countries requiring its industries to internalize the cost of GHG emissions through an emissions trading scheme.5 Ironically however,the implementation of the EU ETS also raises questions about the competitive advantages that may arise depending on the methodology a country uses in the allocation of its emissions allowances. Even though some of these competitive advantages have been addressed in modifications to the EU ETS for the third trading phase (2013 through 2020), there are still distortions and potential conflicts between EU ETS requirements on the one hand and EU state aid rules on the other. This paper will focus on the competitive distortions that can arise in relation to the allocation of free emission allowances under a market-based trading scheme, and attempt to explain how the allocation of emission allowances under the EU ETS, as currently envisioned, will likely conflict with the EU's state aid rules