The ETS Reform and Carbon Leakage : Economic Analysis of the New ETS Directive

After recalling to which extent the inefficiencies emerged during the Emissions Trading Scheme past trading periods are related to its institutional framework, as defined by the Directive 87/2003/EC, this article focuses on the major provisions of the 2008 European Commission Proposal for a new ETS Directive.The aim of this article is to analyze if and how the Emissions Trading Scheme functioning will be improved during the post-Kyoto trading period (2013-2020).The article focuses on three variables. First, it analyzes the new procedure and criteria for setting the ETS cap. Then, it moves to analyze the new default allocation rule, which is auctioning, and the related risk of Carbon Leakage, discussing both the criteria to assess it and the measures to prevent it. Finally the article focuses on the procedure and criteria to divide the ETS cap among the trading sectors in an effective way.The paper concludes that, while the ETS cap setting reform has contributed to improve the ETS effectiveness by reducing market distortions, the same cannot be written in the case of the new allocation rule. Instead of improving the allocation transparency and granting higher rules harmonization, the EC has defined highly discretionary and inefficient criteria to assess the sectors' exposure to Carbon Leakage and the corresponding allocation rule, thus increasing distortions, uncertainty and non-homogeneity within the ETS. While in a theoretical closed economy auctioning is superior to grandfathering, the way auctioning is going to be implemented in the third ETS trading period is far from being the efficient and effective allocation rule described by the European Commission