Carbon Leakage, Free Allocation and Linking Emissions Trading Schemes

Abstract

A sub-global emissions trading scheme (ETS) risks harming competitiveness and causing carbon leakage. These concerns cast doubt on the efficiency and environmental effectiveness of unilateral climate policies. ETSs implemented thus far include measures to address competitiveness and leakage concerns. This paper analyses the extent to which these unilateral measures affect linking of ETSs by taking the European Union Emissions Trading Scheme (EU ETS) and the Australian Carbon Pricing Mechanism (ACPM) as case studies. In both the EU ETS and the ACPM, the free allocation of allowances to emissions-intensive trade-exposed sectors is the primary instrument of addressing leakage and competitiveness concerns. They, however, use different systems of free allocation. Although linking ETSs with different systems of allocation is technically possible, certain differences give rise to efficiency, competitiveness, equity, and environmental effectiveness concerns.