The European emissions trading system: auctions and their challenges

Abstract

This chapter, from a monograph on climate change and European emissions trading, explores the use of auctions as a format for allocation of emission allowances. The author identifies challenges that legislators may face in implementing the currently proposed auctioning scheme in the European Union (EU) Emissions Trading Scheme (ETS). The author first discusses basic elements of auctioning tradable rights as being defined in economic theory, then identifies the main challenges that must be addressed in order to implement auctioning in the EU ETS. Auctions are expected to successfully address the problems of windfall profits and new entrants as well as to lead to the generation of auction revenues. The author concludes that auction theory is best utilized in situations of single-unit objects that are sold; thus, insights that are gained may not be directly transferable to multiple-unit auctions such as that to be used under the EU ETS. The European Commission will have to decide what kinds of regulations to set up to create strongly harmonized and simple auctioning rules that reduce costs or whether it wants to create a system that grants Member States a larger degree of discretion. The author briefly discusses how each of these options will impact bidders, particularly smaller bidders.