Free Allocation Of Allowances Research Articles

EU in search of a Carbon Border Adjustment Mechanism

To meet the targets of the EU’s Fit for 55 package, the European Commission proposed in July 2021 to implement a Carbon Border Adjustment Mechanism (CBAM) to replace free allocation of Emission Trading System (ETS) allowances for the most trade-exposed emitting industries. CBAM aims to prevent carbon leakage and restore a level playing field in high-emitting industries. Its design, as voted by the European Council in March 2022, by the Parliament in June, and ultimately amended by a provisional agreement between the Council and the European Parliament in December 2022, raises several issues. This paper aims to quantify the economic and environmental impacts of different choices regarding this design. Simulations are based on a dynamic general equilibrium model representing imperfect competition, input–output relations, greenhouse gas emissions, the endogenous price of emission quotas and the presence of free allocation of allowances. We show that CBAM is effective in reducing carbon leakage. But its design increases the price of carbon in the European Emissions Trading Scheme. Competitiveness losses in export markets are expected for downstream sectors that are not covered by the CBAM, as well as for European exporters of high-emitting industries, even in the presence of rebates.

Climate action in the making: business and civil society views on the world’s first carbon border levy

Carbon border levies have been suggested as an important tool for ramping up climate action. Such a levy is being negotiated as part of the EU’s Green Deal, with input from public consultations. The success of the EU’s carbon border adjustment mechanism (CBAM) will depend on its design and acceptance. While most analyses focus on resistance from the EU’s major external trade partners, this article analyses the views of non-state actors within the EU. Their views will be decisive for the cohesion and determination of the EU as the CBAM proposal encounters external resistance. Examining the views of European business and civil society organizations expressed by 276 respondents in the EU’s public consultation, we show that there is general support for CBAM but divergent views on its purpose and on what to do about the allocation of free allowances in the EU Emissions Trading System, sectoral coverage, exemptions for third countries, export rebates and emissions scope. The success and strength of CBAM will depend on whether the EU is able to resolve these design issues and reach compromises between the opposing views of business and civil society.Graphical

Economic under-determination: industrial competitiveness and free allowances in the European carbon market

ABSTRACT Tackling climate change has provided a key focus for the creation of what the editors of this special issue have termed ‘environmental intangibles.’ This paper focuses on the European Union Emissions Trading System (EUETS), a climate policy that revolves around the issuance and trading of environmental intangibles called emissions allowances. Set up in the mid-2000s, the cap and trade system has experienced many complications. We propose here to explore a particularly contentious issue: the allocation of free allowances. We will see that deciding on allocation rules leads to vivid debates about whether energy-intensive industries in Europe, such as the manufacturing of cement, can remain competitive in the global economy if climate policy is unilaterally enforced. These debates are focused on a phenomenon referred to as the risk of carbon leakage due to loss of competitiveness. Drawing on an empirical enquiry into the workings of policy-making, the paper examines the ways, in which this risk is framed and questioned through lobbying and evidential work. We suggest that the threat to competitiveness posed by the EUETS can neither be established, nor dismissed; a form of under-determination is maintained and carbon leakage as a never-quite-tangible possibility becomes a battleground for protecting European industry over the environment.

The effect of the EU ETS free allowance allocation on energy mix diversification: the case of Poland’s power sector

ABSTRACT Since 2013, power plants in the EU have been obliged to buy carbon permits instead of receiving them for free. However, in order to ease their energy transition, some Member States that meet certain conditions (mainly a high share of fossil fuels and low income) are allowed to continue to receive free allowances for existing power plants (Article 10c of the EU ETS Directive). In exchange, they must invest in modernizing their electricity sector and diversifying their energy supply. However, up to 70% of the conditional investments have been made in upgrading coal-fired units, which casts doubt on the effectiveness of the measure to increase energy diversification. This paper evaluates the effect that the so-called rule 10c has had on energy diversification. A synthetic control method is applied to aggregate data from Poland, one of the countries eligible for free allowances, to investigate how the lignite and wind share in electricity generation would have evolved had Poland not used the rule 10c derogation. Our results indicate that Poland’s energy diversification would have been the same if allowances had been auctioned instead of allocated for free. Therefore, the policy is only relevant in political terms and involves unjustified revenue loss for affected governments in favour of installations, i.e. subsidies. Our results suggest that rule 10c, as defined, does not incentivize investment in low carbon alternatives. The use of this transitional free allocation will continue to be available in phase IV (2021–2030) of the EU Emission Trading System (EU ETS). Key policy insights Application of the rule 10c derogation under the EU ETS, granting emission allowances for free to fossil fuel-reliant member states, has not achieved the intended goal of energy mix diversification in Poland. Using a synthetic control method, we show that the lignite and wind share of electricity production in Poland would have followed the same trajectory if full auctioning, instead of free allocation, had been applied. Because most conditional investments were used to retrofit coal-fired plants, the policy’s main contribution was to subsidize continued use of coal power. The policy deprived affected governments of auction revenues that could have been used to ease decarbonization.

Climate Neutral Production, Free Allocation of Allowances under Emissions Trading Systems, and the WTO: How to Secure Compatibility with the ASCM

To reach climate neutrality, carbon emissions from the production of basic materials need to be significantly reduced. For governments’ support measures to be consistent with their World Trade Organization obligations, they need to be compatible with the WTO’s Agreement on Subsidies and Countervailing Measures (ASCM). This paper analyzes the ASCM consistency of three selected support schemes, namely: (1) free allocation under emissions trading systems such as the European Union Emissions Trading System (EU ETS) to operators of installations deemed to be at significant risk of carbon leakage; (2) a combination of a charge on carbon-intensive materials with free allocation; and (3) carbon contracts for differences (CCfDs) for operators of climate-neutral installations, in which governments pay out the incremental costs of climate neutral-production processes relative to the costs of conventional primary material production. The analysis reveals that the current system of carbon leakage protection through free allocation is vulnerable to challenges under the ASCM. By contrast, a transition to a combination of free allocation and a charge on carbon-intensive materials would implement consistent carbon-pricing and thus would very likely not amount to a subsidy under the ASCM. In a similar vein, support for climate-neutral installations through CCfDs could be designed in such a way that it confers no benefit, so that it would also not constitute a subsidy.

A case study on China's carbon emission trading system: experiences and recommendations

China officially launched seven state pilot ETS programs starting in 2013 and initiated a national ETS in 2017 respectively. The many accumulated experiences from the pilot programs include such findings as the importance of setting realistic targets balancing the needs for carbon reductions with those of economic growth and pollution control and the need for legislation specifying the actions to be taken, provisions for disclosure, allowance allocations, offsets, infrastructure building, monitoring reporting and verification, and adoption of a compliance mechanism. Deficiencies in the pilot programs are evaluated, such as those derived from lack of a national legal basis and unified rules for the carbon market, an excess of free allocation of allowances, a lack of liquidity of the market, lenient punishment for non-compliance, and absence of a sound monitoring and regulatory mechanism. The requisites for sound market-based programs are described, with particular emphasis on the need for a comprehensive legal basis on which programs can be built. The pluses and minuses of cap and trade market-based programs versus carbon taxes are explored in depth, including the possibilities of combining the two systems. Various bottom up and top down approaches are explored and the key elements of success and failure.

Border Carbon Adjustments and Alternative Measures for the EU ETS: An Evaluation

As part of its Green Deal, the European Commission is considering the introduction of border carbon adjustments and alternative measures. The measures, which would primarily apply to basic materials like steel and cement, pursue a double objective: they are aimed at enhancing the effectiveness of carbon pricing for the transition to climate neutrality but also at avoiding carbon leakage risks. When implementing carbon adjustment mechanisms and alternative measures, various design options might be considered to reform the EU Emissions Trading Scheme (EU ETS). In this paper, we have decided to focus on three main models, which help to highlight the main differences between the available options. Under the first model, importers of basic materials would be required to surrender carbon allowances at the level of a product benchmark or, where lower, at the verified level of foreign carbon intensity. In parallel, allocation of free allowances would be phased out. Under the second model, a symmetric adjustment mechanism for exports and imports would be adopted, including refund to exporters for the carbon costs incurred on basic materials embodied in products. Finally, under the third model, the EU ETS would be complemented with a climate contribution charged for materials sold in the European Union (EU) at the product benchmark level related to the carbon intensity of each material. The free allowance allocation regime would then be modified to be directly linked to the volume of material production at the product benchmark level. In order to contribute to the current policy debate, we evaluate for each of these three models, their legality, coherence with EU climate objectives, effectiveness in carbon leakage prevention, potential international implications, as well as their administrative complexity and compliance costs.

Consistency between the Granting of State Aid and the Polluter-Pays Principle: Aid Aimed at Mitigating Climate Change

Since 2009, the EU ets Directive set up a general rule for the auctioning of emission allowances. It is subject to a number of exemptions. The transitional allocation of free allowances in the electricity sector, and in general the granting of free or below-market-price allowances, are caught by the tfeu prohibition on grants of state aid. However, the EU legislature and its executive—the European Commission—are empowered to grant the EU member states exemptions in order to correct market failures. At face value, such arrangements seem to run contrary to the polluter-pays principle on account that state aid subsidizes emissions of greenhouse gases instead of internalizing their costs into the price of goods and services delivered by the recipient installations. This article explores how such arrangements amount to state aid and analyses the manner in which the exemptions are consistent with the polluter-pays principle.

THE IMPACTS OF THE EU ETS ON NORWEGIAN PLANTS’ ENVIRONMENTAL AND ECONOMIC PERFORMANCE

This paper examines the impacts of the EU Emissions Trading System (ETS) on the environmental and economic performance of Norwegian plants. The ETS is regarded as the cornerstone climate policy in the EU and Norway, but there has been considerable debate regarding its effects due to low quota prices and substantial allocation of free allowances. The rich data allow us to investigate potential effects of the ETS on several important aspects of plant behavior. The results indicate a weak tendency of emissions reductions among Norwegian plants in the second phase of the ETS, but not in the other phases. We find no significant effects on emissions intensity in any of the phases, but positive effects on value added and productivity in the second phase. These positive effects may be due to the large amounts of free allowances, and that plants may have passed on additional marginal costs to consumers.

Taxing Consumption to Mitigate Carbon Leakage

Unilateral actions to reduce CO2 emissions could lead to carbon leakage such as relocation of emission-intensive and trade-exposed industries (EITE). To mitigate such leakage, countries often supplement an emissions trading system (ETS) with free allocation of allowances to exposed industries, e.g. in the form of output-based allocation (OBA). This paper examines the welfare effects of supplementing OBA with a consumption tax on EITE goods. In particular, we investigate the case when only a subset of countries involved in a joint ETS introduces such a tax. The analytical results suggest that the consumption tax would have unambiguously global welfare improving effects, and have welfare improving effects for the tax introducing country as well unless there are strong unfavorable terms-of-trade effects. Numerical simulations in the context of the EU ETS support the analytical findings, including that the consumption tax is welfare improving for the single country that implements the tax.

Have China's pilot emissions trading schemes promoted carbon emission reductions?– the evidence from industrial sub-sectors at the provincial level

Scholars and policy makers put great emphasis on analyzing the mitigation effect of an emissions trading scheme (ETS), while empirical researches on the mitigation effects of China's pilot ETSs are both thin and with significant limitations. This paper tries to analyze this issue from the perspective of industrial sub-sectors at the provincial level. We first calculate the carbon emissions of 37 individual industrial sub-sectors in each of China's 26 provinces from 2005 to 2015, covering both direct and indirect emissions. Cautiously identifying the industrial sub-sectors covered by China's pilot ETSs, we explore the causal impact of China’s pilot ETSs on reducing carbon emissions at the initial stage (2013–2015) and analyze the paths of achieved emission reductions, applying a difference-in-difference (DID) model and a combination of DID estimator and propensity score matching technique. Our results yield robust evidence that China's pilot ETSs have significantly promoted carbon emission reductions of the covered industrial sub-sectors, and this impact has presented an overall enhanced trend according to year-by-year analysis. The results also show that the pilot ETSs have failed to enable covered industrial sub-sectors to effectively cut carbon intensity and the impact on carbon intensity is not obvious in any of the first three years, and the carbon emission reductions have mainly been achieved through the decreased outputs of industrial sub-sectors. China's policy makers should tighten the free allowance allocation approaches in order to facilitate low-carbon technology innovations and reduce carbon intensity of industrial sectors.

The impact of implementing a consumption charge on carbon-intensive materials in Europe

ABSTRACT The production of basic materials accounts for around 25% of global greenhouse gas emissions. Existing measures to reduce emissions from industry are limited due to a combination of competitiveness concerns and a lack of technological options available to producers. In this paper, we assess the possibility of implementing a materials charge to reduce demand for basic industrial products and, hence, also reduce industrial emission levels. The modelling shows that a charge equivalent to around €80/tCO2 could reduce the EU’s total (energy plus process) CO2 emissions by up to 10% by 2050, depending on the substitution options available. The materials charge could lead to small GDP increases and a minor reduction in overall employment levels. Key policy insights Full carbon price pass through along the materials value chain creates incentives for resource efficiency and substitution in the value chain of material use. Most macroeconomic models ignore mitigation opportunities in the value chain, as do carbon pricing mechanisms for industrial emitters, which largely mute incentives for mitigation opportunities with free allowance allocation. Including consumption at a benchmark level in emission trading systems reinstates a full carbon price incentive for all mitigation opportunities while avoiding competitive distortions and carbon leakage risks. Macroeconomic modelling shows that this allows for an additional 10% emission reduction accompanied by a slight GDP increase and employment reduction. Long-term clarity on carbon leakage protection furthermore strengthens low-carbon investment frameworks.

Dynamic Climate Policy Under Firm Relocation: The Implications of Phasing Out Free Allowances

The allocation of free allowances for firms within the European Union Emissions Trading Scheme was found to lead to substantial overcompensation, which is why some stakeholders recently called for phasing out of free allowances in the near term. This paper analyzes the consequences of phasing out free allowances in a two-period model when one country unilaterally implements climate policies. A carbon price induces firms to invest in abatement capital, but may lead to the relocation of some firms. The regulator addresses the relocation problem by offering firms transfers, i.e. free allowances, conditional on maintaining the production in the regulating country. If transfers are unrestricted in both periods, then the regulator implements the first best by equalizing the carbon price with the marginal environmental damage and using transfers to prevent any relocation. However, if transfers in the future period are restricted, the planner optimally implements a declining carbon price path with the first period price exceeding the marginal environmental damage. A high carbon price triggers investments in abatement capital and thus creates a lock-in effect. With a larger abatement capital stock, firms are less affected by carbon prices in the future and therefore less prone to relocate in the second period.

Effectiveness of pilot carbon emissions trading systems in China

ABSTRACTChina is in the process of establishing a national emissions trading system (ETS). Evaluating the implementation effectiveness of the seven pilot ETSs in China is critical for designing this national system. This study administered a questionnaire survey to assess the behaviour of enterprises covered by the seven ETS pilots from the perspective of: the strictness of compliance measures; rules for monitoring, reporting and verification (MRV); the mitigation pressure felt by enterprises; and actual mitigation and trading activities. The results show that the pilot MRV and compliance rules have not yet been fully implemented. The main factors involved are the lack of compulsory force of the regulations and the lack of policy awareness within the affected enterprises. Most enterprises have a shortage of free allowances and thus believe that the ETSs have increased their production costs. Most enterprises have already established mitigation targets. Some of the covered enterprises are aware of their own internal emission reduction costs and most of these have used this as an important reference in trading. Many enterprises have accounted for carbon prices in their long-term investment. The proportion of enterprises that have participated in trading is fairly high; however, reluctance to sell is quite pervasive in the market, and enterprises are mostly motivated to trade simply in order to achieve compliance. Few enterprises are willing to manage their allowances in a market-oriented manner. Different free allowance allocation methods directly affect the pathways enterprises take to control emissions.Key policy insightsIn the national ETS, the compulsory force of ETS provisions should be strengthened.A reasonable level of free allowance shortage should be ensured to promote emission reduction by enterprises.Sufficient information should be provided to guide enterprises in their allowance management to activate the market.To promote the implementation of mitigation technologies by enterprises, actual output-based allocation methods should be used.The government should use market adjustment mechanisms, such as a price floor and ceiling, to ensure that carbon prices are reasonable and stable, so as to guide long-term low carbon investment.

The EU ETS and Dynamic Allocation in Phase IV—An Ex-Ante Assessment

Fear of lowering firms’ competitiveness and carbon leakage is the reason for large amounts of allowances in the European Union’s Emissions Trading System (EU ETS) still being allocated for free. At the same time, unadjusted free allocation of allowances in times of economic recession is partly responsible for the large surplus of allowances that has cumulated in the EU ETS and that is lowering prices in the market. For Phase IV, the introduction of dynamic allocation has been proposed to react to significant changes in production, to prevent the accumulation of further surplus on the one hand and to protect installations from severe underallocation on the other. A reserve of about 400 million allowances is planned for that purpose. This paper analyses the demand for certificates from this reserve under different assumptions on production development as well as different design options for Phase IV. The analysis builds on freely available allocation data from Phase III along with projections of production trends from different time periods in the past. In most of the scenarios, the 400 million allowances are sufficient to fulfil demand for allowances from dynamic allocation until at least the second half of Phase IV (often even for the whole of Phase IV). Even though certain aspects analysed are now not fully compatible with the agreed-upon Phase IV revision, the analysis indicates that the amount of allowances foreseen for dynamic allocation is sufficient for Phase IV. In particular the threshold value of 10% that was introduced in the legislation will ensure that the demand of allowances is likely well below the demand found in the different scenarios in this analysis that neglects this threshold value.

Addressing regional disparities in allowance allocation in China’s national emissions trading scheme

ABSTRACTChina's national emissions trading scheme (ETS) is expected to be operational in 2017. Effectively addressing regional disparities at the provincial level in allowance allocation will greatly affect the acceptance of the allocation approach and thus deserves careful consideration. This article aims to explore possible approaches for addressing regional disparities, by introducing regional adjustment factors (RAF) in free allowance allocation. Based on the principle of ‘national unified rules + stricter adjustment by provincial authorities’, four single factorial and three multi-factorial methods are proposed to calculate the RAFs, through a normalization process. These methods are associated with the most acknowledged factors dealing with regional disparities, including per-capita GDP; per-capita CO2 emissions; industrial sector contribution to GDP; economy-wide emissions control targets and CO2 emissions per unit GDP, per unit power and heat output and per unit industrial added value. A comparative analysis is made for the seven methods, in regard to value distribution and level of matching regional political demand.Key policy insights‘Allowing stricter regional adjustment’ represents a dominant feature for China's national ETS, which aims to address regional disparities and government demands.How the adjustment plan is designed will have a major influence on the operation of the national ETS and regional business competitiveness. Provincial governments need to consider the trade-off between auction revenue and local business competitiveness.Applying the different methods leads to more scattered results for some regions, for whom the choice of adjustment approach will therefore have a greater impact.Based on the analysis, four adjustment methods that generate similar results – the per-capita GDP-based method, the intensity reduction target-based method, the 12th FYP target-based method and intensity-based grandfathering – are recommended for most provincial-level regions, with some exceptions.

Can an emission trading scheme promote the withdrawal of outdated capacity in energy-intensive sectors? A case study on China's iron and steel industry

Outdated capacity and substantial potential for energy conservation are the two main features of energy-intensive sectors in developing countries. Such countries also seek to implement market-based options to further control domestic carbon emissions as well as to promote the withdrawal of outdated capacity and upgrade production level. This paper presents a quantitative assessment of the emission trading scheme (ETS) for China's iron and steel industry. The diverse array of normal and outdated capacities was modeled in a two-country, three-good partial equilibrium model. Simulation results show that the abatement potential can be underestimated if the energy-saving effects that result from emission abatement are not considered. In the scenario analysis, we demonstrated that the free allocation of allowances can cause a competitiveness distortion among domestic normal and outdated capacities. Given the government's intention to promote outdated capacity withdrawal and production-level upgrading, an output-based allocation approach is strongly suggested for China's iron and steel sector.

Benchmarks for Emissions Trading General Principles for Emissions Scope

Greenhouse gas emission benchmarks are widely implemented as a policy tool, as more countries move to implement carbon pricing mechanisms for industrial emissions. In particular, benchmarks are used to determine the level of free allowance allocation in emission trading schemes, which are distributed as a measure to prevent carbon leakage. This paper analyses how benchmark designs impact firms’ production and business model decisions, particularly focusing on the coverage of direct and indirect emissions in the benchmark scope. We develop an analytical model and use the example of a steel mill to analyze and quantify how scope of indirect emissions coverage affect incentives. We seek to clarify generalized principles for efficient benchmark design, that provide a predictable policy framework for innovation and investment to decarbonize energy intensive industry.

Quantifying Impacts of Consumption Based Charge for Carbon Intensive Materials on Products

After the Paris Climate Agreement, it is anticipated that carbon prices will differ across regions for some time. If countries use free allowance allocation as carbon leakage protection, only a fraction of carbon prices are passed through to consumers particularly by carbon intensive materials producers. Adding a consumption charge based on benchmarks applied to the material content can reinstate the carbon price signal. The paper investigates the implications of such a consumption charge for industry and consumers based on material flow analysis and material flow cost accounting. The material‐related carbon liabilities for production, import, export, and consumption are estimated for 4000 commodity groups that contain one or more of the five bulk materials steel, aluminium, plastics, paper, and cement. Assuming an underlying carbon price of 30 Euros per ton of CO2, the total charge to European final consumers is estimated to be about 17 billion EUR. The total charges levied on imports and those waived for exports are each of similar size and roughly amount to half of the total charge to European final consumers. To reduce administrative efforts, the charge is not levied on imported products for which the value of the consumption charge compared to product price falls below a threshold. Thus administrative efforts for 77 to 83% of imports could be avoided while still 85% to 90% of import‐related carbon liabilities are included.

Extending the EU Commission's Proposal for a Reform of the EU Emissions Trading System

Pursuing an evidence based approach we summarize the key elements of the European Commission’s proposal of July 2015 for a reform of the EU Emissions Trading System and offer facts about the current state of EU ETS that underline the needs for such a reform. We supply key data for understanding the current state of EU ETS and report in particular the share of freely allocated allowances in emissions for the various sectors since the start of EU ETS in 2005. This is the most relevant parameter for evaluating the stringency and cost impacts of the EU ETS on sectors and installations. We provide propositions for enhancing the allocation procedure of both free and auctioned allowances, the fundamental element in the cap and trade design of this system. We link this procedure closely to the relevant suggestions of the Commission proposal and offer extensions that can make in particular the allocation of free allowances more targeted and effective. We indicate how the impacts of free allowances can be calculated both for sectors and installations and conclude that these reform steps could reduce the administrative burden of the system.