Free Allocation Research Articles

Allocation or Skill? What is Driving Corporate Trading Performance in the EU ETS?

This study empirically analyzes factors related to companies’ profits from trading emission allowances in the European Union Emissions Trading System (EU ETS) for the period from 2005 to 2017 by combining information on trading activities with company characteristics of more than 6,000 companies. The factors considered include net position (i.e., free allocation of allowances minus emissions), strategic skills (i.e., banking of allowances, timing of trading, transaction frequency, use of intermediaries), skill-related structural factors (i.e., number of installations, sector affiliation), market pressure, year, and region effects. The results from estimating a Panel Heckman Selection Model suggest that companies’ profits from buying and selling emission allowances are related to a company’s net position, banking of allowances, timing of trading, and the number of installations. The findings further indicate that companies choose the number of banked allowances efficiently, that is, they take into account the opportunity costs of selling these allowances on the market. JEL Classification: Q48, Q54, Q58

EXPERIENCE WITH GREENHOUSE GAS EMISSION ALLOWANCE ALLOCATION AND ANALYSIS OF LESSONS FOR VIET NAM

This study analyzes and synthesizes international experiences in allocating greenhouse gas emission quotas, drawing lessons for Viet Nam's developing carbon market. The research examines emission trading systems (ETS) and quota allocation methods from various countries and regions, including the European Union, Germany, Austria, the United Kingdom, Switzerland, the United States, Canada, Nigeria, Kenya, South Africa, China, Japan, and New Zealand. Key findings highlight the importance of diversifying allocation methods, combining free allocation, auctioning, and benchmarking approaches. The study emphasizes the need for flexibility in system design, adapting to specific economic and social conditions of each country. Lessons learned include prioritizing high-emission reduction potential sectors, setting reasonable emission caps based on actual data, ensuring transparency in information disclosure, and establishing effective monitoring and evaluation mechanisms. The research also stresses the importance of providing technical support to businesses, especially small and medium enterprises, in complying with ETS regulations. Additionally, the study addresses concerns such as preventing carbon leakage, assessing social impacts, and ensuring international compatibility of the system. These insights provide a valuable foundation for Viet Nam to develop an effective greenhouse gas ETS that aligns with national conditions and sustainable development goals.

Endowment effects, expectations, and trading behavior in carbon cap and trade

We explain agents' trading behaviors and market outcomes in the presence of endowment effects intensified by expectations-based loss aversion in carbon cap and trade. Building on Kőszegi and Rabin (2006)’s model with forward-looking reference points, we show how firms' concerns about high future compliance costs (through loss aversion and uncertainty) can cause a gap between Willingness-to-Pay and Willingness-to-Accept for allowances. This leads to limited allowance trading and deviation from the socially desirable paths. The problem can be exacerbated under a substantial proportion of free allocation, a fixed (or inflexible) cap as well as uncertain regulatory ambitions, particularly in emerging economies under a variety of uncertainty. Recognizing the regulator's role in dealing with firms' expectations (or concerns) and facilitating innovation investments, we discuss potential alternative systems (e.g., with auction and flexible supply) for decarbonization that incorporate flexibility in terms of innovation timing and realized costs.

Options to enhance China’s national emission trading system design for carbon neutrality

ABSTRACT To better align the emissions trajectory of China’s power sector with the country’s neutrality target for 2060, China’s national Emission Trading System (ETS) needs to be enhanced. This study uses a power system planning model that incorporates an output-based ETS module to explore the effects of three enhanced ETS options: 1) tightening the benchmark faster, 2) introducing auctions, and 3) transitioning to a cap-and-trade ETS. A cap-and-trade ETS can achieve deep decarbonization at the lowest cost by encouraging cheap renewables. With an increased benchmark stringency under free allocation and output-based ETS, the power sector can achieve the same level of emission reduction at a 5.2% higher cost compared to a cap-and-trade ETS. This is due to the extensive development of carbon capture, utilization, and storage (CCUS) technology, facilitated by the free allowance allocation of the output-based ETS. Introducing auctions into an output-based ETS would encourage both renewables and CCUS and increase the cost by 1.4% compared to the cap-and-trade ETS. First, we suggest that auctioning be introduced into an output-based ETS to cost-effectively encourage a diversified power supply. Subsequently, we recommend turning to a cap-and-trade ETS after 2030 to reduce the cost of decarbonization.

The role of border carbon adjustments and subsidies in incentivising investment: comparing equivalence in the context of steel recycling and decarbonisation

The need to decarbonise has accelerated the quest to find solutions for sectors considered emissions-intensive and trade-exposed. Steel production is one such sector. Policymakers are responding with market-pull and technology-push mechanisms. Risks of carbon leakage have prompted consideration and implementation of border carbon mechanisms. Measures have drawn both positive and negative attention in internationally traded markets. This research quantifies the equivalence of differing measures to promote decarbonisation. It simulates the annual cost-saving equivalent and net present values of different mechanisms in a theoretical conversion to steelmaking with Electric Arc Furnace (EAF) technology from traditional steel production. It demonstrates that, under certain assumptions including removal of free allocation of emissions certificates, incentives per tonne of direct and indirect greenhouse gas emissions for carbon pricing and border carbon adjustments lie in the range EUR 18–76 whereas for cost-of-capital support measures it was EUR 24–41 per tCO2e. Whether firms act upon these incentives will depend on appetite for risk, availability of technology, feedstocks, choice they have in making changes and perceived sustainability of the assumptions made in investment analysis. There are implications for regulators, policy makers and managers as they prepare strategies to be competitive in an increasingly carbon-constrained environment.

Achieving Fairness with Intelligent Co Agents

Fairness in resource allocation is a important problem that has many real life consequences. Althoughmany algorithms that try to achieve envy free allocation, proportionality or min max share were proposed that tries to encapsulate fairness this does not suffice because it was inherently assumed that agents are not intelligent and there is uniformity in treatment. This is vastly different from real life where there are many scenarios where agents would actively try to sabotage or reduce the allocation given to their adversaries. Therefore all agents must not be treated the same way. As seen in economics cartels are where certain players collaborate and try to maximize their interest by undermining competition. This could lead to dangerous consequences and unfair means as seen withreal life examples of apple or google undermining competition by monopoly as explained clearly in (Das, Dhamal, Ghalme, Jain, & Gujar, 2022 [1])

Power Generation Mix Optimization under Auction Mechanism for Carbon Emission Rights

As the international community attaches importance to environmental and climate issues, carbon dioxide emissions in various countries have been subject to constraints and limits. The carbon trading market, as a market tool to reduce greenhouse gas emissions, has gone through a development process from a pilot carbon market to a national carbon market in China. At present, the industries included in the national carbon market are mainly the electric power industry, and the carbon emissions of the electric power industry account for about 40% of the national carbon emissions. According to the construction history of foreign carbon markets, China’s future carbon quota allocation will gradually transition from free allocation to auction allocation, and the auction mechanism will bring a heavy economic burden to the electric power industry, especially the thermal power generation industry. Therefore, this study takes Guangdong Province as an example to optimize the power generation mix with the objective of minimizing the total economic cost after the innovative introduction of the carbon quota auction mechanism, constructs an optimization model of the power generation mix based on the auction ratio by comprehensively applying the system dynamics model and the multi-objective linear programming model, systematically researches the power generation structure under different auction ratios with the time scale of months, and quantitatively evaluates the economic inputs needed to reduce the greenhouse gas emissions. The results of the study show that after comprehensively comparing the total economic cost, renewable energy development, and carbon emissions, it is the most scientific and reasonable to set the auction ratio of carbon allowances at 20%, which achieves the best level of economic and environmental benefits.

Assessing the effectiveness of emissions trading schemes: evidence from China

ABSTRACT The effectiveness of carbon price in emissions trading schemes (ETS) is an important issue in China in the context of its ambitious climate change goals. This paper adopts a staggered difference-in-differences model to estimate whether China’s ETS reduced CO2 emissions while maintaining economic growth even under low carbon prices. The results indicate that despite the low carbon prices, the ETS effectively reduced CO2 emissions without undermining the economy. Specifically, an increase of $1 in the carbon price reduced CO2 emissions by 1.69% and increased the per capita GDP by $286. The carbon price primarily achieved emission reduction and promoted economic development through channels, such as technological innovation, foreign direct investment, energy mix, and industrial structure. Carbon leakage to neighboring regions was not evident. Heterogeneity analysis showed that the environmental effects of the carbon price were more pronounced in regions with higher levels of economic development and CO2 emissions. Conversely, the economic effects of the carbon price were more pronounced in regions with lower levels of economic development and CO2 emissions. The carbon price achieved significant economic effects in regions that solely adopted the free allocation mode of emission allowances, while regions that used a combination of free allocation and auctioning experienced substantial emission reduction effects.

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.

Third Time’s a Charm? Assessing the Impact of the Third Phase of the EU ETS on CO2 Emissions and Performance

The EU Emissions Trading System (ETS) is the largest cap-and-trade scheme for CO2 emissions globally. This study evaluates the impact on CO2-equivalents emission of the increased stringency of Phase 3, which marked a significant shift from the previous phases of the EU ETS and significantly reduced the number of emissions permits (EU Allowances—EUA) freely allocated. Our analysis reveals that the increase of purchased EUA had a statistically significant, substantial impact on emissions reduction from Phase 2 to Phase 3, with a decrease in emissions of approximately half a ton for each additional allowance bought. Our (conservative) estimate of the total reduction in emission is 422 MtCO2-eq, 22.5% of the average yearly EU ETS emissions or 4.3–3.0% of emissions in Phases 2 and 3, respectively. Under Article 10c of the ETS directive, lower-income Member States have been allowed to continue the free allocation of EUA to electricity-generating installations during Phase 3 to provide more time and resources for modernization. We show that such derogation had a sizeable and significant detrimental impact on the achievement of emission reduction targets, leading to an increase in emissions of about half a ton for each additional allowance bought; a result that highlights the need for increased efforts on support measures (e.g., the Modernization Fund). We also investigate the impact of the EU ETS on output, capital productivity, and labour productivity. Our analysis indicates that the performances were not negatively impacted by the tightening in regulation that occurred between Phases 2 and 3. We also find no evidence that the derogation status impacted performances, which further ameliorates the concerns about the potential intra-EU competitive distortions induced by the regulation. Our results cast a favourable light on the reduction of the free allocation of EUA and the tightening of the regulation implemented in Phase 4 of the EU ETS.

Current and future protection against carbon leakage in the European Emissions Trading System

With the Fit for 55 package, the European Commission has proposed a comprehensive reform of the European Emissions Trading System and the introduction of a Carbon Border Adjustment Mechanism (CBAM). A key element of this is the switch of carbon leakage protection from free allocation and electricity price compensation to CO2 pricing of imported goods and greater support for technological innovation in the CBAM sectors (aluminum, cement, electricity, fertilizer, iron, steel, and hydrogen). Whether this new approach will be able to prevail in the face of the immense subsidy approach through the Inflation Reduction Act in the US remains to be seen.

Climate reform and transitional industry assistance: Windfall profits for polluters?

Introducing climate change policies such as carbon pricing can bring substantial costs for fossil-fuel-fired electricity generators, with incumbents often granted a transitional allocation of free emission permits. The free allocation of emission permits and the pass-through of carbon prices to higher electricity prices has created substantial concern that these policies allow emissions-intensive firms to reap windfall profits. We use the implementation and later repeal of Australia’s price on carbon to show that coal-fired plants which received free permits had a substantial increase in their profits. This result supports calls for any transitional climate policy assistance to be tied to projected pass-through rates in order to avoid creating wealth transfers from taxpayers to emission-intensive generator owners.

Supporting the Transition to Climate-Neutral Production: An Evaluation Under the Agreement on Subsidies and Countervailing Measures

ABSTRACT To reach climate neutrality, carbon emissions from the production of basic materials need to be curtailed. When governments encourage this transition by adopting support measures, the measures must comply with the Agreement on Subsidies and Countervailing Measures. This article analyzes three selected support schemes under the Agreement on Subsidies and Countervailing Measures: (i) free allocation under emissions trading systems to operators of installations at risk of carbon leakage; (ii) the combination of a charge on carbon-intensive materials with free allocation; and (iii) carbon contracts for difference, under which governments cover the incremental costs of climate-neutral production processes relative to conventional processes. The analysis reveals that the current regime of free allocation is vulnerable to challenges under the Agreement on Subsidies and Countervailing Measures. By contrast, the combination of free allocation and a charge on carbon-intensive materials would ensure consistent carbon pricing and thus would not amount to a subsidy under the Agreement on Subsidies and Countervailing Measures. In a similar vein, the carbon contracts for difference could be designed so that they would not confer a benefit and hence not constitute a subsidy.

Low-Carbon Supply Chain Coordination Based on Carbon Tax and Government Subsidy Policy

To meet the demands of society’s transition to a low-carbon economy, this study analyzes and designs a coordination contract that is suitable for a low-carbon supply chain, under the circumstances of a carbon tax policy and government subsidies; this is to achieve a reduction in emissions and a growth in the total profits of the supply chain, while simultaneously improving the sustainable competitiveness and coordination of the supply chain. Manufacturers and retailers make up the two levels of the supply chain that are the focus of this study. Both centralized and decentralized decision-making models are created using the Stackelberg game method. By analyzing the supply chain decision-making and emission-reduction strategies in both cases, the revenue-sharing contract is designed to achieve the sustainable coordination of the y chain. The results of the numerical analysis show the following: first, that more orders are placed and emissions are reduced under centralized decision-making than under decentralized decision-making; second, that the total supply chain’s profits are higher when all parties comply with the revenue-sharing contract than when there are no contracts; third, that the revenue-sharing contract allows for the free allocation of supply chain gross margins in the enterprise for supply chain coordination.

The role of output-based emission trading system in the decarbonization of China's power sector

The emission trading system (ETS) is a key policy for China to achieve carbon neutrality. China's national ETS started operation and covered the power sector first, which will promote its transformation. This study explores how China's national ETS can support the future decarbonization of the power system. With benchmark tightening, China's ETS can cost-effectively peak CO2 emissions of the power sector before 2030 and reduce 13% of the total emissions by 2035, compared to a No-Carbon-Pricing Scenario. Under the ETS, the allowance price would rise gradually to 350 yuan/tCO2 by 2035. The main driving factor for emissions reduction would be improving the efficiency of coal-fired power generation between 2020 and 2025 and deploying carbon capture and storage (CCS) from 2030, respectively. Fuel-switching away from coal is limited under the ETS with technology-specific benchmarks and free allocation. Regional distributional effects could arise under the ETS. Regions with a higher share of ultra-supercritical units could have allowance surpluses at the beginning, while only regions with CCS-equipped coal-fired units have the potential to gain high allowance surpluses by 2035.

German stakeholder perceptions of an EU carbon border adjustment mechanism

The European Commission has proposed a carbon border adjustment mechanism (CBAM) that would apply the carbon price prevailing in the EU emissions trading system to import-related emissions. We conducted a survey to study perceptions of an EU CBAM among German key stakeholders from industry, civil society, and research in July 2021. We find that substantial support for CBAM exists as well as the expectation that the mechanism will eventually be introduced. We identified divergent views on key design options among stakeholder groups. Stakeholders from industry generally favour the continuation of free allocation of emissions allowances, rebates for exporters from the EU, coverage of only scope 1 emissions, and use of revenues for domestic spending. Stakeholders from civil society prefer phasing out free allocation, coverage only of imports, an emissions scope including all indirect emissions, exempting low-income countries and countries that do implement non-price-based climate policies, and the use of revenues to finance green transformation in low-income countries. Respondents from research would generally rather see free allocation being phased out, emissions coverage of scope 1 and 2, exemptions for low-income countries and countries that do implement non-price-based policies with comparable effects in relevant sectors and a transfer of revenues to support clean technologies in low-income countries and green technologies in the EU. Our survey design allows us to identify three cross-stakeholder group clusters, one containing stakeholders who are comparably more hesitant towards CBAM, a second one with respondents most in favour of introducing CBAM, as well as a ‘middle ground’ cluster which contains views that are often in between the other two. We also compare the survey responses to the design of the Commission’s CBAM proposal to identify the most likely points of political disagreement.

Consignment auctions of emissions trading systems: An agent-based approach based on China’s practice

Policymakers of emissions trading systems (ETSs) around the world are faced with the challenges of how to allocate carbon allowances. On one hand, the free allocation would undermine the efficiency and fairness of ETSs, while on the other hand, a precipitous shift to auctions would put enormous economic pressure on covered entities. The consignment auction is supposed to combine the free allocation and the auction. However, few studies have investigated the consignment auction’s impacts on ETSs and commodity markets from a quantitative perspective. In this paper, an agent-based model is proposed, considering both the primary and secondary carbon markets, the commodity market and the behavior of firms. Simulation results based on China’s data show that, compared with the free allocation, the consignment auction can achieve a higher and more stable carbon price without significantly increasing the cost borne by firms, increase the liquidity of ETSs, and stimulate the technological advances of firms. Compared with the auction, the consignment auction reduces the volatilities of the commodity market induced by ETSs and facilitates the smooth operation of ETSs. Our results also suggest that the consignment auction is particularly suitable for the early stage of ETSs, while the auction remains the best allocation method as the ETS matures, as it significantly promotes long-term technological advances.

A two-step auction-refund allocation rule of CO2 emission permits

Carbon dioxide (CO2) emission permit allocation plays an important role in the emissions trading system (ETS). An appropriate allocation rule helps ensure the acceptance and compliance of firms, as well as the cost efficiency of the ETS. In general, regulators apply the free allocation of such permits, in order to attract firms to participate in a newly-built carbon market. Then, auctioning is used when the carbon market is mature. Firms generally do not welcome auctioning, considering the carbon cost burden, while free allocations have been proven to induce less trade due to the endowment effect or loss aversion and higher non-compliance rate because of the relatively low non-compliance costs. This study proposes a two-step auction-refund allocation rule for CO2 emission permits for covered firms in a newly-built carbon market, which may be more attractive to both firms and regulators. The proposed allocation rule, which may be regarded as a free allocation method, has the advantages of avoiding the endowment effect, enabling price discovery and providing firms more incentives to fulfil their compliance requirements. Furthermore, the proposed allocation rule can help regulators ensure a smooth transition from free allocation to auctioning.

Does China emission trading scheme reduce marginal abatement cost? A perspective of allowance allocation alternatives

Emission trading schemes (ETSs) are regarded as cost-effective environmental regulatory policies; however, because of the loose carbon allowances, it is up for debate whether China's carbon emission trading scheme (CETS) plays a cost-effective role in carbon emission reduction. This paper investigates how the marginal abatement cost (MAC) is changed by the China CETS from a perspective of alternative allowance allocation methods. The empirical strategy adopts the directional distance function and difference-in-difference (DID) analysis, coupled with the industry-by-province level data from 2008 to 2016. The roles of free-auction combined allowance allocation rules and free allocation in the MAC are explored. Furthermore, the heterogeneous effects of adopted free allocation in CETS, i.e., benchmarking (BENCH), emission-based grandfathering (EGRAND), and intensity-based grandfathering (IGRAND) on MAC of industries are investigated. The empirical findings disclose the following. First, China CETS results in an 8% decline in MAC for the regulated industrial sectors in pilot areas. Second, regulated industrial sectors allocated carbon allowances by free rule decrease their MAC by approximately 1%, while those allocated carbon allowances by free-auction combined rule increase their MAC by 11%. Meanwhile, of the free allocation alternatives, IGRAND causes a 24% increase in the MAC, while EGRAND and BENCH allocation methods lead to insignificant changes in the MAC for the regulated industrial sectors.

A Scientometric Analysis and Review of the Emissions Trading System

As a vital market mechanism to mitigate global warming, the emissions trading system (ETS) has critical research and practice value. According to articles from Web of Science’s core collection, quantitative statistics are used to analyze the ETS, including statistics on the number of articles, distributions of time and geography, journals and subjects, productive authors and institutions, academic collation, article citations, and hot topics. Moreover, this paper presents a qualitative analysis of research on the ETS, exploring hot issues, including its origin, allowance allocation, the impact of allowance allocation, and the ETS in the power sector. The results show that it is necessary to launch ETS to mitigate climate change effectively and reduce emissions at a low cost. Allowance allocation as its critical component has also caused heated discussion among scholars. In allowance allocation, exploring a desire to assign the future allowable carbon emissions reasonably and efficiently is vital, yet scholars widely do not accept this. Moreover, free allocation can only be applied to the transitional stage, and auctioning will be inevitable. In addition, scholars have studied the impact of different allowance allocation schemes from macro and micro perspectives and take the power sector, namely the largest emitter, as an example, by linear programming, equilibrium modeling, and multi-agent modeling. However, the quota allocation scheme needs improvement due to firms’ accuracy of emission data. Finally, governments are encouraged to launch the ETS to reduce emissions and combat climate change. The ETS should be improved gradually, including aspects such as cap setting, covering sectors, and the allocation method. Additionally, some key emission sectors and regions can be taken as the research and practice objects in the initial stage of the ETS.