The EU’s Emissions Trading System: free allocation of allowances needed better targeting
Samo Jereb, Kathrine Henderson, Jerneja Vrabič. Colm Friel, Maria Eulàlia, Ernesto Roessing, Kurt Bungartz and Oana Cristina Dumitrescu
July 2020
53 p.
Benchmarks, Carbon leakage, Free allowances, Investments

Executive summary

The reduction of greenhouse gas emissions is one of the main challenges of our times. The EU has established a series of climate change targets to be achieved in 2020, 2030 and 2050. While the EU is firmly on track to achieve its 2020 targets, this is not the case for its – more ambitious – 2030 and 2050 targets. The Commission’s “Green Deal”, put forward in 2019, proposed moving to a target of cutting emissions by between 50 and 55 % by 2030 and achieving “no net emissions” of greenhouse gases by 2050. This implies a significant increase in efforts.

The EU Emissions Trading System is one of the EU’s key climate change mitigation policies and it is the world’s first carbon market. It aims at providing an efficient mechanism to reduce emissions. Under the EU ETS companies need to obtain emission allowances covering their carbon emissions. The default option is for these to be purchased at an auction; they can also be allocated for free.

This audit focused on the free allocation of allowances. In phases 3 and 4 of the EU ETS (years 2013‐2020 and 2021‐2030 respectively), free allowances aim at mitigating the risk of carbon leakage, while the carbon price is intended to provide a progressive incentive for decarbonisation. This is supported by the use of benchmarks derived from the top performers in a given sector. The power sector in eight Member States also received free allowances linked to the modernisation of electricity production.

Our audit question was “Did decisions on free Emissions Trading System allowances provide a reasonable basis to encourage the reduction of greenhouse gas emissions?” We examined whether free allocation of allowances was successfully used to modernise electricity generation, sufficiently targeted and allocated to provide incentives to reduce greenhouse gas emissions, and had not contributed to increasing such emissions. We found that while the use of free allocation was justified, better targeting of free allowances would have had multiple benefits for decarbonisation, public finances and the operation of the single market.

In particular, we found:

(a) The specific rules for free allocation to modernise the electricity generation sector applying to the EU ETS phase 4 have been improved. However, we consider that free allocation to the power sector did not promote decarbonisation in phase 3.

(b) Free allowances were intended to provide an exceptional method of allocating allowances in contrast to the default method (auctioning). However, during phase 3 and the early stages of phase 4, they continue to represent more than 40 % of the total number of available allowances. We found that the number of free allowances allocated to the industry and aviation sectors in phase 3 was not based on their ability to pass through costs and that, while carbon leakage has the potential to affect the EU carbon market and the evolution of the greenhouse gas emissions worldwide, there was limited targeting of the allocation of free allowances.

(c) The approach to allocate free allowances on the basis of benchmarks provided significant incentives for improvement of energy efficiency, but there is scope to improve the application of these benchmarks. The Commission has not quantified the impact of allocation of free allowances on changes in energy efficiency.

Based on these findings, we make recommendations aimed at better targeting the allocation of free allowances as well as improving the methodology for setting benchmarks.

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LifeETX is implemented by a consortium of 10 NGOs working at national and European level