The document summarizes the key changes to the EU Emissions Trading Scheme (EU ETS) for the third trading period starting in 2013. It discusses the shift from mostly free allocation of allowances to auctioning as the default method, with free allocation focused on sectors deemed at high risk of carbon leakage. Benchmarks based on the best performing 10% of installations in the EU will determine free allocation levels. The goals are to introduce EU-wide rules, phase out free allocation, and incentivize emissions reductions without risking carbon leakage.

1. 1
EU Emissions Trading Scheme
Free allocation and the risk of
carbon leakage in the EU ETS
Conference on Climate Policies, International
Regimes & Global Trade
Vancouver, 11 June 2011
Stefan Pauer
DG Climate Action
European Commission

2. Overview of
presentation
1. Introduction to the EU ETS
2. Allocation and carbon leakage in the first
two trading periods
3. Changes for the third trading period
starting in 2013
4. Development and application of the new
rules

3. EU ETS:
Basics
• Mandatory system, applicable since 2005
• Covers ~11.500 large installations in the EU,
accounting for ~2 billion tonnes CO2/year
(~50% of total EU CO2 emissions)
• Environmental outcome guaranteed: cap on
amount of allowances, long-term reduction
• Market system: no price intervention, scarcity
created by cap ensures allowances have value

4. EU ETS:
Cap & trade
• Operators must report verified emissions each year &
hand in 1 emission allowance for each tonne of CO2
emitted
• Mandatory cap on total number of allowances in the
system
• Emission allowances can be traded (i.e. no cap per
installation)
• Carbon price: provides economic incentive to reduce
emissions
• Cost-effective: reductions take place where cheapest

5. Risk of carbon leakage
• Absence of comparable carbon constraints in
third countries may lead to:
 Economic disadvantage for domestic energy-intensive
sectors (competitiveness impact)
 Potential overall increase in greenhouse gas
emissions (environmental impact)
• Big political issue, heated debates
• Policy response needed to address these
concerns

6. Environmental effectiveness
and competiveness
• Best solution for environment and
competitiveness is countries taking action
under a global agreement
• However, transitional solutions exist via
domestic policy:
 Emissions trading is itself a least cost way to meet
emission reduction targets
 Use of international offsets for cost containment
 Free allocation of allowances instead of auctioning

7. Experience from
2005-2012
• Large part of allowances distributed for free,
widespread overallocation
• Allowances distributed via National Allocation Plans
(NAPs), mainly based on historical emissions
• Relatively straightforward approach, but:
 Perverse reward: the more emissions, the more free allowances
 National variations in allocation – risk for distortion of
competition within the EU
 Windfall profits for electricity producers
• Independent ex-post analysis for 2005-2007 detects
no statistical evidence of delocation due to EU ETS
(Ellerman et al., ‘Pricing Carbon’, 2010)

8. Revised EU ETS from
2013 onwards
• Revision of EU ETS agreed in December 2008
• Single EU-wide cap (no more NAPs)
• Paradigm shift: auctioning as default allocation method
 Full auctioning for electricity sector
 More than half of all allowances will be auctioned
 Member States should use at least 50% of auctioning revenues
for climate & energy related purposes
• EU-wide rules for free allocation of allowances
 For other sectors
 Transitional character
 Greenhouse gas performance-based

9. Future distribution of
free allowances
• Total amount of free allocation is limited (fixed in law)
 Distributional issue (who gets how much)
 Zero-sum game to some extent
• Based on ambitious benchmarks of greenhouse gas
performance
• Phasing out of free allocation:
 80% of benchmark level in 2013
 30% of benchmark level in 2020
 With a view to reaching full auctioning by 2027
• Sectors «deemed to be exposed to a significant risk of
carbon leakage»:
 Free allocation at 100% of benchmark level

10. Carbon leakage list
• Criteria:
 Production cost increase: additional costs per gross value added
 Trade exposure: trade intensity with non-EU countries
• Specific thresholds laid down in EU law
• List of sectors determined in 2009, supplemented in
2011
• Sectors on the list will receive a relatively higher share
of free allowances than non-exposed sectors
• Environmental outcome of EU ETS unaffected as cap
ensures emission reductions

11. Benchmarks
• Indicator for amount of greenhouse gases emitted
per amount of product produced
• No emission limit or reduction target, but merely a
threshold for the level of free allocation per unit of
production of an individual installation
• In simplified terms (a number of other factors apply):
allocation = benchmark × historical production
• Benchmarks developed per product (to the extent
feasible)
• Set at the greenhouse gas performance of the
average of the 10% best performing installations in
the EU producing that product

12. Determination of
benchmarks
• Benchmarks calculated without differentiation for
 How a product is produced (different technologies)
 With what input (different types of fuel or raw material)
 Where (located in which EU Member State)
• No exclusion of installations
• Thus: «one product – one benchmark»
• Data collection carried out by European sector
associations, verified by independent third parties
• Benchmarks provide a strong signal for what is
possible in terms of low-carbon production

13. Example benchmark
curve
Ammonia
0
500
1000
1500
2000
2500
3000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37
installations
kgCO2/tproduct

14. Free allocation from
2013 onwards
• Member States to calculate number of free allowances per
installation (ex ante), based on EU-wide rules
• 75% of eligible emissions covered by 52 product benchmarks
• Where no product benchmark applicable, hierarchy of fallback
approaches:
 Heat-based energy benchmark (20% of eligible emissions)
 Fuel-based energy benchmark (5% of eligible emissions)
 Process emissions allocated by grandfathering (less than 1% of eligible
emissions)
• Benchmarks will mean a larger challenge for least efficient
installations
• Commission to monitor the risk of carbon leakage