How neutral is the choice of the allocation mechanism in cap-and-trade schemes? Evidence from the EU-ETS

Abstract

The European Emission Trading Scheme (EU ETS) is the central EU policy instrument aimed at mitigating climate change and to comply with the target agreed in the Kyoto protocol. The EU ETS could result in an harmful impact for the competitiveness of the European firms, as it was unilaterally introduced by the EU, and so firms could be induced to relocate their carbon-intensive production activities in countries with less stringent regulations for mitigating climate change (carbon leakage effect). For this reason, European Union decided to grant most of permits for free in its first phases and to exempt leakage-exposed sectors from auctioning in its third phase. According to Coase (1960), the level of emissions for each firm in equilibrium does not depend on the assignment of property rights over the emissions but this could not be the case in a real world system, with a lot of possible frictions, as transaction costs and behavioural anomalies.  The aim of the paper is to exploit the asymmetry in the allocation mechanisms introduced from the third phase of the EU ETS to evaluate whether different allocation mechanisms are neutral in terms of emission abatement decisions. Results suggest a non-neutral role of the allocation mechanisms, with establishments that received allowances for free having greater emissions than plants that were forced to buy allowances through auctions.