Over-allocation in the European Emission Trading System

Abstract

When setting up the world's largest emission trading system to combat carbon dioxide pollution, European policymakers were facing strong pressure to supply industry with free allocations of emission allowances. This has led to the issue of over-allocation of allowances with, however, limited evidence to which extent this over-allocation occurred. After all, measuring the extent of over-allocation properly requires the construction of a meaningful counter-factual. We propose an approach which exploits a policy change in the allocation of allowances in 2013, when the third phase of the European Emissions Trading System (ETS) started. From then onward, electricity producers were not granted free allowances anymore, in contrast to all other installations which were endowed with allowances. By comparing these groups, we attempt to assess how installations would have behaved in Phase 3, had they still received free allowances as the comparison group did. Compared to Phase 2, electricity producers in Phase 3 were, on average, holding 505804 allowances less. This change in stocks is driven by the policy-induced reduction in the free allowances, while no change can be observed in purchases, sales, and carbon dioxide emissions.

Keywords: European emission trading system, over-allocation, environmental policy, climate policy, event study, carbon dioxide emissions

JEL Classification: Q52, Q54, Q58, D72