Pros and Cons of Auctioning Emission Rights : A Law and Economics Perspective

In this paper we analyze the extent to which the increased role of allowance auctions after 2012 will influence the effectiveness, efficiency and equity of the Emissions Trading Scheme in the European Union (EU ETS). We argue that more auctioning affects neither the effectiveness nor the efficiency of the EU ETS, but that it does affect the equity (or: fairness) of the scheme. First, effectiveness is determined by the emission caps, not by the way the allowances under these caps are allocated. Second, efficiency results from the tradability of the allowances and, more fundamentally, from the internalization of climate damage in the form of a carbon price, not from the allowance allocation method. Third, equity is in fact influenced by the way in which the allowances are allocated. For consumers, the scheme will be fairer after 2012 because more auctioning reduces the windfall profits of producers. For producers, however, the fairness of the scheme will decline because they will lose the wealth transfer of free allowances that made them accept the EU ETS in the first place