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Initial Allocation Mechanism in GHG Emission Trading Systems

This study analyses pros and cons as well as the economic impact of various alternative initial allocation mechanisms in GHG emissions trading systems, such as the auction, grandfathering, benchmarking, etc. The auction is evaluated to be better than the other alternatives in that it is not only compatible with polluter-pay-principle, but also promotes efficient reduction efforts across the whole economic system.

Some complementary measures are needed to tackle the possible distortion of international competitiveness and/or emission leakage related to carbon-intensive trade-dependent industries. Free allocation with updating or border-leveling measures could be devised in coordination with major trade partners to avoid or alleviate these problems.

To mitigate the negative impact on, and to allow smooth and gradual transition of, the economic system, it may be best to move from free initial allocation toward full auction over the longer term. In case both intensity-based free allocation and grandfathering allocation are applied, a gateway mechanism needs to be employed to limit the net flow of emission permits from intensity-based free allocation industries to others.