Allocation and Related Issues for Post-2012 Phases of the EU ETS Page: 70
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Emissions Grandfathering Allocation
6.3.1.2. Ability to limit leakage
Provided grandfathered allocations were based on historical emissions only, they would not
be expected to alter production decisions relative to what would be expected under auctioning
or historical benchmarking, as discussed in the next chapter.
6.3.2. Economic efficiency of trading scheme
6.3.2.1. Consistency with least-cost abatement
The use of grandfathering would be consistent with least-cost abatement subject to certain
conditions. One of these is that the data used to calculate allocations are not updated with
reference to later actions taken by participants. In practice, this is likely to require the use of
historical emissions data from the period before the launch of the trading scheme. Provided
all emissions and other activity data fulfil these conditions, the choice between
grandfathering and other idealised forms of allocation to incumbents (notably, benchmarked
allocations that are also based on historical activity data) can be taken independently of
considerations about cost-effectiveness.
For this conclusion to hold, the requirement to use historic data is relatively restrictive, and
extends not only to emissions data but also to all other data entering into the calculation of
allowances. This includes adjustment factors, such as growth projections, which may
influence abatement decisions if they are calculated based on data since the trading scheme
started (and therefore also increase the cost of reducing emissions). We discuss these issues
in more detail in Chapter 9 on updating allocations.
As noted previously, allocation based on historical emissions also may not result in the least-
cost abatement choices when markets are not perfectly competitive or when market prices are
subject to direct regulation based on average or net costs. Where firms have market power
and the ability to influence prices, they may be able to discourage market entry by keeping
prices below the level that new entrants would require for profitable investment, and they
may conclude that this is a profitable strategy. Such strategic behaviour could be facilitated
by higher levels of free allocations, since these would make it more likely that profits could
be maintained without raising prices. In product markets characterised by market power and
where differences in Member State allocations were sufficiently large, it is possible that firms
would choose not to pass through all of their CO2 opportunity costs into prices as a way to
deter entry by foreign competitors. Failure to pass-through full opportunity costs would not
be consistent with least-cost abatement.
A related issue could arise if capital markets were not particularly liquid or competitive, and
if allowance allocation provided some recipients with investment capabilities that were not
available to others. Note that even if this were the case, it would not necessarily represent an
efficiency issue, if we could assume that investments would be made wherever the economy
signalled that they were most needed. Of course, it would represent a distributional fairness
issue, because some firms would be (somewhat) better able to self-finance investment,
whereas others could be forced to rely more on external financing options. To the extent that
there were concerns about unequal treatment of different firms within the same sector,
options based not on historical emissions but on harmonised historical benchmarks could rate
slightly better in this regard. However, there could be similar concerns about unequalNERA Economic Consulting
70
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Harrison, David, Jr.; Radov, Daniel & Klevnas, Per. Allocation and Related Issues for Post-2012 Phases of the EU ETS, text, October 22, 2007; [Brussels, Belgium]. (https://digital.library.unt.edu/ark:/67531/metadc29374/m1/76/: accessed April 25, 2024), University of North Texas Libraries, UNT Digital Library, https://digital.library.unt.edu; .