Emissions trading: lessons learnt from the 1st phase of the EU ETS and prospects for the 2nd phase

In January 2005, the European Union launched an EU-wide emissions trading scheme (EU ETS) for CO 2 emissions. It covers approximately 45% of total CO 2 emissions and is thus the largest ‘cap-and-trade’ carbon trading scheme in the world – an ambitious and highly challenging policy experiment. As it emerges from its pilot phase and prepares for phase II, the EU ETS now stands at a crossroad: will it quickly address the problems experienced in phase I and establish strong price signals in Europe, or will the prevailing uncertainty continue into phase II? Phase I has indeed proved how much market design matters to its operation and signalling. Unlike normal markets, emissions trading schemes are designed markets, where the demand and supply are dependent on government decisions. The volume of allowance allocation determines scarcity levels and thus the effectiveness of the scheme. Furthermore, the various provisions in the allocation plans can influence investment and operational choices and thus the efficiency of the scheme. Decisions on auctioning and free allocation, as well as on how to split the allocation pie across sectors and installations, will also have distributional consequences. This special issue presents seven articles that consider the influence of allowance allocation, and inform the debate surrounding ‘National allocation plans in the EU ETS: lessons and implications for phase II’. Five articles focus on recent experience with the design of national allocation plans (NAPs) for the period 2008–2012 and provide qualitative and quantitative assessments. These are complemented by two numerical simulations of trade and distributional effects. We summarize their findings in the context of the debate, which we structure into the three key criteria for ETS assessment: market efficiency; distributional effects, and environmental effectiveness.