This report, prepared with assistance from Jaakko Pöyry Consulting, is intended to assist Member States and the European Commission in determining the allocation mechanism to use in conjunction with the Commission’s proposed emissions trading program for carbon dioxide (CO2) and other greenhouse gases (GHGs). In October 2001, the Commission adopted a major package of initiatives to combat climate change, including a proposed Directive on GHG emission trading. Emissions trading will reduce the cost of emission reductions by encouraging these reductions to be made where they are least costly, while achieving a pre-determined emission reduction from the activities covered by the trading program. An important element left to Member States, with Commission approval, is the initial allocation of allowances. Initial allocations provide the starting points for cost-reducing trades among facilities covered by the cap-and-trade program and setting the initial allocation has been of the most contentious issues in developing a workable cap-and-trade program. The initial distribution of allowances is a matter of considerable concern to the affected parties. In addition, the mechanism used to set the initial allocation can affect the efficiency of trading and thus the overall costs of achieving the emissions cap.

The report provides descriptions and evaluations of alternative mechanisms for initial allocation of allowances and is the only report to provide a comprehensive assessment applied to GHG emission trading in Europe and address the empirical issues involved in actually implementing a plant-level allocation scheme in the EU. The authors provide a typology of alternative initial allocation mechanisms and describe the allocation mechanisms that have been used in other programs. They develop criteria for evaluating alternative mechanisms. They also suggest additional analyses that the Member States could undertake to provide a sound basis for developing an initial allocation mechanism.