Allocation Rules in the EU ETS: Impact on Electricity Prices and Economic Efficiency

This paper demonstrates that cost-free allocation, commonly called grand-fathering, implies an increase in electricity prices even when strong competition prevails on electricity markets. As our estimations for Germany´s power sector show, these price increases result in substantial windfall profits, giving rise to public skepticism and calls for an auctioning of certificates in the future. While empirical evidence on the ETS´ impacts is scant, the findings reviewed here indicate that even in the absence of certificate auctioning, energy-intensive industry sectors may suffer heavily from the ETS-induced electricity price increases. We argue that an abrupt transition to a complete auctioning system may endanger the competitive position of energy-intensive industries in Europe, unless all other major industrial and transition countries are integrated into a global emissions trading system.