EU emissions trading: navigating between Scylla and Charybdis

With the introduction of the EU emissions trading system on 1 January 2005, the EU became the world leader in the implementation of a market mechanism in environmental policy. Through the project-based Kyoto mechanisms, the EU trading scheme is linked to the world greenhouse gas market; however, the robustness of that link remains to be tested. Due to effective lobbying of large emitters, allocation is cost-free—either based on historical emissions (traditional ‘grandfathering’) or against projected emissions (which one might call ‘baseline-and-cap trading’)—and in most Member States the trading sectors have received a generous allocation. This may lead to a market with low liquidity and low prices. Nevertheless, the EU Commission has managed to reduce some of the more blatant cases of over-allocation. While the ongoing legal cases may lead to a temporary weakening of demand for allowances, a decision to expand the trading scheme to other sectors and gases, a larger role of auctioning as well as a more stringent post-2008 allocation plans process scheduled for 2006 may correct many of the first period's misconstructions.