Last updated: 5 August 2026.
Quick answer. This article examines to what extent auctioning emission allowances can improve the functioning of the EU Emissions Trading System (EU ETS) compared with the free allocation of allowances initially provided for in the directive that established the scheme. Auctions strengthen the system for five reasons: they create a direct cost for emissions and therefore a stronger incentive for companies to reduce them; they allow the allowance price to be determined more efficiently on the basis of actual supply and demand; their revenue can be reinvested in climate change mitigation and adaptation measures; they prevent the over-allocation and windfall profits that free allocation can produce; and they better apply the polluter pays principle, fundamental in EU environmental law.
To what extent can the reform of the European Union Emissions Trading System (EU ETS) improve its functioning through an auctioning system for emission allowances, as opposed to the free allocation of allowances initially provided for by Directive 87/2003?
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The auctioning system for emission allowances can significantly enhance the functioning of the EU ETS compared to free allocation for several reasons:
a) Economic Incentive: Auctions create a direct cost for emissions, thereby more strongly incentivizing companies to reduce them. With free allocation, this incentive is weaker.
b) Market Efficiency: Auctions allow the price of allowances to be determined more efficiently based on actual supply and demand.
c) Revenue for Climate Policies: Revenue from auctions can be reinvested in climate change mitigation and adaptation measures.
d) Equity: It prevents potential over-allocation and windfall profits that can occur with free allocation.
e) Application of the “Polluter Pays” Principle: It better aligns with this fundamental principle of EU environmental law.
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Frequently asked questions
The question is to what extent the reform of the EU Emissions Trading System can improve its functioning through an auctioning system for emission allowances, as opposed to the free allocation of allowances initially provided for in the directive that created the scheme. The article concludes that auctions can significantly enhance the system’s functioning.
Because auctions create a direct cost for emissions, thereby more strongly incentivising companies to reduce them. With free allocation, companies receive allowances without paying for them, so the incentive to cut emissions is weaker.
Auctions allow the price of emission allowances to be determined more efficiently, based on actual supply and demand, rather than through administrative distribution. This price signal reflects the real scarcity of allowances in the market.
Revenue from auctions can be reinvested in climate change mitigation and adaptation measures, turning the emissions market itself into a source of funding for climate policies.
Auctioning aligns better with the polluter pays principle, a fundamental principle of EU environmental law, since emitters bear a direct cost for their emissions. It also promotes equity by preventing the potential over-allocation and windfall profits that can occur under free allocation.
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