Allocation of allowances
Allowances can be allocated either for free based on historical emissions (a form of so-called grandfathering) or by auctioning. In the five-year period 2008—12, which was also the original commitment period of the Kyoto Protocol, at least 90 per cent of the allowances were to be allocated for free. In practice most Member States allocated close to 100 per cent for free. Until 2012 the cap for emissions from the trading sector, that is, the installations required by the Directive to have a permit, in each Member State was the total number of allowances which that Member State had allocated according to a national allocation plan (NAP). The allocation had to be based on ‘objective and transparent criteria’ and the NAP was to be notified to and assessed by the Commission. The Commission’s assessment of the NAPs, including the interpretation of the objective and transparent criteria, gave rise to several disputes between Member States and the Commission. 
Since 2013, which was the start of the third phase of the EU ETS, an EU-wide cap has applied to the whole trading sector. This is based on the total number of allowances allocated by the Member States, through NAPs approved by the Commission, for the period 2008—12. In 2013 the total quantity of allowances allocated was just below 2.04 billion. This quantity is then decreased annually by 1.74 per cent of the average annual total quantity of allowances issued by Member States for the period 2008—12. This means an annual decrease of approximately 38 million allowances and should by 2020 result in emissions from covered sectors being 21 per cent below those in 2005 (Art 9).
In 2014 the European council agreed that from 2021 onwards the annual reduction factor will instead be 2.2 per cent.41
In the third phase of the EU ETS auctioning is the default system for allocation of allowances, at least in principle. The Directive contains rather detailed rules on how to determine the total quantity of allowances to be auctioned by each Member State. Almost 90 per cent of the allowances to be auctioned are distributed among Member States in shares that are identical to the share of verified emissions under the EU ETS for 2005 or the average of the period from 2005 to 2007. At least 50 per cent of the revenues generated from the auctioning should be used for tackling climate change. This may be done, inter alia, by reducing greenhouse gas emissions, including by contributing to the Global Energy Efficiency and Renewable Energy Fund, by developing renewable energies, and by measures intended to increase energy efficiency and insulation. (Art 10.)
According to a proposed amendment, 57 per cent of the allowances are to be auctioned by Member States from 2021 onwards. Additionally, 2 per cent of the total quantity of allowances between 2021 and 2030 is to be auctioned to establish a fund to improve energy efficiency and modernise the energy systems of certain Member States.^
Due to, inter alia, the global financial crisis of 2007—8 and high imports of international credits into the EU trading system, a surplus of emission allowances has built up, resulting in a very low price for such allowances and, as a consequence, a weak impact of the EU ETS on investment decisions relating to the covered installations. To deal with this the Commission postponed the auctioning of 900 million allowances until 2019—20 (so-called ‘back-loading’).     To address the problem for the longer term, a so-called market stability reserve, operational as of 2019, has also been established.44 Instead of being added to the volumes to be auctioned in 2019 and 2020, 900 million allowances deducted from auctioning volumes during the period 2014—16 are to be placed in the reserve. A procedure is also established according to which each year a number of allowances equal to 12 per cent of the total number in circulation shall be deducted from the volume to be auctioned and be placed in the reserve, unless the number of allowances to be placed in the reserve were less than 100 million. These allowances are then to be added to auction volumes if the relevant total number of allowances in circulation falls below 400 million.45 This is intended to counter large fluctuations in the number of allowances on the market and hence their price. An amendment to the Directive has also been introduced to counter sharp changes in supply due to transition from one trading period to another.46
According to the European Council’s decision in 2014, 10 per cent of the allowances to be auctioned by the Member States are in future to be distributed among those countries whose GDP per capita did not exceed 90 per cent of the EU average in 2013, whereas the rest will be distributed on the basis of verified emissions. A new reserve of 2 per cent of the EU ETS allowances is to be set aside to address particularly high additional investment needs in low-income Member States.   
The Directive also contains rather complex rules on free allocation of emission allowances4® (Art 10a). With some exceptions, no free allocation is to be made to electricity production. With respect to manufacturing, the picture is quite different. Not counting specific support measures, the manufacturing industry received 80 per cent of its allowances for free in 2013. This proportion decreases in a linear fashion each year to reach 30 per cent in 2020.
A very important exception is that installations in sectors or subsectors deemed to be exposed to a significant risk of carbon leakage shall be allocated allowances free of charge at 100 per cent of a benchmark. Carbon leakage does not refer to the physical emission or other escape of carbon dioxide, but to the relocation of greenhouse gas-emitting production from the EU to countries where lower or no costs are imposed on such emissions. The sectors at risk of leakage are hence sectors with competition from countries without an emission reduction scheme or similar policy measures.
Based on criteria set out in the Directive, the Commission has published a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage.49 The list includes a large number of manufacturing and extraction industries, such as manufacture of basic iron and steel and of ferro-alloys, of paper and paperboard, of refined petroleum products, and of cement and lime, as well as mining of most metal ores. The Commission is required to draw up a new list every five years.
In order to provide incentives for reductions in greenhouse gas emissions and energy-efficient techniques, the free allocation is to be based on product benchmarks for individual sectors or subsectors. The starting point for setting such benchmarks is the average performance of the 10 per cent most efficient installations in the sector or subsector in the EU in the years 2007—8 (Art 10a). The product benchmarks and applicable system boundaries are set out in a decision on rules for harmonised free allocation of emission allowances which also contains rules on allocation of emission allowances to new entrants.50 The main implication of the system for free allocation is that installations whose emissions are in line with applicable benchmarks in principle get free allocation of allowances for all their emissions, while less efficient industries will need to lower their emissions or buy allowances.
In Iberdrola the Court of Justice was asked whether a Spanish measure providing for the remuneration of electricity production to be reduced by an amount equivalent to the value of the emission allowances was incompatible with the free allocation of allowances.51 The purpose of the Spanish measure was to prevent so-called windfall profits made by producers who are able to pass on the value of allowances allocated for free in electricity prices. The Court found that Article 10 of the Directive does not prevent Member States from taking measures the purpose and effect of which are to reduce remuneration for electricity production by an amount equal to the increase in such remuneration brought about through the incorporation, in the selling prices offered on the wholesale electricity market, of the value of emission allowances allocated free of charge.52
According to the 2014 European Council Conclusions on the 2030 Climate and Energy Policy Framework, free allocation is to be maintained to prevent carbon leakage. The benchmarks for free allocations are to be periodically reviewed in line with technological progress and both direct and indirect carbon costs will be taken into account. Future allocations should ensure better alignment with changing production levels in different sectors, ensure affordable energy prices, and avoid windfall profits. Member States with a GDP per capita below 60 per cent of the EU average will be allowed to continue to give free allowances to the energy sector up to 2030.53
-  See eg Case C-504/09 P Commission v PolandECLI:EU:C:2012:178.
-  Conclusions on 2030 Climate and Energy Policy Framework (n 23) 2.
-  Proposal for a Directive of the European Parliament and of the Council amending Directive2003/87/EC to enhance cost-effective emission reductions and low-carbon investments (15 July 2015) COM(2015) 337 final, Art 1.
-  Commission Regulation (EU) No 1210/2011 amending Regulation (EU) No 1031/2010 inparticular to determine the volume of greenhouse gas emission allowances to be auctioned prior to 2013  OJ L 308/2.
-  Decision (EU) 2015/1814 of the European Parliament and of the Council concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and amending Directive 2003/87/EC  OJ L 264/1.
-  Ibid, Art 1.
-  46 Dir 2003/87/EC (n 33), Art 10 (1a).
-  Conclusions on 2030 Climate and Energy Policy Framework (n 23) 4.
-  48 The Court of Justice has made clear that the imposition of a gift tax on the allocation of emission allowances is precluded to the extent that allowances which according to the Directive are to beallocated free of charge are affected by such a tax. Case C-43/14 SKO—Energo ECLI:EU:C:2015:120.
-  Commission Decision 2014/746/EU determining, pursuant to Directive 2003/87/EC of theEuropean Parliament and of the Council, a list of sectors and subsectors which are deemed to be exposed to a significant risk of carbon leakage, for the period 2015 to 2019  OJ L 308/114.
-  Commission Decision 2011/278/EU determining transitional Union-wide rules for harmonised free allocation of emission allowances pursuant to Article 10a of Directive 2003/87/EC of theEuropean Parliament and of the Council  OJ L 130/1.