The polluter pays principle and the allocation rules

The polluter pays principle requires the internalization of social costs into production costs. The principle is complied with through the setting of a cap that applies to each and every installation. However, different allocation rules will distribute that cap differently among polluters. The criteria used by each rule will tend to benefit some polluters over others. For instance, grandfather-ing based on historical emissions gives more allowances to the worst polluters, which can then sell them at a profit in the market. Further it tends to create a disadvantage for early actors. Grandfathering coupled with rules on updating and rules on closures compound this problem. Benchmarking may reduce those problems, although that depends on their specific design. Auctioning ensures equal treatment of all polluters in the sense that it distributes the burden in accordance with only one criteria: the level of pollution of each polluter. On the other hand, companies facing different marginal abatement cost (MACs) will be affected differently by auctioning. When the differences in MACs are large, auctioning may lead to strong impacts on the positions of some companies. If those companies are competitors in the market, auctioning could lead to some companies losing their ability to compete. Hence, the introduction of auctioning must take this potential impact into account in order to comply with the principles of equality and proportionality.

The question of whether allocation rules may violate the polluter pays principle must also be analysed from the perspective of state aid rules. We have already seen the defective approach of the Community guidelines on state aid for environmental protection. Moreover, although the Commission considers that free allocation constitutes in principle state aid, the academic literature seems divided on this issue.95 For state aid to exist, all the conditions laid

94 See in general Nordhaus (2007). See for the EU ETS, Del Rio (2006, p. 465).

95 See De Sepibus (2007b); see Lorenz (2004); see Merola and Crichlow (2004); see Weishaar (2007).

down in Article 87 EC must be fulfilled:96 (1) the conferral of an advantage; (2) granted by the State or through State resources; (3) which distorts or threatens to distort competition; (4) by favoring certain undertakings or the production of certain goods or services (the selectivity criterion); (5) and which affects trade between Member States. IƱigo Sanz et al. consider that allocation of allowances for free does not in principle constitute state aid, since the requirements of Article 87 EC are not complied with.97 Angus Johnston considers that free allocation constitutes, prima facie, state aid.98 De Sepibus considers that the question of whether certain allocation methodologies constitute illegal state aid cannot be answered conclusively in the light of prevailing case law.99 In Case T-233/04,100 the CFI considered that the NOx emission trading scheme implemented by The Netherlands did not constitute state aid, since, although it fulfilled the conditions of conferring an advantage through state resources, did not constitute a selective measure. The NOx scheme covered industrial installations with an installed capacity above 20 MW, thereby applying an objective criterion to determine the coverage. Since this is also the approach followed by the EU ETS, the reasoning also applies therein. The case however does not consider whether specific choices within allocation rules may constitute state aid. In its analysis of the second round of NAPs the Commission has sought also to subject allocation rules to state aid scrutiny, when they have the potential to discriminate at sector or installation level. In a number of NAPs, it has considered that a number of choices cannot be justified on the basis of the objectives of Directive 2003/87/EC.101 Whether this approach is successful remains to be seen. Hence, it is not yet clear whether respect for state aid rules seems to require the harmonization of allocation rules.

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