Free Allocation

In an absolute-cap ETS, the regulator must distribute allowances to regulated firms. The two main methods are auctioning (firms buy allowances) and free allocation (firms receive allowances at no cost). Most real-world cap-and-trade schemes start with generous free allocation to ease the transition.

Grandfathering vs. benchmarking

• Grandfathering: allowances are allocated based on a firm's past emissions. Simple, but rewards historical polluters.
• Output-based benchmarking: allocation is tied to current output and a sector efficiency benchmark. Firms that produce more get more allowances — this avoids penalising output growth and is less distortionary for trade-exposed sectors.

Why free allocation matters for competitiveness

Industries exposed to international competition (steel, cement, chemicals) worry that carbon costs will push production — and jobs — to countries without carbon pricing. Free allocation reduces this carbon-leakage risk during the early phases of a scheme.

Phase-out over time

Most schemes gradually reduce free allocation and shift toward full auctioning as the scheme matures and carbon costs become part of normal business planning.

In the simulator

In Absolute cap mode you set a free allocation percentage (default 90%). The remaining allowances are auctioned at the start of each period. Use this to explore how the balance between free allocation and auctioning affects market prices and firm strategies.