Worldwide a keen interest is developing to introduce Greenhouse Gas (GHG) Emissions Trading Schemes (ETSs) for companies. So far the European Union started the largest scheme as from 2005, which is extended and will be further extended in the future towards 2020. In the USA a federal GHG ETS might emerge after the presidential elections in 2009. But now already several groups of US States are developing GHG trading schemes, the Western Climate Initiative (WCI) headed by California, The Regional Greenhouse Gas Intiative (RGGI) at the US East Coast and recently the Midwestern Climate Pact (MCP).

The existing and emerging trading schemes are expected to be linked to each other, which will form the gradual growth of a global carbon market.

Experience and analysis have learned that the method for the allocation of allowances is as important as the scarcity of allowances. The allocation drives the behaviour of companies when they are making decisions to invest in low carbon technologies.

Four allocation methods are discussed: (1) auctioning, (2) cap & trade for individual companies based on historical grandfathering – allocation based on historic emissions – (3) performance-based allocation and (4) performance-based cap & trade.

Auctioning is the ideal method if applied globally, but if not it causes “leakage” of emissions and “import of unemployment”. Border Adjustments to protect industry against the loss of competitiveness are judged to be impossible in practice.

Cap & trade for individual companies based on historical grandfathering causes all kinds of distortions and significant economic rents for electricity producers. In the European Union, historical grandfathering will be abandoned. Performance-based allocation solves all distortions, but now the total cap is not ensured. Therefore we propose performance-based cap & trade is proposed as the solution towards auctioning in the long term. It is argued that auctioning is only feasible when all developed and developing nations – including China, India, Brazil, etc. – have adopted GHG Emissions Tradings Schemes for industrial companies. This prospect is not considered realistic before 2020.