As well as being an essential part of the EU’s commitment to reduce its own emissions the EU ETS is a component of, and serves to reinforce global efforts. It is the major driver behind the global carbon market, which assists low-carbon investment in developing countries through the use of project credits and auction revenues. The scheme has the potential to be the ‘strongest currency’ in a network of interlinked emissions trading schemes that are already emerging in different parts of the world. An effective European system post-2012 could form a focal point for global negotiations up to the Copenhagen 2009 conference and beyond. However, the EU ETS in its current design is far from perfect and to deliver the far-reaching objectives of effectiveness, efficiency and innovation, a significant revision of EU ETS after the first two trading phases is required. In particular, experience has revealed a number of serious problems arising from the free allocation of emissions allowances. A key element of the EC package proposes that most emissions allowances for the period beyond 2012 should be sold in auctions rather than handed out for free to emitters. This report explains the economic rationale for auctioning, and examines the practical implications.