An Experimental Analysis of Auctioning Emissions Allowances under a Loose Cap Charles Holt and Bill Shobe (UVA) Dallas Burtraw, Karen Palmer and Erica Myers (RFF) Jacob Goeree (Caltech) Northeastern Agricultural and Resource Economics Association June 9-10, 2009 Burlington, VT

The Age of Environmental Securitization Advances in technology are making it increasingly profitable to close the commons These will be part of the fabric of traded assets in the economy When governments sell assets, they auction them

Sell, Baby, Sell More cap and trade programs selling allowances rather than grandfathering them –RGGI states selling roughly 90% of total allowances –Federal legislation proposes combination of sales and free allocation with increasing proportion to be sold over time –EU ETS will sell majority of electricity sector emissions in phase III Auctions will emerge as the dominant mechanism for selling allowances Auction performance can be affected by institutional considerations so testing of auction formats in allowance trading context is important.

Previous Emission Auctions Title IV SO 2 auction - discriminatory price, revenue neutral auction Irish EPA - uniform price auctions in EU ETS Virginia NO x auction – sequential English clock auctions for each of two vintages Numerous small EU-ETS auctions – Phase I: Denmark, Hungary, Lithuania, Ireland; more in Phase II. Germany selling in OTC market but legislation requires move to auction.

Regional Greenhouse Gas Initiative 10 Northeast States from Maryland to Maine (excluding PA) “Cap and trade” program for CO 2 starting in 2009 All agreed to auction at least 25% of allowances Several states auctioning close to 100% of allowances RGGI auctions held quarterly starting in September 2008; next auction June 17, 2009 As first program to auction large fraction of GHG allowances, RGGI will have global impact Waxman-Markey draft bill specifies same auction type

RGGI Auction Research Final report to RGGI states, October 2007 Collusion in Auctions for Emission Permits: An Experimental Analysis (Forthcoming, JPAM) Auctions under loose caps (this paper) Price discovery: tracking unanticipated market shifts

RGGI Format Recommendation We recommended a quarterly, sealed-bid, uniform price auction: –Simple, transparent, familiar design –Low cost for seller and buyers –Performs better price discovery than discriminatory and more resistant to explicit collusion than the clock –Provides “lock-in” for needed allowances (as is also true for the clock) We tried treatments where we thought the clock would do better: loose cap, and the price discovery (unanticipated demand shift), and it did no better

Collusion: Clock Underperforms

Price Discovery

Loose Caps are Common “Loose cap” refers to a cap close to business as usual First phase of EU ETS had non-binding cap –EU ETS didn’t allow banking Other cap and trade programs also not binding initially –Phase I of Title IV SO2 non-binding by design –RECLAIM in Southern CA –Chicago program for volatile organic material (ozone precursor) RGGI cap likely to be non-binding in early years

Auction Types Tested Sealed Bid Discriminatory or “Pay as Bid” – high bids win, pay prices bid which may differ (“discriminatory”) Sealed Bid Uniform Price – high bids win, all winners pay the same uniform price, i.e. the highest rejected bid English Clock – multi-round ascending prices, bidders state demand quantities, uniform price Full Information English Clock – clock with information about excess demand revealed after each round

Will Loose Caps Affect Performance of Different Auction Types? Prior research by Smith (1967) suggests that –low excess demand can lead to important differences in revenue generating ability between uniform and discriminatory auctions –this difference doesn’t exist with high excess demand Loose cap provides a stress on auction types: a less competitive environment

Experimental Setup Six sessions per treatment, 8 auctions per session Groups of 6 bidders, with aggregate demand for 45 permits at 0 cost Low emitters (need 1 permit per unit output) and High emitters (need 2 permits) Earnings = sales revenues – costs – permit costs Permit value = (price – cost)/permits needed Veconlab: flexible, web-based, automatic instructions 252 U. of Virginia student subjects, earnings about $30 for sessions lasting 1-2 hour

Experimental Treatments Treatment 1: Loose cap/Tight cap –Loose cap: reduction of 10% below BAU (40 permits) –Tight cap: reduction of 30% (30 permits) Treatment 2: Auction type –Sealed-bid uniform –Sealed-bid discriminatory –English clock –(English clock with full information under loose cap only)

Performance Measures: Walrasian Revenue

Performance Measures 1.Revenue, as a percentage of Walrasian revenue Walrasian revenue, what would be obtained if people bid their values in a uniform price auction (Supply = Demand) 2.Efficiency: maximum efficiency would allocate units to the highest value users; actual efficiency is a percentage of this maximum

Revenue as a Proportion of Walrasian Revenue Auction FormatTest StatisticP-value Uniform Discriminatory Clock34.485

Efficiency No significant differences among auction types or between tight and loose caps

Price changes during sessions Tight capLoose cap Tight Cap: No significant differences among auction formats Loose Cap: First 4 auctions: discriminatory auction raises more revenue than all other formats. Last 4 auctions: only sig. difference is discriminatory > clock with full information (W=0; p=.031)

Uniform Auction Individual Bids

Discriminatory Auction Individual Bids

Conclusions Loose caps provide less competitive “stress test” No difference among four auction formats in terms of efficiency Revenues are higher for the discriminatory format in early auctions, but this difference tapers over time In discriminatory auction bidders learn to bid the market clearing price Auction design matters!