Academic journal article Agricultural and Resource Economics Review

An Experimental Analysis of Auctioning Emission Allowances under a Loose Cap

Academic journal article Agricultural and Resource Economics Review

An Experimental Analysis of Auctioning Emission Allowances under a Loose Cap

Article excerpt

The direct sale of emission allowances by auction is an emerging characteristic of cap-andtrade programs. This study is motivated by the observation that all of the major implementations of cap-and-trade regulations for the control of air pollution have started with a generous allocation of allowances relative to recent emissions history, a situation we refer to as a "loose cap." Typically more stringent reductions are achieved in subsequent years of a program. We use an experimental setting to investigate the effects of a loose cap environment on a variety of auction types. We find that all auction formats studied are efficient in allocating emission allowances, but auction revenues tend to be lower relative to competitive benchmarks when the cap is loose. Regardless of whether the cap is tight or loose, the different auction formats tend to yield comparable revenues toward the end of a series of auctions. However, aggressive bidding behavior in initial discriminatory auctions yields higher revenues than in the other auction formats, a difference that disappears as bidders learn to adjust their bids closer to the cut-off that separates winning and losing bids.

Key Words: auction, carbon dioxide, greenhouse gases, allowance trading, Regional Greenhouse Gas Initiative, RGGI, cap and trade

The emerging trend toward the sale of emission allowances as a major method, or even the primary method, for allocating allowances into the economy has focused attention on the implications of various methods for selling allowances.1 This is especially true given the considerable economic value of the new environmental assets. The U.S. Congressional Budget Office estimates that the aggregate value of allowances under a national greenhouse gas cap-and-trade program would be between $50 billion and $300 billion per year (in 2007 dollars) by 2020. While there have been some experiments with other forms of sale, economic theory, the weight of recent experience, and current policy proposals lead us to expect that auctions will emerge as an important mechanism for selling allowances. It is widely accepted that the performance of different types of auction mechanisms will vary with the institutional context. Taken together, these factors argue strongly for the importance of investigating the performance of different auction designs in the context of an allowance trading program.

This study is motivated by the observation that all of the major implementations of cap-and-trade regulations for the control of air pollution have started with a generous allocation of allowances relative to recent emissions history. At least at the outset, the supply of allowances has been plentiful relative to the number of allowances needed for compliance. In some cases the supply has remained plentiful, while in others the supply has become progressively tighter. We use the term "loose cap" to refer to cases where the supply of emission allowances is relatively high, that is, relatively close to the unconstrained market equilibrium. This might be relevant in absolute terms, if the emissions constraint does not bind at least for a short period of time, but more generally a loose cap is a relative concept. We investigate the performance of alternative types of auctions when the cap is loose and the expected auction price is low.

The relative slackness of an emissions cap could have implications for the preferred design of an allowance auction. Smith (1967) found that, in an experimental setting where bidders in a sealed-bid auction shared a common, but imperfectly known, value for multiple units of a good, a loose cap produced a divergence in the performance of different auction types. Specifically, Smith found that uniform-price auctions generated more revenue than discriminatory-price auctions when excess demand was low, but that uniform and discriminatory auctions generated comparable levels of revenue when excess demand was high.

In this paper, we investigate the effects of a loose cap environment on a variety of auction types. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.