RGGI Auction Design Research:Phase 1 Results

RGGI Stakeholder Meeting, New York City May 31, 2007

Dallas Burtraw, Karen Palmer; RFFCharlie Holt, Bill Shobe; Univ. of Virginia

Jacob Goeree; CalTech

Purpose

To provide the states participating in the Regional Greenhouse Gas Initiative (RGGI) with information that they will need to implement a successful auction of carbon allowances.

Key approach

Use economics laboratory experiments to test auction designs:Networked computers with student subjectsCarefully structured financial incentivesUsed in many auction design applications

FCC spectrum sales, U.S. treasury notes, SO22, NOx, irrigation reductions, timber, and others

Helpful in setting auction design details

Proposal

Phase 1: Literature ReviewAssessment of auction types

Phase 2: Specific performance and design

analysis

Phase 1 Experiments

Auction types:Sealed bid - pay as bid (‘discriminatory’)Sealed bid - uniform price for all winnersMulti-round clock auctions

English (increasing) Dutch (decreasing)English clock with ‘shootout’ round

Interaction with spot market

Stylized setting for experiments

Designed to capture key aspects of market

Simple enough to implement in the lab

Setup

Experimental sessions12 participants per ‘lab session’Univ. of Virginia student subjectsSubjects earn money by buying, trading, and

using allowancesEach subject acts as a firm with a capacity

to produce a productProduction requires that the firm use allowances

‘Low’ users need 1 allowance per capacity unit ‘High’ users need 2 allowances but have lower

production costs

Setup (cont.)

Production costs randomly distributed across ‘firms’Wide cost range (15 sessions), narrow (11 sess.)

Initial sessions run without secondary (spot) market and no banking

Price of product fixed and known Earnings equal price of product sold minus

production costs minus allowance costs

Measures of performance

Efficiency is high if allowances are purchased by firms with the highest value for allowances (results in lowest cost carbon abatement)

Revenue is high if the auction is competitive; firms are not able to collude to pay less than the market price

Session data

Results table

Summary Performance Measures Wide Cost Range

Sessions Narrow Cost

Range Sessions Revenue Efficiency Revenue Efficiency

Uniform Price 77 98 92 99 Discriminatory 76 99 87 99

Clock 71 96 91 100 Shot Clock 72 98 87 94

Dutch 75 99 92 99

Phase 1 Considerations

Revenues and efficiencyAccurate price discoveryLiquidity and price volatilityFairness and transparencyAdministrative costsSetting reservation price

Handling unsold allowances

Preliminary Recommendations

Format and FrequencyReservation PricesFutures MarketMiscellaneous

Format and Frequency

Auction formatMixed auction format

First auction for a vintage: English clock with shootout sealed-bid round

Subsequent auctions sealed-bid English clock enhances price

discoverySealed-bid: low cost, resistant to

collusion, commonly used

Format and Frequency

Define ‘vintage’ to coincide with the enforcement periodMinimize irrelevant differencesReduce transaction costsMaximize number of identical assets

Format and Frequency

Auction frequencyQuarterly throughout the vintageEnhances liquidityLess likely to disrupt spot marketReduced ability for ‘surprise

hoarding’

Reserve Prices

Set firm reserve priceVery important element of auction

designProtects against collusionMay help reduce volatility

Must be willing to have unsold allowances

Option: put unsold allowances in a ‘contingency bank’

Facilitating Futures Markets

Sell some allowances before vintage yearMay not be used before vintage year

Develop price signals about future scarcity

Help reduce risk on long-term investments

Miscellaneous

Allow broad participation in auctionAnyone who can financially qualifyThis enhances price discovery and

efficiencyEfforts to limit participation may be

difficult to enforce

Miscellaneous

Auctions should include binding financial assuranceEscrow, letters of credit, bond ratingNo bids for more than posted

assuranceBidders held responsible for bid

amounts

Questions?

Phase 2 Research

Impact of “non-compliance” entities in auction

Appropriate levels of information revelation Financial assurance and escrow requirements Bidding rules that deter collusion Establishing a credible reserve price

Rules for selling reserve allowances Discriminatory or uniform price sealed-bid

auctions Guidance on selling future allowances