Auction Design for Selling CO₂ Emission Allowances Under the Regional Greenhouse Gas Initiative

The purpose of this study was to design an auction mechanism for use by the Regional Greenhouse Gas Initiative (RGGI) for selling emission allowances. We conducted a series of experiments to investigate the performance of a number of auction types considered to be likely candidates for use in a CO₂ allowance auction: sealed-bid, increasing-price sequential (English clock), and decreasing-price sequential (Dutch) auction forms. We also examined whether sealed-bid auctions should use the pay-as-bid (discriminatory) or uniform-price rules. The auction formats were compared with respect to price discovery, that is, ensuring that the price of allowances at auction reflects their market value, and in limiting collusive behavior. We also examined the effect of reserve prices and allowance banking and did more analysis of how the auction combines with secondary (or spot) markets. We looked at the effects of allowing participation in the auction by brokers or other traders not needing allowances for compliance and of combining auctions with “grandfathering” of some allowances for free to generators. In addition, we performed some experiments to look at so-called “hoarding behavior” and the effects of different mechanisms that have been proposed to limit hoarding. In particular, our experiments examined whether holding auctions with participation limited to generators can reduce the effect of hoarding behavior. The report was written under contract with the New York State Energy Research and Development Authority (NYSERDA)