The Method of Selling Allowances in a Cap- and-Trade Program Can Influence Program Outcomes

The literature and programs that we reviewed present many options for  the design of a mechanism to sell allowances under a cap-and-trade  program. First, because elements of the  mechanism’s design may affect outcomes—such as the price of  allowances obtained at auctions and the cost of the program—it is  important that design choices align with an emissions trading program’s  goals. Second, once a goal is chosen, policymakers have numerous  choices regarding the sale of allowances, including whether to sell them  on an exchange or use auctions. Goals commonly cited by researchers and program officials  include:    Simplicity and transparency. Maximizing participation. Economic efficiency. That is, the price would reflect decisions by covered  entities either to reduce their emissions or to purchase allowances to  cover them, whichever is more cost-effective. Avoiding market manipulation. Revenue generation. For example, policymakers could design a sale so that it is  more likely to achieve high allowance prices. Some goals may also be interrelated—for example, a simple and  transparent design may boost participation and reduce the risk of market  manipulation. German and Danish officials we interviewed expressed general  satisfaction with sales on exchanges and cited their potential strengths in  meeting certain goals. Program officials reported that auctions, the more commonly used sales  mechanism in the EU and RGGI, effectively distributed allowances to  program participants, although several noted that allowance auctions have  not yet been implemented on a large scale. Program officials noted that auctions can also be administered through  exchanges. According to a  program official, this approach allows them to draw on preexisting auction  infrastructure and administrative processes, as allowance bids are subject  to the same rules as other exchange transactions. Even  though they made different bids, each company that bids above a  certain price receives allowances at the same price. In some discriminatory-price auctions,  winning bidders pay the amount of their bid. Previous U.S. federal  government experience with auctions has involved different formats in  different markets. Existing cap-and-trade programs for carbon dioxide allowances—the EU  ETS and RGGI—have employed the uniform-price, single-round format, in  which winning bidders submit secret bids and pay the same price for  allowances. According to literature and economists we interviewed, advantages of this  format include:    Simplicity. Some economists said that other  auction formats, such as clock auctions, may be more conducive to  collusion than single-round auctions, because multiple bidding rounds give  other bidders information and create opportunities for collusion. The clock auction format may also present some disadvantages. Other Auction Design Elements

Apart from format, policymakers would face a number of choices related  to auction design, each of which has implications for program outcomes. Among other things, choices must be made regarding participation rules,  the frequency and timing of auctions, the use of reserve prices or other  price controls, and the monitoring and reporting of auction activities. Participation. Programs that  met these criteria were the European Union’s (EU) Emissions Trading  Scheme (ETS) and the Regional Greenhouse Gas Initiative (RGGI). Participation limits. Given these concerns, many economists and program officials favored  maximizing the number of potential auction participants. Bid limits. For  example, a CBO report said that a reserve price could create a price floor  if the government chose to sell a significant fraction of emission  allowances, as opposed to distributing them for free. In  determining which data to report, program officials recommended that the  government disclose aggregated data such as the quantity of allowances  sold, the number of participants (and the fraction that won allowances),  and the clearing price. Appendix III: Allowance Sales Conducted in the EU ETS and RGGI

Appendix III: Allowance Sales Conducted in  the EU ETS and RGGI Percentage of  each member  state’s cap sold  (or expected to  be sold)
2006 and 2008  (auctions)
2.3 (Phase I)
Auction 1: $33.12 Auction 2: 8.65 Auction 3: 0.01 0.5 (Phase II)
2009 (sale)
2.5 (Phase I)
Auction 1:  9.34 Auction 2:  1.09 5.0 (Phase I)
5.1 Weighted average price:  1.5 (Phase I)
Auction 1: $.07 7.0 (Phase II)
Auctions 1 to 7: 1.3 (Phase II)
Auction 1:  $13.66 Auction 2:  $16.68 8.8 (Phase II)
80.0 Weighted average price:  2008 sales: $27.97 2009 sales: $15.49 raised (rounded)

Appendix IV: GAO Contact and Staff Acknowledgments

	Staff Acknowledgments

In addition to the contact named above, Michael Hix (Assistant Director),  Cindy Gilbert, Robert Grace, Richard Johnson, Jessica Lemke, Micah  McMillan, Benjamin Shouse, Jeanette Soares, Ardith A. Spence, and Kiki  Theodoropolous made key contributions to this report.
Why GAO Did This Study

Congress is considering proposals for market-based programs to limit greenhouse gas emissions. Many proposals involve creating a cap-and-trade program, in which an overall emissions cap is set and entities covered by the program must hold tradable permits--or "allowances"-- to cover their emissions. According to the Congressional Budget Office (CBO), the value of these allowances could total $300 billion annually by 2020. The government could either sell the allowances, give them away for free, or some combination of the two. Some existing cap-and-trade programs have experience selling allowances. For example, member states participating in the European Union's (EU) Emissions Trading Scheme (ETS) have sold up to about 9 percent of their allowances, and the amount of auctioning is expected to increase significantly starting in 2013. In the United States, the 10 northeastern states participating in the Regional Greenhouse Gas Initiative (RGGI) have auctioned about 87 percent of their allowances. This report is part of GAO's response to a request to review climate change policy options. This report describes the implications of different methods for selling allowances, given available information and the experiences of selected programs. GAO reviewed relevant literature and interviewed program officials from the EU and RGGI, economists, and other researchers. This report contains no recommendations.

What GAO Found

The method of selling emissions allowances can have significant implications for a cap-and-trade program's outcomes, and therefore, it is important that the method be chosen based on well-defined goals. Goals often cited by program officials and economists include: maintaining simplicity and transparency, maximizing participation, promoting economic efficiency, generating a price that reflects the marginal cost of reducing emissions, avoiding market manipulation, raising revenues, and minimizing administrative costs. According to program officials, it is important to identify goals prior to choosing a sales method, as tradeoffs may exist. Some goals may also be interrelated--for example, a simple and transparent design may boost participation and reduce the risk of market manipulation. Once goals are identified, policymakers face a number of choices regarding the design of a sales mechanism. Existing programs have used different mechanisms to sell allowances, including direct sales through exchanges and auctions. EU officials described exchange-based sales as effective and easy to implement, although they and other economists questioned whether this approach would be suitable for selling a high volume of allowances. Program officials also reported that auctions, the more commonly used sales mechanism in the EU and RGGI, effectively distributed allowances to program participants. However, some economists noted that auctions are not "one size fits all," and should be designed to take into account market characteristics, such as the number of potential buyers. Using auctions to sell allowances would entail a number of other design choices. For example, policymakers could decide to utilize existing auction infrastructure, such as that used in exchanges or government auctions, or develop a new platform. Choices must also be made regarding the auction format and other design elements. (1) Auction format: The auction format determines, among other things, the price that winning bidders pay for allowances and the number of bidding rounds. To date, ETS and RGGI auctions have used a single round format in which each participant that bids above a certain price receives allowances at that price. Program officials expressed general satisfaction with this format, and economists noted that its relative simplicity may encourage participation. However, some economists also recommended that policymakers consider other formats as well, such as multiple-round auctions, given that experience with large-scale allowance auctions has been limited to date. (2) Other auction design elements: Apart from the auction format, other elements may affect outcomes, including: participation requirements, the frequency and timing of auctions, measures that establish lower or upper limits on allowance prices, and rules governing auction monitoring and the reporting of results.