MEMORANDUM 

To: Kevin Culligan, Erich Eschmann, Scott Benolkin, EPA/CAMD 

From: Barry Galef, Bansari Saha, Jason Lee, Bickey Rimal, ICF International 

Subject: Transaction Costs in Allowance Trading Markets 

Date: September 17, 2008 

This memorandum summarizes ICF’s interim findings on the magnitude of transaction costs in 

allowance trading markets. These findings are primarily based on limited conversations with 

brokers and consultants, review of literature on transaction costs, and information available on 

broker and exchange websites.1

 

Our findings suggest that the costs are fairly standardized and are generally low compared to 

the value of allowances. We found that transaction costs are usually well below the 1- to 2-

percent range of allowance values typically quoted in the economics literature.2

 From our 

discussions with the industry consultant, we also learned that there is enough competition 

amongst the approximately fifteen brokerage houses that any attempt at charging fees in 

excess of market standards will be bid down through competition and entry. In many instances, 

larger clients can negotiate fees even lower than market averages. Moreover, we recently saw 

exchanges such as Chicago Climate Exchange and New York Mercantile Exchange adding the 

SO2 and NOx allowances to their list of commodities. 

In this memorandum, we first present the textbook definition of transaction costs discussing the 

components that constitute the costs. We then present our findings on the magnitude of 

transaction costs in the allowance trading markets, based on the information we were able to 

collect in the last few days. In the third and final section, we quantitatively analyze the 

magnitude of the costs in the CAIR NOx Program. 

Definition of Transaction Costs 

Transaction costs are costs associated with the exchange of goods or services. In the 

allowance trading market, transaction costs are often considered to be the fees charged by 

brokerage firms. These fees are the direct costs associated with buying and selling allowances. 

In addition to these direct costs, there may also exist indirect costs (or, as one broker we spoke 

with called it, costs for “quasi-consulting services”). If a company needs some expert analysis 

or opinions to maximize the value of its allowances, the cost of that analysis can be considered 

an indirect transaction cost because it is indirectly related to actual execution of the trades. In 

most cases, costs for these analytical services are not included in the standard fees, but brokers 

pointed out that these services are only required only in a relatively small fraction of trades 

(perhaps in the range of 5--10 percent of all trades). 

 

1

 We called various brokerage firms listed on the CAMD website, 

http://www.epa.gov/airmarkets/trading/buying.html, and were able to interview representatives from two 

brokerage houses in the last week or so. At their requests though, we would like to keep broker identities 

and their affiliations confidential. 

2 Transaction costs in some “thin” markets--such as those for renewable energy credits—could be higher 

at 3 to 3.5 percent, according to the industry consultant we spoke with. 
2

 

In economic theory, transaction costs have three components: information and search costs, 

bargaining costs, and policing and enforcement costs.3 4

 The first two components—information 

and search costs, and bargaining costs—are standard services provided by brokerage firms. 

These firms facilitate transactions through price discovery and matching buyers with sellers. 

Once the potential counterparty is identified, the buyers and sellers usually complete the 

transaction with each other (see Footnote #6 for a variant to this situation). The identities of 

buyers and sellers are protected during this process. 

Brokerage firms also provide various consulting services or other analytical support based on 

client needs. In most cases, it appears that they provide these services at no extra charge 

provided that the clients enter into an agreement to trade exclusively with them. In some cases, 

though, there seem to be an additional fee, as discussed below. These types of services could 

include analyzing, advising, and strategizing based on the client’s needs. Our discussions with 

the industry consultant confirmed that these indirect services are typically for short-term (i.e., a 

few months to a year) market projections based on brokers’ anticipation about various market 

parameters (for e.g., studying what demand might be based on coal use, expectations about the 

degree to which the next summer months can affect electricity demand, etc.). These expert 

opinions do not involve any sophisticated modeling by the brokerage firms and large EGUs are 

unlikely to rely on them because of doubts about their unbiasedness. Given that most firms 

may not require added payments for conducting these services and these services seem to be 

of low relevance to compliance behavior, costs for these quasi-consulting services appear to be 

trivial in relation to overall transaction costs.5

The third component, the cost of policing and enforcement, is somewhat difficult to interpret 

because the cost to prevent a potential conflict between the seller and the buyer is included in 

the fees charged by the brokerage firms. For example, if a buyer or seller does not have good 

credit, then the brokerage firm can work as an intermediary in the process of exchanging funds 

by opening an escrow account.6

 Moreover, a seller or buyer occasionally may wish to conduct 

the transaction using an exchange. In that case, the cost of using the exchange is an added 

cost but it does prevent any conflict that could occur from the transactions.7

 Though the costs of 

policing and enforcement to prevent a conflict between the seller and the buyer are included in 

the fees charged by brokerage firms, a conflict between a seller/buyer and the brokerage firm is 

not. However, we think a possibility of the brokerage firm counterfeiting allowances is very 

small given that maintaining a good reputation is essential for client-oriented businesses.8

 

 

3

 North and Thomas (1973). 

4 These costs also include any profits a participant in a transaction needs to secure.

5 One broker we spoke with suggested that the average fee for these services range between $5,000-

$10,000 and that they typically provide these services for very few trades. Thus, these costs appear to be 

fairly small and unlikely to make a significant difference to our conclusions. 6

 Brokers told us they do not generally handle the monetary exchanges and prefer that buyers and sellers 

directly conduct the financial transaction. If there are credit concerns, however, some brokerage houses 

will undertake the “clearing functions”. These clearing functions may include the use of escrow accounts 

or ensuring allowances get delivered on time. If brokers are asked to provide these services, they 

typically provide them as complimentary services as long as their brokerage firm is the exclusive agent in 

the transaction (i.e., to maintain long-term client relationships). Moreover, costs for these clearing 

services tend to be fairly small, according to the industry consultant we spoke with. 7 The cost of using the exchange is an added cost but this cost is also trivial at less than 0.1 percent of 

allowance price.

8

 In 2002, Calpine sued its broker when the company learned that some allowances it had purchased 

were not available. 
3

Fees Charged by Brokerage Firms 

The fees charged by brokerage firms seem to be standard and fairly small compared to 

allowance prices. We conducted interviews with two brokerage firms and both quoted fees in 

the same range. Moreover, when asked the same question during our interview with the 

industry consultant, his response was strikingly similar to those given to us by the brokers, 

providing confirmation that these fees are well standardized due to the competitive nature of the 

brokerage business. Finally, the range for these fees is also comparable to the range we had 

found in our literature review.9

The typical fees charged by brokerage firms for each allowance market are shown below. 

Exhibit 1: Transaction Fee as a Percentage of Allowance Price 

Allowance Type Allowance Price 

($/ton) Broker Fee ($/ton) 

Broker Fee as a 

percentage of 

Allowance Price 

SO2* 300 0.50 < 0.2 % 

Seasonal NOx* 850 10-15 < 1.8 % 

Annual NOx* 5000 20-25 < 0.5 % 

Note: The allowance prices are prices before CAIR was vacated by the DC circuit court. 

*The allowance price for SO2, Seasonal NOx, and Annual NOx are the spot price, seasonal 

NOx 2008 price, and annual NOx 2009 price, respectively. 

Source: Evolution Markets (http://new.evomarkets.com/index.php?page=ResourcesMarket_Updates-Monthly_Market_Updates) 

Given that the SO2 allowance price was about $300/ton just days before the CAIR vacatur, the 

transaction costs appear to be less than 0.2 percent of the allowance value. Considering the 

fact that SO2 allowance price was hovering around $550/ton in the second half of 2007 and 

gradually came down to the $300/ton level, transaction costs for SO2 allowances could have 

been significantly lower than 0.2 percent of the allowance value if CAIR had not been vacated.10 

For seasonal NOx allowances, the price was $850/ton, so these costs are less than 1.8 percent. 

For CAIR annual NOx allowances, the allowance price was $5,000/ton before CAIR was 

vacated by the court, which translates to less than 0.5 percent.11 

 

9 One industry expert, Gary Hart, had stated that the typical fee charged by brokerage firm is $0.50 for 

each SO2 allowance. His statement is presented in “The U.S. Acid Rain Program: Key Insights from the 

Design, Operation, and Assessment of a Cap-and-Trade Program.” 10 “SO2 Markets – July 2008 Monthly Market Update,” Evolution Markets, 

http://new.evomarkets.com/index.php?page=Emissions_Markets-Markets-NOx_Seasonal_Allowances 11 The seasonal NOx price of $850/ton and the annual NOx price of $5,000/ton were in effect days before 

the CAIR ruling. In general, prices were in the range of $750/ton to $850/ton for seasonal NOx allowances 

and in the range of $3,000/ton to $5,000/ton for the annual NOx allowances in 2008, according to the 

“NOx Monthly Market Update (07/08)” published by Evolution Markets. 
4

Exchange Fees 

According to our research, costs of using exchanges are much lower than the fees charged by 

brokerage firms, as shown in Exhibit 2 below. On a per ton basis, these exchange fees 

translate to less than 10 cents/ton for SO2, less than a dollar/ton for seasonal NOx and up to 

$2.50/ton for annual NOx, which are much lower than the broker fees shown in Exhibit 1 above. 

Exhibit 2: Summary of Trading Fees per Contract at CCFE and NYMEX 

Product 

CCFE Green Exchange (NYMEX) 

Contract 

Size 

Member 

Fee (per 

contract) 

NonMember 

Fee (per 

contract) 

Contract 

Size 

Transaction 

Fee (per 

contract) 

SO2 Futures 25 tons $1.60 $2.00 100 tons $6.00 

Seasonal NOx Futures 5 tons $2.00 $2.50 10 tons $7.00 

Annual NOx Futures 1 ton $2.00 $2.50 10 tons $7.00 

The actual transaction fees for using exchanges are thus less than 0.1 percent of the allowance 

values, as shown in Exhibits 3 and 4 below. Exhibit 3 presents exchange fees related to the US 

SO2 and NOx markets while Exhibit 4 presents comparable numbers for the EU CO2 market. 

Exhibit 3: Summary of Trading Fees per Contract in terms of 

percentage of Allowance Price 

Product 

CCFE Green Exchange 

(NYMEX) 

Member 

Fee 

NonMember 

Fee 

Transaction Fee 

SO2 Futures 0.02% 0.03% 0.02% 

Seasonal NOx Futures 0.05% 0.06% 0.08% 

Annual NOx Futures 0.04% 0.05% 0.01% 

Note: This table has been corrected to take into account the size of each contract. 
5

Exhibit 4: Transaction Fee at selected Exchanges for CO2 

Allowance 

Exchange 

Transaction Fee 

($ per 1,000 

metric tons) 

Transaction 

Fee as a 

percentage of 

CO2 Allowance 

Value 

ECX 2.8 - 3.5 0.01% 

NordPool 4.2 0.01% 

EEX 1.4 - 4.2 0.01% 

Green Exchange (NYMEX) 2 0.01% 

The CO2 Allowance price was $34.28 (as of 09/05/08) 

Source: Point Carbon (http://www.mfe.govt.nz/publications/climate/issuesinternational-carbon-market-oct07/html/index.html), NYMEX 

(http://nymex.greenfutures.com/markets/) 

There are additional fees associated with using the exchanges, such as annual fees and 

application fees, but we assume those are paid by brokers annually, and are minimal costs of 

doing business for brokerage firms. 

Estimating Transaction Costs for the NOx Program 

We quantified the total transaction costs under the CAIR NOx program by using emission 

projections from IPM. We also estimated the number of allowances that each fossil unit could 

get by assigning the allowances given to each state in proportion to the heat input in 2010, 

adjusted for fuel type. This fuel type adjustment counted only 60 percent of the heat input for oil 

units and 40 percent for gas units, paralleling how the allowances are calculated for each state. 

Once the NOx allowances for each unit under CAIR are estimated, we calculated the number of 

allowances each unit would need to sell or buy. These make up the number of allowances that 

need to be transacted. We then applied the $20 to $25 per ton for the transaction fee to 

estimate the overall percentage of transaction costs as a share of total allowance transactions. 

Results indicate that transaction costs for the NOX program were generally very small at less 

than one-half of one percent. 

Exhibit 5: Summary of Transaction Costs under CAIR Annual NOx Program in 2010

Fee for Transacting NOx Allowance $20 - $25/ton 

Total Transaction Costs $21 – $26 million 

Total Value of Transacted Allowances $5.28 billion 

Transaction Costs (%) 0.4 – 0.5% 

Note: We used $5,000/ton for the NOx allowance price since that was the market price before the 

CAIR vacatur. Even if we use the IPM projected price of $1,079/ton for CAIR NOx allowance in 

2010, the percentage of the transaction cost is only about 2 percent. 
6

Using information gathered from our discussions with brokers, we also quantified the costs for 

advisory services charged by brokerage firms for their market analyses. We estimated the 

number of utility operators to be about 360 and assumed that 5 to 10 percent of them could 

seek some sort of advisory services each year (using approximate figures quoted by a broker). 

We then multiplied the resulting operators seeking consulting services by $5,000 - $10,000, 

which was the fee range also suggested by the broker in our conversation. As shown in Exhibit 

6 below, the resulting estimated cost of advisory services are very small compared to the 

transaction costs charged by the brokerage firms. When these advisory service costs are 

added to the transaction costs, the overall transaction cost percentages remain very close to the 

0.4 – 0.5 percent of the total NOx allowance value. 

Exhibit 6: Summary of Advisory Service Costs under CAIR Program in 2010 

Fee for Each Advisory Service $5,000 - $10,000 

Number of Operators 36012

% of Operators Seeking Advisory Service 5% -10% 

Total Costs of Advisory Service $90,000 - $360,000 

These costs appear on their face to be too small too discourage the affected units from seeking 

a distribution of emissions close to the least-cost outcome. Moreover, these low transaction 

cost estimates also seem to validate the industry consultant’s opinion that transaction costs are 

generally very small and are not expected to affect program outcome.13 As we have already 

discussed with you, it should be possible to strengthen this tentative conclusion, though, using a 

simple modeling approach. 

 

12 From the units we projected to be participating in the transactions under CAIR in 2010, we matched 

their ORIS codes with the Operator ID numbers in the latest eGRID database to identify the unique 

number of operators under CAIR.

13 The consultant felt that high transaction costs, if present, might discourage speculators but are unlikely 

to affect those who need to trade for compliance purposes.