Climate Change: Observations on Options for Selling Emissions Allowances in a Cap-and-Trade Program
Published: 2010-02-24T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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.

section_title: Letter
paragraphs: Concerns about the effects of climate change have led the Congress to  consider legislation that would limit emissions of greenhouse gases  nationwide. Elevated concentrations of greenhouse gases in the  atmosphere as a result of human activities could increase global  temperatures and affect ecosystems, agricultural production,  infrastructure, and human health. Among greenhouse gases produced by  human activity, carbon dioxide is emitted in by far the largest volume,  mostly as a result of the combustion of fossil fuels for electricity,  transportation, and industrial processes. Many of the legislative proposals  to limit greenhouse gas emissions would create a cap-and-trade program  under which the government would place an overall cap on emissions and  issue tradable permits. Entities covered by the program would have to  surrender enough permits for all of their emissions at the end of specified  time periods. Depending on the program, these “covered entities” may  include power plants, oil refineries, and other manufacturing facilities.  Each permit—known as an “allowance”—would represent a set quantity of  greenhouse gas emissions, such as one metric ton. Allowances could be  purchased and sold, creating a market in which the price of emissions  fluctuates with supply and demand.
As we testified in August 2009, the government has two main options for  distributing allowances, the value of which could total hundreds of billions  of dollars annually by 2020. One option is to give allowances away for  free, which would transfer their value to recipients and may compensate  covered entities for costs incurred as a result of the program. Another  option is to sell allowances, which would generate revenue that could be  distributed in a number of ways—for example, tax cuts that improve  economic efficiency or lump sum rebates to consumers. Selling  allowances could also discourage efforts to gain free allowances through  lobbying or other activities and help ensure that the price of emissions is  the same for both new entrants and existing entities. As a result, many  experts we interviewed for a previous report suggested that a cap-and- trade program should maximize the share of allowances sold. Existing  cap-and-trade programs that regulate greenhouse gases have used two  principal methods to sell allowances—sales on an exchange and  auctions—and their experiences with these methods may offer valuable  lessons as Congress considers establishing a cap-and-trade program.
This report is one of four responding to your request for information on  climate change policy options. Our objective was to describe the  implications of different options for selling emissions allowances in a cap- and-trade program, given available information and the experiences of  selected programs. To address this objective, we reviewed and analyzed  academic and professional literature produced by research organizations,  academic institutions, environmental groups, and industry associations,  including international research. We also analyzed information on two  cap-and-trade programs that have sold allowances—the European Union’s  (EU) Emissions Trading Scheme (ETS) and the Regional Greenhouse Gas  Initiative (RGGI), an initiative of 10 U.S. Northeast and Mid-Atlantic states.  We collected information on these programs from EU member state  officials, European Commission officials, RGGI program officials,  academic literature, and research organizations. In addition to  interviewing officials involved with RGGI auctions, we selected a  nonprobability sample of five EU member states—Austria, Denmark,  Germany, Ireland, and the United Kingdom—for in-depth study, based on a  review of background literature and interviews with knowledgeable  officials. This sample enabled us to assess allowance sales that exhibited  variation in several key areas: the size of the allowance market, the share  of allowances auctioned, the design of the sale, and the amount of revenue  generated. While the sample allowed us to learn about many important  aspects of, and variations in, the design of allowance sales, it was not  intended to provide findings that would be generalizable to all allowance  sales. We also met with ETS officials and other stakeholders to discuss  allowance sales methods used in individual EU member states as well as  preparations for future large-scale auctions. Appendix I provides a more  detailed description of our scope and methodology.
We conducted our work from December 2008 to February 2010 in  accordance with all sections of GAO’s Quality Assurance Framework that  are relevant to our objectives. The framework requires that we plan and  perform the engagement to obtain sufficient and appropriate evidence to  meet our stated objectives and discuss any limitations in our work. We  believe that the information and data obtained, and the analysis  conducted, provide a reasonable basis for any findings and conclusions in  this product.
subsections: section_title: Background
paragraphs: Existing cap-and-trade programs that regulate greenhouse gases, such as  the EU ETS, have experience in the sale of allowances. As we reported in  November 2008, the ETS began the first of its trading periods, or “phases,”  in 2005. In Phase I, which ran from 2005 to 2007, member states were  allowed to auction up to 5 percent of their allowances, with the remainder  distributed to covered entities free of charge. The auctioning limit  increased to 10 percent in Phase II, which is to run from 2008 to 2012. The  EU’s decentralized approach gives member states the authority to design  and execute their own sales. While some member states chose to sell or  auction a portion of their allowances in Phases I and II, the quantity sold  has been a relatively small percentage of the overall quantity of allowances  distributed (see appendix III for more information). For Phase III, which  begins in 2013, the EU decided to increase the amount of auctioning  significantly, and as a result approximately half of all the allowances will  be auctioned. The EU is currently assessing various auction design  options for Phase III and beyond—including holding centralized, EU-wide  auctions—and plans to adopt an official auctioning regulation by June  2010.
U.S. programs also offer experience in emissions allowance auctions. The  federal government has auctioned allowances for the emission of sulfur  dioxide under its Acid Rain Program since 1993, and the Commonwealth  of Virginia auctioned allowances for nitrogen oxide emissions—a pollutant  that contributes to the formation of smog—in 2004. More recently, in 2005,  RGGI was created to regulate the carbon dioxide emissions of large fossil  fuel-fired generators in participating states. RGGI has auctioned nearly 87  percent of emissions allowances issued under the program for 2009, and  each of the six centralized auctions held since September 2008 has raised  between $38 million and $117 million for programs to promote energy  efficiency and renewable energy projects, among other uses. In addition to  auctions for emissions allowances, the U.S. government has experience  conducting other types of auctions, such as for government securities,  surplus property, oil leases, timber harvests, and electromagnetic  spectrum licenses. The Treasury Department’s Bureau of Public Debt, for  example, conducts more than 250 public auctions per year involving over  $5 trillion in marketable securities.
In a cap-and-trade program for greenhouse gas emissions, covered entities  and other interested parties will be able to buy allowances not only from  the government, but also from participants in the secondary trading  market. In the ETS, for example, allowances can be purchased through  over-the-counter markets or on exchanges such as the European Climate  Exchange in London or BlueNext in Paris. Secondary market trading can  involve a range of intermediaries—including banks and brokers—and  several types of allowance transactions can occur. “Spot” sales involve the  immediate payment and delivery of allowances between two parties.  Market participants may also trade “forward” or “futures” contracts, both  of which allow for delivery of allowances at a later date. Futures  contracts may be attractive to covered entities that wish to secure an  allowance price in advance and reduce uncertainty about future  compliance costs. Because the value of futures contracts fluctuates based  on the current market price of allowances, parties that do not have a  compliance obligation under the program may also wish to purchase them  as an investment.
section_title: The Method of Selling Allowances in a Cap- and-Trade Program Can Influence Program Outcomes
paragraphs: 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. We drew two major observations from the literature and the cap- and-trade programs we reviewed. 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. If policymakers choose auctions—as did  the majority of countries participating in the ETS and the RGGI states— they must also make important design choices in the areas of format,  participation requirements, frequency and timing, price controls, and rules  for reporting and monitoring.
subsections: section_title: Establishing Clear Goals Is Critical
paragraphs: Program officials and economists suggested establishing clear goals to  help guide the design and implementation of government allowance sales  in a cap-and-trade program. Identifying priorities early is critical to  developing an effective sales approach, as certain designs may better serve  certain goals. Goals commonly cited by researchers and program officials  include:    Simplicity and transparency. Many economists and program officials  recommended that allowance sales be simple and transparent for all  participants. Sales should be guided by rules that are clear and  understandable—both to participants and to the general public—to  encourage participation, prevent discrimination, and ensure easy access to  allowances. To that end, several economists and program officials  recommended selecting an auction format that is easy to use and does not  involve complicated bidding procedures. Reporting sales results in a  public and timely manner can also help to create a transparent market.
Maximizing participation. Ensuring sufficient levels of participation in  allowance sales is critical, according to available information and program  officials we interviewed. Participation fosters competition and limits  opportunities for collusion. Economists and program officials also advised  that sales should not discriminate against any one group of participants,  whether by excluding them directly or indirectly, such as through high  transaction costs. Participation can also be encouraged with a simple and  transparent auction design.
Economic efficiency. Economic literature suggests that efficiency is a key  goal for allowance sales. In the case of allowance auctions, economic  efficiency can be achieved if allowances are purchased by those who value  them the most. A general measure of the efficiency of an auction,  therefore, is its ability to generate bids that accurately reflect how much  value a bidder places on the allowance. If efficiency is achieved, the  resource—in this case, the right to emit greenhouse gases—is allocated to  its highest-valued use. Efficiency may be affected by strategic bidding  behavior or collusion if these activities artificially depress the price of  allowances.
Facilitating price discovery. Allowance sales may help facilitate price  discovery—the process of determining a commodity’s price based on  supply and demand. Sales that successfully facilitate price discovery will  generate an allowance price that accurately reflects the marginal cost of  reducing emissions. 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. Economists expect that this  process of price discovery will prompt emissions reductions by those  covered entities that can undertake them most cost-effectively. Without  effective price discovery, the overall efficiency of the allowance market  may be diminished, increasing the program’s costs to the economy.  According to several program officials involved in the ETS, the need for  price discovery depends on the volume of allowances sold under the  program. If only a small percentage is sold, and the rest freely allocated,  price discovery will be accomplished in the secondary market.
Avoiding market manipulation. According to economic literature,  allowance sales should limit opportunities for participants to collude or  engage in other forms of market manipulation. Collusion to depress  allowance prices, if successful, could distort price signals, reduce  revenues collected by the government from the sale of allowances, and  cause participants and observers to question the fairness and transparency  of the program. In addition, if allowance ownership were to become  concentrated among a small group of participants in the secondary  market, these participants could then withhold allowances from the  market, driving up prices and impeding efficiency. However, several  program officials and economists said it would be difficult to pursue such  a strategy in the presence of a liquid market, since participants would have  to acquire large shares of allowances both at individual auctions and in the  secondary market. In addition, literature and economists we interviewed  suggest that a U.S. cap-and-trade program for carbon dioxide allowances  would likely attract a large number of participants. According to them,  broad participation would prevent any single participant from gaining  undue influence within the market, limiting opportunities for collusion and  market manipulation.
Revenue generation. Available literature suggests that policymakers could  also aim to maximize the level of revenues collected from the sale of  allowances. For example, policymakers could design a sale so that it is  more likely to achieve high allowance prices. However, while maximizing  revenue is a common goal in other government auctions of public assets,  high allowance prices could increase the burden of a cap-and-trade  program on covered entities or consumers of their products, which could  erode political support for the program. Furthermore, some program  officials noted that it would be much easier to accomplish this goal by  increasing the stringency of the emissions cap.
Minimizing administrative and transaction costs. Several economists  and program officials recommended minimizing the administrative and  transaction costs associated with allowance sales. Administrative costs  are the time and resources governments spend designing and  implementing allowance sales; available information suggests that most of  these costs are incurred in the design phase of the program. Transaction  costs, on the other hand, refer to costs incurred by participants in  obtaining allowances—for example, costs associated with registering for  an auction, developing a bidding strategy, and any bidding fees. According  to available information, high transaction costs could discourage  participation, and smaller entities in particular may face  disproportionately high costs relative to the value of allowances they  purchase. According to economic literature, the design of an allowance  sale can have a significant impact on both administrative and transaction  costs. For instance, weekly auctions may result in higher administrative  and transaction costs than those held less frequently, although using  existing infrastructure may help to minimize these costs. While several  economists noted that any costs incurred by governments and participants  would likely be minor compared to the value of the allowances, program  officials said that keeping these costs low would help ensure ongoing  support for the program.
According to available literature and economists we interviewed,  identifying the goals of the sale in advance can help policymakers evaluate  the likely effects of a given sales method. This is especially important  given that trade-offs may result from decisions regarding the various  aspects of auction design. For example, a method that increases revenue  collected from allowance sales may not be the most economically efficient  approach. Some goals may also be interrelated—for example, a simple and  transparent design may boost participation and reduce the risk of market  manipulation.
section_title: Many Design Options Are Available to Meet Established Goals
paragraphs: The literature and programs that we reviewed present many options for  the design of a mechanism to sell allowances in a cap-and-trade program.  Each option has implications that will help determine the extent to which  a program meets its goals. At a high level, policymakers face a choice  about using auctions or other types of sales to distribute allowances.  Auctions, if used, would entail additional design choices.
subsections: section_title: Sales or Auctions
paragraphs: According to available literature, selling emissions allowances through an  exchange enables buyers to purchase allowances from an electronic  platform as they would stocks or other commodities. While sales on an  exchange are less widely used for emissions allowance distribution than  auctions, two ETS member states have had experience with exchange- based sales: Germany (in ETS’s Phase II) and Denmark (in ETS’s Phase  I). Germany’s sales, directed by Germany’s state-owned bank, took place  through two major European exchanges—the European Climate Exchange  and the European Energy Exchange. Allowances were sold daily,  according to rules specified by the government. The bank used the same  process as other members of the exchange wishing to trade allowances,  such that buyers could not distinguish the government from other  participants in the secondary market. Denmark’s sales method differed  from Germany’s in that it paid a fee to two private firms to sell allowances  on European exchanges. Rather than instructing the two firms to sell  allowances daily, as Germany did, Denmark structured the fees paid to the  firms such that they received an incentive to sell when they judged price  conditions to be most favorable.
German and Danish officials we interviewed expressed general  satisfaction with sales on exchanges and cited their potential strengths in  meeting certain goals. For example, Germany’s goal was to match the  average secondary market price as closely as possible without disrupting  the market, according to officials. Information provided by Germany’s  state-owned bank shows that the allowance price yielded through the  exchanges did in fact mirror the market price of allowances sold during  the same time period. Several officials praised the efficiency of such sales  and reported general satisfaction among participants. Other potential  advantages of sales over auctions include:    Lower administrative costs. Germany and Denmark used existing  exchanges, which made it unnecessary to design and administer auctions.
Ease of use. Some member state officials we interviewed said that sales on  exchanges are simpler than auctions on separate platforms because many  of the large companies affected by the ETS are already registered and  active participants in the exchanges. According to German officials, this is  one reason Germany continued using existing exchanges when it made the  transition from sales to auctioning in 2010.
Despite these possible advantages, implementing such sales may prove  challenging given the scale of a potential U.S. program. While Germany  expects to sell or auction 40 million allowances annually in Phase II of the  ETS—the highest volume among EU member states to date—legislation  being considered by the U.S. Congress proposes initially auctioning over 1  billion allowances in 2012 alone. On such a large scale, auctions may be  more feasible or desirable than sales, according to several economists and  program officials. For example, European officials said that if large  volumes of allowances are sold in this manner, it may be difficult to ensure  that all participants, including smaller entities, are equally able to buy  allowances at the market price. Some program officials also expressed  reservations that that if a high volume of allowances were sold through  exchanges, the government would become the dominant seller in the  secondary market and affect the price formation process. Moreover, one  economist pointed out that no extensive studies had been undertaken on  the performance of sales on exchanges, whereas auctions are well  understood as a mechanism of distributing government assets.
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. According to economic  literature and the economists and officials we interviewed, potential  strengths of auctions include:    Price discovery. As economists and officials have noted, the process of  auctioning helps to establish the cost of emission reductions and maintain  an allowance price that reflects that cost. Auctions enable a government to  put allowances together in “batches” and sell them at predetermined  times, and may help regulated entities make business decisions that  incorporate the cost of compliance with emissions regulations. As one  economist explained, auctions encourage covered entities to assess their  marginal costs of emissions abatement, consider their allowance needs  carefully, and bid accordingly. However, some economists and officials  said that regardless of whether auctions or sales are used, price discovery  will occur in the secondary market, once that market becomes established.
Simplicity. Many of our interviewees cited auctions’ simplicity as an  advantage over sales because auctions are well-understood. RGGI officials  reported that covered entities with a range of auction experience received  training in the RGGI auction process and had no trouble familiarizing  themselves with it.
Lower transaction costs. Holding periodic auctions—weekly, monthly, or  quarterly, for example—may decrease the per-transaction cost of buying  and selling allowances, since buyers and sellers would not need to devote  the time and resources necessary to participate in daily trading.
Transparency. According to economists and officials, auctions take place  under established rules and time frames, and thus convey clear  information about when and how the government will sell allowances.  According to European Commission officials, establishing a clear and  predictable auction calendar can help inform market participants of the  precise timing of volumes coming into the market, thereby avoiding  unnecessary uncertainty and price volatility. Sales on exchanges may be  less transparent, since it is difficult to monitor who is selling allowances  and at what time.
Program officials noted that auctions can also be administered through  exchanges. For example, Germany decided to conduct auctions using an  existing European trading exchange beginning in 2010. 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. The European  Commission’s for the draft auctioning regulation governing ETS auctions  in Phase III and beyond also proposes using an exchange or other trading  platform to vet participants and administer auctions.
Allowance auctions could also be administered in other ways. For  example, policymakers could use existing government auction  mechanisms—such as those used by the U.S. Treasury to auction  securities—to auction allowances. Alternatively, policymakers could  choose to create a new auctioning platform or hire contractors to  administer auction processes. For example, RGGI opted to use a  proprietary auctioning platform, run by a contractor with experience in  administering auctions for energy commodities.
If auctions are used, several other design determinations must be made,  including: format, timing and size, participation requirements, price  controls, and monitoring and reporting requirements.
section_title: Auction Format
paragraphs: The choice of auction format can affect how well the auction aligns with  predetermined goals, such as maximizing simplicity, avoiding market  manipulation, and aiding in price discovery. We focused our analysis on  two classes of auctions most commonly discussed in the context of  emissions allowance auctions—”uniform-price” and “discriminatory-price”  auctions.
Choosing an appropriate auction format involves answering two key  questions:    What price should winning bidders pay for allowances?
In uniform-price auctions, all winning bidders pay the same price for  the items purchased. In the hypothetical example illustrated in table 1,  5 companies bid for 10 allowances in a uniform-price auction. Even  though they made different bids, each company that bids above a  certain price receives allowances at the same price. This “clearing  price” is the highest price point at which all of the 10 allowances  available would be sold. In this example, companies A, B, and C each  receive allowances at the clearing price of $3.50, although Company C  receives only 2 of the 3 requested allowances because the number of  bids at or above the clearing price exceeds the number of allowances  available at this price. Companies D and E, which bid below the  clearing price, receive no allowances.
In “discriminatory-price” auctions, winning bidders pay different prices for  allowances purchased at auction. In some discriminatory-price auctions,  winning bidders pay the amount of their bid. For example, in the  hypothetical auction presented in table 1, Company A would get its full  share of requested allowances at $5 each, Company B would pay $4 each,  and Company C would receive part of its request at $3.50 per allowance.
How many rounds of bidding should take place?
In a typical single-round auction, participants place bids once during a  predetermined time period. Because participants do not see other bids  before the outcome is announced, no opportunity is provided to change  a bid based on information about others’ bids. The single-round auction  is thus sometimes referred to as a “sealed-bid” auction. Figure 1  presents a simplified version of the RGGI software interface that  participants use for RGGI’s single-round auctions. As the figure shows,  participants assemble a bid sheet, specifying the quantity of allowances  requested at a stated bid price. Each participant may submit several  bids at several different prices, if desired. According to a RGGI  program official, when RGGI’s auction results are tabulated by the  auction administrator’s automated system, the results appear in a  format similar to that shown in table 1. Participants whose bids appear  above the line receive allowances, those bidding at the clearing price  receive a partial allocation, and those below the line do not receive  allowances.
Auctions with multiple rounds of bidding occur in several formats,  among them the “English” auction, in which the auction administrator  raises the price of allowances round by round, and the “Dutch” auction,  in which the auction administrator decreases the price round by round.  Both the English and Dutch auctions are commonly referred to as  “clock auctions,” since the price is raised or lowered incrementally, like  a clock’s hands. Participants in multiple-round auctions have the  opportunity to change the quantity of allowances for which they bid— or drop out of the bidding—as information is revealed round by round.  Importantly, economists note that to discourage participants from  potentially distorting allowance prices by increasing the quantity for  which they bid in later rounds—after competitors have revealed their  strategies—a clock auction can include a rule against increasing the bid  quantity after the first bidding round.
In designing an auction, policymakers may consider selecting a format that  is sensitive to the context of the allowance market. Previous U.S. federal  government experience with auctions has involved different formats in  different markets. For example, in 1994 the Federal Communications  Commission chose to auction spectrum licenses in a simultaneous  multiple-round format. By contrast, Environmental Protection Agency  auctions of allowances to emit sulfur dioxide involve a single round where  successful bidders pay as they bid, and auctions of government securities  held by the U.S. Department of the Treasury involve uniform pricing.
In interviews and in economic literature, officials and economists have  emphasized the importance of tailoring an auction for carbon dioxide  allowances to the characteristics of the market, which may be different  from other markets where auctions have been used. An auction of carbon  dioxide allowances would sell many identical items—permits to emit a  specified quantity of carbon dioxide in a particular time period.  Additionally, bidders in this market could include a large number of  covered entities that emit carbon dioxide. These characteristics reveal  both similarities and differences from some of the other markets listed  above. For example, not all broadband spectrum licenses are alike, and  their value to a buyer may further depend on the portfolio of licenses held.  Furthermore, the number of potential buyers may be greater in the market  for carbon dioxide emissions than sulfur dioxide emissions, in part  because carbon dioxide is emitted in greater volume.
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. Several program officials we spoke with expressed general  satisfaction with this format, and the draft auctioning regulation governing  ETS auctions in Phase III and beyond also proposes this approach.  According to literature and economists we interviewed, advantages of this  format include:    Simplicity. For regulated entities that have participated in auctions, the  simplicity and familiarity of the uniform-price, single-round format may  prove valuable, according to several economists. This format has also  proved easy to learn for those unfamiliar with auction processes,  according to officials, as it involves relatively simple bidding procedures.  One economist also reported that the uniform-price, single-round format is  well-suited to automation compared to other auction formats, with much  of the work handled by sophisticated but inexpensive computer programs.  This economist pointed to RGGI, a small organization handling large pools  of assets, as a case study in how simple the uniform-price, single-round  auction can be to administer.
Avoidance of market manipulation. 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.
Reduced risks for bidders. Program officials and economists also said that  the uniform-price, single-round format may alleviate concerns that could  arise in discriminatory-price auctions. If a discriminatory-price auction  requires participants to pay the value of their bids, for example, they run  the risk of overbidding and paying more than other winning bidders for  allowances. This may be of particular concern for small and inexperienced  bidders, who may lack the information and resources to formulate a  sophisticated bidding strategy. Uniform-price auctions reduce the  possibility of making a costly bidding mistake, since all winning  participants pay the same allowance price. For this reason, some  economists believe that uniform-price auctions will generate greater  participation than discriminatory-price auctions.
Despite the strengths of the uniform-price, single-round format, some  economists suggested that policymakers undertake further study before  selecting an auction format. One study suggests that laboratory  experiments with auction format options may provide insights that  theoretical studies cannot, given the context-specific nature of the  performance of various auction formats. One economist also said that  legislation need not specify a single auction format and could instead  instruct government agencies responsible for the program to choose  among various format options. Several RGGI states followed this path, by  issuing regulations authorizing the auction administrator to use the  uniform-price, single-round auction format or the ascending price,  multiple-round format. Policymakers could also leave room to revisit the  auction format stipulated in cap-and-trade legislation, although  introducing significant changes at later stages would require participants  to relearn auctioning procedures.
Among auction format options other than the uniform-price, single-round  format, the clock format may have comparative strengths in achieving  certain goals, according to economists we interviewed. For example,  economic literature suggests that clock auctions may lead to more reliable  price discovery, since each participant may raise its bids in an attempt to  win allowances, so that allowances go to those who are willing to pay the  most. However, economists who did experimental work on auction  formats said that a clock auction fared no better in terms of price  discovery than a uniform-price, single-round auction. Another argument  for the clock format arises if multiple products are sold at an auction. For  example, in addition to auctioning allowances for the current year, the  government could decide to auction allowances of other future-year  vintages—that is, allowances sold in advance of the compliance year(s) in  which they may be remitted. A clock format would allow bidders to  express preferences for different vintages, which may allow more readily  for substitution of one vintage for another and prevent price irregularities.
The clock auction format may also present some disadvantages. An official  involved with Ireland’s auctions said they chose a uniform-price, single- round format after determining that a clock auction would be  comparatively expensive and difficult to implement. The format may also  complicate participation: one economist involved with Virginia’s clock  auctions of nitrogen oxide allowances received complaints about  participants having to work at a computer terminal all day to compete in  the auction. A single-round auction format, by contrast, would only require  participants to submit a single bid sheet, similar to that shown in figure 1  above. The economist also pointed out that having thousands of  participants monitoring a day of multiple-round auctioning in a large  federal program would increase the cost of both participating in the  program and administering it.
section_title: Other Auction Design Elements
paragraphs: 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. We  briefly describe each of these considerations below and provide additional  detail in appendix II.
Participation. Maintaining high levels of auction participation can lead to  greater competition which, in turn, can reduce the risk of collusion or  other market manipulation. To maximize participation, economists and  program officials recommended opening auctions up to as wide of a group  of bidders as possible, including financial institutions and other entities  that do not have compliance obligations under the program. According to  them, limiting participation can increase the risk of market manipulation,  making it difficult to ensure that all covered entities have access to  allowances. In addition, program officials said that a well-designed vetting  and registration system can reduce the risk that a participant will default  on a bid.
Frequency and timing. According to economists, the frequency of  auctions should be driven by the volume of allowances sold: higher  volumes of allowances may require more frequent auctions. Available  information suggests that holding frequent auctions, such as monthly or  weekly, can help maintain market liquidity and provide flexibility to  covered entities. On the other hand, some officials said frequent auctions  may also complicate planning and increase administrative costs,  depending on how the auctions are conducted. In terms of timing, many  officials recommended auctioning future-year vintage allowances, which  allow covered entities to secure allowances in advance and reduce the  risks associated with fluctuating prices.
Price controls. Price controls could be implemented in a number of ways.  A reserve price would set a price below which no allowances can be sold  at an auction. Several program officials and economists suggested that  setting a reserve price can be an effective way to guard against low  auction clearing prices that may result from collusion or low participation.  In addition, in some cases a reserve price may serve as a “price floor”  throughout the secondary market. According to some economists and  researchers, a price floor may help provide incentives for investment in  low carbon technologies; however, some program officials cautioned that  price floors could unduly interfere with the functioning of the allowance  market. At the other end of the price spectrum, policymakers could also  set upper limits on the price of allowances through price ceilings. While  price ceilings could provide insurance against sustained high allowance  prices, some program officials advised against the use of these measures,  which they said could compromise emissions goals and impede  international linkage of programs.
Monitoring and reporting. An effective system to report auction results  and monitor activity can increase transparency and help oversight entities  identify and correct instances of market abuse. Information on auction  results can also provide information with which to evaluate and improve  the program. As a result, several officials and economists recommended  establishing a market monitor to track activity at auctions and in the  secondary market. However, in reporting auction results, economists and  officials cautioned against reporting certain information, such as bidders’  identities, which they said could inadvertently facilitate collusion.
We conducted our work from December 2008 to February 2010 in  accordance with all sections of GAO’s Quality Assurance Framework that  are relevant to our objectives. The framework requires that we plan and  perform the engagement to obtain sufficient and appropriate evidence to  meet our stated objectives and discuss any limitations in our work. We  believe that the information and data obtained, and the analysis  conducted, provide a reasonable basis for any findings and conclusions in  this product.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the appropriate  congressional committees and other interested parties. In addition, the  report will be available at no charge on GAO’s Web site at  http://www.gao.gov.
If you or your staff have any questions about this report, please contact me  at (202) 512-3841 or stephensonj@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. Individuals making key contributions to this report are  listed in appendix IV.
section_title: Appendix I: Scope and Methodology
paragraphs: Our review assesses the implications of different options for selling  allowances in cap-and-trade programs. To address this objective, we first  identified cap-and-trade programs that regulate carbon dioxide emissions  and have sold allowances through auctions or other means. Programs that  met these criteria were the European Union’s (EU) Emissions Trading  Scheme (ETS) and the Regional Greenhouse Gas Initiative (RGGI). We  then selected a nonprobability sample of 5 member states involved in the  ETS—Austria, Denmark, Germany, Ireland, and the United Kingdom—in  order to assess different methods that EU governments have used to sell  allowances. This sample enabled us to assess allowance sales that  exhibited variation in several key areas: the size of the allowance market,  the share of allowances auctioned, the design of the sale, and the amount  of revenue generated. While the sample allowed us to learn about many  important aspects of, and variations in, the design of allowance sales, it  was not intended to provide findings that would be generalizable to all  allowance sales.
To identify various options for selling allowances, we identified and  reviewed over 40 works of academic and professional research produced  by economists, industry associations, research organizations, academic  institutions, and environmental groups, including international research.  We identified these works through an internet and database search using  relevant key words such as “allowance sales” and “auction design.” We  also analyzed literature from government agencies, including the  Congressional Budget Office (CBO) and the Congressional Research  Service (CRS). Reviewing this research helped us to assess the different  methods for designing an allowance sales mechanism and the potential  implications of these methods. We did not independently assess the  validity of data, assumptions, or methodologies underlying the economic  studies we reviewed. We met with U.S. and international stakeholders  including officials from RGGI and the European Commission as well as  program officials in Austria, Denmark, Germany, Ireland, and the United  Kingdom. We also conducted semistructured interviews with leading  economists and researchers selected on the basis of their expertise in  climate policy or auction design.
section_title: Appendix II: Other Elements of Auction Design
paragraphs: There are several key elements of auction design, in addition to format,  that can affect whether an auction meets its established goals. This  appendix provides more detail on the observations and recommendations  of program officials, economists, and the economic literature regarding  the following auction design elements: participation, frequency and timing,  price controls, and reporting and monitoring.
subsections: section_title: Participation Requirements
paragraphs: Policymakers may shape participation in a cap-and-trade auction through  various aspects of auction design. For example, auctions could be  designed to restrict participation or to provide special assistance to  smaller entities. Available information suggests that maintaining high rates  of participation in allowance auctions can help promote liquidity and  reduce the risk of collusion. We discuss three auction characteristics that  help determine participation: participation limits, bid limits, and  procedures for vetting and registration.
Participation limits. Available literature suggests that limiting or  eliminating the ability of certain entities to participate in allowance  auctions could reduce the amount of revenue generated through the  auctions and hinder the efficient allocation of allowances. For example,  excluding those entities that do not have a compliance obligation under  the program would decrease overall auction participation, which, in turn,  may increase the likelihood of collusive activities to depress allowance  prices. In addition, if the auction clearing price falls below the price in  secondary markets—whether due to collusion or other factors—auction  participants may be able to buy allowances at auction and sell them on the  secondary market for profit, thus capturing revenues that would have  otherwise gone to the government. According to one study, the end result  would be an implicit subsidy to the entities allowed to participate in the  auction and a corresponding reduction in government revenue. Moreover,  some program officials maintained that restricting certain groups from  participating may present practical challenges given the interrelated  nature of the marketplace—for example, while a buyer may not be a  covered entity under the cap-and-trade program, it could be a parent  company, supplier, or partner to a covered entity. According to  researchers involved in the design of RGGI’s auctions, attempting to  assess and monitor these relationships could prove costly for an auction  administrator.
Given these concerns, many economists and program officials favored  maximizing the number of potential auction participants. Auctions held  within the ETS and RGGI, for example, have allowed noncovered  entities—including banks, brokers, and other private firms—to purchase  allowances at auctions. In fact, noncovered entities have purchased  between 16 and 30 percent of allowances sold in RGGI auctions thus far,  according to auction results data published on RGGI’s Web site.  Economists and officials involved with these programs said that financial  entities can play an important role in the market. For example, banks and  brokers can foster liquidity and help provide regular price signals to  covered entities. Smaller entities, in particular, may prefer purchasing  allowances at financial institutions, as this relieves them of the need to  learn the particulars of the auction process and develop an appropriate  bidding strategy.
Bid limits. To prevent entities from hoarding allowances—which could  allow these entities to gain a competitive advantage or raise the price of  allowances, among other things—policymakers could set limits on the  amount of allowances entities can purchase at auction. For example, in  RGGI, associated entities can purchase no more than 25 percent of the  allowances available in a given auction. However, such limits may be  difficult to enforce, according to one program official, since one entity  may be able to bid on behalf of another. Moreover, several economists and  program officials we spoke with suggested that hoarding behavior would  be highly unlikely in a future U.S. program, since an entity aiming to  corner the market may have to buy the majority of allowances across  several consecutive auctions, an unlikely possibility given the anticipated  price and volume of allowances and the number of entities seeking them.
Vetting and registration. For an auction to be successful, participants  must meet the financial commitments associated with their bids. Auctions  may therefore include an application and screening process in which  potential bidders demonstrate their eligibility to participate by providing  information such as their credit and bankruptcy history. The process  could also include a declaration of “beneficial ownership,” which would  require bidders to declare whether they would bid on their own account or  on behalf of another entity. According to available information, identifying  the beneficiaries of allowance transactions may help the entity responsible  for monitoring the market spot evidence of potential market manipulation.  Economists and program officials also recommended requiring  participants to post some type of financial assurance, such as a bond,  deposit, or letter of credit demonstrating their ability to pay. Financial  assurance requirements can serve as collateral in the event that  participants are unwilling or unable to pay, and thus should be set at a  level that ensures payment without discouraging participation. In Ireland’s  first auction, for instance, the nonrefundable deposit was set at about  3,000 Euro, or about $3,778. According to program officials, this amount  was later determined to be insufficient to compel payment—for example,  if the prices in the secondary market fell below the clearing price after the  auction, it may have been less expensive for the bidder to simply forfeit  their deposit and nullify the sale. As a result, Irish officials raised the  deposit amount to about 15,000 Euro, or about $18,890, in the second  auction.
While economists emphasize the importance of providing financial  assurance, it is also important not to impose undue costs or paperwork  requirements on participants. As a result, some economists recommended  relying on established measures—such as credit scores—and simplifying  the process as much as possible. An official involved with administering  RGGI, for example, reported that RGGI made several improvements to its  participant qualification procedures—including allowing electronic  submissions and eliminating notarization requirements—after receiving  feedback from participants. Program officials involved with the ETS also  said that outsourcing vetting activities to an entity with experience in  these activities, like an exchange, may help reduce the cost of these  activities.
As existing programs have demonstrated, auction activities—including  attracting and vetting potential auction participants and facilitating the  bidding process—can be undertaken by either the government or a  designated private entity. In RGGI, for example, a private consulting firm  administers the auctions and conducts these activities. In contrast,  Germany uses an existing emissions trading exchange to administer the  auctions and conduct the required due diligence on potential auction  participants. Another option to cut down on the government’s  administrative burden is to implement a “primary participant” model, an  approach used in the United Kingdom to auction both government bonds  and emissions allowances. In United Kingdom allowance auctions, all  bidders must go through one of 11 registered primary participants—all  large financial firms—to place their bids. The primary participants can  also bid on behalf of themselves.
According to one official involved in United Kingdom auctions, this has  improved auction participation and generated higher clearing prices.  However, the official also acknowledged that some large bidders—such as  electricity generators—oppose the primary participant model because it  forces them to disclose their bidding strategy to another entity; they would  rather participate in the auctions directly. As a result, the outline for the  draft auctioning regulation for Phase III and beyond proposes allowing  bidders to access auctions directly.
Under United Kingdom Treasury rules, primary participants must prevent the disclosure of  confidential information they receive from indirect bidders to their employees responsible  for preparing or submitting bids on the primary participant’s behalf. entities will be able to obtain needed allowances without running the risk  of overbidding. However, thus far participation in non-competitive  auctions has been low—of the 100,000 allowances set aside for Austria’s  first non-competitive auction, only about 5,000 were actually sold. Further,  in the European Commission’s 2009 consultation on the auction  regulation, respondents showed little interest in incorporating non- competitive auctions or other special provisions for smaller entities. While  a Commission official we spoke with acknowledged that few small entities  contributed to the consultation, this official and others reported that  smaller entities have generally preferred to purchase their allowances  from banks and brokers rather than at auction.
section_title: Frequency and Timing
paragraphs: If auctions are used to sell allowances, policymakers must consider issues  related to timing, including how frequently to hold auctions and whether  to auction future years’ allowances in advance. According to available  literature and economists we interviewed, the timing of auctions can have  implications for market dynamics, prices, administrative costs, and  participation. A variety of timing approaches are used in existing  programs—for example, RGGI holds quarterly auctions, whereas Germany  began holding two auctions twice weekly in 2010.
Program officials and economists we interviewed said that determining  the appropriate auction frequency depends largely on the number of  allowances auctioned during each year. Several noted that higher volumes  of allowances may require more frequent auctions, so as to ensure a  manageable and constant flow of allowances into the market. Because of  uncertainty about the size of a future U.S. program, one program official  was hesitant to recommend a specific frequency.
Nevertheless, available literature and our interviews point to several  arguments in favor of holding auctions relatively frequently, such as  weekly. First, economic literature indicates that frequent auctions can  help maintain market liquidity and price stability. Because allowances  would be sold in smaller batches, frequent auctions help encourage a  constant flow of allowances into the market, reducing the impact of  individual auctions on market prices. For this reason, the outline for the  draft regulation outline governing Phase III of the ETS and beyond—when  the level of auctioning is expected to increase significantly—proposes  holding auctions at least weekly. Second, frequent auctions may help  covered entities to meet their compliance obligations in a timely and  flexible manner, rather than running the risk of submitting a losing bid and  having to wait several months until the next auction. Third, frequent  auctions may alleviate the need for a covered entity to set aside large  amounts of capital to compete for bigger, less frequently available blocks  of allowances, which may be especially difficult for smaller entities.  Frequent auctions also may facilitate efficient and flexible transactions  through financial or other intermediaries, which can benefit both small  and large covered entities. Finally, smaller, more frequent auctions may  help mitigate the risk that participants could purchase a substantial  fraction of allowances in an attempt to manipulate allowance prices.
However, holding frequent auctions may present trade-offs, according to  available literature. Administrative and transaction costs could rise if  auctions are held more frequently, and higher costs could reduce  participation. In addition, officials involved in administering RGGI’s  quarterly auctions said it would be difficult to conduct necessary pre– and  post-auction activities—including finalizing sales, returning auction  collateral to bidders, and compiling reports—if auctions took place more  frequently. Another potential disadvantage of frequently held auctions is  the risk that participation will be low at some auctions.
Policymakers may choose to sell future-year vintage allowances in  advance of the compliance year(s) in which they may be remitted. For  example, in addition to offering allowances for the current 3-year  compliance period, RGGI auctions also offer participants the ability to  purchase allowances for the second compliance period, which is to start in  2012. In the ETS, allowances for Phase III of the program, which begins in  2013, may be auctioned as early as 2011 or 2012, according to the draft  outline for the auctioning regulation.
Available literature and economists and officials we interviewed identified  several potential benefits associated with auctioning allowances prior to  the compliance period in which they may be remitted. Most importantly, it  enables covered entities to hedge against the uncertainty of future  allowance prices by purchasing them in advance. Auctions of future-year  allowances may be particularly beneficial to electricity generators, which  often establish contracts for fuel and electricity one to three years ahead  of delivery. Entities could also potentially hedge price risk by establishing  futures contracts with financial intermediaries; however, these  intermediaries may charge risk premiums that may be passed on to  customers.
Available information suggests that holding auctions even before the cap- and-trade program’s first compliance period may help to jump-start the  process of price discovery and improve liquidity. For example, RGGI held  its first auction in September 2008, approximately 3 months before the  first compliance period began. A RGGI official said that this early auction  provided price information that proved beneficial to financial institutions  and covered entities alike.
However, holding advance auctions may also present risks. According to  one program official, if actual emissions under the program are lower than  expected, auctioning a greater number of allowances early on may depress  prices in the short term.
section_title: Price Controls
paragraphs: In designing a cap-and-trade program, policymakers may decide to set  limits around the price of emissions allowances sold at auctions or in the  secondary market. For example, setting a reserve price would establish a  minimum price below which no allowances could be sold at auction. The  use of reserve prices is relatively common in greenhouse gas auctions—for  example, RGGI and the EU member states we reviewed all used reserve  prices. Policymakers could also decide to limit the extent to which  allowance prices could rise and fall in the secondary market through price  “floors” or “ceilings”.
Reserve prices and price floors. According to economic literature and  program officials, a reserve price may have several benefits. For example,  a reserve price could reduce incentives for collusion by limiting the  profitability of collusive activities. A reserve price could also be used to  safeguard against unusually low clearing prices at an auction due to low  participation or other unforeseen events. According to one economist, an  auction that produces allowance prices that are substantially lower than  those in the secondary market may raise concerns about efficiency and  equity. Protecting against such a scenario is the primary reason that the  United Kingdom chose to institute reserve prices for its auctions,  according to a program official. However, this official did not expect the  reserve price ever to be triggered, since the likelihood of insufficient  participation or collusion was extremely low.
Despite the fact that allowances are traded in secondary markets—where  the government does not control prices—a reserve price may have effects  that extend beyond the auction itself. In some cases, for example, the  reserve price may effectively set a “price floor” for allowances throughout  the secondary market. According to economic literature, the extent to  which a reserve price serves as a marketwide price floor depends on  several factors, including the share of allowances to be auctioned and the  ability to purchase offset permits or other imported allowances. 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. A key benefit of a  price floor, according to some economists and researchers, is that it  provides more consistent financial incentives for investment in low-carbon  and energy-efficient technologies that could potentially reduce compliance  costs in the long run. By establishing a minimum price on emissions, a  price floor could also result immediately in more intensive use of low- carbon energy sources or encourage consumers to choose goods and  services that are less carbon-intensive.
While few economists and program officials disagreed with the use of  auction reserve prices as a general protective measure, some expressed  concern about using a reserve price to implement a marketwide price  floor. For example, program officials involved in administering the ETS  cautioned that price floors are unnecessary and can unduly interfere with  the functioning of the allowance market. Accordingly, a European  Commission official said that while an auction reserve price may be  incorporated into the auction design, the primary law underpinning the  ETS bars the use of price floors. Finally, some program officials warned  that price floors could limit participation from certain entities—such as  large banks—by reducing their opportunities for profit.
If a reserve price is used, policymakers would also need to consider what  to do if it is triggered. Because no bids below the price would be accepted,  some allowances at the auction would go unsold. One option for  addressing unsold allowances is to retire them by removing them from the  program entirely, an approach some researchers and program officials  support as a way to help preserve the program’s environmental integrity.  Specifically, triggering the reserve price may indicate that the emissions  cap is too generous; retiring allowances that remain unsold at the reserve  price would effectively make the cap more stringent. Another option  would be to “roll forward” any unsold allowances to the next auction, an  approach used by the United Kingdom in allowance auctions. Economists  describe this approach as administratively simple; however, when any  unsold allowances are rolled over, as opposed to retired, future allowance  prices could be lower, reducing incentives for emission reductions. A third  option would entail placing the unsold allowances into a “contingency  bank” and releasing them for sale at the next auction that closed at a price  above a pre-identified trigger price. This approach removes unnecessary  allowances from the program while demand is low but keeps allowance  prices (and compliance costs) from rising as sharply as they otherwise  would in subsequent periods when demand is high. However, one  economist cautioned that managing the bank could introduce political  risks. Importantly, each of these three options applies to a scenario in  which a reserve price is applied at auction. If policymakers decided to  implement a firm price floor that applied throughout the secondary  market, the government would have to guarantee a minimum price to  sellers in that market. In this case, triggering the floor price would indicate  that the quantity of allowances offered for sale at the floor price exceeded  the quantity demanded by market participants. To guarantee the minimum  price, the government could buy back the excess quantity. However, this  could create budgetary and other complications, as the government would  not be able to anticipate market outcomes.
Price ceilings and strategic reserves. To protect against unexpectedly  high compliance costs, some cap-and-trade proposals also involve setting  an upper limit on the price of allowances, either through a price ceiling— often known as a “safety valve”— or by establishing a “strategic reserve”  of allowances. A safety valve would give covered entities the opportunity  to purchase an unlimited amount of additional allowances from the  government at a predetermined price. In the event the allowance price  rose higher than the safety valve price, covered entities could buy  allowances from the government at the lower price rather than purchasing  them on the market. If the safety valve was triggered and additional  allowances released, however, emissions could rise beyond the level set  by the initial cap and compromise the program’s emissions goals. As an  alternative option, policymakers could set a strategic reserve of  allowances to be released only if the price threshold is reached. The key  distinction from a safety valve approach is that the allowances in the  reserve would eventually be paid back in some way, thus maintaining the  integrity of the cap over time. If the allowances in the reserve were used,  for example, the corresponding increase in emissions could be offset, such  as by tightening emissions caps in future years.
Some economists and program officials have cited several possible  advantages associated with price ceilings. Setting a maximum price for  allowances would provide insurance against unexpected price spikes in  allowances—or a sustained period of high prices—either of which could  cause the price of consumer goods and services to rise. If allowance prices  are higher than expected, for example, a price ceiling could limit the costs  to businesses and consumers while new technologies are developed that  may achieve reductions at less cost. Because it provides some parameters  around the cost of the cap-and-trade program, a price ceiling could also  reduce the risk that firms that are both energy-intensive and trade- intensive will face competitive pressures from industries in countries  without comparable limits on greenhouse gas emissions. Finally,  establishing price ceilings in advance may increase the likelihood that the  program will endure through severe economic fluctuations, thus providing  certainty to investors.
Several of the potential disadvantages cited for price floors also apply to  price ceilings—namely, that they may interfere with market functioning  and discourage participation by financial entities. In addition to these  disadvantages, a safety valve could have negative environmental  implications if emissions rise considerably higher than the established  caps. Available information suggests that establishing a safety valve in a  U.S. program could impede linkages with other cap-and-trade programs,  which would allow participants under a U.S. program to trade allowances  with other programs, such as the ETS. In theory, linking can enhance the  cost-effectiveness of the participating programs by enabling covered  entities to take advantage of differences in the cost of abatement options.  However, establishing a safety valve in one program would have  implications for other linked programs—for example, linked countries  may not be able to ensure that their emissions would be below a required  level in a given year. Additionally, a price ceiling could discourage  investment in research and development to create new energy-efficient  technologies by limiting future profits from their sale. Moreover, some  officials reported that price floors and ceilings are unnecessary if the  initial cap is set correctly, using accurate, current emissions data, which  they considered to be a better strategy for regulating prices than using  price controls to artificially manipulate the market.
section_title: Reporting and Monitoring
paragraphs: According to available literature and program officials, establishing a  system to report and monitor auction activities is an important aspect of  auction design. Effective reporting can increase the program’s  transparency and help participants make informed bidding decisions. In  addition, monitoring auction results can help government agencies or  designated private entities identify instances of market abuse and evaluate  whether auctions have met established goals.
Reporting of auction results. If auctions are used, policymakers would  need to consider how and when to report data on auction results. Several  program officials recommended making auction results available  immediately after the auction. According to one official, providing timely  and accurate data on auction results can provide covered entities with  information on costs to use as part of their strategic planning efforts. 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. RGGI makes auction results data available through  an online program called CO2 Allowance Tracking System, which allows  the public to download emissions data and relevant auction results.
While providing timely aggregated data can serve a useful purpose,  economic literature suggests that revealing too much information about  auction results could inadvertently facilitate collusion or limit auction  participation. For example, publicizing the names of auction winners and  their respective purchases may enable entities to determine whether  collusive agreements established prior to the auction were honored. In  addition, program officials said that reporting the identity of bidders  allows market participants to discern the patterns and strategies of others.  According to a European Commission official, entities may choose not to  participate at auctions if they fear that commercially sensitive information  will be revealed through their bidding. Some program officials noted that  while restricting access to such data may run counter to traditional ideas  about transparency, it may serve the public’s best interest to establish  clear limits around the amount and type of auction data released.
Monitoring and oversight. An auction monitoring system can help identify  cases of market abuse, ensure that auctions comply with established rules,  and provide information useful in evaluating and improving auction  design. Several program officials recommended designating a market  monitor to observe and assess activities at auctions and in the secondary  market. The auction monitor could either be a private or public  authority—for example, the RGGI program uses a private consulting firm  to perform a number of market monitoring activities. According to a RGGI  official, these activities include: ensuring auction rules are consistently  applied in each auction, analyzing participant behavior and identifying any  irregularities, and modeling the impact of potential design modifications to  the program. The RGGI market monitor also analyzes secondary market  activity, although the Commodity Futures Trading Commission (CFTC) is  responsible for protecting market participants against fraud, manipulation,  and abusive trading practices.
In Phase I and Phase II of the ETS, individual member states have used  different methods to monitor auction results. For example, the United  Kingdom government manages auctions but has appointed an independent  observer to ensure auctions are conducted in accordance with the law. In  Austria, an energy exchange handles vetting procedures and auction  administration while the government handles oversight. For Phase III of  the ETS and beyond, the EU Directive requires member states to report to  the European Commission on various aspects of auction outcomes,  including issues related to access, price formation, and technical issues. In  addition, the outline for the draft auctioning regulation from Phase III and  beyond foresees the appointment of a single auction monitor.  Respondents to the EU’s consultation on Phase III auctioning generally  favored this proposal, although some respondents noted efforts to curb  market abuse at auctions would be ineffective if these efforts are not  accompanied by similar efforts in the secondary market.
section_title: Appendix III: Allowance Sales Conducted in the EU ETS and RGGI
paragraphs: 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)
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: Staff Acknowledgments
paragraphs: 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.