Policy by Design: Virginia’s NOx Allowance Auction

D. Porter, S. Rassenti, B. Shobe, V. Smith, and A. Winn

June 20, 2005

Why is this interesting?

First time allowances sold for revenueInnovative auction designsExperimental comparisons of auctionsImplementation Timing Bureaucratic issues Broker’s issues

NOx allowances

Nineteen state regional marketAllowances have vintages Use on or after vintage year ’04 and ‘05 had 1,855 allowances in the set-aside At prevailing prices, vintages would earn about $9

millionAllowances may be banked at a risk Subject to “progressive flow control” or discounting if

total stock of banked allowances rises above 10% of total allowances

Criteria for successful auction

Maximize revenues for the stateAuction must be completed by June 30Fair, understandable, and transparent auction process

Results of initial design work

Initial evaluation suggests 3 auction types for evaluation: Combinatorial sealed-bid Combinatorial English clock auction Sequential English clock

Combinatorial sealed bids

For the combinatorial sealed bid“Any/Or” (AO) bidsBids take the form: (p4,Q4 | p5,Q5)

Which includes any linear combination: q4 ≤ Q4; q5 ≤ (1-)Q 5; 0 ≤ ≤ 1

Combinatorial sealed bids - 2

For example, the bid (100, 10| 90, 20) could result in: Q4 = 10 or Q5 = 20 or any linear combination

such as 4 units of 2004 ( =.4) and 12 units of 2005

for (1- =.6) Revenue is maximized by solving an integer

programming problem in Q4, Q5 , and ij

The “English clock”

Seller has many units to sellSeller announces price, bidders announce quantityStart at low price where demand is highIncrease price at set periodsStop when demand equals supplySell all allowances at ending price

Advantages of the clock

Quick and easy to implementReduces political risk Does not reveal WTP of high-value bidder

Combinatorial English clock

Bidders bid on 2 clocks simultaneouslyClock increases for any vintage in excess demandBidders may switch quantities between vintages subject to some limitsWhen both clocks stop, revenue maximizing bids are selected by algorithm

Sequential English clock

Sell one vintage in morning and one in afternoonEach by standard English clockDoes the order make a difference?

Experimental results - revenue

Both clocks beat CSB with elas. demand CEC does a little better than SEC

Clocks fair worse with inelastic demandDifferences in vintage prices does not affect relative performance of CEC and SECFor SEC, order of auction does not matterExternal market probably implies elasticity

Auction timeline

As of mid-April, time pressure appeared to rule out all but the simple sealed bid.RFP for auction brokerage services published May 17Responses were due on May 27Contract was signed on June 8Auction was held on June 24 Light-speed for a state bureaucracy!!

The winning brokerage bid

No mention of clock auctions in the RFPCredible bids from five firmsAll could do a sealed bidAmerex proposed an English clock auction This was a surprise as the ICES work had not been

publicized.

Virginia chose the risky path to maximize revenue from the auction

Sixteen days

5 days of intense discussion on design detail Sequential versus joint auction of vintages Single price or discriminatory pricing How to select winning bids

Auction design finalized on June 14

Programming and paperwork

Programming the Internet applicationWriting contractContacting potential buyersGetting contracts approvedArranging financial assurance Bond ratings, escrow, or letters of credit Bids limited to credit amounts

The auction - bidders

Bidders see only two things The current price That the auction is still open

Bidders enter only quantity bidBidding early is important because winning bids are filled in order receivedMust bid each round to stay in Can’t increase bid in later rounds

The auction - seller

Announce schedule of rounds Time for bidding; time for posting new round

Stay in touch with biddersWhen quantity bid falls below quantity to sell, auction endsSeller chooses top price or next price down to maximize revenues

Price paid

Bidders at top price get goods at seller’s chosen price Even if next to last price is chosen

If final price drops down, additional quantity is sold in time order of bids Bidders who drop quantity in last round may

get some units at their last bid price

Auction results: 2004 vintage

Number for sale: 1,85519 bidders, 10 winnersDay before the auction: Bid: $2,200; Ask: $2,350

Morning of auction over-the-counter sale: $2,250 per tonAuction clearing price: $2,3253.3% over morning trade price!

Auction results: 2005 vintage

Number for sale: 1,85517 bidders, 5 winnersDay before auction: Bid: $3,150; Ask: $3,200

Morning of auction over-the-counter sales: $3,200 per tonAuction clearing price: $3,4257% over the morning trade price!

Revenue exceeds expectations

Total auction revenue: $10,666,250

Auction expenses: under $200,000 Including one-time research costs

Net revenue: $10,466,250