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The Potential For Collusion in Ascending Price Acutions

Posted by Erica Myers on April 11, 2008

The auction design team that authored the October RGGI auction design report recently posted an addendum to on Resources for the Future’s website. The report includes reactions to comments and suggestions that have been made by interested parties and presents new findings based on research done subsequent to the submission of the final report.

One of the more interesting findings is that “clock auctions” may be more susceptible to explicit efforts to collude than sealed-bid formats.

For the purposes of the report and the subsequent addendum, a “clock auction” refers to an ascending uniform price auction, where bidders submit quantity bids for the number of allowances they would buy at a given price. In this case, the initial price is the reserve price and if quantity demanded exceeds the number of allowances being sold, a second round of bidding begins and the price goes up incrementally (like a tick of a clock).

A sealed-bid uniform price auction differs in that there is only a single round of bidding where participants submit demand schedules with both prices and quantities. The highest bids are accepted according to the number of allowances that are for sale and the first rejected bid sets the price for all of the allowances sold in the auction.

The RGGI design team ran a series of experiments to test the performance of different auction designs. The subjects were undergraduate students at the University of Virginia earned real money for participating. When subjects were allowed to collude explicitly through instant message chatroom, they were much more successful in keeping the price well below the competitive equilibrium in the clock auction format as opposed to other auction formats.

An analysis of the actual chat between subjects provides some insight for why collusion is more successful in clock auctions. Most of the initial proposals were based on suggesting quantity reductions for low and high users. The focus on quantity reduction in the clock auction sessions is revealed in some of the participants’ comments: “again, bid for fewer permits earlier on so we can get permits cheaper” and “this will go 5X faster and will all make LOTS more money if everyone just cooperates the first time.” One person suggested “so why doesn’t everyone bid exactly the same amount that we ended last round [auction] with, since we keep getting the same clearing price.” This plan permitted participants to obtain the same final permit allocation without the run up in prices that occurred previously. Of course, quantity discussions occurred with the other auction formats too, but the effect of the clock is to take out the price dimension so that bidders only have to reach an agreement in a single dimension, quantity.

The worry with this type of collusion is that it often leads to inefficient outcomes where those who value the allowances the most are not necessarily the ones who get them.

This chatroom set up is very different than the conditions for the RGGI auctions.  However there is some empirical evidence to suggest that coordinated demand reductions have been used in ascending auctions in the past.

There are several widely cited cases in which coordinated demand reductions are used to defeat ascending price auctions for broadcast spectrum. Just prior to the 2001 Austrian UMTS auction, Telekom Austria announced that it “… would be satisfied with just two out of the 12 blocks for offer and if the [five] other bidders behaved similarly, it should be possible to get the frequencies on sensible terms … but that it would bid on a third block if one of its rivals did …” The other bidders clearly understood and the bidding stopped after a couple of rounds, with each bidder obtaining 2 blocks (Klemperer, 2004, p. 136). The extreme symmetry of this situation differs from the bidding environment faced by bidders in RGGI auctions, but the success of collusion triggered by a public announcement is disturbing.

This type of coordination may be more or less of a concern depending on the individual characteristics of the good being sold, the auction participants, and the regulatory environment.

The addendum also has a description for a combined vintage auction that is designed to correct the inefficiencies that could be caused by having two separate uniform price auctions for two different allowance vintages.   I mentioned this in a previous post.

Posted in Auctions, Cap and Trade | 2 Comments »

Combined Vintage Auctions For RGGI

Posted by Erica Myers on March 19, 2008

On March 17, 2008 the Regional Greenhouse Gas Initiative Inc. announced that the first CO2 allowance auction will be held on September 10, 2008. They have decided to hold quarterly auctions with the second auction scheduled for December 18, 2008. The first compliance period will begin at the beginning of 2009.

September’s auction will be of great interest to policy makers world wide because RGGI will be the first cap and trade program to auction such a large portion of the allowances rather than giving them away for free. The proposed rule for the Phase 3 of the EU ETS is to auction all of the allowances starting in 2013.

RGGI inc. also announced that the format for the auction will be sealed-bid, single-round, uniform-price; the design recommended by RGGI’s auction experts. While the goal is to maintain a consistent auction format, RGGI inc. is retaining the flexibility to transition to a multi-round, ascending price auction format. The virtues of the sealed-bid, single-round, uniform price auction are that is simple to understand, and many industry people are familiar with it (wholesale electricity is sold in uniform price auctions). However, if there are two separate uniform-price sealed-bid auctions, there is nothing to prevent the price of the later vintage from exceeding that of the earlier vintage; a problem cited by Peter Cramton, among others. In a forthcoming addendum to the report, RGGI’s design experts address this concern by recommending a combined vintage auction based on the idea that allowances are bankable and a bid for a later vintage should be treated as a request to purchase either a later vintage or an earlier vintage, whichever is less expensive (The link will be provided when the addendum is posted). This is similar to what Mike Giberson recommended:

“A linked sealed-bid auction would allow bids for the future vintage to specify the premium, if any, which they would pay to receive the current vintage product. Permits could be allocated using a surplus-maximization rule, with a uniform clearing prices for each of the products.”

On the European side, auction experts have also recommended the use of a single-round, sealed-bid, uniform-price auction (auctioning_in_the_eu_ets_-_report.pdf. If RGGI were to successfully employ some kind of a combined vintage sealed-bid format, it may serve as an international example.

While a good auction design is important, a well functioning spot market is crucial for the success of RGGI. If the market is sending the right signals, the differences among many of the proposed auction designs become trivial.

Posted in Auctions, Cap and Trade, Climate Change | 2 Comments »

The oft underappreciated virtue of auctions

Posted by Rich Sweeney on January 28, 2008

It’s information yo. Lately there’s been a lot of political attention paid to the costs/benefits of government permit allocation. However, these discussions have focussed almost entirely on equity considerations and the perceived fairness of outcomes. Little is said about the bureaucratic costs of allocating permits, regardless of what metric you use to do so.

Take carbon emissions. Petr Zapfel, Coordinator for EU Carbon Markets and Energy Policy, just gave a talk here. When asked about allocating based on emissions, he almost shuddered at the informational burden of doing this correctly. Every company would send in their information, then bureaucrats would verify it, publish the findings, and come up with some metric for doling out permits. Such an approach would require an enormous amount of time and man-power.

Instead, the government could just set up an auction, and allow the market to do the leg work. Prices are the most valuable informational tool man has ever come up with, and ignoring this creates a host of unnecessary costs. Moreover, as Dallas pointed out, and Rep. Markey agreed, at he end of his testimony the other day, auctions are actually relatively easy to administer (just look at the electromagnetic spectrum).

Posted in Auctions, Cap and Trade | 1 Comment »