The first auction of allowances for California’s cap and trade market took place on Wednesday November 14 and the results were released on Monday. The state auctioned off allowances for vintage 2013 and 2015 (an allowance can be used in its vintage year or any year after that). The price floor for both auctions was $10.
All of the vintage-2013 allowances made available were sold and the market clearing price was $10.09. In the vintage-2015 auction, the supply made available was about seven times greater than the total number of bids at $10 or above. As a result, the market for those allowances cleared at a price of $10.00.
The results are somewhat surprising to me.
It is worth pointing out that the rules of the market increase the price floor at the rate of inflation plus 5% per year (starting with 2014), so if you bought a permit today, you should be able to sell it for at least $10.50 in 2014 and $11.03 in 2015 (after accounting for inflation). That’s a lot better than the return you can get on a CD these days. So, why doesn’t demand for these allowances as investment vehicles push prices higher?
Some people, no doubt, are going to argue that the low prices for both auctions and low demand for the vintage-2015 allowances signals a lack of confidence that the market will be around that long, possibly due to the ongoing legal challenges.
That may be part of it, but I think the full answer is more complex. This was a uniform-price auction. In a competitive uniform-price auction every participant has an incentive to bid his or her true valuation of the good. Though if you are risk-averse, you might spread your bids out over prices around your best guess of your valuation (known as “laddering” among some emissions market participants). If your true valuation of the good were below $10, your best bet would be to not bid at all.
So then is it just coincidence that the market ended up clearing a few cents above the price floor? It seems improbable that so many independent evaluations ended up with a price in this range. I don’t have a good explanation, but I look forward to reading comments from those who think they do.
NOTE FOR CARB CAP AND TRADE AUCTION MAVENS: There has been some confusion in interpreting the auction results released by CARB. In particular, it reports that “Submitted Bids” for 2013 was more than three times the “Allowances Available for Sale” and yet the “Median Price” in the bid summary is $12.96, higher than the market clearing price. This is a mathematical impossibility if the Median Price refers to the same set of bids as the Submitted Bids. CARB has clarified the issue: the median price is for all bids that were submitted including the ones that were rejected because they exceeded the procurement limits or holding limits for the market participant, or failed to meet the requirements for bid collateral. The distribution in the Bid Price Summary Statistics and the market clearing price reflect only the bids that were not rejected.
Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. Currently, he chairs the California Energy Commission's Petroleum Market Advisory Committee and is a member of the Bay Area Air Quality Management District's Advisory Council.