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EPA's SO2 Allowance Auctions: Insights and Lessons Learned from Experience

This document provides an overview of the EPA's experience with sulfur dioxide (SO2) allowance auctions established under Title IV of the Clean Air Act Amendments. It discusses the purpose and design of the auctions, noting their goal to support new entrants in the market, facilitate price discovery, and contribute to environmental policy. It covers the history of the auctions from 1993 to present, including the transition to EPA administration, recent developments, and key lessons learned regarding auction design and efficiency.

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EPA's SO2 Allowance Auctions: Insights and Lessons Learned from Experience

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  1. EPA’s Experience with Allowance Auctions Brian McLean, USEPA Joe Kruger, National Commission on Energy Policy

  2. Overview of EPA SO2 Auction • Basics • Purpose/goal of EPA auction • Design of the EPA auction • EPA’s experience with the auction • Recent developments • Conclusions/Lessons Learned

  3. Basics • Title IV of the Clean Air Act Amendments provides for a small SO2 auction (about 2.8%) • Auction proceeds are returned to sources • First auction was held in 1993 and the 14th auction was held last March • SO2 auctions are a very small part of the SO2 market

  4. Purpose of the EPA Auction • Provide source of allowances for new entrants • Early fears of “hoarding” • Title IV also included direct sales provision for the same purpose. • Support development of market • Price discovery • But not interfere with private market

  5. Design of EPA Auction • Form, vintages, frequency of auction decided by Congress • Price discriminating auction • Spot and 7-year advance auction • Annual auction, open participation

  6. Design of EPA Auction (continued) • EPA sought credibility for fledgling market • Initially tried to enlist Treasury Dept. • Decided to use a private exchange to administer • Put out a “no-cost” RFP • Chose Chicago Board of Trade (CBOT) (other applicants were NYMEX and Cantor-Fitzgerald) • EPA administers proceeds from auction and returns funds to companies

  7. Early Experience with Auctions • First auction in 1993 • Clearing price ($131) was about half of what was thought to be the “market” price • Some observers attributed low price to auction design (this was refuted by subsequent research) • Over the next year, the market and auction prices largely converged

  8. Allowance Price vs. Auction Clearing Price

  9. Who has been using auction? • Auctions open to everyone • Power producers have bought roughly 2/3 • Traders/brokers have bought roughly 1/3 • NGO’s/Schools/individuals <1% • Additional Provision: Allowances may be offered up for sale • Only 345,000 offered, with 15,000 successfully sold (most over first 4 years)

  10. Recent Developments • In 2005, CBOT decided to stop running auction • EPA took over administration and ran 2006 auction • EPA is integrating auction operation into allowance management software • Greater efficiency • Quicker turnaround

  11. Lessons Learned • The purpose of an auction should guide its design • Auctions important for price discovery in early years when there is limited information • Fears about market power and hoarding were unfounded • Speed, efficiency, accuracy, and transparency are important for ensuring credible administration

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