University of Virginia Economists Design Nation's First Carbon Auction, Happening Today

September 25, 2008

September 25, 2008 — The nation's first auction of carbon dioxide emission allowances is happening today, and two University of Virginia economists played a major role in designing exactly how the auction will work.

Charles A. Holt and William Shobe tested various formats with simulated auctions that let U.Va. students compete to see who could purchase the most permits with an imaginary pile of money. The students took home a real paycheck in proportion to how well they did. Students earned about $35 on average for spending 90 minutes in the simulation, but those with the best results took home up to $100.

In the lab, the students discovered possible ways to exploit the auction designs, such as secretly signaling to another bidder how much to bid. This testing allowed Holt and Shobe to learn the flaws of any particular design long before it would be selling real permits worth millions.

Today's auction is being put on by the Regional Greenhouse Gas Initiative, a consortium of 10 Northeastern states that will regulate emissions from more than 200 power plants within their borders, beginning in January. Every plant will need enough credits to cover the tons of carbon dioxide they will emit during a year. Over 12 million emission credits are on sale, with each giving the right to emit one ton of carbon dioxide. They are expected to sell for between $2 and $7 apiece, said Shobe, and most power plants will need allowances for thousands of tons per year.

The credits can be bought and sold among power plants, and saved for use in a later year. Those power plants that can reduce emissions with alternative energy investments or improved efficiency can sell their excess permits to other plants.

Both presidential candidates have called for the creation of a similar cap-and-trade system for emissions as one of the key ways to deal with global warming. The lessons learned, first in the Wilson Hall economics lab and then in these regional auctions, will inform and influence the design of future cap-and-trade auctions, Holt said.