Environmental Engineering Reference
In-Depth Information
they need. Provided that there is sufficient demand,
companies from these sectors can sell the over-
allocation for cash in the market. Whereas wind-
fall profits arise solely from the primary market
allocation method, over-allocations arise solely
from leniency in the setting of emission targets
for certain industry sectors. That is to say, they
arise from a politicised and biased sector break
downs of the total allocation. For example, indus-
try sources point out that towards the end of the
second trading phase of the EU ETS (2008-2012)
the industrial sectors are estimated to be over-
allocated by around 600 million allowances, whilst
the electricity sector could be under-allocated by
around 1260 million allowances.
However, windfall and sector specific over-
allocation profits are intertwined. With stringent
targets, electricity producers will still realize
windfall profits because higher market prices
for scarcer allowances imply higher opportunity
costs to be passed on. Therefore, a more stringent
emission cap does not necessarily reduce the size
of the windfall profits, but might even increase
those profits. Accordingly, if there is systematic
over-allocation to some industry sectors, profits
from over-allocation could also rise with more
stringent caps. Sector specific over-allocation
should not be confused with an ultimately loose
cap, i.e. an economy wide over-allocation. In this
case, over-allocation in principle should lead to
a low - or zero - carbon price, resulting in low
- or zero - windfall profits. This occurred, for
example, in the EU ETS during 2007 after data
on over-allocation had been published. We will
discuss this incident in more detail further below.
Beyond windfall and over-allocation profits,
free allocations bring about additional social
costs and adverse dynamics - no matter whether
grandfathering or benchmarking is applied. Free
allocations inevitably result in rent-seeking be-
havior by companies and industry organizations
as they invest significant time and resources in
lobbying for generous allocations. On the other
time-consuming and costly for government au-
thorities. Moreover, it is also a risk that the
target level of allocations is completely loose, as
evidenced, for example, in the EU ETS during
2007. All of this has resulted in a more or less
consensual approach within Member States to
allocate relatively stringent emission ceilings to
the electricity sector for the period 2008-2012. But
for the period after 2012, the European Commis-
sion proposed to auction off all allowances to the
electricity industry. An exemption was made for
existing power generators in primarily Eastern
European Member States, where the auctioning
rate must be at least 30% in 2013 and 100% in
2020 (EC, 2009a).
So, finally, auctioning of allowances appears
to be the silver bullet for primary market alloca-
tions.
18
There is a fund of literature on optimal
auction design. Many practical experiences with
public and private auctioning demonstrate that
even minor design imperfections can have sig-
nificant adverse effects on the results (Milgrom,
2004; Klemperer, 2004).
19
Real world auctioning
design needs to tackle issues ranging from bid-
der accreditation, auction integrity, information
asymmetries, transaction cost to market abuse and
collusion. However, in this contribution we will
focus on the specific issue of designing primary
market auctioning when there is active second-
ary markets trading as it will be the case for the
large-scale auctions envisaged for the third trading
phase of the EU ETS. There is only some research
on similar issues in other markets (Bukhchandani
and Huang, 1989; Zhoucheng Zheng, 2002).
We devote the last subsection of this contribu-
tion on deriving some hands-on recommendation
for implementing primary market auctions as an
integral part of secondary markets. But before, we
want to show the principle interaction between
primary market auctions and secondary market
trading. We assume for now that secondary
markets are efficient and liquid and that there
are no arbitrage barriers between auctions and
