Breaking Collusion in Auctions through Speculation: An Experiment on CO2 Emission Permit Markets

• Published date: 01 October 2011
• Author: FLORENCE NAEGELEN,JEAN‐LOUIS RULLIÈRE,BENJAMIN PELLOUX,MICHEL MOUGEOT
• DOI: http://doi.org/10.1111/j.1467-9779.2011.01521.x
• Date: 01 October 2011

BREAKING COLLUSION IN AUCTIONS THROUGH SPECULATION:

ANEXPERIMENT ON CO2EMISSION PERMIT MARKETS

MICHEL MOUGEOT

CRESE University of Franche-Comte

FLORENCE NAEGELEN

CRESE University of Franche-Comte

BENJAMIN PELLOUX

GATE, CNRS, University of Lyon, and CREED, University of Amsterdam

JEAN-LOUIS RULLI `

ERE

GATE, CNRS, University of Lyon

Abstract

The European Emission Trading Scheme (EU-ETS) has

chosen to adopt an auctioning procedure to initially allo-

cate CO2emission permits. Free allocation of permits will

become an exception for the third phase (2013–2020) and

most firms will have to buy all their permits on the market

or via auctions. The ability of bidders to collude is a key

concern about the design of the auction format. To counter

collusion, the auction can be open to bidders without

compliance obligations (speculators). This paper aims at

studying experimentally speculation as a collusion-breaking

Michel Mougeot and Florence Naegelen, CRESE University of Franche-Comte, Av-

enue de l’Observatoire Besanc¸on 25030 cedex, France (michel.mougeot@univ-fcomte.fr,

florence.naegelen@univ-fcomte.fr). Benjamin Pelloux and Jean-Louis Rulli`

ere, GATE,

CNRS and University of Lyon, 93 chemin des Mouilles, 69130 Ecully, France (pel-

loux@gate.cnrs.fr, rulliere@gate.cnrs.fr). Benjamin Pelloux, CREED, University of Ams-

terdam, Roetersstraat 11, 1018 WB Amsterdam, The Netherlands (b.pelloux@uva.nl).

This research has been made possible by a financial support from the Mission Cli-

mat, Caisse des D´

epˆ

ots, Paris, France. Any opinions, findings, and conclusions or recom-

mendations in this material are those of the authors and do not necessarily reflect the

views of the Mission Climat, Caisse des D´

epˆ

ots. The authors are grateful to Ana¨

ıs Delbosc,

Sylvain Boschetto, Sylvain Ferriol for the software and the technical assistance. They thank

Jacob Goeree and Charles Holt, participants of the ESA 2009 American meeting in Tuc-

son, two anonymous referees, and the editor of this review for their helpful comments.

The remaining errors are the authors’ sole responsibility.

Received December 17, 2009; Accepted February 28, 2011.

C

2011 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 13 (5), 2011, pp. 829–856.

829

830 Journal of Public Economic Theory

device in two different auction mechanisms: the uniform-

price sealed-bid auction and the ascending clock auction.

Our results suggest that a uniform sealed-bid auction open

to speculators should be chosen from a revenue maximiza-

tion point of view. In this mechanism, compliance agents

adopt an aggressive strategy toward speculators. This strat-

egy significantly increases the seller’s revenue, compared to

the more collusive clock auction. In the latter, on the con-

trary, bidders accommodate speculators, letting them buy

permits in the auction and buying their necessary permits

on the secondary market. However, as opening the auction

to speculators deteriorates efficiency, the regulator faces a

trade-off between these two objectives.

1. Introduction

In 2005, the European Union initiated the implementation of the first

CO2emission trading scheme. This European Emission Trading Scheme

(EU-ETS) was designed to cap emissions from power generation and much

of heavy industry. It forms the central piece of the European policy on cli-

mate change and is the main instrument to enable European countries to

comply with their objectives of the Tokyo protocol. Based on a cap-and-

trade principle, the EU-ETS is the world’s largest carbon-trading market. It

accounts for over 80% of the global carbon market transactions (about 90

billions euros in 2008). Its liquidity has improved continuously from 260 mil-

lion tons during the first year (12% of the total allocation of allowances)

to 2.75 billion tons in 2008 (130% of the allowances).1The aim of such a

mechanism is to achieve emissions reduction at the lowest overall abatement

cost. The cap corresponds to the overall emission reduction objective and is

set individually on the emissions of each of the installations covered by the

scheme. The permits allocated to firms can be freely traded on the market.

Hence, the EU-ETS puts a price on carbon and creates incentives for the

reduction of CO2emissions.

A crucial issue for a cap-and-trade policy such as EU-ETS is the initial

allocation of allowances. Whereas firms favor an allocation at no cost in a

way related to historical outputs (i.e., to past emissions levels), economists

recommend the introduction of a costly auctioning mechanism.2In the first

phase (2005–2008), permits were mainly allocated to firms according to the

1See Charpin (2009).

2See for instance Cramton and Kerr (2002) or Hepburn et al. (2006). According to

Cramton and Kerr, powerful vested interests in the energy sector are lobbying for the

permits to be allocated on a grandfathering basis.