design of auction, safety valve and revenue recycling within the energy performance commitment (epc)...
TRANSCRIPT
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Design of Auction, Safety Valve and Revenue Recycling
within the Energy Performance Commitment (EPC)
Environmental Resources Management Ltd
& Market Design Inc
26 January 2007
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Presentation Overview
• Project objectives
• Interim findings for each EPC design aspect:
• revenue recycling options
• auction design
• integrated analysis (including safety valve)
• Next steps
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Project Key Objectives
• Many key EPC policy and design decisions have been taken
− Fixed price introductory phase (sales), cap-and-trade fixed volume phases (auctions)
− Use of “safety-valve”; preference for “buy-only” link to ETS
− Revenue recycling to participants on basis of emissions and/or energy management performance
• Design details have not yet been determined
• how does EPC incentivise ‘good practice’ amongst participants?
• Overall objective is therefore: to provide guidance on the auction, ‘safety-valve’ and revenue recycling aspects of the proposed Energy Performance Commitment (EPC).
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3 Aspects Linked – Impact Effectiveness
Task 1:
Design of auction method
Task 2:
Design of revenue recycling
Task 3:
Design of “safety-valve”
Task 4:
Final Scheme Proposal
Integrated analysis
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Revenue recycling
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Revenue recycling
Assessment of alternative options and proposed formulae
• Option 1 (RR1): Auction revenues returned to participants in proportion to average annual emissions
• Option 2 (RR2): Performance ‘banding’ based on emissions reduction performance (allows % reward/penalty)
• Option 3 (RR3): Performance ‘banding’ based on emissions reduction performance and other criteria e.g. use of HH metering
Key criteria include: effectiveness, fairness and simplicity, minimising cost/admin burden to Gov and participants, rewarding early action/incentivising the installation of AMR
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Revenue recycling
We model revenue recycling for x participants over 5 years
• Basic recycling option design details - no. of bands, band allocation, rate of reward/penalty
• Number and size distribution of participants
• Changes in emissions/behaviour across period
Key variables:
Key outputs:
• Determine net winners/losers and extent of wealth transfer
• Identify perverse incentives/’unfair’ outcomes
• Identify optimal option according to key policy criteria
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Revenue recycling
• Different options result in different winners/losers
• Simple payment proportional to emissions - insufficient incentive to reduce emissions (mixed signals)
• Performance banding option - “league table”
− creates incentive to reduce emissions − i.e. reinforces the signals of cap and trade
− equal number of participants in each band creates incentive discontinuity (i.e. 1st place rewarded same as 500th place)
− equal number of participants in each band also requires corrective factor to % reward/penalty
− equal number of emissions in each band may be an alternative option, although outcomes are then highly dependent on participant size distribution
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Revenue recycling
• Use of continuous performance banding− alternative is to have continual linear incentive, i.e. x bands for x
participants; simple, fair and no discontinuities− Participants could still be reported in ‘performance bands’
• Increasing the % performance factor does the following:− reduces auction price due to additional incentive to abate along
MACC− shifts money from those with higher abatement costs to those
with lower abatement costs. − shifts money from growing businesses to declining businesses
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Revenue recycling
• Multi-criteria recycling option
− Participant administrative simplicity maintained (e.g. small increase in reporting requirement only, payments still simple)
− encourages uptake of auto metering and may encourage early action
− however, non-transparent in outcomes and adds complexity to optimal bidding and abatement strategy
− winners and losers will depend on MAC of HH metering and existing availability of the option for each participant
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Revenue recycling
-£10
-£5
£0
£5
£10
£15
1 2 3 4 5 6 7 8 9 10
participant number
Ne
t be
ne
fit o
r lo
ss p
er
tCO2
em
itte
d
RR1
RR2a
RR2b
RR2c
RR1: proportion to average annual emissions
RR2: emissions reduction performance
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Revenue recycling
Key
√√√ meets criteria very well
√√ meets criteria well
√ meets criteria
X does not meet criteria
RR1 √√ √√ √√ √ X √
RR2a √√ √√ √√ √√ X √√
RR2b √√ √√ √√ √√ X √
RR2c √√ √√ √√ √√√ √ √√√
RR3 √√ √√ √ √√√ √√ √√
Key policy criteriaR
ecyc
lin
g o
pti
on
Adm
inis
trat
ive
sim
plic
ity f
or
Gove
rnm
ent
Adm
inis
trat
ive
sim
plic
ity f
or
part
icip
ants
Und
erst
and
ing
of o
ptim
al
stra
tegy
Ince
ntiv
e f
or
emis
sion
s re
duc
tion
Ince
ntiv
es
for
early
act
ion
Dis
trib
utio
nal a
nd e
quity
co
ncern
s
RR1: proportion to average annual emissions
RR2: emissions reduction performance
RR3: RR2 + other criteria
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Auction design
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Auction design
Key attributes of emissions allowances:
• Product is a homogenous, divisible good
• Product is actively traded in secondary market
• Market is un-concentrated
• Downward sloping demand curves
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Impact of revenue recycling (1)
• Reduces the burden of the scheme on participants but complicates bidding incentives
• Bidder’s quantity choice impacts its revenue share in complex way
• Performance factor: % bonus or penalty based on relative performance
• Increasing performance factor
• Reduces auction price
• Shifts money to those with lower abatement costs
• Causes some shift of money from growing businesses to declining businesses
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Impact of revenue recycling (2)
• Scheduling of payments is important consideration
− Auction at start of year 1 + 6 month reconciliation with payments in mid year 2 = 18 months without cash
− However, it is desirable that some time pass between auction and recycled payment
− Solution 1: defer participant payment till start of year 2
− Solution 2: participants make net payments only: “settle-up”
− Solution 3: auction in mid-year or multiple auctions
• Solution 1 recommended: achieves simplicity whilst preserving the strong signal/financial decision associated with payment
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Auction design
Leading auction candidates:
• One static (one round of bidding)
• One dynamic (multiple rounds of bidding)
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Uniform price auction
Price
Quantity
Supply
Demand(as bid)
Q0
P0clearing price
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Ascending clock with proxy bids
Priceclock
Quantity
Supply
Demand
Q0
P0
Excessdemand
Price
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Auction designProxy bids:
Other features:
• Internet auction
• Demand schedules (step function)
• Proportionate rationing
• Report excess demand and distribution of % reductions− can estimate revenue recycling impact
• Bidders can participate as in a static auction
• or can bid dynamically
• Recommendation: clock auction with proxy bids, so bidders can better estimate marginal incentive to abate
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Integrated analysis
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Integrated Analysis
• Auction Design, Revenue Recycling and the Safety Valve all impact on each other
• Tasks 1-3 therefore being conducted as a whole using Case Study modelling
• Case Studies aim to predict potential outcomes of design options
1. identification of the incentives to change behaviour- investing in abatement, participating in sales/auction- auctions must be understandable to participants
› i.e. participants must be able to form an initial strategy and optimise their position within scheme
2. sense checking- are there perverse incentives or unintended
consequences? - e.g. too much/too little abatement capacity- how do abatement costs and auction prices interact?
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Case Study Fundamentals
• Uses marginal incentives• marginal costs modified by recycling payments
• Informed by real data (NERA/Enviros etc)
• Uses scenarios (recycle design, participants, ceilings, etc)
• Outcomes include auction prices, wealth transfer, etc.
• Case Studies developed by ERM in Microsoft Excel, with VB coding
• Models hypothetical cases rather than the system as a whole• Aim is to analyse the effects of design details
• Very flexible: multi-year, assumptions re: MAC curves, behavioural aspects, etc.
• Model largely operational but needs testing
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Key Outstanding Questions (1)
• Recycling Formulae
• Multi-Criteria League Tables
• Distribution of Sizes of Participants
• Distribution of Emissions Projections of Participants
• Baseline Alternatives
• Average emissions since start of scheme, Phase 1 period only, rolling x-year average, etc.
• Payment Scheduling
• Safety Valve
• Buying-in (of alternative allowances)
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Key Outstanding Questions (2)
• Public/Private Sector split
• Ensures that public sector is not a net loser
• Technically possible- 2 revenue pots- Both revenue neutral
• Likely to reduce market efficiency
• Ensures that there will definitely be public sector losers
• Level of participation in abatement/auctions
• Achievability of caps
• Participant behaviour
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Participant Behaviour
• Perfect Solution
• optimal system solution, perfect rationality and information
• Companies act independently of recycling rules
• Risk aversion
• Over-abate
• Others?
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Next Steps
• Draft Final Report due week commencing Feb 5
• Major addition will be Case Study results/conclusions
• Will include final design recommendations
• Final Report due week commencing Feb 19
• Meetings scheduled after each Report delivered