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RGGI Sets First Auction of CO2 Emissions Allowances for September 2008

April 2, 2008

The Regional Greenhouse Gas Initiative (“RGGI”), the multi-state cooperative effort created in 2005 aimed at reducing greenhouse gas emissions in the Northeast from coal-fired power plants, has announced that it will hold its first regional auction of carbon dioxide emissions allowances on September 10, 2008, with a second auction scheduled for December 17, 2008. The announcement of the auction date and establishment of the terms for the auction are key milestones for RGGI.

Background on RGGI

RGGI is made up of ten northeast and mid-Atlantic states.[1] The goal of RGGI is to cut CO2 emissions from power plants by 10 percent by 2019,[2] though the RGGI system may be expanded beyond emissions from power plants in the future.[3] Under the plan, the 10 participating states have agreed to stabilize carbon dioxide emissions from power plants from 2009 to 2014 and then reduce emissions by 2.5 percent per year during the next four years. Compliance with the initiative will begin in January 2009. RGGI’s initial total budget for carbon dioxide emissions for the 10 states is 188 million tons per year.[4]

The first cap and trade rules under RGGI were announced in the fall of 2007,[5] when the states of Massachusetts and Maine issued draft regulations that provided detail on implementing the program in those states. The regulations set threshold limits for plants that would be subject to the rules, established emissions allowances and emissions reduction schedules, provided credits for early reductions of emissions and created the rules under which offset projects would be accepted for emissions credits.[6]

Establishing a Carbon Trading Market in the United States

RGGI is currently the only mandatory carbon trading program in the United States. The European Union (“EU”) currently operates the world’s largest carbon trading system. Launched in January 2005 to assist EU nations in meeting their emission reduction obligations under the Kyoto Protocol, the EU system applies to approximately 12,000 sources and covers nearly 50% of all CO2 emissions in the EU.[7] Each participating government allocates a certain amount of CO2 emissions to each of its facilities. If those facilities emit less, they can sell their emissions credits. If they emit more, they have to buy credits. The initial allocations cover the years 2005-2007.[8]

There have been some significant problems with the EU carbon market. After an initial market capitalization of 205 billion euros ($265 billion), a series of reports from member governments and the European Commission concluded that a surplus had accumulated.[9] Analysts believed that industrial emitters had persuaded the EU governments to over-allocate emissions credits, allowing facilities to obtain and sell credits without making any particular efforts towards improved energy efficiency. This problem was compounded when data was accidentally put on the EU Commission's website that demonstrated the surplus, resulting in prices for credits dropping by 72 percent in three weeks in April and May of 2006, and causing the European carbon market to lose approximately two-thirds of its value.[10]

Development of the RGGI Auction Rules

Against the backdrop of the EU’s problems, RGGI engaged a number of economists and academics to study both the European system and other emissions auctions that have been held within the U.S. (for example, an auction of NOx (nitrogen oxide) held by the State of Virginia and the Irish auction of CO2). After an initial phase of research, a preliminary set of auction rules was developed and then investigated using a round of experiments to measure the efficiency and effectiveness of various auction rules and formats.[11]

The criteria developed for the initial auction rules were: (1) efficiency – that is, making sure that emissions allowances go to those who value them most; (2) price discovery – allowing open information so that the price of an allowance most closely approximates the marginal cost of emissions reduction; (3) facilitating a secondary market in emissions allowances; (4) minimizing price volatility; (5) preventing collusion or market manipulation; (6) transparency; (7) maximizing revenue for the participating states; and (8) familiarity to the electrical production industry and aligning well with energy markets.[12]

While RGGI has acknowledged that its rules may ultimately be preempted by a federal cap and trade market, some believe that the risk of preemption is offset by the benefit of providing bidders current access to future allowances and fostering the development of offsets.[13]

RGGI’s Final Auction Rules

The initial report on auction design recommended that RGGI use a single-round, sealed bid auction. Emissions for different years were to be sold in four-year blocks at quarterly auctions. Selling multiple years of emissions was expected to allow producers to plan for the future,[14] and quarterly auctions were expected to reveal a sufficient amount of price information to prevent volatility and to increase transparency.

Emissions allowances were to be sold in blocks, with a limit on the amount of allowances that any single bidder could purchase. Auctions were to be open, and bidders would be required to disclose beneficial ownership. Both of these recommendations were designed to prevent collusion, as was a recommendation of a joint and uniform auction of emissions allowances irrespective of what state they were generated in. Finally, market monitoring using FERC (Federal Energy Regulations Commission), EPA (Environmental Protection Agency) or the Commodity Futures Trading Commission was recommended.[15]

On March 17, 2008, RGGI announced its final auction rules, a summary of which can be viewed at this link. Most of the rules followed the recommendations made last fall in the Auction Design Report. The newly announced rules govern the format of the emissions allowance auctions, the auction schedule, who may participate, pricing, disposition of unsold allowances, notice and monitoring. The newly proposed rules include the following:

Structure of auction and types of allowances sold:

  • The sale of allowances will occur on a quarterly basis in lot sizes of 1,000 allowances;[16]
  • The initial auction will occur in a single round, using a uniform-price, sealed-bid auction format,[17] though the rules anticipate that multi-period auctions using an ascending price format may be allowed if market conditions require it;
  • The specific methodology of submitting bids is still being designed. RGGI, Inc. has selected World Energy to design and run the auction and specific details on bidding and notification to both successful bidders and unsuccessful bidders are being developed and will be posted on the RGGI website: RGGI.org;[18]
  • Allowances will be identified by the year in which the allowance can be used (called a “vintage”).[19] All vintages within any RGGI state for a particular year will be offered for sale prior to the end of that compliance period;[20]
  • A reserve price of $1.86 per allowance will apply to the first auction.[21] After the first auction, the reserve price will be the higher of $1.86 or 80% of the current market price, based on the Consumer Price Index;[22]
  • Up to 50% of future allowance vintages will be auctioned, for periods extending up to four allocation years into the future.[23]

Participation

  • Any market participants may buy at the auction; however, participants will need to demonstrate financial capability to complete purchases in the forms of letters of credit or bonding;[24]
  • The number of allowances that a bidding entity (i.e., an organization and its affiliates and/or agents) may purchase in a single auction is limited to 25% of the allowances offered for sale in any single auction.[25]

Timing

  • While the first auction will take place in a single round, with a uniform price and sealed bids, RGGI maintains the flexibility to switch formats at a later date to multiple round auctions and ascending prices. RGGI will hold any unsold allowances and put them up for sale in subsequent auctions. In 2012, it will consider retiring any unsold allowances.

Conclusion

While some futures emissions markets exist,[26] the RGGI auction will create the first functioning carbon emissions market in the United States. In addition, RGGI hopes to foster a secondary market in allowances: “Auctions for RGGI CO2 allowances will be taking place with the expectation that there will be an active secondary market for these assets and that a significant amount of allowances will be traded outside of the auctions themselves.”[27] In addition to RGGI, the Western Climate Initiative (“WCI”) has committed to disseminate its own cap and trade rules for the eight western states and two Canadian provinces that are members of the WCI,[28] and the RGGI rules will no doubt serve as a template for the development of those rules.

For all of these reasons, the promulgation of RGGI’s auction rules presents a significant milestone for the Initiative and the implementation of the rules and RGGI’s first auction demonstrates the continuing trend towards state, local and regional action in response to climate change.

For more information, contact any member of Marten Law Group’s Climate Change/Sustainability Practice Group.

[1] The 10 RGGI states are Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island and Vermont. The District of Columbia, Pennsylvania and the province of New Brunswick, Canada are observer members of RGGI. Massachusetts and Maine were the first of the states to promulgate rules which would institute a market-based mechanism for reducing GHG emissions; the state of New York issued a “pre-proposal” draft regulation for comment last December, but has not finalized its rules.

[2] For more information, see the Regional Greenhouse Gas Initiative Website.

[3] See Regional Greenhouse Gas Initiative Memorandum of Understanding.

[4] See CO2 Emissions Data Files for 2000-2006 for Electrical Generating United Subject to RGGI Program, which can be viewed at http://rggi.org/docs/co2_2000_2006.xls

[5] For more information regarding those initial rules, please see States Move Forward With Implementation of Greenhouse Gas Reduction Initiatives, Marten Law Group Environmental News (August 22, 2007).

[6] Massachusetts’ proposed rule, which will be codified as amendments to 310 CMR 7.29, can be viewed here; Maine’s proposed rule, which will appear as Chapter 156 of the Department of Environmental Protections Rules under the Code of Maine Rules, can be viewed here.

[7] Additional information on the EU carbon emission trading system can be found on the European Commission website.

[8] See D. Roberts, EU carbon-trading market hullabaloo, Gristmill (May 16, 2006).

[9] See Emissions Profits in Europe Plunge as Data Questioned, Bloomberg News (May 15, 2006).

[10] Id.

[11] This research is described in a report titled “Auction Design for Selling CO2 Emission Allowances Under the Regional Greenhouse Gas Initiative,” (October 26, 2007), prepared for RGGI by Charles Holt, William Shobe, Dallas Burtraw, Karen Palmer and Jacob Goeree (“Auction Design Report”).

[12] Auction Design Report at 21-23.

[13] See Auction Design Report at 37.

[14] The Auction Design Report recommended selling multiple years of allowances in order to benefit generators which have “lengthy planning horizons and can get significant benefits from an active market for future allowances vintages.” Auction Design Report at 37.

[15] These recommendations can be viewed in the Auction Design Report at 6-9 and 77-81

[16] The use of a quarterly market and the advance sale of future “vintages” of emissions were designed to stop any particular bidder from “surprising” the market with a large, unexpected jump in demand. Auction Design Report at 68.

[17] The Auction Design team felt that sealed bid auctions would limit potential collusion, as would a single-round auction. Auction Design Report at 46.

[18] Author’s April 2, 2008 phone conversation with staff of New York Office of Climate Change.

[19] Under RGGI’s Model Rules, an “allocation year” is a calendar year for which the regulatory agency allocates or awards the allowance. The allocation year is the first year a CO2 allowance or a CO2 offset allowance can be used to demonstrate compliance.

[20] The Auction Design Report concluded that a joint regional auction was preferable to individual state auctions since it avoided the possibility of differences in prices between states and the possibility that states would time their individual auctions to favor their own state markets. This approach also would limit administrative and transaction costs. Auction Design Report at 40.

[21] According to RGGI, this reserve price represents 80% of the ICF International’s modeled 2009 price for allowances of $2.32. See http://www.rggi.org/docs/20080317auction_design.pdf.

[22] The current market price will be set by determining the volume-weighted average of transaction prices reported to the participating states, as well as prices known from previous auctions. Id.

[23] This rule was adopted to allow for planning and also to prevent sudden spikes in demand. See Auction Design Report at 37, 68.

[24] The latter requirement assures that bidders that do not have the actual capability of purchasing allowances do not tie up allowances that would otherwise have gone to qualified bidders.

[25] This limitation was designed to prevent any one bidder from hoarding allowances or attempting to manipulate the secondary market by gaining a competitive advantage which might provide for speculation. Auction Design Report at 68.

[26] The closest analogues to the RGGI market are the SO2 and NOx futures markets run by NYMEX and the Chicago Climate Futures Exchange. The EPA reviews those markets. See Auction Design Report at 43.

[27] Auction Design Report at 11; see also id. at 64-66.

[28] See August 22, 2007 Press Release from WCI.

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