A Perspective on the Allowance Auction
As you now know from our previous posts, EPA uses “cap and trade” within the Acid Rain Program to help regulate the pollutants that cause acid rain. A small component of this process is the sulfur dioxide (SO2) allowance auction. To be honest… I did not really know that much about this part of the Acid Rain Program so I set out to find out as much as I could.
The first thing I learned was that an allowance is a authorization that allows a utility or industrial source to emit one ton of SO2. A small portion of these allowances (about 2.8 percent of all allowances) are auctioned off once a year. Any allowances can be bought, sold, and traded at any time by any individual, corporation, or governing body, including brokers, municipalities, environmental groups, and private citizens. On March 23, 2010, EPA announced the results of the eighteenth annual acid rain allowance auction. The annual auction gives power plants, brokers, and private citizens an opportunity to buy and sell SO2 allowances. It is part of EPA’s successful cap and trade program to reduce emissions contributing to acid rain, fine particle pollution, and regional haze.
I figured I might learn something if I interviewed one of the participants in the allowance auction. I was fortunate enough to talk to one of the participants in the most recent Acid Rain Program Allowance Auction for 2010. Dr. Lynne Lewis is a Professor at Bates College in Lewiston, Maine. Dr. Lewis is Chair of the Economics Department and teaches environmental and natural resource economics, among other topics. I asked Dr. Lewis a few question about why the class she teaches at Bates College participates in the allowance auction and how that is valuable to her students.
Can you explain how you got involved in the ARP allowance auction?
I started this as a classroom experiment at Bates back in 2001. It is an Environmental Economics class so participation in the Acid Rain Program (ARP) allowance auction allows us to experiment with material learned in class about cap and trade. The ARP is the longest running successful cap and trade program in the world.
That makes perfect sense in the context of an Environmental Economics Class, before we move on can you tell me in your own words, how the allowance auction works?
Utilities, brokers and other individuals or groups submit sealed bids and the highest bidders win. There are 125,000 allowances available for auction and you pay what you bid.
Environmental Economics students at Bates have been very successful bidding close to the clearing price (winning bid) by researching the factors that contribute to the price of allowances.
So just to clarify… it is a student project?
It is a class project yes, and it helps us take (Environmental Economic) theory and put it into practice. We are able to examine this program in close detail since we can participate directly.
Why do you feel like this is a valuable exercise?
It teaches students what cap and trade is and why economists promote market mechanisms. An interesting anecdote is that back in 2001 not many students were familiar with the term “cap and trade” but over the past couple of years I have seen an uptick in interest and knowledge level regarding “cap and trade” programs.
It is also valuable for my students to learn how these auctions work. Every year since 2001 we have bought at least one allowance. We explore the positive and negative effects of an allowance trading system.
Here are some great quotes from Dr. Lewis’s students discussing what they have learned about cap and trade and the ARP Allowance Auction.
” I learned a lot about what factors influence the price of tradable SO2 allowances and why it is cost-effective to employ a cap and trade scheme.”
“(I learned about the) understanding of trading and the importance of stringent caps as well as the politics and other factors that make these systems complex.”
“I learned the difference between cap-and-trade and taxes.”
“This exercise helped me get a grasp on how the program actually works.“
Thanks Dr. Lewis for speaking with us!
What do you think about the Acid Rain Program’s SO2 allowance auction? Have you participated in the SO2 Allowance Auction? How do you think SO2 allowances should be auctioned off? Let us know what you think and if you have any questions!
Josh Stewart is the Communications Intern with the EPA’s Clean Air Markets Division. Josh is currently working on his Master’s Degree in Political Management at The George Washington University.
Editor's Note: The opinions expressed here are those of the author. They do not reflect EPA policy, endorsement, or action, and EPA does not verify the accuracy or science of the contents of the blog.
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