The United States’ first cap-and-trade program for greenhouse gas emissions is likely to use a regional auction for the allocation of allowances.

In 2009, the 10 northeastern states that compose the Regional Greenhouse Gas Initiative (RGGI) will launch the first cap-and-trade program for greenhouse gas emissions within the United States. RGGI is a regional initiative among several northeastern and mid-Atlantic states aimed at the reduction of carbon dioxide (CO2) emissions from power plants fired by fossil fuels. CO2 emissions will be capped at levels comparable to emission levels at the start of this decade, and then decreased over time to 10 percent below initial cap levels by 2018.

Consensus seems to have been reached among the participating states that the majority of emission allowances to be used for compliance will be allocated via a regional auction as opposed to direct allocation. This differs from prior cap-and-trade programs where allowances were directly allocated for free. Auctions will be conducted with the expectation that a liquid secondary market also will develop for bilateral sales of allowances.

The “Phase II Report on Auction Design and Recommendations” (Phase II Report) was released on October 26, 2007, and contains a series of recommendations with respect to how a regional auction should be designed. These recommendations are described in greater detail below. The first auction is targeted for the second quarter of 2008.

Beginning on January 1, 2009, CO2 emissions from power plants fired by fossil fuels in participating states will be capped at approximately 188 million tons of CO2 for the entire region. Participating states will be assigned a portion of this base limit. Currently 10 states—Connecticut, Delaware, Maine, Massachusetts, Maryland, New Hampshire, New Jersey, Rhode Island and Vermont—are active RGGI participants. This cap will remain in place until 2015 and thereafter decline by 2.5 percent per year so that each state’s annual emissions budget for 2018 will be 10 percent below its 2009 base. Note that some data indicates that the total emission level for the region in 2005 was 185 million tons, and the 2006 level was approximately 165 million tons.

Proposed Regional Auction Structure Highlights

The RGGI Phase II Report contains the following recommendations for a regional auction process:

  • Uniform Price Single-Round Auction – The regional auction should use a uniform price, single-round, sealed-bid auction format to allocate emission allowances.
  • Quarterly Auctions – The regional auction process should implement quarterly auctions for the current compliance period allowances. On each of the quarterly auction days, an auction should be held for current vintage-year allowances, and an auction should be held for a future vintage. First-quarter auctions should include an auction of allowances from the one-year ahead vintage, second-quarter auctions should include an auction for the two-year ahead vintage, and so forth.
  • Reserve Price – A publicly announced reserve price should be used in each auction. Regardless of how the reserve price is set, no bids for allowances should be accepted if the bid price falls below the reserve price.
  • Unsold Allowances – All unsold allowances should be placed into a contingency reserve account and released after a trigger price is met.
  • Qualified Bidders – Auctions should be open to all financially qualified bidders, however no single entity should be able to purchase more than 33 percent of the allowances sold in any one auction.
  • Market Monitoring – RGGI should take advantage of existing monitoring activities by federal and state agencies and other interested parties. RGGI should coordinate with the Federal Energy Regulatory Commission, the U.S. Environmental Protection Agency, the relevant Independent System Operators and the Commodity Futures Trading Commission.

Process Going Forward RGGI states have collectively developed a set of Model Rules that will serve as a guide for each state to utilize as it develops its own regulatory rules to implement RGGI. All participating states are expected to adopt some form of the Model Rules by December 31, 2008. The proposed regional auction design also will need to be reviewed and adopted by each of the participating states. Certain states are considering the development of individual state auctions for allowances if a regional auction design is not uniformly adopted in time. Thus far, five of the 10 participating states have issued draft RGGI rules.