Tradable Carbon Allowance Auctions: How and Why to Auction

March 1998 | Peter Cramton, Suzi Kerr

Part of the Airlie Carbon Trading Papers, this report argues that an auction is the best way to allocate allowances in a carbon cap-and-trade system.To minimize administrative costs, allowances would be required primarily at the level of oil refineries, natural gas pipelines, natural gas liquid sellers, and coal processing plants. To maximize liquidity in secondary markets, allowances would be fully tradable and bankable. The government would conduct quarterly auctions. A standard ascending-clock auction in which price is gradually raised until there is no excess demand would provide reliable price discovery. An auction is preferred to grandfathering (giving polluters allowances in proportion to past pollution), because it would allow reduced tax distortions, provide more flexibility in distribution of costs, provide greater incentives for innovation, and reduce the need for politically contentious arguments over the allocation of rents.

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