WEAI/AERE 2012 - Individual Paper Abstract


Title: Emissions Markets, Power Markets and Market Power: An Experimental Analysis

Author(s): Noah DORMADY, Sol Price School of Public Policy, University of Southern California, Los Angeles, CA, USA, 951-897-7282, dormady at usc dot edu. [Picture credit: New Energy Powering Old Pollution, Kijkduin Boulevard, The Hague; Kees deVos, from http://www.flickr.com/photos/devos/78635112/ ]

Abstract:

How will emerging auction-based emissions markets function within the context of today's deregulated auction-based energy markets? This paper provides an experimental analysis of a joint energy-emissions market. The impact of market power with collusion among dominant firms is evaluated to determine the extent to which an auction-based tradeable permit market influences performance in an adjacent energy market. The experimental treatment design controls for a variety of real-world institutional features, including stochastic energy demand, permit banking, inter-temporal (multi-round) dynamics, a tightening cap, and resale. Results suggest that the exercise of market power significantly increases energy auction clearing prices, without significantly increasing emissions auction clearing prices, and in some cases, even significantly suppresses them. The institution of auction-based carbon markets in the already-concentrated energy sector can further strengthen the market position of dominant firms who can leverage energy-emissions market linkages to their operational advantage.

This paper will add to a crucial literature on the interactions between these important markets. Key linkages exist between extant energy markets and emissions markets (Downward 2010; Murray 2009). Past scholarship recognizes the implicit role these energy-emissions linkages played during the California crisis (Joskow and Kahn 2002; Kolstad and Wolak 2003). But it is unclear how these linkages will affect efficiency and performance in both markets under auction-based carbon regimes and imperfect competition in both markets. This paper hypothesizes that when firms who are dominant producers in energy markets are also allowed to be dominant buyers in adjacent auction-based carbon markets, these firms will collusively act to inflate energy prices and suppress emissions prices. Therefore, this paper seeks to test the degree to which these energy-emissions linkages can be operationalized by dominant firms through strategic supply/demand reduction.

Past experiments have been used in a similar vein to look at market power in emissions markets (Godby 2000), market power in auction markets in general (Holt 1989), emissions market allocation methodologies (Wrake et al. 2008), collusion in emissions auctions (Burtraw et al. 2008) real-world features of stochastic emissions and allowance banking (Cason and Gangadharan 2006), and enforcement and compliance under a dynamic market (Stranlund et al. 2011). This paper adds to this important line of scholarship by internalizing greater real-world market dynamics than any prior experimental analysis. Furthermore, this paper adds to this literature by being the first of its kind to analyze a joint energyemissions market using human experimentation.

The experiments were conducted in the University of Southern California Law School and included two key treatment groups. One treatment group simulates a baseline market where all firms are operationally equivalent and symmetric. Alternatively, an experimental treatment group simulates a market that operationalizes market power dynamics found in contemporary auction-based emissions markets. This treatment group includes dominant firms and weaker fringe firms who have diminished pricing influence. Both treatment groups include multi-round dynamics to simulate a declining emissions cap across time with resale.