Carbon Auction Revenue and Market Power: An Experimental Analysis

State and regional governments in the U.S. and abroad are looking to market-based approaches to mitigating greenhouse gas emissions from the electric sector, and in the U.S. as a compliance approach to meeting the aggressive targets of the Environmental Protection Agency (EPA)’s Clean Power Plan. Auction-based approaches, like those used in the Northeast U.S. and California, are both recommended strategies under the Plan and attractive to state governments because they can generate significant revenue from the sale of emissions permits. However, given the nature of imperfect competition in existing electricity markets, particularly at the state and regional level, the issue of market power is a concern at the forefront. This paper provides the results from a controlled laboratory experiment of an auction-based emissions market in the electricity sector. The results show that government revenue from auctioning emissions permits is substantially lower when market concentration is only moderately increased. The results hold significant implications for states and other subnational governments that have high revenue expectations from the auctioning of emissions permits.