Designing auctions for different environmental commodities

6 Feb 2014

Auctions have proven their worth as an efficient and cost effective tool for the public purchase of environmental commodities such as water, carbon and biodiversity.

But there are many different ways to design and implement an auction, and the details matter.

Well designed auctions use competition to reveal information from participants, and minimise the potential for strategic bidding.

A key issue is the choice of pricing mechanism. Here, economic theory, laboratory experiments and real-world experience indicate that the uniform-pricing format is in the majority of circumstances the most efficient mechanism, particularly for repeated auctions targeting well known commodities such as water and carbon.

The discriminatory price (‘pay as bid’) format is generally less effective at revealing true costs, resulting in higher prices being paid on average (or in a budget-constrained auction, a lower quantity being purchased). However, if an auction is likely to be dominated by a small number of sellers, offering supply schedules rather than single projects, the choice of auction format is less clear cut.

Environmental auctions often have the potential to deliver a range of benefits in addition to the targeted commodity. For example, some carbon projects offer substantial other environmental and social co-benefits such as biodiversity or Indigenous cultural values.

These can be sought alongside carbon in an auction, through eligibility criteria or weighting projects based on their co-benefits, but this will inevitably come at a cost in terms of the price of quantity of carbon that can be purchased.

There are many details in auction design which can significantly impact on performance (in terms of bid prices and quantities purchased).

Expert advice and experimental testing can prove invaluable in getting these details right. Where some potential participants are unfamiliar with auctions, training and support should be considered.

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