While the ERF was developed with the intention of purchasing abatement at ‘least cost’, in practice, businesses have a clear incentive to inflate their bids well above the cost of reducing emissions – known as “bid-shading”.
In this Market Update we examine the impact of bid-shading on ERF market dynamics, with analysis indicating that rather than bid at ‘least cost’, companies will inflate their bids towards the highest clearing price – irrespective of their project costs – with more advanced companies to optimise their expected value by accepting a lower chance of winning in return for a higher pay-off if they win.
Bid-shading will therefore create a ‘false’ auction cost curve, whereby high cost abatement may be contracted before lower cost projects, while low cost projects may be bid in at a considerable premium, disrupting the Regulator’s objective of purchasing abatement at “…the lowest price at which it is worth your while to undertake the project”.
With the majority of companies expected to inflate their bids towards the highest possible price, analysis indicates that the average price of abatement will climb toward the high end of bids, and will rapidly converge on the maximum clearing price over subsequent options.
Please login to access our full Carbon Market Update (PDF) report, titled “Gaming the ERF? The Role of Bid-Shading & Maximising Returns”, published under our Carbon Market Intelligence service.
