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Steven Stoft

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Papers by Steven Stoft

Kyoto's Climate Game and How to Fix it

Social Science Research Network, 2010

The Kyoto summit initiated an international game of cap and trade. Unlike a national cap-andtrade... more The Kyoto summit initiated an international game of cap and trade. Unlike a national cap-andtrade policy, the essence of this game is the self-selection of national emission targets. This is like the standard global public-goods game except that targets are met in the context of a global carbon market. This changes the outcome of the notoriously uncooperative public-goods game. The equilibrium of the new game may increase or decrease total abatement. If it increases abatement, the resulting carbon price will be no greater than the average public-goods price. Typically, high abaters in the public goods game will target more abatement in the cap-and-trade game, while low abaters will target less. Given such a dismal outcome the Kyoto game should be changed to the global price-target game. In the same setting where cap-and-trade reduces abatement, this game induces optimal abatement. But, realistically, it must include a Green Fund whose strength is linked to the price target. This will induce poor countries to favor as high a price target as rich countries, reversing the polarizing and anti-cooperative tendencies of cap and trade. The Kyoto climate summit began stage one of the international cap-and-trade game. The outcome was not as intended. Instead we have "hot air" for the former Soviet Union, business-as-usual caps for the poor, and binding caps for some cooperative countries. The U.S. and Australia refused to play. Although unexpected, these outcomes loosely reflect the game's non-cooperative outcome (Nash equilibrium). As stage one drags on, national behaviors have continued to follow a key prediction of game theory-polarization of abatement efforts between developed and developing countries. The net result has been little progress and much acrimony. While these outcomes were anticipated by some, the rigorous analysis of the international cap-and-trade game deserves special attention. Published in 2003 by Carsten Helm and expanded and clarified by Holtsmark and Sommervoll in 2008, it has been ignored too long.

Colombia Firm Energy Market

A firm energy market for Colombia is presented. Firm energy-the ability to provide energy in a dr... more A firm energy market for Colombia is presented. Firm energy-the ability to provide energy in a dry period-is the product needed for reliability in Colombia's hydrodominated electricity market. The firm energy market coordinates investment in new resources to assure that sufficient firm energy is available in dry periods. Load procures in an annual auction enough firm energy to cover its needs. The firm energy product includes both a financial call option and the physical capability to supply firm energy. The call option protects load from high spot prices and improves the performance of the spot market during scarcity. The market provides strong performance incentives through the spot energy price. Market power is addressed directly: existing resources cannot impact the firm energy price. Since load is hedged from high spot prices, the market can rely on high prices to balance supply and demand during dry periods, rather than rationing. 1 This paper was funded by Colombia's Comisión de Regulación de Energía y Gas (CREG). We thank the commissioners and staff for many helpful comments.

Global Carbon Pricing: The Path to Climate Cooperation

The MIT Press eBooks, 2017

Pledge-and-review was invented for the United Nations Framework Convention on Climate Change (UNF... more Pledge-and-review was invented for the United Nations Framework Convention on Climate Change (UNFCCC) by Japan in 1991, and it hasn't changed much since. It's what happened in Kyoto, although they tried hard to avoid the fate of each country simply pledging to do whatever it wanted followed by unenforced reviews. It's what happened under the Copenhagen Accord and the Cancún Agreements. And it's what happened again in Paris. At least under Kyoto there was a bit of structure. Countries picked commitment levels relative to 1990. But within the European Union (EU), these ranged from a 30% cut to a 40% increase. There was virtually no structure in Paris; countries pledged almost anything. Now they will review it. And then there may be more pledges and more reviews. Elinor Ostrom, a political scientist, won the 2009 Nobel Prize in economics for her lifelong studies of common-pool dilemmas-one of which is climate change. And her work is part of an enormous literature describing hundreds of real-world systems, thousands of laboratory experiments, and a great deal of theory. Yet after 25 years of failure, climate negotiations stick with an approach that ignores what we know about human cooperation. To save the commons, the users of the commons must cooperate. That requires trust, and trust requires a reciprocal agreement-we will if you will, and you will if we will. For a group, especially a group of 10 or 100 countries, finding a reciprocal agreement requires simplification to a common commitment. Finding that commitment, and finding how to strengthen and stabilize it-that's the job undertaken by this book. But before you delve into that, we would like to show you a sort of magic trick. xii Preface Negotiation design matters. We will now take a group of 10 completely selfish individuals and show you how they cut each other's throats in one game. Then, changing one rule-so they make common commitments instead of individual commitments-you will see those very same people, their temperaments unchanged, cooperate like angels. You and nine other cut-throat individuals (representing countries) play a game. Each player has $10, of which each must simultaneously pledge some part to the common pot. A referee makes sure they honor their pledges but uses two different rules, one per game, for what it means to "honor a pledge." Every dollar (for CO2 abatement) placed in the pot will be doubled (by natural climate benefits) and distributed evenly to all players. So any dollar placed in the pot will be doubled to $2, and 20 cents will be returned to each player. First, in the "individual commitment" game, all pledges are independent of those of others. So the referee makes sure each contributes exactly what he or she pledges. This is the classic public-goods game, and the rational strategy for the narrowly self-interested player is to contribute nothing because this makes a player better off no matter what the others do. The result is the famous tragedy of the commons. Cooperation does not occur, except perhaps on the part of a few committed altruists, who correctly note that if only everyone cooperated, everyone would be better off. Second, consider the "common commitment" game, in which the rule is that the referee interprets a pledge of $x to mean a player will contribute up to $x, but only as much as the lowest pledge. As before, this involves enforcement, but enforcement is weaker in the sense that, unlike before, the referee will not enforce contributions greater than the lowest pledge.

International Climate Games: From Caps to Cooperation

Social Science Research Network, 2010

Greenhouse gas abatement is a public good, so climate policy is a public-goods game and suffers f... more Greenhouse gas abatement is a public good, so climate policy is a public-goods game and suffers from the free-rider incentives that make the outcome of such games notoriously uncooperative. Adopting an international agreement can change the nature of the game, reducing or exacerbating the uncooperative tendencies of the players. We analyze alternative international agreements as variations of the public-goods game, and examine the incentives for cooperation under each alternative. The addition of cap-and-trade rules to the basic public-goods game is found to polarize the free-rider incentives of that game, encouraging those who would abate the most to target even higher abatement levels and those who would abate the least to target lower, and even negative, abatement levels. Such polarization between developed and developing countries is familiar from both the Kyoto and Copenhagen climate summits. R Re es se ea ar rc ch h P Pa ap pe er r N No o. .

Why We Need to Stick with Uniform-Price Auctions in Electricity Markets

The Electricity Journal, 2007

Over the last 20 years, he has published research on auction theory and practice in the leading p... more Over the last 20 years, he has published research on auction theory and practice in the leading peer-reviewed economics journals. During the last 12 years, he has applied this research in the design and implementation of auction markets worldwide, especially in North America and Europe. He has led the design and implementation of dozens of high-stake auctions in the energy and telecommunication industries. He has advised over 26 companies on bidding strategy in energy and telecommunication auctions. Since 1998, he has advised ISO New England on electricity market design, and with Steven Stoft led the design of the proposed forward capacity auction in New England. He received his B.S. in Engineering from Cornell University and his Ph.D. in Business from Stanford University.

Capacity Market Fundamentals

Economics of energy & environmental policy, Apr 1, 2013

Electricity capacity markets work in tandem with electricity energy markets to ensure that invest... more Electricity capacity markets work in tandem with electricity energy markets to ensure that investors build adequate capacity, in line with consumer preferences for reliability. The need for a capacity market stems from several market failures. One particularly notorious problem of electricity markets is low demand flexibility. Most customers are unaware of the real time prices of electricity, have no reason to respond to them, or cannot respond quickly to them, leading to highly price-inelastic demand. This contributes to blackouts in times of scarcity and to the inability of the market to determine the marketclearing prices needed to attract an efficient level and mix of generation capacity. Moreover, the problems caused by this market failure can result in considerable price volatility and market power that would be insignificant if the demand-side of the market were fully functional. Capacity markets are a means to ensure resource adequacy while mitigating other problems due to the demand side flaws. Our paper describes the basic economics behind the adequacy problem and addresses important challenges and misunderstandings in the process of actually designing capacity markets. 1 This paper builds on earlier work, which often provides much expanded discussions and derivations, including

Symposium on "International Climate Negotiations" - Introduction

Economics of Energy and Environmental Policy, 2015

Once again there is hope that a strong international agreement will emerge from the annual-now th... more Once again there is hope that a strong international agreement will emerge from the annual-now the 21st annual-United Nations Conference of the Parties. Before Kyoto, we hoped that the new Protocol would eventually grow into a universal commitment similar to reducing emissions by some percent below 1990 levels, and this would translate into a uniform price on carbon. Instead, repeated negotiation failures led the world to abandon the ideas of having a common commitment and a uniform price after the Copenhagen conference. In the hope of finding a way to repair these failures, we invited renowned experts on climate policy and the economics of cooperation, not just to present their ideas, but to discuss and debate them as they wrote their papers. The continuing discussion has been lively. All authors agree that what was lost at Copenhagen needs to be rediscovered, and that carbon price coherence is not all that is needed, but it is an essential element. While all agree that carbon price coherence is central, that is of no value if it cannot be negotiated. And that negotiation failure has been the sticking point for two decades. A better approach to negotiation will be needed, and so we have made "how to negotiate" the focus of this symposium. This focus requires a distinction that is often overlooked. Two things matter most to the success of a negotiation: what outcome you aim for and how you go about getting there. Everyone knows this, but it is easier to focus on what you want than on how to structure the negotiations. So the "how" part is usually ignored and almost never analyzed systematically. In fact, the "how" part is so important that all papers in this symposium conclude that the Paris approach to the negotiations, pledge and review, will fail because it fails to inhibit free riding. And three papers conclude that the Kyoto approach, attempting to negotiate commitments to national emission quantities, will doom any negotiation process for the same reason. The underlying starting point of all papers is that climate change is a tragedy of the commons and hence characterized by the free-rider dilemma. All authors agree that a uniform global price on carbon is what they want to solve the climate dilemma (although none insist on perfect uniformity). But by examining how to overcome a free-rider dilemma, they all arrive at a critical conclusion: climate change cannot be solved by a patchwork of volunteerism, as Weitzman calls the approach adopted for the Paris conference. And Gollier and Tirole conclude that the "pledge-and-review" approach "will deliver appealing promises and renewed victory statements, only to prolong the waiting game." Again, all authors agree. As an alternative, all four papers of this symposium propose to negotiate an international commitment. Importantly, international commitments are not national policies. Indeed, the commitments under consideration allow for similar national polices that can range from

How to Fix the Inefficiency of Global Cap and Trade

The Economists' Voice, Jan 24, 2012

An International Carbon-Price Commitment Promotes Cooperation

Economics of energy & environmental policy, Apr 1, 2015

To promote cooperation in international climate negotiations, negotiators should focus on a commo... more To promote cooperation in international climate negotiations, negotiators should focus on a common commitment. Such commitments have the advantage of facilitating reciprocal "I will if you will" agreements in a group. Reciprocity is the basis for cooperation in repeated public goods games, and a uniform price would provide a natural focal point for a common international commitment. Such a price is also essential for efficient abatement. Countries would retain flexibility in how to implement the price-with cap-and-trade, a carbon tax, or a hybrid approach. Country risk is reduced relative to risk under international cap-and-trade since carbon revenues stay within the country. Price commitments also tend to equalize effort intensity and can facilitate enforcement. To encourage participation by less-developed countries, a green fund is needed to transfer money from richer to poorer countries. Transfers are smaller and more predictable with a uniform price commitment than with international cap and trade.

A Capacity Market that Makes Sense

The Electricity Journal, Aug 1, 2005

We argue that a capacity market is needed in most restructured electricity markets, and present a... more We argue that a capacity market is needed in most restructured electricity markets, and present a design that avoids problems found in the early capacity markets. The proposed market only rewards capacity that contributes to reliability as demonstrated by its performance during hours in which there is a shortage of operating reserves. The capacity price responds to market conditions, increasing when and where capacity is scarce and decreasing to zero when and where it is plentiful. Market power in the capacity market is addressed by basing the capacity price on actual capacity, rather than bid capacity, so generators cannot increase the capacity price by withholding supply. Actual peak energy rents (the short-run energy and reserve profits of a benchmark peaking unit) are subtracted from the capacity price. This allows the capacity market to more accurately control short-run profits and suppresses market power in the energy market. This design both avoids and hedges energy market risk, and by suppressing market power avoids regulatory risk. Risk reduction saves consumers money as do the performance and investment incentives inherent in the pay-for-performance mechanism. Capacity markets have proven to be one of the most contentious elements of electricity restructuring. Many argue there is no need for a capacity market. Others argue that, while they may be needed, the current designs are woefully inadequate, and are dominated by having no market at all (Cramton 1999) or alternative instruments (Chao and Wilson 2004; Oren 2004). Still others argue capacity markets are essential for encouraging sufficient investment in new capacity (Besser, Farr and Tierney 2002; Stoft 2002). We argue that a capacity market is needed in most restructured electricity markets, and present a design that avoids the many problems found in the early capacity markets. ISO New England (ISO-NE) has proposed a design for the New England market that relies on the principles we present here. Fundamentally, the capacity market we propose is an incentive mechanism to induce supply to invest in sufficient generation in the right locations and of the right type to satisfy a reliability standard at least cost. The capacity market provides strong incentives for suppliers to perform when most needed, reduces risk for both generators and load, and addresses market power both in the capacity market and in the spot energy market.

Some Political Economy of Global Warming

Economics of energy & environmental policy, 2012

Global Climate Policy: Why and How to Change Course

Social Science Research Network, 2012

ABSTRACT Climate negotiations have largely failed, so a change of course is required. This requir... more ABSTRACT Climate negotiations have largely failed, so a change of course is required. This requires that a sizable group of experts recommend a small, clear set of policy guideposts that lead to a more cooperative treaty. This papers proposes a set of three guideposts and derives them from an analysis of the current policy failure. That failure is often blamed on insufficient “political will.” But the real problem is that international cap and trade prevents the harnessing of self interest. However, a treaty that specifies a global carbon price can harness self interest, and will therefore result in cooperation and a higher carbon price than under cap and trade. Nations that commit to the global price can comply by using either taxes or cap and trade programs. A Green Fund would be used to fairly adjust the burden of a uniform price commitment.

Global Climate Games: How Pricing and a Green Fund Foster Cooperation

Economics of energy & environmental policy, Apr 1, 2012

The most efficient global climate policy is to price carbon. The Kyoto-Copenhagen agenda was inte... more The most efficient global climate policy is to price carbon. The Kyoto-Copenhagen agenda was intended to do this with a system of international cap and trade. We view these negotiations as a game in which countries choose their quantity targets based on self interest. Like the analogous public-goods game, in which countries choose their abatement levels, we find this game leads to uncooperative behavior and suggest that this is why the Kyoto approach inevitably failed. By contrast, a game in which all countries vote for a global quantity target or a global price target can lead to a highly cooperative choice of target. However, the assignment of responsibilities for a global quantity target stymies implementation of a global cap. The global-price-target game largely overcomes this barrier, because a uniform global price provides a focal point for cooperation. However low-emission countries apparently prefer a much lower global-price than more prosperous countries unless a Green Fund is implemented. A game that couples such a fund to the global price target can largely overcome this barrier to cooperation. We describe such a game along with its equilibrium outcome, which promises to be inexpensive and cooperative.

Price Is a Better Climate Commitment

The Economists' Voice, Jan 5, 2010

M itigation. Transparency. Financing." That was President Obama's formula for Copenhagen. While e... more M itigation. Transparency. Financing." That was President Obama's formula for Copenhagen. While emission caps may appear transparent, their consequences are opaque, and they impose financial risk rather than provide financing. Caps satisfy only the first part of Obama's formula. Moreover they have been rejected once again by all developing countries, which will leave the bulk of emission increases in the coming years uncapped and outside of any carbon pricing regime.

Simulation of the Colombian Firm Energy Market

RePEc: Research Papers in Economics, 2006

Symposium on International Climate Negotiations

Once again there is hope that a strong international agreement will emerge from the annual-now th... more Once again there is hope that a strong international agreement will emerge from the annual-now the 21st annual-United Nations Conference of the Parties. Before Kyoto, we hoped that the new Protocol would eventually grow into a universal commitment similar to reducing emissions by some percent below 1990 levels, and this would translate into a uniform price on carbon. Instead, repeated negotiation failures led the world to abandon the ideas of having a common commitment and a uniform price after the Copenhagen conference. In the hope of finding a way to repair these failures, we invited renowned experts on climate policy and the economics of cooperation, not just to present their ideas, but to discuss and debate them as they wrote their papers. The continuing discussion has been lively. All authors agree that what was lost at Copenhagen needs to be rediscovered, and that carbon price coherence is not all that is needed, but it is an essential element. While all agree that carbon price coherence is central, that is of no value if it cannot be negotiated. And that negotiation failure has been the sticking point for two decades. A better approach to negotiation will be needed, and so we have made "how to negotiate" the focus of this symposium. This focus requires a distinction that is often overlooked. Two things matter most to the success of a negotiation: what outcome you aim for and how you go about getting there. Everyone knows this, but it is easier to focus on what you want than on how to structure the negotiations. So the "how" part is usually ignored and almost never analyzed systematically. In fact, the "how" part is so important that all papers in this symposium conclude that the Paris approach to the negotiations, pledge and review, will fail because it fails to inhibit free riding. And three papers conclude that the Kyoto approach, attempting to negotiate commitments to national emission quantities, will doom any negotiation process for the same reason. The underlying starting point of all papers is that climate change is a tragedy of the commons and hence characterized by the free-rider dilemma. All authors agree that a uniform global price on carbon is what they want to solve the climate dilemma (although none insist on perfect uniformity). But by examining how to overcome a free-rider dilemma, they all arrive at a critical conclusion: climate change cannot be solved by a patchwork of volunteerism, as Weitzman calls the approach adopted for the Paris conference. And Gollier and Tirole conclude that the "pledge-and-review" approach "will deliver appealing promises and renewed victory statements, only to prolong the waiting game." Again, all authors agree. As an alternative, all four papers of this symposium propose to negotiate an international commitment. Importantly, international commitments are not national policies. Indeed, the commitments under consideration allow for similar national polices that can range from

Uniform-Price Auctions in Electricity Markets

Over the last 20 years, he has published research on auction theory and practice in the leading p... more Over the last 20 years, he has published research on auction theory and practice in the leading peer-reviewed economics journals. During the last 12 years, he has applied this research in the design and implementation of auction markets worldwide, especially in North America and Europe. He has led the design and implementation of dozens of high-stake auctions in the energy and telecommunication industries. He has advised over 26 companies on bidding strategy in energy and telecommunication auctions. Since 1998, he has advised ISO New England on electricity market design, and with Steven Stoft led the design of the proposed forward capacity auction in New England. He received his B.S. in Engineering from Cornell University and his Ph.D. in Business from Stanford University.

The convergence of market designs for adequate generating capacity with special attention to the CAISO's resource adequacy problem

RePEc: Research Papers in Economics, Apr 1, 2006

This paper compares market designs intended to solve the resource adequacy (RA) problem, and find... more This paper compares market designs intended to solve the resource adequacy (RA) problem, and finds that, in spite of rivalrous claims, the most advanced designs have nearly converged. The original dichotomy between approaches based on long-term energy contracts and those based on short-term capacity markets spawned two design tracks. Long-term energy contracts led to call-option obligations which provide marketpower control and the ability to strengthen performance incentives, but this approach fails to replace the missing money at the root of the adequacy problem. Hogan's (2005) energy-only market fills this gap. On the other track, the short-term capacity markets (ICAP) spawned long-term capacity market designs. In 2004, ISO New England proposed a short-term market with hedged performance incentives essentially based on high spot prices. In 2005, we developed for New England a forward capacity market, with load obligated to purchase a target level of capacity covered by an energy call option. The two tracks have now converged on two conclusions: (1) High real-time energy prices should provide performance incentives. (2) High energy prices should be hedged with call options. We argue that two more conclusions are needed: (3) Capacity targets rather than high and volatile spot prices should guide investment, and (4) Long-term physically based options should be purchased in a forward market for capacity. The result will be that adequacy is maintained, performance incentives are restored, market power and risks are reduced from present levels, and prices are hedged down to a level below the present price cap. Proposed solution. To solve the RA problem, the missing money must be restored without reintroducing the market power problems currently controlled by price suppression. Moreover, inadequate investment is not the only problem caused by energyprice suppression; it is only the most obvious. Crucial performance and quality incentives are also missing. All of these problems can be solved with a three step design process. Step 1: Design full-strength spot prices Step 2: Hedge all load with call options Step 3: Purchase an adequate level of hedged capacity The full-strength, High Spot Prices solve the problems caused by suppressing spot prices, but would reintroduce market power and risk problems were they not hedged. Call options that cover all load eliminate these side effects while perfectly preserving the performance and quality incentives of the high prices. All that remains, to restore the missing money and induce an adequate level of capacity, is to pay enough for the capacity-backed hedges. Either a short-term or a forward capacity market (FCM) can be used to buy the capacity at the market price. An FCM is recommended. It buys capacity three years in advance, and gives new capacity multi-year contracts. Existing capacity receives annual contracts at a similar price. The combination provides a low-risk environment for investors, which greatly reduces the risk premiums passed on to load. What the market can't do. The market, without administrative guidance, cannot determine what level of installed capacity is needed to provide adequate reliability. This is a consequence of two Demand-Side Flaws caused by infrastructure problems that will not be remedied for perhaps another decade or more. The administrator has only two choices: set key market parameters without regard for their investment consequences, or adopt a conscious resource adequacy program. This point is important, because one of the most widely accepted reasons for choosing one RA approach over another is the notion that one provides more (or complete) market guidance with respect to how much capacity is adequate. Unfortunately, current markets provide no guidance whatsoever, except by passing through guidance (or confusion) from administrators. For example, MISO states "The principal reason for considering an energy-only market approach … is the expectation that it would allow market incentives, rather than centralized administrative direction, to drive investment decisions." This reason is not correct. The energy-only approach. Hogan's (2005) proposal of an energy-only approach is the inspiration for the MISO's hope of avoiding centralized administrative direction. Yet the transfer of missing money used by that proposal to solve the adequacy problem is controlled by an administratively determined energy+reserve demand curve. The parameters set by administrators fully control the flow of all scarcity revenues above the variable cost of a new peaker. That could amount to $4 billion annually in a 50 GW market. Hence, the energy-only approach, if designed to restore missing money, is nomore free of central planning than an ICAP approach.

Forward reliability markets: Less risk, less market power, more efficiency

Utilities Policy, Sep 1, 2008

A forward reliability market is presented. The market coordinates new entry through the forward p... more A forward reliability market is presented. The market coordinates new entry through the forward procurement of reliability options-physical capacity bundled with a financial option to supply energy above a strike price. The market assures adequate generating resources and prices capacity from the bids of competitive new entry in an annual auction. Efficient performance incentives are maintained from a load-following obligation to supply energy above the strike price. The capacity payment fully hedges load from high spot prices, and reduces supplier risk as well. Market power is reduced in the spot market, since suppliers enter the spot market with a nearly balanced position in times of scarcity. Market power in the reliability market is addressed by not allowing existing supply to impact the capacity price. The approach, which has been adopted in New England and Colombia, is readily adapted to either a thermal system or a hydro system.

How to Negotiate Ambitious Global Emissions Abatement A Statement of Key Principles and an Explanatory Note

Ockenfels thanks the German Science Foundation for support through the Leibniz program and the re... more Ockenfels thanks the German Science Foundation for support through the Leibniz program and the research unit "Design & Behavior" (FOR 1371). Steven Stoft consults on electricity market design and is the author of Carbonomics and Power System Economics. Their research on climate policy can be found at www.pricecarbon.info and www.cramton.umd.edu/papers/climate. Statement on a Global Carbon-Price Commitment* To strengthen national commitments to reduce global carbon emissions, we propose that countries commit to a common global carbon-price path. These commitments would: * This proposal is only intended to address emissions of CO 2 and other GHGs. Separate design efforts are needed for Land Use, Land Use Change and Forestry (LULUCF) and for energy research.