Experimental Market Design and Methodology: The Alaska Gas Pipeline

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4 Experimental design

Our experiments are designed to study the feasibility of using auctions to determine the capacity size and ownership shares in a pipeline that would be jointly constructed, and owned and operated by any number of heterogeneous co-tenant investors willing to pay up front the construction cost and thereby acquire capacity rights to the line in proportion to their investment. In subsequent experiments those not part of the original construction cost would be free to acquire rights from existing holders in subsequent auctions that would allow for the exchange of rights among incumbent and potential new users in response to their changing needs for transport services.

We outline here our conception of a three-stage forward-looking treatment of the market determination of initial capacity, and later adaptive exchanges of capacity rights, options on expansions in pumping capacity in combination with the sale of new lease rights for gas exploration.

4.1 Stage one

We begin with the stage one set of experiments, using the learning from each step in the set to fine tune and improve the auction rules based on the observed behavior and efficiency of the allocations.

These experiments will explore the determination of initial capacity size, individual shares, and financing. We will use two sets of experimental environments : a simple single path pipeline and a three leg network more realistic for any potential future Alaska application.

The Stage two environments will require articulation in greater detail, but concern learning from the results how to fine tune the market for options on exploration and shipping capacity, and so on for Stage three. The Stage One experiments illustrate the methodology for all.

4.2 Stage two

Auctioning options on pipeline capacity and exploration lease rights simultaneously for optimal total and individual combination value.

With capacity determined by Stage one a subsequent auction market will occur for lease exploration rights and for changes, as needed, in the ownership of capacity rights. The value associated with new gas exploration contingent on success is for delivered gas; delivered gas requires capacity rights. Therefore, exploration leases will be auctioned simultaneously along with options on capacity rights.

In order to facilitate the packaging of lease rights with options on capacity rights to deliver gas, bidders will be free to bid as desired for combinations of leases and capacity options, and/or separately on each, depending on their diverse individual circumstances. The options for capacity rights are exercisable conditional on lease holder discovery success. Those with excess capacity rights and/or depleting reserves will be the lowest value bidders, and will be the expected sellers of capacity options at auction; those without excess capacity rights and high values will be the expected buyers; transfer prices and the reallocation of capacity rights—who sells and who buys—are determined by the auction outcome.

After the pattern of exploration success and failure has been realized a new round of trading will determine the final reallocation of capacity rights needed to move the new gas to market. This market allows existing holders of options on capacity and/or owned capacity, who are less successful in finding gas, to recover some investment by selling to those who are more successful.

4.3 Stage three

Auctioning rights to new (pumping) capacity on a pipeline built with reserve expansion capacity.

Depending on the prices and outcomes in the stage two auctions and the extent of new gas discovery, operating capacity may be inadequate; this will trigger an auction for converting reserve pipeline capacity into production by increasing pumping capacity. The accepted bids for such expansion will determine who pays for and who receives a corresponding percentage of the increase in operating capacity. Only those who hold reserve capacity can acquire rights to new pumping capacity. However, by allowing combination bids for reserves and operating capacity, a new entrant can bid to obtain the reserve from willing sellers that is needed to qualify him for rights to operating capacity.

Depending on the prices and outcomes in the stage two auctions and the extent of new gas discovery, operating capacity may be inadequate; this will trigger an auction for converting reserve pipeline capacity into increased pumping capacity. The accepted bids for such expansion will determine who pays for and who receives a corresponding percentage of the increase in operating capacity. Only those who hold reserve capacity can acquire rights to new pumping capacity. However, by allowing combination bids for reserves and operating capacity, a new entrant can bid to obtain the reserve from willing sellers that is needed to qualify him for rights to operating capacity.