EU ETS: Is the Market Stability Reserve the right tool for remedying oversupply?

FNI Climate Policy Perspectives 12, May 2014

The Emissions Trading Scheme (ETS) is the central plank of EU climate policy. It provides a price signal by placing a cap on emissions, and is neutral as to technology choices. While the cap will be met in 2020, the price signal is now too low, driving down the carbon market price and investment in deploying low-carbon technologies.

The low price is a function of the economic climate since 2009. Demand for allowances has proven highly responsive to GDP, but the supply is fixed for each trading phase. The EU ETS is now oversupplied by 2 billion allowances.

Of the options the EC put to public consultation in 2012, it has now chosen to propose a Market Stability Reserve (MSR), to start in 2021. Its function is to withhold allowances from being auctioned when the market surplus is above 833 MtCO2, and re-inject them when the surplus is below 400 MtCO2. It is also triggered by rapid and extreme price rises.

The MSR is not intended to change the fundamental balance of the market, but to use the current oversupply to protect against high volatility as the market moves from surplus to shortfall. It is based on transparent rules and is to operate impartially. It is also compatible with the future decision on a 2030 target.

The MSR might prove more effective in smoothing the transition from surplus to shortfall if it could take effect earlier and more decisively - for example, withdrawing all backloaded allowances before 2019.

Its general efficacy could be improved if the triggers were based on more recent data than the two years currently proposed.