The market stability reserve
Surplus of allowances in the EU ETS can pose a threat to the functioning of the ETS. The presence of the surplus and the resulting low price may affect participants in the EU ETS to not take measures to reduce emissions. This could in turn lead to a deviation from the most cost-effective way to reach long-term emission reduction targets.
The large surplus has led to a low carbon price in the emissions trading system, which reduces the price incentive for carbon dioxide investments.
The Market Stability Reserve (MSR) is a rule-based mechanism that enables the delivery of allowances to respond to changes in demand, thus maintaining the balance of the EU ETS.
The market stability reserve aims to provide a long-term solution to the current imbalance in the market because of a growing surplus of allowances that have accumulated since 2009. The mechanism should also be able to manage any future imbalances.
By controlling the number of allowances available at auctions under the MSR rules, a flexible supply of allowances is achieved.
The function is designed as an objective and rule-based mechanism with automatic adjustment of auction volumes according to predefined conditions:
- Allowances corresponding to 12% of the number of allowances on the market are withheld from auctions and thereby the market. They are added to the reserve when the surplus in the market exceeds 833 million allowances.
- Additions up to 100 million allowances are injected into the market through increased auctioning. They are taken from the reserve if the surplus on the market decreases to less than 400 million allowances.
- If the surplus of allowances on the market does not decrease to less than 400 million but if the price of an emission allowance for more than six consecutive months is three times higher than the average price over the last two years, up to 100 million allowances are injected into the market through an increase of auction volumes with units from the reserve.
The market stability reserve will maintain the surplus of allowances (the number of allowances available on the market) at certain levels. The total number of allowances in the ETS is determined for each year as the difference between the number of allowances issued and the number used for completion. International credits and allowances already placed in the reserve are also taken into account.
By using the total number of allowances on the market as an indicator, imbalances resulting from unexpected market impact and affecting demand can be handled. This allows the EU ETS to maintain the objective of reducing emissions in a cost-effective and economically efficient manner, even if unexpected circumstances should arise.
A first step to addressing the problem in the short term was taken by the European Commission through so-called backloading. This was done through a decision to postpone auctions of 900 millionallowances. These allowances were scheduled to be auctioned during 2014-2016 but the auctions were postponed to 2019-2020 by an addition to the so-called auctioning regulation.
This measure aimed at rebalancing supply and demand of allowances in the short term, to improve the overall function of the third EU ETS phase.
A decision has later been made, which means that the 900 million units instead of being auctioned, are moved into the so-called market stability reserve.