EMISSIONS

Market Stability Reserve and the Future of the ETS

The Market Stability Reserve (MSR) is a measure which aims to tackle the issue of a substantial accumulated surplus of allowances in the ETS since 2009.

The surplus of allowances is largely due to the economic crisis – which reduced emissions more than anticipated – and high imports of international credits. This led to lower carbon prices and a weaker incentive to reduce emissions.

In the short term, the surplus of allowances risk undermining the orderly functioning of the carbon market. In the longer term it could affect the ability of the ETS to meet more demanding emission reduction targets in a cost-effective manner.

The surplus amounted to around 2 billion allowances at the start of Phase III, and increased further to over 2.1 billion in 2013.
In 2015, it was reduced to around 1.78 billion as a consequence of back-loading. Without this measure, the surplus would have been almost 40% higher than it was at the end of 2015.

The MSR regulates the amount of auctioning in the European carbon market, and it can withhold allowances from the market – or release allowances into it – based on the following rules:

The basis for the operation of the MSR is the market surplus (legally referred to as “Total Number of Allowances in Circulation”) and defined as: the allowances issued since 2008 + international credits used for compliance since 2008 - verified emissions since 2008 - any allowances cancelled - allowances currently in the MSR. Note that the aviation sector is excluded from this calculation.

On May 15 of each year (year x), the Commission will publish an official estimate for the total number of allowances in circulation for the previous year (x-1). The first publication took place in 2017 and the total of allowances in circulation for 2016 was 1.69 billion. The next publication of the total number of allowances in circulation will take place on May 15, 2018 – and on the basis of that publication, the MSR will begin its operation in January 2019.

Back-Loading of Auctions in Phase III

As a short-term measure the Commission postponed the auctioning of 900 million allowances until 2019-2020.

This ‘back-loading’ of auction volumes does not reduce the overall number of allowances to be auctioned during Phase III, only the distribution of auctions over the period.

The auction volume is reduced by

  • 400 million allowances in 2014
  • 300 million in 2015
  • 200 million in 2016.

Back-loading was implemented through an amendment to the EU ETS Auctioning Regulation, which entered into force on 27 February 2014.

Market Stability Reserve

As a long-term solution, a market stability reserve will start operating in January 2019.

The reserve will:

  • address the current surplus of allowances
  • improve the system's resilience to major shocks by adjusting the supply of allowances to be auctioned.

The 900 million allowances that were back-loaded in 2014-2016 will be transferred to the reserve rather than auctioned in 2019-2020.

Unallocated allowances will also be transferred to the reserve. The exact amount will only be known in 2020. However, market analysts estimate that around 550 to 700 million allowances could remain unallocated by 2020.

The reserve will operate entirely according to pre-defined rules that leave no discretion to the Commission or Member States in its implementation.

Each year, the Commission will publish by 15 May the total number of allowances in circulation. This will serve as the exclusive indicator on

  • whether allowances will be placed in the reserve, and if so how many, or
  • whether allowances will be released from the reserve.

Efforts to address the market imbalance would also be helped by a faster reduction of the annual emissions cap. This is part of the Commission's proposal for the revision of the EU ETS. In this context, discussions are currently being held in the Council and the European Parliament on temporarily doubling the rate at which allowances will be placed in the reserve.

Rules for withholding allowances:

If the published number of allowances in circulation exceeds 833 million tons, 12% of that amount will be withheld from auctions scheduled on September 1st of year [x] to August 31 of year [x+1].

The MSR will begin withholding allowances in January 2019.

How exactly will the MSR impact auctioning in any given year? Using 2019 as an example – the timing mentioned above means that 8% of the volume announced on 15 May 2018 will be withheld from auctioning from January to August, and 4% of the volume announced on 15 May 2019 will be withheld from auctioning from September to December.

Rules for releasing allowances:

If the published number of allowances in circulation is lower than 400 million tons, 100 million allowances will be released into the auctions scheduled from 1 September of year [x] to 31 August of year [x+1]. If the amount of allowances in the reserve is lower than 100 Mt, all allowances will be released.

Miscellaneous allowances:

The 900 million allowances that were withheld from the market in the years 2014-2016 (as a result of the "backloading" decision) will be placed in the MSR in 2019 and 2020.

Allowances that remain unallocated during phase 3 due to closures, capacity reductions, or partial cessations will be placed in the MSR in 2020. However, the MSR Decision adopted by the Parliament and the Council gives the European Commission the option of proposing an alternative use for some of these allowances and it remains unclear what percentage of the unallocated allowances will end up in the MSR. As of 15 July 2015, our expectation is that 250 Mt will be released back into the market through the New Entrant’s Reserve for Phase 4.

Periodic Reviews

The Commission will publish, within three years of the start of the MSR’s operation and at five-year intervals thereafter, a report reviewing the effectiveness of the mechanism. Where the report indicates that the range is no longer deemed appropriate, the EC should “swiftly” submit a proposal to address this situation, by changing the rules governing the MSR.