The Stability Reserve in EU Carbon Emission Trading

Abstract

In recent years the Europe Unions emission trading system (EU ETS) has experienced very low prices. This has triggered a political discussion about stabilising the EU ETS and improving incentives for investing in CO2 abatement. As a result of this discussion, the EU parliament accepted a proposal of the EU commission on the backloading of EU emission allowances (EUA), where the auctioning of EUAs is postponed to future time periods. Secondly the EU commission proposed a market stability reserve (MSR), which is a quantity based stabilisation policy, triggered by the amount of EUAs in circulation. Both policy measures together mark a significant change of the EU ETS policy framework. Using an agent-based electricity market simulation with endogenous investment and a CO2 market (including banking), we analyse the backloading reform and the proposed market stability reserve. We find backloading to have a short-term impact of CO2 prices; however, with and without backloading the EU ETS shows a risk of high CO2 prices and volatility. The market stability might act counter to its objectives: we found it to create a scarcity of credits and following this a high risk of CO2 price shocks and CO2 price volatility. This is because the target corridor for banking of the MSR is set below the hedging need of power producers.