Backloading and the Market Stability Reserve: A Path to Carbon Price Recovery

Backloading, introduced in 2014, is a reform measure implemented in the carbon market to boost carbon prices and incentivize investments in low-carbon technologies. By temporarily reducing the supply of allowances entering the market through regular government auctions, a shortage in the year-on-year balance of allowances is created. This scarcity increases the likelihood of price increases, assuming that demand surpasses supply.

The carbon market faced challenges due to a combination of economic slowdown and an influx of UN Offset allowances within the EU ETS, leading to a significant oversupply. This oversupply caused prices to plummet from around €30 per tonne in 2005 to below €3 per tonne in 2013. With the oversupply exceeding 2 billion allowances, representing more than one year’s total emissions for the entire EU ETS, the European Commission recognized the need for market reform. Backloading was the first of three structural reform measures, with the market stability reserve (MSR) also being established as a law in 2015. The Phase IV proposal is currently in progress, with completion expected in late 2016 or early 2017.

The backloading process is relatively straightforward: it temporarily reduces the primary supply of allowances entering the market through government auctions in the near term, with the intention of reintroducing them later. The volumes of allowances reduced through backloading were as follows:

  • 2014: 400 million tonnes (Mt)
  • 2015: 300 Mt
  • 2016: 200 Mt

Originally, the backloaded allowances were scheduled to re-enter the market in 2019 and 2020, in addition to the regular auction volumes for those years. However, the establishment of the MSR ensured that these 900 Mt would not re-enter the market during those years, but instead, they would be added to the MSR. Backloading alone could only increase prices in the short term since the total number of allowances in circulation by the end of Phase III would remain the same. The creation of the MSR prevented a flood of allowances from hitting the market in 2019 and 2020, which was projected to push prices back down to the levels witnessed in 2013.