The Market Stability Reserve (MSR) is a reform in the carbon market designed to provide stability and confidence for installations covered under the EU ETS scheme. Its purpose is to stimulate green technology and energy efficiency by ensuring price stability. The EU ETS has faced a significant oversupply, resulting in record-low prices in recent years. Without intervention, these low prices were projected to persist until the end of Phase IV in 2030. Unlike other commodities, low carbon prices are undesirable, and policymakers aim to drive prices to levels that encourage investment. Informally, the target range is between €15 and €20 in Phase III and €25 in Phase IV.
The introduction of the MSR offers supply-side flexibility, enabling a more stable balance between demand and supply in the EU ETS. This helps counteract negative price impacts during demand-side shocks, such as the global recession experienced recently.
Design:
The MSR will commence on January 1st, 2019, incorporating 900 million tonnes (Mt) of backloaded allowances originally intended for release in 2019 and 2020. The MSR operates with threshold levels set at 833 Mt and 400 Mt. It functions by reducing new supply entering the market through government auctions until the calculated surplus falls below 833 Mt. Allowances within the MSR will only reenter the market if the surplus falls below 400 Mt. A certain surplus is necessary to allow for forward hedging, and the threshold levels are established to accommodate this requirement. The MSR will have a uniform 1% withdrawal rate from the surplus per month (equivalent to 12% annually), and the surplus will be reviewed each September for the upcoming year. In addition to the backloaded allowances, all unallocated allowances from Phase III, estimated to exceed 500 Mt, will be included in the MSR. Among these, 50 Mt will be withdrawn and sold to seed an Innovation Fund, while 250 Mt will be allocated to the New Entrant Reserve (NER) in Phase IV. Importantly, these allowances will only enter the market if new participants join the scheme or companies significantly increase their production.
Forecasted Outcome:
Given the low prices resulting from oversupply in the EU ETS, it is logical to anticipate that structural reforms addressing this oversupply will positively impact prices. Independent price forecasts currently support this notion, predicting EUA prices to at least triple by the end of Phase III (2020), with some projections reaching as high as €30. With such substantial forecasted price increases, industrial participants can no longer afford to ignore the EU ETS and its associated costs. Effective budgeting and strategic planning are crucial for managing expenses and maintaining competitiveness in the face of rising prices and decreasing free allocations.
