Recognising the problems with the EU Emissions Trading Scheme, including a vast surplus of carbon allowances, and a continually low carbon price, the European Commission has proposed a Market Stability Reserve to fix the scheme. Sandbag has responded, in this briefing (PDF). A summary of the problems with the proposal and our recommendations are below.
Areas of concern
There is considerable merit in the principle of introducing a Market Stability Reserve. There are, however, potential issues with some elements of the proposal as it stands. Three design elements are of particular concern:
- Late implementation: the reserve does not become operational until 2021
- Sensitive hedging assumptions: the reserve sets fixed supply triggers which risk significantly under or over-adjusting supply if its hedging assumptions are mistaken.
- Slow response time: the reserve takes two years to react to changes in supply
Sandbag recommends the following changes to the proposal:
- Recommendation 1: Start the Market Stability Reserve immediately (Page 5)
The Market Stability Reserve should be agreed and implemented as soon as possible (instead of 2021, as in the Commission proposal) and the 900 million backloaded allowances should not re-enter the market.
- Recommendation 2: Make supply triggers and adjustments less sensitive to error (Page 7)
a) The supply adjustments made by the MSR should be 33% of the difference between the supply and the nearest supply trigger (not a fixed 100 million allowances, as in the Commission proposal)
b) Making the supply triggers decline predictably over time in line with the Linear Reduction Factor (instead of fixing them at 400 to 833 million allowances, as in the Commission proposal)
- Recommendation 3: Improve the response-time of the Market Stability Reserve (Page 10)
We recommend that the Market Stability Reserve should alter the auction calendar from the start of July, two months after the compliance data is submitted, instead of eight months later.