The Market Stability Reserve (MSR) in 2020 will contain about 2.2 billion allowances. The breakdown of this is shown in the chart below under our base case emissions scenario.
This amount is largely already known with a high degree of confidence assuming that unallocated allowances are transferred into the MSR, as prescribed in the Decision establishing it[1]. There are some uncertainties around the amount of unallocated allowances and about how many will be withdrawn from the surplus. However both of these uncertainties are negligible, due to their size[2].
The MSR will grow through the early years of Phase 4 due to the surplus already accumulated and (in the absence of rebasing the cap) emissions continuing below the cap during the early years of Phase 4[3]. We also note that the MSR can be further enhanced by increasing the withdrawal rate either temporarily or as a permanent feature of Phase 4, leading it to grow more rapidly. However, reform of the MSR alone will not bring the market anywhere near to supply and demand balance under any realistic scenario before the mid-2020s.
The implications of this analysis are clear. Two billion allowances can be cancelled from the MSR at the start of Phase 4 leaving a substantial surplus still available to the market, with growing volumes in the MSR. Cancellation of two billion allowances at the start of Phase 4 would thus represent only moderate reform of the EU Emissions Trading System.
[1] Council Decision 2015/1814
[2] The number of unallocated allowances is uncertain, because allocations for Phase 3 are still ongoing, both from the New Entrant Reserve and for existing installations. Furthermore, we do not have full transparency with regard to possible auctioning volume adjustments at the end of Phase 3 – we have therefore assumed that all volumes from the cap that are not explicitly allocated or auctioned will be transferred to the MSR. There is also some uncertainty about the number of allowances that will be withdrawn. However, as this depends on the cumulative surplus which is calculated with a one-year lag, there is little difference due to variations in emissions around expected levels and those affect this total relatively little. In any case, emissions are more likely to be below our base case than above, so it is most likely that this total will increase. Even in the unlikely event that emissions were flat from now until 2020 the total in the MSR would only fall by 29 million tonnes.
[3] See Sandbag’s previous reports – on the MSR and ETS reform options.