The Stability Reserve in EU Carbon Emission Trading: Does it Deliver What it Promises?

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.Engineering, Systems and ServicesTechnology, Policy and Managemen