Making the EU Emissions Trading System fit for the future

Europaflaggen wehen im Wind vor einem RegierungsgebäudeClick to enlarge
The amendment of the ETS Directive is part of the "fit-for-55" legislative package in July 2021.
Source: jorisvo /

Apart from aligning the cap with the new climate target for 2030, the upcoming EU ETS reform also includes a review of the market stability reserve (MSR). A research project commissioned by the UBA proposes to adjust central MSR parameters in order to strengthen its function to stabilize the market in the event of external shocks such as the Covid-19 pandemic.

With a view to the reform of the EU-ETS planned for July 2021 (as part of the comprehensive European legislative package for climate protection "Fit for 55") UBA has commissioned and scientifically supported an analysis of the review and possible adjustment of the Market Stability Reserve (MSR) by Öko-Institut and DIW Berlin. In addition to removing surplus emission allowances from the second and third trading periods, the MSR is intended to stabilise the market in the event of external shocks, such as the significant drop in emissions due to the Covid 19 pandemic in 2020 (minus 13.3 percent compared to the previous year), and to safeguard the function of European emissions trading as a lead instrument in climate protection. Without an adjustment of the MSR parameters, it could happen that - depending on the emissions and cap trajectories - the market surplus in the coming years continues to be significantly above the defined thresholds or even increases.

Analysis of the MSR parameters in different emission scenarios

The report analyses the mode of action of the MSR in different emission scenarios with the help of a calculation tool developed by the Öko-Institut. Assuming that emissions from the stationary ETS decrease in line with renewable energy targets at the EU level and in the member states, and taking into account pandemic effects, the analysis shows that the MSR in its current design is not able to prevent a continuous increase in the total number of allowances in circulation (TNAC) during this decade. Therefore, various options for adjusting the MSR, in particular a change in the withdrawal rate and thresholds, are examined.

The results show that a proportional design of the MSR withdrawal rate, which intervenes relatively more strongly in the case of high surpluses than in the case of relatively lower surpluses, would react much more robustly to different emission and cap scenarios and would therefore be recommended. It would also make sense to dynamically lower the thresholds for activating the MSR based on the reduction of the cap.

In a sensitivity analysis, the recommended parameters (proportional MSR withdrawal rate and dynamically designed threshold values) are also examined under the framework conditions of a tightened cap (emission reduction of minus 65 percent by 2030 compared to 2005).

Other aspects of MSR reform: speed of response, air traffic, deletion, interaction with voluntary deletions under Art.12 (4)

An important aspect is also the speed of reaction when exogenous shocks such as the Covid 19 crisis occur. While a minimum price could significantly increase the reaction speed of the MSR and immediately stabilise the price signal, it would significantly increase the complexity of the system.

The paper also recommends that aviation should continue to be excluded from the definition of the TNAC that is relevant for the MSR cut, as otherwise the MSR's objective of reducing the surpluses accumulated in the stationary sector would not be achieved. The inclusion of aviation is also problematic because climate-damaging non-CO2 effects have not been taken into account in the EU ETS so far.

Finally, the interaction of MSR and the voluntary cancellation of allowances under Article 12(4) is discussed and the paper proposes a simplified rule-based determination to compensate for power plant closures.