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The Market Stability Reserve (MSR) is one of the most important mechanisms within the European Union Emissions Trading System (EU ETS), designed to regulate the imbalance between the supply and demand of emission allowances.
The Market Stability Reserve (MSR) is one of the most important mechanisms within the European Union Emissions Trading System (EU ETS), designed to regulate the imbalance between the supply and demand of emission allowances. By stabilizing carbon prices and introducing upward pressure when necessary, it enhances climate change mitigation efforts. Operating by adjusting the supply of allowances in response to real-time market conditions, the MSR absorbs surplus allowances when supply exceeds predetermined thresholds. It can also release allowances back into the market if scarcity arises. Since its introduction in 2015, the MSR has undergone amendments to align with European climate goals, including a recent review in 2023. Complementing the rising Linear Reduction Factor (LRF), the MSR has effectively contributed to driving EUA prices upward by mitigating oversupply and promoting market stability.
The Market Stability Reserve (MSR) is a key mechanism within the European Union Emissions Trading System (EU ETS) designed to address imbalances in the supply and demand of emission allowances. It serves as a regulatory tool to stabilize the supply and ensure the effectiveness of the EU's efforts to combat climate change.
The MSR operates by adjusting the supply of emission allowances in response to changing market conditions. When there is an excess supply of allowances, the MSR absorbs surplus allowances from the market, thereby reducing oversupply and preventing prices from falling by too much. On the other hand, if allowances become scarce, the MSR releases EUAs into the market to ensure sufficient availability. Historically, the MSR has always absorbed EUAs, never the other way around.
The goal of the MSR is to maintain a balanced carbon market by regulating the supply of emission allowances. By mitigating extreme price fluctuations and preventing prices from being way too low, the MSR provides more predictability for market participants while incentivizing emissions reduction efforts.
The MSR adjusts the supply of emission allowances through a process of an adjustment based on predefined trigger levels. When the total number of allowances in circulation exceeds a certain threshold, allowances are automatically taken out from the market and transferred to the MSR temporarily. Conversely, if allowances in circulation fall below a specified threshold, EUAs are released from the MSR back into the market.
The relationship between market surplus and the operation of the Market Stability Reserve (MSR) is as follows:
In 2022, the TNAC was 1 134 794 738 allowances.
The latest data for 2023 told us that the TNAC is currently 1 111 736 535 EUAs.
The concept of a market stability reserve was first proposed as part of reforms to the EU ETS in response to concerns about price volatility and oversupply of allowances. The MSR was officially introduced in 2015 as part of the EU's efforts to strengthen and improve the functioning of the carbon market. It became operational in 2019.
Since its inception, the MSR has been reviewed to keep up with the European climate ambitions and environmental promises. Initially, the 2015 MSR Decision had set the intake rate at 12 % and the minimum number of allowances at 100 million. However, there was a change in 2018 deciding to double these parameters to 24% and 200 million until the end of 2023.
The latest amendments were voted in 2023. Regulators deceased to keep the doubled figures of 24% and 200 million allowances as thresholds until the end of Phase 4 in 2030. From 2031 on, the intake rate would revert to 12% and the minimum number of allowances to 100 million.
The Linear Reduction Factor (LRF) determines the annual reduction in the total number of emission allowances available in the market. Currently, the LRF stands at 4.3% per year and will go up to 4.4% after 2028. By adjusting the supply of allowances in response to changes in emissions levels, the MSR complements the objectives of the LRF in setting up the emissions volume targets.
The Market Stability Reserve has been effective in raising EUA prices. Following its implementation, tighter market conditions led to a significant increase - from 2020 onward, EUA prices have been rising, going from below €30 ranges to as high as €97.59 in 2022. This trend is attributed to the removal of the structural carbon allowances surplus that was prevailing before the introduction of the MSR.
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