The Market Stability Reserve (MSR) is a mechanism proposed within a broader reform of the EU Emission Trading System. Carbon pricing is one of the key responses to the problem of excessive greenhouse gas emissions in the atmosphere. There are two main types of carbon pricing: carbon trading and carbon taxing. Since each has advantages and disadvantages, there are proposals for a combination of the two pricing approaches: hybrid mechanisms. In the EU, one of the hybrid mechanisms (a market stability reserve) is being proposed to counter the problems the EU ETS is facing with oversupply of allowances and low prices.
What does it do?
There are a certain number of pollution permits available in the EU ETS. One pollution permit covers one tonne of carbon dioxide. The proposed MSR functions in order that if the number of permits becomes too low (below 400 million permits), it would release 100 million permits. If the number of permits in the system becomes too high (above 833 million permits) then the MSR would take 100 million permits out of the system.
This means that the MSR prevents extremes in the supply of permits. By preventing these extremes, it prevents the prices from changing dramatically. This stabilizing of the EU ETS price would increase the reliability of the system and send a signal to investors that it is safe(r) to invest in the system and consequently in low-carbon technologies. The EU is currently proposing that MSR be introduced to the EUETS in 2021 (at the beginning of the fourth phase of the trading programme). There are proposals for an earlier implementation of the mechanism by some EU Member States, such as the UK, that called for the Market Stability Reserve to be brought in by 2017.
Why do it?
By creating a more stable carbon price, the MSR intends to increase the stability of the EUETS market and its resilience to sudden market shocks. This is important because it indicates to investors that carbon is being taxed seriously and consistently. This will make companies more likely to begin investing in low-carbon alternatives.
Does it work?
Whether the MSR will actually improve the effectiveness of the EUETS is still being analyzed and discussed. Given that the number of pollution permits allowed to be used in the EUETS would be the same with or without it, the reserve will not enable the EU ETS to reduce more pollution. The ability of the MSR to decrease changes in the carbon price may mean that this pollution reduction can be achieved more cost-effectively and faster.
EU Commission’s webpage on the structural reform of the EU ETS (link)
EU Commission’s webpage on the EU ETS (link)
EU Commission’s proposal about the establishment and operation of a market stability reserve (pdf)
Position paper by UK Department of Energy and Climate Change about EU ETS reform and MSR (link)
EU procedure webpage over the establishment of the MSR