‘More stable’ EU ETS prices under lower MSR rate

Lowering the intake rate of the EU emissions trading system's (ETS) market stability reserve (MSR) as planned in the coming years will lead to less volatility in the carbon market than if the current rate is retained under higher emission cut scenarios, according to a report published this week.

The MSR tackles oversupply in the carbon market by removing 24pc of excess permits from circulation each year, an intake rate that under current plans will fall to 12pc from 2024. The rate is one of the aspects of the mechanism under consideration as part of a scheduled review of the MSR by the European Commission this year.

Modelling for a European Roundtable on Climate Change and Sustainable Transition (ERCST) report has found that under a "likely" scenario of a 2030 emissions cut target of 63pc for EU ETS-covered sectors, a 12pc MSR intake rate applied from 2024 onwards "guarantees a more stable price environment", as it avoids price spikes.

Maintaining a 24pc absorption rate past this point "would lead instead to price instability without significant additional benefits in terms of emission reductions", the report concludes.

"EU industry would likely better cope with a smooth upward carbon price' trajectory over the trading phase rather than a bumpy one," the report emphasises, which is particularly significant as decarbonisation efforts begin to shift from the power sector to industry.

A 24pc rate could however be useful in the case of a 55pc 2030 emissions cut target for EU ETS sectors, the report says, as it would help to avoid a collapse in carbon prices in the second half of this decade.

Increased flexibility

ERCST's report finds that a more flexibile MSR is needed to ensure the mechanism copes with changes in the market over the coming years.

This is specifically a shift in hedging patterns from the power sector to industry, potential larger holdings of allowances by speculative investors, and the effect of overlapping EU climate policies that will "likely further affect the MSR intakes and ultimately the price impact of the MSR".

This flexibility could come in the form of either more frequent reviews, which are currently scheduled to take place once every five years, or more dynamic parameters, such as varying intake rates at different surplus thresholds.

Reacting to the presentation of the report, Italian utility Enel's Daniele Agostini called dynamic parameters a "very good idea".

But both he and German investment bank Commerzbank's Ingo Ramming warned against increasing the frequency of MSR reviews, emphasising the importance of transparency and predictability in regulatory measures.

Agostini also urged the retention of the 24pc intake rate beyond 2023 to remove the surplus of allowances in the market.

While Brussels-based environmental think-tank Carbon Market Watch's Sam van den Plas argued that the rate should be increased to 36pc "sooner rather than later" to ensure the strength of the mechanism, particularly in the context of a rapidly decarbonising power sector.

He pointed to a report published by the Potsdam Institute for Climate Impact Research this week, which suggests Europe could almost completely phase out coal-fired power by 2030, under a scenario of 63pc emission cuts for EU ETS sectors.

By Victoria Hatherick