The European Union's Emissions Trading Scheme, the world's largest greenhouse gas cap-and-trade program, will be taking a new step to stabilize permit prices. Starting in January 2019, the Market Stability Reserve will go into effect, which aims to stabilize price by reducing the long-standing permit surpluses that have plagued the ETC.
The reserve will:
address the current surplus of allowances
improve the system's resilience to major shocks by adjusting the supply of allowances to be auctioned.
The reserve will operate entirely according to pre-defined rules that leave no discretion to the Commission or Member States in its implementation.
So that's a win for the rules side in the rules vs. discretion debate.
The recent carbon-market reform introduces a so-called Market Stability Reserve (MSR). In effect, this is a central bank for carbon that will remove surplus inventory at a rate of 24 per cent per year over 2019-23 and at 12 per cent per year thereafter. For the first time in its history the EU-ETS will have a mechanism to modulate supply, thereby enabling the absolution of the EU carbon market’s original sin: that of fixed supply in the face of varying demand. The start-up of the MSR from January 2019 will create the biggest supply squeeze the EU-ETS has ever seen. The market surplus is set to fall by more than 1bn tonnes (or more than 60 per cent) over 2019-23, and with power generators and airlines structurally short, and other sectors likely increasingly reluctant to sell their accumulated surpluses, we see a need for material emissions abatement in the power sector over 2019-23.
All that I've read about the MSR indicates that it's not so much a cyclical policy, designed to smooth out abatement costs or increase efficiency in the face of fluctuations in costs or other economic variables. Rather, it seems to be in response to a long-run surplus of permits that has been persisting since the start of the program.
This is all very much related to the economics literature on cost containment for carbon pricing schemes, which discusses proposals like safety valve prices, price floors, and banking and borrowing. It's also perhaps a little bit related to the literature on business cycles and climate policy. I have a paper in this literature, arguing that either a tax or a quantity policy ought to adjust to cyclical fluctuations. Who knows? Maybe the EU-ETS read these papers and used them in designing their reserve.