Impact on carbon costs as EU cut supply of allowances
The annual surplus indicator for the EU Emissions Trading System (ETS) Market Stability Reserve has been published.
The European Commission has published the annual surplus indicator for the EU Emissions Trading System (ETS) Market Stability Reserve. As long as the surplus exceeds the level set in the legislation, a total of 397 million allowances will be placed in the reserve, 24% of the total permits currently in the market. This is an increase on the 2018 publication, which saw almost 265 million allowances placed into the reserve in January 2019. The allowances will be placed into the reserve in the period of September 2019 to August 2020.
Purpose of the Market Stability Reserve
The Market Stability Reserve (MSR) was introduced to address the large oversupply of carbon allowances that built up following the 2008 global financial crisis. This saw carbon prices reach all-time lows for an extended period of time and by the end of 2016, the European Emissions Trading Scheme had an oversupply of 1.7bn tonnes worth of EUAs. The oversaturation of allowances provided a weaker incentive to reduce emissions.
The MSR will see 900 million allowances, which were removed between 2014 and 2016, transferred to the Reserve, rather than be auctioned in 2019-20. After this, unallocated allowances will also be transferred to the reserve.
Each year, the Commission will continue to publish the total number of allowances in circulation by 15 May. This will allow them to examine whether more allowances should be placed into the reserve or whether allowances should instead be released. This will allow the Commission to better regulate the allowances available.
An impact to carbon prices
The restriction of carbon allowances as part of the Market Stability Reserve has been the cause of substantial price increases since 2017. The cost of carbon is currently at €26/tCO2e, having doubled in value year-on-year.
The impact of further allowances placed in the reserve is likely to see continued price rises, as the MSR continues to restrict the availability of supply to the market. The introduction of the reserve caused prices to rise from €4 to over €25 in eighteen months. With the volume of allowances into the EU ETS system remaining tightly restricted, there is the likelihood of further price rises, notably towards the all-time high of €30/tCO2e, last seen in 2008, shortly after the EU ETS was created.
A further increase in carbon prices, particularly if prices were to break to new highs at over €30/tCO2e, would provide a strong bullish signal to the wider energy mix, and likely result in higher wholesale gas and power prices.
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