The Market Stability Reserve: Why Canceling or Just Holding Emission Allowances Are Not Good Options

The Market Stability Reserve

The Market Stability Reserve (MSR) is a mechanism designed to reduce surplus emission rights to stabilize the market. Since 2019, the number of new emission allowances auctioned has been automatically reduced if there are more allowances on the market than needed. If there are more than 833 million surplus allowances, 24 fewer allowances will be auctioned for every 100 unused EUAs in the following year, and will instead be transferred to the MSR and ultimately, automatically cancelled. The number of surplus allowances (TNAC, Total Number of Allowances in Circulation) is published annually by the EU Commission: Essentially, the sum of all used/deleted EUAs is subtracted from the sum of all EUAs ever issued.

Deleting emission allowances is not a good solution

In the past, deleting unused emission allowances was actually the easiest way to contribute to climate protection. Today, this would still technically be possible – but unlike before the introduction of the Market Stability Reserve (MSR), it no longer presents a sensible course of action, as the MSR would reduce efficiency to 76 percent.

The reason for this is that a cancellation of emission rights would reduce the surplus of rights; thus, the automatic reduction of the auction volume in the following year would be smaller than without the cancellation. In order to achieve 100 percent efficiency, the purchased allowances must continue to be considered “unused,” so as not to diminish the reduction in the auction quantity in the following year.

Only when the total number of unused EUAs falls below 833 million can the emission allowances removed from the market be cancelled without risking efficiency. Before then, cancellation would counteract the automatic reduction in auction volumes.

Holding emission allowances only temporarily is not an option

Any EUA held in a portfolio for speculative purposes will eventually be sold and subsequently used to legitimize emissions. Even if the purchase had a price-increasing effect, it would not reduce emissions because the total number of available emission rights would remain the same in the long term. The climate protection effect of EUAs temporarily held in the portfolio is therefore close to zero.

Even interplay with the MSR do not lead to a better result on temporarily held EUAs. It is sometimes argued that a climate protection effect can be achieved indirectly via the MSR, even with emission rights being held only temporarily. It is claimed that holding 100 EUAs prevents them from being used at the same time, increases the surplus of emission allowances and causes the MSR to cancel an additional 24 allowances.

In fact, this reasoning is correct only in one (highly unrealistic) special case. Namely, if

  1. the EUAs held would otherwise have been used to legitimize emissions in the same year
  2. the prevented emitters do not legitimize their emissions by buying other, unused emission rights

Re. 1: If the purchased EUAs had otherwise been held for stockpiling or speculative purposes, the MSR would not be affected by a purchase at all, and the climate change mitigation effect would be zero, because the difference between emission rights issued and used would not have changed. The idea of buying emission rights from a polluter who would otherwise have used them in the same year is anything but a plausible assumption, especially for the secondary market. Why should someone who still needs their emission rights sell them? One could object that the rights would not have been used by the seller, but by another buyer, who now can no longer do so. And this brings us directly to condition 2.

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