Introduced in 2015 by the Council of the European Union (EU) and the European Parliament and put into effect in 2019, the Market Stability Reserve (MSR) was introduced as a central tool to regulate the flaws of the cap-and-trade Emission Trading System (ETS) of the EU. The EU set the goal to reach the climate targets from the Kyoto protocol decided upon in 1997 as well as the Paris agreement adopted in 2015 regarding the reduction of their greenhouse gas emissions (GHGs). Purpose was not only to lower emissions but to achieve this in the most cost-effective and coordinated way. As the largest emission trading system in the world, the EU ETS covers 30 countries and around 10,000 facilities. In total, 40% of the emissions of these countries are covered by the ETS. Recent efforts of the EU’s Green Deal intend to increase the environmental ambitions of the EU even more and reform the MSR along its “Fit for 55 program” . The MSR plays a significant role in this reform and has been used as the central regulating tool in order to improve structural supply-demand imbalances since its implementation.
The goal of this thesis is to outline in what regard the Market Stability Reserve is helpful within the EU ETS to get closer to the EU’s most recent environmental goals and what changes could be made to make it more efficient. In the second chapter, the EU’s sustainability intentions as well as the EU ETS in general will be outlined. The third chapter, will describe the function and mechanisms of the MSR composition in detail as well as what the intentions behind its implementation and changes were as it has considerably changed its structure since its creation . Chapter 3 will also describe and illustrate the market mechanisms of the MSR graphically from a micro economic aspect. Chapter 4 will present four different phenomena of the ETS and highlight how they impact and influence the MSR and how conversely the MSR influences them along with a specific example. The 5th chapter will discuss proposed changes that could help it become more efficient as the system is constantly changing and new reforms are already expected. Chapter 6 will look at future possibilities of the ETS complementing or replacing the MSR. In chapter 7, the core findings of this paper are discussed before concluding the most relevant findings in chapter 8.
Table of Contents
1 Introduction
2 The MSR in the bigger picture
2.1 The Sustainability Goals of the EU
2.2 European Union Emission Trading System
3 Market Stability Reserve
3.1 Roots of the MSR
3.2 Principles of the MSR
3.3 MSR changes in recent years
3.4 Future proposed reform
3.5 Technical background of the MSR
4 Design phenomena of the ETS and MSR
4.1 Waterbed effect
4.2 Effects of the Policy Mix
4.3 Temporary Aspect
4.4 The Green Paradox
4.5 German Coal phase out
5 Proposed changes and the future of the MSR
5.1 Price floor
5.2 Price Stability Reserve
6 Future Perspective of the MSR and ETS
6.1 Future of the Surplus
6.2 Future of the EUA price
7 Discussion
8 Conclusion
Objectives and Research Focus
This thesis examines the role of the Market Stability Reserve (MSR) within the EU Emission Trading System (ETS), evaluating its effectiveness in reaching environmental targets and proposing potential efficiency improvements. The research focuses on how structural supply-demand imbalances are addressed and identifies design phenomena that currently influence the mechanism's performance.
- Analysis of the MSR functionality and its evolution since implementation.
- Investigation of design phenomena such as the waterbed effect and the Green Paradox.
- Evaluation of proposed reforms within the "Fit for 55" legislative package.
- Comparison of the current quantity-based MSR with potential price-based alternatives.
Excerpt from the Book
4.1 Waterbed effect
Perino describes in his 2018 paper the MSR changes made in 2018 as “puncturing” the waterbed. This refers to the effect on a waterbed that occurs when the water is pushed on one side of the bed and it just shifts to another part of the bed, not changing the actual amount of water the bed holds in total (Kerstine Appunn 2019). In the context of the EU ETS the waterbed is the cap of the cap-and-trade, and the water is the emission allowances (ibid.).
If the EUAs are not cancelled, they can be used for later verification. That means that any reduction in allowances due to for example a low carbon innovation does not reduce the actual cap but can be banked or sold to be used later somewhere else. This is the desired effect as it makes innovation cost-effective since the cheapest innovations are prioritized (European Court Of Auditors 2015). On the other side, it does not produce enough incentives for industries where innovations are more cost-intensive if the innovations are still more expensive than the EUA price (Kerstine Appunn 2019). This has for example been the case for electricity from low carbon innovations like solar power in the competition against electricity from emission intensive lignite, coal extraction being found the most sensitive to allowance price variation (ibid; Pyrka et al. 2022). Cases like this have also been the main driver of calls for a EUA price floor (Kerstine Appunn 2019; Perino et al. 2021a).
Summary of Chapters
1 Introduction: Provides an overview of the MSR's role in the EU ETS and states the objectives of this thesis.
2 The MSR in the bigger picture: Outlines the EU's sustainability goals and the fundamental structure of the European Union Emission Trading System.
3 Market Stability Reserve: Details the historical development, principles, and technical mechanisms governing the MSR operation.
4 Design phenomena of the ETS and MSR: Analyzes systemic challenges including the waterbed effect, policy mix impacts, the Green Paradox, and the German coal phase-out.
5 Proposed changes and the future of the MSR: Evaluates potential reforms, focusing on pricing tools like the Carbon Price Floor and Price Stability Reserve.
6 Future Perspective of the MSR and ETS: Forecasts the development of allowance surpluses and price trends under the "Fit for 55" scenarios.
7 Discussion: Synthesizes the findings and critically assesses the balance between MSR's stabilization functions and observed market challenges.
8 Conclusion: Concludes that while the MSR is essential, ongoing refinement is necessary to address unintended consequences of overlapping policies.
Key Terms
Market Stability Reserve, MSR, European Union Emission Trading System, EU ETS, Greenhouse Gas Emissions, Waterbed Effect, Green Paradox, Cap-and-Trade, Carbon Price Floor, Price Stability Reserve, Fit for 55, EUA, Sustainability, Linear Reduction Factor, Emissions Surplus
Frequently Asked Questions
What is the core purpose of this thesis?
This work aims to evaluate how the Market Stability Reserve functions within the EU ETS to reach EU environmental goals and to propose ways to enhance its efficiency.
What are the central topics discussed?
The research covers the MSR's mechanics, its historical development, identified design flaws like the waterbed effect and the Green Paradox, and potential future reforms.
What primary research goal is the thesis addressing?
The primary goal is to outline the MSR's role in improving structural supply-demand imbalances and to analyze which modifications could make it more effective in reducing emissions.
Which scientific methods are utilized?
The thesis utilizes a literature-based analysis, incorporating microeconomic perspectives on market mechanisms and evaluating modeling data from academic studies on ETS performance.
What is the focus of the main section?
The main part analyzes the MSR's technical operation, explores systemic design phenomena, and discusses how these interact with national policies like the German coal phase-out.
Which keywords categorize this work?
Key concepts include MSR, EU ETS, Green Paradox, waterbed effect, carbon pricing, and environmental policy reform.
How does the "Green Paradox" impact the MSR?
The Green Paradox refers to the counterintuitive result where future emission reduction announcements increase present-day emissions, causing the MSR to function inefficiently by cancelling fewer allowances than intended.
What is the "waterbed effect" in the context of the ETS?
It describes a systemic flaw where reductions in emissions achieved outside the ETS cap are offset elsewhere because the total quantity of allowances (the "water") remains constant, unless the surplus is removed via the MSR.
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- Stephan Kruse (Autor:in), 2023, The European Emission Trading System Market Stability Reserve, München, GRIN Verlag, https://www.grin.com/document/1357250
