Potential Impacts of the Planned Market Stability Reserve on Speculators’ Behavior in the EU Emissions Trading System

FCN Working Paper No. 09/2016

48 Pages Posted: 13 Feb 2017

See all articles by Florian Falcke

Florian Falcke

RWTH Aachen University

Reinhard Madlener

RWTH Aachen University

Date Written: August 2016

Abstract

In early 2019, the market stability reserve (MSR), a volume-based regulatory regime for tackling the surplus in emission allowances (EUAs) in the EU Emissions Trading System (EU ETS), will enter into force. The MSR will take EUAs out of the market when the amount of banked and thus unused EUAs exceeds an upper threshold and will release EUAs into the market when the amount of banked EUAs falls under a lower threshold. Over the last years, the design of the MSR has been the topic of controversial discussion. Among other concerns, scientists are afraid that the MSR may increase price volatility and uncertainty, which in turn may enhance speculative activity. In this paper we analyze the effect of the MSR on the behavior of a speculator with market power. For this purpose, the interlinked electricity and carbon market is modeled with an open-source agent-based model, which is expanded by adding the banking behavior of the speculator. The results indicate that with the MSR mechanism being active in the EU ETS, both speculative banking activity and speculator profit increase. We further test the hypothesis that the MSR mechanism itself could be used by a speculator to increase his returns, leading to the conclusion that while this is theoretically possible, it is unlikely to actually happen. The results obtained can help to understand future behavior of market participants in the EU ETS.

Keywords: Global warming, Climate change mitigation, EU ETS, Speculation

JEL Classification: D84, G18, Q48

Suggested Citation

Falcke, Florian and Madlener, Reinhard, Potential Impacts of the Planned Market Stability Reserve on Speculators’ Behavior in the EU Emissions Trading System (August 2016). FCN Working Paper No. 09/2016. Available at SSRN: https://ssrn.com/abstract=2916157 or http://dx.doi.org/10.2139/ssrn.2916157

Florian Falcke

RWTH Aachen University ( email )

Templergraben 55
52056 Aachen, 52056
Germany

Reinhard Madlener (Contact Author)

RWTH Aachen University ( email )

School of Business and Economics / E.ON ERC
Mathieustraße 10
Aachen, 52074
Germany
+49 241 80 49 820 (Phone)
+49 241 80 49 829 (Fax)

HOME PAGE: http://www.eonerc.rwth-aachen.de/fcn

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