Postponing Auctioning Versus Cancellation of Allowances in the EU ETS

Abstract

Policy makers reformed the European Union (EU) Emission Trading System (ETS) to address low prices and price volatility. They reduced the cap and strengthened the Market Stability Reserve (MSR). The effectiveness of these reforms hinges on path dependency of emission and abatement technology. Conversely to pre-existing analysis, we observe that postponing allowance allocations through the MSR can be equally, if not more significant than cancellation. Additional stochastic analysis establishes that the MSR increases price volatility. These findings imply that the reforms gave reducing allowances too much attention, and managing their availability in response to shocks too little.

Keywords: Emissions Trading System, low-carbon investments, Market Stability Reserve

JEL Classification: C61, Q41, Q55, Q58