In the collaboration titled: The October 2014 European Council: A Milestone in the Fight Against Climate Change, we explained that the October 2014 European Council meeting marked a turning point in the European Union’s climate policy. In this context, we observe additional noteworthy elements.
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We also present the collaboration in video format, in case you prefer this option:
Purpose of Creation
Imagine the ETS as a swimming pool. Emission allowances are like the water in the pool, and the total amount of water determines the level. If too much water is poured in, the level rises and overflows. If too much is removed, the level drops and the pool is nearly empty.
The Market Stability Reserve (MSR) functions as a water tower connected to the pool. Its role is to regulate the water level—that is, the volume of emission allowances in the market.
Operational Mechanism
- Absorbing the surplus: When there is an oversupply of emission allowances in the market (i.e., when the water level is too high), the MSR absorbs them, as if storing them in the water tower. This prevents the carbon price from falling excessively and ensures that companies maintain sufficient incentives to reduce their emissions.
- Releasing allowances: Conversely, if there is a shortage of allowances (i.e., when the water level is too low), the MSR can release part of the stored allowances to prevent carbon prices from rising excessively and harming the competitiveness of European businesses.
Achievement of Objectives
The MSR has proven to be an essential instrument for stabilizing the carbon market. By absorbing surplus allowances, it has contributed to:
- Increasing the carbon price: This has provided companies with a stronger incentive to invest in cleaner technologies and reduce their emissions.
- Reducing uncertainty: The MSR has offered greater predictability for investors by lowering carbon price volatility.
- Enhancing ETS effectiveness: By maintaining a balance between the supply and demand of emission allowances, the MSR has improved the ETS’s performance as a tool for emissions reduction.
Practical Example
Consider a steel plant that must purchase emission allowances in order to emit greenhouse gases. If there is an oversupply of allowances in the market (for example, because many factories have closed or reduced their emissions), the price will be low, making it cheaper for the plant to continue polluting. However, if the MSR absorbs part of these allowances, the price will rise, forcing the plant to pay more for its emissions and motivating it to seek ways to reduce them.
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The Green Climate Fund: Financing the Fight Against Climate Change
