The Market Stability Reserve (MSR) is a carbon market reform aimed at providing price stability for installations covered under the EU ETS scheme. This affords them more certainty and confidence when making investment decisions to drive green technology and energy efficiency. A serious over supply in the EU ETS has led to record low prices in recent years and without intervention low prices were forecast until at least the end of Phase IV in 2030. Low prices in all other commodities would be viewed as a good thing, however, carbon is like no other commodity and politicians are trying to drive prices up to levels that will stimulate investment. Unofficially the target appears to be between €15 and €20 in Phase III and €25 in Phase IV. Introducing the MSR will provide the EU ETS with supply side flexibility to allow a more stable balance between demand and supply, negating the negative price impacts in times of demand side shock, such as the recent global recession.
The MSR will start on 1st January 2019 with 900Mt of backloaded allowances that were due to come back to the market in 2019 and 2020. With threshold levels set at 833Mt and 400Mt the MSR will work by reducing new supply entering the market, via government auctions, until the calculated surplus falls below 833Mt. Allowances in the MSR will only be added back into the market if the calculated surplus falls below 400Mt. Some surplus is required to allow for forward hedging and the threshold levels have been set to reflect this. The MSR will have a uniform 1% withdrawal rate from the surplus per month (12% per annum) and the calculated surplus will be reviewed each September for the year ahead. In addition to the backloaded allowances, all of the unallocated allowances from Phase III, estimated to total >500Mt will go into the MSR. Of these, 50Mt will be withdrawn and sold to seed an Innovation Fund and 250Mt will be available to the New Entrant Reserve (NER) in Phase IV. Crucially these allowances will only come to market in the event of new entrants joining the scheme or companies significantly increasing production.
With low prices in the EU ETS due to the over-supply it seems rational that structural reform to address this over-supply should have a positive impact on prices. Independent price forecasts currently reflect this and predict the price of EUAs to at least triple by the end of Phase III (2020) with some forecasters expecting the price to be as high as €30. This magnitude of the forecast price rises mean that the EU ETS and its associated costs are something industrial participants can no longer afford to ignore. When the price rises are combined with decreasing free allocations, effective budgeting and strategy planning are essential to manage costs and maintain competitiveness. To speak to Redshaw Advisors further about the impacts the MSR will have on your carbon risk exposure please click here.