COVID-19 Tests the Market Stability Reserve
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COVID‑19 Tests the Market Stability Reserve Reyer Gerlagh1,3 · Roweno J. R. K. Heijmans1,3 · Knut Einar Rosendahl2,3 Accepted: 2 July 2020 / Published online: 4 August 2020 © The Author(s) 2020
Abstract We compare the decrease in energy demand and CO2 emissions in Europe during the financial crisis 2008–2009 with the expected drop in demand and emissions due to COVID-19, and the price response of the EU Emission Trading System (EU ETS). We ask whether the rather limited current price reduction may be due to the Market Stability Reserve (MSR), implemented in the EU ETS between the two crises. Stylized facts and basic theory are complemented with simulations based on a model of the EU ETS. Together, they suggest a mixed result. The MSR stabilizes the EU ETS price in turbulent times, but imperfectly. We show that the more persistent the COVID-19 shock is, the less the MSR is able to serve its purpose. Keywords COVID-19 · EU ETS · MSR · Environmental policy JEL codes H23 · Q41 · Q54 · Q58
1 Introduction The COVID-19 pandemic brought global economic activity to a sudden halt in the first half of 2020. The result was a substantial fall in energy demand. By the end of April 2020, the IEA (2020) expects global energy demand to fall by 6 percent in 2020, and global CO2 emissions to drop 8 percent. In the Europe Union, impacts are expected to be even greater, with energy consumption falling by 11 percent. As about half of EU’s CO2 emissions are regulated by the EU Emission Trading System (EU ETS), demand for emission allowances (EUAs) will likely fall along with lower emissions, and so, one expects, will EUA prices. Indeed, when the 2008 financial crisis hit, the EUA price dropped by more than 50 percent * Knut Einar Rosendahl [email protected] Reyer Gerlagh [email protected] Roweno J. R. K. Heijmans [email protected] 1
Department of Economics, Tilburg University, Tilburg, The Netherlands
2
School of Economics and Business, Norwegian University of LifeSciences, Ås, Norway
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Oslo Centre for Research on Environmental friendly Energy (CREE), Oslo, Norway
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in only a few months. This observation contrasts with the 2020 COVID-19 crisis, since at the time of writing the EUA price has fallen less in 2020 even though the IEA expects the impact on EU emissions to be “almost double the impact of the global financial crisis”. The present paper discusses whether a recent regulatory change in the EU ETS can explain the seemingly different price response in 2020 vis-à-vis 2008. In 2015, the EU introduced the Market Stability Reserve (MSR), the mechanics of which were crucially revised in 2018. The purpose of the MSR is to “address the current surplus of allowances” and “improve the system’s resilience to major shocks by adjusting the supply of allowances to be auctioned”.1 The COVID-19 pandemic is indeed a “major shock” (see Sect. 2), and the question is whether the MSR is living up to its expectations. So, how does the MSR work? The precise nature of the MSR is exp
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