Market Stability Reserve under exogenous shock: The case of COVID-19 pandemic

The EU implemented the Market Stability Reserve (MSR) in response to the 2008 financial crisis to deal with short-term impacts of future shocks, such as the COVID-19 pandemic. We link a model that intertemporally optimizes the handling of banked allowances every five years with one that simulates the annual working of the EU ETS including the MSR with its potential cancelling. Neglecting the pandemic, 2.16 billion allowances are cancelled. Accounting for the pandemic, 0.28 billion additional allowances are cancelled if the European economy fully recovers by 2021, which even overcompensates the 2020 drop in CO2 emissions. Additional cancelling increases when the pandemics lasts longer, meaning that the MSR even outperforms its initial purpose. Thus, we conclude that no additional policy measures to support abatement are required in response to the COVID-19 pandemic.

Automated summary

The EU's Market Stability Reserve (MSR) was implemented in response to the 2008 financial crisis, but has proven to be effective in dealing with the short-term impacts of future shocks like the COVID-19 pandemic. Research shows that under different scenarios, a significant number of CO2 emission allowances are cancelled, exceeding expectations and demonstrating the effectiveness of the MSR even in unforeseen circumstances. This suggests that additional policy measures to support emissions reduction in response to the COVID-19 pandemic may not be necessary.