EU-ETS Phase IV: allowance prices, design choices and the market stability reserve

The final design choices for Phase IV (2021-2030) of the European Union Emissions Trading System (EU ETS) are about to be made. The European Commission, the European Parliament and the Council of the European Union have all issued proposals for the rules governing Phase IV of the EU ETS. This article uses an analytically tractable simulation model of the EU ETS to project the proposals' impacts on allowance price paths, the number of allowances banked for future use and the number of allowances stored in the market stability reserve (MSR), which will come into effect in 2019. The article finds that all three proposals have virtually the same impact on allowances prices during Phase IV. Price paths diverge between scenarios only in later decades. The analysis also makes it possible to identify how changes in key parameters impact on allowance price paths. Three parameters are investigated: the linear reduction factor (which reduces the annual cap on emissions by a constant amount every year), cancellation of allowances stored in the MSR and the intake rate of the MSR (specifying the amount of allowances withheld from auctions and placed in the MSR). They differ substantially in whether, how and when they affect allowance prices. Increasing the linear reduction factor increases price levels over the entire time horizon. Cancellation of allowances from the MSR increases prices mainly towards the middle of the century and doubling the intake rate of the MSR has no noticeable impact on price paths.Key policy insights:The impact on price paths of design choice proposals for Phase IV of the EU ETS by all three EU legislative bodies are almost identical.Compared to the status quo, the proposals raise prices owing to an increase in the linear reduction factor specifying by how much the number of allowances issued is reduced each year.Cancellation of allowances from the MSR substantially increase prices only after 2030.Doubling the rate at which allowances are transferred into the MSR has virtually no impact on price paths.