Last week the European Commission announced its intention to bring roughly 200-250 million EUAs out of the Market Stability Reserve (MSR) and auction them to raise €20 billion for the Recovery and Resilience Facility (RFF).
The sales will help to fund a €200 billion effort to end Europe’s reliance on Russian fossil fuels and to speed up even further the transition away from carbon intensive energy.
To say the market was surprised is an understatement. EUA prices dropped more than 7% on the news and went on to fall as much as 17% in the next week.
Among the trading community there was a chorus of very unhappy voices lamenting what seemed to be a totally discretionary act of sabotage, coming as it did less than a day after the European Parliament’s environment committee (ENVI) had approved amendments to the “Fit for 55” EU ETS reform package.
To be clear, the Fit for 55 reforms are aimed at raising Europe’s climate ambition to reach a 55% emissions cut by 2030. To do this, the EU ETS cap will be reduced through a one-time adjustment in the cap, the linear reduction factor (the annual cut in the cap) will be raised, benchmarks will be tightened and free allocations will be phased out earlier.
However, the market, seemingly unanimously, feels that the Commission’s plan to sell upwards of 200 million additional EUAs – that were expected to be invalidated in 2024 – from the MSR represents a move in the opposite direction, a watering down of that higher ambition.
At this week’s IETA European Climate Summit in Barcelona, there was a great deal of discussion about the proposed MSR sales, much of it philosophical in nature, and it seems worthwhile to set down some of the main points that were raised.
First, the timing of the announcement.
To have the ENVI vote on one day, followed by the Commission announcement the next seems to define the word “whipsaw” that we journalists are fond of using to describe a market that moves violently in opposite directions.
To be fair to the Commission, the policy to drive Russian fossil fuels out of our energy mix is a very recent development and one that required a quick response. It’s also a high-priority issue that pretty much trumps other considerations, and the fact that ENVI had just completed its work on the Fit for 55 package probably wasn’t a good reason to delay the announcement.
(Also remembering that the MSR sales account for just 10% of the RFF funding.)
And to be fair, the Commission has also been at pains to underline that this is a unique situation requiring a unique response.
I haven’t added up the combined impact on EUA supply of the various elements of the Fit for 55 reforms, but I’m willing to bet there’s not a great of difference in terms of EUAs between the reforms and the MSR sales. Maybe someone can help out with a back-of-the-envelope calculation?
So it’s hardly surprising that the market gave up a whole month of ENVI-related gains in just five sessions.
Second, a fair few people have been noting that by bringing up to 250 million EUAs back out of the MSR between 2023 and 2026 is really simply front-loading what the MSR would have been doing later in the decade.
Many analysts have already suggested that under existing conditions, the MSR would be re-injecting EUAs into the market by around 2027-2028, after the market supply dipped below the 400 million-tonne threshold.
The Commission’s proposal pretty much brings those injections forward by a few years, and therefore delays any MSR injections by.. who knows? Two, three, years? Maybe into Phase 5?
Others have gone on to suggest that the MSR will slowly reabsorb these 250 million EUAs. More supply means a higher total number of allowances in circulation (TNAC), they explain, and therefore a higher MSR withdrawal each year.
However, a few have also pointed out that, because Europe is using more coal this year and will likely be using more coal over the next few years, a lot of these additional EUAs will be “consumed” by compliance, which means they *won’t* appear as part of a higher TNAC. So these proposed MSR sales represent a net addition to total supply that would not have happened without those MSR sales, they say.
Third, the “trust” issue.
In the immediate aftermath of the news, some of the conversation was rather highly-charged and emotive, with words like “brain-dead” and “loss of trust” being thrown around.
Even a week later here in Barcelona, there was still an element of that feeling of betrayal. Much, if not all of the market has been working on the assumption that supply is fixed, or as fixed as it can be. And a discretionary move such as the Commission’s decision comes across as both opportunistic and cynical.
You can picture the scene, can’t you? The Commission is meeting to work out how to scrape together €200 billion for the RFF, and someone notices that the MSR has more than 2.5 billion EUAs just sitting there, doing nothing, while the EUA price is closing in on €90 a tonne.
Which takes me smoothly on to the fourth issue, of “invalidation”.
As the MSR rules are currently written, the entire stock of EUAs, minus the equivalent of one year’s worth of auctions (say, 600 million), is meant to be “invalidated” in 2024.
Now, somewhere along the line “invalidation” has been assumed by the rest of us to mean “cancellation”, and Commission officials stress that this is not the case. “Invalidation” doesn’t mean that those EUAs just vanish into the air, never to be seen again. They remain in the MSR, tagged as “invalidated”.
And this means they can be “re-validated”.
Of course, the 250 million or so EUAs that could, or would, come back to the market from next year would not be subject to any “invalidation” in 2024, so this specific initiative neatly sidesteps that argument.
But there are those who worry that, now that the Commission has found a new cookie jar, that it might be tempted to raid it again in the future, whenever another “unique situation” pops up. Even if the remaining EUAs in the MSR *are* invalidated in 2024, what would stop the Commission from repeating this exercise?
And we return to “trust”.
It also begs the question why the Commission even included the “invalidation” reference in the original MSR regulations.
Clearly, during the process of drawing up the rules, market participants expressed concerns that the MSR might not be a pure and simple mechanism to address the EU ETS oversupply, but that it could become a back-door for additional supply to enter the market without any checks. So Brussels added in the invalidation clause to allay these fears.
If the MSR was meant to operate under strict conditions and guidelines, there would be no reason for “invalidation" to be in the rules unless there was already a concern that something like *this* would happen.
So what happens next?
The proposal cuts across both the “Fit for 55” reforms – which is essentially a reform of the EU ETS directive – and the separate MSR reform proposal. Both of these are slowly going through the legislative process at the moment.
A new piece of legislation will need to be added to both these files, and the responsibility for driving it through Parliament will probably not rest with ENVI, but with other committees like BUDG (budget), CONT (budgetary control) and FISC (tax matters). Maybe even AFET (foreign affairs). So while some ENVI MEPs have expressed their unhappiness with the proposal, they may not have much say in whether it goes through or not.
It’s likely that the MSR sale proposal will catch up with the rest of the ETS reforms around the end of the year, and that the whole shooting match will be done in 2023. So until then, we can only wait.