ELS #Energy - What effects would intervention mechanisms have on the carbon market?

On Wednesday, the European parliament’s lead law maker on reforms to the EU carbon market proposed amendments to the EU ETS directive to make it easier for policymakers to intervene in the market if prices rise too fast. EU ETS in its current form allows for intervention, meaning increasing the supply of allowances, when, for six months at a stretch, the carbon prices have been three times higher than the preceding two years’ carbon price average. This would have to follow a meeting and decision by an EU committee that the price increase does not correspond to market fundamentals. As shown in the graph, the mechanism, in its current form, has never had the opportunity to activate because carbon prices never breached the threshold.

The amendment proposal suggests that the threshold for intervention would be two times the average price rather than three times average price. When the threshold is exceeded for six months at a stretch, 100 million permits will be released from the market stability reserve over a period of six months. If the price conditions were to continue for more than six months, then a committee should be convened to assess whether the price changes correspond to market fundamentals.

Applying the calculation method suggested in the amendment proposal on historical carbon prices shows that the proposed revised intervention mechanism will have significantly more chances to be activated. However, as the release of allowances is always delayed by six months from the threshold being breached, the average price can continue to rise before the intervention, followed by rapid drop when it kicks in. If the allowances are spread out over six months, the sudden drop could be mitigated somewhat. When it comes to the second potential step of the mechanism’s actions the question remains as to where the line is drawn between price changes caused by expectations concerning policy developments and actual policy decisions when assessing whether price changes correspond to changing market fundamentals. Thus, if the proposed revised mechanism gets triggered will it be enough to bring prices down to what fundamentals suggests they should be?

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