COVID-19 Tests the Market Stability Reserve

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.