The legal an economic case for an auction reserve price in the EU emissions trading system

When it first launched in 2005, the European Union emissions trading system (EU ETS) expected to see carbon
dioxide prices of around €30/ton and be a cornerstone of the EU's climate policy. The reality was a cascade of
falling prices, a ballooning privately held emissions bank, and a decade of muted incentives for investment in the
technology and innovation necessary to achieve long-term climate goals. The European Commission responded
with various administrative measures, including postponing the introduction of allowances (“backloading”) and
using a quantity-based criterion for regulating future allowance sales (“the market stability reserve”). While
prices have now begun to recover, it is far from clear whether these measures are sufficient to adequately support
the price of carbon dioxide into the future.
In the meantime, governments outside the EU ETS have begun turning away from carbon pricing and adopting
overlapping regulatory measures that reinforce low prices. Unfortunately, however, this further undermines
confidence in market-based mechanisms for reducing greenhouse gas emissions. Other carbon markets have
responded to such by introducing an auction reserve price that sets a minimum price in allowance auctions, thus
*2 avoiding the unexpectedly low price outcomes experienced in the EU ETS.
Opponents of instituting such an auction reserve price in the EU ETS express two main concerns. First, they fear
that a minimum auction price would interfere with the quantity-based nature of the market. Second, they argue
that a reserve price would be tantamount to a tax, thus triggering a burdensome decision rule requiring unanimity
among EU Member States that would be difficult to overcome.
This Article reviews the economic and legal arguments for and against an auction reserve price. Our economic
analysis concludes that an auction reserve price is necessary to accommodate overlapping policies and for the
allowance market to operate efficiently. Our legal analysis concludes that, inasmuch as an auction reserve price is
not a “provision primarily of a fiscal nature,” nor would it “significantly affect a Member State's choice between
different energy sources,” no legal barriers stand in the way of the introduction of an auction reserve price into
the EU ETS. We then describe two ways by which a reserve price could be introduced into this system.