The legal and 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 carbondioxide prices of around €30/ton and be a cornerstone of the EU's climate policy. The reality was a cascade offalling prices, a ballooning privately held emissions bank, and a decade of muted incentives for investment in thetechnology and innovation necessary to achieve long-term climate goals. The European Commission respondedwith various administrative measures, including postponing the introduction of allowances (“backloading”) andusing a quantity-based criterion for regulating future allowance sales (“the market stability reserve”). Whileprices have now begun to recover, it is far from clear whether these measures are sufficient to adequately supportthe price of carbon dioxide into the future.In the meantime, governments outside the EU ETS have begun turning away from carbon pricing and adoptingoverlapping regulatory measures that reinforce low prices. Unfortunately, however, this further underminesconfidence in market-based mechanisms for reducing greenhouse gas emissions. Other carbon markets haveresponded 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 fearthat a minimum auction price would interfere with the quantity-based nature of the market. Second, they arguethat a reserve price would be tantamount to a tax, thus triggering a burdensome decision rule requiring unanimityamong 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 economicanalysis concludes that an auction reserve price is necessary to accommodate overlapping policies and for theallowance market to operate efficiently. Our legal analysis concludes that, inasmuch as an auction reserve price isnot a “provision primarily of a fiscal nature,” nor would it “significantly affect a Member State's choice betweendifferent energy sources,” no legal barriers stand in the way of the introduction of an auction reserve price intothe EU ETS. We then describe two ways by which a reserve price could be introduced into this system.