Policy Brief: “EU ETS Reform. Key Market Drivers: MSR, LRF and Supply Flexibilities

Policy Brief: “EU ETS Reform. Key Market Drivers: MSR, LRF and Supply Flexibilities

Policy Brief: “EU ETS Reform. Key Market Drivers: MSR, LRF and Supply Flexibilities

On 1 October 2026, the KOBiZE/CAKE team of experts published a new Policy Brief entitled “EU ETS Reform. Key Market Drivers: MSR, LRF and Supply Flexibilities”, focusing on the key changes planned for the EU ETS and their impact on the functioning of the emissions allowances market after 2030.

  EU ETS Reform. Key Market Drivers: MSR, LRF and Supply Flexibilities (1.1 MiB, 56 hits)

The publication primarily analyses the impact of the Linear Reduction Factor (LRF), the Market Stability Reserve (MSR), and additional mechanisms increasing the flexibility of allowance supply on the functioning of the EU ETS. The authors indicate that it is primarily the pace of reduction of the allowance cap after 2030 that will have the greatest impact on the availability of allowances on the market. At the same time, the parameters of the MSR affect the scale and pace of changes in the supply of allowances in circulation.

The brief presents and compares six scenarios, including a reference scenario, the European Commission proposal presented on 17 July this year, the CAKE variant, the ENVI Committee proposal, and scenarios covering alternative MSR parameters and flexibility mechanisms. The analysis examines, among other things, the impact on changes in auction volumes, the emissions cap (the cap), the allowance surplus (the so-called TNAC), operations within the MSR, emission levels, and potential Marginal Compliance Costs (MCC).

The modelling results indicate that, as emissions constraints become more stringent, Marginal Compliance Costs (MCC) may increase significantly over the coming decades, particularly under conditions of limited availability of low-carbon technologies. Under the European Commission proposal, the modelled MCC is approximately EUR 145/tCO₂ in 2030 and increases to approximately EUR 470/tCO₂ in 2040 (in 2020 prices). However, the differences between the scenarios are significant. Under the CAKE scenario, MCC reaches approximately EUR 350/tCO₂ in 2040, while under the ENVI scenario it rises to approximately EUR 650/tCO₂. In scenarios with more constrained allowance supply, MCC reaches the maximum level assumed in the model, indicating that the emissions reduction target cannot be achieved under the assumed technological constraints.

Particular attention is paid to changes in the parameters of the MSR. The analysis shows that more restrictive thresholds result in larger transfers of allowances into the reserve, reducing the surplus of allowances in circulation (TNAC) more rapidly. At the same time, however, they reduce the supply of allowances available on the market and lead to an increase in Marginal Compliance Costs before 2030.

The publication also analyses new sources of flexibility, including permanent CO₂ removals, international units under Article 6 of the Paris Agreement (offsets), and the new ETS Investment Booster instrument. The results indicate that their availability and timely implementation may be of significant importance for maintaining an adequate supply of allowances after 2030.

Key conclusions of the publication:

• The pace of emissions reduction (LRF) after 2030 is a key factor shaping the long-term supply of allowances, having a significantly greater impact on the allowance market than changes in the MSR alone.
• The European Commission proposal combines a lower LRF in the second half of the 2030s, a modified MSR mechanism, and additional flexibility mechanisms. These solutions may increase supply flexibility; however, the analysis indicates that they may not be sufficient to ensure the stable functioning of the market over the longer term. A significant reduction in the MSR thresholds would rapidly reduce the market surplus, but at the cost of a substantial reduction in allowance supply and a significant increase in Marginal Compliance Costs (MCC) towards 2030.
• As the emissions cap becomes more stringent after 2035, constraints on the deployment of clean technologies become increasingly important, leading to a sharp increase in Marginal Compliance Costs.
• The effects of the EU ETS reform will depend primarily on the interaction between the LRF, MSR parameters, and additional flexibility mechanisms, such as permanent CO₂ removals and the use of international emissions reduction units, as well as investment-support instruments, including the ETS Investment Booster. For flexibility mechanisms, their availability, quality, and timely implementation will be of key importance.
• The future EU ETS will require not only an integrated policy package, but also dedicated, transparent, and clearly rules-based governance through an independent institution, such as a European Central Carbon Bank (ECCB) or a European Carbon Market Authority/Agency (ECMA), in order to coordinate its increasingly complex functions related to market stability and CO₂ emissions management.