Contents

1............ Procedural issues and consultation of interested parties. 4

1.1......... Organisation and timing. 4

1.2......... Consultation and expertise. 4

1.3......... Subsidiarity. 6

1.4......... Opinion of the Impact Assessment Board. 6

2............ Policy context 7

3............ Lessons learnt from the functioning of the EU ETS. 7

4............ Problem definition. 8

4.1......... Interaction with possible measures in the context of the 2030 framework. 10

5............ Objectives. 11

5.1......... General objective. 11

5.2......... Specific objective. 11

5.3......... Operational objective. 11

6............ Policy options. 12

6.1......... Option 1: Retiring a number of allowances in phase 3. 14

6.2......... Option 2: Market stability reserve. 14

6.2.1...... Potential sources of supply flexibility. 15

6.2.2...... Functioning of the mechanism.. 16

6.2.3...... Triggers for feeding allowances into the reserve and releasing them.. 17

6.2.4...... Size of the adjustment 23

6.2.5...... Timing. 24

6.2.6...... Other design aspects and characteristics of a market stability reserve. 25

6.3......... Option 3: Combination of a market stability reserve with permanent retirement 26

7............ Analysis of impacts. 26

7.1......... Market balance. 26

7.1.1...... Baseline scenario – Option 0. 29

7.1.2...... Permanent retirement options: Options 1a and 1b. 30

7.1.3...... Options for the market stability reserve. 31

7.1.4...... Option for a combination of a market stability reserve with permanent retirement: Option 3 45

7.2......... Potential impact on carbon price formation. 45

7.2.1...... Baseline option. 46

7.2.2...... Permanent retirement 46

7.2.3...... Market stability reserve. 46

7.2.4...... Combination of a permanent retirement and a market stability reserve. 47

7.3......... Auction revenues. 48

7.4......... EU competitiveness considerations. 48

7.4.1...... Potential direct cost for energy-intensive sectors covered by the EU ETS. 50

7.4.2...... Potential indirect cost 52

7.5......... Social impacts. 52

7.6......... Environmental impacts. 54

8............ Comparison of options and conclusions. 54

9............ Monitoring and evaluation. 55

10.......... Annexes. 58

10.1....... Sensitivity analysis. 58

10.1.1.... Baseline scenario. 58

10.1.2.... 40% GHG emission reduction by 2030. 60

10.2....... Summary of the results of the stakeholder consultation. 63

10.2.1.... Process. 63

10.2.2.... Distribution of replies to the online consultation. 64

10.2.3.... EU remains the best instrument for achieving the EU objective of an economy-wide 80-95% reduction 66

10.2.4.... Option (a): Increasing the EU reduction target to 30% in 2020. 67

10.2.5.... Option (b): Retiring a number of allowances in phase 3. 67

10.2.6.... Option (c): Early revision of the annual linear reduction factor 67

10.2.7.... Option (d): Extension of the scope of the EU ETS to other sectors. 67

10.2.8.... Option (e): Use of access to international credits. 68

10.2.9.... Option (f): Discretionary price management mechanisms. 68

10.2.10.. Other proposals. 69

COMMISSION STAFF WORKING DOCUMENT

IMPACT ASSESSMENT

Accompanying the document

Proposal for a Decision of the European Parliament and of the Council

concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and amending Directive 2003/87/EC

1. Procedural issues and consultation of interested parties

1.1. Organisation and timing

The preparation of the Impact Assessment (IA) for the structural measures to strengthen the EU Emissions Trading System (ETS) formally started in November 2012 with the adoption of a Report on the State of the European Carbon Market in 2012 (from here on referred to as the Carbon Market Report).[1] As the work on the 2030 climate and energy framework plays a role in the assessment of several options for the structural measures , the preparation of this IA was combined with the preparation of the IA for the 2030 framework (from here on referred to as the 2030 IA).

An interservice group for the 2030 framework was established in February 2013 in view of preparing a Green Paper on the matter.[2] It continued to meet to steer the work on the IAs after the paper's adoption. Also in relation to the options for structural measures, the group met three times:

(1) On 16 July 2013 to discuss the first outline of the 2030 IA, including the chapter on the EU ETS, and the lessons learnt;

(2) On 23 September 2013 to discuss the results and analysis of the information submitted by stakeholders on the options for structural measures, first outline of this IA and the progress on the 2030 IA;

(3) On 21 October 2013 to discuss the progress on both IAs.

The final draft IA was submitted to the group on 13 January 2014.

Directorate-General for Climate Action (DG CLIMA) took the lead on this IA. The following services were invited to the steering group: Secretariat-General; Legal Service; DG Competition; DG Economic and Financial Affairs; DG Employment, Social Affairs and Inclusion; DG Energy; DG Enterprise and Industry; DG Environment; DG Internal Market and Services; DG Mobility and Transport; DG Research and Innovation; DG Taxation and Customs Union and DG Trade.

1.2. Consultation and expertise

The Carbon Market Report served as a consultation document. It presents the adverse effects of the severe supply-demand imbalance in the EU ETS and sets out a range of possible structural measures to address it in a sustainable manner.

The Commission launched an online stakeholder consultation, which lasted until 28 February 2013. It did its best to accept late submissions also. The consultation sought input on the expected impacts of individual options, including on emission reductions, ability of the EU ETS to meet the EU long-term target of an 80-95% reduction by 2050 in a cost-effective manner, stakeholders' activities, and employment and households. 232 contributions from a broad spectrum of stakeholders were received. The Commission's minimum consultation standards were met. In addition, two dedicated full-day consultation meetings were organised on 1 March and 19 April 2013. As there appeared to be a growing view among stakeholders that the EU ETS needs some kind of objective and rule-based mechanism to strengthen market stability and increase the resilience to large-scale demand shocks, the Commission organised on 2 October 2013 an expert meeting on this additional option. The main findings of the public consultation are found in Box 1 and a comprehensive summary report in section 10.2.

Box 1: Main findings of the public consultation

The public consultation showed that a large majority of stakeholders continued to hold the view that the EU ETS is the best instrument for achieving the EU objective of an economy-wide 80-95% reduction in greenhouse gas (GHG) emissions by 2050 within an internal market. Most stakeholders recognise that there is a large and growing surplus in the carbon market. Some thought that the Carbon Market Report puts forward the options because the carbon price signal does not generate enough revenue for Member States. Many regretted that the options set out in the Carbon Market Report were not explicitly linked to a clear process on the 2030 framework. Some stakeholders felt that the options appeared to concentrate on the short-term action and did not sufficiently address the underlying issues. According to some, there are significant differences between the economies of Central Europe and the rest of the EU. Functioning of the EU ETS: Stakeholders have mixed views on the extent to which the success of the EU ETS depends on a robust carbon price signal. Many argue that a significant carbon price is necessary so that the low-carbon investment results in a positive business case. Others emphasised that a low carbon price simply indicates that there is little need for additional abatement to meet the current target. Accordingly, views differ on the need for measures in the short-term. Preferred options: Most energy-intensive industries prefer no action before phase 4 (2021-2028). Other stakeholders supporting measures to be taken in phase 3 generally favour: Option (c) for an early revision of the linear reduction factor consistent with a 2030 target, if necessary accompanied by option (b) for a permanent retirement preceeding the application of a new factor (in phase 4 of the EU ETS) in order to swiftly implement the new factor and address the market imbalance well before 2020; Additional option that has emerged from the consultation for a rule-based reserve mechanism to render the auction supply more flexible. A volume-based mechanism based on verified emission data seems to be seen as the preferred choice. Other options: Member States and stakeholders highlighted that other options are not expected to be implemented and thus not have a material impact much before 2020. Hence, they are seen to be considered more in the context of the 2030 framework. Some believed that the options offered in the Carbon Market Report were incomplete. However, apart from the flexible auction supply, hardly any tangible options relevant for addressing the market imbalance were proposed. Most other proposals rather concerned measures for addressing the risk of carbon leakage.

The European Parliament has noted in a number of documents that further improvement of the EU ETS is necessary. In its Resolution on the Roadmap for moving to competitive low carbon economy in 2050, the European Parliament called on the Commission to adopt measures to correct the failings of the EU ETS and allow it to function as originally envisaged, which it reiterated in the Resolution on the Energy Roadmap 2050. Also in the context of the agreement on the Energy Efficiency Directive, it called on the Commission to examine options for action with a view to adopting as soon as possible appropriate structural measures during phase 3 (2013-2020).

The European Council of 22 May 2013 underlined the importance of a well-functioning carbon market in the context of the challenges for Europe's energy policy.

In terms of external expertise, the Commission contracted the National Technical University of Athens, International Institute for Applied System Analysis and EuroCare to model scenarios underpinning the sectoral analysis for the 2030 IA, some which are also behind the analysis for this IA.[3]

1.3. Subsidiarity

The EU ETS is an EU policy instrument. Structural measures can only be implemented through proposals by the Commission to amend the Directive. Moreover, the EU ETS is a climate policy instrument. Articles 191 to 193 of the Treaty on the Functioning of the EU (TFEU) confirm and further specify EU competencies in the area of climate change.

1.4. Opinion of the Impact Assessment Board

The Impact Assessment Board of the Commission assessed a draft version of the IA and issued its opinion on 6 December 2013. The Board issued a positive opinion and made several recommendations and, in the light of them, the final IA:

· Explains better in sections 2 and 4.1 how this initiative fits within the overall improvements/revisions foreseen to the EU ETS in the longer-term (after 2020) and its general coherence with the 2030 climate and energy framework;

· Explains in section 3 the lessons learnt from the functioning of the EU ETS so far;

· Explains in section 2 the role of the EU ETS in the future climate policy mix;

· Clarifies in section 5.3 the objectives that this initiative aims to achieve and how they take into account the need for simplicity and predictability of the EU ETS legal framework;

· Explains better in sections 4.1 and 6 why an early revision of the linear reduction factor was discarded from further analysis in this impact assessment;

· In terms of impacts, it amends section 7.2 giving more context on the limitations to the assessment of impacts on the carbon price. It also amends sections 7.4.2 and 7.5 giving more context on the magnitude of impact on energy prices. It adds a new section 7.3 on auctioning revenue and explains in section 6.2.3.2 whether any of the sub-options entail administrative burden requiring additional information and data to be collected.

2. Policy context

The GHG emission reduction target for 2020 for the sectors covered by the EU ETS is expected to be met. However, the economic recession and the accelerated inflow of international credits have created a surplus of more than 2 billion allowances since beginning of phase 2 (2008-2012).

The Commission in July 2012 undertook steps to consider changes to strengthen the EU ETS based on a two-step approach. As a first step, the EU should slow down the increase in the supply-demand imbalance by postponing (back-loading) part of the auction supply.[4] Back-loading has received a favourable opinion from Member States in the Climate Change Committee in the comitology process. While the measure is now under scrutiny by the European Parliament and the Council, this Impact Assessment takes back-loading for a fact.

The structural measures should be identified as a second step, to enable the EU ETS to address the imbalance in a sustainable manner. With this in mind, the Commission proposed six options for structural measures in the Carbon Market Report.

As outlined by stakeholders, as well as in the Carbon Market Report, a properly functioning EU ETS plays a critical role in driving investments in a wide range of low carbon technologies. If unaddressed, the large imbalance in the EU ETS will impact its ability to do so in the mid- and longer-term. The 2020 framework is but an intermediate step towards a competitive and secure low carbon economy. As a preparatory step for the 2030 framework, the Commission adopted the Green Paper on 27 March 2013. The Green Paper highlights the need to assess the 2030 architecture for EU ETS on a number of elements: the level of the target and potential revision of the linear reduction factor, the extension of the scope of the EU ETS, access to international credits and how to continue avoiding the risk of carbon leakage. Accordingly, the 2030 IA also assesses the options for structural measures and the relevant components form the basis for this IA specifically on the structural measures to address the large supply-demand imbalance in the EU ETS rather than determine the ambition level for 2030. The options considered in this report are not included in the baseline option for the 2030 impact assessment.

This IA also complements the assessments already undertaken in the context of these steps: Staff Working Document on the functioning of the EU ETS[5], Impact Assessment on backloading[6] and the Carbon Market Report.

3. Lessons learnt from the functioning of the EU ETS

The EU ETS regulatory framework has been largely unchanged for the first eight years of the functioning of the system. However, with the start of phase 3 a significant number of architectural and regulatory changes have kicked in 2013, as outlined in the 2012 Staff Working Document. The EU ETS has produced since its start an EU-wide carbon price signal to incentivise daily operational and strategic investment decisions delivering emissions reductions across parts of the EU economy that are responsible for half the EU's GHG emissions.

On the demand side, verified emissions have varied materially over the years. At the start of phase 2, it was expected that the EU ETS cap would be ambitious. However, emissions experienced a very large decrease, with the economic crisis having a considerable impact on industrial production and electricity consumption. In contrast, on the supply side, the annual use of international credits in the EU ETS has actually experienced a significant increase. In 2008 only around 82 million international credits were used for compliance, while this increased to over 500 million credits in 2012. The effect of these two elements has been a strong driver for the large imbalance. The drivers of the surplus and of carbon prices have been analysed in the report Energy Economic Developments in Europe[7].

There is clearly an interaction between the EU ETS, and renewables and energy efficiency policies. However, this was anticipated and taken into account when the 2020 package was prepared and adopted. Specific measures to promote renewable electricity or lower electricity consumption can reduce the carbon price. But they are also expected to deliver additional benefits beyond GHG emission reductions, e.g. concerning synergies with resource efficiency.

The current imbalance is aggravated by this mismatch between the supply of emission allowances, which is fixed due the nature of the EU ETS as a cap-and-trade system (and was decided in more favourable economic circumstances), and demand for them, which is flexible and impacted by economic cycles, fossil fuel prices and other drivers.

4. Problem definition

At the start of phase 3, the EU ETS was characterised by a surplus of around 2 billion allowances.[8] In the baseline scenario[9], this surplus is expected to be at the same level at the end of phase 3 in 2020 and around 1.5 billion at the end of the phase in 2028. In the reference scenario[10], it is expected to grow to more than 2.6 billion allowances by 2020 and gradually decrease to around 2.1 billion by 2028, which means compared to today the surplus at the end of phase 4 would be largely unchanged. If adopted, the recent proposal to change the coverage of aviation under the EU ETS, limiting it to European regional airspace and exempting certain flights from lower income countries with small shares in global aviation[11], would be expected only to further increase this overall surplus.

The IA examines the issues related to the magnitude of the existing structural surplus expected to remain in place for many years and definitely beyond the end of phase 3. The aforementioned 2012 Staff Working Document and backloading Impact Assessment include an analysis of the surplus that materialised in phase 2 and how the transition from phase 2 to phase 3 was expected to impact it. This IA therefore complements these earlier analysis related to the exceptionally rapid build-up by the end of phase 2, due to the transition into phase 3. Figure 1 provides an illustration of the historical and expected growth of the surplus up to 2028 assuming an emission profile of the reference scenario projections.[12]

Figure 1: Historical and projected future profile of supply and demand up to 2028

Costs of emission reductions are expected to be the lower, the earlier the necessary long-term investments take place. Although in a cap-and-trade system, such as the EU ETS, the agreed environmental objective expressed in the cap, limiting total emissions for a given period, is guaranteed, the cost-efficiency objective expressed in the total cost is also of central importance. In principle a market functions well with a certain level of surplus, as it provides a buffer to deal with factors leading to normal fluctuations in the supply-demand balance. For this reason rational economic behaviour results in stock-keeping. However, a large surplus is likely to result in a prolonged downward pressure on the carbon price signal. This may be good for the short-term competitiveness of some sectors but not for the EU at large. The resulting carbon price signal is increasingly distorted and no longer in line with the trend necessary to achieve the long-term decarbonisation target in a cost-effective manner.

A large surplus hence strongly confounds the signal for investments, which are necessary for the transition towards a low-carbon economy, including energy supply[13]. It is a problem as it is expected to result in locking the EU into high carbon capital and investment, in particular considering the currently high gas to coal price ratio.

The latest survey of EU ETS operators in early 2013 by Thomson Reuters Point Carbon reconfirmed that the EU carbon price has become less important for investment decisions. 20% of the operators surveyed said that EU ETS no longer has a significant impact on emission reductions. Because of the risk of carbon lock-in, the large surplus in turn risks putting the EU on a more expensive path to meeting the long term targets. That is bad for the longer term competitiveness of the EU. Put differently, the presence of a large surplus reduces the dynamic efficiency of the market-based outcome and thus increases overall costs when considered over the longer periods that are relevant for the climate change challenge.

As a short term measure to mitigate the effects of this problem in the context of additional temporary imbalances caused by regulatory changes linked to the transition to Phase 3, the Commission proposed to back-load the auctioning of 900 million allowances in the beginning of phase 3. Figure 2 provides an illustration of the supply and demand balance up to 2020 with back-loading. The analytical assumption generally used in this Impact Assessment is that back-loading reduces the auctioning amounts by 400, 300 and 200 million allowances in 2014, 2015 and 2016 respectively. The return of these allowances to the market remains the same as initially proposed, increasing the auctioning amounts by 300 and 600 million allowances in 2019 and 2020 respectively. It should be emphasised, however, that back-loading and the measures considered in this Impact Assessment pursue complementary objectives.

Figure 2 demonstrates that to an extent back-loading can rebalance supply and demand in the EU ETS in the transition into phase 3 compared to a situation without back-loading. As already highlighted in the Carbon Market Report, however, back-loading leads to a rebound in the surplus in 2019 and 2020 and hence does not affect the average size of the structural surplus of around 2 billion allowances in phase 3 and 4, peaking at 2.6 billion in 2020. It is the structural surplus, and solutions for addressing it in a sustainable way and preventing from it accumulating again in the future that are the focus of this Impact Assessment.

Figure 2: Historical and projected future profile of supply and demand up to 2028 with back-loading

4.1. Interaction with possible measures in the context of the 2030 framework

According to stakeholders, the linear reduction factor should be strengthened after 2020 consistently with the GHG emission reduction target for 2030. This target is still to be decided. If the target is decided fast enough to allow for an early revision of the linear reduction factor ahead of 2020, this should lead to a decline in the surplus. Nevertheless, the decline would only happen gradually. For this reason, an early revision of the linear reduction factor is also discarded from further analysis as an option that can address the large imbalance in the short-term.

If, as of phase 4, the linear reduction factor would be increased to a level consistent with a 40% GHG emission reduction by 2030, all scenarios leading to such a reduction still result in a surplus of around 2.3 billion allowances or more by the end of phase 4 (see Figure 3) and even 2030[14]. Under this target, there is also no demand in the EU ETS for international credits as of 2021, given that they would only add to the already very large surplus of allowances. This is also consistent with the current legislation that provides for no additional entitlements created after 2020. If it was allowed to meet a part of the effort through international credits, this would be combined with a higher conditional target. Hence, this is not likely to have a considerable effect on the surplus.

Figure 3: historical and projected future profile of supply and demand up to 2028 with back-loading and a 40% GHG target for 2030

Concerning possible revision of the EU ETS after 2020 to include additional sectors, it still requires further assessment. A first qualitative analysis is taken up in the 2030 impact assessment. It shows that the degree of impact on the market balance will depend on the overall cap under the enlarged scope. In any case, however, an extension of the scope may, like the revision of the linear reduction factor, lead only to a very gradual decline in the surplus.

5. Objectives

5.1. General objective

The general objective of the EU is to achieve the climate objective of limiting global average temperature increase to not more than 2 degrees Celsius above pre-industrial level. The EU ETS, as the main policy instrument at the EU level to reduce GHG emissions, has a central role to achieve the needed emissions reductions up to 2050 in a cost-effective and economically efficient manner.

5.2. Specific objective

The specific objective is to restore the functioning of the European carbon market in the short-term (and beyond) in a context where auctioning of allowances has gained a significant role as of phase 3 in bringing allowances in circulation.

5.3. Operational objective

The operational objective is to ensure inter-temporal efficiency[15] of the carbon market in the short-term and beyond in a market setting characterised by large-scale auctioning, taking into account the need for simplicity and predictability. This requires addressing the structural surplus expected to remain in place even with other possible measures after 2020 in the context of the 2030 framework (i.e. revision of the linear reduction factor, use of international credits, extension of the scope). It also requires increasing the resilience of the EU ETS in the light of the severe economic recession and other potential future large-scale events that may severely disturb the supply-demand balance.

6. Policy options

The baseline option (option 0) includes back-loading of 900 million allowances as outlined in section 4 and the so-called reference scenario concerning the expected emissions. Consistently with the 2030 impact assessment, the reference scenario is assumed as this is the one that sees the fulfilment of all legally binding targets for 2020. A detailed description of the policies and measures includes in the reference scenario is available in the 2030 impact assessment.

In terms of structural measures, the Carbon Market Report outlined a shortlist of six options listed in Table 1. The report acknowledged that some of the options would require considerably more analytical work, time to decide upon and subsequently implement. This was also one of the considerations that stakeholders took into account in their choice of preferred options. Out of those, who supported action in phase 3, the preferred options seem to be: c) early revision of the linear reduction factor to maintain the credibility of the EU ETS in the long-term, ideally combined with b) retirement of allowances to maintain the credibility of the EU ETS in the short term; a variant of option f), which would not focus on the price for allowances but rather on the supply of (auctioned) allowances.

The 2030 IA includes a general assessment of the impacts of those options that can only be implemented and have an impact in the context of a 2030 framework ((c) early revision of the linear reduction factor, (d) extension of the scope of the EU ETS to other sectors and (e) using access to international credits). It confirms that, although all options may be relevant as of phase 4, only a few have the potential to achieve the objective of this IA, to improve the functioning of the EU ETS in the short-term. Option a) of increasing the target is excluded from the focus of the 2030 IA based on the clear stakeholder feedback. Option c) for a revision of the linear reduction factor would be best implemented only after the decision on the 2030 GHG emission reduction target. Even if revised before 2020, it would only create scarcity and restore better aggregate balance in a gradual manner and is not expected to significantly impact the surplus in the short-term. As regards option d), the main limiting factor is the fact that the option requires further analysis and would not directly affect the surplus. In relation to option e), this would only impact the availability of international credits in phase 4. It would not sufficiently change the availability of international credits in the short-term, as more than two thirds of the amount allowed until 2020 is already used up. For more information, see the 2030 IA.

Based on the screening of the six options in terms of stakeholder views and assessment in the 2030 IA, the focus of this more detailed assessment is on the options that could realistically be implemented, and already restore the orderly functioning of the EU ETS in the short-term:

· Option 1: Retirement of a number of allowances in phase 3 (option b) in the Carbon Market Report);

· Option 2: More flexible auction supply in the form of a market stability reserve (additional option building on a variant of option f) in the Carbon Market Report);

· Option 3: Combination of a market stability reserve with retirement of a limited number of allowances in phase 3

Table 1: Comparison of the options from the Carbon Market Report

|| Stakeholder views* || Potential effectiveness in improving the functioning of the European carbon market in phase 3

a) Increasing the EU reduction target to 30% in 2020 || Very limited support || Not focus of the assessment Would have been accompanied by a reduction of auction supply over phase 3 by some 1.4 bn allowances. This might have the potential to improve market functioning in the short-term Reference emission projections for 2020 actually already come very close to levels associated with a 30% reduction target. This means that while the EU might not be ready to increase its target to 30%, the full achievement of other agreed targets can reduce emissions in the EU to the level in line with what would be required to achieve a step up to a 30% target

b) Retiring a number of allowances in phase 3 || Medium support || Retiring a number of allowances early on has the potential to create scarcity and improve market functioning in the short-term

c) Early revision of the annual linear reduction factor || Medium support || Limited potential to improve market functioning in the short-term But expected to have a positive impact in the mid- and long-term

d) Extension of the scope of the EU ETS to other sectors || Limited support (for phase 3) || Limited potential to improve market functioning in the short-term Assessment of administrative challenges and potential to improve market functioning as of phase 4 needs to be further investigated But potential other benefits, e.g. in terms of technology-neutral incentives across sectors

e) Use access to international credits || Limited support (for phase 3) || Very limited potential to sufficiently improve market functioning in the short-term Aggregate surrender of international credits has already used up more than two thirds of the amount allowed until 2020

f) Discretionary price management mechanisms || Very limited support for a mechanism focused on price || Not focus of the assessment EU ETS is an instrument based on volume not price

Additional option || Medium support for a mechanism focused on (auction) supply to address market imbalance || Potential to improve market functioning in the short-term Most useful and simplest mechanism expected to be a reserve of allowances

* Out of those supporting any measures in phase 3

6.1. Option 1: Retiring a number of allowances in phase 3

The market imbalance can be reduced by retiring some of the phase 3 allowances on a permanent basis. A permanent retirement would indirectly increase the reduction target for 2020 and in turn (partially) restore the ambition level of the 2008 climate and energy package. However, as a self-contained measure, it would not directly impact the framework after 2020.

A retirement of a number of allowances would reduce the auction supply, but unlike with backloading this auction supply would not return to market and the allowances would be cancelled. It would not affect the amount of free allocation on the basis of the National Implementation Measures (NIMs) for phase 3.

This option would address the impact of the economic crisis and complementary policies on the demand side, as well as of the supply side drivers, notably the large inflow of international credits.

For the purpose of this assessment, an upper limit is put on the number of retired allowances that is equal to the number required for the step up to a 30% overall GHG reduction target in 2020, i.e. 1400 million allowances. However, under this option the primary aim is not to increase the target to 30%, but rather to address the market imbalance. This sub-option assumes that the permanent retirement starts in 2014 and ends in 2020, with high amounts at the beginning (similar to backloading) to correct the large existing surplus and low amounts of 100 million annually as of 2016.

Of course other amounts of retired allowances could be conceived. As a sensitivity analysis, another sub-option with a lower amount of 500 million allowances is assessed. This sub-option assumes that first 900 million allowances are temporarily withdrawn from the market through backloading, 500 million of these are permanently retired, while the remaining 400 million allowances are returned at the end of phase 2.

6.2. Option 2: Market stability reserve

Contrary to a one-off measure to improve the functioning of the market in light of the current severe economic recession, such as a retirement of allowances, the objective of a permanent mechanism is to increase the efficiency of the EU ETS and its resilience of in the light of any future severe demand shocks. A discretionary price management mechanism was among the options for structural measures to strengthen the EU ETS. Two variations have been put forward in the Carbon Market Report: a price floor and a price management reserve. Neither drew much support in the consultation on the options by stakeholders, who generally highlighted that the EU ETS is an instrument based on volume not on price.[16] Price management would go against the central EU ETS principles and is therefore opposed by most stakeholders. It can also be expected that agreeing on the "right" price thresholds would be very contentious, if not impossible.

However, there is a broad agreement among stakeholders that instead possible measures to be assessed should be i) non-discretionary and rule-based to remove the need for future ad hoc intervention, and ii) volume-based to allow for continued price discovery by the market,[17] and neutral to the overall cap[18]. A mechanism to adjust auction supply aims to address the mismatch between the fixed auction supply and flexible demand by introducing flexibility also on the supply-side in the short-term, without affecting the total long-term supply in place. Keeping the supply flexibility within the cap is essential for a mechanism design that is environmentally viable. Hence, some stakeholders[19] are proposing an idea of a reserve of allowances.

Such a measure may also allow improving the interaction with renewables and energy efficiency policies, and even reduce uncertainty from international negotiations, by playing a helpful role in the 2030 framework and move between an unconditional and possible conditional GHG target.

6.2.1. Potential sources of supply flexibility

Although supply on the carbon market stems from three sources – auctions, free allocation and international credits – the main cause of supply rigidity is the auction supply.

Contrary to the allowance allocated for free, auctioned allowances translate immediately into supply on the market. The Auctioning Regulation[20] provides for a rigid time profile. The volume to be auctioned in each year should be equal to the difference between the total amount of allowances under the cap (which declines in a linear manner) and the amount of allowances handed out for free in that year (in line with the benchmarks), i.e. cap minus free allocation for each year. This time profile was decided back in 2010.

The point in time when free allocation translates into actual supply in the secondary market, on the other hand, depends on the operators’ incentives to sell the allowances they have received. If demand falls, so does the price and the operators are not incentivised to sell allowances received, and may prefer to bank them into subsequent trading periods, reacting in a flexible manner to changes in demand. The rules for free allocation when there are capacity extensions and reductions as well as new entrants and closures provide additional flexibility responding to changes in economic activity. Some stakeholders advocate going further to full ex-post corrections to free allocation based on actual output.[21] While this may be relevant for the discussion on addressing the risk of carbon leakage, it is not relevant in relation to the large supply-demand imbalance.[22] It should be noted that moving to ex-post allocation would change the incentives for industry and in particular would undermine the incentives for emissions reductions for products and sectors with no specific product benchmarks and covered by so-called fall-back allocation approaches.

In relation to international credits, a distinction needs to be made between the overall amount of credits allowed and the annual distribution of this amount over the relevant period (currently for 2008-2020 combined). The annual inflows of international credits are in principle able to react to changes in demand, but in 2011 and 2012 this was rather counteracted by increased inflow of credits in reaction to a regulatory change (disallowing the compliance use of industrial gas credits) that was decided in early 2011 for implementation as of May 2013. The overall amount, on the other hand, is fully fixed. Following the recession, the overall limit has turned out to be rather generous. The combination of these two factors meant that the use of international credits was one of the major drivers of the surplus. As of phase 4, the default situation is that no additional entitlements are created. Any further use of international credits in a 2030 framework needs to address how many could be used (quantity) and what type could be used (quality). In terms of quantity, various solutions could be envisaged to avoid large inflows in the future:

· To ensure a more stable flow of international credits and avoid excessive inflows in an individual year triggered by events like the forthcoming ban of some credit categories, an option would be to break down the overall amount into annual amounts, which would act as annual limits on the use of the international credits. At the same time, if that annual amount was not used up to the full, the remaining amount would be lost, i.e. it could not be added to the amounts for the subsequent years. Although it expected that this may create an incentive to use up the annual amount, it would create a more stable inflow of international credits and avoid circumvention of any additional credit bans by increased use of international credits in preceding years.

· Another option to align the supply / inflow of international credits with demand is to define the allowed use in relation to emissions rather than (free) allocations. This would allow for a higher amount of inflows in times of higher emissions and vice versa.

· To align the use of international credits with its original purpose – cost containment – and prevent the overall amount being too generous, another option would be to make the overall amount subject to demonstrated need. For example, the default amount could start at zero or a low level, but could be increased depending on a price trigger. This could be an absolute trigger or a relative one, like the mechanism in Article 29a of the EU ETS Directive[23].

However, as by the end of phase 2 the aggregate surrender of international credits has used around two thirds of the amount allowed over 2008-2020, changes to the remaining allowed supply for phase 3 would not have sufficient impact. Curtailing the remaining credit entitlements would furthermore disadvantage those installations that have so far made a disproportionally limited use of the possibility to surrender international credits with the intention to consume the entitlement in later years. More flexibility could rather be considered for phase 4 and beyond, in case it should be decided to allow for the use of more international credits after 2020. The option therefore discussed and assessed in the 2030 IA.

6.2.2. Functioning of the mechanism

As the purpose of the mechanism is to make supply more flexible without affecting the cap, the most obvious mechanism is establishing a reserve of auctioned allowances. The auction supply and the size of the reserve would vary over time by:

· Adding allowances to the reserve by deducting them from future auction volumes with the aim of mitigating market instability due to a large temporary surplus in the EU ETS;

· Releasing allowances from the reserve and adding them to future auction volumes with the aim of mitigating market instability due to a large temporary deficit in the EU ETS.

To ensure that the cap is not affected, an increase in the auction volume would only be possible, if there were allowances in the reserve. A market stability reserve would work across trading period boundaries. Allowances that would be in the reserve at the end of a trading period would remain there for the following period. Key design aspects that need to be decided for the establishment of a workable reserve are rules on when to feed allowances into the reserve and when to release them (triggers), how many allowances to feed into it and how many to release (size of the adjustment) and over what time period any adjustment should be made (timing).

The design of such a reserve would need to take careful account of the already accumulated large surplus in the EU ETS and the proposed back-loading of part of the auction volumes from the beginning of phase 3. Experience with implementing back-loading could also provide valuable insight into the operational design and / or review of a reserve with regard the impacts of withholding an amount of allowances from the market on the behaviour of market participants.

Given that a market stability reserve would be purely rule-based and non-discretionary, existing institutional arrangements for auctions (e.g. tasks performed by the Commission and auction platforms) could most cost-effectively be used for implementation purposes.

6.2.3. Triggers for feeding allowances into the reserve and releasing them

Potential triggers can be grouped into external indicator-based, price-based and volume-based. In terms of their level, the basis for the adjustment should be expressed in a range rather than one specific value, which should be continuously targeted, to ensure that the rules kick in only in exceptional circumstances due to large demand shocks and not on frequent basis in normal circumstances.

The mechanism could also be devised as a combination of these triggers, e.g. a volume-based trigger for putting the allowances into the reserve, but a price-based trigger for releasing allowances from the reserve.

6.2.3.1. External indicator-based triggers

Triggers based on external economic activity indicators, such as gross domestic product (GDP) and industrial production, would be most directly related to the underlying causes of decreased demand for emission allowances due to economic shocks. There are limitations in the suitability of macroeconomic indicators, such as the GDP, as the trends in the EU ETS sectors may be prone to different cyclical swings than the wider economy. So more targeted indicators related to industrial or electricity production may be more appropriate. Changes to the size of the reserve could be made if the indicators considerably deviated from a certain range or possibly based on multi-year averages, e.g. if the GDP in year x deviates by 0.5 % from the average GDP over the preceding three years or less.

One could use actual data from the previous year as soon as they become available, or forecasts. In case of the latter, the more forward looking the forecast, the less accurate it is likely to be. Hence, it may be advisable to use forecast for only one year ahead. Still, any trigger based on forecasts will inherently suffer from the disadvantage that forecasts can turn out to be inaccurate, as was the case with the growth forecasts used for the Impact Assessment for the 2008 climate and energy package[24]. However, a trigger based on forecasts will have the advantage of potentially kicking-in before the changes in the economic activity driving demand shocks have happened, while an indicator based on actual data, which is available with a time lag, will only kick-in after the event. The expert meeting on flexible auction supply on 2 October 2013 showed an almost universal preference for the use of actual verified data over forecasts.

A major limitation of external indicator-based triggers is that they are only able to capture changes in the demand for emission allowances due to changes in the economic activity. They are not able to capture changes in the demand due to possible other factors, such as impact of complementary policies, such as the renewables and energy-efficiency policies, which can reduce EU ETS emissions and demand for allowances. They are also not able to capture changes on the supply side, such as occurred in the transition from phase 2 and 3, and any big changes in the inflow of international credits.

6.2.3.2. Volume-based triggers

As the issue the measure aims to address is market imbalance, which is expressed in cumulative surplus, a volume-based trigger would be best designed having either a certain stock of surplus (cumulative surplus) or flow of surplus (changes in cumulative surplus) as a basis. A surplus-based mechanism would aim to maintain the surplus within a pre-defined target range. A market may normally build up some surplus to act as a buffer by providing sufficient liquidity in times of higher demand. This liquidity is absorbed by hedging demand[25], currently mostly in relation to forward electricity sales. However, too large a surplus affects the stability of the carbon market and impedes the effectiveness of the system in incentivising both short-term abatement, such as fuel switching from coal to natural gas, as well as mid- and long-term investments in low carbon technology.

The most useful data source related to the evolution of the surplus is actual data on verified emissions and the use of international credits in the previous year. The use of forecasts is arguable less appropriate here. The expert meeting showed a general agreement on this point, that historical data should be used.

Such a range could be expressed as an absolute range or in relation to the auction quantities or the cap. As an example for the relative range, the levels proposed by stakeholders so far are in the order of magnitude of 40-50% of the annual cap. This means that allowances should be added to auctions when the surplus falls below 40% of the annual cap; and they should be deducted when the surplus exceeds 50% of the annual cap. As the cap decreases, the absolute numbers would change year on year with a band that tapers over time. This may have the disadvantage of going against the possibly increasing trend in hedging needs by also sectors other than the power sector as the amount of free allocation declines. The band could also be determined in absolute levels, e.g. that allowances should be added to the auctions when surplus falls below 400 million allowances and deducted from the auctions, when it exceeds 1000 million allowances. Also in the case of a band expressed as a share of the auctioning amount, the absolute numbers would change year on year, but with a band that would increase over time. However, such a band may be exposed to possible structural breaks in the transition from phase 3 into phase 4, if there were any changes in the free allocation rules, in particular in terms allocation to sectors deemed to be exposed to a significant risk of carbon leakage.

Another aspect to consider is whether to have a constant band or one where the upper level either increases or decreases over time. One possibility would be a band that increases over time so that the surplus is reduced faster at the beginning to restore market balance. Such an approach may be better if an amount of auction supply is not already temporarily removed from the market through back-loading. However, back-loading already acts in a similar way, quickly reducing the market imbalance from the start, so a lower band in the early years may not be needed. The alternative would be a band that decreases over time so that the surplus shrinks or grows in a step-wise and gradual way to prevent big changes in the auction supply and possible large price effects. A band that is relative to the cap already declines in line with the cap, however bigger differences in the level of the band over time would probably be needed to avoid shock-therapy in a situation where a large surplus has already built up.

In terms of the width of the band, a narrower band is expected to lead to more need for intervention than a broader band. As a result, it is likely to lead to a higher number and frequency of adjustments and in turn in less predictability as regards the auction volumes. A broader band would result in a lower number and frequency of adjustments.

Figure 4: Illustration of a supply-based adjustment

An alternative to cumulative surplus as a basis for the trigger could be an annual change in the surplus. For example, allowances could be put into the reserve if the annual change in the surplus (increase or reduction) would exceed a certain amount. Such an approach is expected to react quicker than an approach based on the cumulative surplus, which may take a number of years of large annual changes to reach it.

An advantage of surplus-based triggers is that they would not only address the impact of the economic crisis, but also take into account the complementarity between the EU ETS and renewables and energy efficiency policies, which in the future may trigger an additional increase in the surplus in the EU ETS, as well as supply-side drivers, such as large inflow of international credits.

Choosing values for a volume-based trigger

A crucial issue is determining the upper and lower ends of a volume-based target range, which would trigger putting allowances into a reserve and releasing them. This warrants considering several approaches to establish appropriate values for the target range. These are:

· An analysis of typical hedging needs: Given the primary purpose of a market surplus, typical hedging needs in relation to emission allowances to cover forward sales should guide the decisions about the appropriate level of the band. The hedging needs are for the time being mainly related to the electricity sector, but to the extent that industry (e.g. industry sectors not deemed to be exposed to a significant risk of carbon leakage) may increasingly need to buy allowances on the market rather than having their compliance needs covered by free allocation, total hedging needs may grow too. Hence, a relative band expressed in relation to the cap, which would decrease over time, may have the disadvantage of going against the possible increasing trend in hedging needs. However, only a part of the power sector's hedging behaviour is understood and published data on it far from complete. No legal mandate is in place for power companies to regularly disclose hedging positions beyond certain transactions. Moreover, hedging behaviour may change over time. An option would be to put in place a reporting requirement in terms of hedging data. However, experts acknowledged that there is a risk of strategic behaviour by the reporting companies and little possibility to verify the data. Apart from that, none of the options for a market stability reserve requires additional information and data to be collected.

· An analysis of the average stocks of allowances in phase 2 and 3: Figure 5 compares the average monthly stocks of emission allowances in phases 2 and 3. In phase 2, the majority of emission allowances (around 96%) was allocated for free in one go at the end of February and was not surrendered until April the following year. This means that for two months, there were twice as many allowances in the market as "needed" in a year. In phase 3, with the increasing role of auctioning, which gradually brings allowances in circulation over the year, the average monthly stock of allowances is considerably lower. The difference between the average stock of allowances in circulation in phase 2 and 3 could provide insights about the magnitude of the needed allowances in circulation that still allows for orderly functioning of the market. This difference is around 800 million allowances.

Figure 5: Comparison of monthly stocks of allowances in phase 2 and phase 3

Some stakeholders and experts have submitted estimates of the amount of allowances covering power sectors forward sales and an appropriate range, which show diverging views on the order of magnitude:

· In the expert meeting, a representative of Bloomberg New Energy Finance mentioned a range of 1.2-1.3 billion allowances;

· In the same meeting, a representative of ENEL, proposed a surplus range of 762-956 million allowances[26];

· Fortum proposes a range between 40-50% of the following years cap (i.e. 810-1013 allowances at the start of phase 3 declining to 704-880 allowances at the start of phase 4).[27]

There are mixed views on the whether there exists a "right" range in the first place and whether the values matter. Some experts argued that the values are essential, while others that they do not matter that much because market participants may adjust their behaviour anticipating the impact of the reserve. In any case, the risk of setting the triggers at inappropriate levels could be mitigated by setting a broader range or a declining range, with a higher upper level at the beginning, to allow for a gradual reduction in the market imbalance and learning about the market impacts along the way, which could inform a possible review of the trigger levels. Putting a limit on the size of the annual adjustment can also prevent possible risks of setting the triggers at unsuitable levels, such as responding too strongly to changes in the demand. Furthermore, any excessive price increases due to a too low range would be addressed by the existing safeguard in article 29a of the Directive.

6.2.3.3. Price-based triggers

Price based triggers could be expressed in absolute or relative terms. Absolute thresholds would act as a price corridor with a price floor and price ceiling. A relative approach could function as the existing mechanism in Article 29a of the EU ETS Directive. This provides for the option to advance auction supply, if for more than six months the carbon price is more than three times the average price during the two preceding years. As this is about excessively high prices, the article could serve as the basis for the return of allowances from the reserve to the market, with another trigger determined for feeding the allowances into the reserve.

Price-triggers are a theoretical possibility, but obviously, this would be a price-focused mechanism with all the aforementioned drawbacks, which elicited little interest and support among stakeholders. They frequently pointed out that any price management mechanism would fundamentally modify the EU ETS, as the system would no longer be a quantity-based, market-based instrument for achieving emission reductions in a cost-effective way.[28] One of the main implications of the decision for a quantity-based instrument over a price-based one is that the carbon price signal is not fixed by policy-makers but revealed by the market. In the EU ETS, the carbon price reflects the quantity of allowances and their relative scarcity and not the other way around. With this in mind, stakeholders are asking for a mechanism that complements and enhances the market, and preserves this price discovery.[29] In contrast, a mechanism prescribing a certain price corridor runs counter to a market logic and even substitutes it, by distorting the carbon price level that would otherwise be revealed by the market.

Price-base triggers also suffer from the drawback of being more at risk of manipulation and gaming. There are indications that this risk is not material for volume- and in particular GDP-based triggers, as low concentration of the carbon market considerably mitigates the risk of gaming with a company attempting to influence the annual emissions, let alone the GDP. However, given that the European carbon market is dominated by derivatives (namely futures) a reserve with price triggers may be more prone to cross-market gaming behaviour by market participants influencing price-setting.[30]

As the external indicator-based triggers, it would also require an additional step to determine how many allowances would be deducted or added to the auctions if the price fell outside a certain price range.

Price-base triggers would be able to address the impact of the economic crisis and complementary policies on the demand side, as well as of the supply side drivers, notably the large inflow of international credits.

6.2.3.4. Review of triggers

The appropriateness of the triggers and their levels, the size of the adjustment and the timing could be reviewed on a regular basis. There seems to be a broad consensus among experts on the need for a periodic review of the triggers, which should be well-signalled in advance.

In case of surplus-based triggers the review could include the latest trends in hedging and in case of external indicator-based triggers latest trends in production, sector shares in the GDP and emission intensity. The triggers could be automatically updated by basing them on rolling averages of related data, or they can be revised on a more ad-hoc basis via the comitology process (e.g. once per trading period or every 4 years).

There is a trade-off between certainty for market operators and flexibility to incorporate "learning" by the decision makers. The advantage of the review would be that there would be a smaller regulatory risk of setting the triggers at the wrong levels and that it would allow for learning. The review would also allow for responding to any changes in the market structure, notably continued transition from free allocation for industrial sectors not deemed to be exposed to a significant risk of carbon leakage. On the other hand, it has the drawback of potentially reducing certainty.

One possibility would be to create two different types of trigger: the first type of trigger to determine when allowances go into or out of the reserve, the second type of trigger to launch a review of the first trigger for (moving allowances in or out of the reserve). For example, a surplus-based trigger could determine whether allowances are put into or taken out of the reserve, whereas price trends could be used as a secondary check or second trigger to launch a review. In this case, if excessive price changes occur even with a reserve, they could automatically result in (or trigger) a review of trigger levels based on the cumulative surplus. This second, review trigger could for example be along the lines of the formula in the existing rule in article 29a of the ETS Directive.

The Commission will monitor and evaluate the functioning of the carbon market in its annual report as foreseen under Article 10(5) of the EU ETS Directive. Any need for review of the triggers could be evaluated and signalled in the context of this report.

6.2.4. Size of the adjustment

As the external indicator-based triggers and price-based triggers would not be directly expressed in a number of emission allowances, another aspect to be decided is the amount of allowances put into the reserve or taken out of it, once a trigger is reached. A number of options exist, which are outlined and discussed in the following sections.

6.2.4.1. Function of the distance from the trigger levels

The amounts could be determined as a function of the difference between the upper / lower limit of the band. For example, in the case of external indicator-based triggers the amount could be expressed as X million allowances to be deducted from auction volumes for each percentage point below the band, or X million allowances added for each percentage point above the band. For a price-based system, the amount could be expressed as X million allowances to be deducted from auction volumes for each € below a certain price, or X million allowances to be added for each € above a certain price. The main challenge that this approach poses is that without a perfect knowledge of the emission intensity in case of external indicator-based triggers, and price elasticity in the case of price-based triggers, which would be required to determine such amounts, it is uncertain that the adjustments in amounts of allowances auctioned would actually correspond to the changes in economic activity or bring the price within a desired price corridor.

As the surplus-based triggers and related band would be expressed directly in a number emission allowances, there would in principle be no need for this additional step to determine the size of the necessary adjustment. This could be automatically determined by the difference between the size of the surplus and upper or lower limit of the band.

The advantage of the size of the adjustment depending on the distance from the triggers is in its flexibility in responding to different levels of demand shocks. However, this model may act as shock-therapy in terms of changes in supply. It would also provide less predictability in terms of the size of the adjustment and the final auction volumes. Hence, the adjustment could possibly be determined as a percentage of (as opposed to 100% of) the distance to the trigger level.

6.2.4.2. Fixed independently of the distance from the trigger levels

Alternatively, for all three types of triggers, the amount could also be determined simply as a certain fixed amount to be deducted from the auction volumes or added to them, as soon as the relevant triggers were reached, independent of the distance from the band. For example, allowances should be put into the reserve or taken in instalments of 100 million allowances or X% of the annual auction supply, each time the trigger to feed the reserve is reached.

The adjustment could also be determined as a percentage of the cumulative surplus (e.g. 10%). In absence of further demand shocks, the imbalance and the absolute amount of the adjustment would decline with every preceding adjustment. This would combine the ability of the reserve to respond proportionally to the magnitude of the imbalance, and at the same time to avoid the risk of unwanted impacts due to too large annual adjustments. In this case, the upper level of the trigger could also implicitly be expressed as minimum amount of adjustment. I.e. an adjustment putting allowances into the reserve would happen unless the adjustment, determined as a percentage of the cumulative surplus would fall under a certain absolute amount (e.g. 100 million allowances). In this example, the implicit upper limit would be 1 billion allowances[31].

The advantage of pre-determined amounts is a high degree of predictability in terms of changes to the expected auction volumes and simplicity. The disadvantage is that the size of adjustments may not immediately correspond to the size of the changes in demand. For example, the size of such an adjustment may not be sufficient. However, the difference could decline by additional adjustments in the same instalments over the following years, building the reserve or depleting it in a gradual manner.

6.2.4.3. Limits on the size of the adjustment and the reserve

If the size of the individual adjustments is not fixed, it may be considered to put an upper limit on them in order to ensure more gradual changes to the supply profile and for transparency reasons. There was general agreement among the experts that limits on the size of the annual adjustment are warranted.

An upper limit may be less needed if the triggers would start with a high surplus band to avoid large changes in the auction supply in the situation when a large surplus has already built-up. The auction supply available acts as an ultimate limit on the maximum adjustment that can be done in the period in question. However, for example, it could also be decided that the magnitude of the annual adjustment cannot exceed a certain amount, for example 100 million allowances or tenth of the auction volume in the relevant period. This would ensure that majority of the expected auction volume would come to the market, in case the rules would lead to deductions from the auction volumes. The benefit would be increased predictability of the minimum and maximum levels of annual auction supply. The drawback would be that the adjustments may not be sufficient to fully react adequately and timely to very large demand shocks.

A limit could be put on the maximum size of the reserve, e.g. that it shall never be higher than a certain percentage of the annual cap (this would be a different number every year) or a certain absolute amount (this could remain constant). If the maximum size of the reserve was reached, there could be two possible consequences. Either the auction volumes would remain untouched in line with the default annual volumes or the allowances exceeding the maximum limit (for a prolonged period) would be cancelled. The advantage of the former is that it would ensure predictability of the system in relation to the absolute cap, but the mechanism may no longer be able to achieve its objective of making the EU ETS more resilient to shocks. Conversely, cancelling any excess allowances in the reserve may undermine principle of neutrality of a market stability reserve in terms of the overall cap and the predictability of the system in relation to the absolute cap, but it would still maintain the ability of the mechanism to cope with prolonged periods of surplus accumulation. Reducing the cap would improve the environmental outcome of the EU ETS and ensure predictability in terms of relevant ambition. It could also play a helpful role in the context of the international negotiations and move to the more ambitious conditional target. Reaching the maximum limit could lead to an automatic cancellation of allowances or initiate a review of the cap through ordinary legislative procedure.

6.2.5. Timing

Another design aspect concerns the timing of any adjustments to the auction volumes. A number of alternatives could be contemplated, to a degree also depending on the triggers chosen.

The most obvious would be an annual exercise, with the total volume deducted or added to the auction volumes to be spread over 12 months. In any case, the period over which the adjustment is spread should not exceed the length of the period of the exercise to avoid accumulation of adjustments. I.e. if this was an annual exercise, and the volumes were spread over more than 12 months, the adjustments in month 13 and onwards could already overlap with possible adjustments stemming from following year's exercise.

If the trigger was surplus-based, the necessary data for the previous year (year t-1) - verified emissions and use of international credits - would become available in May of the current year (year t). So the earliest possible timing of the adjustment could be the 2nd half of the current year. This means that the initial auction calendar, which determines in detail the dates and volumes of auctions throughout a year, for year t would be determined without taking into account the possible adjustments. Following the annual compliance period, the auction calendar(s) for year t would be updated, reducing or increasing the volume for the remainder of the year. Another possibility would be to adapt the period of the auction calendar(s) so it more aligned with the compliance year, and runs from May of year t until April of t+1, or 2nd half of year t until 1st half of year t+1.

Alternatively, the adjustment could be done in the following year (year t+1). This way the auction calendar for year t would not require any updates and the auction calendar for year t+1 could already take into account the necessary adjustment from the start. However, adjustments in supply would have a longer delay than in the case of adjustment in the current year. On the other hand, they may provide more predictability to the market as the size of the adjustment would be known several months in advance before it is implemented.

Similar timing options and considerations apply also for the external indicator-based triggers, given the industrial and production indicators for year t-1, would only be available in year t. As mentioned, also forecasts could be used. For example, using the European Economic Forecasts[32] – autumn editions (published in November), the auction calendar for the following year could already take into account the forecast for that year. Currently, according to the Auctioning Regulation, knowing the auction calendar for a year in advance[33] has been decided as appropriate to ensure the necessarily level of predictability.

The calculations to check whether a trigger has been reached and the adjustments could also be done on a less frequent basis, e.g. every two years or half way through the trading period (i.e. every four years). In general a more frequent exercise has the benefit of being able to react more quickly to any significant changes in circumstances, but the drawback of providing less predictability in terms of volumes to be auctioned. A less frequent exercise risks requiring larger adjustments but the volumes for the adjustment can be spread over a longer period.

6.2.6. Other design aspects and characteristics of a market stability reserve

The model of a market stability reserve has a number of other possible advantages and aspects that could be conceived. One is in terms of the use of allowances in the reserve. Some stakeholders proposed ideas that could be relevant in this regards. For example, European Chemical Industry Council (CEFIC) proposes that the new entrants reserve be transformed into an "EU central reserve bank for efficient growth" – that e.g. during the times of economic crisis, unused allowances can be put into a reserve and dynamically reallocated to ETS sectors and the market in times of economic recovery and growth according to agreed rules. Their recommendation seems to be also about additional ex-post adjustments to the free allocation, but some elements could be considered also for a reserve of only auctioned allowances. The Confederation of European Paper Industries (CEPI) recommends using the revenues from the EU ETS to help drive innovation. Taking into account this input, possible uses of the allowances in the reserve could be

· To replenish the new entrants reserve if it were to be depleted based on the existing free allocation rules for significant capacity extensions and new entrants;

· To use some of the auction revenue from the allowances released from the reserve to support the development of breakthrough technologies for the sectors covered by the EU ETS.

The latter could be based on the principles laid down in the NER300 programme. In terms of governance, the European Investment Bank (EIB) could act as a reserve-keeper.

The market stability reserve could also have benefits in the context of international negotiations. A market stability reserve could also allow predictable but quick changes to the EU ambition to match more ambitious commitments by other regions and countries, by committing to permanently retire an amount of allowances in the reserve. This way the EU could credibly signal a possible higher ambition level to the international community and this help advance the international negotiations.

6.3. Option 3: Combination of a market stability reserve with permanent retirement

The market imbalance can also be reduced with a combined approach, both establishing a market stability reserve and permanently retiring a limited number of allowances. This would appear to be consistent with the dual nature of the problem, which is on the one hand the large surplus that the market is experiencing today (a "corrective" element) and on the other hand possible re-emergence of imbalances in the future due to large demand shocks (a "preventive" element).

Contrary to the baseline option, one possible way to implement a combined approach is to permanently retire allowances towards the end of phase 3. Technically this could be done by means of some back-loaded auction supply not being returned to the market. The analytical assumption used is that 500 million allowances are permanently retired. Regarding the design of the market stability reserve part, this option will be based on the central option(s) that will appear from the pre-assessment of different market stability reserve sub-options. The market stability reserve applies as of 2017. This option would be able to address the impact of the economic crisis and complementary policies on the demand side, as well as of the supply side drivers, notably the large inflow of international credits.

7. Analysis of impacts

7.1. Market balance

Table 2 represents two sub-options for the permanent retirement in terms of the numbers of allowances to be permanently retired, which will be assessed in relation to the their impact on the market balance and expected price development. It illustrates changes in the annual auction volumes compared to the baseline option 0, and for ease of comparison also the combined net change due to back-loading and a permanent retirement compared to the initial auction volumes.

Table 2: Sub-options for a permanent retirement – changes in auction volumes

[mio allowances] || Total || 2013 || 2014 || 2015 || 2016 || 2017 || 2018 || 2019 || 2020

Large retirement Option 1a || Change compared to option 0 || -1400 || 0 || 0 || 0 || 0 || -125 || -125 || -425 || -725

Net change compared to initial auction volumes before back-loading || -1400 || 0 || -400 || -300 || -200 || -125 || -125 || -125 || -125

Small retirement Option 1b[34] || Change compared to option 0 || -500 || 0 || 0 || 0 || 0 || 0 || 0 || -167 || -333

Net change compared to initial auction volumes before back-loading || -500 || 0 || -400 || -300 || -200 || 0 || 0 || 133 || 267

Table 3 below represents 7 sub-options for the market stability reserve in terms of when and how many allowances to put into the reserve and when and how many to release, which will be assessed in relation to their impact on the market balance. All sub-options for a market stability reserve include rules for the return of the allowances to the market and are therefore cap-neutral. The options assume that the adjustment is done on an annual basis. The options were chosen to assess the differences in functioning of the reserve with different design elements. Other combinations of elements would be possible, too.

The first set of options focuses on the surplus-based triggers (options 2a-2f), either in relation to the cumulative surplus or change in the surplus. Different levels of the band are chosen in a way to allow a sensitivity analysis in terms of impacts of different levels and widths of the band. The majority of the options are focused on the surplus-based triggers as they have the important benefit of being able to account for the impact of complementary policies, such as renewables and energy efficiency measures. As explained before, price-based triggers are not the focus of this assessment.

In general, two variants are assessed, one where there is some kind of a safeguard to avoid large changes in the auction supply:

· Under option 2b, an upper limit is put on the size of the annual adjustment.

· Under option 2d the adjustment putting allowances into the reserve is calculated as a 10% share of the cumulative surplus, unless the adjustment would fall under 100 million allowances. Adjustments releasing allowances from the reserve are determined as instalments of 100 million allowances.[35]

· Under option 2f the adjustment is limited to 50% of the distance from the band.

The limits at the same time de facto mimic the impact of a fixed amount of the adjustment. For the purpose of this analysis, two different levels of 100 million (limit and instalment in options 2b and 2d) and 200 million (instalment in option 2g) allowances are assessed, as well as an adjustment at the level of 50% of the distance from the band.

One option (option 2g) looks at a reserve with an external indicator-based trigger, more specifically based on the GDP growth forecasts published in the European Economic Forecast – autumn editions. As the band is not directly expressed in emission allowances, external indicator-based triggers in any case require an additional step of determining the amount of allowances placed into / released from the reserve. Given the difficulties of precisely translating the relation between the unit of GDP growth into a number of allowances, the external-based trigger is only assessed in combination with pre-determined adjustment amounts of 200 million allowances.

Table 3: Sub-options for a market stability reserve

|| Option || Trigger || Adjustment amount

Relative narrow band & unlimited || 2a || Total surplus outside 40-50% of the cap || Distance from the band/unlimited

Relative narrow band & limited || 2b || Total surplus outside 40-50% of the cap || Distance from the band/limit of 100 mio allowances

Absolute broad band & unlimited || 2c || Total surplus outside 400-1000 mio allowances || Distance from the band/unlimited

Absolute broad band & limited || 2d || Total surplus outside 400-1000 mio allowances || 10% of cumulative surplus/instalment of 100 mio allowances

Annual change & unlimited || 2e || Annual change in surplus >100 mio allowances || Unlimited/ surplus change above 100 mio allowances

Annual change & 50% || 2f || Annual change in surplus >100 mio allowances || 50% of the surplus change above 100 mio allowances

GDP || 2g || GDP growth forecast outside 2-3% || Instalments of 200 mio allowances

Different impacts of a market stability reserve on the market balance can be expected when the market is faced with a growing imbalance and when the market balance has been restored. Therefore, the assessment is done in steps. Firstly, it assesses the impact of the reserve on the supply-demand balance with a demand shock resulting from a severe recession, using actual phase 2 data as a proxy. Obviously, only a very small amount of allowances was auctioned in phase 2, but for the purpose of this illustration, it is assumed that a similar share of auctioning would be available for any adjustments as in phase 3. The relevant time period for this step is primarily phase 2, but the assessment is extended to show residual impacts on phase 3. This part of the analysis assesses whether a market stability reserve would have prevented the large imbalance that the EU ETS is experiencing today.

In a second step, the assessment will examine what the impact of different options would be in the current situation, after back-loading has been implemented and has to a certain extent already restored market balance in 2014-2016[36]. The reserve would apply as of 2017. Backloaded allowances then return in 2019 and 2020. The relevant period for this step is primarily phase 3. However, analysis is also extended to show impacts in phase 4. Obviously, for the permanent retirement options we only perform the second step of the assessment. This part of the analysis assesses whether the options would correct the large imbalance that the EU ETS is experiencing today.

In a third step, the assessment will examine what the impact of different options would be if they applied as of phase 4, with the first adjustment in 2021. This follows the preference by a number of stakeholders to implement structural measures as of phase 4, as after back-loading this would otherwise result in multiple measures in the space of few years and could impair certainty. So contrary to a permanent retirement, these stakeholders could support flexible supply as of phase 4.[37]

Table 4 represents an option for the combination of a market stability reserve with permanent retirement. The choice of design features for the market stability reserve is informed by the pre-assessment and comparisons of the market stability reserve sub-options in section 7.1.3.4.

Table 4: Sub-option for the combination of a market stability reserve with permanent retirement

|| || Amount of permanent retirement || Reserve triggers || Reserve adjustment amount

Retirement & reserve limited || 3 || 500 mio allowances || Total surplus outside 400-1000 mio allowances || 10% of cumulative surplus/Minimum limit or instalment of 100 mio allowances

The scheduled changes in the auction volumes related to the permanent retirement follow the profile set out in Table 5.

Table 5: Changes in auction volumes related to the permanent retirement

[mio allowances] || Total || 2013 || 2014 || 2015 || 2016 || 2017 || 2018 || 2019 || 2020

Change compared to option 0 || -500 || 0 || 0 || 0 || 0 || 0 || 0 || -167 || -333

Net change compared to initial auction volumes before back-loading || -500 || 0 || -400 || -300 || -200 || 0 || 0 || 133 || 267

7.1.1. Baseline scenario – Option 0

Figure 6 represents the annual deficit or surplus and the total cumulative surplus up in the current situation without a reserve being put in place. It will serve as the basis for comparison with options where a market stability reserve would have been implemented as of 2008. Hence, for the purpose of this particular simulation, it assumes no back-loading, as the market stability reserve would have already been in place and able to address the intended aim of that measure too. As there was only limited auctioning in phase 2, the illustrations show the total annual volume of issued allowances, rather than only auction supply.

Figure 6: Option 0 – Evolution of the surplus in phase 2 (and 3) without a market stability reserve and without back-loading

Figure 7 represents the annual deficit and surplus and total cumulative surplus in the situation without a market stability reserve, but where back-loading has been implemented. It will serve as the basis for the second part of the analysis, comparing the impact of the market stability reserve if it was to be implemented as of 2017.

All figures in this section use the same data as Figure 1.

Figure 7: Option 0 – Evolution of the surplus in phase 3 (and 4) without a market stability reserve, but with back-loading

7.1.2. Permanent retirement options: Options 1a and 1b

Figure 8 provides a graphical presentation of the impacts in terms of market balance of a permanent retirement in two different amounts. Option 1 in the total amount of 1.4 billion allowances would mean that all 900 million allowances foreseen to be back-loaded are permanently retired plus an additional 500 million permanently retired afterwards. Option 2 in the total amount of 500 million allowances would mean that only that amount of back-loaded allowances are permanently retired, with 400 million returned to the market.

Figure 8: Evolution of the surplus in phase 3 and 4 with a retirement -options 1a and 1b

The following observations can be made:

· Both options are expected to reduce the surplus early on. This seems to be more consistent with the objective of inter-temporal efficiency than the baseline option 0.

· The core difference between the two options emerges in the second half of the period. A lower amount of permanent retirement decreases the stabilising effect of the measure. The option with a large retirement (1a) continues to reduce the surplus until 2020 and is likely to support the price in that period. Option with a small retirement (1b), however, results in a rebound in the surplus as of 2016 and an additional expansion of the surplus in 2020 when the back-loaded allowances, which were not permanently retired, are returned to the market. This may result in a renewed downward pressure on the carbon price signal.

7.1.3. Options for the market stability reserve

7.1.3.1. Options with volume triggers based on the cumulative surplus: Options 2a-2d

Impact of a market stability reserve if implemented in phase 2

Figure 9 gives a graphical presentation of the impacts in terms of market balance of a market stability reserve with volume triggers based on the cumulative surplus if it was already in place as of 2008.

Options 2a and 2b assume a relative and narrow band. Option 2a assumes a band with the total surplus within 40-50% of the cap with an adjustment depending on the distance from the band (unlimited adjustment). Option 2b assumes the same band, but limits the amount of the annual adjustment to maximum 200 million allowances. Options 2c and 2d are based on an absolute and broader band of 400 to 1000 million allowances, former with an unlimited adjustment defined as the distance from the band. Option 2d has an annual adjustment putting allowances into the reserve defined as 10% of the cumulative surplus in the preceding year, unless the adjustment would fall below 100 million allowances. Adjustments releasing allowances from the reserve are defined as instalments of 100 million allowances.

The following observations can be made:

· None of the options would have prevented the rapid accumulation of the surplus in 2011 and 2012;

· However, they would have avoided a continued growth of the surplus and reduced the market imbalance substantially and in most cases early in phase 3 compared to the baseline option 0. Hence, they appear to be more effective in ensuring the inter-temporal efficiency;

· Impact of the size of the adjustment:

· As they provide more flexibility in responding to the shocks, options with variable adjustments (2a and 2c) lead to an early and significant reduction in the market imbalance. However, they also lead to significant changes to the initial auction volumes.

· Options with a limit on the adjustment or the adjustment defined as a percentage of the cumulative surplus (2b and 2d) lead to a more gradual and predictable but smaller reduction in the market imbalance. They lead to similar results in phase 3. Of course, the speed of the reduction in the overall surplus will depend on the maximum amount of the adjustment and the percentage of the cumulative surplus, respectively. The higher the values, the quicker the reduction in the surplus would have been. In this particular case, these options do not manage to bring the surplus within the band until 2020 and adjustments reducing the annual auction amounts continue to be needed until the early years of phase 4.

· As for the impact of the levels of the band, in general, the narrower the band, the greater the need for interventions. While there is little difference in the number of interventions putting allowances into the reserve in phase 3, options with a narrower band (2a and 2b) would require more interventions in different directions in phase 4 (first still putting the allowances into reserve and shortly later releasing them from it). Options with a narrower band (2a and 2b) result in higher reserve levels by 2020.

Figure 9: Evolution of the surplus in phase 2 and 3 under options 2a-2d if already implemented in phase 2

Impact of a market stability reserve if implemented in phase 3

Figure 10 provides an illustration of the impacts of the same options, if they were implemented as of 2017, after backloading, and the backloaded allowances would be returned to the market in 2019 and 2020 as scheduled. The following observations can be made:

· While the options are expected to lead to a rebound in the surplus at the end of phase 3, they would result in a gradual decrease as of phase 4. The pattern of a decrease in the market imbalance, followed by an increase and then a more gradual decrease may be inconsistent with the objective of better inter-temporal efficiency.

· Levels of the band: A narrow band (2a and 2b) leads to a higher number of adjustments, first putting allowances into the reserve, followed by adjustments releasing them only a few years later.

· Size of the adjustment: Options without a limit (2a and 2c) reduce the surplus faster as of phase 4. However, they result in quite high variability in auction supply and surplus in the transition into phase 4, with a spike at the end of phase 3 followed by a rapid drop early in phase 4. The options with some kind of a limit (2b and 2d) are slower in reducing the surplus as of phase 4, but results in most stable auction supply and more gradual reduction in the surplus. However, option 2b does not manage to bring the surplus within the band in phase 4 and requires an adjustment putting allowances into the reserve from 2017 throughout phase 4.

Figure 10: Evolution of the surplus in phase 3 and 4 under options 2a-2d if implemented as of phase 3

Impact of a market stability reserve if implemented in phase 4

Figure 11 provides an illustration of the impacts of the same options if they were to apply as of phase 4. The following observations can be made:

· Clearly, none of the options prevent the rebound in the surplus following the return of the back-loaded allowances. Compared to a situation where a reserve would be implemented as of 2017, the surplus in 2020 at the end of phase 3 is always higher.

· However, the options do correct for the expansion of the surplus as of phase 4. As the surplus is higher by then, so are the needed corrections.

· Levels of the band: Without a limit on the size of the adjustment, a narrow band (2a) results in more interventions in opposite directions, first putting allowances into the reserve and releasing them towards the end of the phase.

· Size of the adjustment: Options without any limit (2a and 2c) lead to very high adjustments at the beginning of phase 4, resulting in no auction volumes for 2021 and nothing (2a) or very little (2c) to be auctioned in 2022. However, they bring the surplus within the band in two years. Options with limited adjustments (2b and 2d) result in a slower but much more gradual reduction in the surplus, and ensure continuity of material auction supply throughout the phase. However option 2b is not able to bring the surplus within the band in phase 4 and requires adjustments putting allowances into the reserve every year of phase 4.

Figure 11: Evolution of the surplus in phase 3 and 4 under options 2a-2d if implemented as of phase 4

7.1.3.2. Options with volume triggers based on the change in surplus: Options 2e and 2f

Impact of a market stability reserve if implemented in phase 2

Figure 12 provides a graphical presentation of the impacts of the options with a trigger based on annual changes in the surplus. Both options assume that allowances are put into the market stability reserve if the cumulative surplus grows by at least 100 million allowances in a year and released from it if the cumulative surplus contracts by at least 100 million allowances. Again, the adjustment is determined as the full annual change in surplus above 100 million allowances (2e) or 50% of that amount (2f).

Screening both options leads to the following observations:

· These options start reacting somewhat faster to the accumulation of the surplus and therefore result in a lower expansion of the surplus in 2012 than in the baseline option 0. However, they do little to reduce the surplus further as the market is more in balance, not triggering the rules, which would require putting additional allowances into the market stability reserve. So they are effective in improving the inter-temporal efficiency only to a limited extent.

· Impact of the size of the adjustment: Option with an unlimited adjustment (2e) would have led to a significant reduction in the build-up of the surplus. Option with a lower adjustment at 50% of the distance from the band would have resulted in a proportionately smaller reduction in the size of the surplus.

Figure 12: Evolution of the surplus in phase 2 and 3 under options 2e and 2f if already implemented in phase 2

Impact of a market stability reserve if implemented in phase 3

While both options would not yet address the surplus in a lasting manner in phase 3, they would to a certain extent reduce the surplus shortly after its rebound at the end of phase 3. However, no subsequent adjustment is expected to follow if no unexpected rapid annual changes in the surplus would happen. Again, this means that the options lead to only limited improvements in inter-temporal efficiency.

The option without a limit on the size of the annual adjustment (2e) would lead to double the reduction in the surplus than the one with an adjustment at 50% of the distance from the band (2f). However, it would lead to higher variability in the auction supply and surplus in the transition to phase 4.[38]

Figure 13: Evolution of the surplus in phase 3 and 4 under options 2e and 2f if implemented as of phase 3

Impact of a market stability reserve if implemented in phase 4

Figure 14 provides an illustration of the impact of the same options if they started to apply as of 2021. They would be able to reduce the surplus, but to a lesser extent than if they were implemented in 2017. While the options would be able to respond to further shocks, they would not lead to any additional improvement in the total structural surplus.

Figure 14: Evolution of the surplus in phase 3 and 4 under options 2e and 2f if implemented as of phase 4

7.1.3.3. Option with a trigger based on the GDP growth forecasts

Figure 15 provides an illustration of the impact in terms of market balance of the option using GDP growth as the external trigger. Where the GDP growth forecast is outside a band of 2-3%, allowances would be put in the reserve in instalments of 100 million allowances. The figure shows how the market stability reserve would have worked in the time of the crisis, until today, and assuming GDP growth rates would stay within the band as of 2013.

Figure 15: Evolution of the surplus in phase 3 under option 2g if already implemented in phase 2

The following observations can be made:

By relying on forecasts for GDP growth, this option would have anticipated the major changes in the economic activity, which have been in part responsible for the surplus. The adjustment could already be made in the year for which the forecast applies, and hence their timing aligned with timing of the forecasted drop in demand. However, this kind of approach would not have been able to react to changes in the market balance due to other factors, such as the increased supply of allowances in the transition into phase 3 and due to return of back-loading, and record inflow of international credits due to regulatory changes. Hence, the option would have improved the inter-temporal efficiency, but to a limited extent. These options may be able to react to changes in demand due to impacts of complementary policies, if production trends in terms of overall output as well as fuel input in power generation can be adequately captured.

7.1.3.4. Comparison of sub-options for the market stability reserve

There are many possible combinations of design elements and trigger levels for a market stability reserve. In this section we compare the sub-options and define the most interesting option to be assessed further in the next sections of the impact assessment, based on the assessment of the design parameters in terms of their effectiveness in addressing the market imbalance and other related criteria. Figure 16 provides a comparison of the impacts of the various sub-options for a market stability reserve on the surplus and the size of the reserve if they were already in place in phase 2.

Figure 16: Comparison of the evolution of the surplus and reserve under various sub-options for market stability reserve if already implemented in phase 2

Figure 17 compares the impacts of various sub-options if a market stability reserve was implemented in phase 3. The comparison in terms of the surplus also included the two permanent retirement options (1a and 2b) and two combined options (3a and 3b).

Figure 17: Comparison of the evolution of the surplus and reserve under various sub-options for market stability reserve if implemented as of phase 3

Figure 17 compares the impact of various sub-options if they were implemented in phase 3. The comparison of the impacts on the surplus also includes the two permanent retirement options (1a and 1b). However, they are by definition not relevant for the comparison in terms of the size of the reserve, as a permanent retirement would not lead to one.

Figure 18 compares the impact of various sub-options if they were implemented in phase 4. For ease of comparison the figure depicting the evolution of the surplus also include the two permanent retirement options. However, they are not included in the figure on the reserve, as they do no lead to any allowances being put into a reserve.

Figure 18: Comparison of the evolution of the surplus and reserve under various sub-options for market stability reserve if implemented as of phase 4

The results of the assessment are shown in Table 6. The following summary explanation can be given with respect to the scores given:

· The surplus-based triggers get a better score as regards their ability to capture changes in demand not only due to macroeconomic changes, but also other factors such as impact of complementary policies, as well as supply side factors such as changes in inflow of international credits.

· Out of surplus-based triggers, those based on a cumulative surplus are expected to perform better that those based on annual changes in correcting the surplus. While triggers based on changes in the balance may be more effective in preventing a market imbalance, they do not lead to further reduction of the surplus after the market is more in balance.

· Those surplus-based triggers with an absolute band score better in relation to simplicity. Moreover, a relative band which tapers off in line with the decreasing cap may perform poorly with an increasing trend in hedging needs.

· A broader band gets a better score in terms of number of needed adjustments. Such a reserve rule is expected to lead to lower amounts and frequency of adjustments as well as lower variability in auction volumes. In contrast, a narrower band is likely to lead to higher number of interventions and in different directions, i.e. a number of adjustments putting allowances into the market stability reserve only to be followed by release of those allowances shortly after.

· Limited adjustments, either with an explicit limit on the amount of adjustment or determined as a certain percentage of the cumulative surplus, get a better score in terms of predictability. They also lead to more continuity in terms of auctions, and gradual changes to the surplus a