European Commission getting rid of excess carbon emission permits

Question

According to this Economist article,

For a long time after it was launched in 2005, the [European Trading System] barely functioned; a glut of allowances (which give the holder the right to emit an amount of greenhouse gases) kept prices close to zero. But after the European Commission sucked out excess permits in 2019, the market began to thrive.

the European Commission got rid of, so-called, excess permits.

What were these excess permits of carbon emissions? Is it the amount of permits that are still up for sale (or to be distributed for free); and hence, aren't used?

And how did the European Comission get rid of them? Is it by decreasing the cap of overall supply of permits within the EU?

This article of the European Environment Agency designates the surplus of permits as a market stability reserve.

The Swedish Energy Agency, describes the market stability reserve as, a rule-based mechanism that enables the delivery of allowances to respond to changes in demand, thus maintaining the balance of the EU ETS.

It says

If the surplus of allowances on the market does not decrease to less than 400 million but if the price of an emission allowance for more than six consecutive months is three times higher than the average price over the last two years, up to 100 million allowances are injected into the market through an increase of auction volumes with units from the reserve.

Hence the number of allowances is dynamic, set according to the condition of the market. But isn't this ultimately limited by the overall EU cap that is decided politically? Also, what is the unit of an allowance?

Answer 1

What were these excess permits of carbon emissions? Is it the amount of permits that are still up for sale (or to be distributed for free); and hence, aren't used?

Page 92 of the ETS handbook states that since 2009, because of the economic crisis of 2008, a higher than expected imports of international carbon credits and a large uptake of renewables led to a significant surplus of allowances in the EU ETS.

So, yes, excess permits are the ones that aren't used by the holder in the near future. According to the ETS handbook, page 92, in early 2012 there were 1 billions surplus allowances. And 2 billions by the start of 2013.

From the handbook:

The presence of the surplus and resulting low price may discourage participants in the EU ETS from taking actions now to reduce emissions, which may result in a deviation from the most cost-efficient path to long-term emission reduction goals. The large surplus has led to persistently low carbon prices in the EU ETS, reducing the price incentive for low-carbon investments.

One mechanism of tackling this surplus in allowances is the creation of a market stability reserve (MSR).

And how did the European Comission get rid of them? Is it by decreasing the cap of overall supply of permits within the EU?

The MSR acts to combat this imbalance of allowances. From the handbook, page 95:

Using the total number of allowances in the market as an indicator, market imbalances due to unexpected shocks that impact demand, such as the economic crisis, can be addressed. This allows the EU ETS to maintain its objective to reduce emissions in a cost-effective and economically efficient manner, even under unexpected circumstances.

Hence, this way, each year the number of allowances injected into the market by auction will take the market demand into account.

So, yes, the amount of overall supply of permits, by auction, will be decreased if there is an excess. This will act as a carbon reduction incentive, by keeping prices competitive.

From this diagram of the ETS handbook, company B, with a shortage of allowances, has two options. Either buy from company A's surplus allowances or buy them at an ETS auction.

Also, what is the unit of an allowance?

The website of the European Commission states that each allowance gives the holder the right to emit one tonne of carbon dioxide (CO2), or the equivalent amount of other powerful greenhouse gases, nitrous oxide (N2O) and perfluorocarbons (PFCs).

But isn't this ultimately limited by the overall EU cap that is decided politically?

Yes, indeed the total amount of allowances injected into the market by the ETS is determined politically. This overall cap will decrease accordingly, to realize the European Green Deal; no net emissions of green house gasses by 2050.