From quantity to price: rethinking supply adjustment in the European carbon market

The 2026 review of the EU ETS, expected by July, has attracted considerable attention. As examined in a first contribution to this series, the upcoming legislative choices are being shaped by competing interests, with concerns over industrial competitiveness and carbon costs weighing alongside considerations of environmental integrity.

The Market Stability Reserve (MSR), introduced in 2019, was designed to address a surplus world. It is a rule-based mechanism that withdraws allowances when the Total Number of Allowances in Circulation (TNAC), the indicator that serves as the MSR’s trigger, exceeds an upper threshold and releases them when it falls below a lower one. By that measure, it has worked: the TNAC has fallen to around 1.15 billion, more than 2.5 billion allowances have been permanently cancelled, and confidence in the carbon price signal has been substantially restored (Borghesi et al., 2023).  

The MSR is explicitly included in the July proposal. On 1 April 2026, the Commission tabled a legislative proposal amending its legal basis, ending the invalidation of allowances held in the reserve above the current 400 million threshold and allowing them to be retained as a liquidity buffer instead. This measure is the first of a wider MSR review, expected to conclude alongside the July proposal. It is a narrow step, leaving the underlying mechanism including its trigger, its activation thresholds, and its intake and release rules, largely unchanged. Whether and how these parameters should evolve is a question the July package is still expected to address. 

The limits of a quantity-based trigger under scarcity 

The TNAC can send conflicting signals: a rising TNAC may reflect genuine oversupply, but it may equally reflect actors banking permits in anticipation of future scarcity, a situation that itself drives prices up. As scarcity increases and market participants increasingly factor in an ever-tighter cap trajectory, this ambiguity is likely to become more pronounced. The backward-looking nature of the indicator accentuates the issue: the TNAC measures accumulated allowance supply rather than current market conditions, so it responds to changes in scarcity with a lag. As the cap tightens and the TNAC falls toward its operative thresholds, the release mechanism draws down the buffer accumulated during the surplus phase, precisely when tighter market conditions make stabilisation most consequential.  

These dynamics are documented in the academic literature on the MSR (Borghesi et al., 2023; Perino et al., 2022) and are expected to become more salient after 2030, as the system enters scarcity and legacy indicators lose informational content (Pahle et al., 2025). 

Price-based supply adjustment offers a different approach. Unlike the TNAC, price is forward-looking: it reflects market participants’ expectations of future scarcity, not just accumulated past supply. Conditioning intervention on price rather than on a volume-based indicator thus allows the mechanism to respond more directly to current and anticipated market conditions. The literature associates price-based mechanisms with faster responsiveness and clearer signals to investors, and improved investment incentives (Burtraw et al., 2022; Heijmans, 2023). Price-based mechanisms are also the predominant approach in other major emissions trading systems, including California, Quebec, RGGI, New Zealand, and the UK ETS, making the EU ETS comparatively unusual in its continued reliance on a volume-based trigger. 

The April 2026 proposal preserves the TNAC in full, and a fundamental redesign of the trigger is unlikely to be addressed in the July proposal. Yet as the system transitions toward scarcity, the question of whether and how the trigger should evolve toward price-based adjustment is one that is likely to remain on the agenda beyond the current reform cycle.  

Design options for price-based supply adjustment 

Moving from a quantity-based to a price-based trigger is not a single design choice but a set of them. The report “Managing market tightness in the EU ETS on the path to net-zero: design options and trade-offs in price-based supply adjustments” (Raude & Borghesi., 2026) organises these choices around two core dimensions: trigger design, which determines when intervention is activates, and intervention design, which determines how allowances supply responds once a trigger condition is met. Analysing each dimension separately provides the building blocks for understanding how they interact in practice, since a given trigger architecture can produce very different market outcomes depending on the intervention it is paired with.  

Across these two dimensions, the report identifies five stylised archetypes, ranging from an incremental adaptation of the existing MSR architecture that replaces the TNAC with a price-based signal, through increasingly engineered designs involving price corridors, multi-tier triggers, high-frequency micro-adjustments, up to a last-resort emergency mechanism. Each represents an internally consistent configuration with distinct stabilisation properties, assessed across four market regimes: surplus, tightening, deep scarcity, and price shocks.  

The performance assessment reveals a fundamental trade-off: mechanisms with sufficient responsiveness to contain extreme prices cannot simultaneously guarantee a fixed emissions cap, while those that preserve environmental integrity face capacity constraints under deep scarcity. This points toward hybrid configurations, combining elements across archetypes, as the most promising direction for the post-2030 EU ETS. 

Conclusion 

The 2026 EU ETS review will shape how the system manages the transition from a surplus era to a scarcity regime, including the question of how its market stability mechanism should evolve. While the advantages of price-based supply adjustment over quantity-based indicators are well documented in the literature and reflected in the practice of other emissions trading systems, moving in that direction raises a wide range of design choices. The range of viable configurations is itself a resource: designs can be tailored to different stabilisation objectives and political constraints. As the system moves further into scarcity, this is a conversation that is likely to extend well beyond the current review cycle.