Market substitution arguments are often raised by proponents of fossil fuel production projects to deny that their project will cause a net increase in aggregate greenhouse gas emissions, or to at least reduce the extent of the greenhouse gas emissions deemed attributable to the proposed project. The gist of the claim is that production necessary to meet market demand for the relevant fossil fuel will, if not supplied by the proposed project, be supplied by another project(s), elsewhere (potentially, though not necessarily, in another jurisdiction).  

It is necessary to distinguish two variants of the argument. The first, which we may call the Perfect Market Substitution argument, asserts that if the proposed project were not to proceed, the equivalent additional amount of fossil fuels would be produced by another project.¹ The second, which we may call the Partial Market Substitution argument, asserts that if the proposed project were not to proceed, some additional amount of fossil fuels would be produced by another project, but less than the amount produced by the proposed project. 

It is a question of law whether market substitution effects are relevant considerations for an administrative or judicial decision-maker when assessing the greenhouse gas emissions of a proposed project.² 

Where market substitution effects are considered legally relevant, then the extent of any market substitution is a question of fact. Evidence is needed to establish the likely extent of any such substitution (and its implications for net aggregate emissions, discussed below).³  

The extent of market substitution in a given case depends on the relationship between the amount of the good supplied, the price of the good, and demand for the good. The relationship between a change in supply and price is known as the elasticity of supply; and the relationship between a change in demand and price is known as the elasticity of demand.  

For the Perfect Market Substitution argument to be true, it would have to be the case that either demand for the relevant type of fossil fuel is perfectly inelastic (i.e. the aggregate amount of the product demanded by consumers in that market is completely insensitive to a change in the equilibrium price), or supply of the good is perfectly elastic (i.e. the aggregate amount of the product that producers could supply would need to be fully responsive to any change in the equilibrium price), such that the quantity supplied in aggregate would remain the same notwithstanding changes in output by any particular supplier.  

Though theoretical possibilities, real-world markets do not function that way—and certainly markets for fossil fuels do not. Rather, aggregate supply for fossil fuels typically cannot immediately and fully adjust to changes in supply (and hence to changes in equilibrium price), and aggregate demand for fossil fuels is at least somewhat sensitive to changes in prices. Accordingly, the Perfect Market Substitution argument will standardly be difficult to sustain empirically. It follows that that a proposed fossil fuel project, once approved and producing, will typically increase the aggregate supply of that fuel, lowering the equilibrium market price, and thus cause an increase in the quantity of the fuel consumed, all else equal. 

This conclusion is consistent with the more plausible claim that, in any given case, there will be partial market substitution. The challenge for the decision-maker is then to ascertain the extent of the substitution. Here, the parties will seek to adduce evidence of the likely substitution effects. Historical elasticities of demand and supply are questions of fact amenable to observational study (empirical economic analysis), and these can be used to calibrate models of the relevant market, which can in turn be used to project the effects of the project’s approval or rejection. However, the factors affecting demand and supply may change over time, so models may not accurately predict future market outcomes; they are, at best, assumption-contingent projections of market outcomes, and must be treated as such by decision-makers. 

Similar caveats apply to the use of scholarly studies of fossil fuel markets, elasticities and substitution effects. Nonetheless, the papers by Erickson, Lazarus and Piggot (2018), Erickson and Lazarus (2014), Faehn et al (2017), and Erickson and Lazarus (2018) can be adduced to reject the Perfect Market Substitution argument and, potentially, to provide indicative estimates of elasticities used in peer-reviewed studies of fossil fuel markets. It is important to note that much of the empirical evidence is focused on oil; the literature base for substitution effects as they apply to natural gas and coal is much less developed. However, for both of these fuels, arguments against perfect substitution hold given economic theory.⁴ 

Three further issues are important to discuss in relation to market substitution, each of which links to other categories in the REDLINE database. 

First, while the discussion above has focused on questions about the extent to which a decision about a proposed fossil fuel production project ultimately affects the aggregate quantity of the fuel consumed, estimating the net aggregate effect on emissions requires additional assumptions and/or evidence. This is because emissions associated with the extraction, processing and distribution of fossil fuels vary from site to site, depending on various factors. It will therefore not necessarily be the case that the emissions per unit of output from the proposed project will be the same as those from the project(s) that will (partially) substitute for the output of the proposed project, should the proposed project be rejected or otherwise not proceed. Alternatively, the proposed project could substitute one type of fossil fuel for a different energy source with a different lifecycle emissions profile altogether. 

Fossil fuel project proponents may claim that the proposed project will actually lead to lower net aggregate emissions on the ground that the proposed project’s upstream (and perhaps mid-stream) emissions are lower than those of expected substitute projects producing the same fuel, or that the project would displace consumption of a more emissions-intensive fuel (the latter argument is often made by fossil gas producers). Such claims effectively entail a combination of a market substitution argument (either perfect market substitution or high partial substitution) with an argument to the effect that the proposed project’s emissions per unit of output are lower than those of the substitute project(s). The latter argument requires identifying the likely substitute projects (by constructing a supply curve for the relevant product) and adducing evidence of the latter’s lifecycle emissions. See further our category page on Upstream Emissions. 

The second issue to keep in mind is that, if market substitution effects are deemed legally relevant to the calculation of the greenhouse gas emissions from a proposed project, then, on pain of inconsistency, decision-makers should also take account of other indirect / non-proximate effects of the project. Fossil fuel production projects unquestionably cause absolute greenhouse gas emissions—in the process of extraction and when they are combusted by the end user. Any legal decision to admit market substitution effects into the assessment of a proposed project’s emissions thus requires a shift from assessing emissions from the project to assessing the net aggregate emissions resulting from the project. It also requires the adoption of counterfactual reasoning: the decision-maker is called upon to assess not simply the emissions that the project would cause, but what would (counterfactually) happen if the project were not to proceed, e.g., if the project were to be rejected. If the decision-maker is legally required to take account of such non-proximate and counterfactual market effects, it should also take into account other non-proximate, counterfactual effects, including the effect of rejecting the project on, for instance, anti-fossil fuel moral and legal norms (such as emerging norms prohibiting new fossil fuel projects), on policy and judicial decisions in other jurisdictions, and on the valuation of fossil fuel companies (and hence stock prices).⁵ It is advised that this line of argument be raised only in response to a decision deeming market-substitution arguments relevant; the preferable position generally is to simply focus on the direct effects of the proposed project.⁶ See further our category page on Non-price effects (e.g. norm-diffusion) and on National and Subnational Supply-Side Policies.  

Third, to the extent that rejecting a proposed project would lead to market substitution that causes additional overseas emissions, it may (depending on the country in which the substitute emissions are produced) be consistent with equity considerations that the reductions occur in the country of the proposed project. However, again, evidence would be needed to establish that any substitute production would likely come from a particular country. See our category page on Equity Considerations. 

Footnotes:

1 For an example of a Perfect Substitution argument, see WildEarth Guardians v. US Bureau of Land Management, 870 F 3d 1222 https://cases.justia.com/federal/appellate-courts/ca10/15-8109/15-8109-2017-09-15.pdf?ts=1505491258 (p. 6).

2 The argument was deemed relevant, but found to be “arbitrary and capricious”, by the US Court of Appeals (10th Circuit) in WildEarth Guardians. The argument was effectively deemed legally irrelevant in the landmark decision of the New South Wales (Australia) Land and Environment Court in Gloucester Resources Limited v Minister for Planning and Environment (No 2) [2019] NSWLEC 1200, at [538], [545]; see also the decision of the Hague District Court in Milieudefensie v Royal Dutch Shell PLC (26 May 2021) C/09/571932/HA ZA 19-379, English Version (Milieudefensie v RDS) para [4.4.49].

3 See especially WildEarth Guardians, pp.17-29.

4 These arguments were deployed by both Friends of the Earth and South Lakeland Action On Climate Change (SLACC) in the recent West Cumbria coalmine planning inquiry. See https://legacy.cumberland.gov.uk/planning-environment/wcm.asp.

5 For instance, in Gloucester Resources, Preston CJ stressed that “‘[i]f approval for the Project in the developed country of Australia were to be refused, on grounds including the adverse effects of the mine’s GHG emissions on climate change, there is no inevitability that developing countries such as India or Indonesia will instead approve a new coking coal mine instead of the Project, rather than following Australia’s lead to refuse a new coal mine”.

6 As Preston CJ concluded in Gloucester Resources, “If a development will cause an environmental impact that is found to be unacceptable, the environmental impact does not become acceptable because a hypothetical and uncertain alternative development might also cause the same unacceptable environmental impact. The environmental impact remains unacceptable regardless of where it is caused. The potential for a hypothetical but uncertain alternative development to cause the same unacceptable environmental impact is not a reason to approve a definite development that will certainly cause the unacceptable environmental impacts”, at para [545].