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Climate Policies in a Fossil Fuel Producing Country - Demand Versus Supply Side Policies

Taran Fæhn, Cathrine Hagem, Lars Lindholt, Ståle Mæland, Knut Einar Rosendahl (2014)

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The article advocates for using supply-side policies (on top of more traditionally favoured demand-side policies) to achieve emissions reductions. It considers the cost-effective combination of the two policies, using Norway as a case study (although the findings are relevant for all fossil fuel producing countries). 

The article uses data for 2020 and assumptions about demand and supply elasticities, data for domestic abatement costs and foregone profits for Norwegian oil production, and a transparent model of international fossil fuel markets. 
The study assumes a global contribution target for Norway of 5 Mt of CO2 by 2020 and considers whether it would be more cost effective to achieve those emissions reductions solely by reducing emissions within Norway via demand-side measures or by combining such measures with measures to reduce the supply of Norwegian oil, which reduce emissions outside of Norway, due to price effects (i.e. the increased price of oil reduces overseas oil consumption). The article finds that it is cost-effective for Norway to use mostly supply-side measures to achieve the assumed emissions reductions, specifically reducing oil extraction. The cost of achieving the specified emissions reductions by combining both supply and demand-side measures is significantly cheaper than pursuing demand-side measures alone (specifically less than half the cost). The article finds that two-thirds of the emissions reductions to reach the global contribution target should be achieved through supply measures. The optimal combination of demand and supply measures would be annual cuts in Norwegian oil extraction of around 3.5 million Sm3, and annual reductions of 2.5 million tonnes of CO2. Optimal supply and demand policies involve a tax per tonne of domestic carbon emissions and a tax per barrel of domestic oil extraction. 

The article demonstrates the importance and benefits of supply-side policies, illustrating through modelling that a country’s unilateral restrictive supply-side policies more cost-effectively achieve global emissions reductions than solely or primarily using demand-side measures that reduce emissions in the territory of the country. The article reinforces the efficacy of supply-side policies and therefore the potential effectiveness of restricting supply. The analysis in the article can be used to counter market substitution arguments that suggest refusing an extraction project will not, or not cost-effectively, achieve global emissions-reductions.  

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