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Limiting fossil fuel production as the next big step in climate policy

Peter Erickson, Michael Lazarus, and Georgia Piggot (2018)

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The article outlines the economic and political rationales for using supply-side or production-based climate policies that restrict fossil fuel extraction.

The economic theory suggests that emissions can be reduced by limiting fossil fuel production, as doing so will increase prices and thereby reduce consumption. The efficacy of this measure is based on elasticities of supply and demand (how consumer demand and producer supply change in response to price). Specifically, the less producers are able to respond to price increases in fossil fuels by increasing the amount they produce (the lower the price elasticity of supply), and the more consumers are able to respond to price increases by reducing the amount they demand (the higher the price elasticity of demand) the more effective restrictions in supply will be at achieving emissions reductions. A benefit of using supply-side policies in conjunction with demand-side policies is the ability of supply-side measures to reduce the risk of carbon leakage across borders. Where countries only reduce demand without reducing supply, overseas consumers may use more fuel because lower demand will suppress prices in traded fuel markets. However, by reducing both demand and supply at the same time, countries can limit price-induced cross-border carbon leakage.

The article uses California as a case study because of its significant oil extraction industry and emissions from oil-derived products. It suggests that if California removes its oil from the market, a small increase in world oil prices would occur, having two effects: producers from other regions would produce more oil; and consumers around the world would use less oil. The article uses economic modelling based on elasticities of supply and demand, to consider a scenario where California stops issuing permits for new oil wells. For every barrel of oil not extracted, the change in global oil consumption is given by the ratio of the elasticity of demand to the difference between the elasticities of demand and supply. The model drew elasticity values from past modelling efforts, estimating that for each barrel not produced in California, global oil consumption would drop by 0.2–0.6 barrels over the long term. 

From these calculations, the model concludes that by limiting oil production, California could reduce global oil consumption by 16–48 million barrels per year—equivalent to a reduction in global emissions of 6–19 MtCO2 (only counting carbon from each oil-based fuel). Further information on the economic model used in this analysis can be found in Erickson and Lazarus (2014).

The article can be used in response to market substitution arguments by fossil fuel proponents that suggest limiting the supply of fossil fuels will not affect demand because other producers will offset any reductions by ‘substituting’ in supply. Using modelling (based on empirical evidence), it can be shown that restricting supply of fossil fuels in a specific region can result in a reduction of consumption and therefore a reduction of emissions. This reinforces the efficacy of rejecting a fossil fuel extraction project and counters a market substitution argument that seeks to deny the project will have an impact on reducing emissions because of supply / demand assumptions.

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