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Partners, Not Rivals: The Power of Parallel Supply-Side and Demand-Side Climate Policy

Brian C. Prest (2022)

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The paper compares and contrasts the emissions leakage risk of supply-side and demand-side policies to show that both types of policies can induce leakage on their own, but that when pursued in tandem, they can mitigate or eliminate leakage.  

The paper notes that demand-side policies create leakage where they reduce the price of internationally-traded fossil fuels, making it cheaper for overseas consumers to burn emissions. Supply-side policies create leakage by raising fossil fuel prices, which encourages production overseas as overseas production becomes more profitable.  

The paper uses neoclassical economic theory to demonstrate that utilising supply and demand-side policies concurrently and with equal ambition can avoid leakage. The theoretical model used focuses on oil and the state of the global oil market as in 2022. The model measures the effect of a policy on emissions based on how much the policy reduces market equilibrium of global oil consumption. It shows that the only way leakage can be eliminated under a demand-side policy is in circumstances that do not reflect a “reasonable approximation of reality” (e.g. where global demand is perfectly inelastic, and where global supply is perfectly elastic). The model shows that using either a demand-only or supply-only approach results in leakage, which reduces the global emissions-reduction effects of such policies.  

Where demand and supply-side policies are pursued at the same level, leakage is avoided because there is no net pressure on the price of oil, not inducing any increase in overseas production or consumption. The paper then uses an empirically calibrated model from US and global oil and gas markets to quantitatively assess the synergies of using supply (reduced development on US federal land/waters of oil and gas) and demand-side policies (fuel economy standards), resulting in findings that corroborate the economic analyses in this paper (i.e. that pursuing both policies in tandem mitigates leakage and results in greater reductions in oil than pursuing only one type of policy). 

The paper also canvasses a range of other benefits to using both policies. These benefits include mitigating price impacts on actors, improving diplomatic relationships as countries would be able to demonstrate their commitment across both measures, and reducing inequities in environmental impacts across countries (e.g. by spreading more equally the co-benefits of reduced production). 

The paper ultimately suggests supply-side and demand-side policies should not be pitted against each other, but should be treated as complementary tools. 

The paper supports using supply-side policies with demand-side policies to achieve greater emissions reductions and to achieve a range of other non-price benefits such as reducing other environmental impacts. This can be used to support the justifications for rejecting fossil fuel projects, even where jurisdictions also utilise demand-side measures. 

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