Climate change treaties wrongheaded, argues radical plan to lock-up fossil fuels

By Will Parker on April 12, 2012 in Climate Change, News

An intriguing analysis of fossil fuel trading and environmental policy shows that rather than attempting to limit consumption via pollution permits, taxation, and climate change treaties; buying coal, oil and other dirty fossil fuel deposits and then leaving them in the ground is a far more effective way to fight climate change.

Study author Bard Harstad, from Northwestern University, suggests that the single best policy for a multi-national climate coalition is to purchase the extraction rights of dirty fossil fuels in non-participating countries (also called “third countries”), and then conserve, rather than exploit, the deposits. The notion is a radical departure from the traditional view that focuses on reducing the demand for fuel.

“One of the biggest challenges for multi-national climate agreements is the role of non-participating countries. If a climate coalition reduces demand for fossil fuel, the world price of oil goes down and non-participating countries find it profitable to consume and pollute more. Similarly, if the coalition seeks to reduce the supply or extraction of fossil fuels, the world price increases and these countries find it optimal to supply more,” explained Harstad, an associate professor of managerial economics and decision sciences. “Thus, both on the demand-side and the supply-side the result is carbon leakage, which is an increase in pollution abroad relative to the emission-reduction at home. To limit carbon leakage, the coalition may set up tariffs or other border measures, but this will distort trade.”

Harstad’s analysis argues that by letting coalition countries buy extraction rights in third countries – and preserve rather than exploit the fuel deposits – climate coalitions can circumvent the traditional problems of a demand-side policy.

The most obvious benefit from this policy is that emissions are reduced if one buys and conserves deposits. But more interestingly, (thanks to market forces) the coalition finds it cheapest to buy the marginal deposits (ie, deposits that are not very profitable to exploit, but still quite polluting when consumed). After selling its marginal deposits, a non-participating country’s level of supply will be less sensitive to changes in the world fuel price. Consequently, there is no longer carbon leakage on the supply-side, and the coalition can limit its own supply without fearing that the non-participants will increase theirs.

“This does the trick,” Harstad notes. “After purchasing marginal extraction rights, the coalition implements its ideal policy simply by reducing its supply, not its demand. Fossil fuel prices are then equalized across countries. Also, the resulting fossil fuel price seems high enough to motivate even non-participating countries to invest effectively in new technologies, such as renewable energy sources. For these reasons, the policy is socially optimal in the analysis, even if some countries do not participate.”

Multi-national companies are already trading extraction rights and climate coalitions should as well, says Harstad. “Progress on international climate policy is best achieved by simply utilizing the existing market for extraction rights,” he concludes. His study will appear in a forthcoming issue of the Journal of Political Economy.