Balancing the carbon budget for oil: The distributive effects of alternative policies

Keeping temperature change below 2°C will require leaving large reserves of fossil fuels unextracted. We assess alternative policies to achieve this goal in a world divided into two regions, one regulated with emissions pricing and one unregulated, supplied by multiple resource pools with different extraction costs and a carbon-free backstop whose costs decline over time. Global emissions can be reduced by combinations of three policies: (1) increasing the size of the regulated coalition, (2) raising the tax (or tightening the cap) within the regulated coalition, and (3) accelerating cost reductions of the clean technology. We ask how combinations achieving the same cumulative CO2 emissions (the “carbon budget”) affect the discounted surplus of regulated and unregulated consumers and the wealth of the extractors. We first evaluate these policy alternatives in a two-pool, theoretical model with high and low-cost extractors and, once tradeoffs are illuminated, in a calibrated oil market model. A global CO2 tax is both cost-effective and the best policy for regulated consumers. Extractors and unregulated consumers, however, prefer a technology-only policy. When the regulating coalition is subglobal, support for the clean substitute is desired and often required. But the preferred policy portfolio of the coalition involves a tighter cap and less technology policy than is globally optimal, leaving room for bargaining over who pays for clean innovation.