The climate policy of an oil producing country – demand-side versus supply-side policies

1. The climate policy of an oil producing country – demand-side versus supply-side policies By Taran Fæhn, Cathrine Hagem, Lars Lindholt, Ståle Mæland and Knut Einar Rosendahl, Statistics Norway

2. Main Research Question • Given a target for domestic contribution to global emissions reductions – what is the optimal combination of reduced fossil fuel consumption and reduced fossil fuel production?.

3. Motivation Ongoing political debate in Norway – prior to the elections • The role of petroleum extraction in the Norwegian climate policies • Parliament’s ambitious, expensive agreement on domestic demand-side • Why only demand-side? Oil interests against environmental interests • Debate fuelled substantially by our recent reports and media activity! Literature: • Demand side carbon leakage of unilateral climate policies • Increaseddemandabroad • Bohm, 1993, Markusen et al. (1993; 1995), Rauscher (1997) and Böhringer et al. (2010) • Supply-side carbon leakages • Increasedsupplyabroad • Harstad (2012) shows that the best policy is simply to buy marginal foreign fossil fuel deposits and conserve them (inelastic supply on the margin) • Optimal combinations of supply side versus demand side • Hoel (1994), Golombek et al. (1995) • Demand side versus supply side – Norway, Hagem (1994).

4. Our contributions • Update previous numerical estimates • Emission intensities in extraction can vary among countries • Imperfect competition • Empirical cost assessments of marginal cuts in Norwegian oil production • A survey of the fossil fuel market elasticity estimates from the literature

5. Model: Domestic objective function • Maximise welfare (W), subject to the global climate policy target : • First order cond.:

6. Model: The energy market • Three fossil fuel markets (oil, coal and gas) • Static model • less suitable for existing extraction fields (Hotelling, green paradox) • suitable for new developments, including enhanced oil recovery (EOR) investments • Global emissions, E, including extraction emissions: • Fossil fuel market equilibria: • Oil market: net Home import = fringe supply abroad + OPEC (dominant producer) - demand abroad • Gas and coal markets: , i = c, g

7. Leakage rates Reducedoildemand at homereducesoilprice and, thus, affectsdemandabroad for o (>0) and c, g (<0) Reducedoilproductionincreasesoilprice and, thus, affectssupplyabroadofoil (>0) and ofc,g (<0)

8. Global emissions effects T = (i) gross (direct) effects + (ii) leakages through oil market + (iii) leakages through gas and coal markets a = (iv) effects on domestic extraction emissions b = (v) effects on foreign extraction emissions Table 1. 1 unit reduced oil extraction/consumption – net global emission reductions. Benchmark assumptions. Benchmark: elDopo=-0.5, elDgpo = elDcpo =0.1, elSopo =0.5, a´= 90/1000, b´= 300, b´opec =76

9. Marginal cost of forgone oil consumption for Norway • Climate Cure 2020: tasked to estimate costs of unilateral 2020 ambitions of the Parliament; • scenario with new demand side policies only in NETS (assumption: global contribution ambitions) • Marginal cost of forgone profits from Norwegian oil extraction • Data: Costs of cutting present production in several small, relatively costly fields in decline-phase • We assess: fairly representative for 2020

10. Leakage-adjusted domestic demand-side marginal abatement cost curve and the marginal supply-side abatement cost curve • Combine the two and calculate their effects on global emissions when leakages are accounted for • The domestic contribution target to global cuts is nearly 6 millt CO2 • Demandside from left; supplyside from right. • Top of demand side: Only demandside (Klimakur) • Top of supply side: Only supply side (cheaper as in Hagem 1994) • Intercept: the cost effective combination: Around two thirds of the measures to reduce global emissions should be supply side measures

11. Policy impacts: tax consumption and production: • Demand side policies: Carbon tax rate: 248 USD/t CO2 • Only oil demand cuts • 40% of the Climate Cure costs • Supply side policies: Oil production tax: 53 USD/barrel(!) • App. half of the oil price • 3.4 percent of present domestic oil extraction • 50% tax could potentially lead to much larger cuts (if supply side is cheaper than estimated) • Alternatives: • Only tax undeveloped fields • More restrictive concession&exploration policies • Less aggressive recovery ambitions in present fields

13. Conclusions • Global emissions will most probably decrease when Norway cuts oil extraction • Though many sources of uncertainty, robust conclusion: • The lion heart of the cuts should be implemented through supply side policies • 2/3 in benchmark • Rely on • Home country wishes to make unilateral actions • Offsets are not feasible or preferred alternatives • The objective is to cut global emissions • Compared to the costs of demand policies only, costs are cut by 60%

14. Thank you for your attention Discussionpaper: Fæhn, T, C. Hagem, L. Lindholt, S. Mæland, and K.-E. Rosendahl (2013):Climate policies in a fossil fuel producing country Demand versus supply side policies, Discussion papers 747, Statistics Norway