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The Green Paradox, A Hotelling Cul de Sac

Abstract:
The green paradox is an effect by which an increasing tax per unit on oil production, aimed at tracking damages from CO2 emissions, induces an increase in world production and a decrease in price in the near term. The increase is a rational response in a Hotelling exhaustible-resource model. We simulate the decisions of a price-taking producer in response to a tax of various shapes. In contrast to a Hotelling model, our extraction technology involves irreversible, lumpy investments in exploration and development. In addition, we assume output from a developed reserve is subject to natural decline at a rate that is determined by the sunk development investment and the geology of the reserve. Decisions are far more complicated, and results far subtler, than in the Hotelling framework. Given a price path, we show that almost any form of tax causes a reduction in the level of development and initial production, thereby contradicting the hypothesis of the green paradox.
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Keywords: green paradox, natural decline, exploration and development, sunk cost, Hotelling resource model

DOI: 10.5547/2160-5890.8.2.rcai


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Published in Volume 8, Number 2 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.