Climate Policy

Climate Policy 7 (2007) 60–72

Synthesis Article

Profitability of fossil-fuel production under different instruments in international climate policies

Finn Roar Aune, Snorre Kverndokk, Lars Lindholt and Knut Einar Rosendahl

This article discusses how different climate policy instruments such as CO₂ taxes and renewable energy subsidies affect the profitability of fossil-fuel production, given that a fixed global climate target shall be achieved in the long term. Within an intertemporal framework, the model analyses show that CO₂ taxes reduce the short-term profitability to a greater extent than technology subsidies, since the competition from CO₂-free energy sources does not become particularly noticeable until decades later. Due to, for example, the discounting of future revenues, most fossil-fuel producers prefer subsidies to their competitors rather than CO₂ taxes. However, this conclusion does not apply to all producers. Oil producers outside OPEC lose the most on the subsidizing of CO₂-free energy, while CO₂ taxes only slightly reduce their profits. This is connected to OPEC's role in the oil market, as the cartel chooses to reduce its extraction significantly in the tax scenario. The results seem to be consistent with the observed behaviour of important players in the climate negotiations.

Keywords: climate policy; energy markets; technological change

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