Limit pricing, climate policies, and imperfect substitution

Abstract

The effects of climate policies are often studied under perfect competition and constant marginal extraction costs. In this paper, we allow for monopolistic fossil fuel supply and more general cost functions, which, in the presence of perfectly substitutable renewables, gives rise to limit-pricing behavior. Four phases of supply may exist in equilibrium: sole supply of fossil fuels below the limit price, sole supply of fossil fuels at the limit price, simultaneous supply of fossil fuels and renewables at the limit price, and sole supply of renewables at the limit price. The consequences of climate policies for initial extraction depend on the initial phase: in case of sole supply of fossil fuels at the limit price, a renewables subsidy increases initial extraction, whereas a carbon tax leaves initial extraction unaffected. With simultaneous supply at the limit price or with sole supply of fossil fuels below the limit price, a renewables subsidy and a carbon tax lower initial extraction. Both policy instruments decrease cumulative extraction. If fossil fuels and renewables are imperfect but good substitutes, the monopolist will exhibit 'limit-pricing resembling' behavior, by keeping the effective price of fossil close to that of renewables for considerable time.

An Oligopoly-Fringe Model with HARA Preferences

“…On the contrary, under similar conditions such a subsidy may cause a decrease in initial extraction under monopolistic resource supply (e.g. Van der Meijden and Withagen, 2019). In terms of market power, the situation in our model is somewhere in between these extreme cases of perfect competition and monopoly.…”

“…We incorporate an important feature of the oil market and energy sector in general: The existence of renewables that provide perfect substitutes for oil and that can be produced in unlimited amounts. This implies that an equilibrium may include a phase of limitpricing by oil cartel members (see, e.g., Van der Meijden et al (2018), Andrade de Sá and Daubanes (2016) and Van der Meijden and Withagen (2019) for recent work and Hoel (1978), Salant (1979) and Gilbert and Goldman (1978) for early contributions), where the price is maintained at a level that precludes entry of suppliers using the backstop technology.…”

How the COVID-19 Crisis is Showing us the Complexities in the Global Energy Transition

“…Recent results using mathematical models of strategic interactions suggest that oil players (mainly OPEC) may exhibit limit-pricing behaviors regarding RES [32][33][34]. US$/barrel [37], respectively.…”

Does the South African Carbon Tax Incentivise Mines to Invest in Solar Photovoltaic?

“…Research on the ability of carbon pricing to encourage decarbonisation in the mining industry has been minimal. Carbon pricing research has focused on the negative impact on GDP, competitiveness, and profits (Datta, 2017;Modiba, 2019;Van der Meijdena & Withagen, 2019;Van Heerden et al, 2016). Thus, a gap exists in the literature on evaluating the adequacy of the ability of carbon pricing policies to decarbonise mining industries.…”