Climate Policy and Resource Extraction with Variable Markups and Imperfect Substitutes

Abstract

In a resource extraction model that features imperfect substitution and endogenous market power, we analytically characterize the effect of anticipated future demand shocks on the resource extraction path. We show that the resource owner’s market share and reserves-to-extraction ratio are sufficient to calculate the supply response under constant elasticity of substitution between alternative energy resources. The analytical characterization of the extraction response allows us to conduct scenario analyses based on available oil market data. Applying data on OPEC, we find a relatively small increase in current extraction due to an anticipated decrease in the price of alternative energy resources, which implies that endogenous markup adjustments of OPEC countries largely reduce the adverse consequences of anticipated climate policies due to intertemporal carbon leakage.