Biofuel Mandating and the Green Paradox

Abstract

The green paradox arises when producers of carbon resources hasten extraction, in anticipation of future climate policies. Overlooked, in this proliferating literature, is the ability for clean substitute producers to anticipate and react to such policy. We show that when a finite carbon resource and clean substitute are consumed simultaneously, preannounced climate policy leads to the green paradox when producers of the clean substitute are myopic. Conversely, when they can accumulate capacity and are therefore forward looking, the green paradox may or may not result. In this setting, we analytically show that its occurrence depends both on the size of the discount rate and the remaining stock of carbon resource. These and other drivers of the green paradox are subsequently investigated in a detailed multi-producer game-theoretic model calibrated to real-world global oil market data. The timing of mandating policy is shown to be the single most important variable for mitigating the green paradox. Moreover, for EU-2020 and US-2022 style biofuel mandating targets, a rather robust 0.3 percent decline in global crude oil supply is observed during the pre-mandate phase, suggesting that concerns over the green paradox may be overstated.