Abstract
We study oil extraction by a monopolist who faces demand from a climate-aware and a climate-ignorant region. A renewable, perfect substitute for oil is available at constant unit cost. The climate-aware region uses a carbon tax and a renewables subsidy as policy instruments. Due to heterogeneity in climate policies between regions, the oil price path possibly contains two limit-pricing phases. We specify conditions under which a tightening of climate policies results in lower initial carbon emissions. A renewables subsidy and a carbon tax effectively force the monopolist to sell more oil to the climate-ignorant region, during the stage when demand from the climate-aware region has already vanished. We calibrate the model and numerically investigate climate damage and welfare effects of the policies of the climate-aware region. We find that both the carbon tax and a renewables subsidy lower climate damage, even though cumulative emissions are fixed.
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