Effective climate policy needs non-combustion uses for hydrocarbons

Abstract

A central issue that is discussed in climate policy is the fear of owners of stocks of fossil hydrocarbon deposits that high CO2 taxes and bans on the combustion use of hydrocarbons will turn their stocks into stranded assets. They might react by extracting and selling their reserves today: a rush to burn results. We show how the stranded-asset problem could be avoided or strongly moderated. We analyze a simple intertemporal equilibrium with a given stock of fossil hydrocarbons. The key variable for a climate-neutral solution to the rush-to-burn problem is to maintain existing and generate new markets for climate-neutral products from fossil hydrocarbons in the future. We give examples of such products. In this framework subsidies for such products (or for their innovation) also reduce the rush-to-burn problem. In contrast, the creation of substitutes for fossil hydrocarbon-based climate-neutral products, or subsidies for such products reduce the market for products made from fossil hydrocarbons. This aggravates the stranded-assets problem and thus has a climate-damaging effect.