The exploitation of fossil fuels under the threat of global warming and carbon taxes: A dynamic game approach

Abstract

This paper considers efficient and monopolistic extraction of non-renewable (energy) resources when the resource consumption leads simultaneously to a stock externality (‘global warming’). The case of monopolistic supply leads to a dynamic game between cartelised producers and a consumers' government. For this game, we compute linear Markov perfect strategies that are characterized by preemption of the tax at the wellhead (when compared with the open loop solution). Unfortunately, the general, asymmetric two-state variable model does not allow for an explicit analytical solution. Therefore, a simplified version with one state variable (neglecting depreciation of the stock of the pollutant) is studied and a numerical example is presented. It turns out that the simplified and analytically solved framework provides a good approximation of the initial phase of the transient behaviour but not of the long run.