The upside hedge value of California's global warming policy given uncertain future oil prices

Abstract

The economic modeling that policymakers typically rely on—and all the economic modeling of AB 32 (California's Global Warming Solutions Act)—assumes smooth future price paths, ignoring the reality of significant price volatility of fuels derived from crude oil. To add some insight into the value of reduced exposure to gasoline and diesel price spikes as a result of climate policies like AB 32, we define the benefit of upside hedge value: the extra avoided expenditures on gasoline and diesel fuel that accrue when their prices spike. We develop two historically-grounded price spike scenarios: a moderate spike of 25% and a large spike of 50%. After accounting for short-term price elasticity of demand effects, we estimate the upside hedge value to be between $2.4 billion and $5.2 billion (all 2007 dollars) for the moderate and large hypothetical shock scenarios, respectively.