Marginal Extraction Cost Research Articles

An oligopoly model for analysing oil extraction in the presence of renewable substitutes

ABSTRACT Optimal oil extraction models have often focused on economic costs and benefits in oil production. Anthropogenic pressures in accelerating climate change have become increasingly important in energy policy analysis. Renewables have gained prominence in climate policy analysis and academic discourse, and to some extent with different governments. The two strands of literature, the economically optimal extraction and climate change induced renewable substitutions, have developed separately. A Cournot-Nash equilibrium model was formulated and applied to conduct simulation experiments over a longer time horizon of 150 years. The findings indicated that if there is no renewable substitution, global oil reserves will be fully extracted in less than eighty-seven years, with slight differences depending on variations on marginal cost of oil extraction. Further, reductions in unit cost of renewable production have a greater impact on oil extraction than the respective marginal cost of oil extraction. If the unit cost of renewables falls closer to the level of currently low marginal cost for oil producers, then renewable substitution for oil would accelerate – rendering oil extraction uneconomical long before known oil reserves would be exhausted.

The Stackelberg Games of Water Extraction with Myopic Agents

We consider a discrete-time, infinite-horizon dynamic game of groundwater extraction. A Water Agency charges an extraction cost to water users and controls the marginal extraction cost so that it depends not only on the level of groundwater but also on total water extraction (through a parameter [Formula: see text] that represents the degree of strategic interactions between water users) and on rainfall (through parameter [Formula: see text]). The water users are selfish and myopic, and the goal of the agency is to give them incentives so as to improve their total discounted welfare. We look at this problem in several situations. In the first situation, the parameters [Formula: see text] and [Formula: see text] are considered to be fixed over time. The first result shows that when the Water Agency is patient (the discount factor tends to 1), the optimal marginal extraction cost asks for strategic interactions between agents. The contrary holds for a discount factor near 0. In a second situation, we look at the dynamic Stackelberg game where the Agency decides at each time what cost parameter they must announce. We study theoretically and numerically the solution to this problem. Simulations illustrate the possibility that threshold policies are good candidates for optimal policies.

Using market mechanism to stimulate sustainable use of the non-renewable environmental resource (groundwater) in Barind Tract of Bangladesh

Agriculture, the main economic driver of Barind Tract, is highly dependent on groundwater for surface water paucity in the area. Notwithstanding, farmers use water capriciously due to its low price that makes a substantial drop in the water table. In this context, the research attempts to determine a market-based water pricing mechanism to encourage an optimal use of the scarce non-renewable resource. Required data was collected by questionnaire survey, Focus Group Discussion (FGD), Contingent Valuation Method, expert-opinion survey and subsequent literature works. The results reveal that depletion level has arrived at 20, 11, 7.5 feet in high, mid and low tract respectively over the last 22 years, which results in a number of economic-environmental externalities in the area. The research monetarily evaluated the cost of externalities and incorporated it with the marginal cost of extraction to increase efficiency of an existing pricing system. Regarding human reaction to price elasticity, the new price can be a reliable attempt to reduce an overconsumption pattern of water. Quantity of consumed water can be reduced to 14190.4 m3, 17759.59 m3 and 38510.6 m3 in a year in high, mid and low tract area respectively with its implementation. The research will serve as an initiative to conserve the valuable groundwater resource for future generations by managing consumer practice.

Limit pricing, climate policies, and imperfect substitution

The effects of climate policies are often studied under perfect competition and constant marginal extraction costs. In this paper, we allow for monopolistic fossil fuel supply and more general cost functions, which, in the presence of perfectly substitutable renewables, gives rise to limit-pricing behavior. Four phases of supply may exist in equilibrium: sole supply of fossil fuels below the limit price, sole supply of fossil fuels at the limit price, simultaneous supply of fossil fuels and renewables at the limit price, and sole supply of renewables at the limit price. The consequences of climate policies for initial extraction depend on the initial phase: in case of sole supply of fossil fuels at the limit price, a renewables subsidy increases initial extraction, whereas a carbon tax leaves initial extraction unaffected. With simultaneous supply at the limit price or with sole supply of fossil fuels below the limit price, a renewables subsidy and a carbon tax lower initial extraction. Both policy instruments decrease cumulative extraction. If fossil fuels and renewables are imperfect but good substitutes, the monopolist will exhibit ‘limit-pricing resembling’ behavior, by keeping the effective price of fossil close to that of renewables for considerable time.

Slowing Fossil Fuel Extraction: A Role for Taxation of Exports, Capital Gains and Interest Income

AbstractThis paper develops a model of a growing open economy rich in non‐renewable resources, the extraction of which negatively impacts domestic productivity and whose sector competes with final production for capital. We analyse how tax rates on capital gains and interest income and the time trend of an export revenue tax rate could slow the extraction of resources for export. We find that taxing capital gains and interest income at the same rate and setting an export revenue tax rate to decline at the marginal social cost of extraction would defer extraction. An export revenue tax rate need not fall over time to curb depletion if capital gains are taxed at a lower rate than interest income, which is second best to taxing asset returns at the same rate when the resources sector competes for capital.

Optimal groundwater management under climate change and technical progress

We develop a dynamic model of groundwater extraction for irrigation where climate change and technical change are included as exogenous state variables in addition to the usual state variable of the stock of groundwater. Our key contributions are (i) an intuitive description of the conditions under which groundwater extraction can be non-monotonic, (ii) a numerical demonstration that extraction is non-monotonic in an important region overlying the Ogallala Aquifer, and (iii) the predicted gains from management are substantially larger after accounting for climate and technical change. Intuitively, optimal extraction is increasing in early periods when the marginal benefits of extraction are increasing sufficiently fast due to climate and technical change compared to the increase in the marginal cost of extraction. In contrast, most previous studies include the stock of groundwater as the only state variable and recommend a monotonically decreasing extraction path. We conduct numerical simulations for a region in Kansas overlying the Ogallala Aquifer and find that optimal groundwater extraction peaks 23 years in the future and the gains from management are large (29.5%). Consistent with previous literature, the predicted gains from management are relatively small (6.1%) when ignoring climate and technical change. The realized gains from management are not substantially impacted by incorrect assumptions of climate and technical change when formulating the optimal plan.

Partial privatization in an exhaustible resource industry

The paper proposes a two-stage mixed duopoly model of exhaustible resource market where at the first stage the government decides on the degree of privatization of public firm and at the second stage the public and private firms decide simultaneously on the two-period extraction paths. It is demonstrated that if the two firms have symmetric technologies with increasing marginal extraction costs and the same resource stocks, then neither full nationalization of any of the two firms nor full privatization will be socially desirable. It is shown that the presence of a semi-public firm improves intertemporal allocation of the fixed resource stock. Thus, partial privatization is optimal even under exogenously fixed total outputs of each firm. For asymmetric cost case, when the public firm is less efficient than the private firm, we derive the conditions under which full nationalization or full privatization is optimal.

Oil nationalisations as protracted affairs: evidence from Venezuela

AbstractEmpirical studies tend to treat oil nationalisations as basically discrete, sudden events, an approach that in some cases might be misleading and adds little to disentangle causality. On a contrary vein, we take a closer look at the 1970s nationalisation of Venezuela's oil industry and find evidence that this was a rather protracted affair, expanding over a 17‐year period. We argue that although the transfer of all assets to government hands was not completed until 1975, oil companies fully anticipated such move as early as 1958 and started to operate in a way compatible with a much shorter time horizon. Specifically, we use an estimate of the resource rent (defined as output price minus marginal extraction cost) to show a major shift in oil firms' implicit time horizon after 1958. Our results help to explain the rather weak causality link found in the data between oil nationalisations and price fluctuations.

The green paradox and learning-by-doing in the renewable energy sector

The green paradox conveys the idea that climate policies may have unintended side effects when taking into account the reaction of fossil fuel suppliers. The prospect of carbon taxes being implemented in the future induces resource owners to extract more rapidly which increases present carbon dioxide emissions and accelerates global warming. However, our results suggest that future carbon taxes may decrease present emissions if resource owners face increasing marginal extraction costs and if there is a clean energy source that is a perfect substitute and exhibits learning-by-doing (LBD).If the marginal extraction cost curve is sufficiently flat, resource owners respond to a future carbon tax by lowering total extraction and only slightly increasing present extraction. Moreover, taxation leads to higher energy prices which induces renewable energy firms to increase output not only in the future, but also in the present because of the anticipated benefits from LBD. This crowds out energy from the combustion of fossil fuels and may outweigh the initial increase in present extraction, leading to less emissions in the present.

Measuring Sustainability in the UN System of Environmental-Economic Accounting

The adoption of the System of Environmental-Economic Accounting 2012: Central Framework as a UN statistical standard is a landmark in environmental accounting. The SEEA has the same authority and weight as the System of National Accounts in the pantheon of official statistics. The SEEA defines the unit value of depletion of an exhaustible resource to equal the average unit value of the asset (the total asset value divided by the physical stock of resource). By applying this definition to a non-optimal Dasgupta–Heal–Solow model of an extractive economy, we show that ‘depletion-adjusted net saving’ as defined in the SEEA supports a generalized version of the Hartwick Rule. This measure of saving can guide policies for sustainable development in extractive economies, in particular fiscal policies concerning consumption and investment expenditures funded by resource rents. The conditions required to support this finding are (i) that extraction declines over time at a constant rate, and (ii) that the marginal cost of resource extraction is constant. A less general result holds in the case of increasing marginal extraction costs.

Modeling peak oil and the geological constraints on oil production

We propose a model to reconcile the theory of inter-temporal non-renewable resource depletion with well-known stylized facts concerning the exploitation of exhaustible resources such as oil. Our approach introduces geological constraints into a Hotelling type extraction–exploration model. We show that such constraints, in combination with initially small reserves and strictly convex exploration costs, can coherently explain bell-shaped peaks in natural resource extraction and hence U-shapes in prices. As production increases, marginal profits (marginal revenues less marginal extraction cost) are observed to decline, while as production decreases, marginal profits rise at a positive rate that is not necessarily the rate of discount.A numerical calibration to the global oil market predicts substantially higher future oil prices and considerably lower global oil production with the more realistic geological constraints set-up than with the Hotelling simulation. While mainly (small) non-OPEC producers increase production in response to higher oil prices induced by the geological constraints, most (large) producers’ production declines, leading to a lower peak level for global oil production. High future oil prices therefore, do not necessarily translate to increased oil supplies on global markets.

Is the Gisser and Sánchez model too simple to discuss the economic relevance of groundwater management?

This paper discusses the framing of the model of Gisser and Sánchez (1980) [9] which is commonly reproduced by the follow-up literature. We note that results on the magnitude of welfare gains from optimal groundwater management are affected by the models׳ limitations, such as the commonly used assumption on the linear relationship between pumping cost and the water table level, and the absence of considerations for non-consumptive benefits. We question the appropriateness of these assumptions since the stock effect (the dependence of extraction cost and/or that of benefits on the stock of resource) affects the time variation of the shadow price. We demonstrate that this leads to a declining value of in situ resource over time. As such, its addition on marginal extraction cost may be negligible, and consequently favors the validation of the Gisser–Sánchez effect.

Modeling Peak Oil and the Geological Constraints on Oil Production

We propose a model to reconcile the theory of inter-temporal non-renewable resource depletion with well-known stylized facts concerning the exploitation of exhaustible resources such as oil. Our approach introduces geological constraints into a Hotelling type extraction-exploration model. We show that such constraints, in combination with initially small reserves and strictly convex exploration costs, can coherently explain bell-shaped peaks in natural resource extraction and hence U-shapes in prices. As production increases, marginal profits (marginal revenues less marginal extraction cost) are observed to decline, while as production decreases, marginal profits rise at a positive rate that is not necessarily the rate of discount. A numerical calibration of the model to the world oil market shows that geological constraints have the potential to substantially increase the future oil price. While some (small) non-OPEC producers are found to increase production in response to higher oil prices induced by the geological constraints, most (large) producers’ production declines, leading to a lower peak level for global oil production.

Modeling Peak Oil and the Geological Constraints on Oil Production

Geological constraints are considered in the context of a Hotelling type extraction-exploration model for an exhaustible resource. It is shown that such constraints, in combination with initially small reserves and strictly convex exploration costs, can coherently explain bellshaped peaks in natural resource extraction, and hence U-shapes in prices. As production increases, marginal profits (marginal revenues less marginal extraction cost) are observed to decline, while as production decreases, marginal profits rise at a positive rate that is not necessarily the rate of discount. A numerical application of the model to the world oil market shows that geological constraints have the potential to substantially increase the future oil price. While some non-OPEC producers are found to increase production in response to higher oil prices induced by the geological constraints, most producers’ production declines, leading to a lower peak level for global oil production.

Econometric modelling of world oil supplies: terminal price and the time to depletion

AbstractThis paper develops a novel approach by which to identify the price of oil at the time of depletion; the so‐called ‘terminal price’ of oil. It is shown that while the terminal price is independent of both gross domestic product growth and the price elasticity of energy demand, it is dependent on the world real interest rate and the total lifetime stock of oil resources, as well as on the marginal extraction and scarcity cost parameters. The theoretical predictions of this model are evaluated using data on the cost of extraction, cumulative production and proven reserves. The predicted terminal prices seem sensible for a range of parameters and variables, as illustrated by the sensitivity analysis. Using the terminal price of oil, we calculate the time to depletion and determine the extraction and price profiles over the lifetime of the resource. The extraction profiles generated seem to be in line with the actual production and the predicted prices are generally in line with those currently observed.

The benefits of storage and non‐renewable resource price dynamics

Abstract Both the Theory of Storage and the Hotelling model play a prominent role in the study of non‐renewable resource prices. This paper combines these approaches by modifying the Hotelling model to allow firms to hold inventory in addition to in‐ground reserves, contributing three new results. First, inventory is more likely to be held if future demand and/or the marginal cost of extraction are uncertain. Second, the market price of the commodity is based on the Theory of Storage when inventory is held. Third, the optimal extraction of the resource is based on the Hotelling model.

How Do Environmental and Natural Resource Economics Texts Deal with the Simple Model of the Intertemporal Allocation of a Nonrenewable Resource?

Textbooks in Environmental and Natural Resource Economics invariably deal with the problem of allocating a non-renewable resource over time. The simplest version of that problem is the case of a resource that is to be allocated over two periods. The resource has a constant Marginal Extraction Cost (MEC). Most textbooks treat this case before moving on to more complex and realistic cases. This paper suggests the results that should be emphasized and the method that should be used to arrive at those results. It also points out the possible confusions that should be avoided. Finally, it examines how several well-known textbooks treat this issue.

Market Power in Water Markets

Water markets with market power are analysed as multi-market Cournot competition in which the river structure constrains access to local markets and limited resources impose capacity constraints. Conditions for uniqueness are identified. Lerner indices are larger under binding resource constraints. The number of cases explodes in the number of local markets. Under quadratic benefit functions and symmetric constant marginal extraction costs, closed-form solutions for selected cases are derived, and numerical implementation through a single optimization program is available. Upstream locations face less competition than downstream. Observed price patterns in the Goulburn-Murray Irrigation District are consistent with the theoretical results.

When additional resource stocks reduce welfare

In the dominant firm model, we show that an increase of the fringe's reserves of a nonrenewable resource may lead to a decrease in aggregate discounted social welfare. This happens when the difference between the fringe's extraction cost and the dominant firm's is positive and large enough. We also show that welfare might decrease if the fringe's marginal extraction cost decreases.

Optimal fossil-fuel taxation with backstop technologies and tenure risk

The paper derives the global welfare-optimizing time path for a tax on fossil fuels causing a negative stock externality (climate change), under increasing marginal extraction cost, and in the presence of an unlimited backstop resource causing no externality. In a basic competitive case, the optimal tax equals the Pigou rate, equivalent to the present discounted value of marginal damage costs. We consider two separate types of tenure insecurity for resource owners, and their impact on the tax implementing the optimal policy. When insecure control is with respect to future ownership to the resource, competitive extraction is higher than otherwise, and the efficiency-implementing tax exceeds the Pigou rate. When tenure insecurity instead implies possible expropriation (“holdup”) of investment in extraction capacity, it deters extraction, and the optimal tax is lower than the Pigou rate.