Transitioning to renewable energy fast-tracks fossil fuel extraction---it’s been empirically proven

Climate legislation often establishes goals for the future to give companies and consumers time to adapt and plan for a transition away from fossil fuels. For example, the European Union enacted the goal to be climate neutral (net zero emissions) by 2050, and China established the same goal for 2060. Fossil fuels are exhaustible resources, and their finite availability dictates their use and price path (Hotelling 1931). This scarcity leads to a price that exceeds the marginal extraction cost, resulting in resource rents that ensure less is consumed today and fossil fuels are saved for the future. The literature on the “Green Paradox” highlights that climate legislation, which limit future fossil fuel use, give resource owners an incentive to extract more in the present and medium term before the regulation binds, leading to lower prices and accelerated resource depletion today. This theoretical literature is based on Hotelling’s seminal model (Hoel 2010a, Sinn 2008a, Sinn 2008b, Van der Ploeg and Withagen 2012, Van der Ploeg and Withagen 2015). By the same logic, a global carbon tax on fossil fuels with scarcity rents will not be passed on to consumers. If producers did so, then demand for fossil fuels would fall, cumulative consumption would decrease and not all fossil fuels would be used, incentivizing resource owners to lower fossil fuel prices to sell all units. In the end, much of a carbon tax would be absorbed by producer rents with limited effect on fossil fuel use (Dasgupta, Heal and Stiglitz 1980, Heal and Schlenker 2019). What is common to this literature is the concern that climate legislation might not lead to the desired reductions in cumulative fossil fuel use and may even accelerate consumption today. Our paper adds to the emerging empirical literature on the “Green Paradox” (Lemoine 2017, Di Maria, Lange and van der Werf 2014, Merrill 2018, Grafton, Kompas, Long and To 2014). Specifically, we test the predictions of the “Green Paradox” using a news based index of climate policy salience, a prediction market with contracts contingent on climate policy passing, as well as an event study of an unexpected court ruling mandating reductions in future fossil fuel emissions. We consistently find evidence of the mechanism behind the “Green Paradox:” additional restrictions, or an increased likelihood of future restrictions on oil use, reduce both the oil spot price and oil futures prices in the years for which futures data are traded, i.e., the following two years. This occurs as supply is reallocated from the future to the present. This pattern holds true when analyzing monthly returns in conjunction with decades-long data on policy stringency, when using high-frequency daily data on oil prices coupled with daily changes in prediction market prices, as well as when estimating the oil price return after a surprising verdict.