Sunday, March 24, 2019


This commentary was provoked by recent reports that Norway’s sovereign wealth fund is to sell off its investments in companies that explore for oil and natural gas. This has been welcomed by some environmentalists campaigning for disinvestment from the hydrocarbon-based economy. In fact the Norwegian move is not really a signal of environmental virtue or ethical investing, and is best interpreted simply as a prudent rebalancing of their investment portfolio, a point made forcefully by Nick Butler in a recent FT article (18 March 2019). Butler regrets that this disinvestment is not balanced by “positive” investment in low carbon alternatives.

Butler goes on to claim, again correctly, that environmentalists may also be disappointed because, as he says, the evidence is that the oil companies are anticipating a continuing demand for their product, with few forecasts anticipating a peak before the mid-2030s. If these forecasts are correct and we are unable to prevent continuing growth in production and consumption, then it is bad news for hopes that the ambitious aspirations of the Paris agreement can be met, and that global warming can be limited to the 1.5o C. This is regarded by many climate scientists as the upper limit consistent with avoiding the most dangerous environmental and climate outcomes.

There are however some related factors that should concern us in relation to oil industry incentives for investment. One is the so-called Green Paradox[1]. This argues, very logically, that if fossil fuel producers perceive that they face increasingly hostile restrictions on output, and gradually increasing carbon taxes, then they have a strong incentive to accelerate production and accelerate the depletion of their reserves. Implicitly the same argument would apply to many of the main sources of demand for oil, where the product depends on oil consumption either in the production stage

And yet that is more or less exactly the future carbon scenario that is most often presented in policy forums, that of a gradually increasing carbon tax. Needless to say, there is little evidence yet of the sort of collapsing investment that would seriously reduce supplies, nor of the much higher oil prices that could result, at least temporarily, from serious disincentives to production. The oil price seems to be stuck somewhere around the $60/ bbl mark, near the bottom of the $60 - $120 “credible range” recognised by many industry analysts.

In consequence it should be no surprise that production and consumption continue to rise. A rational policy to reverse this, and to overcome the Green Paradox, would be to recognise that, if anything, immediate near-term emissions, given that CO2 is cumulative, do more damage per tonne than future emissions[2] and have a significantly higher social cost. Rational policy towards climate should therefore include a policy for a price/tax on emissions that starts high rather than climbs gradually. This would make fossil fuel extraction and investment less profitable, and also provide an additional non-distorting incentive for low carbon investment of all kinds, an objective that many of us share.

Of course, it will be argued that this may have redistributive consequences, but green taxes offer their own answer in this respect. Revenues from taxing emissions offset the need for other taxes, or can be used for redistributive agendas.


From an economic analysis perspective, the Green/ Sinn Paradox may not seem very surprising. It simply represents a potential consequence of policies that are poorly thought out (at least from a climate perspective). There are of course other factors that lead some oil rich states to favour accelerated exploitation, notably the desire for an immediate boost to the domestic economy, even at the expense of longer term considerations. But the Sinn paradox provides an additional incentive.

The source of the disconnection, between the science led climate imperative and the current economics of fossil fuel industries, is explored in more depth on another page: CUMULATIVE CARBON. HAS THE ECONOMICS LOST CONTACT WITH THE PHYSICS?

[1] aka the Sinn paradox, it was first discussed by Hans Werner Sinn.
[2] See link above.

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