Too Much Oil

Fear for oil exhaustion and its consequences for economic growth has been a driver of a rich literature on exhaustible resources. But our view on oil has remarkably changed. We now also worry about too much oil because of climate change damages associated with oil and other fossil fuel use. In this climate change debate, economists have pointed to a green paradox: when policy makers stimulate the development of low carbon energy sources to (partly) replace fossil fuels in the future, oil markets may anticipate a future reduction in demand and increase current supply. The availability of 'green' technologies may increase damages. The insight comes from the basic exhaustible resource model. We reproduce the green paradox, and to facilitate discussion, differentiate between a weak and a strong version, related to short-term and long-term effects, respectively. Then we analyze the green paradox in two standard modifications of the exhaustible resource model. We find that increasing fossil fuel extraction costs counteracts the strong green paradox, while imperfect energy substitutes may make both the weak and strong green paradox vanish. (JEL codes: Q31 and Q54).