Journal Article

Polluting resource extraction and climate risk

Hashem, Israa, Marrouch, Walid

2023

Overview

Using a fossil fuel extraction model that treats the atmosphere as a depletable resource, we study the optimal price of carbon in the presence of endogenous uncertainty around a climatic regime shift. We find that the optimal carbon tax should account an uncertainty‐adjusted cost term associated with the environment's scarcity. This term is shown to be sensitive to the natural sequestration rate of the atmosphere and to the probability surrounding a climate tail event. Our analysis also shows that in the presence of uncertainty, the shadow price of the environment should grow at a faster rate. Lastly, compared to the endogenous uncertainty case, we find that if the probability surrounding a regime shift is exogenously given, this shadow price should even grow at a higher rate. Considerations for Management Based on our theoretical analysis, considerations for resource management may include: • Beside direct damages, optimal carbon pricing should account for a cost term related to the environment's scarcity. • As the probability of facing an extreme climate event increase, this cost term amplifies. • The cost term disappears for a sufficiently high abatement effort. • Compared to endogenous uncertainty, exogenous uncertainty enforces placing a higher value on the environment's shadow price.

• Publisher: John Wiley & Sons, Inc
• Subject: Atmosphere / Carbon / Carbon taxes / climate risk / Comparative analysis / Energy minerals / Environmental risk / fossil fuel / Fossil fuels / Resource management / scarcity / Shadow prices / Shadows / Theoretical analysis / Uncertainty