Limit-Pricing and the (Un)Effectiveness of the Carbon Tax

This paper questions the ability of a carbon tax to reduce oil extraction. Demand for oil is very price inelastic. Facing such demand, an extractive cartel induces the highest price that does not destroy its demand: it tolerates ”non-drastic” substitutes but deters substitution possibilities that have the potential to drastically deteriorate its demand. Limit-pricing equilibria of non-renewable resource markets sharply differ from conventional Hotelling outcomes. Oil taxes become neutral. Policies only reduce current oil extraction when they support existing non-drastic substitutes. Since the carbon tax applies to oil and to its current carbon substitutes, it induces higher oil current production.