The “green power paradox” grabs Hotelling by the ankles, turns him upside down, and shakes the change out of his pockets.
Harold Hotelling’s classic article, “The Economics of Exhaustible Resources,” observes that the owner of an exhaustible resource stock always is making choices in the shadow of the future. If the owner produces and sells a bit today, that necessarily involves sacrificing the opportunity to produce and sell that bit in the future. Given that the resource is exhaustible, we expect the price to increase as the stock of resources nears exhaustion. The resource owner’s choice, then, is whether to sell at a low price today or a higher price tomorrow.
Hotelling’s mathematics says the resource price will tend to increase at the rate of interest, at least under certain conditions (The intuition: if the rate of price increase is below the rate of interest then it will pay to produce more quickly now; if the price increases are any faster then it will pay to produce more slowly. The adjustments will tend to keep the rate of resource price increases in line with interest rates.)
The green paradox emerges when, in a world of exhaustible energy resources, a new renewable energy supply is introduced. Suddenly, the heavy hand of the future is lifted a little. Therefore, even as the exhaustible energy resource dwindles, no longer can the owner expect ever rising prices. In fact, as the technology of the renewable energy resource improves, the price of all energy resources should drop.
In a world of constantly improving renewable energy technology, the owner of an exhaustible resource may be choosing between a low price today and an even lower price tomorrow. The implication: produce and sell now, before the price drops again!
Paradoxically, government promotion of alternative energy technology as a means to fight global warming may be encouraging the rapid exploitation of fossil fuels!
(This is my optimistic, Julian Simon-esque version of the Green Paradox, with resources becoming cheaper over time. A similar pessimistic version can obtain if owners of an exhaustible energy resource expect that regulatory controls on production will become increasingly onerous over time. Produce now while the controls are light instead of keeping your resource in the ground where future regulations may insist it stay.
And finally, if you are a combination resource optimist and a regulatory pessimist, then you ought to stop reading this post right now and go drill, baby, drill!)
SEE: Hans-Werner Sinn, The Green Paradox, MIT Press (2012). Related Sinn: “Greenhouse gases: Demand control policies, supply and the time path of carbon prices.”
HT: Marginal Revolution.