Strategic Carbon Taxation and Energy Pricing: The Role of Innovation

This paper investigates the strategic interactions between carbon taxation by a resource-consumers’ coalition and (wellhead) energy pricing by a producers’ cartel under possible innovation in a cheap carbon-free technology through a dynamic game. The arrival time of innovation is uncertain, but can be affected by the amount spent on R&D. The results show that the expectation of possible innovation decreases both the initial carbon tax and producer price, resulting in higher initial resource extraction or carbon emissions. Even though this 'green paradox' effect will appear in the cooperative case (no strategic interactions) as well, the presence of strategic interactions between resource producers and consumers can somewhat restrain such an effect. The optimal R&D to stimulate innovation is an increasing function of the initial CO2 concentration for both the resource consumers and a global planner. However, the resource consumers can over-invest in R&D (compared with the global efficient investment.