Unilateral Emission Pricing and OPEC’s Behaviour

A major drawback associated with unilateral climate policies is the risk of carbon leakage: price changes in international markets for fossil fuels and energy-intensive goods might lead to the relocation of emissions from countries with emission regulation to unregulated regions. Obviously, carbon leakage hampers the cost-effectiveness of unilateral action. Branger and Quirion (2014) provide a comprehensive overview and meta-analysis of the applied literature on unilateral climate policy and carbon leakage. One common finding is that carbon leakage to a large extent takes place through price changes on international energy markets. However, most previous studies assume international energy market to be perfectly competitive, thus disregarding empirical evidence on non-competitive behaviour of members of the Organization of Petroleum Exporting Countries (OPEC) in the crude oil market (see literature below).

As shown in Böhringer et al. (2014), the assumption of imperfect competition in the international crude oil market may substantially affect outcomes with respect to carbon leakage as well as global and regional cost implications of unilateral climate policies. A computable general equilibrium (CGE) model is used to assess two different climate policy scenarios for the EU, with five alternative assumptions about OPEC’s strategic response. As to EU climate policy design, the EU unilaterally implements a cap on global emissions. As to behavioural assumption on OPEC, OPEC can either act competitively; or ration its crude oil supply in order to hold the crude oil price, or crude oil revenues, or its supply quantity fixed; or act as a dominant producer maximizing its crude oil profits. The main finding is that if OPEC acts as a dominant producer, the oil price increases when the EU introduces its climate policy. This is due to OPEC’s incentive to shift over climate rents from emission pricing: since the EU pursues a global emissions target, OPEC can drive down EU’s CO₂ price via an increased oil price. As the oil price increases, non-EU demand declines and hence leakage through the oil market turns negative. However, global cost-effectiveness of unilateral emission reduction is seriously deteriorated under the assumption of imperfect competition because too much of the mitigation takes place through reduction in oil consumption.

In this paper, we elaborate on the analysis in Böhringer et al. (2014). More specifically, we test the robustness of the conclusions to variations in four potentially critical assumptions: (i) the size of the climate coalition, (ii) the size of the oil cartel, (iii) oil–gas price linkages in the EU and Japan, and (iv) subsidies to domestic oil consumption within OPEC. Our primary objective is to foster our understanding on how such variations affect the implications of OPEC’s strategic behaviour.

As to (i) — the size of the climate coalition — we take into account that countries outside the EU might also implement stringent carbon pricing or equivalent emission regulations.¹ In the context of the 21st Conference of Parties (COP21) to the United Nations Framework Convention on Climate Change in Paris in December 2015, many countries communicated their intended nationally determined contributions (INDCs) to reduce greenhouse gas (GHG) emissions (UNFCCC, 2015). The United States, for example, stated a target of reducing GHG emissions by 26–28% below 2005 levels by 2025, and has launched a clean power plan to reduce CO₂ emissions in the power sector in addition to existing policies such as fuel efficiency standards for cars. China as the major greenhouse gas emitter world-wide announced that it will establish a national emission trading system from 2017 onwards, preluded by seven pilot trading schemes at the provincial level (Zhang, 2015), to peak emissions around 2030. It remains to be seen how the voluntary INDCs of countries will be followed up in more detail over the next years, but for our analysis it seems reasonable to enlarge the climate policy size beyond the EU by additional members such as the US, other remaining OECD countries, or China.

As to (ii) — the size of the oil cartel — one string of literature treats OPEC as a whole acting as a dominant producer or price leader (e.g., Böckem, 2004). Another string finds dominant behaviour only for OPEC-core (e.g., Hansen and Lindholt, 2008) — consisting of Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates — or only Saudi Arabia (e.g., Alhajji and Huettner, 2000a). For strategic responses to unilateral climate policies, the market share of the cartel plays a major role as a determinant of actual market power. To account for different perspectives on OPEC members’ roles in the oil market, we vary the cartel size and incorporate scenarios where only OPEC-core or only Saudi Arabia instead of OPEC as a whole acts strategically.

As to (iii) — oil–gas price linkages in the EU and Japan — price responses to emission regulation across fossil fuels drive fuel switching, and thus the scope for emission abatement via reductions in the CO₂ intensity of energy use. Fuel switching from coal to gas in electricity generation is thereby considered to be of particular importance for cost-effective CO₂ emission reduction (Delarue and D’haeseleer, 2008). However, gas import prices in the EU and in the Asia–Pacific region are closely linked to the international crude oil price. In continental Europe natural gas import prices have traditionally been determined through long-term contracts related to oil products including an annual contract quantity with a minimum take-or-pay level (European Commission, 2007). Although there is an increasing tendency towards competitive pricing along the installation of gas hubs and augmented spot-priced liquefied natural gas (LNG) supplies over recent years (Stern and Rogers, 2014) — import prices are still strongly determined by oil-indexed contracts, particularly in central and southern Europe. Without domestic gas resources and transnational pipeline connections, Japan is by far the world’s largest importer of LNG. For the past 25 years Japan’s LNG import prices have been closely linked to international crude oil prices through the so-called “Japanese Customs-Cleared Crude Oil” (JCC) index (Rogers and Stern, 2014). Against this background, we investigate the sensitivity of initial conclusions in Böhringer et al. (2014) when accounting for price linkages between the international crude oil price and the import price for natural gas in the EU and Japan.

As to (iv) — subsidies to domestic oil consumption within OPEC — we acknowledge that fossil fuel consumption is highly subsidized in many countries, incentivizing demand and distorting allocative efficiency of resource allocations. In 2011, the IEA (2012) estimated total fossil fuel subsidies to be 523 billion USD, with oil subsidies of 285 billion USD constituting the major part. OPEC members stand out for very high subsidies to domestic oil consumption, with Iran and Saudi Arabia accounting for almost 90 billion USD.² We reflect the policy practice of domestic oil subsidies in OPEC countries, which implies that OPEC countries do not exploit market power on their domestic markets.

Our simulation results on variations of key assumptions (i)–(iv) suggest that negative leakage through the oil market as identified in Böhringer et al. (2014) cannot be generalized and constitutes a rather special outcome. The implications of strategic responses by OPEC to unilateral emission pricing hinge in particular on the size of the climate coalition and the size of the oil cartel. As a prime example, OPEC’s ability to lower the coalition’s CO₂ price is reduced markedly when China is part of the coalition. The reasoning is that China brings plenty of low-cost coal-related abatement options into the coalition which implicitly lowers OPEC’s incentives to cut back supply. When only OPEC-core or Saudi Arabia acts dominantly instead of OPEC as a whole, the results resemble the outcome of a competitive market setting: the cartels’ market share is no longer sufficiently large to noticeably impact on the EU’s CO₂ price. A price linkage between the crude oil price and gas import prices gives opposing incentives to OPEC when assuming dominant behaviour, which in total leads to a market outcome which is similar to the case without the price link, except for declining gas imports in Europe and Japan. Assuming existing subsidies to domestic consumers within OPEC does not significantly change OPEC’s supply decision when facing an EU climate policy, only OPEC’s crude oil consumption share is slightly higher than without subsidies.

The remainder of this paper is organized as follows. In section “Literature Review”, we briefly review some previous and relevant literature. Then in section “Model and Data” we provide a non-technical description of the CGE model and empirical data underlying our simulation analysis. In section “Base-Year Statistics”, we present base-year statistics to identify key drivers of the counterfactual simulation results, while in section “Policy Scenarios and Simulation Results” we lay out policy scenarios and discuss in detail our simulation results. Then section “Conclusion” contains our conclusions.

Our paper relates to different strands of literature. First, there are a number of studies analyzing strategic behaviour in energy markets, including studies of the game between OPEC and climate coalitions, see for example Bråten and Golombek (1998), Liski and Tahvonen (2004), Rubio and Escriche (2001), Tahvonen (1995, 1996), and Wirl (1994, 1995). These studies focus on oil resource rents, and how a climate coalition may capture some of this rent by imposing emission constraints. Dullieux et al. (2011) introduce a carbon stock constraint imposed by oil-importing countries, and study the Markov-perfect Nash equilibrium of a dynamic game between these countries and oil-exporting countries. Their main finding is that the oil exporters are only able to shift rents if the marginal environmental damages below the stock constraint are sufficiently small. Wirl (2012) compares strategic price and quantity instruments for both the cartel and the climate coalition, concluding that price instruments dominate quantity instruments for both the cartel and the coalition. A similar conclusion is found by Strand (2013) for a climate coalition, which also has access to an offset market (such as CDM). A price instrument (emission tax) is preferred over a quantity instrument (emission cap) since the global fuel price is lower with the price instrument which is more effective in curtailing the strategic scope for the fuel exporter.

Kverndokk and Rosendahl (2013) show that fuel efficiency improvements in a climate coalition will lead to higher fuel prices if the dominant producer’s market share is sufficiently large. Haurie and Vielle (2010) show that it is optimal for OPEC as a dominant producer to lose market share in order to keep the oil price from falling too much.

Our paper also relates to literature on the green paradox, initiated by Sinn (2008) and reviewed in Jensen et al. (2015). The main message from this literature is that climate policies could lead to increased emissions of CO₂, as owners of fossil fuel resources may find it profitable to shift extraction of their non-renewable resources from the future to the present. This effect may be particularly strong if CO₂ prices are expected to increase over time.³ Studies of the green paradox obviously require a dynamic model building on the non-renewable resource theory established by Hotelling (1931). In this vein, Gerlagh and Liski (2011) use a dynamic model of non-renewable resources to look into strategic behaviour by a monopolist owning a non-renewable resource (using oil as the motivating example), who faces competition from a new substitute.⁴

For our analysis, we assume that OPEC or a subgroup of OPEC acts as a dominant producer in the oil market. Thus, our findings rest on this assumption being reasonable. There is limited consensus in the literature regarding OPEC’s behaviour, except that most studies reject the hypothesis of competitive behaviour (see e.g., Alhajji and Huettner, 2000a; Böckem, 2004; Hansen and Lindholt, 2008; Huntington et al., 2013; Kaufmann et al., 2008; Smith, 2005). Most studies consider the dominant producer model, and some empirical support has been found for either OPEC as a whole (e.g., Böckem, 2004; Golombek et al., 2014), or OPEC-core (e.g., Hansen and Lindholt, 2008), or only Saudi Arabia (e.g., Alhajji and Huettner, 2000a) acting as the dominant producer. Some numerical models have assumed Cournot behaviour (e.g., Berg et al., 2002; Okullo et al., 2015; Salant, 1982), whereas the target revenue hypothesis was tested by Alhajji and Huettner (2000b) for individual countries (not Saudi Arabia) with mixed conclusions. Smith (2005) considers a variety of models, finding that “all traditional explanations of OPEC behaviour (i.e., competitive, Cournot, dominant-firm, etc.) are strongly rejected, except the hypothesis that OPEC acts as a bureaucratic syndicate”, which he characterizes as “a cartel weighed down by the cost of forging and enforcing consensus among its members”.

Our conceptual framework is based on the dominant producer model where the strategic element can be summarized as follows (see the Appendix A for a brief formal description). First, the climate coalition announces its climate target, formulated as a cap on emissions, and decides to implement an economy-wide CO₂ price in order to reach this target. Since climate change is a global problem, we postulate that the climate coalition is concerned about global emissions, and consequently pursues a global emission reduction target through unilateral action. Next, whereas competitive producers in the fossil fuel markets adjust their supply according to the price of the fuel they sell, the dominant producer in the oil market (OPEC, OPEC-Core, or Saudi Arabia) adjusts its production in order to maximize its profits from this market. In particular, the dominant producer realizes that its supply of oil does not only affect the price of oil, but also the price of CO₂ implemented by the coalition, which again has a feedback effect on the oil price through the demand for oil. Consequently, if the dominant producer decides to reduce its supply, more of the rent in the oil market will be shifted back to the dominant producer, partly due to a lower CO₂ price. This gives the producer more incentives to cut back on its supply compared to a situation where the climate coalition had instead imposed a fixed CO₂ price.

In order to quantify the magnitude of these mechanisms, we use a canonical static computable general equilibrium (CGE) model of global trade and energy use. CGE models are widely used for the economic impact assessment of policy measures as they capture price-responsive supply and demand adjustments to external policy shocks in a comprehensive and consistent manner. Below we provide a brief nontechnical description of our CGE model — a more elaborate description along with algebraic details can be found in Böhringer et al. (2014). Parameterization of the model is based on the latest version of the Global Trade Analysis Project (GTAP 9) dataset (Narayanan et al., 2015).

Each model region has a representative agent that receives income from three primary factors: labour, capital, and fossil fuel resources. Labour and capital are intersectorally mobile within a region but immobile between regions; fossil fuel resources are specific to the fossil fuel production sectors coal, crude oil, and natural gas in each region.

Production and consumption activities are represented through multi-level nested constant elasticity of substitution (CES) functions, which capture price-responsive trade-offs between primary factors, energy inputs as well as intermediate material inputs. Fossil fuel production is calibrated to match exogenous estimates of fossil-fuel supply elasticities.⁵

Final consumption in each region is determined by the representative agent who maximizes welfare subject to a budget constraint with fixed investment and exogenous government provision of public goods and services. A balance of payment constraint incorporates the base-year trade deficit or surplus for each region.

Crude oil is treated as a homogeneous commodity, i.e., all crude oil flows through a global market with one world-market price. For all other commodities, bilateral trade is specified following Armington’s (1969) differentiated goods approach, where domestic and foreign goods are distinguished by origin.

CO₂ emissions are linked in fixed proportions to the use of coal, oil and gas, with CO₂ coefficients differentiated by fuels.

In order to introduce imperfect competition on the crude oil market, we calibrate the cost function within the respective cartel (OPEC, OPEC core, or Saudi Arabia) such that it is consistent with crude oil profit maximization in the base-year data. Across policy simulations, the respective cartel rations its crude oil supply in order to maximize profits.

Our CGE simulation analysis builds on most recent data from the Global Trade Analysis Project (GTAP). Version 9 of the GTAP database includes national accounts on production and consumption, bilateral trade flows as well as fuel- and sector-specific CO₂ emissions for 140 regions and 57 sectors for the year 2011 (Narayanan et al., 2015). We aggregate sectors and regions in the GTAP database towards a composite dataset that reflects the specific requirements of our policy issue — see Table 1 for an overview of sectors and regions included in the model.

As to production sectors, our composite dataset includes all major primary and secondary energy carriers: coal, crude oil, natural gas, refined oil products, and electricity. In addition, we separate the main emission-intensive and trade-exposed sectors: chemical products, nonmetallic minerals, iron and steel products, and non-ferrous metals; these sectors are most affected from shifts in comparative advantage triggered by unilateral emission caps and are hence important to represent. As to regions, the composite dataset comprises 12 regions that are most relevant for our policy analysis, namely (i) countries and regions that adopt climate policies in one or more of our scenarios: Europe, the United States, remaining OECD, and China; (ii) regions that can exert market power in the crude oil market: Saudi Arabia, a composite region called remaining OPEC-core consisting of Qatar, Kuwait, and the United Arab Emirates, and remaining OPEC; and (iii) other countries and regions: Japan, India, Russia, other middle-income countries, and other low-income countries.

To determine the free parameters of functional forms that characterize production technologies and consumer preferences, one requires a coherent observation of economic transactions for a particular base year: in our case GTAP 9 data for the base year 2011. Base-year data together with exogenous elasticity values calibrate the functional forms such that the GTAP dataset is consistent with market structure assumptions and optimizing behaviour of economic agents.

We present base-year statistics to gain insights into important drivers of economic adjustment triggered by policy interference. In the context of our analysis, most relevant are fuel-specific emissions, crude oil supply and consumption patterns, as well as EU’s and Japan’s gas import dependency.

The implications of emission regulation for international fuel markets and emission leakage are driven by the size and the composition of fossil fuels subjected to emission pricing. As more countries adopt a given percentage reduction in their base-year emissions, global energy demand drops further thereby inducing a stronger decline in international energy prices. While this leads to higher energy (emission) demands in non-regulated countries outside the climate coalition, the leakage rate shrinks with the coalition size since emission reduction in the enlarged coalition dominates (Böhringer et al., 2014). Beyond the size of the abatement coalition, oil market outcomes critically hinge on the amounts of fuel-specific emissions in the abatement coalition, because they determine how much of the mitigation takes places through reduced oil consumption: if countries with relatively few oil-related emissions decide to set a cap, the oil market will be less affected.

Figure 1 shows the amounts and percentage shares of coal-, gas-, and oil-related emissions in regions that are candidates for unilateral climate policies in our analysis. In terms of CO₂ emissions, the EU, the US, and remaining OECD rely heavily on oil: the oil-related emissions amount to a share of roughly 50% in the EU and remaining OECD, and over 40% in the US. China, however, exhibits only a share of 20% oil-related emissions, the remaining 80% are stemming from coal combustion. This fact already foreshadows that emission caps in coalitions of OECD countries shock the oil market more pronouncedly than coalitions including China. The amount of base-year emissions rises sharply with the coalition size from 4.1 Gt of CO₂ in the EU to 17.2 Gt of CO₂ for the coalition of OECD and China. The share of coal-related emissions jumps from around 30% for OECD countries to around 50% as soon as China joins the coalition, while at the same time the share of oil-related emissions drops from 45–50% to about 35%.

Crude oil supply and consumption patterns are an important driver of market outcomes in our analysis of unilateral climate policies. Besides the residual crude oil demand elasticity, the most important determinant of a cartel’s ability to utilize market power is its market share. Furthermore, the extent to which crude oil consumption subsidies affect policy outcomes is obviously driven by the share of subsidized oil.

Saudi Arabia alone has a market share of 13%, OPEC-core (Saudi Arabia, Kuwait, Qatar, and United Arab Emirates) sums to 21% of world crude oil supply, and OPEC as a whole exhibits 46%. Clearly, joint OPEC decisions when assuming dominant behaviour will be markedly more potent than action by only Saudi Arabia or OPEC-core.

On the consumption side, OPEC countries do not play a big role compared to the major oil consumers EU (19% of world supply), the US (21%), and China (9%): OPEC countries combined consume 10% of world supply. Thus, only one-tenth of world crude oil consumption is affected when we assume consumption subsidies within OPEC.

Oil–gas price linkages in the EU or Japan reduce substitution between oil and gas when oil prices change. At first glance, this gives OPEC an additional incentive to cut back supply when acting dominantly. At second glance, however, the price linkage hinders substitution from coal to gas within the EU if the oil price is increased; with emission constraints for the EU, the CO₂ price will go up which disincentivizes OPEC to curtail oil supply. At the same time, gas consumption in Japan is disincentivized when prices are linked and the oil price increases, which stimulates substitution away from gas. In total, leakage to Japan could either decrease or increase (note that we only consider oil–gas price linkage with the EU as the unilaterally abating region).

The effects of oil–gas price linkages for the EU and Japan depend on the respective gas import shares in overall domestic fossil fuel use. In both regions, gas is a major fuel source with a share of 26% of energy use in the EU and 19% in Japan. More than two-thirds of EU’s consumed gas is imported, in Japan more than 95%.

Our analysis investigates the effects of unilateral climate policies for alternative assumptions of OPEC behaviour. We adopt the core setting of Böhringer et al. (2014), i.e., with the EU as the unilaterally abating region. In addition we vary key assumptions about (i) the size of the climate coalition, (ii) the size of the oil cartel, (iii) oil–gas price linkages in the EU and Japan, and (iv) subsidies to domestic oil consumption in OPEC. The base-year data for 2011 provided by GTAP 9 characterizes our business-as-usual (see section “Base-Year Statistics”), and all scenarios are simulated with respect to this business-as-usual. If not denoted otherwise, simulation results below are reported as percentage changes compared to the business-as-usual.

The core setting refers to unilateral climate policy on behalf of the EU⁶ and distinguishes two different assumptions about OPEC’s behaviour (see Table 2): OPEC either behaves competitively as a price-taker (COM) or as a dominant producer, exploiting its market power and rationing crude oil supply in order to maximize crude oil profits (DOM). In the COM scenario, the EU reduces its emissions by 20% compared to business-as-usual via uniform CO₂ emission pricing.⁷ In the DOM scenario, EU’s emission reduction target is scaled endogenously such that the global level of emissions is the same as under COM. If, for example, carbon leakage is reduced in DOM compared to COM through OPEC’s supply decision, the domestic abatement effort of the EU falls below 20% with a respective decrease in the CO₂ price compared to COM. Assuring an identical level of global emissions across the two scenarios allows the economic welfare analysis to abstain from the valuation of changes in global emissions.

Beyond the core setting, we consider variations in key assumptions along four dimensions as listed in Table 3.

First, OPEC’s strategic scope and incentives to act strategically might change when facing different climate coalitions. Therefore, we investigate additional coalitions of abating countries, i.e.: the EU and the US (denoted EU × USA); the EU, the US, and China (EU × USA × CHN ); OECD (OECD); and OECD plus China (OECD × CHN ). For each climate coalition, the target level of global emission reduction is determined in the same manner as described above for the EU. That is, the global target emerges from a constellation where the abatement coalition jointly reduces its emissions by 20% compared to business-as-usual via a uniform CO₂ price assuming competitive behaviour on behalf of OPEC (COM).

Secondly, we incorporate variations in the cartel size where only OPEC-core — consisting of Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates — or only Saudi Arabia acts as a dominant producer in the DOM case.

Thirdly, we introduce a price linkage between the international crude oil price and the import price for natural gas imports in the EU and Japan: the percentage change of gas import prices in the two regions is bonded to the percentage change of the crude oil price.⁸

Fourthly, we consider a situation where OPEC members — in case of imperfect competition — do not exploit market power on domestic markets, but subsidize crude oil consumption such that domestic consumers pay the producer price.

Our discussion on simulation results focuses on the effects on the international crude oil market, leakage rates,⁹ and macroeconomic adjustment cost at the regional and global level.¹⁰ We begin with the core setting, where the EU undertakes unilateral climate action and OPEC acts either as a price taker or a dominant producer. Subsequently, we lay out how results change as we vary key assumptions along the four dimensions listed in Table 3.

Not surprisingly, the results in our core setting are in line with the findings in Böhringer et al. (2014).¹¹Figure 2 summarizes the oil market outcome. If the oil market is perceived as competitive, unilateral emission reduction by the EU induces a crude oil price drop of 0.8%. Accordingly, both OPEC supply and Non-OPEC crude oil supply slightly drop. Oil consumption within the EU decreases by 5.3%, while it increases by 0.8% outside the EU, indicating leakage through the oil market. Looking at leakage in more detail, Figure 3 decomposes the overall leakage rate into leakage rates for coal-, gas-, and oil-related emissions. We see that overall leakage amounts to 19%, with about a third stemming from leakage through the oil market.

If OPEC behaves as a dominant producer, results look quite different. OPEC cuts back crude oil supply by 3.1% and as a consequence the international oil price increases by 0.6%. Crude oil consumption outside the EU drops marginally by 0.02%, i.e., we obtain a slight negative oil-related leakage.¹² Leakage through the coal and gas markets slightly increases compared to COM due to substitution away from oil. The reason for OPEC’s incentive to cut back supply and increase the international crude oil price is strategic rent seeking: Higher oil prices lead to less oil consumption in- and outside the EU; with a fixed global target for CO₂ emissions, higher oil prices attenuate leakage and thereby relax the EU emissions constraint. As a consequence, the EU-wide CO₂ price drops.¹³

This mechanism enables OPEC to convert part of the EU’s carbon rents into domestic crude oil rents by cutting back crude oil supply.

Figure 4 shows the economic adjustment costs of unilateral climate policies at the global level as well as across specific regions, here: EU, OPEC and the rest of the world (ROW). Global adjustment costs are more than one-third higher under the assumption of dominant OPEC behaviour (DOM) compared to a competitive market structure (COM). Due to OPEC’s strategy to increase the oil price under DOM, too much mitigation takes place through reduced oil consumption and the consequential substitution to other fuels deteriorates efficient CO₂ emission abatement via fuel switching. The differential assumptions on the oil market structure have important implications not only for the magnitude but also for the distribution of economic adjustment costs to unilateral climate policy. Already under COM, OPEC is hit hard as EU’s demand for oil drops significantly together with a slight decline in the international crude oil price — thus leading to a marked decrease in OPEC’s oil export revenues. If we rather assume that OPEC acts as a dominant producer, its adjustment costs are much higher in relative terms compared to a competitive market setting (0.8% of business-asusual GDP under DOM compared to 0.46% under COM). The reason is that market power is characterized in the business-as-usual by markup earnings in OPEC, parts of which are lost through reduced oil demand under EU’s climate policy.¹⁴

On economic adjustment costs in the EU, the higher oil price under DOM as a strategic response to unilateral emission pricing has two opposing effects. On the one hand, distorted fuel substitution reduces the cost-effectiveness of domestic abatement compared to COM. On the other hand, OPEC’s strategic response leads to lower emissions in non-EU countries, implying reduced leakage rates and thus relaxes the domestic CO₂ constraint for a fixed global level of emissions. In total, adjustment costs for the EU are nearly identical under the two alternative settings. The rest of the world faces about one and a half times higher costs under DOM compared to COM, however at a rather low level of 0.05% of business-as-usual GDP.

The impacts of unilateral emission pricing hinge critically on the size and composition of the abatement coalition.

Figures 5 and 6 show the economic effects on the international crude oil market for different climate coalitions assuming either competitive (COM) or strategic OPEC behaviour (DOM).

With competitive oil markets (Figure 5), we see that the drop in the international crude oil price becomes more pronounced as the coalition size increases from EU to include the US (EU × USA) and all other OECD countries (OECD): While the EU alone induces a price drop of 0.8%, combined action by the EU and the US decreases the price by 1.6%, and a joint OECD policy leads to a decline of 2.4% reflecting larger cuts in crude oil demand along with the expansion of the coalition size. The changes in OPEC and Non-OPEC oil production as well as in oil consumption by coalition and non-coalition countries are aligned with the observed price reductions. When China joins the coalition — either EU × USA (towards EU × USA × CHN) or OECD (towards OECD ×CHN) — impacts on the crude oil market become slightly attenuated.

The reasoning behind is illustrated in Figure 7 joint with Figure 1 (see section “Base-Year Statistics”): while total emission abatement obviously increases as China joins the climate coalition, abatement of oil-related CO₂ emissions in fact decreases. This is because China supplies a larger amount of low-cost abatement options of coal-related CO₂ emissions to the coalition. Note that abatement in OECD countries is markedly lower when China enters the coalition — the CO₂ price necessary to reach the coalition target of 20% emission reduction declines substantially indicating low-cost abatement options in China (see Table 4). With the assumption of a competitive oil market (COM), the coalition EU × USA reduces total emissions by 1.9 Gt of CO₂, of which 0.20 Gt are oil-related. If China joins the coalition, total emission reduction amounts to 2.7 Gt of CO₂ with only 0.18 Gt being oil-related. As a consequence, the negative demand shock on the crude oil market is reduced. Leakage rates are reported in Figure 8 and — as expected — decline with the coalition size: from 19% for the EU to 3.7% under joint action for the coalition of OECD and China.

If we turn to the cases where OPEC acts as a dominant producer (Figure 6) and compare it with the competitive market case (Figure 5), we find a similar outcome as in the core setting when looking at each coalition individually: OPEC reduces supply significantly more under DOM than under COM; as a consequence the oil price is markedly higher. However, our core setting where the EU acts unilaterally is the only scenario where the oil price change is positive. Towards the larger coalitions the initial negative demand shock in the oil market associated with the coalition’s emissions constraint is too big to achieve a price increase vis-à-vis the business-as-usual.

Similar to the cases with perfect competition, the initial demand shock, the price drop as well as OPEC’s cutback in supply is increasing as the USA or other OECD countries join the EU in the abatement coalition. However, this does no longer hold when we take the coalitions including China into consideration. In these cases, OPEC has a significantly lower incentive to cut back supply. If we start from an initial coalition compromising the EU and the USA where OPEC decrease supply by 3.5% (compared to business-as-usual), the effects of adding other OECD regions versus adding China are quite different. With other OECD countries joining the coalition, OPEC decreases supply further to 4.0%. With China joining the abatement coalition, OPEC supply is no longer cut by 3.5% but only by 2.2%.

Key to OPEC’s incentives for curtailing crude oil production is its ability to impact the CO₂ price within the climate coalition and thereby shifting over emission regulation rents.¹⁵ Table 4 shows the CO₂ prices across the five abatement coalitions. We see that for unilateral abatement of the EU, OPEC’s supply decision leads to a pronounced decline in the CO₂ price by 7 USD/tCO₂ from 51 USD/tCO₂ to 44 USD/tCO₂. For the two coalitions including China, the price drop between COM and DOM amounts only to 0.4 USD/tCO₂. There are two intertwined drivers of OPEC’s strategic scope to shift rents. First, the amount of CO₂ emission reduction within the coalition that is achieved through reduced oil consumption (Figure 7): If this amount is substantial, OPEC can to a larger degree substitute the CO₂ price with a higher crude oil price. Secondly, the (oil-specific) leakage rate: If there is substantial leakage through the oil market, OPEC can reduce the coalition’s CO₂ price through a higher crude oil price (recall that the coalition pursues a fixed target for global emission reductions). Both drivers for OPEC’s strategic power become weaker when China joins the abatement coalition. With China being part of the abatement coalition, less abatement is achieved via reduced oil consumption. At the same time, the problem of leakage and in particular oil-specific leakage is less pronounced in percentage terms (China joining a coalition roughly halves overall leakage rates as well as oil-specific leakage rates — see Figure 8).

Regarding leakage, we find the same pattern for different coalition sizes as in the core setting when switching from COM to DOM: the overall leakage rate drops because oil-related leakage is reduced substantially along with OPEC’s cutback in crude oil supply. Coal- and gas-related leakages increase due to substitution away from oil. The EU remains the only case where oil-related leakage actually turns negative (see the respective oil market outcomes displayed in Figure 6).

Economic adjustment costs at the global and regional level are reported in Figure 9. For each individual coalition, the same logic applies as in the core setting: imperfect competition in the crude oil market increases global costs and a major share of the burden is borne by OPEC itself. Again, it becomes obvious that China supplies plenty of low-cost abatement options to the coalition — not only global costs but also the coalitions’, OPEC’s, and the rest of the world’s (ROW) costs decline as soon as China joins either the EU and USA, or OECD as whole.

Next we investigate the implications of changes in the oil cartel size.

We compare three cases where either OPEC as a whole, OPEC-core — consisting of Saudi Arabia, Kuwait, Qatar, and United Arab Emirates — or only Saudi Arabia exerts market power.

Figure 10 shows the outcomes in the crude oil market for the different cartel sizes in comparison to the competitive market setting (COM).¹⁶ The effects on the crude oil market get more similar to the competitive market outcome (COM) as the cartel size declines, i.e., when we consider OPEC-core or Saudi Arabia instead of OPEC as a whole. While the crude oil price increases by 0.64% as an optimal response to EU’s climate policy with OPEC as a dominant producer, the price drops by 0.59% and 0.77%, respectively, when OPEC-core or Saudi Arabia acts strategically. In the competitive setting, the price drops by 0.82%. The price changes are mirrored by respective supply decisions of the cartel.

Accordingly, leakage only drops to 17.5% in case of OPEC-core and 18.2% in case of Saudi Arabia stand-alone (compared to 18.5% under COM — see Figure 11). The impacts on the leakage rate are mainly driven by the initial (business-as-usual) cartel’s share of world crude oil supply, which amounts to 46% for OPEC, 21% for OPEC-core, and 13% for Saudi Arabia (see section “Base-Year Statistics”). Only OPEC as whole exhibits sufficient market power to effect larger changes under DOM compared to COM.

Figure 12 depicts economic adjustment costs at the global and regional level across different cartel sizes. As the group of dominant producers becomes smaller and the oil market transits towards a competitive setting, global adjustment costs due to unilateral abatement of the EU decline. In terms of adjustment costs, Saudi Arabia is best off when it forms the cartel stand-alone. As the biggest crude oil producer, Saudi Arabia bears the largest part of the burden across OPEC countries when all OPEC countries act jointly as a dominant producer.¹⁷

Figures 13–15 summarize the outcome on the crude oil market, total and fuel-specific leakage rates, as well as global and regional cost implications for the cases of an oil–gas price linkage (COM&YES_LINK,DOM&YES_LINK) or domestic consumption subsidies in OPEC (DOM&YES_SUB).¹⁸

Linking import prices for natural gas in the EU and Japan with the crude oil price gives two opposing incentives to OPEC when acting strategically. On the one hand, the price link reduces substitution from oil to gas in the affected regions triggered by oil price increases; OPEC thus faces an additional incentive to increase crude oil prices and cut back supply. On the other hand, the linkage hinders substitution from coal to gas, which exerts an upward pressure on the CO₂ emission price, given a fixed (constant) global emission constraint; this in turn affects demand for crude oil negatively and provides an incentive to keep the oil price low.

For a competitive oil market setting, the price link has almost no influence. Assuming strategic OPEC behaviour, we observe an oil price increase by 0.84% with a price link compared to 0.64% without — in other words, the incentive to further increase the crude oil price slightly prevails.

Gas imports in the EU decrease only by 1–2 percentage points in scenarios with oil–gas price linkage compared to no price linkage. Leakage drops to 11.4%, which is slightly less than without price linkage. In particular, leakage to Japan drops from 0.36% to 0.04% as gas imports decrease by 0.5% compared to an increase of 1.1% without price link.

If we assume that domestic crude oil consumption within OPEC is subsidized (YES_SUB), we obtain very similar results to the core setting with respect to oil market outcomes, leakage rates, and cost implications (comparing DOM&YES_SUB with DOM in Figures 13–15). This is not very surprising given that OPEC subsidies apply to less than 10% of world crude oil consumption. OPEC cuts back supply by 2.9% under DOM&YES_SUB compared to 3.1% in the core setting without subsidies. The oil price increases are 0.53% and 0.64%, respectively.

The only remarkable change that occurs for the case of oil subsidies is that the share of OPEC oil consumption in global crude oil consumption increases by 0.9% compared to 0.1% under DOM. Consumption in the EU, on the other hand, drops by 5.3% (DOM&YES_SUB) and 5.2% (DOM), respectively.

In order to test the robustness of our main insights we perform sensitivity analysis on five key policy and parameter assumptions in our scenarios. We focus on the first dimension of our scenario extensions, namely the coalition size, as these scenarios brought about the largest deviations from our core setting.

Specifically, we apply scenarios with (a) lower and higher emission reduction targets for the coalition; (b) lower and higher trade responsiveness to price changes; (c) lower and higher fossil fuel supply elasticities; (d) stylized US shale oil and shale gas supply; and (e) lower and higher energy demand elasticities.

Qualitative insights and conclusions from our central case setting remain robust throughout our sensitivity analysis: OPEC’s ability to impact on the coalitions CO₂ price through strategic supply decisions hinges critically on the climate coalition and is particularly lower when China is part of the coalition. Nonetheless, the sensitivity analysis reveals important implications of the specific assumptions.

Along (a), we find that the leakage rate increases slightly with the reduction target. Furthermore, we find that oil leakage marks a larger share of total leakage as the reduction target (and hence the endogenous CO₂ emission price) rises due to an increasing net demand for oil-intensive products outside the coalition (see Footnote 14).

As to (b), OPEC’s ability to act strategically in the DOM scenario is not much affected by the trade responsiveness.

Regarding fossil fuel supply (c), we find that OPEC’s ability to act strategically depends crucially on the price responsiveness of Non-OPEC oil producers. With high supply elasticity, the oil price drops when the climate policy is introduced, irrespective of which climate coalition we consider, whereas with low supply elasticity, the oil price increases even when China is part of the coalition.

Respecting for the employment of new extracting technologies in the US (d) by increasing US supply elasticities, OPEC is less able to exercise market power as the US supply reacts more swiftly to price changes. Even under the EU coalition the oil price no longer increases but slightly drops. Market outcomes under DOM move closer towards a competitive market.

Lower energy demand elasticities (e) require higher endogenous CO₂ prices to effect the same emission reduction, which ceteris paribus leads to higher leakage rates through larger competitiveness losses of domestic emission-intensive and trade-exposed industries. At the same time, they reduce leakage that is stimulated through reduced international energy prices. In the DOM case we find that OPEC’s incentive to cut back supply increases with the assumed global energy demand elasticity. The reason is that the optimal markup in the business-asusual is lower if the demand elasticity is higher.¹⁹ Then the impact of the emission cap (setting the demand elasticity de facto to zero if we disregard fuel-switching) on the optimal markup is more pronounced when the benchmark demand elasticity is higher. Thus, assuming a higher demand elasticity already in the benchmark, the introduction of the cap induces a higher incentive for OPEC to cut back supply.

A more detailed description of the sensitivity analysis results is provided in Appendix B, where the outcomes for all scenarios are shown in Tables B2–B6 at the end of the Section.

Furthermore, the model framework we apply is static, and a relevant question is how our results might change in a dynamic setting where expectations on how the climate policy develops over time play a central role as reflected in the green paradox literature (see Section “Literature Review”). For instance, if the emissions cap is expected to become more ambitious, oil producers may want to accelerate supply. The basic mechanisms identified in our static framework are still present and will tend to mitigate the near-term supply increase by the dominant producer if the green paradox materializes. The net effect will of course depend on the relative strengths of these two effects.

Böhringer et al. (2014) show that imperfect competition in the oil market may have substantial influence on leakage and economic adjustment cost triggered by unilateral EU climate policies. Oil-related leakage may even turn negative due to OPEC’s incentives to increase the oil price compared to business-as-usual.

In the current paper, we have tested the robustness of these findings by changing key assumptions along four dimensions: (i) the size and composition of the climate coalition, (ii) the size of the crude oil cartel, (iii) linkages between the crude oil price and gas import prices in the EU and Japan, and (iv) subsidies to domestic oil consumption in OPEC countries.

Our analysis indicates that OPEC’s ability to lower the coalition’s CO₂ price and thus to shift over rents is reduced markedly when China becomes part of the abatement coalition. The reason is that China provides lots of low-cost coal-related abatement options to the coalition. As a consequence, effects on the oil market get attenuated, and likewise OPEC’s strong incentive to cut back crude oil supply. Regarding the implications of the cartel size, we find that when only OPEC-core or Saudi Arabia act dominantly instead of OPEC as a whole, the respective economic effects resemble to a large extent the results for a fully competitive crude oil market setting: The cartel’s market share in these cases is simply not large enough to impact markedly on the coalition’s CO₂ price. A price linkage between the crude oil price and gas import prices gives opposing incentives to OPEC when assuming dominant behaviour, which in total leads to a market outcome which is similar to the case without the price link. Likewise, subsidies to domestic consumers in OPEC do not markedly change OPEC’s supply decision when facing an EU climate policy.

To conclude, although OPEC’s behaviour may be of importance for the extent of carbon leakage, the phenomenon of negative oil-related leakage identified in Böhringer et al. (2014) seems to be of less policy relevance when adopting alternative assumptions. The oil cartel’s effects on leakage depend most significantly on the size of the cartel, the size of the climate coalition, and the price responsiveness in the oil market, particularly with respect to Non-OPEC supply.

In this Appendix we provide a simplified analytical description of how the dominant producer reacts to the climate policy implemented by the climate coalition.²⁰ The underlying assumption behind the dominant producer model is that the dominant producer maximizes profits, taking into account price responses both on the demand side and among other producers.

Let x_j denote production of producer (group) j, where j = DOM (dominant producer), COM (competitive producers). Furthermore, let x_COM (p) denote the joint supply function of competitive producers, and x_D(p) the global oil demand function, where in equilibrium x_D = x_DOM +x_COM. Thus, the dominant producer’s residual demand function is x_DOM(p) = x_D(p) −x_COM(p). The maximization problem of the dominant producer can then be written as²¹:

This gives the following first-order condition (with respect to p):

or (simplifying):

The second term on the right-hand side is the optimal markup, which is bigger the lower is the price responsiveness of global oil demand and oil supply from competitive producers. If either of these is very price elastic, it is optimal for the dominant producer to choose a price just above marginal costs. Otherwise, it is optimal to choose a more substantial markup.

Assume that the climate coalition imposes a cap on global emissions of CO₂. To simplify, we first disregard emissions from other sources than oil, meaning that there is de facto a (presumably binding) cap on global oil consumption. It is straightforward to show that the first-order condition for OPEC then changes to:

We see that the only difference between Equations (A4) and (A3) is that $xD′(p)$ has been removed, which means that the denominator of the markup has declined. This tends to increase the optimal markup, as long as the supply of the dominant producer (the nominator) is not reduced too much. If the cap is only marginally below the business-asusual (BaU) level, it follows that the oil price will increase when the cap is introduced: If the oil price does not increase, competitive supply will not increase, and hence the supply of the dominant producer cannot be reduced more than marginally. Hence, the markup in Equation (A4) must exceed the markup in Equation (A3) (assuming that the demand elasticity is strictly negative). If the cap is stricter, the nominator in Equation (A4) decreases more substantially if the oil price is not reduced, and hence the markup may either increase or decrease. Thus, in this case the oil price may become either higher or lower than the BaU price level.

The explanation for a (possibly) higher oil price is that the dominant producer by assumption knows that the coalition’s CO₂ price will adjust endogenously depending on the global oil price. Thus, it is optimal for the producer to try to reap a larger share of the oil rent. This would be different if the coalition instead introduced a fixed CO₂ tax, whereas a cap on emissions within the coalition could still lead to a higher oil price (but the likelihood is smaller compared to a cap on global emissions). One important implication of a higher oil price is that carbon leakage in the oil market becomes negative.

What if we introduce other fossil fuels, which we do in the numerical analysis? Equation (A4) then becomes:

where x_D,C and x_D,NC denote oil consumption in the climate coalition and the non-coalition, respectively, and p^F and p^CO2 denote the price (vector) of other fuels and CO₂, respectively.

Before the climate policy is introduced, the fourth term in the denominator (with p^CO2) is not present. When the cap on global emissions is imposed, this term becomes active and is typically negative: A higher oil price reduces demand for oil and hence dampens the pressure on the emissions cap, leading to a lower price on CO₂. Thus, the effect of this term is to increase the optimal markup.

What can we say about Equation (A5) compared to Equation (A4)? First, the higher the share of oil in the global emission account, the more the CO₂ price will respond to oil price changes in order to keep emissions below the imposed cap (cf.$∂pCO2/∂p$ in Equation (A5)). Second, the more oil consumption reacts to changes in the CO₂ price, relative to other fuel consumption’s responses to CO₂ price changes, the more important this mechanism will be for the dominant producer (cf. $∂xD,C/∂pCO2$ in Equation (A5)). Put differently, the more the CO₂ price channel dampens the reduction in oil demand from a higher oil price, the more profitable it is for the dominant producer to cut back on its oil supply.

We test the robustness of our main insights by varying key policy and parameter assumptions in our scenarios. In this sensitivity analysis we focus on the first dimension of our scenario extensions, namely the coalition size, as these scenarios brought about the largest deviations from our core setting.

We vary key policy and parameter assumptions in five categories, specifically the emission reduction target, trade responsiveness to price changes, fossil fuel supply, US shale oil and shale gas supply, as well as energy demand.²² To facilitate comparison, Table B1 summarizes the results on the oil market, leakage, and adjustment costs from our central case setting.

Qualitative insights and conclusions from our central case setting remain robust throughout our sensitivity analysis: OPEC’s ability to impact on the coalitions CO₂ price through strategic supply decisions hinges critically on the climate coalition and is particularly lower when China is part of the coalition. However, the sensitivity analysis also shows that OPEC’s ability to act strategically depends crucially on the price responsiveness of Non-OPEC oil producers. With high supply elasticity, the oil price drops irrespective of which climate coalition we consider, whereas with low supply elasticity, the oil price increases even when China is part of the coalition.

We describe the main effects that alter the results compared to the central case setting in each category of the sensitivity analysis below. Tables B2–B6 show outcomes for the scenarios in the sensitivity analysis. For the sake of readability, we moved result tables to the end of this section.

We consider scenarios with a reduction target of 10% (denoted RED-10) and 30% (denoted RED-30) to assess the importance of the stringency of climate policy in the coalition. Table B2 provides the summarized results.

Under the competitive market assumption (COM), impacts on the oil market are reduced to slightly less than half with a reduction target of 10% (RED-10) and doubled under a 30% target (RED-30) across the different coalitions compared to the central case. The leakage rate increases slightly with the reduction target. Furthermore, we find that oil leakage marks a larger share of total leakage as the reduction target (and hence the endogenous CO₂ emission price) rises due to an increasing net demand for oil-intensive products outside the coalition (see Footnote 14).

This also explains why oil consumption outside the coalition slightly increases despite an increasing oil price under the dominant producer assumption (DOM) in the RED-30 case (coalition: EU). Thus, oil-related leakage is always positive with the higher reduction target. On the other hand, with the lower reduction target oil-related leakage is negative both with the EU and the EU × USA coalitions. With bigger coalitions, leakage through the oil market is positive as in the central case setting.

To account for varying degrees of trade responsiveness to relative price changes, we introduce additional scenarios where we either halve (denoted ARM_lo) or double (denoted ARM_hi) the Armington trade elasticities in the model. The results are summarized in Table B3.

Increasing trade elasticities (ARM_hi) facilitate relocation of production from coalition to the non-coalition countries. Accordingly, leakage increases somewhat with the trade responsiveness. Also, the coalition is to a lesser extent able to pass through its increasing production cost from carbon pricing and thus bears larger shares of the burden as trade responsiveness increases.

OPEC’s ability to act strategically in the DOM scenario is not much affected by the trade responsiveness, however, although oil-related leakage turns slightly positive in the case with high trade elasticity and EU as the climate coalition. Besides that, the effects on the oil market and on oil-related leakage are quite similar to the central case.

As shown in Appendix A (Equations (A4) and (A5)), the price responsiveness of Non-OPEC oil producers is crucial for OPEC’s optimal markup. High price responsiveness reduces OPEC’s ability to influence the oil price. To investigate the importance of this in our context, we either halve (scenario denoted FFS_lo) or double (denoted FFS_hi) fossil fuel supply elasticities in the model. The outcomes are summarized in Table B4.

Under COM, lower fossil fuel supply elasticities imply more carbon leakage as negative demand shocks through climate policies lead to smaller cut backs in global supply. If OPEC behaves as a dominant producer (DOM), lower supply elasticities augment its incentive to increase the oil price as Non-OPEC producers are to a lesser extent able to step up their supply. Hence, under FFS_lo and with the EU coalition, OPEC cuts back its supply by 7%, increasing the oil price by 4%, leading to an oil-related leakage of −20%. Total leakage becomes close to zero. Even under the climate coalitions including China, the oil price slightly increases when supply elasticities are halved, leading to negative oil leakage.

Higher fossil fuel supply elasticities (FFS_hi) work the other way around. In this case, the outcomes move closer towards competitive market outcomes (COM), and the oil price decreases even in the case with EU as the climate coalition. Thus, we conclude that the price elasticities of oil supply are particularly important for the conclusions about OPEC’s behaviour and its influence on oil-related leakage.

The surge in shale oil and gas production in the US over the last 5–10 years due to significant improvements in extracting technologies (fracking and horizontal drilling) has had a substantial impacts on the oil and gas markets, and have probably reduced OPEC’s ability to combine high prices and high market shares in the oil market (Baumeister and Kilian, 2014). To examine the importance of this in a stylized manner, we include simulations with the fourfold (denoted US_4) and eightfold (denoted US_8) of the core supply elasticities for crude oil and natural gas in the US. Results are presented in Table B5.

Under COM, higher oil and gas supply elasticities work in the same direction as higher global supply elasticities (see above). Under the dominant producer assumption (DOM), OPEC is less able to exercise market power as US supply reacts more swiftly to price changes, such that even under the EU coalition the oil price no longer increases but slightly drops. This effect increases for US_8 and the market outcome under DOM moves closer towards a competitive market (see Equations (A4) and (A5) in Appendix A). We notice that the oil market results in the US_8 scenarios are quite close to the results in the FFS_hi scenarios discussed above.

The analysis in Appendix A shows the relevance of energy demand elasticities for OPEC’s optimal markup under the dominant producer assumption (compare e.g., Equations (A3) and (A4)). We introduce scenario EDE_lo with a lower energy demand elasticity and EDE_hi with a higher energy demand elasticity than in the core setting.²³

Concerning carbon leakage in the COM case, two opposing effects drive the results: on the one hand, lower energy demand elasticities (within the climate coalition) require higher endogenous CO₂ prices to effect the same emission reduction, which ceteris paribus leads to higher leakage rates through larger competitiveness losses of domestic emission-intensive and trade-exposed industries. On the other hand, lower demand elasticities (outside the coalition) dampen leakage that is stimulated through reduced international energy prices. In total, leakage is slightly higher both in EDE_lo and in EDE_hi than in our central case.

In the DOM case, we find that OPEC’s incentive to cut back supply increases with the assumed global energy demand elasticity: for the EU coalition, oil leakage remains positive for lower demand elasticities, but is strongly negative with higher demand elasticities. Even for the coalition EU and USA (EU × USA) oil leakage is negative with higher elasticities (under DOM). The reasoning is provided in Equations (A3) and (A4) in Appendix A: The optimal markup is higher if the demand elasticity is lower. However, the impact of the emission cap (setting the demand elasticity de facto to zero if we disregard fuel-switching) on the optimal markup is more pronounced when the benchmark demand elasticity is higher. Thus, assuming a higher demand elasticity already in the benchmark, the introduction of the cap induces a higher incentive for OPEC to cut back supply.