Carbon Offset Provision with Guilt-Ridden Consumers

Abstract

Carbon offsets allow consumers to mitigate their guilt associated with their electricity emissions. On the one hand, when offsets are purchased in an industry unrelated to electricity, offsets are complements to consumption and the introduction of an offset market causes consumption of electricity to rise. On the other hand, when offsets are purchased in a related industry – namely, to satisfy consumer demand for green electricity – consumption of dirty electricity and offsets are substitutes and dirty electricity consumption falls. In general, however, net emissions decline. We find three exceptions to this rule. When offsets are purchased in an unrelated market, too much consumer confidence in the effectiveness of offsets to sequester carbon from the atmosphere can lead to a rise in net emissions. Similarly, if there is no latent demand for offsets in their absence, the introduction of offsets can potentially cause a rise in net emissions when ‘dirty’ producers have market power. When offsets are purchased to fund green energy emissions can rise if ‘dirty’ producers can engage in pre-emptive strategic commitments and the price of offsets is chosen endogenously.

Keywords: carbon offsets, greenhouse gases, electricity markets, strategic behaviour

JEL Classification: L94, Q42, Q58