[E] How Does the Cost of Capital Affect Oil Supply?
Le 5 juin 2025
Auteurs:
Helena Cordt, Department of Technology, Management and Economics, Technical University of Denmark (DTU)
Julien Daubanes, Department of Technology, Management and Economics, Technical University of Denmark (DTU), Center for Energy and Environmental Policy Research, Massachusetts Institute of Technology (MIT), and CESifo
Yiding Ma, Department of Technology, Management and Economics, Technical University of Denmark (DTU)
Abstract:
In the past decade, a rapidly growing number of investors have committed to stop financing the production of carbon resources. While investors’ sacrifice increases the cost of capital for oil production projects, no normative benchmark exists indicating the financial returns that markets should forego to produce incentives aligned with climate objectives. To fill this gap, we harness economic modeling, empirical calibration, and numerical simulations. We build a model of the oil market in which the industry’s cost of capital affects drilling decisions. We calibrate the model using data covering all U.S. oil assets and simulate the dynamic competitive equilibrium in two counterfactual scenarios for the period 2000-2030: one with carbon pricing, and one with “green finance,” modeled as an augmented cost of capital. In our setting, a $60 carbon price decreases oil-related emissions by 15%. By contrast, an increase in the cost of capital by 5 percentage points results in an increase in emissions by 2%. On the one hand, green finance (slightly) increases the marginal cost of oil production; on the other hand, it generates short-termism, inducing the industry to exploit oil fields that would have remained untapped otherwise. For moderate increases in the cost of capital, the second effect dominates, making green finance counterproductive. Green finance becomes effective only when it makes the net present value of oil projects negative, which requires unrealistically high costs of capital.
