Incentives Matter in Mitigating Climate Change

I believe strongly in the need to mitigate the impact of climate change, but I feel that “Divest Princeton” is the wrong solution.

First, disinvestment does not change the economics of the petrochemical business. There will still be profit opportunities while demand remains high and plenty of dollars from internally generated profit at petrochemical companies to fund them.

Second, attempts to reduce exploration (and thus future supply) artificially, either by shaming oil companies or by influencing public policy, are misguided. In the absence of reductions in demand, supply-demand imbalances will lead to large increases in energy prices. As we have seen from the consequences of the Ukraine war, governments are not willing to accept higher energy prices as a means to force reductions in demand, particularly when they will disproportionately affect the least affluent. Instead, we see pumping of reserve oil supplies, shifts back to dirtier energy sources like coal, and efforts to lower gas taxes. These are not desirable outcomes.

Divestment is a feel-good idea to make oil companies somebody else’s responsibility but has little real benefit. Clean energy is the simple low-pain solution but not yet fully practical for all purposes. Reduction in energy demand is the painful short-term way to reduce emissions.

But there’s another approach that can help in the near-term: Work with companies instead of trying to demonize them. Petrochemical companies have reduced exploration in recent years because of expectations that cleaner energy will make projects less profitable in the future. Incentives matter. Instead of trying to manage environmental impact through arbitrary regulations and one-off incentives (e.g. on electric cars), think of ways to align incentives towards overall goals. For example, if car and energy company profits were taxed based on revenues multiplied by an emissions factor, I’m sure that there would be a dramatic increase in innovation to drive down emissions.