ABSTRACT
The chapter begins with a broad overview of fossil fuel use. It next turns to a basic analysis of fossil fuels as exhaustible resources using the dynamic model presented in chapter two. This is used to derive an extremely important result of the economics of exhaustible resource literature: the prediction that depletion over time will be associated with exponentially rising prices (the Hotelling price path). This is followed by a discussion of the debate in the scholarly literature over interpretation of the actual real-world experience in world oil markets over the past 50 years. The chapter then turns to policy analysis, after briefly describing the various environmental impacts of fossil fuel consumption. This section begins with a basic externalities model that predicts overproduction of goods that are produced using fossil fuels. This discussion is supplemented with a transaction cost analysis to conclude that some sort of corrective policy might be warranted. The discussion then turns to two different types of policies designed to address overpumping in common-pool oil and gas reservoirs. The first is the fiscal approach, which involves levying taxes (severance taxes) on individual companies in order to get them to bear some of the costs of the external impacts they impose on other companies. The second is the property rights approach as embodied in the practice of unitization, under which an entire oil and gas field is put under the control of a single company charged with making production decisions for the entire field. The chapter concludes with an extended discussion of hydraulic fracturing (fracking), including a discussion of the public choice factors that help explain regulatory policy in the United States with regard to fracking.
