How to keep fossil fuel reserves in the ground in a way that is equitable, politically palatable and reduces disruption to energy and social infrastructures is a daunting challenge. Many people have suggested paying the owners of reserves to forgo extraction, but is this the right path to go down? Freddie Daley (SUS-POL at the University of Sussex) and Marcel Llavero Pasquina (EJAtlas) explore the issue.

There is a growing scientific and political consensus that a rapid and managed phase-out of fossil fuels is essential for keeping the goals of the Paris Agreement alive. This requires the immediate cessation of new investments into new fossil fuel production, the premature retirement of existing fossil fuel infrastructures, and the abandonment of large reserves of hydrocarbons, which must remain unburned.

A number of countries, such as Costa Rica, France and Ireland have decided to unilaterally forgo (some) extraction of fossil fuels. However, it is currently unknown how large-scale and globally coordinated efforts to keep reserves in the ground will impact global commodity markets and cycles, geopolitical (re)alignments, trade flows, and regional and national economies, although some have explored the possibilities (see here and here). In more localised settings, there are bound to be large disputes over forgone government revenues that result from fossil fuel production and export, and the potential for employment losses in economies dependent on extraction.  

In order to mitigate these inevitable disruptions, several policies have been suggested whereby the owners of fossil fuel reserves, which is usually assumed to be sovereign nation states, are compensated for not extracting them to cover the benefits that would have otherwise been accrued. Kenya, for instance, states in its Nationally Determined Contribution (NDC) that it is willing to forgo extraction if compensated. 

The Yasuní-ITT initiative in Ecuador is probably the most well known example of such a policy approach. Launched in 2007, the Ecuadorian government offered to forego extraction of its largest oil reservoir in a biodiverse-rich national park, which was projected to contain 20% of the country's oil reserves, on the basis of it receiving international compensation totalling half the expected revenues. The initiative collapsed in 2013 after a fraction of the requested funds were raised and, despite a referendum in 2023 where Ecuadorians overwhelmingly voted to halt extraction, the government might continue extraction invoking the need to fund a crack-down on organised crime.   

In the academic literature, scholars have suggested a range of institutional mechanisms to keep fossil fuel reserves in the ground. One of particular interest is the reverse auction idea, where proven reserves are kept in the ground through a mechanism similar to public procurement tenuring: a competitive bid process elicits the quantity of reserves kept in the ground and the price paid to the owner of the reserves. Such a system, its proponents suggest, would “guarantee that expenditures on compensation are kept to a minimum and that the right-holders over reserves whose potential to generate rents is the lowest are the ones that accept lower bids”. 

Even its proponents, however, note that such a system, based on a price oriented market-based mechanism, would be insufficient in delivering socially desirable outcomes. But, we argue, the approach does more than that. Paying the owners of fossil fuel reserves for forgoing extraction gives rise to three major paradoxes and three practical public policy implications if introduced at scale. We analyse each in turn. 

Maria Lupin via Unsplash

The first paradox of paying states to forgo extraction is that it introduces perverse incentives to discover and extract fossil fuels. If the premise of payment is on the basis of proved, probable and possible fossil fuel reserves, fossil fuel exploration would likely increase. If, for instance, a group of states agree to pay a specific price for forgoing a certain amount of conventional oil resources, such a move would have the indirect effect of incentivising proven reserves. As such, states interested in cashing-in on forgone extraction would look to bolster their proven reserves which, in turn, would expand exploration efforts.  

The second paradox of pursuing such a mechanism is created through the power dynamics of resource ownership. Under this proposed framework, forgone reserves are effectively ‘held ransom’ by the rights holder who would incrementally accrue bargaining power as humanity moves into an increasingly carbon constrained policy landscape. If compensatory payments dry up or face delay, or exogenous shocks change the calculus of forgoing extraction, rights holders can threaten to extract in a dangerous, or perhaps lethal, game of climate brinkmanship. Not only does this paradox speak to issues of compliance and enforcement within multilateral agreements, it also emphasises the heightened jeopardy of relying upon such a mechanism in the crucial decades ahead. 

The third paradox is that institutionalising a framework whereby the owners of reserves are compensated could, in fact, entrench climate injustice. If we analyse the geographic spread of carbon bombs - reserves in excess of one gigatonnes of potential CO2e - then compensation for forgone extraction would flow in large part to some of the largest historic emitters that have benefited substantially from fossil fuel extraction to date. For instance, the top seven proprietors of carbon bombs are China, the USA, Russia, Saudi Arabia, Australia, Canada and Qatar. Of course, such states could be omitted from such a framework on the grounds of their historic extraction and contribution to global emissions, but this would threaten the legitimacy of the initiative and reduce the pool of capital that could be drawn upon to compensate states for forgoing extraction. 

Beyond these three paradoxes, there are three major practical implications that would arise from introducing such a mechanism. The first is the cyclical nature of global commodity markets. Acceptable prices for forgone extraction would have to be equal to, or above, the ‘spot’ price of specific fossil fuels on global markets in order to solicit compliance. But, as we have seen over the past four years, commodity markets are subject to sudden and erratic price swings. As such, donor countries could be left paying over the odds to keep reserves in the ground, or in the case of elevated prices, recipients would be incentivised to pull out of such an agreement to extract and sell fossil fuels on international markets. As the proposed mechanism has already legitimised a ‘market-based’ approach, these dynamics would be entirely understandable. 

Moreover, it is not entirely clear what would happen to prices of fossil fuel on international commodity markets if large amounts of supply were taken off without corresponding reductions in demand. This could lead to rebound effects, by which the payment for forgone extraction in one place incentivises extraction elsewhere without any benefit to the environment or climate. Added to this, is how such an initiative would interact with other actors within commodity markets who are crucial for setting prices (spot and future) and market signals: speculators. 

The second practical implication relates to very real risk of policy reversals due to changes in government and the dynamics of electoral politics. In the past decade, we have seen policy reversals around supply-side climate policies, where newly elected governments have reneged on commitments for ideological reasons or policy imperatives like energy security. This has happened in New Zealand and Costa Rica, for example. It is highly likely that policy reversal around extraction would occur under such a framework - even more so as norms around the rules-based international law appear to be eroding globally. 

The third practical implication relates to who owns the reserves which, in turn, determines who benefits financially from accruing compensatory payments. In discussions around the pros and cons of this mechanism, it is often assumed that governments will be the primary recipients of payments as the principal owners of reserves. While this will be the case in many instances, the assumption belies the diversity of structures, actors and networks that own reserves. There is, for instance, an array of publicly listed fossil fuel majors that own substantial reserves, configurations of private and state-backed capital, and the increasing presence of asset managers. This complex and sometimes opaque network of ownership of fossil fuel reserves throws up questions of justice and highlights the lack of clarity over property rights. 

These paradoxes and practical implications highlight the contested nature of supply-side climate policies and their multifaceted vulnerabilities in an increasingly polarised world. Thinking through these problems should invite critical debate around the parameters of commodification and its limits in defining the scale and pace of phasing out fossil fuels. These paradoxes should also stimulate debate about the unintended consequences of certain ‘solutions’ and their path dependencies. Yet these paradoxes should not - in any way - detract from the urgent endeavour of co-creating just, equitable and global solutions to keeping reserves safely in the ground and ending the age of fossil fuels. 

A shorter version of this article appeared in The Ecologist on the 15th July, 2024, https://theecologist.org/2024/jul/15/pay-polluter