Fiscal regime uncertainty, risk aversion, and exhaustible resource depletion: OIES paper: EE3

Abstract

How does uncertainty about future rent tax liability affect the competitive supply pattern for an exhaustible resource? Historically, changes in tax and regulatory clauses have been a frequent occurrence in the Petroleum industry, and appear to have contributed to the climate of uncertainty about future rent appropriation. This paper develops a generally applicable framework to tackle this question. The analysis modifies the classic Hotelling problem of exhaustible resource management to embody producer risk-aversion in terms of the underlying portfolio allocation behaviour of firms' owners, using a simple mean-variance approach. The construct is then used to derive equilibrium price profiles for the resource under a number of different methods of characterizing the risk, including a "continuous" variety under which mean-variance analysis gives general results. By and large, the results suggest that this type of uncertainty promotes excessively rapid depletion. Important exceptions arise where rent variability (i) does not increase the more distant the horizon; and (ii) exhibits a negative correlation with dominant sources of risk in investors' portfolios