| Summary: | I develop a differential game between an oil cartel, and an importer investing in R&D to reduce the cost of a substitute to oil. The equilibrium dynamics mirror the recent oil price collapse: prices first increase, but eventually fall as the cartel is forced to deter unconventional (shale) oil. Interpreting the substitute as clean energy, I assess future climate policy. Credible carbon taxes are below the Pigovian level, implying the importer certainly cannot capture resource rents. Without a tax instrument, the importer curtails long-run pollution using a costly R&D programme. Normatively, carbon taxes are necessary to tackle climate change efficiently.
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