Financial Markets and Oil Prices in a Schumpeterian Context of CO2-Allowance Markets

CO2 allowance pricing plays an increasingly important role in the EU, Switzerland, the US, Japan, China and other countries. One crucial question is how the CO2 allowance price and the oil price and financial markets, particularly stock markets, are linked. In the enhanced Hotelling approach developed here, the relevant links can be identified in a clear way for countries with CO2 allowance pricing and it is shown that a rise of the relative CO2 allowance price will reduce the oil price in equilibrium and could bring about a rise of stock market prices. The relative oil price is a negative function of the ratio of the real interest rate to the expected oil price inflation rate. Moreover, it is shown that the oil/gas market analysis can be linked to key aspects of the golden age debate in neoclassical growth theory and that the rate of technological progress has an ambiguous influence on the relative price of oil. Factors which reduce (raise) the relative oil price will raise (reduce) the general stock market price index, while the impact on the energy (oil & gas) sub-index in the stock market should be opposite. Policymakers should take the links between innovation and oil/gas prices and the stock markets into account where the linkages between the latter to CO2 mitigation innovation developments also have to be considered; and macroprudential supervisors certainly have to consider these dynamics. If national CO2 Emission Trading Systems are integrated internationally, there will be crucial global effects on climate neutrality, financial markets and output.