Abstract

This study investigates the relationship between oil prices and global CO2 emissions under an instrumental variable research design. In the first stage, we take advantage of the global oil market model developed by Baumeister and Hamilton (2019) to produce exogenous shocks to the oil supply and global economic activity. In the second stage, we use these shocks to compute impulse responses to observed oil prices and CO2 emissions. Finally, based on the latter computations, we obtain the dynamic multiplier that measures the shock-specific effect driving a 1% increase in the oil price on the cumulative CO2 emissions. Our results reveal a nuanced relationship: not all increases in oil prices uniformly lead to a reduction in CO2 emissions. Reductions in CO2 emissions are predominantly observed when increases in oil prices are supply-driven, revealing a substitution effect from fossil fuel to renewable energies in the energy market. However, CO2 emissions increase when oil prices are higher during times with positive shocks to global economic activity.