Bottom-Up Strategic Linking of Carbon Markets: Which Climate Coalitions Would Farsighted Players Form?

Abstract

We present typical scenarios and general insights from a novel dynamic model of farsighted cli- mate coalition formation involving market linkage and cap coordination, using a simple analytical model of the underlying cost-benet structure. In our model, the six major emitters of CO2 can link domestic cap-and-trade systems to form one or several international carbon markets, and can either choose their emissions caps non-cooperatively or form a hierarchy of cap-coordinating coalitions inside each market. Based on individual and collective rationality and an assumed dis- tribution of bargaining power, we derive scenarios of such a climate coalition formation process which show that arst-best state with a coordinated global carbon market might well emerge bottom-up, and underline the importance of coordinating caps immediately when linking carbon markets. Surprisingly, the process tends to involve less uncertainty when agreements can be ter- minated unanimously or unilaterally, depending on the level of farsightedness.