Monopoly, unilateral climate policies and limit pricing

Abstract

We examine the behavior of a fossil fuel monopolist who faces demand from two regions: a ‘climate club’ and the ‘rest of the world’ (ROW). Each region is able to produce a perfect substitute for fossil energy at constant marginal costs. The climate club uses a carbon tax and a renewables subsidy as policy instruments. The ROW is policy-inactive. We fully characterize the market equilibrium and show that, due to differences in climate policies between the climate club and the ROW, the monopolistic fossil fuel supplier may choose for two limit-pricing phases to postpone entry of renewables producers: First in the climate club and later in the ROW. As soon as energy demand from the climate club shifts from fossil fuels to renewables, the monopolist abruptly increases the fossil price for the ROW.