Market power with interdependent demand: Sale of emission permits and natural gas from the Former Soviet Union
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- CICERO Working Papers 
With implementation of the Kyoto Protocol, the Former Soviet Union countries, and Russia in particular, will most likely be able to exert market power in the emission permit market. However, since these countries are also big exporters of fossil fuels, their incentives to boost the permit price may be weak. However, a significant share of Russia’s fossil fuel exports is natural gas. A high permit price may boost the demand for natural gas through substitution from more polluting fuels and thus increase gas profits. Therefore, being a natural gas exporter may increase the incentives to exert monopoly power in the permit market. Moreover, a large fossil fuel exporter may use its market position to influence the effective demand for permits. Hence, the relationship between permit income and fossil fuels exports runs in both directions. We explore the interdependence between the revenues from permit and fossil fuel exports both theoretically and empirically. A numerical general equilibrium model finds that the fact that the Former Soviet Union is a big gas exporter has a negligible effect on the incentives to exert monopoly power in the permit market. However, there are significant impacts on the optimal level of gas exports. JEL classification: Q4, D58, L12, Q28, Q48.