* Carmakers willing to shoulder bulk of upgrade costs
* Positioning comes amid talks to avert bans on older models
* Government has been split on how to tackle issue (Recasts with outcome of talks)
By Holger Hansen and Markus Wacket
BERLIN/HAMBURG, Oct 1 (Reuters) - Bleary-eyed leaders of Germany's coalition parties emerged in the small hours of Tuesday morning to say they had agreed on a way of cutting pollution in cities while avoiding unpopular driving bans.
But they were tight-lipped on the details of their plan, saying only that ministers would outline the details of a "highly complex" agreement later in the day.
Earlier, conservative Transport Minister Andreas Scheuer said German carmakers were willing to bear most of the cost of upgrading old diesel cars to reduce air pollution in German cities, but it was not yet clear how drivers would be spared the bill.
Volkswagen, Germany's largest carmaker, has agreed to cover 2,400 euros ($2,780) of the estimated 3,000-euro cost of hardware retrofits on its diesel cars, Scheuer said on a live video chat on Instagram.
"Now we have to discuss in the coalition how we handle the gap of 600 euros," he added. Scheuer has sided with carmakers in calling for incentives for owners of older vehicles to trade them in for newer models. Svenja Schulze, a Social Democrat (SPD), favours hardware retrofits that are unpopular with auto makers.
A statement after the talks tersely promised a "concept for clean air in our cities," while an unexpected pledge to build more wind and solar energy plants hinted at the horse-trading that took place as the three awkward partners struggled to unite around a common position.
The past few weeks have seen support slide to all-time lows for both Chancellor Angela Merkel's conservative party and its Social Democrat (SPD) partners, as her government rowed over everything from diesel to immigration and the threat of far-right violence.
The marathon talks, which they promised would become a regular fixture, also yielded agreement on a new law promoting skilled immigration, they said.
The diesel compromise is likely to feature both trade-in incentives and retrofits. Scheuer said Volkswagen was willing to offer trade-in deals worth up to 8,000 euros, BMW 6,000 euros and Daimler up to 5,000 euros, as well as leasing options.
One complaint of German carmakers is that foreign rivals would not be covered by any requirement for retrofits. Volvo of Sweden said it was not working on any such upgrades, but is looking at incentives to encourage customers to trade in diesels for newer, cleaner cars.
That option is also being considered by several other foreign carmakers, said Reinhard Zirpel, head of the VDIK car importers' association. "We have legal, technical and business reservations about hardware upgrades," he told the Tagesspiegel daily.
Scheuer also said his Christian Social Union, the Bavarian sister party to Merkel's Christian Democrats - did not want diesel drivers to face any additional expense.
The SPD's Schulze said a deal must include hardware upgrades and that the entire cost should be borne by the industry: "The car industry caused the problem, and now they have to fix it," she told SWR Radio in an interview.
Volkswagen's admission in 2015 that it cheated U.S. diesel emissions tests led to the discovery that diesel vehicles from several manufacturers routinely exceed pollution limits in normal driving conditions, prompting a regulatory crackdown.
At the same time, the German courts have paved the way for city driving bans to tackle levels of nitrogen oxide that exceed European safety levels. The first, in Frankfurt, the financial capital, is due to take effect in February.
Volkswagen doubts that hardware retrofits on older diesels are technically feasible and is only willing to foot the bill if it does not have to bear liability for any engine damage that may result, a company source said.
That should not be an obstacle to a solution, according to suppliers of catalytic converters - devices that can be installed in cars to convert harmful exhaust pollutants into less harmful gases. ($1 = 0.8623 euros) (Reporting by Holger Hansen and Markus Wacket Writing by Douglas Busvine and Thomas Escritt; Editing by Adrian Croftand Leslie Adler)