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Long-term vs. Short-term Contracts; A European perspective on natural gas

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Author Info
Neuhoff, K.
von Hirschhausen, C.

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Abstract

This paper analyses the economics of long-term gas contracts under changing institutional conditions, mainly gas sector liberalisation. The paper is motivated by the increasingly tense debate in continental Europe, UK and the US on the security of long-term gas supply. We discuss the main issues regarding long-term contracts, i.e. the changing role of the flexibility clause, the effect of abandoning the destination clause, and the strategic behaviour of producers between long-term sales and spot-sales. The literature suggests consumers and producers benefit from risk hedging through long-term contracts. Furthermore long-term contracts may reduce exercise of market power. This was argued to benefit consumers at the ‘expense’ of producers’ profits. Our analysis shows if the long-run demand elasticity is significantly lower than the short-run elasticity, both strategic producers and consumers benefit from lower prices and larger market volume. Some policy implications of the findings are also discussed.

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Publisher Info
Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0539.

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Length: 22
Date of creation: Sep 2005
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Handle: RePEc:cam:camdae:0539

Note: EPRG 05
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Web page: http://www.econ.cam.ac.uk/index.htm

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Related research
Keywords: contracts gas market power demand elasticity liberalisation Europe

Find related papers by JEL classification:
L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
L95 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Gas Utilities; Pipelines; Water Utilities

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  1. Masten, Scott E & Crocker, Keith J, 1985. "Efficient Adaptation in Long-term Contracts: Take-or-Pay Provisions for Natural Gas," American Economic Review, American Economic Association, vol. 75(5), pages 1083-93, December. [Downloadable!] (restricted)
  2. Williamson, Oliver E, 1983. "Credible Commitments: Using Hostages to Support Exchange," American Economic Review, American Economic Association, vol. 73(4), pages 519-40, September. [Downloadable!] (restricted)
  3. Parsons, John E, 1989. " Estimating the Strategic Value of Long-term Forward Purchase Contracts Using Auction Models," Journal of Finance, American Finance Association, vol. 44(4), pages 981-1010, September. [Downloadable!] (restricted)
  4. Mulherin, J Harold, 1986. "Complexity in Long-term Contracts: An Analysis of Natural Gas Contractual Provisions," Journal of Law, Economics and Organization, Oxford University Press, vol. 2(1), pages 105-17, Spring.
  5. Keith J. Crocker & Scott E. Masten, 1988. "Mitigating Contractual Hazards: Unilateral Options and Contract Length," RAND Journal of Economics, The RAND Corporation, vol. 19(3), pages 327-343, Autumn. [Downloadable!] (restricted)
  6. Masten, Scott E, 1988. "Minimum Bill Contracts: Theory and Policy," Journal of Industrial Economics, Blackwell Publishing, vol. 37(1), pages 85-97, September. [Downloadable!] (restricted)
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  1. Newell, Richard G. & Pizer, William A., 2006. "Indexed Regulation," Discussion Papers dp-06-32, Resources For the Future. [Downloadable!]
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