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

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  • Neuhoff, K.
  • von Hirschhausen, C.

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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Bibliographic 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
Date of revision:
Handle: RePEc:cam:camdae:0539

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

Related research

Keywords: contracts; gas; market power; demand elasticity; liberalisation; Europe;

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References

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  1. 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.
  2. Masten, Scott E, 1988. "Minimum Bill Contracts: Theory and Policy," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 37(1), pages 85-97, September.
  3. 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, Oxford University Press, vol. 2(1), pages 105-17, Spring.
  4. Williamson, Oliver E, 1983. "Credible Commitments: Using Hostages to Support Exchange," American Economic Review, American Economic Association, American Economic Association, vol. 73(4), pages 519-40, September.
  5. 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, American Economic Association, vol. 75(5), pages 1083-93, December.
  6. Ken Costello & Hillard G. Huntington & James F. Wilson, 2005. "After the Natural Gas Bubble: An Economic Evaluation of the Recent U.S. National Petroleum Council Study," The Energy Journal, International Association for Energy Economics, International Association for Energy Economics, vol. 0(Number 2), pages 89-110.
  7. Javier Estrada & Ole Fugleberg, 1989. "Price Elasticities of Natural Gas Demand in France and West Germany," The Energy Journal, International Association for Energy Economics, International Association for Energy Economics, vol. 0(Number 3), pages 77-90.
  8. Parsons, John E, 1989. " Estimating the Strategic Value of Long-term Forward Purchase Contracts Using Auction Models," Journal of Finance, American Finance Association, American Finance Association, vol. 44(4), pages 981-1010, September.
  9. Mohammed A. Al-Sahlawi, 1989. "The Demand for Natural Gas: A Survey of Price and Income Elasticities," The Energy Journal, International Association for Energy Economics, International Association for Energy Economics, vol. 0(Number 1), pages 77-90.
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Cited by:
  1. Han, Lei, 2009. "Market acceptance of cloud computing: An analysis of market structure, price models and service requirements," Bayreuth Reports on Information Systems Management 42, University of Bayreuth, Chair of Information Systems Management.
  2. Michèle Breton & Mohammed Kharbach, 2009. "Who benefits from price indexation?," Economics Bulletin, AccessEcon, vol. 29(4), pages 2732-2737.
  3. Newell, Richard G. & Pizer, William A., 2006. "Indexed Regulation," Discussion Papers, Resources For the Future dp-06-32, Resources For the Future.
  4. Roques, F.A., 2007. "Technology Choices for New Entrants in Liberalised Markets: The Value of Operating Flexibility and Contractual Arrangements," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 0759, Faculty of Economics, University of Cambridge.

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