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

Author

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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.

Suggested Citation

  • Neuhoff, K. & von Hirschhausen, C., 2005. "Long-term vs. Short-term Contracts; A European perspective on natural gas," Cambridge Working Papers in Economics 0539, Faculty of Economics, University of Cambridge.
  • Handle: RePEc:cam:camdae:0539
    Note: EPRG 05
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    File URL: http://www.electricitypolicy.org.uk/pubs/wp/eprg0505.pdf
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    References listed on IDEAS

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    1. Williamson, Oliver E, 1983. "Credible Commitments: Using Hostages to Support Exchange," American Economic Review, American Economic Association, vol. 73(4), pages 519-540, September.
    2. 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, vol. 0(Number 1), pages 77-90.
    3. Javier Estrada & Ole Fugleberg, 1989. "Price Elasticities of Natural Gas Demand in France and West Germany," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3), pages 77-90.
    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 105-117, Spring.
    5. Masten, Scott E, 1988. "Minimum Bill Contracts: Theory and Policy," Journal of Industrial Economics, Wiley Blackwell, vol. 37(1), pages 85-97, September.
    6. 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 1083-1093, December.
    7. 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.
    8. 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, vol. 0(Number 2), pages 89-110.
    9. 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.
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    Citations

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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. Newell, Richard G. & Pizer, William A., 2008. "Indexed regulation," Journal of Environmental Economics and Management, Elsevier, vol. 56(3), pages 221-233, November.
    3. Roques, Fabien A., 2008. "Technology choices for new entrants in liberalized markets: The value of operating flexibility and contractual arrangements," Utilities Policy, Elsevier, vol. 16(4), pages 245-253, December.
    4. Catherine Locatelli, 2007. "Les stratégies d'internationalisation de Gazprom, enjeu de la constitution d'une grande compagnie d'Etat russe," Post-Print halshs-00115377, HAL.
    5. Michèle Breton & Mohammed Kharbach, 2009. "Who benefits from price indexation?," Economics Bulletin, AccessEcon, vol. 29(4), pages 2732-2737.
    6. Anne Neumann & Sophia Rüster & Christian von Hirschhausen, 2015. "Long-Term Contracts in the Natural Gas Industry: Literature Survey and Data on 426 Contracts (1965-2014)," Data Documentation 77, DIW Berlin, German Institute for Economic Research.
    7. repec:taf:ceasxx:v:61:y:2009:i:5:p:833-856 is not listed on IDEAS

    More about this item

    Keywords

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

    JEL classification:

    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • L95 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Gas Utilities; Pipelines; Water Utilities

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