Bargaining, vertical control, and (de)regulation in the European gas market

Abstract

In the market for natural gas in Europe, negotiations play an important role in the determination of terms of trade between various agents. Due to the small number of countries involved in the trade of nautral gas on the European continent, this market could be characterized as a ‘bilateral oligopoly’. As trade between a buyer and a seller can be implemented only if the parties make investments in relationship-specific infrastructure (pipelines and terminals), the agents, once these investments have been undertaken, are locked into a bilateral monopoly position. Since the parties cannot rely on the market once the investments are undertaken, a trade agreement is usually governed by a long-term contract, established between a selling country (or a national enterprise) and a buyer, which is normally a transmission company, reselling gas to local distribution companies in various regions. Long-term contracts will not only regulate trade between upstream suppliers and transmission companies; such contracts are also prevalent in regulating trade between transmission companies and downstream firms, such as local distribution companies. Hence, there is no ordinary spot market for natural gas, but a set of segmented or geographically separated markets, where terms of trade are determined in a complex interrelated bargaining game comprising upstream as well as downstream agents. Within such a market structure, a transmission company has a rather strong market power, as a player ‘in between’ the upstream suppliers and the downstream buyers; for further details, see Bjerkholt, Gjelsvik and Olsen (1989).