European market integration for gas? : volume flexibility and political risk
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Is the European gas market integrated? Are there substantial price differences between gas from different export countries? Time series of Norwegian, Dutch and Russian gas export prices to Germany in 1990-1998 are examined. Cointegration tests show that that the different beach prices for gas to Germany move proportionally over time, indicating an integrated gas market (the Law of One Price holds). We find differences in mean prices, with Russian gas being sold at prices systematically lower than Dutch and Norwegian gas. Surveying the features of the long term take-or-pay contracts for gas sales, we discuss possible explanations for the price discrepancy. Among the explanatory factors are differences in volume flexibility (swing) and perceived political risk. This paper examines the degree of market integration of the European natural gas market, with a focus on German import from the Netherlands, Norway and Russia. Theory predicts that in an integrated market, prices from different suppliers should move in the same direction, and price differentials should only be present if there are differences in transportation costs or quality. However, the explanation behind price discrepancies may be somewhat more complicated in the European natural gas market. Natural gas is overwhelmingly sold on complex long-term contracts that have a number of features that may influence the contract price, and hence lead to price variations across contracts. Furthermore, there may be elements of political risk that can influence relative prices. We investigate the degree of market integration in the German market by examining the relationship between the import prices from the three main suppliers, the Netherlands, Norway and Russia. Since the prices appear to be nonstationary, cointegration analysis will be the empirical tool. We will also examine the underlying determinants of our empirical results, particularly on the impact of the contract structure. An analysis of the long term take-or-pay gas export contracts is given, and the export strategies of the Netherlands, Norway and Russia are examined in relation to our empirical findings. Germany is a natural candidate for a case study since this is the largest national gas market on the Continent, has a central position with respect to the distribution of gas across the European market, and is one of the few markets where three of the largest producers all supply considerable quantities. Germany is also an interesting case in light of the EU Gas Directive, since the liberalisation of the German natural gas market will have a major influence on the development in the rest of Europe.