Efficient Contracting and Market Power: Evidence from the U.S. Natural Gas Industry

Abstract

It is well recognized by economists that long-term contracting under an array of price and non-price provisions may be an efficient response to small-numbers bargaining problems. Empirical work to distinguish such issues from predictions of models of market power and bargaining has been sparse, principally because the necessary data on individual transactions are seldom publicly available. The U.S. natural gas industry is well suited for such tests both because of the small number of buyers (pipelines) and sellers (producers) in each market and the large capital commitments required of transacting parties at the inning of the contract. We present a model of the bilateral bargaining process is natural gas field markets under uncertainty. We identify the 'initial price' as the outcome of the bargaining aver a fixed payment for pipeline to producer, and describe "price-escalator provisions" as a means of making the contract responsive at the margin to changes in the valuation of gas over the term of the agreement. Our econometric work rakes use of a large, detailed data set on during the l950s. Empirical evidence from models of price determination and the use of most-favored-nation clauses is supportive of the theoretical model.