Liberalization and the volatility of gas prices: Exploring their relation in times of abundance and scarcity

Abstract

Agencies and analysts attribute the current volatility of natural gas prices to a temporary convergence of exogenous shocks such as the post-COVID-19 economic recovery and the conflict in Ukraine. This paper hypothesizes that long-term structural and policy factors endogenous to the energy sector also play a relevant role. Through a case study of three major gas markets – UK, US, and EU – the paper finds that countries characterized by abundant domestic production are less exposed to price volatility as they benefit from lower market uncertainty and asset specificity. This encourages energy firms to outsource production and rely on more flexible and shorter-term contracts. A structural condition of abundance supported by liberalization policies and a developed infrastructure network allows energy firms to easily switch suppliers or buyers without being exposed to the opportunistic behavior of the commercial counterparty, increasing market competition and reducing prices. By contrast, import-dependent countries face greater uncertainty and asset specificity, as supplies and prices are not guaranteed and they heavily depend from trends in international markets. In this context, the contractual and structural flexibility brought about by liberalization policies may expose to further insecurity of supply and volatility of prices, as exporters are contractually disengaged from commitments on volumes and prices. In periods of international scarcity, they may redirect supplies to importers that offer a premium in price. This suggests that import-dependent countries could reduce their exposure to price volatility (i) by increasing domestic production (ii) while envisaging the coexistence of contractual models based on both market competition and vertical integration, to take advantage from low spot prices in periods of international abundance and contain the surge in periods of scarcity.