Market failures and government policies in gas markets 1

This memorandum analyses the fundamental characteristics of the natural gas market and its consequences for government policies. In the past, the European gas market was dominated by state-owned monopolists but since the start of the liberalisation, privatisation and re-regulation in the early 1990s, the market has fundamentally changed. Nevertheless, governments are still involved in the gas industry, not only in gas exporting countries such as Russia, but also in a country like the Netherlands where the government has imposed a cap on production from the main gas field (Groningen) as well as owns shares in the main wholesale trader (Gasunie Trade & Supply) which has the obligation to accept all gas offered by producers on the small fields. In the main report of this project we present a cost-benefit analysis of the Dutch gas-depletion policy. In this memorandum we explore the natural-gas market more broadly, looking for factors why government intervention may be needed using the welfare-economic approach according to which government intervention should be based on the presence of market failures. After a brief description of the main characteristics of the gas industry, we systematically analyse sources of market failures, such as geopolitical factors, economies of scale and externalities, and finally go into the question which policy options may be chosen to address those market failures. 1 This memorandum is written as part of the project on Dutch gas-depletion policies (see Mulder and Zwart, 2006). The authors of this memorandum benefited from discussions with representatives of the gas industry and government as well as a number of external of internal colleagues. Of course, the usual disclaimer applies. CPB Memorandum CPB Netherlands Bureau for Economic Policy Analysis Sector : Regulation and Competition Unit/Project : A welfare-economic analysis of the Dutch gas-depletion policy Author(s) : Machiel Mulder and Gijsbert Zwart Number : 143 Date : 23 February 2006