Do firms sell forward for strategic reasons? An application to the wholesale market for natural gas

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Building on a model of the interaction of risk-averse firms that compete in forward and spot markets, we develop an empirical strategy to test whether oligopolistic firms use forward contracts for strategic motives, for risk-hedging, or for both. An increase in the number of players weakens the incentives to sell forward for risk-hedging reasons. However, if strategic motives are also relevant, then an increase in the number of players strengthens the incentives to sell forward. This difference provides the analyst with a way to identify whether strategic considerations are important at motivating firms to sell forward. Using data from the Dutch wholesale market for natural gas where we observe the number of players, spot and forward sales, and churn rates, we find evidence that strategic reasons play an important role at explaining the observed firms' (inverse) hedge ratios. In addition, the data lend support to the existence of a learning effect by wholesalers. Terms of use: Documents inJEL-Code: D43, L13, G13, L95.

Market Structure, Risk Preferences, and Forward Contracting Incentives*

“…Hughes and Kao [1997] and van Eijkel et al . [2016] examine both the strategic and the risk‐hedging effects of forward contracts in settings where generators engage in Cournot competition. Hughes and Kao relax Allaz and Vila's assumption that forward contracts are observed publicly.…”

“…van Eijkel et al . [2016] couple a similar theoretical analysis with empirical data from the Dutch wholesale natural gas market to demonstrate that generators sign forward contracts both to reduce risk and to secure a strategic advantage in subsequent wholesale market competition.…”

“…The empirical literature (e.g., Bessembinder and Lemmon [2002]; van Eijkel et al . [2016]; van Koten [2021]) documents the use of forward contracts to hedge against the risk associated with profit variation in wholesale electricity markets.…”

“…Forward contracts have been shown to facilitate risk management and to promote expanded wholesale production of electricity (Pierpont [2020]; van Eijkel et al . [2016]; Wolak [2022]). Expanded production arises because forward contracts reduce the output a generator has exposed to the wholesale price.…”

Relaxing competition through speculation: Committing to a negative supply slope

“…Ferreira's theoretical argument is also relevant in practice. Van Eijkel and Moraga-González's (2010) nd that rms in the Dutch gas market are able to infer competitors' contract positions and that contracts are used for strategic rather than hedging reasons. Finally, it can be noted that vertical integration with a retailer that is selling the good at a xed retail price is equivalent to observable contracting.…”