Vertical integration in the natural gas value chain: Historical and current developments

Term Paper (Advanced seminar), 2009

26 Pages, Grade: 1,7


List of contents

1 Introduction
1.1 Vertical Integration – a literature overview

2 The natural gas sector
2.1 Natural gas and its development
2.1.1 Natural gas
2.1.2 Development of the gas market in Germany and USA
2.2 Value chain – from the wellhead to the gas stove

3 Hypothesis and model
3.1 Theoretical framework
3.1.1 Production cost approach
3.1.2 Neo classical approach
3.1.3 Transaction cost theory
3.2 Looking for Vertical integration on the value chain
3.2.1 Production – Transport (– Storage) – Distribution Interface
3.2.3 Implementation of theories

4 Current market situation – test on vertical integration

5 Results

6 Conclusion

List of figures

Figure 1: D omestic conveyance in Germany 2006 (Source: Erdgas im Überblick /E.ON Ruhrgas AG, p. 9)

Figure 2: Natural gas value chain (Source: own graphic referring to

Figure 3: Choice of an Organisational Structure Dependent on Transaction Attributes (Source: Rüster, Neumann 2006, p.32)

Figure 4: Map of European natural gas hubs (Source: E.ON-Ruhrgas AG )

Figure 5: European pipeline network in 1970 (Source: European Energy Forum)

Figure 6: European pipeline network in 2000 (Source: European Energy Forum)

List of tables

Table 1: chemical composition of L-/H-Gas (Source :

Table 2: Conveyance and consumption of Natural gas in regions of the world 2004 (Source: Weltenergiereport 2005)

Table 3: Up- and downstream activities on the German natural gas value chain (Source: own table with data from the market players’ homepages)


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List of symbols

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1 Introduction

In times of globalization, raising energy demand and energy prizes, the supply with natural gas becomes more and more important. Especially the dependency of Western Europe in general and Germany in particular from foreign exports forces the governments to secure energy supply in cooperation with all market participants.

For the period of the last 25 years the structure of natural gas markets worldwide changed significantly in technical, institutional and economic settings. The aim of several liberalization processes in the natural gas market by the German government and the European Union was a creation of competitive markets and breaking up monopolistic (vertically integrated) structures in the natural gas industry. (Neumann, Hirschhausen 2006, p.5) Even though there is still vertical integration taking place and some regional markets are nearly monopolistic.

On the next pages we will give an overview about the market structure and the corporate strategies (and its determinants) of the German and European natural gas sector. The focus of this work is on vertical integration in theory and practice.

1.1 Vertical Integration – a literature overview

Looking on the literature of vertical integration (VI), we can see that economics and legal policy makers have ignored the topic of VI for decades since Ronald H. Coase wrote his 1937 article about “The nature of the Firm”. Coase was the first economist, introducing transaction costs, which come along with exchange relationships on the market. It is the origin of transaction cost economics (TCE).[1] With the development of the new institutional economics (NIE) during the 1970’s and 1980’s Williamson (1971, 1983, 1985 etc.) and Klein, Crawford and Alchian (1978) developed further the Coase’s work of TCE. Williamson pointed out that asset specificity and uncertainty lead into a high level of transaction costs and Klein (et. al) argued that the hold-up problem arises when a high level of relationship-specific investments is required. All of these factors explain the requirements for a new institutional framework or new institutional organization than just “normal” contracting (Williamson, 1983). With the introduction of the concept of incomplete contracts (Grossmann and Hart (1986), Hart and Moore (1988)) and the definition of ownership as residual rights over assets (Grossmann and Hart (1986)) the property rights approach (PRA) arose. Neumann and Hirschhausen (2006) identified this approach as a theoretical response to TCE. The PRA assumes that incentives for VI come from the advantage of residual rights of control over assets situations where specific investments have to be done. With the theory of incomplete contracts PRA argues that VI is desirable if it is too expensive or impossible to write down all specific rights in a contract. In his 2003 paper “Vertical Integration” Joskow argues that the PRA assumes inefficiencies only arising from ex ante investments whereas TCE identifies inefficiencies ex ante and ex post as well. This can be explained with the role of the contracts in both theories (Saussier (2002)).[2]


[1] His work was influenced by the question, whether a company should buy all products through the market or produce the product on its own, without any market transaction. The answer was given by Coase through two arguments. On the one side internal costs rise with the degree of organization and on the other side the capability of the entrepreneur to make the best use of a factor is limited and decreases with further transaction that is organized within the firm.

[2] Besides all these different theories the economics agree that the size of transaction cost depends on the degree of asset specificity, the level of uncertainty and the frequency of the transactions. To minimize these transaction costs the two parties in a trading relationship have different possibilities of organizational and institutional arrangements, starting at anonymous spot trading and end, via long-term contracting, at VI (Neumann, von Hirschhausen (2006)).

Excerpt out of 26 pages


Vertical integration in the natural gas value chain: Historical and current developments
Technical University of Berlin  (Institut für Volkswirtschaftslehre und Wirtschaftsrecht (IVWR))
Infrastruktur- und Wettbewerbspolitik
Catalog Number
ISBN (eBook)
ISBN (Book)
File size
684 KB
vertical integration, long-term contracts, value chain, natural gas, neoclassical approach, case study, Germany, Europe, transaction cost economics, TCE, new institutional economics, NIE, property rights approach, PRA, Coase, Williamson, Joskow, neoclassical theorie
Quote paper
Svetlana Sailer (Author)Enrico Selk (Author)Gernot Baumgart (Author), 2009, Vertical integration in the natural gas value chain: Historical and current developments, Munich, GRIN Verlag,


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