Forward Integration and Market Entry – Evidence from Natural Gas Markets for Household Customers in Germany

In contrast to residential electricity markets in Germany, the entry of newcomers in residential natural gas markets is not frequently observed. Newcomers might face difficulties in purchasing gas on the wholesale market and in transporting it across geographically distinct market areas within Germany. The latter caused by pipeline capacity constraints between those areas, while the wholesale markets, on the other hand, suffer liquidity problems. For newcomers themselves gas imports to Germany are de facto unrealizable due to pipeline bottlenecks at the border. These pipelines are operated by gas importing firms, which maintain long-term contracts with mainly foreign gas producers. About 90 percent of total consumption is imported by 5 major gas importing firms. Two of those namely, E.on and RWE, are extensively forward integrated with retail (downstream) incumbents supplying retail markets. Due to potential abuse of the market power in wholesale and retail markets, the German Federal Cartel Office prohibited further forward integration from 2005/2006 to 2010. The Authority argued that the very few dominant gas importing companies, which also own and operate the gas pipelines, could have an incentive to foreclose the competitors or deter entry in retail markets.

Our study aims at investigating the effects of vertical integration between gas importers and retail incumbents on market entry of newcomers. To preserve retail subsidiaries’ profits, natural gas importers may wish to deter market entry, since in markets for household customers entry induces business stealing rather than market expansion. To analyze possible vertical integration issues empirically we employ cross sectional data (for September 2009) for about 500 sub markets for household customers in Germany. For this purpose ownership and market entry data were merged, and market and consumer characteristics were taken into account. Applying a structural entry model, which is based on market entry model introduced by Bresnahan and Riess (1991), our estimation results do not show clear evidence that market entry of newcomers is restricted by vertical integration. Therefore, we conclude that the decision of the German Federal Cartel Office to repeal the regulation of vertical integration in 2010 was appropriate. However, the estimation results show that in high quality gas markets, there are more market entries than in low quality gas areas. Further investigations have to be conducted for those markets.

Nikogosian, Vigen and Jürgen Weigand (2012), Forward Integration and Market Entry – Evidence from Natural Gas Markets for Household Customers in Germany, ZEW Discussion Paper No. 12-062, Mannheim.