Russia and Ukraine Natural Gas Disputes Illustrate the Bilateral Monopoly Problem

Michael Giberson

At the Streetwise Professor, Craig Pirrong writes that the periodic interruptions in natural gas flows from Russia across Ukraine present a “classic bilateral monopoly situation.”

Bottom line–there are no saints involved in this episode.  There is a classic bilateral monopoly situation.  Each side is using its leverage to try to extract as much from the other as possible.  There is a substantial rent to be had, and Ukraine and Russia/Gazprom are using every lever they can to get the lion’s share of that rent.


In essence, Ukraine is using the market power inherent in its control of the pipeline between Russia and Europe in exactly the same way Russia/Gazprom has used the market power inherent in its (government granted) monopoly over the pipeline between Turkmenistan and Europe.  And which it also uses, by the way, to stifle competition from other Russian producers of gas.

His prognosis:

This conflict is inherent in the dysfunctional market structure upstream and midstream.  State mandated monopolies over transportation in Russia and Ukraine, with no system of open access and common carriage, distort markets.  When these monopolies are back to back, rent seeking battles are inevitable.

Absent some regime of open access, or common carriage at regulated rates, the distortions in the Eurasian gas market will persist.  The second best alternative is to create additional pipeline routes connecting other sources of gas (Turkmenistan, Kazakhstan) with consumers downstream.  Importantly, these additional routes must not be in control of the incumbents–notably Gazprom–so Nord Stream and Blue Stream South Stream don’t help.  An additional, non-Gazprom pipeline would create additional competition (though far from anything resembling perfect competition) both for the gas, and for the transport of gas.

This is not likely to happen anytime soon, given the difficult economics of Nabucco, the dynamics of the new Great Game in Central Asia (and Russia’s strong strategic hand in that game, and its ruthlessness in playing it), and the pathetic dithering of the Europeans.  Which means that the gas wars will remain as regular a New Years event as the Rose Bowl and hangovers.