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Effects of higher domestic gas prices in Russia on the European gas market: A game theoretical Hotelling model

Anton Orlov

Domestic gas prices in Russia are substantially lower than export netback prices. The Russian government aims to increase the domestic price level in the long term. The objective of this paper is to analyse the long-term effects of higher gas prices in Russia on the European gas market. The analysis is based on a modified analytical and a numerical Hotelling model. The main findings are as follows. Under a price elasticity of demand equalling −0.5, a 70% increase in the domestic gas price in Russia results in an annual average reduction in domestic gas consumption of 116 bcm. The export supply to Europe could be affected via two channels: (i) a stock effect and (ii) scarcity rents. The results show that in the presence of a stock effect with an elasticity equalling unity, the annual average increase in the export supply to Europe could account for 33.7 bcm. Although Russia may not face a resource constraint in the short and medium terms, scarcity effects could become more relevant in the future. A reduction in domestic gas consumption could reduce the future scarcity rent, implying a higher potential for exporting gas in the long term. Overall, total gas consumption in Europe could annually increase by 17.5 bcm on average. As the stock elasticity increases, so does the increase in total gas consumption. Furthermore, the results show that increasing the domestic gas price is associated with an annual average increase in the export tax revenue from gas of 38.4 billion USD and an annual average reduction in the domestic gas subsidy of 34.1 billion USD.

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