Grais & Zheng Strategic Interdependence in the East-West Gas Trade

# _-_ **_I'(PR)_** a **_(PR_** - **_CW[EPc/Pa)] -FR,s_** _(7)_

where the argument T in P.(.) has been replaced by the expression in (6) reflecting the transiter's behavior. The gas supplier will select _PR_ to maximize its profit as presented in (7). The price chosen will be the one at which the marginal revenue and cost of an increase in _PA_ are equal, the marginal cost being the revenue foregone ty the ensuing decline in demand. The profit maximization will result in a price _PR_ such as:

# **_P.jPpjCgFRS,FpP4iY,ereA)_** (8)

## D. Interactions between Players

Russia is assumed to have a leadership role in the supply of gas to Western markets. It is the largest supplier that can satisfy Western Europe's demand at an economic cost in the short to medium term. This position gives _it_ an influential role in the determination of the price it can charge. The above framework captures Russia's leadership role in the fact that the critical decision that deternines the game outcome is the Russian gas supplier's determination of the price **_P._** Once that decision is made, the other players in the chain will use their decision rule to react. The transiter and the Western importer will determine the transit fee T and the demand of gas G, respectively. The further assumption of behavioral coordination is based on the presumption that no player is expected to challenge the leadership role of the Russian supplier in the short to medium term (entailing that this hierarchical decision structure is likely to last for a while) and the players' acceptability of the sequential nature of the decision-making procedure in the chain. However, if developments render Russia desperate for foreign exchange, its leadership role may come into question and the framework proposed here would need to be modified.

The framework considered in the foregoing assumes an asymmetry in the avail;bility of information to the players. In order to proceed with its decision-making on P, the Russian supplier needs to have access to information on other players' decision parameters (e.g., factors affecting demand in European markets, Y, _A,_ **_P,,_** i.e. the parameters entering the other players' decision rules). However the transiter needs ony to observe the determinasts of the Western importer's demand while the latter decides on the basis of only the price signal PG and information on his own environment. The assumption on information asymmetry reflects the reluctance of Gazprom to allow foreign equity participation in either gas production or transit companies and its active efforts to get involved in downstream activities.

Before 1990, the transiters and the suppliers formed a coalition. Then Czechoslovakia, Ukraine, Belarus and Russia shared information, production resources and revenues in cooperation. The configuration of the transit system that emerged after 1991 has not allowed the pursuit of previous cooperation and is making attempts at reviving difficult. This feature is captured in the non-cooperative nature of the game framework proposed in the above9.

Finally the decisions made can be undone and adjusted in response to changes in the environment of each participant. There is always the possibility of recontracting within the same framework which gives the game its repeatable feature.

**_5_**