Сompetition and Security of Supply after Vertical Integration : Should Russia Be Kept Off the Downstream Natural Gas Market?

We analyse the effect of vertical integration in a two-stage oligopoly where the supply of one of the upstream players is insecure because this player suffers from stochastic costs. He may decide not to deliver if costs are too high. We formulate this situation as a model of the European gas market with Russia as the unreliable player but there are also other applications.While Russia's attempts to buy considerable parts of the European downstream industry have faced strong political opposition, we argue that Russian participation in the downstream market would decrease consumer prices and increase the security of supply. We show that there are circumstances when the conventional wisdom that vertical integration is advantageous (Spengler, 1950, Abiru, 1988; Boots et al., 2004, for the gas market) is not always true. In Russia's case, however, it is