The length of contracts and collusion☆

Many commodities (including energy, agricultural products and metals) are sold both on spot markets and through long-term contracts which commit the parties to exchange the commodity in each of a number of spot market periods. This paper shows how the length of contracts affects the possibility of collusion in a repeated price-setting game. Contracts can both help and hinder collusion, because they reduce the size of the spot market, cutting both the immediate gain from defection and the punishment for deviation. Firms can always sustain some collusive price above marginal cost if they sell the right number of contracts, of any duration, whatever their discount factor. As the duration of contracts increases, however, collusion becomes harder to sustain. (C) 2009 Elsevier B.V. All rights reserved.