On the co-existence of spot and contract markets: the delivery requirement as contract externality

A contract between an upstream and a downstream party consistsof a contract price and a delivery requirement. Contract formationentails an externality. It changes the probability distributionof the spot market price by removing high reservation pricebuyers and various sellers from the spot market. The first effectdecreases the expected spot market price when the number ofcontracts is small, whereas the decrease in the number of sellersand additional residual contract demand increase the expectedspot market price beyond a certain number of contracts. It impliesan endogenous upper bound on the number of contracts. Contractprices are positively related to the number of contracts. Finally,additional contract formation reduces the variance of the spotmarket price when the number of contracts is sufficiently large.