The strategic motivation for long term contract and oligopolistic collusion: Explanation on iron ore benchmark price mechanism

We explore the strategic interactions among oligopolists providing future and spot output simultaneously in condition of uncertainty and risk-averse downstream user. Upstream oligopolistic motivation for providing long term contracts is weakened since downstream users´ risk-aversion leads to long term contract price lower than expected spot price while demand fluctuation is stochastic. Although this to some extant alleviates competition intensity among oligopolists, they will still provide long term contracts strategically. Furthermore, a more realistic assumption is made about demand fluctuation, i.e., demand is intertemporally correlated. We find that oligopolists are more likely to turn off future market and only provide output in spot market in periods with high growing demand. This study does not only offer a new perspective to understand oligopolistic behaviors in the iron ore industry and other industries such as electricity and natural gas which have similar characteristics, but also can help understand business strategies such as competition in multi-markets and intertemporally bundling.