Up to this point, my analysis has examined the behavior of nonregulated NG prices and their peculiarities, as set by forces combining two types of competition: GOG and gas-on-substitute. However, a full picture of NG price formation has to include the influence of government policies on NG prices. The impact of government policies causes NG prices to differ from those determined purely by commercial forces in global and national gas markets. This chapter will focus both on the impact of government intervention on the behavior of competitive, nonregulated gas prices in segmented NG markets and on the possible use of policy to encourage synergies between renewables and NG as a transitional fuel.

Government intervention in markets of all sorts is justified by the theory of externalities. Externalities, or external effects, are typically not reflected in competitive, nonregulated market pricing and therefore constitute what is in essence a form of market failure. Put in other words, the price that is optimal from the point of view of private interests is not always optimal when public interests are taken into consideration.

Acting on the basis of asserted public interest, governments intervene in the work of the market to decrease demand for a good that is associated with negative external effects or to increase demand for a good that is associated with positive effects. The scope of government intervention is determined by the size of the external costs and benefits and by the practical ability to achieve these goals through government intervention. The definition of externalities differs from country to country and is subject to change in line with evolution of definitions of public interest. For the NG sector, the definition of public interest is typically outlined in the national energy strategy for a particular country.

Economic externalities represent the impacts of production and consumption on entities other than those producing and consuming that are not reflected in prices. Externalities can be either positive or negative. An extreme example of a negative externality can be illustrated by the hypothetical owner of a lignite power plant in the Beijing region paying for coal, labor and other inputs and charging a reasonable fee for the energy sold, but not bearing any costs for the damage to the health of the citizens of the Chinese capital caused by the air pollution.