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Lumpy Investment in Regulated Natural Gas Pipelines: An Application of the Theory of the Second Best

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  • Dagobert Brito

    ()

  • Juan Rosellón

    ()

Abstract

We address investment in regulated natural gas pipelines when investment is lumpy and the demand for gas is stochastic. This is a problem that can be solved in theory as a dynamic program, but a practical solution depends on functions and parameters that are either subjective or cannot be estimated. We then reformulate the problem from the standpoint of consumers that face incomplete markets. It is shown that for reasonable parameter values consumers prefer to pay for excess capacity rather than bear the risk of congestion. These strategies can be implemented with reasonably straightforward policies. Since the demand for gas is very inelastic, the welfare losses associated from small deviations from a first best optimum are minimal. This implies that the gas pipeline system can be regulated with a relatively simple set of transparent rules without any significant loss of welfare.

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Bibliographic Info

Article provided by Springer in its journal Networks and Spatial Economics.

Volume (Year): 11 (2011)
Issue (Month): 3 (September)
Pages: 533-553

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Handle: RePEc:kap:netspa:v:11:y:2011:i:3:p:533-553

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Web page: http://www.springerlink.com/link.asp?id=106607

Related research

Keywords: Transmission investment; Natural-gas regulation; Congestion management; Gas pipelines; Second-best theory;

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References

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Citations

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Cited by:
  1. Anne Neumann & Juan Rosellón & Hannes Weigt, 2011. "Removing Cross-Border Capacity Bottlenecks in the European Natural Gas Market: A Proposed Merchant-Regulatory Mechanism," Discussion Papers of DIW Berlin 1145, DIW Berlin, German Institute for Economic Research.
  2. Ibrahim Abada & Steven Gabriel & Vincent Briat & Olivier Massol, 2013. "A Generalized Nash–Cournot Model for the Northwestern European Natural Gas Markets with a Fuel Substitution Demand Function: The GaMMES Model," Networks and Spatial Economics, Springer, vol. 13(1), pages 1-42, March.

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