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Pricing flexibility under rate-of-return regulation: Effects on network infrastructure investment

Matthew E. Oliver

Economic Modelling, 2019, vol. 78, issue C, 150-161

Abstract: When a commodity market relies upon a regulated network service industry—e.g., telecommunications, electricity, or natural gas transmission—economic efficiency in that commodity market is a crucial consideration for regulatory design. This is because insufficient infrastructure investment relative to network demand results in congestion. The extraction of associated rents has distortionary effects on commodity spot market prices. Greater regulatory flexibility in network pricing can alleviate such issues by cultivating the incentives needed for stakeholders to invest in transmission capacity. To illustrate this effect I derive and numerically solve stylized optimality conditions for access and usage prices for a gas pipeline operator under alternative regulatory models. My results have general implications for regulation in network infrastructure industries, as energy and telecommunications markets are expected to expand considerably over the coming decades.

Keywords: Rate-of-return regulation; Price cap regulation; Network infrastructure investment; Transmission capacity; Natural gas pipelines (search for similar items in EconPapers)
JEL-codes: L51 L90 L95 Q48 (search for similar items in EconPapers)
Date: 2019
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