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

Dagobert Brito and Juan Rosellon

No 1024, Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research

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.

Keywords: Transmission investment; Natural-gas regulation; Congestion management; Gas pipelines; Second-best theory (search for similar items in EconPapers)
JEL-codes: L51 L95 (search for similar items in EconPapers)
Pages: 19 p.
Date: 2010
New Economics Papers: this item is included in nep-ene and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Lumpy Investment in Regulated Natural Gas Pipelines: An Application of the Theory of the Second Best (2011)
Working Paper: Lumpy Investment in Regulated Natural Gas Pipelines: An Application of the Theory of The Second Best (2008)
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