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

Juan Rosellon and Dagobert Brito

No DTE 426, Working Papers from CIDE, División de Economía

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: Lumpy Investment; Regulated Natural Gas Pipelines; Theory of The Second Best (search for similar items in EconPapers)
JEL-codes: L95 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2008-09
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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 (2010)
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