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IMPLICATIONS OF THE ELASTICITY OF NATURAL GAS IN MEXICO ON INVESTMENT IN GAS PIPELINES AND IN SETTING THE ARBITRAGE POINT

Brito, Dagobert and Rosellon, Juan (2004): IMPLICATIONS OF THE ELASTICITY OF NATURAL GAS IN MEXICO ON INVESTMENT IN GAS PIPELINES AND IN SETTING THE ARBITRAGE POINT.

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Abstract

We address the optimal timing of investment in gas pipelines when the demand for gas is stochastic. We will show that this is a problem that can be solved in theory, but the practical solution depends on functions and parameters that are either subjective or cannot be estimated. We will then reformulate the problem in a manner that can Pareto rank investment strategies. These strategies can be implemented with reasonably straightforward policies. The demand for gas is very inelastic and thus 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 rules without any significant loss of welfare. Regulation of the gas pipeline system can be transparent and a result may be a good candidate for some institutional arrangement in which there is substantial private investment in gas pipelines.

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