Gas Pipeline Transportation: Competing within Ex-Ante Increasing Returns to Scale and Sunk Costs

Abstract

In the present decade the Chilean economy has witnessed a vigorous development in the natural gas industry, with cruel battles among competing corporations that look for the success of their gas pipeline projects. This paper analyzes industrial organization implications of gas pipeline transportation technology providing a theoretical foundation for what current believes on natural monopoly's saw as impossible: three gas wars and one gas-electric war. There are two key components that determine the capacity of a gas pipeline: ex-ante increasing returns to scale, and the commitment value of sunk costs. Contrarily to the standard paradigm on natural monopolies, it is shown that ex-ante increasing returns to scale with sunk costs are not sufficient to preclude entry by competing firms, implying that the scale economy in the natural gas pipeline industry does not make it a natural monopoly. Welfare analysis show that strategic entry deterrence has a positive effect on welfare, effect that results from the threat that the potential intruders impose on the incumbent firm.