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On the Pricing of Natural Gas Pipeline Capacity

Tepper School of Business, Carnegie Mellon University, Pittsburgh, Pennsylvania 15213
ns7{at}andrew.cmu.edu

Pipelines play a critical role in matching the supply and demand of natural gas. The pricing of their capacity is an important problem in practice for pipeline companies and the users of this capacity, which include shippers such as natural gas merchants, producers, and local distribution companies. This paper conducts a normative analysis of how pipeline capacity should be priced by each of these players. Although the trading value of this capacity should be relevant to merchants and its substitution and congestion values to shippers and pipelines, respectively, this analysis shows that all of these are equivalent values. Thus pipeline capacity should be priced at its trading value, a prediction that can be empirically investigated. This paper also conducts an empirical analysis of this prediction based on transacted prices of transport contracts for the capacity of the Tennessee Gas Pipeline, a major interstate pipeline in the United States, and finds support for it. This analysis suggests that the uncertainty in the evolution of natural gas prices is an important driver of operational performance in the pricing of pipeline capacity. The results of this paper have potential relevance for the pricing of the capacity of other commodity conversion assets.

Key Words: pricing and revenue management; operations management/finance interface; econometric analysis; petroleum/natural gas industries; real options
History: Received: October 22, 2008; accepted: July 10, 2009.