Welfare Properties of Network Bypass

One result of the deregulation of utilities in New Zealand has been the bypass of existing networks. We investigate two cases of bypass in the distribution of natural gas, and compare the welfare properties of regulation vs.\ the `laissez-faire' equilibrium. We demonstrate that installing a redundant bypass can be simultaneously profitable and socially undesirable. Bypass is costly, but it reduces market power and increases the variety of goods available to consumers. Regulation is an alternative mechanism to discipline the behavior of the incumbent, but provides no variety to consumers. We find that desirability of the two regulatory regimes depends critically on the degree of differentiation between the existing and potential network. Both marginal and average cost price regulation are considered