Problem
The Canada Energy Regulator (CER) recently rejected the application by Enbridge Pipelines to change from a common carrier to a contract carrier. Regardless of its carrier status, the CER would exercise regulatory control over Enbridge's tolls to control its market power. Think of them being set to give Enbridge a competitive rate of return on its equity. Tolls are the prices that Enbridge charges for transporting oil.
Consider a pipeline with K units of capacity that connects the producing fields in A with the refiners in GC. The pipeline has proposed that instead of being regulated as a common carrier, (where all shipments are tolled the same and if demand is in excess of capacity, all shippers are apportioned the same percentage) that capacity be contracted to N shippers. The N shippers would have property rights to use their capacity (to ship their own oil or provide transport services to other shippers) or sell their contactual rights. The holder of the contractual rights, in exchange for these use rights, must pay CER approved tolls for the duration of the contract. The regulator has denied the application to convert to contract carriage on the basis that the capacity market created involving the N firms with contractual rights will not be competitive.
A. How would one of the N firms exercise market power?
B. What would determine if any of the N firms could exercise market power in oil transportation?
C. How would analysis of market power by the N firms be affected if unused capacity must be provided by the pipeline to potential shippers at a cost-based rate? [Assume that contract holders must commit to their usage in the next month sufficiently in advance that unused capacity can be made available to shippers prior to the beginning of the next month.]
D. Comment on whether a switch to contracting could ever enhance the exercise of market power.