The low cost of quality improvements in the electricity distribution sector of Brazil

We analyze the impact of introducing output-based incentives in the price-cap regulatory regime of the Brazilian electricity distribution sector. We focus on the trade-off between operating costs and quality improvement, hypothesizing a positive relationship. Operating costs include maintenance and repair expenses. The regulator sets limits for service continuity and non-technical energy losses in each regulatory period. Service continuity refers to the average length of interruptions in electricity distribution. Non-technical losses refer to losses due to factors specific to the distribution segment. Quality incentives include peer-pressure and penalties/rewards for compliance with minimum quality standards. We model operating costs using a GMM framework to acknowledge endogeneity of variables. The model is dynamic given the inclusion of regulatory lags to recognize past cost behavior. Findings reveal a small trade-off between costs and quality. We conclude that quality improvements are not costly relative to the potential savings from complying with quality standards. We also find that the impact on operating costs is larger when energy losses increase compared to the cost effect due to increases in duration of outages. These findings suggest areas of attention in managerial decision making, and serve as valuable information to the regulator in tailoring quality incentives for this sector.