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Conditional Yardstick Competition in Energy Regulation

Author

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  • Timo Kuosmanen
  • Andrew L. Johnson

Abstract

Yardstick competition is a regulation regime that forces local monopolies to compete against a variable cost or total cost benchmark. The variable cost benchmark ignores the fixed capital, creating a strong incentive to over-invest, whereas the total cost benchmark assumes all costs to be variable, ignoring the investment risk. We propose theoretical, methodological, and operational advances to increase applicability of yardstick competition in energy regulation. In the proposed conditional yardstick regime capital is treated as a fixed input, and the local monopolies compete against the variable cost conditional on the fixed input. We develop a benchmarking method that can handle multiple outputs, heterogeneity, and shape constraints to ensure incentive compatibility. We discuss the real-world application of the proposed regime to the Finnish electricity distribution firms in 2016-2023. We argue that smarter regulation of network industries can contribute to lower risk premiums and help to achieve win-win solutions both in terms of reliability and affordability.

Suggested Citation

  • Timo Kuosmanen & Andrew L. Johnson, 2020. "Conditional Yardstick Competition in Energy Regulation," The Energy Journal, , vol. 41(1_suppl), pages 67-92, June.
    • Handle: RePEc:sae:enejou:v:41:y:2020:i:1_suppl:p:67-92
    DOI: 10.5547/01956574.41.SI1.tkuo
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    References listed on IDEAS

    as
    1. Oseni, Musiliu O. & Pollitt, Michael G., 2016. "The promotion of regional integration of electricity markets: Lessons for developing countries," Energy Policy, Elsevier, vol. 88(C), pages 628-638.
    2. Mark Armstrong & Simon Cowan & John Vickers, 1994. "Regulatory Reform: Economic Analysis and British Experience," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262510790, April.
    3. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, April.
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    Citations

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    Cited by:

    1. Timo Kuosmanen & Sheng Dai, 2023. "Modeling economies of scope in joint production: Convex regression of input distance function," Papers 2311.11637, arXiv.org.
    2. Asantewaa, Adwoa & Jamasb, Tooraj & Llorca, Manuel, 2023. "Electricity sector reforms and cost efficiency: The case of small electricity systems in Sub-Sahara Africa," Economic Analysis and Policy, Elsevier, vol. 80(C), pages 880-893.
    3. Asantewaa, Adwoa & Jamasb, Tooraj & Llorca, Manuel, 2022. "Reforming Small Electricity Systems: Market Design and Competition," Working Papers 12-2022, Copenhagen Business School, Department of Economics.
    4. Zhiqiang Liao, 2024. "Variable selection in convex nonparametric least squares via structured Lasso: An application to the Swedish electricity distribution networks," Papers 2409.01911, arXiv.org, revised Nov 2024.
    5. Liao, Zhiqiang & Dai, Sheng & Kuosmanen, Timo, 2024. "Convex support vector regression," European Journal of Operational Research, Elsevier, vol. 313(3), pages 858-870.

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    More about this item

    Keywords

    Electricity distribution; Heterogeneity; Incentive regulation;
    All these keywords.

    JEL classification:

    • F0 - International Economics - - General

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