The traditional view of electricity distribution is that it is
a natural monopoly. Few authors have explored the question as to
whether electricity distributors truly are natural monopolies or
not, while observation of the current industrial practice tends to
suggest that a market for distribution activities does actually
exist.
Slide 3
In 2002, Stephen Littlechild showed that privatisation of the
electricity industry in the UK had made the generation and retail
supply of electricity competitive based, on access to transmission
and distribution systems. However, he questioned whether the
remaining fraction could be exposed more directly to the
competitive market.
Slide 4
In this paper we discuss this question for the electricity
distribution sector.
Slide 5
In the electricity distribution case, in practice, monopoly and
outsourcing seem to coexist and this gives an ambiguous status to
the sector.
Slide 6
Therefore we open this section with a theoretical debate over
the question of whether competition for the market could improve
productive efficiency of public service utilities.
Slide 7
Firstly, we analyze the literature exploring natural monopoly
questions in the context of electricity distribution. We then
confront the traditional view to the current practice of the
industry in the distribution segment and underline the existence of
a form of competition (competition for the market) which seems to
be developing in this sector.
Slide 8
Finally, we discuss the organisational and policy implications
of introducing competition for the market in this segment.
Slide 9
We conclude by arguing that indeed, the traditional approach
considering the electricity distribution sector is that of a
natural monopoly and that this seems to be appropriate when it
comes to provision of the infrastructure (the low voltage wires).
It makes no sense to duplicate an electricity distribution network
if access to it can be granted for all customers at an economically
efficient price.
Slide 10
However, our main argument is that what is essential in
understanding industry practice is to distinguish the provision of
the infrastructure from the provision of the supplied services
associated with it. The services, in this case, are not only the
delivery of electricity to connection points, but also operating
the infrastructure and maintaining a defined quality of
service.
Slide 11
Our proposal is, hence, to consider the separation between (a)
infrastructure provision in distribution and (b) associated
services. We draw some lessons from other network industries, which
would imply the possibility of putting distribution operation
activities out to tender, either partially or wholly.
Slide 12
It is generally assumed that competition is impossible in the
electricity distribution business. This has been explained by the
presence of local electricity networks, which cannot be duplicated
at a reasonable cost (Newbery, 1999). Hence, these networks have
natural monopoly characteristics which justify, indeed necessitate,
public regulation of the sector.
Slide 13
However, in the 1960s, the failures of regulation raised a
debate on the alternatives to traditional modes of regulation,
initiated by Demsetz (1968). He argued that, the theory of natural
monopoly is deficient for it fails to reveal the logical steps that
carry it from scale economies in production to monopoly price in
the market place.
Slide 14
Thus, even if scale economies impose a single supplier ex-post,
competition is possible through auctioning the right to serve.2
This way, competition would lead to a lower price than the natural
monopoly price, due to the initial selection of the most efficient
candidate.
Slide 15
From this paper, I figured out that the network part of the
business, the distribution, kept its regulated monopoly status,
while the supply part has been opened to competition.
Slide 16
In the economic literature competition is the most appropriate
tool to improve efficiency. However, competition is impossible when
the reproduction of the infrastructure is uneconomic or when the
cost of the good or service is the lowest when supplied by a single
firm. The latter is the case of natural monopoly. It is considered
to apply in the case of electricity distribution as it is widely
believed that one company can distribute energy at a lower cost
than any two companies with two parallel infrastructures.
Slide 17
Few authors have empirically explored the question as to
whether the underlying cost structure of electricity distributors
really indicates a natural monopoly: (Kinnunen, 2003; Viljainen,
2005; Ajodhia, 2006) assume that distributors are natural
monopolies. Indeed, it is always less expensive to connect a new
customer to an existing network rather than building a parallel
network for this purpose. In 1998 Salvanes and Tjotta studied the
Norwegian electricity distribution sector and found that it is
characterised as a natural monopoly. Their subadditivity test shows
that the mean output is more efficiently produced by a single firm
than by two firms, considering all feasible share of production for
both firms. In 1999, Gunn and Sharp questioned the natural monopoly
characteristics of the distribution considering that while much has
been written on the electricity industry in general, little
attention has been focused on electricity distribution. This is
probably due to widespread acceptance of the belief that it is a
natural monopoly.
Slide 18
In 1987 the Government of New Zealand removed the exclusive
territorial franchises of electricity supply companies in order to
allow them to compete with each other for retail energy services.
As a consequence, each distributor obtained open access rights to
construct new lines in any of the other companies previous
franchise areas. Thus, the companies responsible for electricity
distribution and retailing in New Zealand are in fact competing
with each other, not just for retail services i.e. energy sale,
which was intended, but for distribution services as well i.e.
network connection. As this type of competition seems contrary to
the natural monopoly hypothesis in electricity distribution.
Slide 19
According to Gunn and Sharp (1999),New Zealands regulatory
regime is such that electricity distribution has taken on the two
key characteristics of a contestable market: no barriers to entry
(particularly in the form of sunk costs) and no price response by
the incumbent to entry by a competitor. The authors concluded that,
New Zealands electricity distributors may well be sustainable
natural monopolies even if this regime introduces elements of
contestability which, in theory, might allow potentially
inefficient competitive behaviour.
Slide 20
The first limitation is related to the unbundling of the
distribution activity from the supply activity as imposed by the
European Directive. The aim was to stimulate competition in a
sector which had historically been vertically integrated. Thus,
these Directives led to a reorganisation of the distribution
business and to consequential changes in the cost structure of
distribution companies. The second limitation is related to the
cost structure of a distribution company. The evaluation of their
costs should take into account fixed costs as well as variable
costs, i.e. capital and operating costs. The third limitation is
related to the current transformations of organisational forms of
distribution companies
Slide 21
Hence we propose a view that clearly distinguishes between (a)
the owner of the network and (b) the operator of the network. In
what follows we provide practical examples supporting this
argument.
Slide 22
The current allocation of functions of the electricity
distribution sector makes the studies discussed above (Salvanes and
Tjotta, 1998; Gunn and Sharp, 1999) difficult to apply. The reason
is that the authors have studied distribution using a single cost
function with natural monopoly characteristics while current
practice in the industry shows that part of these monopolistic
activities are less expensive when performed outside the supposed
monopoly. For example in France, part of distribution activities
are either shared between EDF distribution centres or fully
externalised to third companies. In the United Kingdom the
situation is similar: distribution activities have been contracted
out to companies other than the owner of the network (EDF Energy
won a bid for ensuring the maintenance and reliability of London
Underground network).