Yardstick Regulation of Electricity Distribution Utilities Based on the Estimation of an Average Cost Function

In this paper we estimate an average-cost function for a panel of 45 Swiss electricity distribution utilities as a basis for yardstick regulation of the distribution-network access prices. Unlike the existing literature, we separate the electricity sales function of utilities from the network operation function. Several exogenous variables measuring the heterogeneity of the service areas were included in the model specification in order to allow the regulator to set differentiated benchmark prices incorporating this heterogeneity. We can identify different exogenous service area characteristics that affect average cost. These are the load factor, the customer density and the output density of different consumer groups. Moreover, the estimation results indicate the existence of significant economies of scale; i.e. most of the Swiss utilities in our sample are too small to reach minimum efficient scale. However, to give the small utilities incentives to merge the size of the utilities must not be included in the yardstick calculation.