Regulation and efficiency in UK public utilities

Stead, Alexander David

Economics; Business
October 2017

Thesis or dissertation


Rights
© 2017 Alexander David Stead. All rights reserved. No part of this publication may be reproduced without the written permission of the copyright holder.
Abstract

[From the Introduction]:
The divestiture of formerly nationalised public utilities during the 1980s and 1990s in the UK and elsewhere was accompanied by the vertical unbundling of their natural monopoly elements, i.e. the physical distribution networks, from upstream activities such as electricity generation and gas supply and downstream activities such as retail in order to facilitate competition in the latter. The expectation was that opening up these upstream activities to private firms would foster competition, which would in turn lead to improvements in efficiency, lower prices and increased consumer welfare. There are, on the other hand, possibilities for considerable rents to be made; these could be in the form of profits, but given the regulation that the firms face and the degree of informational asymmetry between utility managers and other stakeholders, such as regulators, shareholders, and customers, they may also take the form of slack within the firm, and the maximisation of managerial utility.

We analyse the effect of RPI-X regulation on the efficiency of the UK’s water and sewage and electricity distribution industries using stochastic frontier analysis. We extend the literature in several ways; first, in the case of the water and sewage industry, we look at efficiency not only on the cost side, but also on the revenue side. Second, following the findings of Restrepo-Tobón and Kumbhakar (2014) on the shortcomings of the direct estimation of the alternative profit frontier, we show that the profit maximisation problem of a monopolist with fixed scale characteristics separates into separate cost minimisation and revenue maximisation problems, then derive an alternative specification for the revenue frontier with a firmer basis in theory. Third, we include the publicly-owned Northern Ireland Water and Scottish Water, and the three former Scottish Water Authorities that preceded the latter, in our water cost and revenue analyses, and likewise include Northern Ireland Electricity in one of our cost analyses, providing an original insight into the performance of these utilities relative to their English and Welsh and Great British counterparts, respectively. In addition, we use more recent samples than those found in the literature, providing new evidence relating to the latest price control periods in both industries.

We derive two new formulae for calculating the marginal effects of environmental variables on efficiency, and apply these to analyse the impact of annual price caps and time trends on revenue and cost efficiency, giving an insight into the static and dynamic impacts of RPI-X regulation, while also examining the impact of board composition variables and public ownership.

This thesis is organised into seven chapters. In the remainder of Chapter 1, we give a short history of the UK water and electricity industries. In Chapter 2, we introduce basic efficiency-related concepts, before moving on to discuss issues of market power and firm performance in utility firms,
and the theory relating to utility regulation.

In Chapter 3, we review the literature on frontier analysis, introducing some of the main data envelopment analysis (DEA) and stochastic frontier analysis (SFA) methods in particular. The relative advantages and disadvantages of each method are considered, and the features of the method used in the subsequent empirical chapters are discussed.

Chapter 4 reviews the empirical literature on the performance of water and electricity utilities in the UK and internationally, along with several papers on the impact of regulation on the performance in other utility industries. Chapter 5 and Chapter 6 apply SFA to analyse the efficiency of UK water and sewage and electricity distribution utilities, respectively. Efficiency predictions are discussed and compared, trends are discussed, and the marginal effects of our environmental variables on the various efficiency measures are derived and discussed at length.

Finally, Chapter 7 summarises the conclusions from our analyses and relates them back to the existing literature, and discusses implications for utility performance and policy. The limitations of this thesis, and suggestions for future research, are also discussed.

Publisher
Business School, The University of Hull
Supervisor
Dobson, Stephen; Trotter, Steve; Hammond, Christopher J.
Qualification level
Doctoral
Qualification name
PhD
Language
English
Extent
2 MB
Identifier
hull:16418
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