ARE COMBINATION GAS AND ELECTRIC UTILITIES MULTIPRODUCT NATURAL MONOPOLIES? - Merrile Sing Presentation Eco 435 Date 31 January 2012

Overview of the presentation - Introduction -Literature review -Theoretical background and model -Data -Empirical Results -conclusion

Gas and electric services are provided in some locations by a single firm, in others by two firms. Since 1920s and 1930s there has been public debate about breaking up combination gas and electric utilities when holding companies dominated the energy industries. The public debate concerning the costs of combination versus separate gas and electric utilities started During 70s. This paper examines the scope and scale economies in the gas and electric utility industries to determine whether these services are more efficiently supplied by combination gas and electric utilities or by separate utilities. Introduction

Some relevant literatures Troxel (1947) argues that the potential cost savings from combining operations are greater than the losses from reduced competition. Kahn (1971) concludes that efficiency gains from cost reduction are not significant enough to justify precluding competition between two monopolies. Stevenson (1982) finds that reduced competition raised the cost of electricity generation by over 5% in Mayo (1984) finds that, with the exception of small firms, Combination utilities have higher costs than separate gas and electric utilities.

This paper estimates a multiproduct cost function for a cross section of 108 combination and separate gas and electric utilities using 1981 data. The estimated cost function indicates diseconomies of scope at the mean combination utility output vector. The average combination gas and electric utility, thus, is not a natural monopoly.

Theoretical background and model The cost structure of electric and gas utilities may be described with a multiproduct cost function: C = g(Y,P, D) where C = total costs Y = output vector P = input price vector D = distribution cost ratio (customers per square mile of service area). The cost function incorporates two assumptions about firm behavior: firms face exogenous output bundles and input prices, and subject to a given technology, firms employ input levels that minimize production costs

Functional form The cost structure of gas and electric utilities is estimated with a multiproduct hybrid translog cost function.

Data The cost equations are estimated with 1981 data from 108 utilities: 43 combination gas and electric utilities, 34 electric utilities, and 31 gas utilities. The universe of investor-owner electric utilities from the U.S. Department of Energy's Statistics of Privately Owned Electric Utilities and of gas distribution and combination utilities from the Statistical Services Department of the American Gas Association is paired down. Also, the author had included only those combination utilities that received at least 15% of their revenues from gas sales and at least 15% of their revenues from electricity sales in 198.

Empirical result regions of both scope economies and scope diseconomies. At the mean output vector for the combination utilities, (Ye, Yg) = ( , ) economies of scope are not present. Thus, the mean combination gas and electric utility is not a natural monopoly. SCj is at the combination utility mean output vector, suggesting that costs for the average combination utility could be decreased by 7.2% if electricity and gas are supplied separately. At the mean combination utility output vector product-specific economies of scale are present for electricity(S e = 1.66) but not for gas (Sg =.80)

Conclusion The estimated hybrid translog cost function for gas and electric utilities indicates that the multi-product cost function contains regions of both scope economies and diseconomies, with diseconomies of scope present at the mean combination utility output vector. Since many instances of scope diseconomies are found. It is concluded that factors other than cost savings must be advanced to explain mergers between gas and electric utilities. These findings do not imply that existing combination utilities should be split into separate gas and electric utilities. Also no evidence is found for the benefits from competition between two regulated energy utilities are substantially greater than the costs of corporate reorganization.

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