Efficiency and restructuring in regulated energy networks: evidence from Germany and the US [Elektronische Ressource] / vorgelegt von Borge Hess

Efficiency and restructuring in regulated energy networks: evidence from Germany and the US [Elektronische Ressource] / vorgelegt von Borge Hess

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Efficiency and Restructuring in Regulated Energy Networks: Evidence from Germany and the US Dissertation vorgelegt von Dipl.-Volkswirt Borge Hess (geb. 02. Juni 1977) am 26. Februar 2008 an der Fakultät Wirtschaftswissenschaften der Technischen Universität Dresden zur Erlangung des akademischen Grades Doctor rerum politicarum (Dr. rer. pol.) Verteidigt am 10. Dezember 2009 Betreuender Hochschullehrer / 1. Gutachter: Prof. Dr. Christian von Hirschhausen (TU Dresden) Gutachter: Prof. Dr. Bernhard Wieland (TU Dresden) Prof. Dr. Andreas Stephan (Jönköping International Business School) Abstract Although the German framework of incentive-based energy regulation appears to be well-defined because it draws from international experience and eliminates several present drawbacks existing with revenue-cap regulation doubts of industry and politicians concerning the application of benchmarking techniques and more importantly, the future industry structure, remain. The regulation scheme is based on experience with energy sector reforms in the US due to it being a precursor in this regard, e.g. by introducing incentive-based regulation as early as 1994 and publishing the relevant data in a very detailed way.

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Efficiency and Restructuring in
Regulated Energy Networks:
Evidence from Germany and the US

Dissertation


vorgelegt von

Dipl.-Volkswirt Borge Hess
(geb. 02. Juni 1977)

am 26. Februar 2008

an der

Fakultät Wirtschaftswissenschaften
der Technischen Universität Dresden

zur Erlangung des akademischen Grades
Doctor rerum politicarum (Dr. rer. pol.)


Verteidigt am 10. Dezember 2009



Betreuender Hochschullehrer /
1. Gutachter: Prof. Dr. Christian von Hirschhausen
(TU Dresden)
Gutachter: Prof. Dr. Bernhard Wieland
(TU Dresden)
Prof. Dr. Andreas Stephan
(Jönköping International Business School) Abstract
Although the German framework of incentive-based energy regulation appears to be well-defined
because it draws from international experience and eliminates several present drawbacks existing with
revenue-cap regulation doubts of industry and politicians concerning the application of benchmarking
techniques and more importantly, the future industry structure, remain. The regulation scheme is based
on experience with energy sector reforms in the US due to it being a precursor in this regard, e.g. by
introducing incentive-based regulation as early as 1994 and publishing the relevant data in a very
detailed way.
This thesis therefore brings together the two issues of certain efficiency measurement problems and
the industry restructuring in Germany and the US in order to contribute to the current discussion of
robust benchmarking and to provide political implications related to the industry’s structure.
Therefore, the application of DEA and SFA constitutes the heart of the whole study. These techniques
are applied on German electricity DSOs as well as on data for US electricity DSOs and US gas TSOs.
The application to US data can then be used to derive information about business strategies and their
success in a sector that is being restructured. The US experience will lead to relevant German policy
implications with respect to the future structure of the energy industry in Germany.

Key words: electricity, natural gas, distribution, incentive regulation,
benchmarking, efficiency analysis, Data Envelopment Analysis
(DEA), Stochastic Frontier Analysis (SFA), mergers & acquisitions,
Germany, USA
I Acknowledgements
I am deeply grateful to my advisor, Christian von Hirschhausen, for his support in writing the thesis
and the opportunity to present research work associated to this thesis on international conferences and
to participate in several interesting workshops.
Furthermore, I would like thank those researches that introduced me to the subject of this thesis for
their effort and many fruitful discussions: Harold Fried, Subal Kumbhakar, Spiro Stefanou, Loren
Tauer, and especially to Andreas Stephan for agreeing additionally to be an examiner of my thesis. I
also acknowledge Helmut Seitz who kindly agreed to support my dissertation.
Many thanks go to my colleague Astrid Cullmann for intensive conversations and for her support all
the time. Moreover, I am grateful to my fellow colleagues at Dresden University of Technology,
especially Jan Abrell, Gunnar Dittrich, Elisabetta Fiorentino, Gerhard Kempkes, Maria Nieswand, and
Carsten Pohl, as well as Annika Frohloff, Christian Growitsch, and Ferdinand Pavel for discussions
and their help at different stages throughout my work.
Finally, I wish to thank my parents and my friends for their mental support.


Dresden, February 2008 Borge Hess

II Content
Abstract .................................................................................................................................................... I
Acknowledgements ................................................................................................................................. II
Content .................................................................................................................................................. III
List of Figures ........................................................................................................................................ V
List of Tables ......................................................................................................................................... VI
List of Appreciations ............................................................................................................................ VII
List of Symbols .................................................................................................................................. VIII
1 Introduction ..................................................................................................................................... 1
1.1 Motivation ............................................................................................................................... 1
1.2 Outline ..................................................................................................................................... 6
2 Analytical Foundations of Production Economics .......................................................................... 7
2.1 Introduction ............................................................................................................................. 7
2.2 Production Technology ........................................................................................................... 7
2.2.1 Set-Theoretic Representation ............................................................................................ 7
2.2.2 Production Frontiers .......................................................................................................... 9
2.2.3 Input Distance Functions ................................................................................................... 9
2.2.4 Cost Frontiers .................................................................................................................. 11
2.3 Technical and Cost Efficiency............................................................................................... 12
2.4 Economies of Scale ............................................................................................................... 15
3 Benchmarking Approaches ........................................................................................................... 16
3.1 Introduction ........................................................................................................................... 16
3.2 Overview ............................................................................................................................... 16
3.3 Non-Parametric Frontier Approaches.................................................................................... 18
3.3.1 Data Envelopment Analysis ............................................................................................ 18
3.3.2 Investigating Potential Gains from Mergers .................................................................... 21
3.3.3 Outlier Detection and Bootstrapping Procedures ............................................................ 24
3.4 Parametric Frontier Approaches ............................................................................................ 26
3.4.1 Stochastic Frontier Analysis ............................................................................................ 28
3.4.2 Panel Data Models ........................................................................................................... 30
4 Efficiency and Restructuring in Germany ..................................................................................... 36
4.1 Introduction ........................................................................................................................... 36
4.2 Industry Restructuring in the German Electricity Industry ................................................... 37
4.3 Literature Review .................................................................................................................. 38
4.4 Data ....................................................................................................................................... 40
4.5 Evaluating Structural Differences ......................................................................................... 42
4.5.1 Introduction ..................................................................................................................... 42
4.5.2 Methodology .................................................................................................................... 42
4.5.3 Hypotheses and Model Specification .............................................................................. 44
4.5.4 Empirical Results ............................................................................................................. 47
4.5.5 Conclusion ....................................................................................................................... 50

III 4.6 Evaluating Potential Gains from Mergers ............................................................................. 51
4.6.1 Introduction ..................................................................................................................... 51
4.6.2 Methodology .................................................................................................................... 52
4.6.3 Empirical Results ............................................................................................................. 53
4.6.4 Conclusions ..................................................................................................................... 59
4.7 Conclusion ............................................................................................................................. 60
5 Efficiency and Restructuring in the US ......................................................................................... 61
5.1 Introduction ........................................................................................................................... 61
5.2 Industry Restructuring in the US Electricity Industry ........................................................... 61
5.3 Industry Restructuring in the US Natural Gas Industry ........................................................ 64
5.4 Literature Review .................................................................................................................. 66
5.5 Data ....................................................................................................................................... 67
5.6 Evaluating Parametric Frontier Estimation Techniques ........................................................ 73
5.6.1 Introduction ..................................................................................................................... 73
5.6.2 Methodology .................................................................................................................... 74
5.6.3 Estimation Results ........................................................................................................... 75
5.6.4 Conclusions ..................................................................................................................... 77
5.7 Evaluating Gains from Mergers in the Electricity Industry .................................................. 78
5.7.1 Introduction ..................................................................................................................... 78
5.7.2 Methodology .................................................................................................................... 78
5.7.3 Estimation Results ........................................................................................................... 80
5.7.4 Conclusion ....................................................................................................................... 85
5.8 Evaluating Business Strategies in the Natural Gas Industry ................................................. 86
5.8.1 Introduction ..................................................................................................................... 86
5.8.2 Methodology .................................................................................................................... 86
5.8.3 Estimation Results ........................................................................................................... 87
5.8.4 Conclusion ....................................................................................................................... 90
5.9 Conclusion ............................................................................................................................. 91
6 Summary and Conclusions ............................................................................................................ 93
A Appendix A ................................................................................................................................... 97
B Appendix B ................................................................................................................................. 103
References ........................................................................................................................................... 106

IV List of Figures
Figure 2.1: Input Requirements ............................................................................................................... 8
Figure 2.2: An Input Distance Function with Two Inputs ..................................................................... 10
Figure 2.3: The Measurement and Decomposition of Cost Efficiency ................................................. 14
Figure 3.1: Overview of Benchmarking Approaches ............................................................................ 17
Figure 3.2: Scale Efficiency Measurement in DEA .............................................................................. 21
Figure 3.3: Overview of Parametric Frontier Approaches .................................................................... 27
Figure 3.4: The Stochastic Production Frontier .................................................................................... 29
Figure 4.1: Restructuring within the Transmission Business in Germany ............................................ 38
Figure 4.2: German Electricity Distribution System Operators ............................................................ 38
Figure 4.3: Outlier in DEA Model 2 of Hirschhausen, Cullmann, and Kappeler (335 obs.) ................ 48
Figure 4.4: Synergy and Scale Effects According to Size ..................................................................... 54
Figure 5.1: U.S. Investor-Owned Electric Utility Holding Companies ................................................. 62
Figure 5.2: U.S. Natural Gas Pipeline Network .................................................................................... 64
Figure 5.3: U.S. Principal Interstate Natural Gas Flow Summary, 2005 .............................................. 65


V List of Tables
Table 3.1: Returns to Scale Specifications in Data Envelopment Analysis .......................................... 20
Table 3.2: Econometric Specification of the Stochastic Production Frontier ....................................... 33
Table 4.1: Summary Statistics; German Electricity Distribution Companies (323 Observations) ....... 41
Table 4.2: Regional Differences of the Sample of East and West German Utilities ............................. 44
Table 4.3: The Model Specification Used ............................................................................................. 47
Table 4.4: DEA Results under CRS of the Models of Hirschhausen, Cullmann, and Kappeler ........... 48
Table 4.5: DEA and SFA Results .......................................................................................................... 49
Table 4.6: Pearson Correlation Coefficients ......................................................................................... 50
Table 4.7: Summary of Merger Effects with (Pair-wise Merger, 322 obs.) .......................................... 53
Table 4.8: Ten Most Promising Mergers ............................................................................................... 55
Table 4.9: Characteristics of Mergers and the Sample .......................................................................... 56
Table 4.10: Relative Similarity and Synergy and Scale Effects ............................................................ 58
Table 4.11: Comparison of Synergy Effects from Different Merger Scenarios .................................... 59
Table 5.1: Summary Statistics; US Electricity Distribution Companies (1,296 Observations) ............ 69
Table 5.2: Year of Mergers Covered of Electricity Distribution Companies ........................................ 70
Table 5.3: Summary Statistics; US Electricity Distribution Companies (864 Observations) ............... 70
Table 5.4: Summary Statistics; US Gas Transmission Companies (470 Observations) ....................... 71
Table 5.5: Year and Frequency of Acquisitions Covered of US Gas Transmission Companies .......... 72
Table 5.6: Distance Function Parameters: Panel Data (1994-2005) ..................................................... 76
Table 5.7: Summary of Efficiency Measures ........................................................................................ 76
Table 5.8: Estimation Results of the Cost Function .............................................................................. 80
Table 5.9: Estimation Results of the Efficiency Function ..................................................................... 82
Table 5.10: Summary of Inefficiency Measures ................................................................................... 84
Table 5.11: Economies of Scale Estimates for the Median Company .................................................. 84
Table 5.12: Estimation Results of the Production Function .................................................................. 88
Table 5.13: Estimation Results of the Efficiency Function ................................................................... 89
Table 5.14: Summary of Efficiency Measures ...................................................................................... 90
Table A.1: Mergers in the Electricity Sector Approved by FERC 1995-2001 ...................................... 97
Table A.2: Overview of the Holding Structure in 2007; US Gas Transmission Companies ................ 98
Table A.3: Variable Definition and Sources; US Electricity Distribution Companies ....................... 101
Table A.4: Variable Definition and Sources; US Gas Transmission Companies................................ 102


VI List of Appreciations
Appreciations Explanation
AE Allocative Efficiency
BNetzA Bundesnetzagentur
CAPEX Capital Expenditures
CE Cost Efficiency
COLS Corrected Ordinary Least Squares
CRS Constant Returns to Scale
DEA Data Envelopment Analysis
DMU, DMUs Decision Making Unit(s)
DOJ US Department of Justice
DSO, DSOs Distribution System Operator(s)
EIA Energy Information Administration
ES Economies of Scale
FE Fixed Effects
FERC Federal Energy Regulatory Commission
FDH Free Disposal Hull
GLS Generalized Least Squares
GWh Giga Watt Hour
HCK Hirschhausen, Cullmann, and Kappeler (2006)
HE Synergy or Harmony Effect
IDI Inverse Density Index
IOU, IOUs Investor Owned Utility (Utilities)
kWh Kilo Watt Hour
M&As Mergers and Acquisitions
ML, MLE Maximum Likelihood (Estimation)
MWh Mega Watt Hour
MOLS Modified Ordinary Least Squares
NDRS Non-Decreasing Returns to Scale
NIRS Non-Increasing Returns to Scale
OPEX Operating expenditures
OLS Ordinary Least Squares
RE Random Effects
RPI Retail Price Index
SE Scale Efficiency Effect
SFA Stochastic Frontier Analysis
VII Appreciations Explanation
TE Technical Efficiency
TFP Total Factor Productivity
TOTEX Total Expenditures
TSO, TSOs Transmission System Operator(s)
UK United Kingdom
US, USA United States of America
VRS Variable Returns to Scale
X-factor Performance Improvement Factor


List of Symbols
Symbol Explanation
C Total Costs
c(.) Cost Function/Frontier
d Dummy Variable
D (.) I Input Distance Function
E Electricity Sold
Eff L(y) Input Efficient Subset
f(.) Production Function/Frontier
J Measure of Potential Gains from Synergy of Merged Companies (Synergy H
Index)
Isoq L(y) Input Isoquants
J Number of Merging Companies
Excluded Dataset with i observations in Wilson Outlier Procedure, Wilson L(i)
(1993)
L(y) Input Requirement Set
r Residual Term in Panel Data Models
S Entire Dataset in Wilson Outlier Procedure, Wilson (1993)
J
S Measure of Potential Gains from Scale of Merged Companies (Scale Index)
t Time Trend
J Measure of Potential Gains from Reducing Technical Inefficiency of Merged T
Companies (Technical Efficiency Index)
u Inefficiency
v Statistical Noise
X, x, x Output Quantity, Output Set
Y, y, y Input Quantity, Input Set
z Structural Variables
VIII