Estimating the cost of improving quality in electricity distribution: A parametric distance function approach

The quality of electricity distribution is being more and more scrutinized by regulatory authorities, with explicit reward and penalty schemes based on quality targets having been introduced in many countries. It is then of prime importance to know the cost of improving the quality for a distribution system operator. In this paper, we focus on one dimension of quality, the continuity of supply, and we estimated the cost of preventing power outages. For that, we make use of the parametric distance function approach, assuming that outages enter in the firm production set as an input, an imperfect substitute for maintenance activities and capital investment. This allows us to identify the sources of technical inefficiency and the underlying trade-off faced by operators between quality and other inputs and costs. For this purpose, we use panel data on 92 electricity distribution units operated by ERDF (Electricite de France - Reseau Distribution) in the 2003-2005 financial years. Assuming a multi-output multi-input translog technology, we estimate that the cost of preventing one interruption is equal to 10.7 for an average DSO. Furthermore, as one would expect, marginal quality improvements tend to be more expensive as quality itself improves. (C) 2012 Elsevier Ltd. All rights reserved.