Strategic Cost shifting in the Swedish District Heating and Electricity Markets

Firms that operate combined heat and power (CHP) plants in Sweden face strong incentives to let their district heating (DH) customers subsidize the sales of electricity. This study investigates whether firms exploit the variation in competitive intensity across the two markets and 1) shift costs from electricity to DH, and 2) pass on any cost increase to consumers. A major empirical challenge is that firms endogenously decide whether to operate a CHP plant or not. Two different matching procedures are used to circumvent this problem. The results show that 1) compared with a similar non-CHP firm, the average CHP firm reports a DH cost that is 20ý25% higher, 2) the extra cost that CHP firms report is fully passed on to consumers and 3) with reported costs, the price-cost margin is 8% for both groups and with imputed costs the margin increases to 30-35% for the CHP firms. The results are consistent with the presence of strategic cost shifting, which can be tackled through either stricter accounting rules or DH price regulation.