Frontier Analysis of UK Distribution Networks and the Question of Mergers: A Critique of Ofgem
Since privatization, the 14 UK electricity distribution network operators (DNOs), being natural monopolies, have been subject to RPI-X regulation by the UK regulator (Ofgem). Mergers between the 14 DNOs have formed 7 identifiable ownerships (management teams). It is argued in this research that Ofgem has not used a sufficiently robust approach to benchmarking, and has therefore failed to accurately assess network efficiency gains. Furthermore, Ofgem has used invalid arguments against further mergers. By using more informative panel datasets, as well as a more robust estimation technique (Stochastic Frontier Analysis), this research reveals two crucial facts. Firstly, there is almost no more room for the DNOs in question to become more cost efficient, as the industry is operating close to minimum efficient scale. This suggests that Ofgem needs to widen its scope of benchmarking and regulation (e.g. quality-incorporated benchmarking). Secondly, there seems to be no increasing returns to scale in the industry, a more appropriate reason why further mergers should not take place.
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