Identifying firm-level costs in District Heating when firms can endogenously exploit variation in competitive intensity across product markets

Abstract: Price constraints in the Swedish district heating (DH) market were removed in 1996 and since then there has been an ongoing debate about whether price regulation should be re-introduced or not. One of the problems for policy makers is that they have lacked important economic measures such as reliable data on firm-level costs. In this study, total firmlevel cost is estimated controlling for that DH firms can endogenously exploit variation in competitive intensity across the DH and electricity markets. Since the electricity market is subject to more intense competition, firms that provide both DH and electricity have incentives to strategically allocate costs from the electricity operation to the DH operation. This suspicion invalidates descriptive comparisons of costs based on the statistics provided by the Swedish Energy Markets Inspectorate. With a nearest-neighbor covariate matching algorithm it is revealed that firms that provide both DH and electricity inflate their DH costs with on average 16.00 %. This strategic cost manipulation is fully passed on to consumers who therefore are forced to subsidize the firms’ aggressive supply of electricity. To circumvent this problem, policy makers are advocated to price regulate firms that offer both DH and electricity.