Ownership and district heating prices: The case of an unregulated natural monopoly
Results of the study
The results show that district heating prices in networks owned by private companies are 3% higher than the average price of municipally-owned networks, and that the price differential is concentrated in the fixed component. The fixed component of the district heating price in networks owned by private companies is 17% and 24% higher than the average fixed price component in municipally-owned networks for MDB and SFH, respectively, which may indicate that private companies generally prioritize profit maximization.
District heating prices are slightly higher in private networks than in municipally-owned networks. The different objectives of municipal and private companies may partially explain these differences. Energy companies use a price-setting strategy based on the price of district heating substitutes, such as heat pumps. Self-regulation platforms such as the “Price Dialogue” can increase transparency between energy companies and consumers.
District heating networks are local natural monopolies, and, as such, the possibility of exercising market power cannot be ruled out. District heating prices in Sweden are unregulated and differ between networks, which have different ownership types. The ownership of district heating networks has diversified since deregulation measures were introduced in 1996. These price differentials may be justified by local network characteristics that affect the costs of district heating systems. However, if ownership could also explain the differences in prices, these effects need to be estimated. Ownership may affect price setting if the objectives of the companies differ. For example, private companies may prioritize profit maximization, while municipal companies may have broader social objectives, which allow them to sacrifice profits to achieve such objectives. The research article “Ownership and district heating prices: The case of an unregulated natural monopoly” investigates to what degree ownership can explain the differences in prices among district heating networks. The empirical analysis is based on data on district heating prices, ownership status, and network characteristics for the period 2012-2017.
Differences in Swedish district heating prices
District heating prices typically have a two-part tariff structure consisting of a fixed and a variable component. District heating companies primarily use a fixed fee, a variable component, and seasonal variations to increase their ability to compete with heat pumps. In the absence of district heating’s fixed charges and seasonal adjustments, consumers may find it attractive to install heat pumps as a complement to district heating. They would then use heat pumps as the main heating source in the winter and district heating in the summer.
I examine whether the price differential corresponds to the fixed and variable components of the price in multi-dwelling buildings and single-family houses. This distinction between the price components is useful in investigating whether the objectives of the companies, characterized by their ownership type, explain the price differentials between the Swedish district heating networks. In the case of a two-part tariff, a profit-maximizing monopolist may use the fixed component of the price to extract as much as possible of the consumer surplus. Likewise, a cost-based monopolist may use the fixed price component to cover their fixed costs and avoid losses.
District heating is not exempt from the competition of other heating alternatives, at least in the long run, considering switching costs. For example, ground-source heat pumps have become more competitive in recent years because of their increased efficiency. Besides, electricity prices may also affect the relative prices of district heating and heat pumps. Another aspect that characterizes the Swedish district heating market is the Price Dialogue, a self-regulation platform instituted by district heating and real estate companies where these parties meet and discuss future prices.
Private contra municipally-owned heating networks
The objectives of the companies may explain, at least partially, the price differentials between district heating networks. Privately-owned companies generally prioritize profit maximization. In contrast, municipally-owned companies have other social and political objectives that prevent them from increasing prices. Despite the social objectives of municipal companies, they also have the possibility to exercise some market power. However, if so, the results imply that municipally-owned companies exercise market power to a lesser degree than privately-owned ones.
The investigation also confirm that district heating prices are correlated with the price of heating with heat pumps, regardless of ownership, which suggests a general price-setting strategy based on the price of substitutes. Concerning the Price Dialogue, the results show that district heating prices in multi-dwelling buildings are 2.7% higher in networks that are members of the Price Dialogue compared with those that are not. In single-family houses the difference is 1.3% However, this result should not be interpreted as a causal relationship. The Price Dialogue aims to promote transparency and trust between district heating companies and their customers. It is unclear whether more transparency and trust could affect the possibilities to set higher prices.
From a policy perspective, the question of price regulation is always valid in natural monopolies where market power may be exercised. However, price regulation is not always justified because regulating prices is not costless. Relative to the average household’s disposable income, the differences in prices between ownership types are minimal, and it is very unlikely that consumers will exert pressure in favor of price regulation, at least in the current situation.
Text by: Alejandro Egüez, e-mail
Centre for Environmental and Resource Economics (CERE), Umeå University
References
Here you find the doctoral thesis by Alejandro Egüez which the above article is based on.
Energy efficiency, district heating and waste management: essays on environmental economics
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