Persistent and Transient Cost Efficiency An Application to the Swiss Hydropower Sector

Massimo Filippini,William H Greene,Thomas Geissmann

doi:10.2139/ssrn.2791525

Massimo Filippini, William H Greene + Show 1 more

Open Access

https://doi.org/10.2139/ssrn.2791525

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Abstract

Over the past few years, the price of electricity on the European market has decreased significantly and thereby the competitiveness and profitability of the Swiss hydropower firms has deteriorated. With one possibility to improve the sector’s competitiveness being an increase in the firms’ level of cost efficiency, the goal of this study is to quantify the firms’ level of persistent and transient cost efficiency using the generalized true random effects (GTRE) model introduced by Colombi et al. (2014) and Filippini and Greene (2015). Applying this newly developed GTRE model to a total cost function, the level of cost efficiency of 65 Swiss hydropower firms is analyzed for the period between 2000 and 2013. For comparison, a true random effects (TRE) specification is estimated alongside, serving as a benchmark for the transient level of cost efficiency. The results of the GTRE model show the presence of persistent as well as transient cost inefficiency. The existing level of persistent inefficiency could hinder the hydropower firms from reacting flexibly to new market environments.

Highlights

Ever since Switzerland’s electrification at the beginning of the 20th century, hydropower has been the country’s main domestic source of electricity
The generalized true random effects model (GTREM) predicts the aggregate level of cost inefficiency to amount to 21.8% (8.0% transient, 13.8% persistent) on average between 2000 and 2013
Microeconomic theory demands the cost function to be increasing in generated electricity and input prices

Summary

Introduction

Ever since Switzerland’s electrification at the beginning of the 20th century, hydropower has been the country’s main domestic source of electricity. Swiss hydropower firms have consolidated their position as reliable, cost effective and renewable base and peak load electricity producers. Hydropower has enabled Switzerland to play an active role on the European electricity market. The pursued business models can roughly be summarized as follows: run-of-river plants produce base load electricity while storage and pump-storage plants use their natural water inflows to help covering electricity demand at peak hours, usually occurring at noon and early evening. All three technology types produce for the domestic market, and are extensively involved in exporting activities to the European grid.

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