Estimating the marginal cost of improving services quality in electricity distribution utilities of Pakistan

Services quality of electricity distribution utilities has become an issue of prime importance for policymakers since the introduction of incentive-based regulation in electricity markets around the globe. Incentives-based regulatory scheme rewards distribution utilities for cost-savings as well as for improving services quality, creating a conflict in reaching optimal services quality. Therefore, regulators have now started to design regu-latory mechanisms by incorporating services quality in their incentive structures. In this regard, it is important for regulators to know about the cost of improving services quality for electricity distribution utilities. Thus, objective of this study is to present a comprehensive econometric framework to estimate the marginal cost of improving services quality associated with losses and interruptions. This study has used panel data for eight distribution utilities from 2006 to 2018. Results of One step system GMM indicate that distribution utilities exhibit diseconomies of scale which are higher than economies of density. Our results suggest that marginal cost of reducing distribution losses is Rs 44/kWh while the marginal cost of reducing 1 min interruption is Rs 0.02. We therefore suggest regulators to use the estimated marginal costs as a benchmark for designing effective incentives-based regulatory framework for distribution utilities in Pakistan.