Environmental and Energy Efficiency of EU Electricity Industry: An Almost Spatial Two Stages DEA Approach.

• Author: Bigerna, Simona
• Position: European Union - Data Envelopment Analysis - Report - Statistical table

1. INTRODUCTION

   The analysis of the dynamics of Environmental and Energy Efficiency (hereafter EEE) is attracting growing attention in recent years in both academic and policy level since innovation and diffusion of more energy-efficient technologies is a key factor of the EU 2030 Climate and Energy Strategy to make carbon free power generation and increase the energy performance of national system.

   EEE in production, transformation and consumption allows to reach European Union (EU) greenhouse gas reduction target faster (EEA, 2016). EEE is a crucial key in the transformation sector to make carbon free power generation. Internal and external factors are changing the traditionally largely asset-based industry moving to a new and more complex decentralized generation system. Internal factors refer to technological changes (Jamasb and Pollitt, 2008) and to the fuel energy mix that deeply changed in EU countries also due to the widened spread of renewable energy sources (Krozer, 2013). External factors involve policy and regulatory interventions (Knittel, 2002), changes in consumers' preferences (Stigka et al., 2014) and environmental attitude (Bigerna et al., 2016).

   This paper intends to contribute to the literature developing a framework to measure the technical EEE of EU electricity industries taking into account: i) both non-separable "good" and "bad" outputs; ii) the impact of sector and environmental regulation; iii) the spatial component in technical efficiency explanation.

   The methodological approach is based on a two stage strategy; first, a non-parametric methods such as Data Envelopment Analysis (DEA) is used to measure the EEE in electricity sector using the Malmquist Index (MI) of Total Factor Productivity (TFP), the overall TFP growth is then decomposed into its three components: i) technological change, ii) pure efficiency change and iii) scale efficiency change in order to obtain a more complex picture of the effects of policy on TFP change. In the second stage we apply an econometric analysis regressing the measure of efficiency derived in the first stage on the sector and environmental regulation indicators and on the spatial contiguity indicator.

   Three are the novelties of this paper. First the efficiency valuation of the electricity sector considers, along with the electricity production, the greenhouse gas emissions as the undesirable output (Scheel, 2001; Yang and Pollit, 2009). Second, we enlarge the boundary of regulation analysis takes into the account, along with the market regulation indicators, the effects on the efficiency of the environmental policy stringency. Third, we analyze the effect of spatial contiguity on the aggregated MI.

   The paper is organized as follows. Section 2 presents a literature review, methods and data used in the analysis explaining first the DEA approach used to evaluate the TFP growth and then the dynamic panel method applied to evaluate the effect of the stringency of both sector and environmental policy tools and spatial contiguity. Empirical results are presented and discussed in Section 3. Finally, some concluding remarks are exposed in Section 4.

2. MATERIALS AND METHODS

   2.1 Related literature

   The reform programs in the European Electricity sectors were undertaken for various reasons: political ideology, improving government finance, promoting an European single market, expanding the internal market to network services (Florio, 2014), reducing the operating costs and the retail prices (Joskow, 2008). The reforms have addressed different aspects of liberalization such as unbundling network from generation to retailing, reducing collusion among large companies, eliminating barriers to entry and transforming individual state owned monopolies into a single competitive market. The pro-competitive reforms made this traditionally large asset based industry into decentralized generation system. Restructuring, liberalizing and privatizing the electricity sector in EU countries have been the focus of many studies to evaluate the performance of electricity sector and to assess implementation of reforms. Numerous papers provide conceptual discussions of electricity market restructuring and prescribe the appropriate steps to be taken in implementing reforms.

   An overview of experiences in several OECD countries where generation segments has largely been deregulated while transmission and distribution continue to be regulated is provided by Al-Sunaidy and Green (2006) and Joskow (2008). Al-Sunaidy and Green (2006) show that one compelling reason for the reform in the electricity generation is the lack of natural monopoly in this segment which is common feature of the transmission segment. Joskow (2008) presents the standard liberalization prescriptions to successfully reforming the electricity-supply industry and to promote performance improvements; some of the main steps are privatization of formerly state-owned and vertically integrated monopolies; vertical separation (or unbundling) of the sector to prevent cross-subsidization among various segments and to ensure equal access to the network for all competitors. They also recommend the horizontal restructuring of the generation segment to allow competition in power production, and the integration of transmission facilities with network operation to create an independent system operator.

   Jamasb and Pollitt (2005) discuss the progress of electricity market reform in EU countries. The authors noted that EU countries reached significant level of competition through the liberalization process, but the achievement of an European single market for electricity if far from being realized.

   The link between efficiency and regulation in the electricity sector has been already studied by several authors: Steiner (2000), Hattori and Tsutsui (2004), Pollit (2008), Fiorio and Florio (2013), Pompei (2013), Hyland (2016) and Ajayi et al. (2017).

   The ambiguous impact of unbundling vertically-integrated monopolies has been discussed by Pollit (2008) which highlights the two potentially opposite effects: on one hand unbundling fosters competition and improves the operational efficiency, on the other it implies the loss of scope and coordination economies, increasing operational costs. The empirical analysis of Hattori and Tsutsui (2004) finds that competition and unbundling caused an increase of wholesale prices in OECD countries.

   Fiorio and Florio (2013) investigated the effect of reform on a different notion of efficiency explained by the level of retail prices in 15 Countries for the years 1978-2006. Findings are not univocal: unbundling and free entry market regulation are not statistically significant, while privatize ownership is associated to higher electricity prices. Private ownership may decrease inefficiencies, but this will not necessarily translate in lower prices due to the lower elasticity of electricity demand. Authors highlight the core role of regulation to protect consumers: increasing competition will result in lower operational costs and benefits for consumers only if there is a stringent regulatory oversight.

   To depict the stringency of electricity market regulation and analyze the effect on the performance of the sector, we restrict the scope to OECD's Product Market Regulatory (PMR) indicator to obtain an harmonized index at the country level. The index evaluates at country level how regulation fosters competition reducing state involvement in business sectors, making it easier for entrepreneurs to create firms and to expand them and facilitating the entry of foreign products and firms.

   Steiner (2000) makes the first use of OECD regulatory database to design 8 indicators used to analyse the effect of the first wave of reforms for the 19 OECD countries. She finds that privatization and a lower degree of vertical integration have positive effect on a physical measure of efficiency derived from the utilisation capacity and the optimal reserve margin rate. In this vein even Pompei (2013) and Fiorio and Florio (2013) used the OECD regulatory indicators as measures of the stringency of market regulation. Pompei (2013) uses OECD regulatory indicator to look at the effects of the reforms on the TFP growth for the electricity sectors of 19 OECD countries. He finds that lower entry barriers promote the shift of technological frontier, while vertical integration worsen the pure efficiency, that is the ratio between output produced and the input deployed. Ajayi et al. (2017) analyze the performance of OECD's power generation sectors in terms of cost efficiency accounting for the impact of electricity market structures. The research findings suggests there is a significant impact of OECD's PMR indexes (explaining the market structure) on cost. Hyland (2016) estimates the impact of restructuring process on wholesale electricity prices using as market restructuring variable the index from OECD's Energy Transport and Communication Regulation (ETCR) database. She finds that restructuring has, as of yet, no statistically significant impact on electricity prices.

   The significant change taking place in European energy markets concurrently with market restructuring is the increased focus on decarbonization as a policy objective. Climate change and greenhouse gas emission have become environmental concerns more and more pressing in the political agenda, addressing governments to stimulate eco-innovation. EEE has become one of the core pillar of the EU 2030 Climate and Energy Strategy. In particular EEE has been identified as a preferential means to improve the performance of the national energy system as it could help foster sustainable energy transition and eco-innovation.

   International debate has provided several definitions of eco-innovation, among them, the most complete one is given by Kemp and Pearson (2007), according to which eco-innovation is "the production, assimilation or exploitation of product, product...