Price Responsiveness in District Heating: Single Houses and Residential Buildings—a Cross-Sectional Analysis

Price responsiveness is argued to be one important factor determining the possibility for a natural monopoly such as a district heating company to exercise its monopoly power. Increased price responsiveness, measured, for example, by the own price elasticity, reduces monopoly power, as consumers increasingly reduce demand as a response to a price increase. However, consumers in single houses having individual metering have presumably higher price responsiveness compared to consumers in residential buildings using collective metering. One major question raised in this paper is thus whether single houses show larger price responsiveness compared to residential buildings. Using cross-sectional data for 187 networks in Sweden for the year 2007 indicates that even if single houses have higher price responsiveness, district heating reveals in general a very inelastic behavior. 1. Introduction The Swedish energy markets were reregulated in 1996 and this had a significant influence on the market for district heating. The district heating market consists of many local vertically integrated natural monopolists that produce and distribute hot water to end consumers. Before the reregulation these companies were run as regulated municipal companies, regulated through the municipal nonprofit law. After the reregulation the district heating plants is expected to operate in a businesslike manner (Electricity Act, SFS 1997:857). The reregulation also led to substantial shifts in ownership with many district heating plants being sold to private actors or turned into joint-stock companies. That district heating that constitutes a natural monopoly; that is, the average cost of production is decreasing as production increases up to at least the point where the entire demand is satisfied, has continuously been advocated by the Swedish Competition Authority [1] and the Swedish Energy Markets Inspectorate [2]. One company can consequently always provide the entire market at lower cost than two or more companies. However, just because a company that holds a natural monopoly position in a local market for district heating does not necessarily mean that the company can exercise a monopoly power, the market needs to lack close substitutes. District heating companies have the natural monopoly power for providing district heating but not in the entire heat market covering other alternative systems such as pellet burners and different kind of heat exchangers. Close substitutes combined with high (positive) cross-price elasticity and high own price elasticity reduce any natural