Capacity Cost Allocation in the Provision of Urban Public Services: The Case of Gas Distribution

ABSTRACT This paper analyzes the pattern of price discrimination and cross-subsidization that result from traditional gas distribution cost allocation procedures. A gas distribution capital cost function is developed, using the Box-Cox transformation and estimation procedure applied to a cross-section of 65 communities, and is used to assess the deviations between distribution marginal costs and actual cost allocations. The major conclusions are that current pricing practices produce an aggregate net subsidy to all combined customer classes, that both intra- and inter-class cross-subsidizations are occurring, with the commercial and small industrial markets as the major losers, and that the smaller communities tend to subsidize the larger ones. These results support a move away from current, company-level pricing practices towards locally differentiated pricing.