In recent years changes of regulation in European electricity industry have been oriented towards a gradual liberalization of the sector, stressing the issue of energy provision for selling in the open market. Within the Italian regulatory framework, since local public firms cannot compete against other bigger operators in auctions for energy CIP 6/92 and for the import rights, they have addressed themselves towards
upstream integration, i.e. in the generation stage. In this study we analyze the cost efficiency of vertical integration, by estimating a translog multiproduct cost function for a sample of 14 local electric utilities operating in both generation and distribution during the period 1994-2000. The empirical evidence suggests the presence of widespread cost complementarities between the two stages and points to vertical integration as a crucial success factor for local public firms. Thanks to the cost savings it enables, vertical
integration allows electric local utilities to reach both the minimum production capacity and the efficiency that are required to compete in the open market.