UK Water Cost of Capital
31 July 2003
By Dr. Richard Hern
NERA was commissioned by Water UK to estimate the cost of capital for the water industry as an input into its 2004 price review (PR04). This report sets out NERA's approach to estimating the cost of capital for the UK water industry and presents the best estimate of its cost of capital using this approach. The NERA team derived empirical evidence of whether the regulatory allowed rate of return has been set at a level which is sufficient to compensate equity investors for risk exposures using a comparison of the ratio of market valuation of core regulated assets with the regulatory capital values (RCVs) of the quoted and acquired water companies over the period 1998-2003.
By analyzing both the market to asset ratios (MARS) for the companies, as well as employing the CAPM-WACC methodology -- the methodology currently used by OFWAT and other UK regulators as the primary tool used to estimate utilities' cost of capital at price reviews -- the NERA team found that the true market WACC is likely to be around 1% higher than OFWAT's allowed WACC.
A complete summary of NERA's analyses for Water UK examining financing issues in the UK water industry are available in "Evidence on the Cost of Capital for UK Water."
