The Cost of Capital for Merchant Power Generation: The Example of Drax

Thu Feb 25 16:27:21 EST 2010
By Tomas Haug and Dr. Richard Hern

The Cost of Capital for Merchant Power Generation: The Example of Drax

Across the world, the power generation industry requires massive new investment but questions remain about the right mix (e.g., between capital-intensive nuclear or CCS coal and cheap-to-build but expensive-to-run CCGT). At the same time, the industry continues to adapt to deregulation, with new players entering the industry and incumbents expanding out of their traditional markets, driving merger activity. With deregulation has come privatization and increased scrutiny from antitrust watchdogs, sometimes resulting in forced restructurings and divestments. In all these settings, the cost of capital for power generation is a key parameter for decision-making, but there is little consensus across the investment community about what figures to use. In this issue of Energy Market Insights, Tomas Haug and Dr. Richard Hern review recent evidence on the cost of capital for Drax -- a large coal-fired power station located in the north of England -- focusing their review on beta risk. Drax provides a unique benchmark in that it is one of the few publicly quoted, focused merchant generation businesses in the world. The authors show how an understanding of both finance and energy markets is key to creating estimates of the cost of capital and hence reliable valuations.

Click here to read more of NERA's Energy Market Insights.