Innovative analytical approach to WACC estimation for Elengy

The Situation

French liquid natural gas (LNG) terminal operators are subject to revenue regulation similar to energy networks. The French Energy Regulatory Commission’s (CRE) new tariff period for the use of LNG terminals, called tarifs des terminaux méthaniers, or ATTM5, starts in April 2017 and applies for a period of approximately four years. Although they are subject to revenue regulation in France, LNG terminal operators differ from classical energy network operators in that they do not exhibit all the features of a typical natural monopoly. Facing increasing international competition and uncertainty over the renewal of gradually expiring long-term contracts, LNG terminal operators are subject to volume risks that would not be adequately accounted for through a traditional weighted average cost of capital (WACC) estimation as applied to classical energy networks. 

NERA's Role

Elengy, a subsidiary of French energy company ENGIE, is the owner and operator of the LNG terminals Montoir-de-Bretagne and Fos Tonkin. Elengy asked NERA Director Thomas Haug, Director Jeanne Lubek and Principal Dominik Huebler to provide an assessment of the appropriate regulatory WACC allowance for French LNG terminal operators, taking into account both the empirical evidence on parameters used in classical WACC estimation (beta, market risk premium, etc.) and the specific risks related to the operation of LNG terminals under a revenue cap regime. Estimating the appropriate compensation for the specific risks of LNG terminal operators represented a particular challenge given scarce market evidence for estimating specific idiosyncratic risks while taking into account the French regulatory context.

NERA drew on the analytical tools provided by real option analysis in recognition of the fact that LNG operators face asymmetrical revenue risks; downside risks due to lower capacity utilisation in a competitive market environment are not offset by symmetrical upside risks as revenue regulation is effectively capping potential revenues. Asymmetric return prospects are a common feature in real option analysis, which allows for quantifying and pricing the risks based on empirically observable parameters, notably return volatility. The application of real option analysis to the context of regulated LNG terminal operators represented an innovative analytical approach, which allowed for the estimation of the appropriate risk compensation based on a stringent economic methodology.

The Result

In addition to an estimation of the classical WACC parameters in the challenging context of a historic low-risk environment, NERA derived a methodologically robust and transparent estimate of the specific risk premium for regulated French LNG terminal operators using the innovative technique of real option analysis. Based inter alia on empirical return volatility, NERA estimated the risk premium at slightly more than 2% (pre-tax). An external consultant assessing NERA’s cost of capital estimate, on CRE’s mandate, recognised the merits of the real option analysis approach for quantifying what has traditionally been a highly uncertain and controversial return element. With its ATTM5 decision from 18 January 2017, the CRE decided to apply an LNG-specific risk premium of 2% (pre-tax).