The Research Institute for Regulatory Economics of Vienna University of Economic and Business held a workshop on “Energy Markets in Transition – Investment and Innovation Incentives, and Paris Climate Targets”. NERA Director Tomas Haug and Research Officer Lorenz Wieshammer discussed up-to-date methods for quantifying the cost of capital for regulated networks, taking into account current market conditions. Starting from Weighted Average Cost of Capital (WACC) parameters set by Austrian regulator E-Control for gas transmission system operators (German: “Fernleitungsnetzbetreiber”) and applying them from 2017, the presentation identified two aspects of the utmost importance when setting the cost of capital in a market where risk-free interest rates have declined to an all-time low:
Historic data suggests the market returns expected by investors do not decline to the same degree that risk-free rates decline. For this reason, several European regulators consider the total market return instead of looking separately at the risk-free rate and the equity risk premium.
Coupons of bonds issued when interest rates were higher than in 2016 increase the average cost of debt for regulated utilities. Setting the cost of debt allowance based on current rates thus underestimates the cost of embedded debt.
NERA regularly advises utilities, investors, and regulators on cost of capital issues as well as provides economic support during regulatory litigation cases.
The NERA presentation (in German) is available from the University of Vienna webpage.