Con su lt a t ion D ocu m e n t on t h e
Cost of Ca pit a l for Re gion a l N e t w or k M a n a ge r s
Proj ect Num ber 101729
Th e Cost of Ca pit a l for Re gion a l N e t w or k M a n a ge r s
Pr oj e ct N u m be r 1 0 1 7 2 9
1. I n t r odu ct ion
Cent rica plc is pleased t o respond t o t his consult at ion docum ent . I n m aking t his response, we are not com m ent ing only from a UK int erest . As t he parent of Oxxio, we are also act ive in t he Dut ch m arket and reliant upon net w orks which are subj ect t o price cont rol.
The consult at ion begins t he process by which t he pricing of regional dist ribut ion net w orks w ill be set . We not e t hat a new m et hod and x- fact ors have t o be
det erm ined over t he next six m ont hs for elect ricit y and by m id 2007 for gas. Aft er t he past six years, while t he cost of capit al has rem ained const ant , we agree it is
appropriat e t o re- consider t he subj ect in t he light of lat est pract ice and regulat ory developm ent s.
Overall we are sat isfied by t he approach proposed for det erm ining t he cost of capit al for regional net w ork m anagers. From a t echnical point of view , it is com prehensive, coherent and sound.
Our answ ers t o t he specific quest ions in t he consult at ion are based in part on our experience of net work price cont rol in t he U.K. Our response concent rat es on t hose quest ions where we have part icular know ledge or views on t he issue.
2. An sw e r s t o Qu e st ion s
Qu e st ion 1 : Th e Boa r d pr opose s n ot using a se pa r a t e cost of ca pit a l for
e le ct r icit y gr id a nd ga s n e t w or k m a na ge r s. D o you a gr e e w it h t h is a ppr oa ch ? Considering t he proposed cost of capit al wit h t hose adopt ed by t he UK regulat or for dist ribut ion price cont rol show s t here is broad com parabilit y ( especially at t he higher end of t he range) , alt hough t here are differences at t he individual com ponent level. However, t he Board is suggest ing a com m on cost of capit al for gas and elect ricit y, arguing t hat gas and dist ribut ion net work m anagers face t he sam e regulat or and t he sam e regulat ory risk. We are not convinced by t his argum ent , alt hough using t he sam e cost of capit al cannot be ruled out .
We see t hat differences in t he condit ion of t he various regional net works and bet ween gas and elect ricit y m ay m ean different invest m ent needs t o bring t he net w orks t o a com parable st at e. Since t he cost of capit al is t he m inim um ret urn t hat invest ors w ill accept for invest ing in a part icular com pany relat ive t o ot her invest m ent s, t hat ret urn will vary for exam ple according t o t he risk of net work upgrades being necessary or t he scale of t he invest m ent . Separat e cost s of capit al – at t he least for gas and elect ricit y – should be adopt ed unless it can be shown t hat invest ors, aft er t aking account of t he risks involved, require t he sam e ret urns.
Qu e st ion 2 : D o y ou con side r a life t o m a t u r it y of 1 0 y e a r s t o be a good life t o m a t u r it y for de t e r m in in g t he r isk - fr e e r a t e ?
Qu e st ion 3 : D o you a gr e e w it h t h e chose n r e fe r e n ce pe r iod of 2 - 5 ye a r s for t h e r isk - fr e e r a t e ?
We have no reason t o consider t his an inappropriat e period.
Qu e st ion 4 : W h a t in you r vie w a r e t h e a dva n t a ge s a n d disa dva n t a ge s of u sin g in de x e d bon ds?
We have no view s on t his.
Qu e st ion 5 : D o you a gr e e w it h t h e pr oposa l t o u se D u t ch gove r n m e n t bonds?
We have no view s on t his.
Qu e st ion 6 : D o you a gr e e w it h t h e pr opose d m e t hod for de t e r m in ing t h e de bt pr e m ium a n d t h e pr opose d le ve l of t h e pr e m ium ?
Yes
Qu e st ion 7 : W h a t is you r opin ion of de t e r m in ing t h e cost of ca pit a l on t he ba sis of t he pr e se n t le ve l of ge a r ing of 6 0 % ?
60% is in line w it h t he assum pt ions used by UK regulat ors on efficient capit al st ruct ure.
Qu e st ion 8 : D o you a gr e e w it h t h e w a y in w h ich t h e t a x r a t e is de t e r m ine d a bove ?
We are pleased t hat t he proposals in t his regard recognise t he risks of using pre- t ax cost s of capit al. I n cases where t he out t urn m arginal rat e has been lower t han t he assum ed rat e, t he regulat ed com pany receives a w indfall w hich is not ret urned t o cust om ers. A post - t ax cost of capit al approach avoids t he risk t hat out - perform ance w ill be perm anent ly ret ained by t he net w ork com pany.
Consequent ly, t he proposal is m ore consist ent w it h incent ive regulat ion, w here
com panies are incent ivised t o out - perform regulat ory assum pt ions via t he ret ent ion of t he out - perform ance for a period of t im e, but t he out - perform ance is subsequent ly passed on t o cust om ers in t he form of lower prices.
Qu e st ion 9 : D o you a gr e e w it h t h e u se of bot h t h e r e a lise d a nd e x pe ct e d e qu it y r isk pr e m ium in de t e r m in in g t he e qu it y r isk pr e m ium ?
No, we believe t hat t he cost of capit al should be based on ex- ant e assum pt ions only. Taking account of hist orical prem ium s w ill inflat e t he equit y risk prem ium .
UK experience would suggest a ret urn on equit y in t he range of 5% - 7.25% for t he average firm . This com pares wit h 7.8% - 10.3% im plied by t he current proposals.
Qu e st ion 1 0 : D o you a gr e e w it h t h e se le ct e d ba ndw idt h of 4 % - 6 % for t h e e qu it y r isk pr e m ium ?
Qu e st ion 1 1 : W h a t do you t h ink of t h e cr it e r ia u se d t o de t e r m in e t h e r e fe r e n ce gr oup? W h a t do you t h in k of t h e com posit ion of t he r e fe r e n ce gr oup?
These seem t o be reasonable.
Qu e st ion 1 2 : W h a t is your opin ion of t he use of bot h da ily a n d w e e k ly da t a in de t e r m in in g t h e e quit y be t a ?
This seem s t o be a reasonable approach.
Qu e st ion 1 3 : D o you sh a r e t h e Boa r d’s pr e fe r e n ce for t h e u se of na t iona l sh a r e in dice s for ca lcu la t ing t he be t a s?
This seem s t o be a reasonable approach.
Qu e st ion 1 4 : D o you a gr e e w it h t h e a pplica t ion of t he V a sice k cor r e ct ion t o t h e be t a ?
We have no view on t his quest ion.
Qu e st ion 1 5 : D o you a gr e e w it h t h e u se of t h e M odiglia n i- M ille r for m u la in con ve r t ing e qu it y be t a s in t o a sse t be t a s?
We have no view s on t his quest ion.
Qu e st ion 1 6 : D o you a gr e e w it h t h e a bove - m e n t ione d m e t h od for de t e r m in in g t h e CPI ?
We have no view s on t his quest ion.
Qu e st ion 1 7 : W h a t is your opin ion of t he pr opose d ba n dw idt h for t h e r e a l pr e - t a x cost of ca pit a l? H ow sh ou ld t h e Boa r d u lt im a t e ly de r ive t he cost of ca pit a l fr om t h is ba ndw idt h ?
As we believe t he m et hodology used inflat es t he equit y risk prem ium , t he result ing cost of capit al bandwidt h w ill in our view be generally t oo high.
That said, and t urning t o t he second part of t he quest ion, t he m idpoint of t he range would be appropriat e where t he level of capit al expendit ure expect ed t o be m ade is broadly consist ent w it h t he hist orical levels and t here has not been any significant concern about t he condit ion of t he net works. The higher end of t he range would be m ore appropriat e where significant increases in capit al expendit ure are required ( e.g. t o address concerns about t he condit ion of t he net work) in order t o avoid t he risk of t he necessary invest m ent s not being m ade.
