The WACC as a methodology to approximate the spread for the allowed rate of return in the Spanish framework

Abstract

In this research the allowed rate of return for electricity network investors for the next regulatory period (2020-2025) in Spain is analysed. The main purpose of this research is to propose a methodology to estimate the spread to be added to the allowed rate of return for transmission and distribution activities according to the Spanish regulation. Among the different ways to estimate such value, the Weighted Average Cost of Capital (WACC) was selected since it is commonly used by most of European regulators from different industries as the most accurate approach to recognize the fair return to network industries. In order to come up with an orthodox and suitable methodology, theoretical principles, benchmarking analysis, recommendations of financial experts and preceding methodologies were analysed; additionally, the economic context, industrial organisation and current regulatory framework were also taken into account in order to properly reflect the Spanish reality. The estimation of all the involved parameters – Risk Free Rate (RFR), Beta coefficient, Optimal gearing ratio, among others – comprises the most challenging task due to the different considerations applying to the specific framework in Spain. Important parameters that are critical in the proposed methodology refer to the selection of a suitable peer group of utilities and the selection of the period of study that better estimates the next regulatory period. Furthermore, questions regarding the expected investors and the appropriate cost of debt were tackled by proposing different scenarios. Results obtained in the case studies provide a range of possibilities regarding the allowed rate of return; however, a conclusive outcome was suggested based on critical considerations. Also, it was found that this conclusive outcome is in line with the assumption that costs of underestimating the allowed rate of return are higher in the long term that costs of overestimating it.