In 2018 and 2019, the National Markets and Competition Commission (CNMC) established the rate of return for regulated network activities in the energy sector in Spain. In 2018, the CNMC launched an initial public consultation on the calculation of the weighted average cost of capital (WACC) for activities in which operators had the opportunity to submit their proposals. In 2019, the Spanish government transposed European directives and transferred legal jurisdiction to the CNMC to define the rate of return, based on the WACC methodology, and to define the remuneration of network operators. Later that year, the CNMC launched a second public consultation on the WACC.

NERA was retained by a large operator in the electricity distribution business to provide a report to be submitted in the public consultations and to give support during the process. NERA also held meetings with the CNMC and prepared supplementary documents to address specific issues.

The NERA report addressed all the issues and parameters necessary to calculate the WACC, following the well-established CAPM methodology.

NERA produced a formal report submitted by the client in the public consultations, and supported the client in the process.

As well as producing its own estimate, NERA critiqued some of the methodological decisions made by the CNMC: for example, the use of a 6-year averaging period to calculate the rate of return or the equity beta of comparable companies, since it matched the length of the regulatory period. However, reliance on a period of this length on the part the CNMC is not supported by any evidence on the actual cost of debt of the companies or on the rationale of the equity holders. On the contrary, NERA presented arguments to support that the averaging period should be longer given that the average cost of embedded debt of energy companies was the result of debt issued for longer horizons and that the possibility of reducing costs by refinancing was limited.

In addition, NERA assessed the CNMC’s calculation of the market risk premium and its reliance on the geometric mean and the definition of the reference market.

One of the main flaws in the CNMC’s approach that NERA addressed was the calculation of the cost of debt given that the CNMC looked at the marginal cost (and not the expected average cost), the cost of debt of vertically integrated companies (and not the cost for electricity distribution), and German and French companies (without considering the risk differential for doing business in Spain).

NERA’s report also demonstrated that the legal requirements to consider the financial situation of the settlement system, the cyclical situation of the Spanish economy, and future investment needs supported an increase in the rate of return.