The New Zealand Commerce Commission today released its final determination on one aspect of its approach to estimating the Weighted Average Cost of Capital (WACC) for regulated electricity lines and gas pipeline businesses in New Zealand. When determining regulated prices for these businesses, the Commission needs to determine an appropriate return on capital. Prior to this decision, the Commission did so by estimating a WACC range and applying the rate that corresponded to the 75th percentile of that range.
Following a recent judicial appeal, several consumer groups asked the Commission to urgently review its methodology. The Major Electricity Users’ Group argued that the Commission should apply the midpoint of its estimated range rather than the 75th percentile. In response to this request, the Commission commenced a nine-month review of its approach to this specific aspect of its WACC methodology.
The Commission concluded that:
- a regulated business’s true WACC cannot be observed – it must be estimated, usually with imprecision
- allowing a business too low a return on capital (i.e. relative to its true required return) may result in under-investment and a reduction in service quality
- the harm to consumers from under-investment likely outweighs the harm to consumers from over-estimating WACC and
- going forward, it would apply the 67th percentile of the WACC range rather than the 75th percentile.
The Commission took account of a wide range of evidence submitted by stakeholders, including modelling and analysis undertaken by Frontier (Australia), on behalf of Transpower New Zealand Ltd. Frontier’s work examined the impact on consumer and overall societal welfare associated with applying different WACC percentiles when setting regulated prices.
Frontier regularly advises clients on cost of capital and network regulation issues. For more information, please contact m.okeeffe@frontier-economics.com.au or phone +61 3 9620 4488.
