| Practice area: | Competition & Antitrust | Energy | Energy economics | Regulatory economics |
|---|---|
| Client: | Ofgem |
| Published: | October, 2010 |
| Keywords: | quantitative analysis |
This report estimates the cost of capital for small independent gas transport (IGT)companies. The report was submitted to Ofgem as part of their consultation on the cost of capital for the legacy IGT sector in the UK as part of their normal 5-year review. London Economics has estimated the weighted-average cost of capital (WACC) for small companies in the IGT sector. We focus on new estimates WACC parameters for the small company debt premium and the small company equity premium. For the small company debt premium, we provide LE’s own estimates; the estimates are based on a) the actual data on recent borrowings in the sector b) previous regulatory findings—and the fact that the financial crisis has most likely raised the cost of debt relative to the previous 2002 Ofgem Decision, c) our own modelling of debt spreads using two different approaches (regression using debt spreads and UK bonds, and using CDS spreads), and d) our own professional judgment. The sum of this evidence suggested a debt spread in the range of 270 to 360 basis points over the risk free rate. For the cost of equity, we also have provided our own estimates based on a) existing international, professional, and academic research on the small company premium, b) previous regulatory findings, c) our own modelling of the cost of equity small company premium using two different approaches (regressions using the Fama and French 3-factor model; regressions on UK data using the Fama and French methodology. We also present data on UK company betas and company size classes), and d) our own professional judgment