Financial structure, capital costs and investment risks for European Transmission System Operators

Details

Supervisors

Agrell, Per Joakim

Faculty

Louvain School of Management

Degree label

Master [120] en Ingénieur de gestion

Abstract

Electricity is probably one of the most important consumable on earth. Who could imagine living without it just one day as it is used for many reasons. We need electricity to light rooms and roads, to heat food, to watch television, to use a computer or a mobile phone. Power is certainly one of the different thing of which people are the most dependent. While it is common knowledge how to produce power, the situation is different when it comes to describe its path from generation to the final consumer. Originally there was only one company in each country responsible for the production, transport and supply of electricity. During the Thatcher era in the UK, a lot of privatization occurred in order to balance the budget of the British government and to reduce its dominance on the economy. Late 1980’s the privatization became a trend in Europe as many government followed the British example. In 1996 the European Union voted the first energy package. The goal of this policy was to put an end historic, state-owned, vertically integrated power companies by liberalizing the market and set up the bases for an Internal Energy Market. That had for consequence the cut off of the electricity supply chain and the arrival of private shareholders. Instead of one company there are now four called: generator, transporter, distributor and supplier. With this package also came the institution of a regulator for each country, responsible of the market efficiency and the control of the transmission and distribution monopolies. In 2003 the second energy package allowed new companies to enter the market to foster competition in the supply section. In 2009 the third energy package was voted. The goal is to further liberalize the market for energy. One point of this package is the obligation of unbundling between the transmission and distribution with the production and supply. In this research the focus is set on the transmission part. Transmission System Operators (TSOs) are monopolies responsible for the transmission and security of supply. As they are monopolies they are regulated by National Regulatory Authorities (NRAs) which determine and fix the allowed revenues in collaboration with their TSO. Most regulated revenues are based on the WACC of the TSO. Therefore NRAs establish a methodology to fix the cost debt and the cost of equity for their TSO. However they do not take the ownership into account when determining the WACC. The goal of this thesis is to determine whether or not the ownership structure of a TSO has an impact on the cost of debt and equity. As the cost of debt and equity are confidential data, those costs were computed based on the observed cost of debt and return on equity. The dataset of 16 TSOs regroup different data over the period 2011-2013. Those data are : the ownership structure, the observed cost of debt, the observed cost of equity, the capital structure, the grid size, the observed WACC. The model used is a multiple linear regression where the dependent variables are the cost of debt and equity, the leverage or capital structure is a control variable and the ownership, an indicator variable, is the explanatory variable on which the focus is set. The hypotheses to test are: 1) the cost of debt for a state-owned TSO is lower than of a privately-owned one 2) the cost of equity for a state-owned TSO is lower than of a privately-owned one. In a first phase, there is analysis to determine the linearity and the normality of the model. Being significant, the model is used to test the hypotheses. The model computed on R appeared statistically significant as both hypotheses could not be rejected with a confidence interval of 95%. For both hypotheses the model expressed a positive correlation between the ownership and the different financing costs. It is then showed that privately-owned TSOs have an average cost of equity 6% higher than state-owned companies. At the same time, privately-owned companies have an average of 3% higher cost of debt than of state-owned. This led to a discussion on whether there is an ideal capital structure and ownership structure for a TSO. TSOs being very low risk companies because of their daily generated cash flows and the low risk on assets, they have a high capacity to borrow money. However their regulators try to limit their capital structure to around 66% of debt in the capital. This is due to the risk for TSOs to be downgraded in credit rating as they are all in the investment grade category. It is then concluded that it is possible to have an ideal capital structure that would minimize the total financing costs. Concerning ownership structure, state-owned companies enjoy lower financing cost and no political risks and they seek to maximize social welfare. Conversely, privately-owned companies seek profit and have higher financing costs. However, as private companies they are seen more efficient in their management. Governments having troubles make the ends meets it is highly unlikely that they will invest in TSOs or re-nationalize them unless there is a major crisis as for banks in 2008. Therefore there is no realistic ideal ownership structure. As conclusion, the model used was significant enough to prove empirically that private TSOs have higher costs than of state-owned. This research is also interesting for TSO because it can help them to situate themselves in the sector by comparing their different costs. At the same time NRAs can use this research to adapt their regulated revenues depending on the ownership structure of TSOs.