Rate of return guidelines for the Victorian gas review

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Client Australian Energy Regulator (AER)
Dates 2013
Service(s)Policy & Economics, Regulation & Competition
AER sought advice on the weighted average cost of capital (WACC) for the Victorian gas review and rate of return guidelines. Specifically, they sought advice on the estimation of the risk free rate and market risk premium (MRP) components of the cost of equity determined using the capital asset pricing model (CAPM). There were two parts to the advice: a review of the AER’s overall approach; and a review of market evidence on the cost of equity.

For the first part, CEPA reviewed academic literature on finance and the cost of equity, including the stability of the cost of equity and the relationships between elements of the cost of equity. We also reviewed market evidence and regulatory precedent on these issues. CEPA then applied a set of assessment criteria to assess whether the existing approach was appropriate and to suggest alternatives.

For the second part, CEPA examined valuation approaches and adjustments made to the cost of equity. The CEPA team also reviewed an Ernst & Young report provided to the AER and made recommendations on an appropriate cost of equity.