Estimation of the cost of capital for Project NEMO

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Client Ofgem
Dates 2013
Sector(s)Energy
Service(s)Policy & Economics, Regulation & Competition
Ofgem, together with the Belgian Regulator, CREG, worked on finalising the design parameters of a regulatory regime for interconnector investment based on a cap and floor approach. This regime will be developed using project “NEMO” (a proposed 1 GW interconnector between GB and Belgium) as a pilot project.

CEPA were commissioned to examine the way in which the weighted average cost of capital (WACC) should be estimated for this proposed regime. CEPA advised Ofgem on the appropriate methodology for calculating the allowed return (cost of capital) for Project NEMO, as well as providing an indicative estimate of the allowed return that should be applied to Project NEMO. CEPA developed an approach that will be equally applicable to future interconnector projects (regardless of whether the interconnector is to be financed through corporate finance or project finance).

The study consisted of four sequential stages:
  • identification of the considerations that need to be addressed when setting the allowed return for the cap and floor regime for interconnector investment;
  • development a detailed methodology for calculating the allowed return that should be applied to the cap and floor;
  • application of the methodology developed in stage 2 to arrive at estimates of the allowed return for NEMO; and
  • evaluation of the pros and cons of different approaches to determining the cost of capital that is to be fed into the calculation of the cap, and the establishment of a recommended approach.
Each stage culminated with a draft report for Ofgem and a meeting with both Ofgem and CREG. Additionally, throughout the project we consulted with key stakeholders in the European Cross-Border Electricity Interconnectors Market.

Subsequent to this report, CEPA have been commissioned by Ofgem to conduct further follow up work to the initial study and the operation of the cap and floor mechanism for forthcoming projects in addition to Project NEMO.
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