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The cost of equity for RIIO-2

Oxera has published a report that provides initial estimates of the cost of equity for the RIIO-2 price controls. The report recommends a range of 5.51 – 6.34% for the real (RPI-deflated) cost of equity for energy networks in Great Britain from 2021 onwards.
The report considers the following issues:

  • how to translate from current market data on government bond yields into a risk-free rate (RFR) assumption that will remain valid for the period up to at least 2026 and potentially as far as 2031;
  • how to account for the possibility that ‘flight to safety’ effects have increased the equity risk premium (ERP) and thereby mitigated the impact of low RFRs on the expected equity market return;
  • how to determine an asset beta when the only UK energy network with an equity market listing (National Grid) derives less than half of its revenues from businesses regulated under the RIIO framework.

A central feature of the report is a review of the theoretical and empirical basis for changes in the ERP to offset changes in the RFR. The evidence supports the view that the total market return (i.e. the sum of the RFR and ERP) is more stable than the equity risk premium alone.


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