The WACC as a methodology to approximate the spread for the allowed rate of return for renewable generation and generation in isolated energy systems in Spain

The Spanish electricity regulatory framework states that the regulated sectors must be remunerated
through a reasonable rate of return, calculated as a spread to be added to the average government
bonds yield. In that context, the objective of this work is to use the well-known financial model of
the Weighted Average Cost of Capital (WACC) to approximate the allowed rate of return for
renewable energy generation and generation in the isolated energy systems. As of today, the allowed
rate of return has been set without any clear methodology. This work pretends to provide the regulator
with a replicable methodology that can be used in the following regulatory periods and that is clear
to all stakeholders. The WACC / CAPM model is selected because of its widespread use among
energy regulators and within different industries.
The methodology followed consisted on an extensive analysis of the Spanish regulatory framework
and a comprehensive benchmarking of selected European cases that could provide additional insights
and research elements. Although in general this work has relied on the WACC /CAPM model, it has
been supplemented: in spite of its extensive use and strong grounding in financial theory, the
WACC/CAPM model has certain limitations that make it unsuitable as the sole model for assessing
rates of return to renewable projects. To tackle some of these insufficiencies, the model has been
complemented to include asymmetric risks and price risk. A liquidity test was also added to the
methodology. In the same way, it was decided that the peer group of companies used to calculate
the rate of return for generation in the isolated systems will be the same as the one used for
transmission and distribution activities. Regarding the methodological choices to the CAPM, like
frequency of the data or reference market used, a complete analysis is presented.
The results suggest that the WACC/CAPM based rates of return are lower (in approximately 60bps)
than the allowed rates in the current regulatory framework. This can be explained through the
differences in the economic environment when those rates were set and nowadays, even though
historical data of the past 6 years have been considered. These differences in the economic situation
should be taken into account on the next regulatory period. Regarding the existing spread between
the rate for renewables and the rest of regulated activities (Namely, T&D and Isolated Systems) the
obtained results are in line with the present regulatory framework, with a difference of about 100bps.