Internal consistency of risk free rate and MRP in the CAPM

2.2. AER methodology will cause the cost of equity to be at a historically low level
32. The AER’s Aurora draft decision assumes that equity investors investing in a 60%
geared electricity distribution business require a 9.08% nominal (6.4% real) return on
equity. This is by far the lowest cost of equity allowance set by the AER, or the ACCC
before it, for an energy transport business. By comparison, the allowed cost of equity
decisions prior to the global financial crisis of late 2008 were universally above 11%,
and averaged around 12%.
Figure 2: AER cost of equity decisions for regulated energy businesses
13.0%
12.5%
12.0%
11.5%
11.0%
10.5%
10.0%
9.5%
9.0%
8.5%
SPI PowerNet
Source: Regulator’s decisions, CEG analysis. Note that 2009 decision for EnergyAustralia et. al. is before
amendment by the ACT.
33. Figure 2 above demonstrates an important phenomenon: The allowed cost of equity
set by the AER has been lower after the global financial crisis than before it – with the
Aurora draft decision being the most extreme example of this trend.
34. The mechanical explanation for this phenomenon is relatively simple to understand. It
reflects the AER’s methodology which applies the Capital Asset Pricing Model in a
manner that:
� sets the risk free rate equal to the prevailing risk free rate (which is very volatile);
and
Competition Economists Group
www.CEG-AP.COM
GasNet
TransGrid,
EnergyAustralia
SP AusNet
APTPPL
ElectraNet GasNet
Powerlink
EnergyAustralia, Integral
Energy, Country Energy,
TransGrid, Transend
Post Lehman/AIG collapse
ETSA Utilities
ActewAGL
Energex/Ergon
JGN
JEN
Citipower, Powercor,
United Energy, SP AusNet
Aurora draft decision
8.0%
1-Jan-02 1-Jan-03 1-Jan-04 1-Jan-05 1-Jan-06 1-Jan-07 1-Jan-08 1-Jan-09 1-Jan-10 1-Jan-11
5
Amadeus
APT Allgas