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EDF Energy - Reducing WACC by implementing RAB as a source of financing


The weighted average cost of capital (WACC) is the weighted average cost of a firm’s capital structure (Mian & Vélez-Pareja, 2008). This is a company’s cost of equity and the cost of debt added together. According to Mian and Vélez-Pareja (2008), there are complications with the calculations for WACC however these are mainly due to misinterpretation and misuse by companies. Reducing WACC is something companies aim to accomplish and EDF Energy are no different.

EDF Energy are currently undergoing construction of a new nuclear power station called Hinkley Point C which is projected to cost roughly £22 billion (The Financial Times, 2019b). This is a significant amount of money and so financing will be an issue for EDF Energy. On top of that, Hinkley Point C, as well as other projects in France and Finland, have been plagued with problems, causing long delays and extra unexpected costs (The Financial Times, 2019b). The problems with these projects have seen their share price in France drop by almost 39% in the last year (The Financial Times, 2019b) (Yahoo Finance, 2019).

Electricite de France S.A. (EDF.PA) share price over the last 12 months. Source: Yahoo Finance
Due to these high project costs, raising capital to fund these projects can be very difficult, especially because they won’t be making any money until the construction is complete. For this reason, EDF are very interested in different methods of raising finance (The Financial Times, 2019a).

One of the methods of financing these new nuclear power stations, one of which is Sizewell C, EDF’s new proposed project which will be identical in design to the currently under construction Hinkley Point C, is using the Regulated Asset Base system (The Financial Times, 2019a) (The Financial Times, 2019c).  The Regulated Asset Base model allows a company to take money from customers bills who are going to be using the service in order to finance a large-scale project. In return, customers will receive a cheaper, more reliable service once the project is complete. The company can also receive subsidies from the government as part of this model as well as raise cash from pension funds that accept a much lower return on investment (Makovšek & Veryard, 2016) (The Financial Times, 2019c). This is a system which is mainly used by utilities such as gas, water and airports (The Financial Times, 2019c). There is also usually a regulatory body which sets price caps in order to ensure companies don’t abuse the Regulatory Asset Base System in order to make a higher profit (Newbery, 1997).

However, according to The Financial Times (2019a), using the Regulated Asset Base model for funding new nuclear energy projects is ‘far from convincing.’ This is because the regulated asset base model is mainly used in industries with a proven track record of being reliable. For example, water projects also require large-scale investment and are an important part of our country’s infrastructure. Yet, there is little construction risk for water projects whereas the construction risks for nuclear projects are high and, as shown by EDF’s current construction projects such as Hinkley Point C, they often suffer from delays and extra costs due to complications (The Financial Times, 2019a) (The Financial Times, 2019b). Also, the Regulated Asset Base system has never been used for a project as lengthy as a nuclear power station and so it is relatively untested in such a long, complicated project (The Financial Times, 2019c).  This shifts the risk of the project from the company to the customers as those are the ones who will end up paying upfront over the duration of the project and so if there were any additional costs or delays, it would be the consumers who suffer (The Financial Times, 2019c) Also, if the project was to be scrapped half-way through construction, there is no guarantee that the consumers will receive any of their money back (The Financial Times, 2019c).


EDF are actively encouraging the government to allow them to use the Regulatory Asset Base System for their planned construction of Sizewell C (The Financial Times, 2019c). EDF are claiming the use of the Regulatory Asset Base System could reduce their WACC (The Financial Times, 2019c).
Source: The Financial Times 

EDF have calculated the use of the Regulatory Asset Base model can reduce their WACC from 9.2% (Hinkley Point C project) to around 6% (for Sizewell C) (The Financial Times, 2019c). Also, EDF have argued that the reduction in cost of capital for the project would allow them to sell their electricity at a much lower price, making nuclear energy more affordable (The Financial Times, 2019c).

In Conclusion, the use of the Regulatory Asset Base system in the nuclear energy industry would be extremely beneficial for companies like EDF, allowing them to raise capital easier and reduce their WACC as well as offset their risk to customers (The Financial Times, 2019c). However, the use of the Regulatory Asset Base system could spell trouble for customers because, although they may receive cheaper rates for nuclear energy if planned nuclear projects are successful, nuclear projects are notoriously plagued with setbacks, adding additional costs and lengthy delays. This could cause customers to lose out as they are taking on the risk of the project as opposed to companies like EDF (The Financial Times, 2019c).  



Reference List

Makovšek, D., & Veryard, D. (2016). The Regulatory Asset Base and Project Finance Models.

Mian, M. A., & Vélez-Pareja, I. (2008). Applicability of the classic WACC concept in practice. Latin American Business Review, 8(2), 19-40.

Newbery, D. M. (1997). Determining the regulatory asset base for utility price regulation. Utilities Policy, 6(1), 1-8.

The Financial Times. (2019a). How can we pay for new nuclear power stations? | Financial Times. Retrieved from https://www.ft.com/content/4b81682e-cf19-11e9-99a4-b5ded7a7fe3f

The Financial Times. (2019b). EDF increases Hinkley Point C nuclear plant costs | Financial Times. Retrieved from https://www.ft.com/content/92102452-df62-11e9-9743-db5a370481bc

The Financial Times. (2019c). EDF seeks to charge customers upfront for UK nuclear plants | Financial Times. Retrieved from https://www.ft.com/content/f9a96304-e980-11e8-885c-e64da4c0f981

Yahoo Finance. (2019). Retrieved from https://uk.finance.yahoo.com/

Comments

  1. Emily Whiteley12 November 2019 at 03:53

    A very informative read Lewis! Interesting to read into how EDF are financing their new projects, do you think the implementation of the regulatory asset base system will be successful for EDF? I'll be interested to see if their lower estimated WACC level will be achieved.

    ReplyDelete
    Replies
    1. Lewis Wright2 December 2019 at 07:33

      Yes, I do think that the implementation of the regulatory asset base will be successful for EDF. I believe the current government is very keen on implementing this model in order to make nuclear energy more affordable. If implemented, I do think EDF's WACC will reduce however it will be interesting to see how it affects their consumers as nuclear projects have a poor track record when it comes to keeping to budget and staying on time.

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