In Europe, electric power grids and offshore and on-shore pipelines for gas transmission are subject to regulatory oversight. FTI Consulting and its subsidiary, Compass Lexecon help European energy companies use economic analysis, econometrics and financial modelling to analyse complex issues of pricing, valuation and risk management that occur in regulated energy networks.
Our experts combine world-renowned academic expertise in economics with strong energy industry sector knowledge of the markets in which energy companies operate, and the engineering and operating issues they confront, to advise on the effect of regulations on their business strategies.
How We Help
To use energy networks, customers must pay some form of tariff, often known as an access charge. These charges are typically designed to allow the energy network to recover the costs of providing the service, but also need to be structured appropriately to provide the right incentives to users of those networks. FTI Consulting and its subsidiary, Compass Lexecon Energy professionals offer extensive experience assisting energy network companies to develop charging approaches in a variety of circumstances. Clients seek our advice for:
- Network Charging Approaches. There are many different approaches for charging for connections to, and for using, electricity or gas networks, including capacity, commodity, fixed and variable charges and, increasingly, different tariffs at different times of day and year. The tariffs levied on users need to enable network companies to recover their allowed revenues, so a critical component of tariff design is an assessment of different customer rates of usage or extent of usage of the network, as is the cost of providing different types of services to different types of customers (including in different locations).
- Tariff Calculation Models. In addition to usage assessments, FTI Consulting and its subsidiary, Compass Lexecon Energy professionals also develop quantitative models to calculate tariff levels which a company should be allowed to recover and how. Such models are designed to reflect regulatory requirements and to ensure that tariffs are recovered fairly across the network’s customer base. In addition, we use tariff calculation models to help users of energy networks determine if tariffs are fair or if they need to be negotiated with either the network provider or the regulators.
An organisation is “cost efficient” when it conducts its business at the least possible cost. An important step in improving and achieving cost efficiency is identifying and measuring the scope for efficiency improvement. Efficiency benchmarking techniques have widespread use in regulated industries across the world. Organisations or units within an organisation are compared to each other, in order to identify the “efficient frontier” and measure the scope for efficiency improvement relative to this frontier. Regulated prices are intended, in part, to reflect efficient costs, and regulators are particularly interested in assessing what the efficient level of costs is. Network operating, maintenance, renewal, or enhancement costs are often benchmarked. Efficiency benchmarking techniques are used to assess business plans, identify the scope for efficiency improvements, and to regulate prices accordingly. Clients seek our advice for:
- Efficiency Benchmarking Using Simple Performance Metrics. Simple key performance indicators (KPI), such as network maintenance cost per kilometre of gas pipeline, can be compared between organisations (external benchmarking) or between units within an organisation or regions across a network (internal benchmarking). These comparisons are versatile, and they are straightforward to calculate, monitor and interpret. Whilst they provide a good starting point in assessing the efficiency of a business, they do not take into account important differences between comparators, and may lead to a misleading assessment of efficiency. More sophisticated methods can be used to provide a more accurate assessment of efficiency.
- Efficiency Benchmarking Using State-Of-The-Art Econometric Frontier Analysis. In order to achieve a “fair comparison” between organisation, econometric analysis is often used to control important differences between comparators that: (1) may affect costs, but (2) are outside of business control (and therefore cannot be ascribed to cost inefficiency). In the energy sector, these factors include geographic differences in employee wages, and the particular characteristics of energy networks including age, condition and complexity. FTI Consulting combines world-renowned expertise in economics and econometrics, with deep energy industry knowledge. We apply state-of-the-art econometric analysis including “stochastic frontier analysis” (SFA) to estimate efficient costs in these industries. We advise the regulators that set these price controls, as well as the energy businesses that operate within them.
- Efficiency Benchmarking Using Data Envelopment Analysis (DEA). Data envelopment analysis (DEA) is an alternative method for efficiency benchmarking. Although it does not use econometrics, this method allows for accounting for non-controllable factors before assessing efficiency. DEA is sometimes used on its own, or to verify the results from econometric analysis. When used on its own, DEA benefits from the deep sector expertise and modelling expertise that FTI Consulting professionals can provide.
- Functional Benchmarking. Functional benchmarking refers to the benchmarking of back-office business costs, for example, those relating to IT, administration, or human resources. FTI Consulting Network Regulation professionals compare unit costs for specific functions for the company we are benchmarking with costs in comparative companies. FTI Consulting Energy professionals have considerable experience addressing the main challenge presented by this methodology is the identification of the appropriate comparators; this is because very different conclusions on efficiency can be reached when using different sets of comparators.
- Total Factor Productivity Assessment. If a company’s costs are decreasing, is might be because salaries are decreasing, because it is selling less, or because its markets are shrinking. There are many reasons why you can have increases or decreases in costs or in what you produce. FTI Consulting economists and accounting experts have deep experience in total factor productivity assessment, especially with regulated companies and industries, using key metrics to help companies estimate what their efficiency and productivity are and whether they are increasing or decreasing.
Network Regulation, Policy & Strategy
FTI Consulting works with economic regulators, regulated energy networks and their investors to design or influence policies and tariffs that strike an appropriate balance between affordability and financeability that meets the needs of customers, investors, the environment and broader society. We do this by applying a combination of economics, econometrics, finance and accounting skills and deep sector knowledge to produce solutions tailored to the specific circumstances of our client. Clients seek our advice for:
- Network Tariff Design & Implementation. FTI Consulting and its subsidiary, Compass Lexecon work with regulators or with the network businesses themselves to identify whether tariffs are fair and reasonable. We evaluate the different components of those charges such as the cost of capital or the costs of the business. Also, we evaluate the commercial incentives those businesses should have to operate in a competitive market. We help design the systems of regulation and then determine what the parameters should be, what sort of values should be attached to the framework, and that helps to determine the ultimate charges to be levied.
For example, our consultants advise companies in this area through a combination of: advice on the appropriate conceptual definition of tariffs, such as the definition of “cost reflective pricing” in different circumstances and on the appropriate methodology for calculating access prices, advice on the allocation of costs between activities, customer types and tariff bands, e.g. based on a range of regulatory accounting concepts such as Fully Allocated Cost (FAC), Stand Alone Cost (SAC) or Long Run Incremental Cost (LRIC), assessment of margins for different customer types, designing and applying tests of whether tariffs are compliant with competition law, e.g. margin squeeze tests, design, build, review and/or audit of wholesale and retail tariff models, and advice on tariff structure in the context of commercial strategy.
- Incentive Mechanisms (Price Controls). Incentive mechanisms are designed to encourage regulated monopolies to align their interests more with those of their customers (e.g. in relation to quality of service or performance of environmental obligations). These incentives can be financial in nature, or purely reputational, and FTI Consulting Energy professionals work with energy companies and regulators to ensure incentive mechanisms are appropriately targeted, proportionately complex and implementable in practice.
- Cost of Capital. As a key determinant of the profits investors are able to make, the allowed cost of capital is a key — and hotly contested — parameter in the price setting process for regulated network businesses. FTI Consulting has extensive experience in this field and our professionals are experts at pragmatically bringing cutting-edge methods from academic literature to bear in the real world, regarding what is likely to be acceptable to stakeholders across the industry.
For example, our regulatory accountants, finance experts and economists have solid expertise in the calculation of the weighted average cost of capital (WACC) allowed for regulated activities or in the context of competition cases. They have wide-ranging experience of the practical application of theoretical concepts in real world scenarios and sound understanding of financial markets and of the challenges that arise in estimating the cost of capital in the midst of unpredictable economic and financial conditions.
Our experience covers all aspects of WACC analysis, including identification and assessment of relevant benchmark companies, determining the appropriate time series of market data to use in the calculations, assessing the approach to determining notional gearing, design and application of financeability tests, evaluation of CAPM results against alternative theoretical models including Dividend Growth and Residual Income Models, Fama-French and other multi-factor models, arguments for and quantification of small company premium, indexation of the cost of debt, the impact of changes in inflation indices, e.g. a switch from RPI to CPI, and adjustments to the cost of capital in the context of market reviews and tests of excessive profitability.
- Cost Allocation and Regulated Asset Base Assessments. The operating and capital costs of a business are other key inputs to the determination of allowed revenues that can be recovered by regulated businesses. Key to robust determinations of cost allowances is measuring the costs incurred in different parts of the business (e.g. regulated or unregulated, upstream/downstream, etc.), that requires a deep knowledge of both the businesses involved and the accounting and economic methods available for apportioning costs to different business units. FTI Consulting and its subsidiary, Compass Lexecon have extensive experience in these arenas and our professionals are experts at combining textbook theory with real-world challenges around data quality and availability.
- New Methods of Regulation. FTI Consulting has been on the forefront of developing and proposing new ways to regulate energy assets to help get regulated companies’ and their customers’ interests more aligned. We have helped design a cap and floor regime that provides an upper and lower limit for revenues and profits of new electricity interconnectors in Great Britain, while we also have extensive experience of applying regulation to previously unregulated assets that have experienced financial difficulties as a result of unforeseen changes in gas and electricity markets.
- Assistance in Regulatory Negotiation. Aligning the interests of investors and customers is intrinsically difficult, and from time to time regulated energy networks (or their investors) might want to influence, or indeed challenge, the economic regulation that they are subject to, e.g. by avoiding extensive, unpredictable reforms to the framework, or by strengthening the rewards available to companies for exceeding customer expectations. Successfully influencing regulation requires an understanding of different scenarios to select a preferred option, a solid evidence base in support of a preferred outcome and a plan to negotiate, influence and convince regulatory decision makers. FTI Consulting Energy professionals are highly experienced at developing compelling arguments for regulatory change, building on our deep and clear understanding of the regulations and our relationships with many regulators built up over our many years working in the industry.
- Assistance in Exemption Regulation. Developers of some energy network assets, such as gas and electricity interconnectors, sometimes seek an exemption from certain EU regulations. To do this, it is necessary to go through a process of first securing the approval of local regulators before presenting to the European Commission. FTI Consulting Energy professionals are highly experienced in working with clients to gain such exemptions from local regulators and with the European Commission.
Price Control Design
Regulators face a constant challenge of better aligning incentives and sharing the risks more appropriately between customers and shareholders with more innovative approaches to the design of regulatory regimes. More targeted incentive schemes relating to the outcomes valued by customers, less prescriptive approaches to how companies can achieve (and benefit from) efficiency savings and longer durations of price controls to encourage longer-term planning have all been considered. Different regulators have adopted different approaches according to the circumstances of their sector and jurisdictions that they operate within. FTI Consulting and its subsidiary, Compass Lexecon have been at the heart of the development of these new approaches, combining theoretical evaluation of different options with quantitative scenario-based modelling of potential impacts to arrive at optimal price control designs. Clients seek our advice for:
- Appeals in Regulatory Decision. Even the lengthiest evidence-based regulatory consultations can lead to determinations that have conceptual or practical flaws. Given the highly material strategic and financial implications of such decisions, and the potential impact on shareholder value, there is considerable precedent for regulatory appeals and disputes. Successful outcomes require exceptional levels of expertise as well as the ability to articulate complex arguments such that robust decisions can be taken by the relevant appellate bodies.
FTI Consulting, in conjunction with its subsidiary Compass Lexecon, is a leading provider of services to law firms and regulated companies in the context of appeals of sector regulators’ decisions to appellate bodies, such as the Competition and Markets Authority (CMA) in the UK. The team has also had experience of working on appeals of regulatory decisions in other jurisdictions. Our work typically involves assisting companies assess the strengths and weaknesses of its position and to shape their arguments to be as influential as possible with the appellate body, having due regard to whether this is a specialist agency such as the CMA or a court which may have limited experience of regulatory law and financial economics.
When undertaking this work, we draw on the experience of our team that includes a number of ex-Competition Commission staff and former senior regulators. Where appropriate, drawing on our range of expertise across all aspects of price controls, we help companies buttress their arguments with additional supporting evidence.
- Sector Enquiries. In addition to individual company enquiries, government authorities also may look into entire markets or sectors that are perceived to be not performing well. For example, governments might suspect that competition isn’t working as well in a market with multiple competitors selling similar products at similar prices. FTI Consulting and its subsidiary, Compass Lexecon provide competition economics services to help either government entities or individual sector or market participants to build a solid case for status quo or for remedial market change. This is a rigorous process, where every nuance in the competitive landscape is examined, and that delivers a clear plan of action to resolve any problems identified.
The energy team within the FTI Consulting Strategic Communications Practice includes sector experts with experience representing a broad range of organisations and companies, from start-ups to multinationals. Clients that own regulated networks benefit from the team’s relationships with key influencers to seize opportunities, manage crises, navigate market disruptions, articulate brands, stake a competitive position, and preserve a client’s permission to operate. We have the breadth and depth of experience to help clients clarify, persuade and ensure that the right message reaches the right audience at the right time. Clients seek our advice for:
- Corporate Communications. Historically, the energy industry in general and its participants have not communicated their stories effectively. External communications has been non-existent or very guarded at best. As a result, corporate reputations and the public trust have not been high. Companies need to be able to tell their story, not just after a crisis, but also on an ongoing basis to communicate what they’re about, what they’re doing and why and why they’re competent and can be trusted. Corporate communications delivers the everyday “heartbeat” outreach to build, sustain and defend a corporate reputation. FTI Consulting Strategic Communications professionals are highly experienced and well equipped to support your company, the innovative things you’re doing, why you’re doing it, the fact that you’re a responsible company, in a responsible industry, that you provide employment, and that you provide an essential service.
- Issues & Crisis Management. There are two main types of crisis situations — the crisis of reputation where important audiences are losing faith in a company, its performance, and its leadership; or a high impact/low probability crisis such as an explosion at a pipeline facility or the death of a senior executive. To help clients prepare for either eventuality, FTI Consulting professionals take a campaign-like approach to these challenges, closely coordinating with management teams, as well as legal, financial and other advisers to provide strategic counsel on all aspects of internal and external communications. We help identify, prioritise and track issues — economic, financial, political, industrial, or technical — that can impact on the client’s performance, its reputation, and its value. We then advise on how to address them proactively to achieve a positive outcome.
- Stakeholder Communications. Companies must consider each stakeholder group separately to engage in a proper dialogue with them. It is critical that all stakeholders be identified. FTI Consulting Strategic Communications specialists research all possible stakeholder groups, not just establishing who they are and how important they are to the company, but also what they want and need to know and what information the client can give them. This includes examining how our client has been communicating to them in the past and what it should be saying today and in the future. In addition, and as important, clients need to listen to their stakeholders so that relevant messages can be crafted and addressed to each audience specifically. FTI Consulting analyses and prioritises stakeholders and messages and develops programs for clients that help facilitate audience-specific messaging to create a proper dialogue with those people who have the greatest financial influence on the client’s business.
- Public Affairs & Policy. Legislation and regulation have an enormous impact on your company and the industry. Political stakeholders, elected representatives at local and national levels, civil servants, people who work in the executive arm of the government, advisers, policy think tanks, commentators, and academics all play an important part in the public debate on network regulation. It is critical that a company’s communications help it be better known among these groups, help it be listened to more, and help its interests be better understood when decisions are being made that affect its business. FTI Consulting works with individual companies, and with their trade associations, to seek to affect government policy regarding permitting and licensing issues, as well as issues affecting existing installations such as state aid, patent discounts, etc. We also undertake grassroots campaigning in local communities to overcome resistance to a client’s new installation.
- Research. In-depth market and stakeholder analyses can help companies solve complex business and communications problems. The FTI Consulting Strategic Communications multi-disciplinary team consists of professionals who have served in major strategy firms, research consultancies, political campaigns, financial institutions and academic institutions. Working closely with energy sector experts within FTI Consulting, our team rigorously researches stakeholder perceptions, client brands, competitive operations, as well as the financial markets. In addition, our international network enables us to conduct research in all relevant countries.
- Government Relations. Legislative and regulatory pressures are becoming more prevalent in all energy sectors, which increase a network company’s compliance obligations and can jeopardise its license to operate. Managing political risk is a growing imperative for effective corporate governance and business planning. FTI Consulting combines public policy, capital markets and sector-specific expertise to offer a unique capability for companies operating at the critical intersection between business and government. Our involvement can extend from specific issues to ongoing government campaigning in support of client positions on network regulations, tax, environmental or public policy issues.
- Competition Investigations. From time to time, participants in network regulation may find themselves involved in some way in competition investigations relating to alleged antitrust violations, regulatory scrutiny of an M&A transaction, claims of state aid, or sector inquiries. Communicating effectively to the press, to relevant regulatory and legislative stakeholders, and to a firm’s investors and employees is a key component of protecting the firm’s reputation, allowing the business to function normally while the investigation is ongoing, and securing a rationale outcome. In these situations, FTI Consulting Strategic Communications professionals specialise in helping clients to interact constructively with political and regulatory audiences in articulating the larger business and political contexts in which the company operates, and the ways in which the public benefits as a result.
- Rebranding & New Message Development. Rebranding can be a defensive or offensive strategy. The company may need to distance itself from a negative perception that exists in the minds of consumers, investors, competitors, and other stakeholders. Or, on the other hand, the company may want to communicate a new corporate strategy and messaging that the old brand cannot support. In either case, rebranding usually involves radical changes. FTI Consulting Strategic Communications specialists work with our client to develop a consistent message framework for addressing key issues that affect the new brand. At the same time, we take a structured, research-based approach to identify, map and prioritise stakeholders to help create tailored messages that will strengthen stakeholder support. Then we go to work developing the new brand's logo, name, legal names, image, marketing strategy and advertising and public relations themes.
In Europe, infrastructure — including electric power grids and offshore and on-shore pipelines for oil and gas transmission — are increasingly attractive to investors seeking relatively stable and predictable returns such as pension, sovereign wealth and infrastructure funds. At the same time, substantial investment into enhancing and replacing infrastructure is required, but many of Europe’s largest utility companies are balance-sheet constrained. This combination of factors has precipitated a significant number of M&A transactions in recent years, as sellers seek to de-leverage and recycle capital, while buyers seek to access the safe, stable and predictable returns their own investors seek. Key to valuation of investment opportunities across the energy sector is an understanding of the regulatory and commercial environments these businesses operate in, and might operate in in future. Clients seek our advice for:
- Regulatory Due Diligence. It is critical for companies seeking to buy assets, particularly regulated network assets that they have a full understanding of the regulatory environment within which the target assets function. FTI Consulting and its subsidiary, Compass Lexecon have professionals to conduct the necessary regulatory due diligence for clients, including what the regulations are, how they are likely to evolve, what are the inherent and anticipated risks to the assets and how these are likely to impact on the overall value of the assets.
- Commercial Due Diligence. Commercial due diligence analyses network assets on the basis of markets served, competitors, market shares, regulations, pricing policies, revenue, profitability and how they all are likely to change in the future. FTI Consulting and its subsidiary, Compass Lexecon are well versed in conducting commercial due diligence. If you are buying or selling transmission or distribution network assets, for example, our energy professionals can offer informed advice on potential rates of return under the existing regulatory regime and how changes to the regime in future might impact those returns and offer opportunity or risk to future profits.
- Asset Valuation. For public and private companies in the energy industry, FTI Consulting and its subsidiary, Compass Lexecon have professionals that have performed asset valuations for numerous purposes, including fair market value, fairness opinions, purchase price allocations, impairment testing, dispute resolution, transaction analysis and pricing, and restructuring. A range of techniques exist for valuing assets and our professionals are adept at selecting and applying the most appropriate method in a given set of circumstances.