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.
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
Advice on tariff structure in the context of commercial strategy
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.
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
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.
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.
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.
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.
