Konsultrapport Return on Investment Elnät DFC Economics (2024)

Document: Return on investment for the Swedish energy network sector — A report for Energimarknadsinspektionen, DFC Economics, December 2024. Commissioned by Ei.

Authors: Alberto Pototschnig (Director, DFC Economics; former Director of ACER — the years are not in the raw) and Francesco Volpato (Principal, DFC Economics).

Source type: Consultant report (Ei procurement — analytical input to RP5 regulatory methodology)

Purpose

DFC was commissioned by Ei to assess alternative methodologies for setting the allowed rate of return on capital for Swedish electricity and gas network operators, in the context of Ei’s considered move (the raw: “is considering”) from replacement-cost (kapacitetsbevarande) to historical-cost (förmögenhetsbevarande) RAV valuation for RP5.

This is the more recommendations-oriented companion to Source - Konsultrapport Avkastningsmetoder Elnät Montell och Partners (2024), which provided the broader methodological survey. DFC provides an independent expert view with explicit “way forward” recommendations. Alberto Pototschnig’s authority as former ACER director makes this particularly significant.

Current Ei methodology (baseline)

Ei currently uses:

• WACC (real): CAPM for equity cost; BBB rating for debt cost; debt/equity from comparables
• Replacement cost RAV (kapacitetsbevarande) for electricity networks: unit price lists (normvärdeslistan, see Source - Konsultrapport Normvärdeslista 2024-2027 Sweco (2022)) at start of period; indexed within period by a construction cost index
• Historical cost RAV for gas networks: set at historical cost, revalued annually by sector-specific index

Key Swedish structural features

Four features that make Ei question whether CAPM is the most appropriate approach (per the raw, Ei’s concerns as relayed to DFC — DFC itself is more sceptical, e.g. that ownership/size should not affect the return and that a small-company premium is less relevant in Sweden):

1. Public ownership: Most regulated undertakings are owned by municipalities or the central government. They have access to borrowing from what the raw calls “Interbank, a cooperative bank with an AAA rating” (wiki inference: probably Kommuninvest) at more favourable rates.
2. Capital structure: Capital structure differs greatly among undertakings, but a considerable part finance investments mostly through equity (very low debt-to-equity compared with utilities internationally).
3. Small size: DSOs are much smaller than EU comparables used for beta estimation.
4. Few comparables: Ei’s criteria (≥50% T&D revenue, listed on a European stock exchange, ≥25% float) yield very few truly comparable companies.

Recommendations (Section 4)

4.2 — On the Regulatory Asset Value (RAV)

DFC’s view: backward-looking (historical-cost) methodologies are better suited to properly remunerate invested capital, lowering investor risk and helping the sector attract the capital it needs for new investment.

Recommendation: Move to förmögenhetsbevarande (historical cost RAV). The current replacement cost approach:

• Exposes grid companies to unnecessary sector-specific inflation risk (construction costs may diverge from consumer price index)
• Does not guarantee funding for replacement of assets at end of life (technology may have changed)

4.3 — On the cost of debt

Ei’s current BBB reference is appropriate. The AAA borrowing advantage enjoyed by municipal DSOs is an owner benefit (public provides the guarantee), not a regulated-service characteristic — it should accrue to the owners (i.e. citizens), not reduce regulatory cost of debt across the sector.

4.4 — On the cost of equity

Keep CAPM — it remains the best available method despite its shortcomings. All alternatives (APT, Fama-French, DDM) fail to resolve the key challenge of identifying suitable comparables; they introduce additional complexity without solving the core estimation problem. DFC recommends aligning with CEER-member practice on beta and capital structure benchmarks.

Capital structure: the raw’s primary position is that municipal companies’ actual structure should not set the sector-wide WACC, and if historic ratios are used the sample must be limited to fully commercial undertakings; a 60/40 reference (which the raw itself writes ambiguously, while its comparables sit near 40% debt) is only a fallback (“in any case… reference could be made to” CEER), reported under §4.1.

4.5 — On nominal vs. real rate of return

DFC’s conclusion: a nominal-value approach is preferable for setting the allowed rate of return on capital in energy-network regulation.

Recommendation: Switch to nominal WACC with unindexed historical cost RAV.

Rationale:

• Majority of European regulators use the nominal approach
• Avoids the need to index the RAV (eliminates construction cost index dependency)
• Provides earlier remuneration to investors — consistent with regulated undertakings having higher time value of money than society/consumers
• NPV of the allowed remuneration is preserved as long as the same inflation index is used for both RAV indexation and rate deflation (not the case with the current construction cost index, which diverges from CPI)

Both approaches (nominal with unindexed RAV, real with indexed RAV) yield the same NPV only if the same inflation rate is used throughout. The current Swedish approach mixes a real WACC with a construction-cost-indexed RAV — these diverge, creating under- or over-remuneration depending on whether construction costs exceed or lag CPI.

Transition note: The raw says Finland “has just been through a similar transition, with safeguards for the regulated undertakings” (Table 2 lists Finland as nominal/historical cost); it does not call it a template. §4.5 also warns the transition must be carefully managed — the RAV may see a step change, with a trade-off between revenue continuity and consumer overpayment.

Comparison with Montell & Partners

(Not in the DFC report; the Montell & Partners column is unverifiable here.) The wiki reads both reports as reaching convergent conclusions, strengthening Ei’s basis for the RP5 methodology decisions.

Relevance to wiki topics

• Ei: RP5 capital cost methodology; the transition from replacement cost to historical cost is the major RP5 methodological change (alongside TOTEX/lösningsneutralitet)
• Source - Ei Inriktning intäktsramar 2028-2031 (2025): The Inriktning document previewed these changes; DFC provides the formal external endorsement
• Why Swedish Local Flex Markets Are Thin — Structural Causes: Important clarification — the kapacitetsbevarande → förmögenhetsbevarande transition does not fix the CAPEX bias favouring grid investment over flex. The CAPEX bias arises from the difference between earning a return on investments vs. cost recovery only for flex opex (§9.5.8). Both methods treat this the same way. The TOTEX reform (flexibility costs treated as equivalent to investment for incentive purposes) is the separate fix, targeted for RP5 via ellagen 5 kap 12a§.