The Impact of Liberalization and Environmental Policy On Financial Risk-Return Profiles of European Energy Utilities

Abstract

We examine the impact of liberalization, energy efficiency, renewable energy, and security of supply legislations on the risk-return profiles of European energy utilities over the period 1996 to 2013. Results show that, after controlling for equity market and commodity risk factors, the EU policies which focused on liberalization and environmental objectives have increased return and return volatility of energy utilities. This reflects a fundamental change in these companies’ risk-reward tradeoff. Specifically, liberalization and energy efficiency policies impact financial return and volatility in the short- and long-term. Renewables and security of supply policies provide the largest impacts on long-term volatility and returns, respectively. We highlight a tension between liberalization and environmental objectives. Increased volatility raises the cost of capital for utilities, negatively impacting their ability to raise the estimated €1.3 trillion investment capital needed to transition to a decarbonized ‘smart’ energy system.

Keywords: Liberalization, Environmental Policy, Financial Risk, Financial Return

JEL Classification: G12, G18, G38, L51