Estimating the Cost of Capital for California Electric Utilities
35 Pages Posted: 27 May 2020
Date Written: May 26, 2020
This paper sets the theoretical and empirical framework to estimate a fair rate of return for the providers of equity capital to California utilities. We triangulate this answer by: (1) estimating the cost of equity by the Dividend-Discount Model, and its close cousin the Price-to-Equity Model, (2) the Capital Asset Pricing Model in backward and forward-looking settings, and (3) an insurance type model where we impute the actuarial cost of the wildfires on the equity base. The next three sections of this paper explore the cost of equity for California utilities vs. their peers using the above three approaches. We do, indeed, show that the cost of equity for California utilities is significantly higher than their peer group. We also demonstrate that the CAPM model fails to capture many of the complexities of our existing world and propose approaches to remedy CAPM’s failings. The subsequent section demonstrates that if capital providers are not fairly compensated, California may not be able to attract sufficient capital to further its environmental and other policy objectives. That PG&E’s equity holders are now short-term type investors (hedge funds) as opposed to long-term investors reinforces the above prediction. Finally, we delineate our concluding takeaways.
Keywords: cost of capital, electric utilities
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