Determining the Cost of Capital for Turkish Electricity Distribution Utilities: Analysis and Recommendations
Determining the Cost of Capital for Turkish Electricity Distribution Utilities: Analysis and Recommendations
Yazar: Gözen, Mustafa
Dergi: İstanbul Üniversitesi İşletme Fakültesi Dergisi, Vol. 41 No. 1, 2012

Turkey has been transforming her electricity market to a competitive one since the electricity market law was approved by the parliament in 2001. As part of the new regime, electricity distribution activities are subject to incentive-based regulation by the energy regulator - EMRA. At the beginning of each implementation period, initial revenue is allowed by EMRA for a distribution utility in which a rate of return for investments in the utility is added. Setting a fair rate is relatively easy for mature markets; however, it is rather difficult for countries like Turkey. The models applicable to Turkey take the perspective of a global investor, provide different results and thus are not helpful as they do not even guide EMRA in accomplishing its tasks. As a result, EMRA is applying the same rate to all utilities. This would be logical when the state or the same private group owns all utilities in the country. However, the Turkish government is now privatizing distribution utilities. Currently, different distribution utilities have different shareholders with different return expectations. Therefore, each utility must be allowed different rates of return. Unfortunately, the models applicable to Turkey provide either countrywide or industry specific cost of capital figures.ReferencesElectricity Market Law, Energy Market Regulatory Authority of Turkey, http://www.epdk.org.tr/english/regulations/electric/law/EML.doc, (20.07.2010).Regulatory Accounting Guidelines, Energy Market Regulatory Authority of Turkey, http://www.epdk.org.tr/english/regulations/ electric/RAG.doc, (16.08.2010.P. Grout, The cost of capital in regulated industries in The Regulatory Challenge (M. Bishop, J. Kay, C. Mayer, Eds.), Oxford University Press, Oxford, 1994, p. 387-407.I. Alexander, T. Irwin, Price Caps, Rate-of-Return Regulation, and the Cost of Capital, Note No.87, The World Bank Group, Washington, D.C., 1996.G. Whittington, Regulatory asset value and the cost of capital, in Regulating Utilities: Understanding the Issues (M.E. Beesley, Ed.), The Institute of Economic Affairs in association with London Business School, London, 1998, p. 91-113.K. Rocha, F. Camacho, G. Braganca, Return on capital of Brazilian electricity distributors: A comparative analysis, Energy Policy 35, 2526-2537 (2007).J. Sabal, The discount rate in emerging markets: A guide, Journal of Applied Corporate Finance 16 (2.3), 155-166, 2004.J.O. Mariscal, M.L. Rafaelina, The valuation of Mexican stocks: An extension of the capital asset pricing model 1-18, Goldman Sachs Latin American Research, New York, 1993, http://faculty.fuqua.duke.edu/~charvey/Teaching/BA456_2006/GS_ The_valuation_of_mexican_stocks.pdf, (19.08.2010).C.R. Harvey, 12 ways to calculate the international cost of capital, October 14, 2005, http://faculty.fuqua.duke.edu/~charvey, (24.05.2010).A. Damodaran, Country risk and company exposure: Theory and practice, Journal of Applied Finance Fall/Winter, 63-76 (2003).A. Damodaran, Equity risk premiums (ERP): Determinants, estimation and implications, October 22, 2009, http://papers.ssrn.com/sol3/ papers.cfm?abstract_ id=1492717, (24.05.2010).A. Damodaran, Measuring country risk, 2010, http://www.qfinance.com/ contentFiles/QF01/g4fqn4jz/10/0/measuring-country-risk.pdf, (27.07.2010).S.P. Voll, S. Bhattacharyya, A. Juris, Cost of capital for privatised distribution companies: A working paper for a calculation for India, Working paper, October. NERA, Washington D.C., 1998, http://www.nera.com/image/3867.pdf, (29.05.2010).S. Godfrey, R. Espinosa, A practical approach to calculating costs of equity for investments in emerging markets, Journal of Applied Corporate Finance Fall, 80-89 (1996).L.E. Pereiro, The practice of investment valuation in emerging markets: Evidence from Argentina, Journal of Multinational Financial Management 16: 160-183 (2006).J.O. Mariscal, K. Hargis, A long-term perspective on short-term risk: Long-term discount rates for emerging markets, Global Emerging Markets Report, October 26, 1-23, Goldman Sachs Portfolio Strategy, New York, 1999, http://pages.stern.nyu.edu/~jmei/hargis.pdf, (19.08.2010).L.E. Pereiro, The valuation of closely-held companies in Latin America, Emerging Markets Review 2, 330-370 (2001).D. Lessard, Incorporating country risk in the valuation of offshore projects, Journal of Applied Corporate Finance 9, 52-63 (1996).M. Zenner, E. Akaydin, "A practical approach to the international valuation and capital allocation puzzle", Global Corporate Finance Report. SalomonSmithBarney, July 26, 2002 New York, http://finance.wharton.upenn.edu/~benninga/hungary/ solomon2002.pdf, (20.05.2010).J. Estrada, The cost of equity in emerging markets: A downside risk approach, Emerging Markets Quarterly 4, 19-30 (2000).S.A. Ross, The arbitrage theory of capital asset pricing, Journal of Economic Theory December, 341-360 (1976).C.B. Erb, R.H. Campbell, T.E. Viskanta, Country risk and global equity selection, Journal of Portfolio Management 21, 74-83 (1995).C.B. Erb, R.H. Campbell, T.E. Viskanta, Expected returns and volatility in 135 countries, Journal of Portfolio Management Spring, 46-58 (1996).C. Lee, D. Ng, B. Swaminathan, International asset pricing: Evidence from the cross section of implied cost of capital, 14th Annual Conference on Financial Economics and Accounting (FEA) November 1, 2003, http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=485762, (20.07.2010).C. Lee, D. Ng, B Swaminathan, Testing international asset pricing models using implied costs of capital, Journal of Financial and Quantitative Analysis 44(2), 307-335 (2009).G. Bekaert, C.R. Harvey, Time-varying world market integration, Journal of Finance 50, 403-444 (1995).A.C. Shapiro, Multinational Financial Management, 7th Edition, John Wiley & Sons, Inc., New York, 2003.T.E. Copeland, J.F. Weston, K. Shastri, Financial Theory and Corporate Policy, 4th Edition, Pearson Addison Wesley, Boston, 2005.R.A. Brealey, S.C., Myers, F. Allen, Principles of Corporate Finance, 9th Edition, McGraw-Hill Education (Asia), Singapore, 2008.J. Estrada, Discount rates in emerging markets: Four models and an application, Journal of Applied Corporate Finance 19(2), 72-77 (2007).T.E. Copeland, T. Koller, J. Murrin, Valuation: Measuring and Managing the Value of Companies, John Wiley & Sons, Inc., New Jersey, 2000.Public finance statistics, Eurobond spreads, Undersecretariat of Treasury of Republic of Turkey, http://www.treasury.gov.tr, (26.07.2010).Inflation rates for Turkey, Central Bank of the Republic of Turkey, in Turkish, http://www.tcmb.gov.tr, (28.07.2010.Inflation rates for the U.S., http://www.inflationdata.com, (27.07.2010).A. Damodaran, Valuation in emerging markets, in International Finance and Accounting Handbook (F.D.S. Choi, Ed.), 3rd Edition, Chapter 9, John Wiley & Sons, Inc., New Jersey, 2003.Update on Turkish Economy - 2008, Undersecretariat of Treasury of Republic of Turkey, http://www.treasury.gov.tr/iro_files/Newsletter/2009/idi-20091203.pdf, (27.07.2010).A. Damodaran, Risk Premiums for Other Markets, January, http://pages.stern.nyu.edu/~adamodar, (25.07.2010).Credit default swap spreads for Turkey, Deutsche Bank Research, http://www.dbresearch.com/servlet/reweb2.ReWEB?rwdspl=0&rwnode=DBR_INTERNET_EN-PROD$CDS&rwsite=DBR_INTERNET_EN-PROD, (23.08.2010).A. Damodaran, Cost of capital by industry sector, http://pages.stern.nyu.edu/~adamodar, (25.08.2010).T. Koller, M. Goedhart, D. Wessels, Valuation: Measuring and Managing the Value of Companies, fourth ed. John Wiley & Sons, Inc., New Jersey, 2005.I. Welch, The consensus estimate for the equity premium by academic financial economists in December 2007: An update to Welch (2000), Working Paper, January 18, 2008, Brown University, Providence, Rhode Island, http://papers.ssrn.com/ sol3/papers.cfm?abstract_id=1084918, (13.07.2010).Cleveland Fed Estimates of Inflation Expectations, News Release, The Federal Reserve Bank of Cleveland, http://www.clevelandfed.org/research/data/inflation_ expectations/index.cfm, (10.08.2010).Weighted average cost of capital, Discussion Paper DP56, August, Independent Pricing and Regulatory Tribunal of New South Wales, Sydney, Australia, 2002.A. Damodaran, Total betas by sectors, http://pages.stern.nyu.edu/~adamodar, (24.08.2010).Market Data Center, Wall Street Journal, http://online.wsj.com/mdc/public/ page/marketsdata_europe.html, (27.07.2010).EMRA Board resolution regarding WACC for electricity distribution utilities for the second implementation period between 2011 and 2015, EMRA, http://www.epdk.gov.tr/mevzuat/kurul/elektrik/2776/2776.doc, in Turkish, (04.10.2010).J.C. Hull, The Evaluation of Risk in Business Investment, 1st Edition, Pergamon Press, United Kingdom, 1980.P. Sercu, R. Uppal, International Financial Markets and the Firm, South-Western College Publishing; Ohio, 1995.C.R. Harvey, Predictable risk and returns in emerging markets, The Review of Financial Studies 8(3), 773-816 (1995).M. Spackman, Discount rates and rates of return in the public sector: economic issues, Working Paper No.113, Government Economic Service, HM Treasury, London, 1991.Privatization of electricity utilities, Privatization Administration of Republic of Turkey, http://www.oib.gov.tr/index_eng.htm. Accessed 25 August 2010.A. Kahn, The Economics of Regulation, Principles and Institutions, MIT Press, London, 1989.

Turkey has been transforming her electricity market to a competitive one since the electricity market law was approved by the parliament in 2001. As part of the new regime, electricity distribution activities are subject to incentive-based regulation by the energy regulator - EMRA. At the beginning of each implementation period, initial revenue is allowed by EMRA for a distribution utility in which a rate of return for investments in the utility is added. Setting a fair rate is relatively easy for mature markets; however, it is rather difficult for countries like Turkey. The models applicable to Turkey take the perspective of a global investor, provide different results and thus are not helpful as they do not even guide EMRA in accomplishing its tasks. As a result, EMRA is applying the same rate to all utilities. This would be logical when the state or the same private group owns all utilities in the country. However, the Turkish government is now privatizing distribution utilities. Currently, different distribution utilities have different shareholders with different return expectations. Therefore, each utility must be allowed different rates of return. Unfortunately, the models applicable to Turkey provide either countrywide or industry specific cost of capital figures.ReferencesElectricity Market Law, Energy Market Regulatory Authority of Turkey, http://www.epdk.org.tr/english/regulations/electric/law/EML.doc, (20.07.2010).Regulatory Accounting Guidelines, Energy Market Regulatory Authority of Turkey, http://www.epdk.org.tr/english/regulations/ electric/RAG.doc, (16.08.2010.P. Grout, The cost of capital in regulated industries in The Regulatory Challenge (M. Bishop, J. Kay, C. Mayer, Eds.), Oxford University Press, Oxford, 1994, p. 387-407.I. Alexander, T. Irwin, Price Caps, Rate-of-Return Regulation, and the Cost of Capital, Note No.87, The World Bank Group, Washington, D.C., 1996.G. Whittington, Regulatory asset value and the cost of capital, in Regulating Utilities: Understanding the Issues (M.E. Beesley, Ed.), The Institute of Economic Affairs in association with London Business School, London, 1998, p. 91-113.K. Rocha, F. Camacho, G. Braganca, Return on capital of Brazilian electricity distributors: A comparative analysis, Energy Policy 35, 2526-2537 (2007).J. Sabal, The discount rate in emerging markets: A guide, Journal of Applied Corporate Finance 16 (2.3), 155-166, 2004.J.O. Mariscal, M.L. Rafaelina, The valuation of Mexican stocks: An extension of the capital asset pricing model 1-18, Goldman Sachs Latin American Research, New York, 1993, http://faculty.fuqua.duke.edu/~charvey/Teaching/BA456_2006/GS_ The_valuation_of_mexican_stocks.pdf, (19.08.2010).C.R. Harvey, 12 ways to calculate the international cost of capital, October 14, 2005, http://faculty.fuqua.duke.edu/~charvey, (24.05.2010).A. Damodaran, Country risk and company exposure: Theory and practice, Journal of Applied Finance Fall/Winter, 63-76 (2003).A. Damodaran, Equity risk premiums (ERP): Determinants, estimation and implications, October 22, 2009, http://papers.ssrn.com/sol3/ papers.cfm?abstract_ id=1492717, (24.05.2010).A. Damodaran, Measuring country risk, 2010, http://www.qfinance.com/ contentFiles/QF01/g4fqn4jz/10/0/measuring-country-risk.pdf, (27.07.2010).S.P. Voll, S. Bhattacharyya, A. Juris, Cost of capital for privatised distribution companies: A working paper for a calculation for India, Working paper, October. NERA, Washington D.C., 1998, http://www.nera.com/image/3867.pdf, (29.05.2010).S. Godfrey, R. Espinosa, A practical approach to calculating costs of equity for investments in emerging markets, Journal of Applied Corporate Finance Fall, 80-89 (1996).L.E. Pereiro, The practice of investment valuation in emerging markets: Evidence from Argentina, Journal of Multinational Financial Management 16: 160-183 (2006).J.O. Mariscal, K. Hargis, A long-term perspective on short-term risk: Long-term discount rates for emerging markets, Global Emerging Markets Report, October 26, 1-23, Goldman Sachs Portfolio Strategy, New York, 1999, http://pages.stern.nyu.edu/~jmei/hargis.pdf, (19.08.2010).L.E. Pereiro, The valuation of closely-held companies in Latin America, Emerging Markets Review 2, 330-370 (2001).D. Lessard, Incorporating country risk in the valuation of offshore projects, Journal of Applied Corporate Finance 9, 52-63 (1996).M. Zenner, E. Akaydin, "A practical approach to the international valuation and capital allocation puzzle", Global Corporate Finance Report. SalomonSmithBarney, July 26, 2002 New York, http://finance.wharton.upenn.edu/~benninga/hungary/ solomon2002.pdf, (20.05.2010).J. Estrada, The cost of equity in emerging markets: A downside risk approach, Emerging Markets Quarterly 4, 19-30 (2000).S.A. Ross, The arbitrage theory of capital asset pricing, Journal of Economic Theory December, 341-360 (1976).C.B. Erb, R.H. Campbell, T.E. Viskanta, Country risk and global equity selection, Journal of Portfolio Management 21, 74-83 (1995).C.B. Erb, R.H. Campbell, T.E. Viskanta, Expected returns and volatility in 135 countries, Journal of Portfolio Management Spring, 46-58 (1996).C. Lee, D. Ng, B. Swaminathan, International asset pricing: Evidence from the cross section of implied cost of capital, 14th Annual Conference on Financial Economics and Accounting (FEA) November 1, 2003, http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=485762, (20.07.2010).C. Lee, D. Ng, B Swaminathan, Testing international asset pricing models using implied costs of capital, Journal of Financial and Quantitative Analysis 44(2), 307-335 (2009).G. Bekaert, C.R. Harvey, Time-varying world market integration, Journal of Finance 50, 403-444 (1995).A.C. Shapiro, Multinational Financial Management, 7th Edition, John Wiley & Sons, Inc., New York, 2003.T.E. Copeland, J.F. Weston, K. Shastri, Financial Theory and Corporate Policy, 4th Edition, Pearson Addison Wesley, Boston, 2005.R.A. Brealey, S.C., Myers, F. Allen, Principles of Corporate Finance, 9th Edition, McGraw-Hill Education (Asia), Singapore, 2008.J. Estrada, Discount rates in emerging markets: Four models and an application, Journal of Applied Corporate Finance 19(2), 72-77 (2007).T.E. Copeland, T. Koller, J. Murrin, Valuation: Measuring and Managing the Value of Companies, John Wiley & Sons, Inc., New Jersey, 2000.Public finance statistics, Eurobond spreads, Undersecretariat of Treasury of Republic of Turkey, http://www.treasury.gov.tr, (26.07.2010).Inflation rates for Turkey, Central Bank of the Republic of Turkey, in Turkish, http://www.tcmb.gov.tr, (28.07.2010.Inflation rates for the U.S., http://www.inflationdata.com, (27.07.2010).A. Damodaran, Valuation in emerging markets, in International Finance and Accounting Handbook (F.D.S. Choi, Ed.), 3rd Edition, Chapter 9, John Wiley & Sons, Inc., New Jersey, 2003.Update on Turkish Economy - 2008, Undersecretariat of Treasury of Republic of Turkey, http://www.treasury.gov.tr/iro_files/Newsletter/2009/idi-20091203.pdf, (27.07.2010).A. Damodaran, Risk Premiums for Other Markets, January, http://pages.stern.nyu.edu/~adamodar, (25.07.2010).Credit default swap spreads for Turkey, Deutsche Bank Research, http://www.dbresearch.com/servlet/reweb2.ReWEB?rwdspl=0&rwnode=DBR_INTERNET_EN-PROD$CDS&rwsite=DBR_INTERNET_EN-PROD, (23.08.2010).A. Damodaran, Cost of capital by industry sector, http://pages.stern.nyu.edu/~adamodar, (25.08.2010).T. Koller, M. Goedhart, D. Wessels, Valuation: Measuring and Managing the Value of Companies, fourth ed. John Wiley & Sons, Inc., New Jersey, 2005.I. Welch, The consensus estimate for the equity premium by academic financial economists in December 2007: An update to Welch (2000), Working Paper, January 18, 2008, Brown University, Providence, Rhode Island, http://papers.ssrn.com/ sol3/papers.cfm?abstract_id=1084918, (13.07.2010).Cleveland Fed Estimates of Inflation Expectations, News Release, The Federal Reserve Bank of Cleveland, http://www.clevelandfed.org/research/data/inflation_ expectations/index.cfm, (10.08.2010).Weighted average cost of capital, Discussion Paper DP56, August, Independent Pricing and Regulatory Tribunal of New South Wales, Sydney, Australia, 2002.A. Damodaran, Total betas by sectors, http://pages.stern.nyu.edu/~adamodar, (24.08.2010).Market Data Center, Wall Street Journal, http://online.wsj.com/mdc/public/ page/marketsdata_europe.html, (27.07.2010).EMRA Board resolution regarding WACC for electricity distribution utilities for the second implementation period between 2011 and 2015, EMRA, http://www.epdk.gov.tr/mevzuat/kurul/elektrik/2776/2776.doc, in Turkish, (04.10.2010).J.C. Hull, The Evaluation of Risk in Business Investment, 1st Edition, Pergamon Press, United Kingdom, 1980.P. Sercu, R. Uppal, International Financial Markets and the Firm, South-Western College Publishing; Ohio, 1995.C.R. Harvey, Predictable risk and returns in emerging markets, The Review of Financial Studies 8(3), 773-816 (1995).M. Spackman, Discount rates and rates of return in the public sector: economic issues, Working Paper No.113, Government Economic Service, HM Treasury, London, 1991.Privatization of electricity utilities, Privatization Administration of Republic of Turkey, http://www.oib.gov.tr/index_eng.htm. Accessed 25 August 2010.A. Kahn, The Economics of Regulation, Principles and Institutions, MIT Press, London, 1989.