No room for experimenting with the WACC

In response to political pressure, the Federal Council has signalled its intentions to reduce the regulatory interest rate on the electricity grids (WACC) by adapting the method used to calculate it. This would barely reduce energy costs for consumers, while also leaving the grids exposed to maintenance- and expansion-related risks. The following contains an assessment of the situation.

For some years now, there have been calls to reduce the regulatory interest rate on the grids (WACC) in order to relieve some of the cost pressure on consumers. The Federal Council carried out a comprehensive review of the method underpinning the WACC in 2021, but ultimately decided not to make any changes. With the 2021–2022 energy crisis causing in some cases extreme rises in electricity prices, these calls have grown louder still. Then, in mid-June 2024, the Federal Council began the consultation process on a draft outlining a change in method that would involve an amendment to the Electricity Supply Ordinance, with the consultation set to end in early October.

What is the WACC?

The electricity grid is a natural monopoly, since ultimately parallel operation of such grids would be highly inefficient. Owing to this monopoly situation, the grid is heavily regulated, such as with respect to ensuring non-discriminatory access. Another highly regulated aspect is the setting of grid tariffs. In Switzerland, the primary approach is a form of cost-based regulation known as cost-plus: each year, the grid operators report their total costs to the regulator ElCom, which they then include in the grid tariffs and can thus pass on to consumers. In addition to operating costs, grid operators can also account for capital costs in their tariffs. This is where the regulatory WACC (weighted average cost of capital) comes into play, as it dictates the amount of the chargeable capital costs. The WACC thus covers the costs of debt capital, as well as guaranteeing an appropriate level of return or profit for investors. The Federal Council sets out the underlying calculation method in an ordinance. The inputs for the model and the resulting WACC are updated on a yearly basis.

In simplified terms, the WACC formula calculates interest on debt capital and return on equity, which it then weights with a defined composition of debt capital and equity. To determine the return on equity, the expected market return for the risk taken on by the distribution grid operators is corrected in comparison to the overall market using what is known as the beta factor.

The Federal Council’s proposal

According to the consultation, the Federal Council is proposing a change to the long-established calculation method. Under the new terms, the WACC would continue to be formed from a combination of a risk-free interest rate and a return on equity. However, while the existing method achieves greater stability by applying upper and lower bounds to the risk-free interest rate, this would be eliminated from the new method. Instead, a certain stabilising effect is expected to emerge from the changes in how the parameters interact.

Method adjustment leads to uncertainty

The previous method had the clear advantage of being tried and tested in practice over many years, allowing it to achieve the requisite security of investment. Compared to other types of investment, the amortisation periods associated with electricity grids are very long, with investments being tied up for 60 years or more. As a result, a particularly stable return on the capital is also required. The lower bounds helped to ensure that there was an incentive to invest even during periods of low interest rates. In other countries where these lower bounds are absent from the methods used, the WACC has had to be artificially supported by regulatory intervention. 

Report commissioned by the Association of Swiss Electricity Companies (VSE)

At the other end of the scale are the upper bounds, which are intended to put the brakes on the WACC in times of extraordinarily high interest rates.

Changing to a new method would lead to uncertainty for investors, with the potential impacts of this change varying significantly depending on how the market evolves. Generally speaking, however, the WACC would decrease considerably, especially at times when interest rates are low. This would make it harder to raise the capital needed to expand the grid during these periods.

Adjusting the comparison group is not the answer

In the current climate, the biggest impact on the WACC would not be the change in the method itself, but rather an associated reduction of the beta factor, which is instrumental in determining the chargeable return on equity (see above). A comparison group is used to estimate the beta factor in each case. The intention is to limit this to just five foreign transmission grid operators, instead of also including distribution grid operators as before. In addition, the beta factor determined in this way would no longer be corrected for uncertainty in the estimate.

The artificial lowering of the beta factor is based on the argument that the risks to Swiss grid operators are much lower compared to those abroad. Although the regulation systems in neighbouring countries do contain some conceptual differences (incentive-based as opposed to cost-based regulation), they are often materially very similar to the Swiss system in their implementation. Furthermore, domestic grid operators still face various risks in spite of cost regulation, such as certain costs being defined as non-chargeable after the fact or loss-making regulatory evaluations being made for them. Ultimately, decreasing the size of the comparison group and switching to the use of an uncorrected beta factor would lead to a less robust estimate of the beta factor in general.

Little benefit to consumers

According to the Federal Council, the adjustments would reduce the WACC by around 0.57 percentage points (from 3.98% to 3.41%) in the present environment. This represents a substantial cut for grid operators, and would make it significantly harder to raise capital – including building up the corresponding equity. Conversely, any hopes that this would significantly reduce the cost of electricity for consumers are likely to be in vain. According to calculations by the federal government, this measure would cut electricity tariffs by CHF 0.0022/kWh. For an overall electricity tariff of CHF 0.29/kWh (2025 household median), this represents a reduction of less than 1% (in detail: CHF 0.0022 / CHF 0.29 = 0.76%). Even when looking at grid tariffs, the reduction is still less than 2%. This means that the proposed adjustment does not offer a realistic solution to the substantial rise in electricity tariffs during the energy crisis, while also putting grid expansion at risk.

Collateral damage for renewable energy

The changes are not limited to grid tariffs alone: the level of funding for renewable energies is also determined using WACC rates that are based directly on the method for the grid WACC. The proposed change of method would also reduce the subsidies for renewable energies in periods of low interest rates. This would have the effect of disincentivising investors, particularly if, when refinancing the investment costs further down the line, interest rates are expected to be significantly higher than at the time the subsidy was granted.

No time for experimentation

On 9 June, the public approved the new electricity law, which envisages a large-scale expansion of renewable energies, in particular solar installations. This expansion represents a major challenge for grid operators: if the targets are met, the peak load on the grid could triple over the next decade. Even with counter-measures such as curtailing peak power from solar installations and making better use of consumption flexibility, these targets would require substantial expansion and reinforcement of the grid. In view of these investments and the associated high capital requirements, the planned adjustment of the WACC method and the resulting uncertainty are unfathomable.

Furthermore, with the energy crisis abating, market prices and consumer costs have already fallen again and this trend is set to continue. In order to prevent similar price fluctuations for consumers in the future, the new electricity law requires energy suppliers to do more to guard against price jumps when procuring basic supply. The best way to further ease the burden on small-scale consumers is to completely open the market, allowing them to choose the most affordable electricity supplier instead of being tied to the local supplier. By contrast, reducing the WACC is neither an effective nor a sustainable response to the energy crisis. On the contrary, a rapid expansion of renewable energies is needed to ensure affordable electricity in the future. And this can only be achieved with strong electricity grids.