What makes financial planning in a regulated environment so different?

Key insights

  • Not only does company strategy have an impact on financial performance and investment decisions, changing regulatory requirements also play a role. Therefore in a regulated environment, a financial plan must take account of both.
  • Two real-life case studies illustrate aspects of financial planning that are specific to the energy sector, but they can also be used in other regulated sectors.

A considerable number of case studies on financial planning have been developed, but it is more difficult to find ones that deal with financial planning in a regulated environment. For the Future Grid Managers Programme, Professor Filip Roodhooft, along with colleagues from the Energy Centre, straight away developed two that play out in the regulated energy sector. In the leading roles are the Belgian distribution system operator (DSO) Eandis, now Fluvius, and the French transmission system operator (TSO) Réseau de Transport d’Électricité (RTE).

Regulatory risk

With the First Energy Package in 1996, the European Commission kicked off the liberalisation of the energy market in the EU. Along the way, the gas and electricity sectors moved from being monolithic state monopolies to regulated markets. Vertically integrated energy companies were disentangled: today, electricity transport services – transmission and distribution – are separated from production and supply. However although competition has been introduced, electricity networks are regarded as natural monopolies, and these need to be regulated. Independent energy regulators monitor the development of the electricity grid, investments and prices. The rise of renewable energy and decentralised power generation, and the continuous development of new technologies, have led to regulators regularly revising their policies. “In this kind of context, a financial plan must take account of an extra dimension: regulatory risk”, says Filip. 

Should smart meters be rolled out or not?

The case study on DSO Eandis takes place towards the end of 2014. At that point, CEO Walter Van den Bossche was working on the financial plan, but he faced a greater challenge than in previous years: a decision had to be made about investing in and rolling out smart meters. Up to that point, Eandis had been subject to a regime of rate-of-return regulation (cost+), in which it was able to recoup its costs through distribution tariffs. This regime had also allowed room for infrastructure investments, but was to be replaced by a new incentive system that was still to be determined – a price cap or a revenue cap. Now, the lifetime of an investment amounts to more than ten years, whilst a negotiated pricing policy for DSOs in Belgian is typically only valid for between four and five years. Could the investment go ahead, and if it did, what would be the most advantageous financing structure? It was therefore a question of taking account of the regulatory risk and developing a financial planning model that would help evaluate the investment in smart meters in a variety of scenarios.

High voltage

In late 2013, Olivier Lavoine, CFO of RTE, was faced with a similar problem. There was an ambitious infrastructure investment programme on the table, but there was a lack of clarity as to the regulations. Originally, TSOs, including RTE, were subject to rate-of-return regulation (cost+), but from 2014 onwards, there would be a switch to a revenue cap system, which meant that you had two separate negotiation processes – one for investments and another to determine the income limit. However there was a chance that for investments, the regulator would follow the example set by other EU Member States and opt for a different approach. Moreover, the pricing policy could also change from one regulatory period to another, partly as a consequence of the investments planned by RTE – the income limit could be replaced by a price cap, for example. So Olivier Lavoine also had to develop a financial planning model with which he could analyse the impact of the planned long-term investments, taking account of uncertainties in the regulations.

Experimenting with real models

“Using case studies, we want to familiarise students with the use of financial planning models in a regulated sector”, explains Filip. “We introduce them to key financial terms and concepts, tailored to their familiar environments – we draw up a profit and loss statement, establish the cash flow and future cash position, analyse the need for working capital and the possible sources of financing, look at what an ROE is, etc. Indeed, participants in the Future Grid Managers Programme are not necessarily well versed in the financial aspects of management.”

“Then we apply the theory using financial models that the companies in question also use themselves. For educational purposes, we have admittedly simplified them a little, but they still paint an accurate picture. In this way, students gain insight into the specific aspects of financial planning models for regulated companies. With the spreadsheets that sit alongside the case studies, they can experiment at will with different scenarios. And to top it all off, there are two videos in which Walter Van den Bossche and Olivier Lavoine tell their story.”

“Students who use these case studies have a better understanding of how financial performance and investment decisions are not only determined by business strategy, but also by regulation and changes to those regulations, and how various factors help shape the interaction between regulators and regulated companies”, he concludes.

Applicable to other regulated sectors too

Although these case studies concern the energy sector, their use does not have to be limited to the Future Grid Managers Programme or other programmes for energy professionals, Filip emphasises: “They are useful for any kind of regulated sector. So you can easily integrate them into custom in-company programmes.”

The range of case studies available has now been enhanced with two extremely realistic versions. “I am therefore especially grateful to Walter Van den Bossche and Olivier Lavoine for their collaboration”, Filip adds. “Without them, these case studies would never have been possible.”

The two case studies, “Eandis: Financing the Roll Out of Smart Meters in a Regulated Environment” and “RTE: Financing Electricity Transmission Investments in a Regulated Environment”, are published by Ivey Publishing. As well as the case study descriptions, you will also find teaching notes, spreadsheets and video material.

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