Risk and Returns Sensitivity in UK Electricity Utilities, 1990-1999

Utilities regulation attempts to attenuate the effects of market failure. Contemporary systems of regulation are generally either rate of return or price cap (RPI-X) systems. This paper addresses the issue of the levels of excess returns and risk inherent in investment in the equity of regulated electricity distribution utilities in England and Wales, where an RPI-X system has been used. It uses the techniques of the Kalman Filter to estimate daily betas for the regional electricity companies in the period from privatization to end-1998. The paper demonstrates that these utilities' risk is time-variant. It demonstrates, also, that there have been significant political and regulatory influences in the systematic risk faced by electricity utility shareholders. It finds beta to be mean reverting, with little evidence of cyclical variation across the regulatory review cycle. The paper also confirms that significant excess returns have been generated over the history of the privatized electricity distribution sector in the UK and it suggests that over-estimation of the systematic risk faced by investors in the sector may imply further excess returns in the next regulatory review period