regulation and incentives for investment: an investor ... 4... · presentation by steven boulton...

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ACCC Regulatory Conference 2006The international experience with regulation

Regulation and incentives for investment: an investor perspective

Presentation by Steven BoultonChief Executive Babcock & Brown Infrastructure

Friday 28 July 2006 Marriott Hotel Surfers Paradise Queensland

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Infrastructure may be a monopoly, but the investment market is not

To attract investment the regulated risk/return must be competitivewith rates set in an international capital market

BBI has a global mandate for investment – the regulatory regime in a jurisdiction can significantly influence the decision on where to invest -alternative jurisdictions are competing for capital

The investment market is competitive

3

AGENDA

1. Introduction to BBI

2. Regulatory Environments – Summary by Asset

3. The Need for Investment

4. What Investment Environment do Investors Seek

5. Case Study: DBCT – Queensland Competition Authority

6. Case Study: Powerco – NZ Commerce Commission

7. Conclusion

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4

BBI – has a globally diversified investment & asset portfolio

* NWEC acquisition is subject to NWEC shareholder and regulatory approvals

• Geographically diverse with both local and offshore investments:– Australia (all states)– New Zealand (North Island)– Europe (UK, Channel Islands, Portugal, Belgium, Spain and Germany)– United States (New York and Mid North West*)

• Multiple regulatory environments– Asset portfolio covers a multitude of different regulatory approaches– Staggered term and reset periods in different countries

• Global deal origination for acquisition– Network of Babcock & Brown professionals in 21 offices worldwide– Complementary opportunities sourced via operating subsidiary relationships

• Asset classes:– Energy distribution and transmission – Transport – Power generation

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The global diversification of BBI

DBCT

Powerco

IEGCSC

Ecogen

RedbankWNR

BBW

BBW

NWEC*

* NWEC acquisition is subject to shareholder and regulatory approvals

BBW

PDPorts

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AGENDA





5. Case study: DBCT – Queensland Competition Authority


7. Conclusion

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7

Regulatory Environments – Summary By AssetASSET MARKET POSITION ECONOMIC

REGULATION REGULATOR(S) REGULATORY REGIME - SUMMARY

NWEC

• Monopoly position in Montana, South Dakota and Nebraska.

• 75% regulated operating income and 25% unregulated

• Yes for electricity and gas

• Various State regulators

• Montana PSC • SthDakota PUC • Nebraska PSC

• Revenue set based on a version of the building blocks approach with focus on original cost for a historic test period and cost of equity (rather than WACC), assumed gearing with actual cost of debt used.

• Rates calculated based on consumption estimates and total revenue number

• No specific reset period • Company can initiate rate review.

Powerco

• 2nd largest electricity and gas distribution entity in NZ

• Only reticulated natural gas supplier in Tasmania

• Yes for electricity and gas in New Zealand

• Franchise for key C&I customers in Tas. No economic regulation at present.

• New Zealand Commerce Commission

• Electricity - threshold (CPI-X) scheme for price and quality. Reset is 2009 potential for building blocks approach to be introduced.

• Gas – under provisional pricing control - Building blocks approach focused on WACC. ODV used to assess asset values. Likely to be regular resets.

IEG

• UK ‘last mile’ gas distribution – 2nd largest supplier.

• Isle of Man & Channel Islands – integrated gas supplier, competing with other fuel sources

• Portugal – major LPG distributor

• Nil in Channel Islands, Isle of Man and Portugal

• Ofgem in UK with capacity charges (fixed revenue per connection)

• Ofgem in UK • Legacy Networks (those contracted before Jan 2004) regulated under a ‘reasonable profits’ test. Will migrate to RPC over time.

• Relative Price Control (RPC) Networks (those contracted after 31 Dec 2003). Aggregate of IGT and upstream distributor charges must not exceed charge that would have applied had the connection been made directly to upstream distributor.

• RPC does not directly constrain profits or return on investment.

• No reviews of RPC model are planned before 2014.

CSC • Key asset for electricity

transmission between Long Island and New England

• Yes • FERC • Regulator (FERC) approval for transmission capacity rate and long term contract out to 2032.

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Regulatory Environments – Summary By AssetASSET MARKET POSITION ECONOMIC

REGULATION REGULATOR(S) REGULATORY REGIME - SUMMARY

PD Ports

• Major landlord port • Owns 2nd largest port in UK

by volume (55m tonnes of cargo ) (Teesport)

• 10th largest port in UK/Europe

• Deepest sea port on Eastern seaboard of UK

• Nil. • Has Statutory Harbour

Authority status allowing it to set conservancy tariffs.

• Sets lease rates for owned property.

• N/A

• N/A

WestNet Rail

• Rail access provider in Western Australia

• Yes • WA Economic Regulatory Authority (ERA)

• Access Code covers freight rail network • Negotiate/Arbitrate model with charges set

within a regulatory floor and ceiling for a specified route section

• Regulatory ceiling acts to cap revenues based on capital costs (with asset values based on a theoretical Modern Equivalent Asset (MEA) value and a WACC applied), operating costs and access related overhead costs. Ceiling set for three years updated annually for WACC and CPI –X.

• Floor is to stop cross-subsidisation and is a minimum charge based on incremental cost.

• Basically building blocks approach with MEA rather than DORC and negotiations within floor and ceiling

DBCT

• One of the world’s largest coal export terminals.

• Yes • QCA • Revenue cap – building blocks approach. • Operating costs passed through to customers • Clear ex-ante process for regulatory approval of

expansion costs. • Regulatory term through to December 2009.

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AGENDA







7. Conclusion

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Is there a need for investment in Infrastructure?

Infrastructure investment as a proportion of GDP has steadily declined since 1985

Sourced from CRA Report “The Future of Infrastructure” for UBS, 2006

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Is there a need for investment? – Electricity

• Growth in electricity demand:

– Economic prosperity increases demand - :

- 42% increase in peak demand in South East Queensland in last five years -

- 7% increase in Auckland this year

- Air-conditioning in US is 5% of total load but 20% of peak demand

– Digital economy –

- has increased demand from 25 Watts per sq metre in 1980s to 90 Watts today

- demands higher quality of supply

• Capacity utilization is at critical levels – outages speak for themselves

• Downtime now costs more - greater proportion of economy dependent on electricity

• Ageing assets - substantial network asset investments made in 1960/70’s – and its been diminishing since

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The asset replacement cycle – indicativeFirst wave of investment 25-40 years ago – assets now require replacing……...replacement

assets need to respond to new quality and security demands of customers

1940

1950

1960

1970

1980

1990

2000

2010

2020

2030

2040

2050

Initial investment Replacement investment

We are here

5

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Asset replacement cycle: UK Electricity

£0

£500

£1,000

£1,500

£2,000

£2,500

1950

1960

1970

1980

1990

2000

2010

2020

2030

Rea

l Pou

nds

2004 Decision by Ofgem 48% real increase

Initial investment Replacement

Ofgem held capex steady but replacement requirement was rising

“We conclude that the Regulator’s policy...of both tightly limiting capital expenditure for replacement and continuing the pressure to reduce operational expenditure on maintenance is incompatible with the long-term stability of the electricity network” …House of Commons Committee UK, 2004

Source: Benchmark Economics

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Asset replacement cycle: NSW Electricity

$-

$100

$200

$300

$400

1919

1929

1939

1949

1959

1969

1979

1989

1999

2009

2019

2029

Annual capex ($M)2002

IPART - Pricing determination 200480% increase

Ageing assets is not a new phenomenon but a feature of electricity supply networks…….ESC Draft Decision 2005.

Source Benchmark Economics

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Asset replacement cycle – NZ Electricity Distribution Network

A similar wave of replacement investment is required….NZ investment only has a slight time

lag in peak investment, yet very similar historical profile.

Future investment requirements for businesses expecting to install large relative additions to their capital have also been raised as

potential cases for special treatment. However these investment needs should not require special treatment provided price caps are set

on the basis of long run efficient costs and returns to capital..…Meyrick and Associates, Regulation of Electricity Line Businesses,

Resetting the Price Path Threshold, Comparative Option Paper

Source: Benchmark Economics

$-

$5,000,000

$10,000,000

$15,000,000

$20,000,000

$25,000,000

$30,000,000

$35,000,000

$40,000,000

1940

1950

1960

1970

1980

1990

2000

2010

2020

2030

2040

2050

INIT

IAL

+ REPLA

CEM

ENT

CAPEX

($19

99)

Initial investment Replacement investment

We are here

6

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AGENDA







7. Conclusion

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Investment IS necessary - what do investors seek….

• Consistency, stability and predictability

• Balanced and transparent regulatory regime

• Competitive return

• Return of capital over a reasonable time frame

Few regulatory regimes in Australia or New Zealand fully provide this environment – although regulators’ commentary tries to persuade otherwise.

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Consistency, stability and predictability

Consider:

• Electricity is one of the most capital intensive industries

• Asset lives between 50 and 70 years

• That is, between 9 and 14 regulatory price resets in an asset lifetime

Powerlink 6.9$ Transgrid 6.6$ Transend 6.5$

EnergyAustralia 5.0$ Macquarie Generation 3.2$ Qantas 1.1$ Telstra 1.1$ BHP Billiton 0.9$ AGL 0.7$ Blue Scope 0.6$ Orgin 0.4$ One Steel 0.4$ Orica 0.3$ Wesfarmers 0.2$ David Jones 0.1$ Woolworths 0.1$

Fixed assets / revenue

Long-lived assets make certainty and predictability a prerequisite for investment

7

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Consistency, stability and predictability

• Stability and Predictability MUST mean less regulatory discretion– A high level of discretion for the regulator must result in increased uncertainty

and exposure to regulatory fads or opportunism which creates a disincentive to invest

– A high level of discretion leads to investor perception that regulators manipulate parameters to achieve pre-conceived outcomes

• High level statements of principles do not provide consistency or predictability – the devil is in the detail

• The endless search for the “right” answer is counter-productive:– For example, continuing debate on WACC parameters, seemingly at every

regulatory determination, results in uncertainty of rate of return and is a disincentive to invest

• In Australia and New Zealand, regulators currently have a high degree of discretion

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• Level of autonomy in setting WACC parameters and consequent potential for change over time increases the cost of capital –- but not the rate of return:

“In recent years the sector has experienced prolonged challenges from regulatory uncertainty…the regulatory regime is now a hybrid of ‘light-handed’ and interventionist approaches, increasing uncertainty for industry participants…

These challenges are now heightened, and accordingly Fitch’s outlook for the sector continues to be negative” …Fitch Ratings (2005)

• Lack of certainty and predictability is driving a wedge between initial investment and replacement investment

“Regulatory uncertainty, short time frames,…and (regulatory creep) negatively impact on performance. This creates risk for existing investment and discourages new investment.”… Westpac, NZ (2004)

• The future is a competitive investment market - investors have choices in making future investments (acquisitions, major enhancement, bolt-on and incremental opportunities)

Consistency, stability and predictability – How are we faring?

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Within a single revenue model for gas regulation, the NZ Commerce Commission used different asset valuation methodologies……compounded by using valuations from different periods (to no common standard). Consequently investors have concerns about regulatory ‘cherry picking’ and opportunism……

Estimate of depreciable asset base for tax depreciation

Estimate of depreciation

Estimate of reasonable return

Purpose

Acquisition cost

ODV

ODV

Valuation Methodology

$371 M

$205 M

$205 M

Asset value

8

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Victoria ESC 2005 Price re-set

Draft Decision, June 2005

After 16 months of “extensive consultation in formulating its Draft Decision”… ESC:

• Reduced Po adjustments by 50 – 75%

• Increased capex by up to 38%

…and there are up to 14 price resets in the life of electricity assets

66828.8Powercor

53716.7SP AusNet

44422.7United Energy

38423.5CitiPower

21715.1AGLE

CapexPo

50314.7United Energy

6949.3SP AusNet

92617.3Powercor

4868.7CitiPower

2323.8AGLE

CapexPo

Final Decision, October 2005

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Balanced and Transparent Regulatory Regime• An effective accountability regime is particularly important where regulators have a

high degree of discretion

• There is little accountability on regulators in Australia and New Zealand for their decisions, as:

– The investment impact of regulatory decisions made today can take many years to become apparent; and

– Some regulators in Australia and New Zealand face little or no exposure to merits review

• Merits Review is necessary to engender confidence:– Should be a fundamental right– Lack of Merits Review means there are no ‘checks and balances’. Investors see

the regulator as prosecutor, judge and jury– Arguments that the introduction of Merits Review will result in delays in final

regulatory decisions are weak - assets are long life, impact of the regulators decisions are significant

– Decisions of lower courts in Australia are subject to review of higher courts – like everyone else regulators are capable of error; some redress for the regulated is simply a matter of natural justice

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Competitive Return• Return on capital must be appropriate to attract investment – needs a real world

commercial perspective

• CAPM invariably used but is imprecise and can only provide a range (at best)– The eminent economist Robert Solow observed that:

“models are an attempt to make impossibly precise statements about an inherently imprecise world”.

– Productivity Commission agreed:- CAPM is theoretical model based on debatable assumptions- There is no single correct method to calculate rate of return- There is a range of plausible values- Parameters need to be made more explicit

• Most commentators agree that the long run consequences of setting too low a WACC are more serious than setting too high a WACC

– Some regulators recognise this:“We’ve got some material provided by the Allen Consulting Group suggesting that the [equity] beta measure based on market evidence is around the 0.7 or 0.75 mark. There’s good evidence for us to rely on, if we wanted to go there, but we take a cautious approach and we’ve adopted an average equity beta (of 1).” …ACCC

9

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Competitive Return (Cont)

• Although Return on Capital is important, the overall return is affected by other “building block” parameters –– for example setting an appropriate asset value and efficiency target (the ‘x’)

is critical

• Regulatory approach to setting all parameters within the building block needs to be consistent – For example using asset values and gearing determined by the regulator as

‘efficient’ but then utilising real tax values is inconsistent

• Once a parameter has been set it should not be adjusted except if there is compelling evidence to do so

• In short, inadequate returns, inconsistent arguments in setting parameter values and continually adjusting parameter values will inhibit investment in the long term

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AGENDA







7. Conclusion

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Case Study – Dalrymple Bay Coal Terminal (DBCT)

• DBCT was BBI’s foundation asset, and now represents circa 17% of BBI’s asset base (will be 11% post the proposed GasNet and NorthWestern acquisitions)

• DBCT is a regulated asset and terms and conditions of access (including tariffs) are regulated under the QCA Act by the QCA

• The QCA released a Final Decision on the DBCT Access Undertaking and approved an Access Undertaking based on the Final Decision

• DBCT’s current capacity is 54.5 Mtpa, and is fully contracted

• There is growing global demand for QLD’s Bowen Basin coal

• DBCT is the key export gateway of the Bowen Basin coal mining region in central QLD

• Underlying customer demand supports DBCT’s expansion

• Extensive and prolonged regulatory review of DBCT recently completed

10

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Case Study – DBCT (cont)• DBCT regulatory process attracted criticism from some parties - especially in

relation to the time it took to reach an outcome – but some significant positive outcomes were achieved

• The QCA engaged in extensive consultation on asset value

• QCA has set the DORC and will not revisit except under exceptional circumstances (e.g. material error) – this provides a high degree of certainty going forward

• QCA has approved an access undertaking that sets out a clear ex-ante process for determining whether expansion costs are efficient and therefore allowed in the DORC – this provides a degree of certainty (and confidence) for the investor

• The QCA has stated that once expansion costs are accepted into the DORC they WILL NOT be optimised out at a later date

• A consultative ‘open’ environment now exists between BBI (DBCT) and the QCA –there is frequent contact between the parties.

• Main concern for BBI is whether the QCA will revisit the WACC once expansion capital has been committed and investment made

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AGENDA







7. Conclusion

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Case Study – Powerco NZ Commerce CommissionElectricity Lines Regulation (Current)• August 2001: An initial threshold regime was introduced for the period 08 August 2001 to 31 March 2004 based

on a “price freeze” and quality threshold for the year to 2004

• During 2002 and 2003 the threshold targeted threshold regime was developed, which consisted of:

– Price thresholds based on CPI-X

– Quality threshold based on network reliability (quality measured by SAIDI and SAIFI not to exceed previous 5 year average + margin (i.e. no material deterioration))

– No profit thresholds (although this is assessed to determine X)

– Transmission costs and TLA rates to be treated as pass-through costs for lines businesses

– A breach of the thresholds triggers investigation and possible price control

– The regime applied for the five-year period from 01 April 2004 to 31 March 2009

• During 2003 the initial assessment was undertaken to determine the specific “X” factor for each company. This was undertaken using industry productivity, company productivity and company profitability (productivity and profitability were ranked)

– Powerco achieved an X = 2% (the highest X factor)….in our view the regime didn’t properly consider cost and asset drivers for a significantly rural network like Powerco

– Profitability analysis used a simple form of building blocks based on asset valuations (ODV); going forward a choice between ODV and DHC for valuation purposes was proposed

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5 x RAW INPUTS WEIGHTING WEIGHTING 3 x RAW OUTPUTSPRODUCTIVITY

=INPUTS

X divided by XOUTPUTS

X X

X X

X

Meyrick MTFP Productivity Analysis to Determine C1 Factors

OPEX = Direct $/km x km +Indirect $/Cust x # Custs

O/H & U/GLINE CAPACITY =System km x MVA factor

TRANSFORMER CAPACITY =installed MVA

OTHER ASSETS =% ODV (2%TO 4%)

INPUTweights formed

by share of cost of each five inputs to total costs = sum of opex and nominal

depreaciation.

ODV alloacted to four asset

classes using weighted

average shares in density

groups = rural high;

rural low;urban high;urban low

WEIGHTED INPUTS

Multilateral Total Factor Productivity

(MTFP) Calculation

MTFP ScoresELB's ranked by score into three groups to allocate C1 factors of -1, 0 & +1

WEIGHTED OUTPUTS

OUTPUTweights formed

from an econometric Leontief cost

function using share of each observation's

estimated costs in total costs

for all ELB's in all time periods

Energy kWh 22%

Line MVA-km32%

Connections46%

TROUGHPUT (Energy) = electricity supplied in kWh

LINE CAPACITY =System km x MVA factor

CONNECTIONS = Number of connected consumers (ICP's)

The analysis and structure is complex and whilst innovative sets a new unproven model which cannot be understood by investors….

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K e y E L B2 9 2 1 A lp in e E n e rg y2 8 8 2 B u lle r E le c tr ic ity2 7 6 3 C e n t ra lin e s2 6 2 9 4 C o u n tie s P o w e r2 5 1 2 5 D u n e d in E le c C o m b in e d2 4 1 1 6 E a s tla n d N e tw o rk C o m b2 3 5 7 E le c tra2 2 3 8 E le c tr ic ity A s h b u r to n2 1 2 1 9 E le c tr ic ity In v e rc a rg il l2 0 2 2 1 0 H o r iz o n E n e rg y1 9 2 3 1 1 M a in P o w e r1 8 2 8 1 2 M a r lb o ro u g h L in e s1 7 4 1 3 N e ls o n E le c t r ic it y1 6 2 4 1 4 N e tw o rk T a s m a n1 5 7 1 5 N e tw o rk W a ita k i1 4 1 5 1 6 N o r th p o w e r1 3 1 9 1 7 O r io n N e w Z e a la n d1 2 1 1 8 O ta g o P o w e r1 1 1 7 1 9 P o w e rc o C o m b in e d1 0 1 8 2 0 S c a n p o w e r9 2 5 2 1 T h e L in e s C o m p a n y C o m b8 2 0 2 2 T h e P o w e r C o m p a n y7 1 6 2 3 T o p E n e rg y6 1 4 2 4 U n is o n5 2 6 2 5 U n ite d N e tw o rk s C o m b4 1 0 2 6 V e c to r3 2 7 2 7 W a ip a N e tw o rk s2 1 3 2 8 W E L N e tw o rk s1 9 2 9 W e s tp o w e r

R A N K 1 2 3 4 5 6 7 8 9 1 0 1 1 1 2 1 3 1 4 1 5 1 6 1 7 1 8 1 9 2 0 2 1 2 2 2 3 2 4 2 5 2 6 2 7 2 8 2 9

Effic

ienc

y bu

t ref

erre

d to

as

prod

uctiv

ity

C 2 = -1 C 2 = 0 C 2 = + 1P ro f ita b ility

C 1 / C 2 M a tr ix - M e y r ic k F in a l r e p o r t

C1 =

+1

C1 =

0C

1 = -1

C = - 2

C = - 1

C = 0

C = + 1

C = 0

C = - 1

C = 0

C = + 1

Lines Businesses are ranked on the dimensions of profitability and productivity with ‘X’ factors then applied…….

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2 92 82 72 62 52 42 32 22 12 01 91 81 71 61 51 41 31 21 11 0987654321

R A N K 1 2 3 4 5 6 7 8 9 1 0 1 1 1 2 1 3 1 4 1 5 1 6 1 7 1 8 1 9 2 0 2 1 2 2 2 3 2 4 2 5 2 6 2 7 2 8 2 9

P ro fita b ility

C1 =

+1

C1 =

0C

1 = -1Ef

ficie

ncy

but r

efer

red

to a

s pr

oduc

tivity

C 2 = -1 C 2 = 0 C 2 = + 1

C 1 / C 2 M a tr ix - P o w e rc o to Im p ro v e to C = 0

C = - 2

C = - 1

C = 0C = + 1

C = 0

C = - 1 C = 0

P o w e rc o is h e reO R

P o w e rc o c o u ld h a v eR E D U C E D O p e x b y 1 2 %

P o w e rc o c o u ld h a v e IN C R E A S E D O p e x b y 1 4 %

C = + 1 O RP o w e rc o w o u ld h a v e n e e d e d to :IN C R E A S E e n e rg y th ro u g h p u t b y 2 1 % ; O RIN C R E A S E c o n n e c tio n s b y 1 0 % ; O RR E D U C E lin e le n g th b y 4 0 % ; O RR E D U C E tra n s fo rm e r c a p a c ity b y 2 3 % W H IL S TM A IN T A IN IN G a ll o th e r in p u ts & o u tp u ts th e s a m e

The dilemma……how to control the input/output factors and whether to increase or decrease costs?

12

34

Entities cannot demonstrably control most of the inputs and outputs. Powerco cannot meet peer performance through cost controls…….

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Key ELB29 2 CE 1 Alpine Energy28 8 2 Buller Electricity27 6 3 Centralines26 29 4 Counties Power25 12 IE 5 Dunedin Elec Combined24 11 6 Eastland Network Comb23 5 7 Electra22 3 8 Electricity Ashburton21 21 9 Electricity Invercargill20 22 10 Horizon Energy19 23 11 MainPower18 28 12 Marlborough Lines17 4 13 Nelson Electricity16 24 14 Network Tasman15 EA 7 15 Network Waitaki14 15 16 Northpower13 19 17 Orion New Zealand12 1 18 Otago Power11 17 19 Powerco Combined10 18 20 Scanpower9 25 21 The Lines Company Comb8 20 22 The Power Company7 16 23 Top Energy6 14 24 Unison5 26 25 UnitedNetworks Comb4 10 26 Vector3 27 27 Waipa Networks2 13 28 WEL Networks1 9 29 Westpower

RANK 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29

Profitability

C1 / C2 Matrix - Australian DNO's added

C1 =

+1

C1 =

0C

1 = -1

Effic

ienc

y bu

t ref

erre

d to

as

prod

uctiv

ity

C2 = -1 C2 = 0 C2 = +1

Load factor%

Opex per km$/km

Opex per Cust$/ICP

Load densityMWh/ICP

Customer densityICP's/km

Energy AustraliaIntegral Energy

Network Characteristics

Country EnergyNZ ELB Average

29.923.13.9

11.3

18.5 166 4964

13.9 378 149216.1 181 1819 64%

56%

60%19.9 232 5351 58%

C = - 2

C = - 1

C = 0

C = + 1

C = 0

C = - 1

C = 0

C = + 1

Energy AustraliaCPI - 1%

IPART CPI + 7% / + 1.6%

Integral EnergyCPI - 3%?

IPART CPI + 5% / + 1.5%

Country EnergyCPI - 2%

IPART CPI + 7% / + 2.5%

Data Sources:NZ data from Meyrick Final Report Regulation of ELB's 1996-2003

Australian data from IPART Public Disclosure of Regulatory Accounts 2003 and NSW Electricity Distribution Pricing 2004-2009 Final Report.Note: A$ coverted to NZ$ at prevailing exchange rate

Where would Australian ELB’s fit?

What are investors to make of this?

36

Case Study – Powerco NZ Commerce CommissionElectricity Lines Regulation (Current)• Complex regulatory framework and authorities;

– Commerce Commission;– Electricity Commission;– Complaints Commission– Gas industry Company

• Utilities regulation has a combination of historic light-handed, new multi dimensional thresholds structure and price controls (with no international or historic precedents)

• Thresholds structure is both complex (a black box?) and seemingly inconsistent

• Lack of thorough early analysis in the production of robust inputs for the model has created uncertainty

– Old value ODV applied in original thresholds but not reviewed post update of ODV, plus ODV does not include all assets a new entrant would have to construct/acquire to operate

– Complete disallowance for merger/acquisition costs but benefits passed through to consumers

• Backwards looking regime with retrospective application

• Investors would like more certainty from regulators

13

37

Case Study – Powerco NZ Commerce CommissionElectricity Lines Regulation (Current)• Electricity Regulation

– Importantly BBI are not arguing for no regulation for electricity networks rather BBI is arguing for quality regulation:

- Stable and predictable environment- Changes to established regulatory practice are implemented on a forward looking

basis with use of engineering based data and information (restrict use of theoretical economic modelling)

- Reasonable returns and asset valuations reflecting ‘real world’ requirements- Introduction of Merit Review

– In short the principles of good regulation should be adopted to reduce regulatory discretion and increase certainty.

• Conclusion– Electricity Regulation in NZ is complex, evolving and the future is uncertain – creates an additional

hurdle to ongoing investment and stifles the opportunity for the most sizable efficiency savings available (merger/acquisitions). BBI will need to review what compelling reasons remain for further investments in NZ given the current regulatory position and rates of return etc (eg for Unison) –particularly with the availability of quality investment opportunities elsewhere

38

Case Study – NZ Commerce Commission, Gas Network Regulation

• Commerce Commission has moved to regulate gas pricing despite gas being a competitive fuel – with competition from LPG, electricity and other fuel sources. It is not clear that regulation is actually required

• Commerce Commission was to apply a Net Public Benefit test, instead, it applied a Net Acquirer Benefit test. Consistency/predictability/balance issues?

• Application of different asset valuation methodologies (capture of non-cash tax position and direct transfer of value to acquirers) sends strong signals to investors about the power to penalise investment on an ex-post basis.

• There is no provision for Merits Review in New Zealand – severely reducing the regulator’s accountability.

• Powerco has initiated judicial review on decision to introduce price control for gas - Trial judge has given Powerco leave to cross-examine a number of Commerce Commission staff and Commission’s experts. A step towards transparency.

• A notice of appeal has been lodged by the Commerce Commission – the Commission is appealing against a process that from an investors perspective provides both transparency and accountability

• Conclusion – BBI will continue to provide constructive input to the current regulatory processes but will also need to review the investment risk equation in the NZ gas distribution sector given the current regulatory position and rates of return - particularly given availability of quality investment opportunities elsewhere which would provide superior risk/return outcomes

39

AGENDA







7. Conclusion

14

40

Conclusion• BBI Invests in a number of jurisdictions, each with different regulatory regimes

• The regulatory environment in place, its development, recent history and behaviour of the regulators does influence whether and where international capital is invested – best practice regulatory regimes will help attract capital

• Investors are seeking:– Consistency, stability and predictability

– Balanced and transparent regulatory regime

– Competitive return

– Return of capital over a reasonable time frame

• Elements of the existing regulatory regimes in Australia and New Zealand do not fully provide this environment – although regulators’ commentary tries to persuade otherwise.

• The New Zealand gas regulatory environment is currently perceived as comparatively more uncertain and is now a less attractive environment in which to invest

• The expanding international market for infrastructure investment will have an impact on the regulatory approach – investment capital is not limitless and firms will make decisions to prioritise their investments particularly in infrastructure when a growing wave of investment capital is needed in all areas including electricity, gas, roading, water etc.

• Regulators are going to become involved in the more commercial realities of participating in a “regulatory competitive market” - capital flight does exist.

regulation and incentives for investment: an investor ... 4... · presentation by steven boulton...

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