Investment types

Contracts calling for investments to be made throughout the entire operation stage usually provide for expansion, replacement and quality investments. Expansion investments are aimed at expanding the service; replacement investments are intended for the maintenance of existing assets in order to ensure service continuity and provision at the existing quality levels; and quality investments are new investments aimed at improving service quality. In the many contracts that provide for investment obligations, such investments are usually treated as not fulfilled only when the relevant coverage and/or quality goals have not been met.

Table 11 : Investment forecasting and control

Source: The Regulation of Investment in Utilities: Concepts and Applications - I. Alexander and C. Harris (2004)

In this case, there is a physical investment plan -which requires an estimate of the future investment requirements based on demand growth, the condition of existing physical assets, quality improvements, etc. - that defines goals by periods, and a financial plan that, in general terms, is only indicative and is used as a control instrument by the regulator. Thus, provided that the coverage and/or quality goals are reached, no penalty should be applied based on the failure to fulfill the investment obligations defined in the contracts.

Defining and penalizing non-compliance in physical terms creates incentives for efficient investments; if the values defined in the financial plan act as the allowed cap, the incentive will be greater where the operator can take for itself the difference gained by making efficient investments. On the contrary, defining and penalizing non-compliance in financial terms leads the operator to expend the amount set to reach the goal, with no certainty that this will be done efficiently through necessary and relevant investments.