The regulator's oversight task will also cover the decision to incorporate new investments into the regulated capital base. In other words, it is necessary to decide on a mechanism to treat those investments that are to be remunerated, particularly the ones that had not been planned for. Basically, there are two major approaches to this issue. Both extreme approaches entail an ex-ante assessment, through which investment needs are defined before the actual investments are made, or an ex-post assessment that entails an after-the-fact analysis.
For instance, when updating the capital base from a tariff period to the next ("roll forward")121 for the new period regulators may choose to use the investment values approved by the regulator for the ending period, as it is the case with the British regulator where an operator has overinvested (Ex-ante valuation), or take for the next period the value of investments actually performed, as done for instance by the British regulator where an operator spends less than allowed (Ex-post valuation). The Ex-post valuation could also allow the regulator to have the regulatory asset base include values entailing overinvestment, provided that the "used and useful" criterion is met. Put differently, the goal of the mechanism for the treatment of investments is to assess the relevance of certain investments to be factored into subsequent compensation or tariff adjustment calculations.
BOX 20 : The "used and useful" principle
| "…it has long been held that investors are entitled to a return only upon that portion of their investment that is used and useful in the public service. The "used and useful" principle presupposes that the actual dollars of investment have been expended. If the properties are in service during the test period, the company may be entitled to include related operating and maintenance expense in its cost of service; but if the capital costs have not been incurred, it is not entitled to a return on a payment not yet made. The accrual of an obligation to pay is insufficient to justify inclusion in rate base. Under the phrase "used and useful", the agency does not reach the question whether the capital was prudently invested, because even if it has been prudently invested but will not produce investments used and useful in the public service, the agency may exclude such properties from the rate base… The "useful" aspect of the phrase also contains an element of whether ratepayers will benefit from the investment… The used and useful principle rests on basic cost definitions and concepts of fairness. If property is not used and useful, the addition of those capital costs to the currents costs represents a basic misalignment of service costs." |
Source: Leonard Saul Goodman. The Process of Ratemaking. Public Utilities Reports, Inc. 1998. (Pg. 799-780).
However, there are other middle-of-the-road approaches that combine both extremes, to a greater or a lesser extent; as explained by Alexander and Harris (2004), each of such approaches (Table 12) entails different costs and demand risks.
The Ex-ante ex-post approach entails defining investment needs at the beginning of the tariff period, and reviewing and assessing actual investments at the end of the period, when the capital base to be remunerated at the new review will be defined. Accordingly, at the end of the first tariff period, it is possible that certain investments that had not been initially provided for will be accounted for in the next period, in which case the risk of inclusion costs is borne by the consumers, or perhaps no such investment will be recognized, and the overinvestment costs will be borne by the operator.
The Interim determination approach allows the operator or regulator to reconsider investment decisions during the tariff period in the face of significant expenditures that had not been planned for. The risk of inclusion costs is also borne by the consumers and, as it will be true in all cases, the risk of overinvestment costs will be borne by the operator.
Under the efficient firm approach, the regulator defines cost and investment goals in direct relation to an efficient company at the beginning of each tariff period, irrespective of actual investments and costs in the preceding period. As a matter of fact, as it is also the case with the pure Ex-post approach, the operator will bear both types of costs risks, namely the inclusion costs risk (since, if accepted, the investments will have already been made) and the risk of overinvestment costs.
Lastly, some regulators have implemented trigger clauses for cases where the assets being constructed are accounted for in the capital base. The inclusion of these assets implies a prepayment by the consumers for a service they are not yet enjoying. Through this scheme, an operator that completes the investment and increases its revenue is rewarded; however, the operator is punished if revenue is reduced as a result of the operator's failure to complete the investment on schedule. Under this scheme, the risk of inclusion costs will also be borne by the consumers, and the overinvestment risk will be borne by the operator.
Table 12 : Regulatory treatment of investments
|
| Costs Risks | Demand Risks | ||
| Approach | Inclusion | Excess | Under 100% | Obsolescence |
| Ex-ante ex-post | Consumer | Operator | Mixed | Operator |
| Interim determination | Consumer | Operator | Mixed | Operator |
| Ex-post | Operator | Operator | Mixed | Operator |
| Model company | Operator | Operator | Operator | Operator |
| Trigger clause | Consumer | Operator | Mixed | Operator |
Source: Ian Alexander and Clive Harris, "The Regulation of Investment in Utilities: Concepts and Applications." August 2004.
There are also demand-related risks. The first of such risks has to do with an overestimation of demand. Indeed, demand estimates may end up being higher than actual demand and, accordingly, lead to investments in excess of those actually needed. In general, such risk is shared by the consumers and the operator, except under the model-company approach as, because of this approach's philosophy, such risk is fully borne by the operator.
The second demand risk has to do with asset obsolescence. When the capital base to be remunerated is periodically analyzed to verify that it is optimal, the operator risks having a portion of the assets excluded from the capital base. This risk is of fundamental importance in the telecom sector, where technology change moves at a fast pace.
Most certainly all such decisions by the regulator will be the cause of conflicts with the operators, as the latter will try to justify their defaults to avoid penalties while seeking to have all investments recognized. The way to avoid or at least reduce such conflicts is by properly defining the procedures, particularly those concerned with the treatment of new investments, and making the discussion a public, participatory one. The purpose is, on the one hand, to maintain consistency in the treatment accorded to the involved operators and, on the other, to guarantee the transparency of any such decision.
Lastly, the various forms of PPP involve different information needs to successfully carry out the oversight task.122 Some times, owing not only to the selected PPP form but also to the type of investment, the information asymmetry to be faced by the regulator will be greater than in other cases (this happens with large investments involving extended construction periods), which is why the regulator will be at a disadvantage and will not be able to make a proper decision at the time of the evaluation. In such cases, the regulator may resort to competition for the market, demanding that the operator contract such investments out by public bidding. In their eagerness to get the contract, the bidders will submit their best investment plans, reduce information asymmetry and guarantee to the regulator that the investment will be carried out in the most economically-efficient manner possible.
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121 The term 'roll-forward' refers to how the initial capital base, once determined, is adjusted over time to reflect changes in the value of productive capability of the existing asset base and new investment in the business.
122 Rodriguez Pardina and Schlirf Rapti, "Regulatory Requirements under different forms of utility service delivery." PPIAF - The World Bank, February 2007.