The Regulatory Environment and The Investor Perspective The - - PowerPoint PPT Presentation

ACCC Regulatory Conference 26th & 27th March 2001.

The Regulatory Environment and The Investor Perspective

The Regulated Utility

• Predictability
• Transparency
• Efficiency

The Investment Decision

• Operational profitability
• Capital expenditure
• Taxation
• Financial reserves
• Reporting

The profile of …

Financial Assessments

• The investment decision is based on the

value of cashflows received.

• Financing risks can be separated into

Funding risk Interest rate risk

Benchmark Interest Rates

• Nominal interest rates
• Inflation indexed bonds
• “Break-even” inflation

Benchmark Interest Rates

Nominal yield = Break-even Inflation + Real yield observed in the market = Average Prospective Inflation + Historic inflation effect +Real yield observed = Average Prospective Inflation + Real yield Real yield = Real yield observed in the market + Historic inflation effect.

Benchmark Interest Rates

• What happens if the market for Commonwealth

Bonds becomes distorted?

• Is there an increasing potential for utility debt to

be issued to the wholesale market?

• The potential for the formation of aggregated debt

financing vehicles, with an investment profile which reflects the financial risk of the utility.

Benchmark Interest Rates

Commonwealth CPI Bond Yields

2% 3% 4% 5% 6% 1 9 8 5 1 9 8 7 1 9 8 9 1 9 9 1 1 9 9 3 1 9 9 5 1 9 9 7 1 9 9 9 2 1

Revenue change potential

% Revenue change, with 5yr WACC reset

including inflation allowance, relative to year 1.

• 15%
• 10%
• 5%

0% 5% 10% 15% 20% 25% 1 6 11 16

Year

WACC

Revenue change potential

% Revenue change, WACC with annual interest rate adjustment including inflation allowance, relative to year 1.

• 15%
• 10%
• 5%

0% 5% 10% 15% 20% 25% 1 6 11 16

Year

WACC

WACC determination

!The benefit of all stakeholders will be improved where the process of determining financial rates

• f return are:
• Objective,

taken from market benchmarks

• Practical,

in that the implicit funding should be marketable

• Predictable,

relative to current market benchmarks.

Movement in Real WACC

• The regulation of utilities were initiated with

the Real WACC, pre tax, 10.5%

• Current Real WACC, pre tax, 7.0%?
• The total movement -3½ %
• real interest rates -2½ %
• model / parameters - 1%
• These movements have altered the investment

decisions and are driving changes to maintain equitable investment returns.

Compensating for the Changing Returns

Options Reduce Operating Costs More Efficient Funding Change Risk Apportionment

Asset Co Operating Contract Capex approval Audit of Assets

• 1. Operates the assets
• 2. Manages the business
• 3. Guarantees return to

Owner Co

• 4. Seeks approval of Asset

Co to Capex

• 5. Competes for Contract
• 1. Infrastructure Investor

(Institutional)

• 2. Funds Capex
• 3. Approves Capex Program
• 4. Audits Op Co’s

Performance on Asset Management

Concept of Asset Owner and Operator

Op Co Conventional Utility

Who Bears the Risks?

Asset Co:

• WACC Risk
• Stranded Assets

OP Co:

• Asset based risks eg breakdowns and supply outages
• Level of operating and maintenance costs
• Supply and operating agreements
• Meeting KPI’s

Potential Third Party:

• Revenue risk - potential to hedge?

Considerations for Regulators

Transparency

• Separation of ownership costs and operating costs
• Clear definition of Capex and Opex
• Audit of operator’s asset management

Efficiency

• Contestability of operation reduces regulation
• Lower cost due to funding and competition
• Focus on asset management

Predicability

• Returns to stakeholders
• Reduced risk

Rowville Transformer

Features:

• Asset Ownership is passive - TXU the operator
• O&M is contracted for 29.5 years
• No regulatory reset
• Debt which is inflation linked
• Revenue is inflation linked

Risks

• Operator has to ensure asset “is fit for purpose”
• Asset owner takes force majeure and tax risk

UK Example - Purchase of Welsh Water by Glas Consortium

Features:

• Community purchasing the utility-non profit entity
• Debt funded
• Operations tendered in multiple contracts
• Ofwat conditional approval

Concerns of Regulator:

• Minimal equity
• Lack of shareholders - incentive for continued efficiency
• Potential lack of control over contractors

The Regulated Utility

• Predictability
• Transparency
• Efficiency