Regulatory Risk: Cost of Capital, Investment in Network
Infrastructure and Investment Incentives
3 - 4 September 2008
On 3 and 4 September 2008 WIK hosted the netconomica, a top-class cross-sectoral conference with 57 participants from 9 countries. The objective of this symposium was a knowledge transfer from one infrastructure sector to another and from academia to industry. This year’s netconomica focused on the role of regulatory risks in different network industries ranging from the impact of regulatory uncertainty on cost of capital to network investment incentives and their funding. Ten high-ranked experts gave papers in keynote lectures and panel discussions on specific sector experience and discussed a potential experience transfer on other infrastructure sectors with renowned representatives from national and international regulators, authorities, respected institutions, top-class academics and representatives of the industry.
Prominent issues were:
- Risk in network industries: Regulatory practice in Germany
- Cost of capital in regulated network industries
- Incentive regulation and investments in network infrastructures in electricity and telecommunication
- Regulation and risk in the gas and railway sectors
- Context of regulation, risks and cost of capital
- Regulatory impacts on the infrastructure sector, and
- Regulating access to networks: telecoms and energy.
In his welcome speech Dr. Karl-Heinz Neumann (General Manager WIK) highlighted the historical role of WIK in the development of regulation on different infrastructure markets and emphasized the increasing convergence of issues in these sectors. Therefore, the netconomica will - henceforth annually - provide a forum for these cross-sectoral hot issues dedicating this year’s focus on regulatory risks regarding cost of capital, infrastructure investments and related incentives. In the following Matthias Kurth (President, Federal Network Agency , Germany ) and Harold Furchtgott-Roth (CEO, Furchtgott-Roth Economic Enterprises, USA and former FCC commissioner) opened the conference with their keynote lectures.
In his inaugural address Matthias Kurth challenged the auditorium to seize regulatory risks equally as regulatory chance for the network industries. Against the background of the subprime crisis regulatees could benefit from a win-win situation due to a stable rate of return and therefore a more stable business environment compared to a high but volatile one potentially leading to bankruptcy. Moreover, Kurth highlighted the regulatory challenge to set adequate incentives for efficient infrastructure investments. In this context he gave an overview of the essential features of the current regulatory framework and the underlying approach of the Federal Network Agency in electricity and gas. Following these considerations Kurth concluded that the German regulatory regime founds and promotes the basis for a stable and efficient investment climate in both sectors which he characterized as "ladder of investment". In the following keynote Harold Furchtgott-Roth highlighted the significant paradigm shift in terms of regulatory risks which has undergone the networks industries in the USA . While cost of capital were low in the US in the 1980s, the former and the underlying challenges substantially increased in the past 15 years for which Furchgott-Rotth provided a range of reasons.
Subsequent to the first two keynotes Dr. Christian Growitsch, head of the department Energy Markets and Energy Regulation, WIK, led over to the first panel session on „Electricity and Telecommunication". Professor Ingo Vogelsang ( Boston University ) opened this session with his paper on „Incentive regulation and investments in network infrastructure". Vogelsang illustrated the link between the impacts of different regulatory approaches on different types of investments taking into account the trade-off between efficiency targets and the investment behaviour of the network operators. As a matter of principle he concluded that a light handed regulation promotes investments while a tight regulation rather hampers investments. Moreover, he discussed the issue of regulatory commitment as an essential feature of regulatory risks. Concluding, he argued the bounds of regulatory commitment and expressed his general concern regarding the compatibility of incentive regulation and long-term investments. Subsequently, Professor Justus Haucap (University of Erlangen-Nürnberg) took the chance to further develop Vogelsang’s comments. As a potential reason for the positive perception of efficiency increase compared to investment benefits Haucap highlighted the directly perceivable customer benefit. Moreover, he illustrated options to strengthen the competencies of the regulator e.g. by means of asymmetric veto rights. In conclusion, he reconsidered the option of state aid (e.g. in broadband infrastructure) and its economic justification.
The first day of the netconomica ended with a networking dinner in a restaurant on the Drachenfels.
The second conference day was opened by Dr. Michael Pollitt ( University of Cambridge ) with a panel on gas and railway. Pollitt gave an overview of regulatory risks in these sectors from regulatory practice in the UK . As lessons learned for gas from railway Pollitt highlighted the introduction of an international benchmarking approach. On the other hand, British railway regulation’s learnings from gas would consist in sustainable investment incentives as regards the infrastructure in deficit as well as in tackling the issue of the ownership structure and the rather arbitrary treatment of risks. In his answer, discussant Professor Achim Czerny (WHU – Otto Beisheim School of Management) emphasized the importance of addressing the issue of implementing revenue caps in the British railway sectors under the crucial precondition of generating appropriate investment incentives in the infrastructure.
In the following, Professor Martin Hellwig (Max-Planck-Institute for Collective Goods) discussed in his keynote basic implications of regulation, risks and cost of capital and showed the audience room for improvement in the regulatory practice. According to Hellwig, this would consist in a substantial debate about taxation as an integral part of the Capital Asset Pricing Models (CAPM) as well as in the application of a risk premium on the basis of asset specific risks instead of the market portfolio. As thought-provoking impulse Hellwig named a debate on the role of debt in the CAPM as well as a conceptual analysis of the evaluation of the rate of return under the conditions of dynamic markets. In his concluding remark Hellwig raised a challenging question on the relevance of assessing the issue of cost of capital when the rate of return actually seems to have a bigger impact on strategic managerial decisions than on refinancing investments.
The third panel on regulatory impacts on the infrastructure sector from a financial investor’s perspective was opened by Georg Vietor (Executive Director, Macquarie Corporate Finance, Germany ). Vietor broached the issue of the advantages of infrastructure investments which he basically sees in a predetermined cash-flow and risk development, a longer life-cycle of the assets and little dependency on volatile capital markets. Unfavourable for investors however seems the dependency on changing market conditions and the long term implications of decisions. Professor Roman Inderst ( University of Frankfurt and London School of Economics) discussed the future challenges of financial investors as regards specific market risks, afterwards. In particular, these risks would result in the impact of regulation on cost of capital. Moreover, Inderst discussed the effect of an increasing leverage in the infrastructure sectors and the underlying risk of underinvestments. In this context he advised against the risk of short term investments strategies but simultaneously illustrated the positive implications of the increasing activities of international investors in the German market. From his perspective these advantages particularly stem from a stimulation of competition, international experience and a positive impact on regulatory routines.
In the concluding session, Professor Marcel Boyer ( University of Montreal ) presented the context of regulating access to networks in the telecoms and energy markets and the resulting impacts on network charges. Boyer focussed his presentation on his paper on „Real Options, Network Development, and Network Access" from August 2008. This approach gives the incumbent the right but not the obligation to invest in network extension whilst the entrant is flexible in his decision to enter or exit from the market. Important decision criteria in this context are optimal timing and optimal size of the investment which are however influenced by the determinants flexibility, irreversibility and uncertainty on both sides. According to Boyer, a potential solution from this trade-off would be an optimal balance between static and dynamic efficiency, though still subject to academic research. Professor Felix Höffler (WHU – Otto Beisheim School of Management) replied with the question on how network user should appropriately contribute to network extensions and highlighted the difficulty of an adequate adjustment of network charges. The concluding discussion on this issue revealed that the main connecting factors of this hot issue were identified but still shows remaining room for further explanation.
This session completed a remarkable conference which has shown that the intensive discussions in the different panels are significant evidence for the explosiveness and the importance of this year’s subject of the conference.