Course topics
This training course covers five focus areas which touch upon topics related to capex integration and the application of practical approaches for the assessment and appraisal of investments.
The training modules build up on each other and guide participants step-by-step through the content:
- Integration of capital expenditures in the price control
- Methods for assessment of capital expenditures
- Cost benefit analysis (CBA)
- Mathematical techniques for investment decisions
- Assets utilization, stranded assets and regulatory policy
For each training module, the conceptual concepts are firstly provided, followed by appropriate examples and practical exercises that guide the participants to understand the practical use of the methods for investment analysis and to support regulatory decision-making.
INTEGRATION OF CAPITAL EXPENDITURES IN THE PRICE CONTROL
Capital expenditures are the investments made by regulated companies to acquire or upgrade physical assets. They are one of the major building blocks in the revenue setting process and are essential for the reliable provision of the respective regulated services. Specifically, the allowed revenue include the return on assets and depreciation associated with the regulated assets. The return on assets is comprised on the regulatory asset base multiplied by a rate of return.
The choice of the regulatory regime and the behavior of the regulator both have a direct impact on risk, capital costs and investment incentives of regulated companies.
This training module addresses the integration of capital expenditures into the regulatory asset base. Firstly, a classification of the type of investments is provided, for example replacement versus extension investments, reliability versus economic investments.
Furthermore, the different characteristics of investments in transmission and distribution infrastructure will also be provided. Moreover, the ex-ante and ex-post inclusion of investments in the regulatory asset base will be explained. In the former case the investment allowance is set with reference to planned investments.
Consequently, regulatory arrangements include provisions dealing with differences between planned and actual capital expenditure at each review. In contrast the ex-post integration assesses the efficiency of the actual investment expenditure incurred. These approaches will be explained in more detail, highlighting the treatment and differences of each approach in the price control.
In addition to the conceptual part of the training module, appropriate examples and exercises that help the participants to understand the differences of each approach in the regulatory arrangements is also provided.
METHODS FOR ASSESSMENT OF CAPITAL EXPENDITURES
To support decision-making of capital expenditures, energy regulators and companies apply different methods to support the assessment. These may include simple comparative ratios (capex by asset groups and time) or more complex methods based on the analysis of unit cost, econometric analysis or engineering / technical analysis. The assessment of capital expenditures may also be provided in the framework of integrated efficiency analysis of total expenditures or costbenefits analysis. In some cases, a combination of methods is applied to support the assessment and evaluation of the respective investment.
This training module explains the conceptual properties of these methods and their practical application for the assessment of capital expenditures. This conceptual part is supported with practical examples and experiences from different regulatory jurisdictions.
COST BENEFIT ANALYSIS (CBA)
A cost benefit analysis is a common tool applied for investment decision making by systematically comparing the long-term costs and benefits arising over the life span of an investment project. It is widely applied on the societal level (collective impact) as well as the company (i.e. the investor’s) level (individual impact).
Whereas in the private sector, appraisal of investments and financial analysis of company’s costs and benefits takes place against maximizing the company’s net benefits, the economic CBA focuses on the overall long-term costs and benefits taking a broader perspective and including externalities, such as environmental and reliability impacts, to broader groups of stakeholders. This gives the economic CBA a wider economic character with the objectives of studying the impact on the aggregated welfare of the parties affected by the project.
In this training module, we provide the conceptual background to cost-benefit analysis, and a practical example using cost-benefit analysis for evaluating an investment.
MATHEMATICAL TECHNIQUES FOR INVESTMENT DECISIONS
Investment appraisal techniques can be used when assessing investments in general as well as investments in the energy business.
This training module provides an overview of the main mathematical techniques:
- Net Present Value (NPV)
- Internal Rate of Return (IRR)
- Payback Period
- Cost Benefit Ratio (CBR)
For each technique, an explanation of their purpose, their applications and their advantages and disadvantages will also be presented. Multiple techniques or combination of techniques can be used to assess the economic feasibility of investments.
The NPV technique represents the difference between the present value of cash inflows and the present value of cash outflows of a potential investment. As a result, the NPV methodology provides today’s value of an investment and it assesses the profitability of a projected investment or project.
The IRR assesses the rate at which the project “breaks even”. Similarly, to NPV the discount rate is the rate that reduces the NPV of an investment to zero. It is used to compare projects with different lifespans or amount of required capital. The payback period represents the length of time necessary for an investment to pay back the initial capital expenditure.
The CBR provides the ratio of the benefits of a project relative to its costs, all expressed in monetary terms and in discounted present values.
This training model draws attention to the practical exercises showing the formulas for each of the techniques and in the form of a case study. Examples and exercises of each investment appraisal technique will be demonstrated which will help the participants to understand the practical use of the methods for investment appraisal. Finally, an assessment and interpretation of the results will be presented and discussed in the context of investment appraisal of the applied techniques.
ASSETS UTILIZATION, STRANDED ASSETS AND REGULATORY POLICY
Regulatory approaches typically presume future consumers will meet a substantial proportion of the capital costs of investments made today in the infrastructure. Yet changes in demand, technological innovations and decarbonization targets may make this presumption less certain resulting in potential stranded assets. This means the effective economic life of the asset is reduced and/or its residual value is less than originally assumed.
The risk of asset stranding may be mitigated by preventive measures seeking to improve the coordination in the planning process and the steering of the penetration of new technologies in terms of time and geographic areas. The preventive measures can also be extended towards revisiting and redesign of the respective infrastructure tariffs aiming to improve the price signals and accordingly the asset utilization.
Regulators and policy may also opt for compensation measures that provide remuneration to the companies in or outside the regulated tariffs. Examples for the former include changes in depreciation allowance or regulatory asset base for the purposes of the revenue setting process, and for the latter budget support or funding through sector levies. The challenge is to preserve financial stability of the regulated company and at the same time to prevent from substantial final burden for the other stakeholders.
In this training module we explain the different potential options for regulatory treatment of potential asset stranding. The advantages and disadvantages and the possible impact to the sector stakeholders will also be addressed.
