10.5.5 Short-Term Regulatory Focus
Usually, economic regulators have mandates to protect, in the short and long-term,
the consumer’s interest, security of supply and service delivery.
The trade-off between short-term vs long-term is often tackled by adjusting the
five-yearly pricing review cycles or plans to the longer strategic goals of infrastructure companies. It is essential that economic regulators and infrastructure companies
collaborate in planning strategies on how to adapt at the right moment, be it
replacement cycle or price review. This will bring in better agreement between a
regulator and an organisation about some outputs required over a longer period than
just the context of five-yearly price reviews.
However, given the present preference on short-term value for money, economic
regulators have not really addressed the specific impacts of climate change, associated with uncertainties. Thus, a longer-term focus is required.
10.5.6 Capital Projects Discounting
Financial appraisal of a project includes, inter alia, the determination of its net
present value, the internal rate of return, and the cost benefit analysis. These
calculations use inputs such as the cost of the project, operation and maintenance
costs, potential benefits, the duration of the project and the discounting rate of
capital. This discounting rate is a key parameter, in the sense, that when a private
investor examines his potential benefits from a project, he will first scrutinise what
banks can offer him if he just deposited his money with them, or what interest rate
they would claim him if he borrowed money from them. Basically, the investor
wants to know whether (1) he can borrow money from the bank (2) invest it in his
project (3) and still make a profit or rather he would be better off with earning bank
interest on his savings.
A few decades ago, this discount rate was quite high (up to 14–20%), then
gradually decreased to a few percent. However, even with a few percent (3–5%),
many long-term capital projects (such as those involving climate change adaptation)
tend to be heavily penalised and therefore, the problem and issues under hand are not
effectively addressed.
In response to this problem, there have been proposals (HM Treasury 2011;
Koundouri 2008) for long term projects (more than 50 years) involving substantial
and irreversible wealth transfers between generations (infrastructure, environment,
climate change impacts, infrastructure resilience, etc) to consider discount rates
between 0 and 3%.
Such low rates may seem surprising. However, in contrast to financial appraisal,
economic analysis examines projects from the country’s perspective and usually
always advocates lower discount rates. From this point of view, governments can
10.5 Challenges and Barriers
303
Usually, economic regulators have mandates to protect, in the short and long-term,
the consumer’s interest, security of supply and service delivery.
The trade-off between short-term vs long-term is often tackled by adjusting the
five-yearly pricing review cycles or plans to the longer strategic goals of infrastructure companies. It is essential that economic regulators and infrastructure companies
collaborate in planning strategies on how to adapt at the right moment, be it
replacement cycle or price review. This will bring in better agreement between a
regulator and an organisation about some outputs required over a longer period than
just the context of five-yearly price reviews.
However, given the present preference on short-term value for money, economic
regulators have not really addressed the specific impacts of climate change, associated with uncertainties. Thus, a longer-term focus is required.
10.5.6 Capital Projects Discounting
Financial appraisal of a project includes, inter alia, the determination of its net
present value, the internal rate of return, and the cost benefit analysis. These
calculations use inputs such as the cost of the project, operation and maintenance
costs, potential benefits, the duration of the project and the discounting rate of
capital. This discounting rate is a key parameter, in the sense, that when a private
investor examines his potential benefits from a project, he will first scrutinise what
banks can offer him if he just deposited his money with them, or what interest rate
they would claim him if he borrowed money from them. Basically, the investor
wants to know whether (1) he can borrow money from the bank (2) invest it in his
project (3) and still make a profit or rather he would be better off with earning bank
interest on his savings.
A few decades ago, this discount rate was quite high (up to 14–20%), then
gradually decreased to a few percent. However, even with a few percent (3–5%),
many long-term capital projects (such as those involving climate change adaptation)
tend to be heavily penalised and therefore, the problem and issues under hand are not
effectively addressed.
In response to this problem, there have been proposals (HM Treasury 2011;
Koundouri 2008) for long term projects (more than 50 years) involving substantial
and irreversible wealth transfers between generations (infrastructure, environment,
climate change impacts, infrastructure resilience, etc) to consider discount rates
between 0 and 3%.
Such low rates may seem surprising. However, in contrast to financial appraisal,
economic analysis examines projects from the country’s perspective and usually
always advocates lower discount rates. From this point of view, governments can
10.5 Challenges and Barriers
303