Oxera is pleased to have contributed to the State of the Nation 2020: Infrastructure and the 2050 net-zero target report by the Institute of Civil Engineers. Despite the increasing importance of the climate change agenda within the regulated infrastructure industry, significant barriers are still in the way of unlocking the delivery of the 2050 carbon targets. Energy networks that have historically generated relatively low returns on account of being natural monopoly, relatively low-risk businesses, are increasingly expected to take a lead in driving the integration and delivery of new technologies, e.g. in Carbon Capture Storage (CCS) hydrogen and biogas—while also keeping the cost of funding low to protect consumers. At the same time, the uncertainty about the optimal path to delivery of decarbonisation leads to challenges in assessing what the feasible set of ‘no regrets’ investments comprises at any point.

Building on a toolkit of existing regulatory mechanisms—and balancing risks appropriately between investors, consumers and taxpayers—can help to achieve the decarbonisation objectives in an efficient and reliable manner. Relevant considerations include the application of models such as:

• subsidy-based, co-investment or regulatory de-risking regimes, where some form of ex ante risk-sharing is seen as appropriate. The UK experience of delivering large-scale investments in the regulated infrastructure space shows that various regulatory and policy tools can be used to balance risk between stakeholders to reduce upfront investment risks and achieve lower costs of financing (e.g. the case of Thames Tideway Tunnel);
• fair bet framework, as implemented for the fibre rollout, can allow companies to earn a higher return ex post due to investors’ exposure to significant upfront risks;
• regulatory asset base (RAB) regime, as employed for energy and water networks, can be adapted on a case-by-case basis to be applied to new areas, e.g. in relation to nuclear power generation.

To be employed effectively in the context of decarbonisation objectives, the existing regulatory mechanisms need to be adapted to allow regulated entities to undertake higher marginal risk investments over the longer term. This in turn requires for the regulators to be able to employ the best combination of tools on a case by case basis. As technologies mature and the nature of risk to which the investors are exposed changes, the regulatory model will also evolve.

Contact: Sahar Shamsi, Alex Smirnov