recommended that \u2018access holidays\u2019 for new infrastructure investment be permitted and, indeed, encouraged. The PC\u2019s final report was more sanguine, citing practical and theoretical issues, and proposed instead some relatively minor measures to alleviate problems of regulatory uncertainty.
For many years, we have conducted research on the impact of access regulation on investment. At its heart, access regulation is all about investment incentives. By opening up bottleneck infrastructure assets to use by non-owners, investment by upstream and downstream firms can be encouraged in an industry. However, it is well known that such open access may undermine incentives to invest in the bottleneck infrastructure itself. Thus, there is a tension between the investment incentives for those who provide access and those who seek access to a particular facility.
Our research has focussed on this tension and particularly the ability of access price regulation to manage it. This is possible through a form of what economist\u2019s term \u2018fully distributed cost pricing\u2019 if regulators have sufficient information. That pricing takes investment value and apportions cost recovery between the provider and potential seekers. However, this requires some degree of regulatory foresight and commitment. That is, the regulator would have to announce its intention to price in this manner and then stick to it when an access dispute actually arose. Such commitment is difficult to achieve in practice.
In this article, we consider the alternative way to balance investment incentives by granting those who build of new infrastructure a guaranteed period free of a mandated access regime \u2013 that is, an access holiday. An access holiday is like a patent for infrastructure investment but, in contrast to intellectual property protection, following the holiday\u2019s end, an open access regime would be imposed. This is both a means to ensure that market power does not endure as well as an opportunity to continue to allow the investor some ability to earn returns on the investment over its entire life.
It is critical to recognise that the need for an access holiday comes directly from an imperfection in the process of access price regulation. The ACCC argued to the PC that it could adequately award investment incentives under the current system by building a premium into access prices themselves. In principle, this is true. In practice, it turns out to be much more difficult.
The key underlying issue is the so-called truncation problem. Infrastructure investments are risky because they have varying potential levels of success. Moreover, the more successful an investment is, the more likely are there to be firms seeking access to the infrastructure. So if the regulator were to build a premium into access prices, that premium will only be paid when the investment is nominally a success. No payment is made if the investment proves to be a commercial failure. What this means is that, for the regulator to encourage investment in the face of uncertainty, it needs to build in a sufficient premium when the investment is a success to compensate the investor for the low returns that could arise if the investment is a failure. This requires the investor after the fact \u2013 that is, when the investment is successful \u2013 convincing the regulator that failure was possible. This is a hard-sell and not surprisingly, many investors are sceptical about whether they can achieve this.
But the problems of providing adequate incentives just through access prices do not stop there. It is not simply that a premium be paid in the event access is sought. Instead, the premium should actually be higher the more successful is the investment. Put crudely, in order to cover initial project risk, investors should be allowed to \u2018milk\u2019 their investment more the more successful is that investment. But it is precisely in the high success situations that the regulator may also perceive high returns from encouraging competition. Thus, a regulator could easily be tempted or swayed by public or political pressure, to cut back on the premium precisely when the long-term encouragement of investment would require otherwise.
So, on the one hand, the ACCC is right: access pricing can do the job. But on the other hand, we think it may be too optimistic about its own abilities to achieve appropriate access pricing. It is for this reason that an alternative needs to be developed.
Access holidays provide that alternative. First, they aresimple \u2013 a guaranteed period when infrastructure investors are free to earn whatever returns they can. Second, an access holiday is easy tocommit to upfront \u2013 like a patent there can be an application and examination
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