Babcock plays the regulatory game - day six
Babcock plays the regulatory game - day six
As I mentioned in the first post in this series, Babcock & Brown is not a bank. That means it’s not regulated by APRA and doesn’t need to worry about capital adequacy and the like. But regulation plays a large part in its business, because many of the assets it owns and manages – power stations, ports, wind farms and the like – are either natural monopolies or former government businesses, and the government therefore likes to moderate how much money they can make.
Regulation comes in as many different forms as there are assets. Airports in Australia are subject to ‘light-handed regulation’ – don’t abuse your power and you’ll be left to your own devices. But at the other end of the scale are monopolies where the government (or its representative) has complete control over the price you can charge.
For example, the price the Dalrymple Bay Coal Terminal can charge users is set by the Queensland Competition Authority with reference to the amount of capital invested. It’s know as a WACC (weighted average cost of capital) model, where the regulator sets a price that’s supposed to provide a particular return on the owner’s investment.
At Dalrymple Bay, the regulator’s most recent determination was that – based on assets of $850m, a WACC of 9.02%, annual capital expenditure of $30m and corporate overheads of $6m – the owner of the terminal (B&B Infrastructure) should collect $86.8m a year in revenue.
You might think this type of arrangement would make for a boring and straightforward business, but for the MBAs working at places like Babcock it simply represents a challenge. Convince the regulator that Dalrymple Bay’s overheads are $10m not $6m, and you’ll collect an extra $4m a year in revenue. Convince it that your cost of capital is 10% and not 9%, and another $8m a year will land in your pot.
For Babcock, regulation is not so much a risk as an opportunity to put its skills to the test. With increasing private investment in public infrastructure and new frameworks on the slate for carbon trading and renewable energy, it’s a set of skills that might well come in handy.
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Comments
Stop - you are depressing me. The Dalrymple Coal example is very sad - where is the incentive to improve productivity? It reminds me of my days working in Govt when the incentive was basically to spend your budget to make sure you got given at least as much to spend next year. Surely a more sensible approach would be to allow some sort of base amount of revenue (no ideas on how to come up with that) and then let them profit share productivity gains with their customers.
They do actually provide productivity incentives. Once the charge as been set, it's in DBCT's interests to get the costs as low as possible and the throughput as high as possible (you just need to pretend you're being as efficient as possible up front). With DBCT, the following are additions to the agreement (I've copied and pasted out of the determination).
• modified revenue cap – provides DBCT Management with revenue certainty over volume outcomes and includes an incentive mechanism that allows DBCT Management to earn, and permanently retain, up to 2% above the revenue cap in a given year for initiatives demonstrated to improve capital productivity at the terminal;
• take-or-pay model – provides an incentive for users to adopt contractual commitments that more accurately reflect their expected usage patterns, with penalties applying to users that under- or over-ship with respect to contracted tonnage. For instance, a surcharge of 25% to incremental tonnes above 110% of contracted tonnage and an additional 25% to the incremental tonnes above 125% of contracted tonnage;
Waiting with bated breath for the remaining instalments
Large central planning by Government over the long term can cost shareholders big time major policy changes example Tabcorp gaming industry monolopy.
Warren Buffet was caught by US Air his quote
I was so beguiled by the Company's long history of profitable operations, and by the protection, I overlooked the crucial point: Revenues would increasingly feel the effects of an unregulated fiercely competitive market whereas its cost structure was a holdover from the days when regulation protected profits.
In other words beware of Companies that look for government support for increasing profits this sounds like the day of 1980s under Bonds and skases large management fees for very little work.
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