Ownership is not the key to overvalued assets

Another day, another popular piece in the Financial Times about fat-cat private operators exploiting naïve regulators and captive users for private gain.

Titled The gold-plated reason for Heathrow’s bloated runway costs, the article starts by questioning why the airport’s private operators aren’t kicking up more of a fuss over the £14 billion ($19.8 billion; €16 billion) price tag for Heathrow’s third runway, by far the most expensive option to increase airport capacity in the south-east of England.

The answer, according to the FT, is that they have no incentive to do so, because the more money spent building-out Heathrow, the bigger its regulated asset base becomes. Since the latter determines investors’ allowed return and revenues, they are quite content to fatten Heathrow’s RAB, which has tripled to £15 billion since private owners first landed at the airport in 2006.

“Heathrow is encouraged to fund everything with debt by a regulatory system that allows it to keep the gains from financial engineering [and] debt providers are so sure that revenues will always be forthcoming that they have willingly stumped up for the capex,” the FT concludes.

Case closed, right? Well, not quite. You see, another report from the Gratan Institute, an Australian think tank, on Australia’s electricity networks finds pretty much the opposite. That is, it too finds evidence of questionable spending in the country’s electricity sector, estimating that “RABs have outgrown network use by about A$20 billion ($15.3 billion; €12.4 billion)”. But here’s the kicker: the vast majority of that purported overspend (A$18.5 billion) was done by public – not private – network operators in Queensland and New South Wales.

According to the report, RAB per customer in publicly owned networks grew by 76 percent between 2004-15 compared with 13 percent growth for privately owned networks. Therefore, when New South Wales decided to privatise Transgrid, Ausgrid and Endeavour Energy, it did so on the back of overvalued RABs to the tune of A$1.6 billion, A$5.4 billion and A$850 million, respectively, Gratan said. Since TransGrid sold for 1.67 times RAB, Ausgrid 1.41 times and Endeavour 1.69 times, the state government netted a tidy profit.

Let’s pause here for a second to insert a few caveats. Firstly, it is highly likely that Gratan’s conclusions and calculations will be disputed by the relevant actors in this story (we were not able to get comment by the time of publication). Secondly, no one is saying the private sector is above gaming RABs. Philippe Taillardat, a director at Conquest Group, recently called out “spending unnecessary capex to artificially increase regulated revenues” as an unsustainable industry practice ripe for change.

But while the latter fits like a glove into the prevailing narrative, what possible incentives could publicly owned operators have to overspend public money? Quite a few, as it turns out, but three flagged up by Gratan are worth highlighting: one, governments and regulators are scared of underinvesting, which, in turn, can prompt overspend; two, electricity profits can be a less visible way to raise government revenues compared with new taxes; and three, the higher WACC associated with these assets attracts “money [chasing] above-market returns”. The latter is in line with the FT’s swipe at debt providers and just goes to show that, when in doubt, blame the bankers.

What these two examples demonstrate, though, is how irrelevant ownership is, with both the public and private sectors amply capable of gaming the system. As economist Dieter Helm put it last month, referring to the UK’s regulated water companies:

“A better approach from obsessing about the less important issue of who owns water companies is to come up with ways of organising and regulating the industry fit for the new challenges of the coming decades. The answers to these much more important questions do not turn on ownership. They turn on control, and on regulation.”

For consumers’ sake, let’s hope the conversation moves forward sooner rather than later.