This QCA paper considers various issues in the implementation of an annuity approach to recover the sunk cost of regulated assets. This work was motivated by the need to document methods we have applied and to highlight a number of issues that arise in the context of determining price paths over time.
There are two common approaches for recovering the return on and the return of capital:
- the regulated asset base (RAB) building blocks approach
- the annuity approach.
This project analyses and compares the application of annuities in lieu of the RAB building blocks approach for pricing purposes.
The QCA released an information paper on the issues in the application of annuities on 4 February 2014.
This paper illustrates various examples of the use of annuities in economic regulation. Both the annuity approach and the RAB building blocks approach can be defined to achieve the NPV=0 principle, but the resulting annual prices may be different.
The paper debunks many misconceptions associated with annuities, including the proposition that the use of annuities would lead to lower prices.
The paper also illustrates that the application of rolling annual annuities may result in under-recovery of sunk asset cost, and introduces an alternative known as the aggregated rolling annuity.
The paper examines the two common approaches for recovering the sunk cost of regulated assets – the regulated asset base (RAB) building blocks approach and the annuity approach – and how they can be defined to achieve the financial capital maintenance principle (also known as NPV=0 principle).
The paper considers a number of issues associated with the application of annuities, including:
- the use of capital annuities to recover the cost of existing assets or to fund new assets
- the application of renewals annuities, misconceptions associated with annuities
- potential shortcomings associated with rolling annual annuities.