Anticipatory Investment in Regulated Infrastructure: A Real Options Approach and Competitive Benchmark

Timely investment in capacity and fair pricing are critical for the development of infrastructure sectors and regulation plays a central role in their investment decisions and consumer welfare. Considering the natural monopoly characteristics of many infrastructure sectors and uncertainty in demand for new capacity, this paper develops a real options model to determine the optimal timing and capacity for anticipatory investments in infrastructure. We design a novel ex-ante regulatory framework to explore how perfect competition can serve as benchmark for regulating anticipatory investment in infrastructure under uncertainty. We compare optimal timing and capacity for anticipatory investment in infrastructure between the realistic monopoly model and an ideal competitive model. We show that our proposed price-cap regulatory model based on competitive benchmark would not only ensure timely investment in infrastructure but also spurs consumer participation by offering fairer access pricing and more capacity provision. This paper can serve as a reference for anticipatory investment in infrastructure development.