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Has liberalisation gone too far

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Has liberalisation gone too far

    PUBLIC SERVICES INTERNATIONAL RESEARCH UNIT

    PSIRU

    HAS LIBERALISATION GONE TOO FAR? A REVIEW OF THE

    ISSUES IN WATER AND ENERGY

    by Kate Bayliss, David Hall, and Emanuele Lobina

    March 2001

    Public Services International Research Unit (PSIRU)

    Contents

    1 Introduction ............................................................................................................. 3 2 Monopolies: competition and regulation .................................................................. 3 2.1 Lack of competition ............................................................................................. 3 2.2 The challenges of regulation ................................................................................ 4 2.3 Rigid contracts ..................................................................................................... 4

    2.3.1 Water ........................................................................................................... 5

    2.3.2 Electricity .................................................................................................... 5 3 Excess supply of public enterprises .......................................................................... 6 4 Corruption ............................................................................................................... 6 5 The role of governments .......................................................................................... 8 5.1 Fiscal priorities often dominate ............................................................................ 8 5.2 Continued government support after privatisation ............................................... 8 6 The practices of private firms................................................................................... 9

     6.1 Services become vulnerable to the whims of multinationals ............................... 10

    6.2 Lack of transparency .......................................................................................... 10

    6.3 Up and down stream contracts ........................................................................... 10 6.4 Higher prices ..................................................................................................... 11 7 Disappointing performance .................................................................................... 11 8 Privatisation rejected by the private sector ............................................................. 13 8.1 UK water firms propose „mutualisation‟ ............................................................ 13

    9 Conclusions ........................................................................................................... 14

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1 Introduction

    This paper considers developments in liberalisation and privatisation in water and energy in industrialised and developing countries. Such policies are often dominated by short term priorities and some problems are beginning to emerge. This paper provides a review of some of the key issues.

    Most of the information provided here has been extracted from recent and forthcoming papers produced by Public Services International Research Unit PSIRU) which can be found on the PSIRU website, www.psiru.org .

Some relevant recent titles include:

Subject Date Title

    Feb 2001 UK Water privatisation a briefing UK water

    Feb 2001 The Public Sector Water Undertaking - a necessary option Public water

    Feb 2001 The California Electricity Crisis- overview and international lessons California energy

    Feb 2001 Globalisation, privatisation and healthcare a preliminary report Healthcare

    Dec 2000 The Nordic Energy Market Nordic energy

    Dec 2000 Independent Power Producers: A review of the issues Energy IPPs

    Nov 2000 Impact of electricity privatisation - lessons from the UK (and Hungary) Energy UK

    Nov 2000 World Bank and privatisation: a flawed development tool World Bank

    Sep 2000 Privatisation of water and energy in Africa Africa utilities

2 Monopolies: competition and regulation

    Water and electricity services are not competitive (despite recent developments in the supply of electricity in the UK). The companies providing these services are monopolies. To reduce the scope for monopolistic exploitation, policy makers try to inject competition where possible. Uncompetitive enterprises are regulated but sometimes with questionable effectiveness.

2.1 Lack of competition

    One way to introduce an element of competition in privatisation is to invite firms to tender for the concession to provide such services for a limited timeframe. However, only a few international firms are able to participate in tenders for the supply of water and / or electricity.

    When it comes to water privatisation, the private part of the industry is dominated worldwide by the French multinationals Vivendi and Suez-Lyonnaise, and SAUR, and three UK companies,

    Thames Water (now owned by the German conglomerate RWE), Anglian Water, and international water actually jointly owned by two construction multinationals, Bechtel of the USA 1and Edison of Italy). Attempts by the USA company Azurix owned by Enron to break into

    the market have been a failure (compounded by exposure for corrupt practices in Ghana).

    Some of the privatisations have in any case happened without any competitive tendering at all, even between the private sector companies. For example, all the private concessions in Czech

    Republic, Hungary and Poland up to 1997 were awarded without any competitive tendering 2process , as was the SODECI concession in Cote d’Ivoire, yet they are now long-term

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    monopolies. In May 2000, Suez Lyonnaise were the only bidders for Cameroon’s water supply

    network.

    This is a serious weakness of public-private partnerships in water and energy. The principal argument advanced for any form of privatisation is the theoretical benefits of competition. A one-off invitation for tenders from 5 or 6 companies well-known to each other, followed by for a 3 25 to 30 year monopoly before retendering, does not deliver much competition.

2.2 The challenges of regulation

    Water and energy regulators are supposed to be independent of government, and privatisation is lauded for taking decisions out of the hands of politically motivated bureaucrats, and applying purely economic decision-making criteria. This does not seem to be borne out in practice:

    ; In the UK, water regulation toughened considerably when there was a change in government

    (see section below) with higher taxes and stricter pricing than the previous government. This

    challenges the notion that the regulator is an independent body. Clearly, setting the

    parameters for the delivery of essential services is a political function under private as well as

    government ownership.

    Political intervention, aside, regulating privatised utilities is a difficult task. In the UK, the regulators, Ofgem, have to regularly intervene to stop the companies that run UK electricity from exploiting the market. How much more difficult then is the job of the regulator in developing countries where organisations are staffed by poorly paid public sector workers with little exposure to international corporate activities and where the „opposition‟ consists of highly paid internationally trained corporate executives. What is more, the regulator has little at hand in the way of sanctions, should the firm refuse to adhere to the rules of the regulator. Many tenders for water and energy receive very few bids so terminating the concession and awarding it to a competitor may not be a valid option.

    In practice studies have found that it is difficult for regulators to exercise effective control in the public interest: “In many countries, regulatory structures are still embryonic, in others they lack transparency, while in others they appear to be excessively complex in their organisational 4structure, laying them vulnerable to political interference”.

; A recent study of public-private-partnerships in South Africa concluded that “lack of public

    sector capacity is, as the BOTT experience demonstrates, an important reason not to 5privatise, rather than a justification for public-private sector partnerships” The same is true

    in the countries of the former Soviet Union: “The capacity of most NIS governments to

    effectively regulate private sector participation, particularly the more extensive forms, is an 6important constraining factor [on developing public-private partnerships].”

    ; In the Philippines, March 2000, the private owner of the Manila water company challenged

    the government to take back the franchise if the regulator did not concede to the company‟s 7demands for changing the terms of the original agreement.

2.3 Rigid contracts

    Water and electricity privatisations usually take the form of a concession contract which lasts for a number of years. One of the problems here is that regulation is irrelevant because the terms of the agreement are fixed in advance. Because they are fixed for such a long time period, the terms

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    of these agreements can stifle competition and leave little incentive for the firm to do anything other than keep prices high and costs down once they have won the contract.

    2.3.1 Water

    Most privatised water operations are not management contracts, but long-term concessions, usually of 20-30 years - BOTs usually involve concessions lasting a similar period. These contracts can be very difficult to alter or cancel if circumstances change, because of the legal and administrative processes involved, and because the company will have a vested interest in investing much time, effort and legal manpower into renegotiating a contract rather than terminating it. Such problems have been found in Tucuman (Argentina), Szeged (Hungary) and

    Cochabamba (Bolivia) - the multinational companies concerned pursued legal claims for

    compensation which could make it impossibly expensive to go ahead with ending the contract.

    Even in developed countries terminating a water concession can be very difficult. In Valencia, Spain, the local council tried to re-tender the water concession which was expiring after 99 years with the same company (a SAUR subsidiary). The company threatened to sue for damages if any 8competitor was allowed to take over the system. When Suez-Lyonnaise had been convicted of

    paying a bribe to get the water concession in Grenoble, France, it still took 5 years before the 9council finally replaced the company with a municipal service.

    2.3.2 Electricity

    Privatisation of the electricity sector usually starts with privatisation of the generation of electricity through the licensing of Independent Power Producers (IPPs). Governments contract to buy the power produced under the terms of a Power Purchase Agreement (PAA), where the price and amount of power to be bought are set for thirty years or more in advance. These are the terms under which IPPs agree to operateIPPs are presented as an attractive option because they are supposed to facilitate investment where a bankrupt public sector can barely afford to make ends meet; and because they allow the private sector to operate without the need for lengthy regulations to be in place beforehand, because the conditions of operating can be specified in the terms of the IPP contract. However, the rigidity of such arrangements has been problematic. The terms of PPAs can be fixed for decades and circumstances can change dramatically over such a timeframe. Yet, the terms by which governments have to purchase power from IPPs remain inflexible. Governments are tied into buying the same amount of power, regardless of fluctuations in demand or alternative sources of supply. Prices are fixed in foreign exchange, regardless of how this might relate to domestic prices or to what utilities are able to charge customers.

    Investors have no incentive to respond to market conditions or to compete with other producers. The only competition comes in the contract negotiating stage (and not always then). This is in itself a disincentive for new investors as, even if they can produce power more cheaply, the electricity utility is unable to switch to alternative sources for the duration of the PPA. Governments get left with „stranded assets‟ which means that they are committed to paying

    higher prices for electricity (or compensation to the IPP), even if a cheaper competitor comes on to the market which might be due to technological progress and access to cheap power inputs such as gas or hydro.

    This arrangement has been disastrous in Asia where the financial crisis has caused the currency to devalue, causing the price of electricity to escalate in terms of the domestic currency. Governments are unable to pass these costs on the domestic consumers and have accumulated massive debts.

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    ; In the Philippines the electricity utility, Napocor, has amassed extensive debts due to the

    terms of its IPPs. Around $9bn, of the $15bn total liabilities consists of obligations under

    power purchase agreements with IPPs.

    ; In Indonesia state electricity company PT Perusahaan Listrik Negara (PLN) announced a

    twelve fold increase in losses of in the first half of the year 2000. These losses were made

    despite a 30 percent increase in revenue over the period, largely because a stronger US dollar

    caused a big increase in the cost of power from IPPs.

    ; In India, the Gujarat State Electricity Board (GEB) is to pay around Rs500 crore to three

    independent power projects including Essar Power, Gujarat Torrent Electricity Company

    (GTEC) and Gujarat Industrial Power Company (GIPCL). However, GEB will not buy power

    from them because of the fuel that they use (high cost naphtha). GEB has to continue with

    payment because it is committed to paying a fixed cost of these power projects as per the 10 power purchase agreements signed between GEB and the three companies.

3 Excess supply of public enterprises

    Governments are privatising water and electricity utilities all over the world often at the bidding

    of the IMF / World Bank. The result is that countries are now having to compete to attract one of the small pool of international investors who participate in these international tenders. As the stakes are so high often substantial amounts of World Bank loan funding are contingent on such deals governments have to offer generous concessions to entice the investor. This state of affairs is recognised by the World Bank,.

    In India, the World Bank‟s Project Appraisal Document for the Haryana Power Restructuring Project cites the lack of investor interest as a risk of the project not succeeding which is exacerbated by the fact that other states are competing for investors because they are all carrying out the same policies. The document states the proposed method of minimising the risk:

    “Haryana has decided to provide an attractive regulatory environment; and to prepare carefully the privatisation strategy, taking into account privatisation plans in other states. Possibility to re-design privatisation method to reduce financial exposure of 11private sector at cost of lower revenues to Haryana.”

    Such an approach may have serious adverse long term consequences as it is difficult to strengthen an „attractive‟ regulatory regime after the privatisation has been completed. Furthermore, the government of Haryana may suffer even more severe financial problems if the contract is arranged so that the private sector financial exposure is reduced at the expense of the government.

4 Corruption

    Corruption is a systematic feature of privatisation processes, in water and electricity as much as any other area. The reasons for this have been well summarized by a World Bank paper: “…the

    privatisation process itself can create corrupt incentives. A firm may pay to be included in the list of qualified bidders or to restrict their number. It may pay to obtain a low assessment of the public property to be leased or sold off, or to be favoured in the selection process …firms that make payoffs may expect not only to win the contract or the privatisation auction, but also to 12obtain inefficient subsidies, monopoly benefits, and regulatory laxness in the future”.

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    This is borne out by experience in the UK, where police say that „the overwhelming majority of

    corruption cases in Britain are connected to the award of contracts. Compulsory contracting-out in local government, and the new Private Finance Initiative have produced an explosion in the 13 number of such deals‟

Some examples,

    ; UK In 1999 former government minister Aitken was jailed for lying to cover up a meeting to

    broker bribes for such contracts: - UK multinational GEC had agreed to pay a commission

    worth 10 per cent of the value of possible sales into an account controlled by Aitken‟s 14solicitor.

    ; France: Corruption is one of the practices adopted by French water multinationals to secure

    enormous profits. With an increasing body of evidence exposing the irregularities and the

    “costs” of the French system of delegated management, this should not be promoted as a

    global model.

    In Grenoble, the mayor and a Lyonnaise des Eaux executive were convicted in 1996 of for

    respectively accepting and paying bribes. LdE were awarded the contract for the city‟s water

    and sanitation services in 1989. The corrupt deal was lucrative for Lyonnaise des Eaux and

    expensive for consumers. For example. Eau Secours estimates that:

    o From 1990 to 1995, tariff increases brought Lyonnaise des Eaux excess income of

    FF70m (US$10m) for water supply and FF26m for sewerage. Following the re-

    negotiation of the contract, excess income amounted to FF13.7m for water and FF2.3m

    for sewerage.

    o Over the period 1989-95, the company invoiced more water than was actually consumed.

    The amount invoiced in excess corresponded to over 51 per cent of the total volume

    invoiced. Profit: FF21m.

    Also in France the former mayor of Angoulème was jailed in 1997 for two years, with

    another two years suspended, for taking bribes from companies bidding for contracts,

    including Générale des Eaux. Executives of Générale des Eaux were also convicted of 15bribing the mayor of St-Denis (Ile de la Réunion) to obtain the water concession.

    The same companies - Suez-Lyonnaise and Vivendi, together with Bouygues have been

    investigated for corruption practiced by their construction divisions, in a scandal described as 16„an agreed system for misappropriation of public funds‟. The companies ran a corrupt

    cartel over building work for schools in the Ile-de-France region (around Paris) between 1989

    and 1996. Contracts worth FF2.8 billion (about US$500m) were shared out by the three

    groups.

    ; In Lesotho, subsidiaries of a dozen multinationals - from the UK, France, Italy, Germany,

    Canada, Sweden and Switzerland - are being prosecuted for paying bribes to obtain contracts

    in the Lesotho Highlands project a huge water supply scheme. The companies include

    Suez-Lyonnaise, Bouygues, and RWE, the German energy and construction group which is 17expanding into water.

; Most IPPs in Indonesia provided family and friends of Suharto with “loan-financed” shares

    in the company. The idea was that they paid for the shares with the dividends from the shares.

    The shares are essentially a gift but in this way they escape the attention of US and

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    international anti-corruption legislators. This arrangement has the added advantage of the

    beneficiaries having an interest in the project being profitable as soon as possible and this

    might be something over which they have some influence. IPPs in Indonesia have been

    irritated by the bribery allegations. Most officials say that the issue in Indonesia has not been 18 one of bribery but one of extortion.

5 The role of governments

5.1 Fiscal priorities often dominate

    Governments and municipalities usually expect privatisations to benefit their own finances, by using the proceeds of a sale to reduce the debts or deficits of the government itself. But this can conflict with the financial needs of the utility itself, because the price that a company is willing to pay to obtain a concession will depend on the profit stream that the private company can expect, which in turn will be affected by the price it charges to users, and how generous the conditions such as regulation are. So what is good for the government‟s finances may not be best for end users.

This has been recognised as a serious problem in France, where a national audit report said that

    “privatising concessions has been converted into a way of improving the balance sheets of municipalities at the expense of the user/taxpayer”. Since 1996, it has been illegal in France for 19any council to sell a water concession to a private company. But the same problem occurs in

    other countries where it is still legal to do this. In Budapest (Hungary) in 1997, the water supply

    concession was awarded not to the consortium which offered the cheapest price for water, but to the consortium led by Suez-Lyonnaise and RWE which promised the council an extra 3

    billion forints in payment - although the price of water to consumers was higher by 3 forints per 20cubic meter than another bid.

5.2 Continued government support after privatisation

    Governments continue to intervene in privatised water and electricity sectors. The private sector often enjoys significant financial support from public authorities. According to a World Bank report, this support may include: Cash contributions during the construction period; subsidies

    during the operating period eg in the form of non-refundable grants; and a favourable tax regime 21- including tax holidays, refunding of tax on construction and operating costs.” It may also

    include subsidised access to investment finance, for example, the Malaysian government,

    supported by its A+ credit rating, funded a private $2.4bn national sewerage concession with a 22soft loan.

    Another example of multiple assistance from public authorities can be seen in Nelspruit, capital of Mpumalanga province in South Africa, where water supply was contracted in 1999 to a private concession operated by Biwater, of the UK. The main argument used at the time for the concession was the need to attract private finance. But since then Biwater has (a) brought in as a 23partner Nuon, a Dutch municipally-owned company, to provide some of the necessary finance

    (b) benefited from a new water treatment plant at Matsulu, a suburb of Nelspruit, which the government of Portugal financed, and the South African government constructed , but is being 24handed over free to the new private operator.

    Privatisation does not does not absolve the government from its mandate to maintain affordable and stable energy prices for the country. Privatisation present a difficult challenges as there is a delicate balance to be achieved in allowing prices to be high enough for investors to cover costs

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    and make an adequate return and low enough to be affordable so as not to harm the domestic economy. The conflicting pressures on governments and companies means that setting prices is always likely to be a thorny issue.

; In the Dominican Republic electricity prices increase by around 51% on privatisation. The

    government attempted to absorb 42% and pass on 9% to the consumer. This subsidy has been

    costing the government around five million dollars every month. The government has

    accumulated arrears of more than $US100m. With mounting arrears, IPPs (which now

    provide about 40% of the country's power) began to pull the plug on power supplies,

    exacerbating blackouts which have been lasting up to 24 hours affecting businesses, schools

    and hospitals. Consumers have started to withhold payment of electricity bills in protest

    against daily blackouts lasting more than 20 hours and 'abusive rates' charged by power 25 companies.

    ; Similarly in Georgia, the state distributor, Telasi, has been taken over by AES and the

    government faces the problem of how to provide assistance for payments for poorer

    consumers including pensioners. They have an arrangement using “offsets” by which

    subsidies for these users are financed by the waiving of fees paid by AES to state owned

    power generators. This then means that generators face cash shortages which will constrain

    future investment capacity. One suggested solution is to privatise the generators and sell them

    to AES but this does not solve the problem of providing affordable energy to low income

    consumers. Privatising other aspects of the network will not affect the government‟s need to 26subsidise commercial tariffs for electricity.

    Alternatively, governments impose price restrictions to prevent private sector price volatility reaching the end user:

    ; In California, the two electricity utilities, PG&E and Edison were driven to the edge of

    bankruptcy when wholesale prices increased sevenfold in 2000 from the previous year. The 27companies had previously agreed to freeze retail prices (see PSIRU paper on California).

; In Hungary, the country‟s six electricity distribution companies (EDCs) which are majority

    owned by E.on and RWE of Germany and EdF of France, have threatened legal action

    against the government. The dispute is over the tariffs which the EDCs are allowed to charge

    end users. The government has restricted the increase in tariffs to 6 percent, which was the

    expected inflation rate. However the actual inflation is nearer 10 percent and the price that the

    EDCs have to pay the government electricity utility, MVM, for supply has increased by 13 28percent.

6 The practices of private firms

    Privatisation has been pursued because it is assumed that the private sector‟s single-minded

    pursuit of profit will increase the efficiency of state utilities. Furthermore, private firms will be at arm‟s length from the government and so will not be under pressure to maintain supplies to non-

    payers or to keep prices artificially low to placate the electorate.

    However, the issue does not end here. Rather, when the profit motive is applied to electricity and water, policy makers need to be aware of a number of further likely outcomes. Firstly, firms will only be attracted to enterprises where they can make a profit. Secondly, this drive for profit puts pressure on firms to reduce expenditure and therefore investment in anything not related to

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    revenue collection may be a low priority. Thirdly, the drive for profit will make firms steer clear of competition and regulation as much as possible and fourthly, the utilities will be assets on the balance sheets of multinational firms to be traded when the profit motive dictates.

Some features of private management are discussed below:

6.1 Services become vulnerable to the whims of multinationals

    MNCs trade essential services all the time. For example, in Venezuela, AES promised Union

    Fenosa the right to buy some non-core assets belonging to Grupo EDC in return for its agreement not to enter a bidding war for the Venezuelan utility. The assets included three Colombian power companies and two profitable non-regulated power firms in Venezuela Domegas and 29Genevapca. Thus for the people of Colombia and Venezuela, the owners of their essential supply of electricity can change as a result of companies colluding to avoid competition.

    The almost transient status of these utilities in the eyes of their parent companies raises concerns about their financial stability and in Australia and New Zealand has affected their credit rating 30as the support of the parent company cannot be assured.

6.2 Lack of transparency

    Commercial companies invariably prefer confidentiality and secrecy, as it protects their ability to manage financial affairs to maximize the benefit to their owners. Private water operators frequently insist that the contract itself should be a secret document even from the elected

    councillors of the authority which has given the contract.

    In Fort Beaufort, South Africa, the contract prevents any member of the public from seeing the contract without the explicit approval of the company WSSA (owned by multinational, Suez-Lyonnaise): “2.2.2: Confidentiality: the documentation contained herein has been developed

    exclusively by the operator (WSSA) and shall not be disclosed to third parties without the written 31approval of the operator." According to a Suez-Lyonnaise executive at the World water Forum at The Hague March 2000, it is universal company policy to keep the contract documents secret.

    Documents relating to the privatised Budapest Sewerage Company, where Vivendi is the multinational, are kept secret, even from council officials, and Budapest City Council debates 32related issues only in closed sessions.

6.3 Up and down stream contracts

    When water is privatised contracts for building and construction of new works can often be reserved to the construction companies of the same group the parent company has an interest in

    high priced contracts being placed with its own subsidiaries. For example, both Suez-Lyonnaise and Vivendi have large water engineering subsidiaries, and own major suppliers of chemicals and materials, which are likely to receive preferential treatment in procurement by the groups‟

    concessions.

    Vivendi (Générale des Eaux) was awarded the operating concession in Szeged (Hungary) in 1993, through its subsidiary Szegedi Vizmu. At the same time a works company, 70% owned by Générale des Eaux, was also established which has an annual contract for all the maintenance 33work, and exclusive rights to all works contracts issued by Szegedi Vizmu.

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