Donal Palcic: Eoin Reeves and I have an opinion piece in the Irish Times today on the information that emerged in relation to the government's plans for privatisation during the latest visit by the troika.
Showing posts with label eoin reeves. Show all posts
Showing posts with label eoin reeves. Show all posts
Tuesday, 31 January 2012
Thursday, 8 September 2011
Full privatisation of Aer Lingus
Donal Palcic and Eoin Reeves: Yesterday the Minister for Transport signalled the possibility of selling the remaining 25 per cent stake in Aer Lingus (as recommended by the report of the Review Group on State Assets and Liabilities published last April). News of other planned sales, such as the sale of a partial stake in the ESB, is expected over the coming days. So does the sale of the remaining government held shares in Aer Lingus make sense? This can be assessed in terms of the government’s objectives. First, this is about raising exchequer revenues, so how much can the government expect to realise? With shares trading at 67.5 cent as of this morning (compared to the IPO price of 220 cent) a 25 per cent stake is likely to be worth in the region of €90m (leaving a lot more to be sold if the €2bn target in the programme for government is to be reached). Net revenues will of course be reduced when professional expenses and discounts are taken into account.
Are there any other advantages to be accrued from the mooted sale? The common argument in support of selling state owned enterprises (SOEs) is that performance will improve under private ownership. But Aer Lingus operates as a privately owned enterprise and is not subject to obvious political interference (a problem traditionally faced by some SOEs). So selling the remaining 25 per cent will not have any impact in terms of improving enterprise performance.
What are the likely downsides to the possible sale? The obvious one is that the 25 per cent stake constitutes an important degree of state influence over the island economy’s airline. We have discussed the importance of the state retaining control over strategically important industries before here and here. But suffice to say that Eircom provides an example of one of the biggest privatisation failures worldwide and this could have been avoided if the state had not relinquished complete control when it privatised the company. The lessons in relation to Aer Lingus are obvious.
One of the big strategic issues in relation to Aer Lingus concerns the Heathrow slots. The Minister for Transport stated that the strategic reasons for retaining a stake in the airline no longer exist and that the issue of Heathrow landing slots was not as important as it was since people are now using connections other than Heathrow. Aer Lingus has 23 landing slots in Heathrow. Currently 13 slots are being used on the Dublin route [BMI also operates on this route and has 4 landing slots], 4 on the Cork route, 3 on the Shannon route and 3 on the Belfast route.
Data from the UK’s Civil Aviation Authority shows that, in 2010, over 9.5 million passengers travelled from the Republic of Ireland to the UK, with just over 51 per cent of all passengers travelling to London. A quick glance at the traffic on the Dublin, Cork and Shannon to Heathrow routes for 2010 (see table above) illustrates the importance of the Heathrow link, with slightly over 44 per cent of passengers to London going through Heathrow. In general, the vast majority of passengers from Ireland to Heathrow are carried by Aer lingus (they are the sole operator from Cork and Shannon; while on the Dublin Heathrow route they operate significantly more flights than BMI).
While the number of passengers travelling to airports in London other than Heathrow has increased considerably over the years, based on the above figures for 2010, it is hard to see how the Minister can claim that the “strategic” argument for retaining a stake in Aer Lingus no longer applies. For an island nation like Ireland, which is heavily dependent on international connectivity, the Dublin/Cork/Shannon to Heathrow routes are of considerable strategic importance. Although the sale of the government’s 25 per cent stake does not mean that flights on these routes will stop overnight, it does leave the government powerless to prevent an undesirable change in ownership in the future (think Eircom).
Given the relatively small amount of cash that is likely to be raised, one must question whether this mooted proposal makes sense. Our scepticism appears to be shared by the company itself, which reportedly is not in favour of a quick sale. Moreover, Joe Gill of Bloxham sounded a sceptical note when interviewed by Matt Cooper on Today FM yesterday. Mr. Gill raised the issue of the Heathrow slots and also highlighted the difficulties posed by the company’s pension deficit (in the region of €400m). He also suggested that a special dividend by cash-rich Aer Lingus (it has cash balances of approximately €350 million) offers an easier way for the government to raise much needed cash from the company. Notwithstanding the issues that arise in forcing a special dividend one wonders if this route makes more sense than relinquishing full control over the airline.
Thursday, 21 April 2011
Palcic and Reeves on privatisation
Given the week that's in it, PE readers may be interested in a new book by Donal Palcic and Eoin Reeves, Privatisation in Ireland: Lessons from a European Economy. Further details are available here.
Monday, 19 July 2010
Costly Business: Privatisation and Exchequer Revenues
Donal Palcic and Eoin Reeves: The recent revelation that the government has established a group to report and advise on – among other things – the potential for privatising state-owned enterprises (SOEs) raises a number of important issues. These issues concern the precise rationale for any sell off, the method of sale adopted and the likely outcomes in economic and social terms.
It appears that the principal rationale for any potential privatisation is to raise revenue for the exchequer in order to deal with the country’s acute fiscal crisis. Although privatisation can raise useful revenues for the exchequer in the short- to medium-term it cannot, however, be justified on this basis alone. In a recent article published in Administration, we show that the revenues generated from privatisations, both in Ireland and abroad, are rarely maximised.
In Ireland, ten SOEs have been privatised to date and the exchequer has accrued over €8.3 billion. However, we show that the exchequer has foregone over €2.1 billion as a result of a combination of costs related to the underpricing of shares, debt write-offs, fees to advisors, underwriters etc., and the establishment of employee share ownership plans (ESOPs), which account for approximately half of the foregone revenues.
This is shown in the table below, where direct costs refer to advisory fees etc, and indirect costs refer to the cost of debt write offs and the underpricing of shares. Admittedly, the aggregate costs are dominated by the biggest divestiture to date (Eircom), however, there were questionable decisions in relation to a number of other sales. For example, when the refinery and terminal operations of the Irish National Petroleum Corporation (INPC) were sold in 2001, the sale involved a large debt write-off and other costs which amounted to €76 million. The Whitegate and Bantry assets were sold for €116 million, but six years later the new owners put the Whitegate refinery up for sale for a price of approximately €350 million.
It appears that the principal rationale for any potential privatisation is to raise revenue for the exchequer in order to deal with the country’s acute fiscal crisis. Although privatisation can raise useful revenues for the exchequer in the short- to medium-term it cannot, however, be justified on this basis alone. In a recent article published in Administration, we show that the revenues generated from privatisations, both in Ireland and abroad, are rarely maximised.
In Ireland, ten SOEs have been privatised to date and the exchequer has accrued over €8.3 billion. However, we show that the exchequer has foregone over €2.1 billion as a result of a combination of costs related to the underpricing of shares, debt write-offs, fees to advisors, underwriters etc., and the establishment of employee share ownership plans (ESOPs), which account for approximately half of the foregone revenues.
This is shown in the table below, where direct costs refer to advisory fees etc, and indirect costs refer to the cost of debt write offs and the underpricing of shares. Admittedly, the aggregate costs are dominated by the biggest divestiture to date (Eircom), however, there were questionable decisions in relation to a number of other sales. For example, when the refinery and terminal operations of the Irish National Petroleum Corporation (INPC) were sold in 2001, the sale involved a large debt write-off and other costs which amounted to €76 million. The Whitegate and Bantry assets were sold for €116 million, but six years later the new owners put the Whitegate refinery up for sale for a price of approximately €350 million.
The cost of ESOPs in the table above is calculated as the difference in the revenues received by the exchequer for the 14.9 per cent transferred to employees and the value of that stake based on the sale price of the firm. For example, in the case of the TSB, employees received a 5 per cent stake in return for accepting a transformation agreement, and purchased a further 9.9 per cent stake for €25.15 million. Based on the €430 million price paid by IL&P for the TSB, the 14.9 per cent stake was worth just over €64 million.
In the case of Eircom, employees also received a 5 per cent stake in exchange for the acceptance of a transformation agreement, and purchased a 9.9 per cent stake for €241 million. Based on the proceeds from the flotation of the government’s 50.1 per cent stake in July 1999 (which raised €4.2 billion), the 14.9 per cent stake transferred to the ESOP was worth approximately €1.25 billion. The difference between the amount received by the exchequer for the 14.9 per cent stake and its actual value amounts to over €1.01 billion.
Some degree of privatisation appears inevitable but sales will undoubtedly involve the exchequer incurring big costs in order to bring in some much-needed cash. Can this be justified? Perhaps, if there are compensating gains such as improved enterprise performance and public service delivery. However, the Irish track record is not hugely impressive in this regard.
The question of privatising public enterprises requires careful consideration of all the costs and benefits. Ideally the decision to sell these companies should be made in the context of an overall strategy for the sector, but this doesn’t exist. Instead, the issue of privatisation is under consideration as a revenue raising measure. Past experience shows us that there are reasons to be fearful about the quality of decision making in relation to the disposal of such assets. The firesale approach that appears to be imminent is a worrying development.
Monday, 25 January 2010
More Light Touch Regulation? Dublin's Waste Collection Market
Eoin Reeves: In late December 2009 the Irish Times reported that High Court judge (Mr Justice Liam McKechnie) ruled that Dublin’s four local authorities had breached competition law by abusing their dominant position in the household waste collection market in a bid to remove rival private operators. According to the Irish Times:
“Mr Justice Liam McKechnie today quashed a variation to the Dublin region waste management plan whereby only the councils, or contractors appointed by them, could collect household waste”.
A number of interesting issues arise from this particular ruling.
First, according to the Irish Times (December 21st) the judge stated that the actions of the local authorities:
“substantially strengthen the position of the local authorities and substantially influence the structure of the market to the detriment of competition.”
My understanding is that the local authorities sought to exercise more control over the waste collection market by putting contract(s) for waste collection out to competitive tender. The successful bidder would then enjoy monopoly rights to collect waste in accordance with a written contract. This would replace the current system where private operators such as Panda and Greenstar collect waste on the basis of permits (not contracts) issued by the local authorities. These private collectors then compete against each other for customers. Would the change to competitive tendering influence the structure of the market to the detriment of competition as the judge stated?
In my view this argument is very questionable and I have strong reservations about the soundness of the judgement (as reported in the media). It is not clear that the judge has made the distinction between competition in the market and competition for the market.
When the privatisation of refuse collection services came into vogue in the Great Britain in the late 1980s the proponents of privatisation argued that the benefits of competition could be reaped via competitive tendering (competition for the market) and that this was an efficient substitute for competition in the market. In terms of cost efficiency they were proved correct with a host of empirical studies demonstrating that significant costs savings (between 15%-20% on average) were made by moving from direct public provision to private provision after competitive tendering (notwithstanding issues in relation to deterioration of working conditions etc). A key point was that the competitive tension inherent in the tendering process was the key to efficiency gains. These gains were not attributable to privatisation per se. This was evident in cases where local authorities won contracts and also delivered cost savings after competitive tendering.
For a service like refuse collection the argument for competitive tendering is compelling in terms of cost savings. Moreover, the nature of the service is straightforward so writing and enforcing contracts should not be problematic. The contract serves as an instrument for regulating a market where externalities are potentially significant (e.g. illegal dumping in the face of prices set by the private sector) and where market concentration can emerge as dominant private operators squeeze out rivals. The implication of the ‘McKechnie ruling’ is that a market free-for-all is necessary if arrangements are not to be anti-competitive. This results in a light-touch form of regulation compared to contracting out.
It is interesting the note that the Competition Authority has examined this issue in a document published in 2005. Mr. Paul Gorecki, who was then Director of the Monopolies Division in The Competition Authority summarised the findings of the report as follows
“The market for household waste collection is not working well for consumers. Competition law is neither an appropriate or effective remedy in this case. However extensive international experience demonstrates that competitive tendering is the best method of ensuring that household waste collection providers deliver consumers good service at competitive prices.”
Assuming that Dublin’s local authorities were indeed seeking to replace a permit system with competitive tendering there are serious question around the economic reasoning behind the McKechnie ruling.
Some other issues arose from this ruling. These concern the PPP contract for the Poolbeg Incinerator as well as the role of consultants and their influence in shaping public policy. I hope to return to these issues in later posts.
“Mr Justice Liam McKechnie today quashed a variation to the Dublin region waste management plan whereby only the councils, or contractors appointed by them, could collect household waste”.
A number of interesting issues arise from this particular ruling.
First, according to the Irish Times (December 21st) the judge stated that the actions of the local authorities:
“substantially strengthen the position of the local authorities and substantially influence the structure of the market to the detriment of competition.”
My understanding is that the local authorities sought to exercise more control over the waste collection market by putting contract(s) for waste collection out to competitive tender. The successful bidder would then enjoy monopoly rights to collect waste in accordance with a written contract. This would replace the current system where private operators such as Panda and Greenstar collect waste on the basis of permits (not contracts) issued by the local authorities. These private collectors then compete against each other for customers. Would the change to competitive tendering influence the structure of the market to the detriment of competition as the judge stated?
In my view this argument is very questionable and I have strong reservations about the soundness of the judgement (as reported in the media). It is not clear that the judge has made the distinction between competition in the market and competition for the market.
When the privatisation of refuse collection services came into vogue in the Great Britain in the late 1980s the proponents of privatisation argued that the benefits of competition could be reaped via competitive tendering (competition for the market) and that this was an efficient substitute for competition in the market. In terms of cost efficiency they were proved correct with a host of empirical studies demonstrating that significant costs savings (between 15%-20% on average) were made by moving from direct public provision to private provision after competitive tendering (notwithstanding issues in relation to deterioration of working conditions etc). A key point was that the competitive tension inherent in the tendering process was the key to efficiency gains. These gains were not attributable to privatisation per se. This was evident in cases where local authorities won contracts and also delivered cost savings after competitive tendering.
For a service like refuse collection the argument for competitive tendering is compelling in terms of cost savings. Moreover, the nature of the service is straightforward so writing and enforcing contracts should not be problematic. The contract serves as an instrument for regulating a market where externalities are potentially significant (e.g. illegal dumping in the face of prices set by the private sector) and where market concentration can emerge as dominant private operators squeeze out rivals. The implication of the ‘McKechnie ruling’ is that a market free-for-all is necessary if arrangements are not to be anti-competitive. This results in a light-touch form of regulation compared to contracting out.
It is interesting the note that the Competition Authority has examined this issue in a document published in 2005. Mr. Paul Gorecki, who was then Director of the Monopolies Division in The Competition Authority summarised the findings of the report as follows
“The market for household waste collection is not working well for consumers. Competition law is neither an appropriate or effective remedy in this case. However extensive international experience demonstrates that competitive tendering is the best method of ensuring that household waste collection providers deliver consumers good service at competitive prices.”
Assuming that Dublin’s local authorities were indeed seeking to replace a permit system with competitive tendering there are serious question around the economic reasoning behind the McKechnie ruling.
Some other issues arose from this ruling. These concern the PPP contract for the Poolbeg Incinerator as well as the role of consultants and their influence in shaping public policy. I hope to return to these issues in later posts.
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