Ensuring effective privatization

The Government should “just focus on ESB,” investment analyst Nigel Hawkins tells Meadhbh Monahan.

An advocate of privatisation, the Adam Smith Institute’s Nigel Hawkins tells eolas that, in considering the sale of state assets, the Government should make sure it gets ESB “right” because it could generate up to €8 billion. The other assets identified in the McCarthy report only have the potential to generate millions.

The McCarthy report recognised that out of its 55 recommendations, the proposal to sell ESB’s electricity distribution businesses, generation assets, international investment and consulting and engineering business as a single entity was the “most important”. However, the Government has now decided to sell a minority stake in that company.

Ireland’s energy sector contains the most substantial assets. As well as ESB, Bord Gáis Éireann and Bord na Móna are identified in the McCarthy report.

Privatisation, according to Hawkins, can enable investment, improve customer services, enable a more competitive market, and raise proceeds for government.

For example, since the British regional water authorities were privatised in 1989, the private water companies have invested £80 billion in the UK economy. Lower telecoms prices followed the privatisation of British Telecom but water prices have increased substantially, Hawkins points out.

Job losses are the main disadvantage of privatisation.

“Whilst employees may gain if they have to stay there with a better package or some shares, the reality is that, by virtue, privatisation does mean some job losses,” Hawkins states.

“You could argue that non-privatised jobs are overstaffed,” he contends, “but job losses would ultimately be a factor.”

In addition, “where heavy investment is involved, you do need price increases.”

Controlling who are acceptable shareholders is another drawback, according to Hawkins.

“It can be quite difficult to control. They can be difficult to regulate unless the regulation is strong,” he explains.

Due to Ireland’s deficit (32.4 per cent of GDP in 2010), the Government is likely to judge that the advantages will outweigh the disadvantages.

However, Hawkins warns that the scale of the deficit means that “a lot will need to be done” to reduce the debt.

“Selling ESB for a few billion, compared with the net debt, is not going to transform the situation overnight from the very high debt to minimal debt,” Hawkins notes.

Mistakes

The analyst further warns that “some governments frankly make mistakes when they undertake privatisations.”

Railtrack is a case in point. In 1993, the rail privatisation legislation was passed and Railtrack took control of the UK’s rail infrastructure. However, the UK Government “grossly underestimated the amount of capital investment that was required.”

Following fatal accidents at Southall in 1997 and Ladbroke Grove in 1999, the company was asked to improve its safety and performance. Another fatal crash at Hatfield in 2000 resulted in approximately £580 million being spent on repairs, Railtrack’s shares dropping and the company going into administration.

“On reflection, the capital spend assumptions were far too low and, as a result, literally over a weekend, it was put into administration very controversially,” Hawkins reflects.

In the energy sector, the privatisation of British Energy “went very well” initially. Established in 1995 to operate eight nuclear power stations in England and Scotland and one coal-fired power station, British Energy was privatised in 1996 and operated one-fifth of Great Britain’s power.

Following the liberalisation of the wholesale power market in 2001, prices were substantially reduced.

“Because British Energy was almost totally dependent on the revenue from these plants, prices coming down by a third had a very disproportionate impact on their profits,” Hawkins explains.

As a result, British Energy share prices “absolutely plummeted” to 18 pence in 2002.

The lesson for ESB, Hawkins states, is that “it’s far easier to adjust the electricity system, trading etc. before you privatise, rather than trying to do it afterwards.”

He advises that the system must be “absolutely top class initially rather than doing a rushed job.”

Hawkins sees the privatisation of the UK National Grid as a good example of the process working in the British energy sector. It was privatised as part of the overall privatisation of the electricity industry in 1990, with the regional electricity companies owning a percentage each of the national grid. They sold these off in the mid-1990s and the company now focuses on high transmission grid rather than generation. National Grid, according to Hawkins, is now “the biggest grid company, to my knowledge, in the world and is undertaking a very large investment programme, which is being financed.”

Advice

Long-term investors, whether pension funds or structural asset companies, want “something that will endure and be absolutely reliable,” Hawkins claims.

Regulation must be “as certain as it can be.” Looking 10 to 15 years ahead, investors want to be able to say: “Yes, they are allowed certain exponential price increases”, rather than in two years’ time saying: “Let’s change this and change that.”

Hawkins concludes that “due to [the] increasing deficit, privatisation is becoming of interest to people,” therefore the Government has to get it right.

“Despite political concerns, the ESB partial privatisation is crucially important,” he claims.

If the Government can get that right, “it would be very good for Ireland.”