Friday, October 11, 2013

Lessons from Britain's utilities privatization

Britain has privatized its last remaining large public utility. The decision to privatize the Royal Mail has attracted considerable investor interest as well as triggering a reassessment of the outcomes of the massive privatizations of the eighties. For the record, the privatization involved selling 52.2% of Royal Mail, valued at £3.3bn.

The floatation was over-subscribed seven times, attracting 700,000 retail applications, encouraged by the low 330 p share price. In fact, the low listing price was immediately borne out when the share debuted at 450 p, before easing down to 441 p, or 36% higher than the listing price. This does naturally raise questions about whether the utility was sold too cheap. However, emboldened by the over-subscription and to pre-empt "stagging" (selling immediately after the debut), the government had announced that investors who had applied for more than £10,000 worth shares would return empty handed.

But an assessment of the utilities privatization of the eighties raises many questions about the value addition that has accompanied ownership transfers. The FT draws attention to a study of the privatization of railways which finds large private profiteering without capital investments and large subsidy outflows from the government. The report finds that the franchising policy has artificially boosted the profits of the privately owned train operating companies (TOCs) while loading debt into the publicly guaranteed Network Rail,
Network Rail has been inflating the profits of the TOCs by lowering track access charges from £3.19 billion in 1994 to £1.59bn in 2012... This hidden sum is nearly twice as large as direct government subsidies to the TOCs and the cost of servicing this growing debt is now larger than the cost of annual railway maintenance. Now, half of the new debt currently being issued by Network Rail covers the cost of servicing existing debt. Direct public expenditure on rail has more than doubled since privatisation and is currently running at £4 billion a year... despite fares rising which are now higher than in other major European countries.
In the context of British government decision to cap rail commuter fares and calls to do the same with energy prices, an FT commentator argues that
If the regulatory balance is wrong or the competitive structure ineffective, the public ends up paying too much, corporate profits become too high and private sector shareholders get a free ride from tax payers... mysterious pricing, hidden state subsidies, consumer confusion and inbuilt advantages to established operators appear systemic in the privatized utilities... Failure to construct an effective market mechanism risks creating faux competition, characterized by cosy rivalry rather than head-to-head battles that drive down prices and transform public service. In turn, this facilitates low-risk profit opportunities for the private sector on the back of officially condoned oligopolies and hidden state subsidies.
The British rail privatization had unbundled the system into three parts. An infrastructure company, Network Rail (earlier Railtrack) owns the track, rolling stock operating companies (ROSCOs) own the trains, and TOC's run the trains. There are currently 17 TOC franchises (down from the original 25), operating both long distance inter-city routes as well as urbanized commuter lines. The ownership of the franchises have changed hands many times. 

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