Privatization Depends on Regulation

As it is unlikely that BlackRock wants to be in the business of loaning money to governments, we’ll assume that their interest is in privately owned infrastructure in the public utility industries of electricity generations, transmission, and distribution: natural gas pipelines and distribution systems; oil and products pipelines; and water treatment and distribution. The other infrastructure industries available to private capital would be airports, seaports, toll roads and mass transit.

In most countries all these infrastructure industries already exist so any infusion of new private capital would most likely be in the form of new concessions or privatization and expansion of existing public utilities. The International Finance Corporation (IFC) has defined privatization as “any transfer of control of ownership or control from the public to the private sector.” The IFC writes that a more exacting definition would include that the transfer results in the private operators or owners having “substantive independent power” with respect to the property. Thus, the privatization process includes a transfer from government to the private sector which can also be described in terms of the “investor” or “investors”. An example is that of privatization of a state-owned electric utility.

A government privatizes its holding in a sector of industry to meet national political and economic goals. The privatization process may also include consideration of international agreements such as the planned entry of the country as a member of the European Community.

A government’s political objectives can include such goals as:

the desire to obtain funds from the sales of an enterprise which can be redistributed to other areas of government responsibility,
the desire to restructure the industry to improve performance;
the desire to have future expansion and enhancements financed by private rather than public capital and other reasons specific to a particular country.

Governments may also have other specific political goals, which encourage privatization.

A government’s economic objectives of privatization can include such things as:

general benefits coming from expectations of competitive prices,
more reliable service and construction of sufficient capacity to meet economic growth targets.

More specific objectives in some countries have included the desire to encourage rational pricing among customer classes, maintain a competitive energy environment and finance the ability to conform to new environmental requirements.

The private sector, represented by interested investors, will consider general country economic factors, electric industry regulatory conditions and specific enterprise information in evaluating a decision to invest in a particular privatization offering.

Any newly announced privatization offer will face competition for investors’ capital. This competition will come from; other new privatization being offered at the same time, new stock and debt issues from existing electric companies, ability to purchase shares of established electric companies in other markets and investment opportunities in other industries in the same country or other countries. As the subject is investment in the electric industry an investor will also consider the structure of the country’s electric power industry in some detail.

The general country factors considered by investors include both political consideration and economic factors. The political consideration includes a country’s: economic policies, trade policies, foreign investment policies, cultural factors, and regulatory policies.

The types of economic factors considered by investors when making the decision whether to invest in a specific country include factors of: foreign exchange risk, inflation rates, levels of tariffs, valuation issues, ability to obtain accurate financial data and financing options.

An investment in the electric power sector is unique in the sense that a particular electric power enterprise is in physical connection to a specific electric power grid and in a specific location. Electric power assets consisting of such properties as central station power plants, high voltage transmission lines and low voltage electric distribution wires cannot be moved to other locations. The investor in any sector of the electric industry is very much concerned with the structure of the electric power market and the regulation of that industry in its current location. There is no ability to move the assets elsewhere should the investor find that the assets are in an unfavorable location.

An investor in any portion of the electric power sector will have an interest in the current economic situation and future prospects. The investor will take into account such things as the national structure of the electric power industry, how the country’s electric system fits in with regional electric power arrangements and prospects, and what effects international energy developments including technologies and fuel price changes have on the electric industry.

Investment opportunities in a specific privatization offer will be reviewed by investors for: financial conditions, operational issues and from the aspect of competitive position. The financial condition review will look at key indicators. These will include regulatory professionalism and ranking, the prospects for revenue stability and growth prospects, expense control, quality of earnings stream, and estimates of future financial prospects. A review of operational issues would encompass such things as the physical condition of assets, future capital requirements and identification of operational problems. The investor’s interest in the competitive position of the individual organization would cause investigation of such areas as; the current market structure, competitive threats, the current organizations readiness or ability to compete and the overall ability of the firm in its current condition to attract additional capital.

Finally, the key investment considerations should be the quality of enabling legislation, independence of regulator from parliamentary hindrance, professionalism of regulatory practices and the availability and willingness of courts to enforce the law. The private investor must be convinced that the government regulator will treat the investor’s public utility investment fairly.

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Privatization Depends on Regulation

By Branko Terzic

Privatization can be a tool to meet government’s political and economic objectives.

Investor considerations in privatization in the electric sector