18/11/2015 EXECUTIVE SUMMARY
Andreas Theophanous Neofytos Epaminonda Kyriakos E. Georgiou
THE EAC AND THE PROSPECT OF PRIVATIZATION For and against and other options
This study takes place under special circumstances. According to the Memorandum of Understanding (MoU), the Republic of Cyprus has committed to raise €1,4 billion through the implementation of a privatization plan, including CYTA (telecoms), EAC (electricity), CPA (commercial activities of ports) as well as land assets. However, the MoU obligations can be fulfilled without the privatization of all state-owned enterprises (SOEs). Furthermore, the MoU should not be considered as an infallible document.
From its establishment in 1952 the EAC managed to have a successful path of growth. The EAC is a vertically integrated organization serving public utility and constitutes a natural monopoly in the relatively small electricity market of Cyprus. The network activities of the vertically integrated EAC consist of four domains: generation, transmission, distribution and supply. The EAC is an advanced and financially strong organization with assets reaching over €2 billion. Over the years it has proven to be a profitable state-owned organization, without any cash flow problems which also contributes financially to the state.
It is also noted that among the citizens there is the perception of political intervention, corruption, conflict of interest and mismanagement in the environment of the SOEs, including EAC. This is the main reason a sizable portion of citizens is favoring the idea of privatization of SOEs.
Even though during the last three years there was a significant decrease in the electricity price in Cyprus, prices are still among the highest in EU. This is mainly due to the high fuel cost (mazout and diesel used in production), seasonal demand and high daily-fluctuations in demand. Price reduction is one of the major challenges EAC is facing. The use of natural gas is expected to be a cheaper form of fuel and to contribute to the electricity price reduction.
In the case of privatization of the Organization or part of it, the main question is how the electricity prices and the quality of service will be affected and what would be the overall impact on the economy. Major concerns are also how the employees as well as issues of national security affected.
International experience indicates that the systematic efforts for privatization of public utility organizations over the last decade did not have the expected results. In many cases the state has regained the control and management of these privatized companies. Great Britain constitutes a classic example of privatization failure in the electricity sector. In Germany, many municipalities regained ownership of the privatized local energy companies. The wholesale/retail competition of electricity is not performing well and resulted in price increase and customer dissatisfaction. If the privatization efforts of electricity companies have failed to a great extent in most of the bigger European countries, where the electricity markets are much bigger than the market in Cyprus, the question raised is why there are efforts towards the privatization of the EAC in Cyprus.
Special attention is given to the EU Directive 2009/72/ΕC concerning Common Rules for the Internal Market in Electricity. The above Directive became the base for the EU Third Energy Package. Cyprus has gained explicit derogations (exemptions) regarding legal and ownership unbundling; therefore the acquis communautaire allows EAC to remain a vertically integrated organization in a natural monopoly. The reason EU granted Cyprus, Malta and Luxemburg the explicit derogations is because these countries belong to the category of small and isolated networks. The legal and ownership unbundling of the network activities not only involves high risks in the safety of electricity supply, but also creates additional functioning cost with insufficient benefits. Neither the acquis communautaire imposes the privatization of public electricity sector. In contrast, with the Article 345 of the Lisbon Treaty, EU maintains a neutral position regarding the ownership status of such organizations and Article 106 accepts the state-owned enterprises offering public utilities.
Cyprus is in full harmonization with the EU Directives concerning the liberalization of the electricity market and the promotion of renewable energy sources. The ownership unbundling of the EAC followed by partial sale to private entities is not necessary for the sake of attracting investments. With the involvement of renewable energy sources, especially photovoltaic and solar-thermal systems in the production of electricity, the government can achieve major flows of investment in the energy sector.
In this study we examine two cost benefit scenarios: In Scenario 1 we examine the case where the EAC remains a vertically integrated organization of public utility under government ownership and control. In Scenario 2 we consider the functional and legal/ownership unbundling of the EAC into two or more entities followed by partial privatization. It is noted that Scenario 2 coincides with the provisions of the final MoU regarding the privatization of EAC and the government objectives for legal/ownership unbundling and partial privatization of EAC activities.
While this study was finalized, the Interim Report of the consultants (Exergia-MRC) commissioned by the government was completed and publicized. The Interim Report considers 12 possible scenarios and recommends the unbundling of EAC activities, the formation of two companies: Generation/Supply activities and Networks (Transmission/Distribution), followed by partial sale of minority shares and management to private sector, while the state retains majority control in both entities. The Interim Report was prepared based on the Key Government Objectives (KGO), basically reflecting on government policy favoring privatizations. It has been stated publicly that the results of the Interim Report most likely were “guided”. The main concern is not which unbundling/privatization model is the best of EAC; instead the unbundling/privatization of the vertically integrated EAC should not be an option. The vertically integrated EAC holds a vital role in Cyprus economy and efforts towards privatization constitute high risk experiments.
The involvement of private investors in the activities of EAC most likely will cause conflict of interest, interference and unrest in the harmonious functioning of the EAC. The collective efforts and synergies achieved by a vertically integrated organization will disappear, creating at the same time various problems such as insufficient communication, lack of cooperation, lack of flexibility, friction and delays. Until nowadays, the vertically integrated EAC has carried out well its goals for “safe, varied and sustainable supply of electricity at competitive prices”. Something that most likely will not be guaranteed in the case of the EAC dismantling and with the involvement of the private sector.
The functional and financial unbundling of EAC activities, which is expected to identify areas of concern requiring improvement is necessary to be completed. At least time should be allowed for this to take place before any decisions for the future of EAC are taken. With this procedure possible «fat»
The EAC will continue to function as a vertically integrated Organization and with the completion of the functional and financial unbundling is expected to improve its efficiency and effectiveness. The above is mandated not only by the peculiarities of the small Cyprus electricity market, but also because of the future energy prospects of Cyprus. It is also necessary to advance a strict implementation of a Code of Public Governance in order to eliminate the external interference and rationalize the functioning and administration of the EAC.
Taking into consideration the small size of Cyprus market, a partial privatization of EAC activities will not create the necessary conditions for a real competitive market. Economies of scale will be lost and inevitably prices will increase. Undoubtedly the priority of the private sector is to maximize profits followed by lack of investment in research and development, insufficient infrastructure maintenance, lack of environmental care and reduced social work. This is what is mostly indicated by experience and record at the European and international level.
The energy developments in South-East Mediterranean and the future prospects of natural gas are additional important reasons why the EAC should remain a state-owned organization in order to better serve the public interest. At least the Cyprus government should freeze its efforts promoting scenarios of dismantling and privatization of the EAC and instead follow a “wait and see” scenario, keeping the EAC as a vertically integrated organization until better evaluation of the surrounding energy challenges.
