Thursday, July 12, 2012

Should Greece Restructure and Privatize its Power Company?

The New Democracy-led coalition is gearing up for its first big fight against the labor union of the Public Power Corporation (PPC, or ΔΕΗ in Greek). This is good news because we will know soon whether the government has what it takes to implement reforms. Lose this battle, and it will lose the war. Yet amid the bullying and the threats, there is also a quasi-argument brewing: an argument that Greece’s low tariffs for electricity are proof enough that the system is not broken. Is that true?

PPC is right in a very narrow sense. In 2011, Greece’s residential tariffs were the fourth lowest in the European Union and 23% below the EU-27 average (excluding taxes). But that is not the whole story. The state regulates prices, so it’s not hard to mandate that prices remain low. Therefore, the price level itself is not a very useful guide. How should we, instead, think about prices?

First, retail tariffs have not increased according to fuel costs, as they should in a market system. As the International Energy Agency (IEA) notes in its 2011 Country Report on Greece: “The tariff system has caused several distortions in the electricity market. The average wholesale price of electricity tripled from 2004 to 2008, but the regulated end‐user tariffs were increased by only 40% for industrial users and by 25% for households.”


Second, industrial consumers are subsidizing residential consumers. In the EU, tariffs for industry are on average 29% below those for residential consumers, which makes sense it is cheaper to supply bigger consumers in bulk than to supply smaller customers one by one. Yet in Greece, industrial tariffs are almost the same (-2%) as tariffs for the residential sector. Only four EU countries have a bigger discrepancy between residential and industrial prices and none are part of the EU-15. Therefore one reason that the Greek consumer pays so little is that the bill is picked by Greek industry.

Third, the regulated tariff does not cover the cost of electricity production. In a November 2007 strategy presentation, PPC claimed that the gap between the company’s revenues and the real market price for electricity was 25%. So this is another reason to not cheer about low prices: if they cannot cover the cost of production, they are unsustainable.

Fourth, PPC is expensive to run. Take payroll: the company’s staff has fallen from 31,645 in 2000 to 20,821 in 2011, a 34% drop. Yet, its payroll has risen by 23% in the same period – in fact, its payroll had risen by 66% by 2009 before it came down. These numbers mean that real compensation for PPC employees rose by 75% between 2000 and 2009 and by 29% in 2000-2011. By contrast, compensation in the Greek economy as a whole was up 15% and 4% respectively in the same period. PPC employees are doing very well, so why not take that extra cost in salary and give it back to the Greek consumer?


Fifth, the company overall is underperforming. Amazingly, the best benchmarking data to prove this point come from PPC itself. In 2007, return on equity was 1.1% versus 17.1% for the four largest European utilities. Return on capital employed was 2.1% versus 10.1% for six big European utilities. In a number of other metrics – return on sales and capital turnover – the company was lagging its peers. This is no wonder if power prices barely cover costs and staff costs have gone up when the number of employees has declined.


Sixth, it is not clear that the company’s trajectory is sustainable. At times, PPC is cash positive. But in part this is because it is depleting its coal mines – look at the finances of the coal mines by themselves, and they barely make money, which means that PPC is benefiting from investments in coal made a long time ago. But coal production peaked in 2002 and has declined by 21% since then. What is more, as the IEA noted, “In March 2008 … the EU Commission found that PPC’s right to privileged access to lignite violates EU competition rules.” Access to cheap coal is not a sustained competitive advantage.

Seventh and linked to the sixth, is the significant carbon intensity of the Greek economy which is due, in large part, to the heavy dependence on coal for power generation. Greece’s carbon intensity per unit of energy is 25% higher than the EU average. Besides the obvious implication for climate change, this also exposes Greece in general, and coal-fired generation in particular, to significant cash costs to buy emissions permits to keep polluting. As the IEA notes, “lignite‐fired power plants in Greece emitted an average of 1 tonne of CO2 per MWh generated in 2009, whereas the gas‐fired plants emitted 350 kg of CO2 per MWh.” This is again a looming cost for the Greek consumer.


Eighth, PPC does not provide great service. The Council of European Energy Regulators (CEER) conducts a Benchmarking Report on the Quality of Electricity Supply. Its top measure of quality is “unplanned interruptions excluding exceptional events.” Greece had 134 minutes in 2009 (latest data available), putting it 6th from the bottom in a list of 19 countries. Only Portugal, among the EU-15, had a worse number. Relative to the best service (Germany), Greece had ten times more minutes interrupted. That’s not very good.

Ninth, PPC’s dominant position distorts the market for wholesale power and prevents any meaningful competition from emerging. So without a reform of PPC, the power market cannot be reformed in any meaningful and the new investment that the country needs to meet its power needs will always lag what would have been possible if PPC did not have a dominant role.

*

One of my earliest memories when I went to college in the United States was furiously unplugging my laptop when I heard thunderstorms outside. My roommate looked at me and was puzzled: “what are you doing?” I said I am protecting my computer because we will lose power.” He gave me a perplexed look. It turns out that this is not quite what happens in America.

Deregulating the power sector is a serious debate and one that requires a focus on getting regulation right and on ensuring that we do not replace a public monopoly with a private one. But PPC is intimately connected with lights going out during inclement weather and with the A/C doing down in the midst of the summer heat wave. Sometimes, this happens because the power company cannot do its job. But sometimes it happens because its bullies in the labor union want to send a message to the rest of us. They get paid too much money to be sending those messages and to be bullying anyone. It’s time to end this farce.

6 comments:

  1. Dear Nikos,
    Thanks for this - as always - very interesting article. There is one thing that struck me as odd: Under point four, you show a graph that seems to suggest that wages in the Greek economy as a whole rose relatively moderately over the last decade. This is somewhat in contrast with the impression that I got from other sources, that wages rose rather strongly in Greece (with a negative impact on the competitive position), for example here:
    http://sdw.ecb.europa.eu/quickview.do?SERIES_KEY=119.ESA.A.GR.N.1000.UNLACO.0000.TTTT.D.N.I
    or here:
    http://articles.businessinsider.com/2011-11-28/markets/30449211_1_wage-growth-unit-labor-big-spike

    Compensation per employee is not the same as unit labor cost. Still, I am surprised that the blue line in your graph is relatively flat. Do you have an explanation?

    ReplyDelete
  2. Perhaps the blue line represents just the private sector wages? I don't know, it does appear low...

    Back to the main theme of the post. I think Nikos is right on, THE battle against the mafiozi PPC union will show if Greece has a chance. I am not sure it is a plus having Samaras in charge of reducing the govt sector when I just watched the guy he appointed as the coordinator have the words "There will not be any firings" come out of his mouth....

    Tic tac...

    ReplyDelete
    Replies
    1. It is a different metric indeed. This is what I am using

      http://ec.europa.eu/economy_finance/db_indicators/ameco/zipped_en.htm

      If you look at 2009 vs 2000, unit labor costs show 38% increase vs. 15% for real compensation per employee(according to the ECB link you pasted anonymous). The PPC number is ~75%.

      So using this metric makes the comparison less egregious.

      Delete
  3. Keep PPC. Privatizing Germanys energy providers was no benefit but now we have the same bad companies, but less control.

    Beside your economic problems you have the climate change problem in Greece too. You will have more and not less problems to solve the climate change problem, when you create a powerful private opponent to your energy politics. Because you have to reorganise the energy sector anyway due to the climate change problem, you need to reorganise PPC anyway, no matter, whether it is a private company or not. Now imagine, PPC will be bought by an foreign investor, you will run into a lot of law suits when transforming the energy sector because the investor will benefit from his investment and he will do it mostly with the power plants you sold him and not by further investments. Here in Germany the privatized energy providers are the big stoppers of the progress towards green energy.

    You named the problems of PPC: solve them but don't rely on others to do it for you.

    Since you

    ReplyDelete
  4. A last remark: Going towards green energy means, that energy production becomes more local and it is driven by many private investors. So you will have a privatization of this sector not by selling PPC but by restructuring towards green energy. To be successful, you need control over the energy network and that is why you need PPC in public hands.

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  5. Indeed, the energy network is of a very high systemic importance, and experience shows that its probably not a good idea to put its control in the hands of private companies. And the US are actually one of the negative examples (the had embaraasing large scale blackouts in the past). Not that the situation is so much better in Germany, sadly (the network isn't fit for new green energy plants yet). So, why not break up the power company into an infrastructure entity, run by the state, and one or several power producing companies? That would keep the handling of the system under public control and at the same time spark healthy competition among the power suppliers. Imho that's the way the Greek government should go.

    ReplyDelete

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