Have infrastructure investors reaped excessive profits from regulated utilities, as claimed by some politicians?
When you’ve got the chair of the Australian Competition and Consumer Commission reported as saying that privatisation has damaged the Australian economy; the Australian Energy Regulator handing down determinations reducing the total amount that transmission network service providers can recover from consumers; and, in the UK, Ofwat delivering strongly pro-consumer determinations and handing out record penalties for serious service failure, then you’d have to say ‘yes’. Infrastructure investors have been dining very well indeed on regulated monopolies.
Average Australian airport users would also regard profit margins of between 50 percent and 70 percent on car parking as excessive.
Infrastructure investors shouldn’t dismiss what consumer organisations and politicians are saying. In the UK, regulators are taking heed of consumer complaints and politicians’ concerns by toughening their approach to poor service performance and excessive returns.
This stance will remain for as long as infrastructure investors continue to be perceived as dining well at the expense of consumers. These regulatory determinations have put investors on an overdue diet. The reality of reduced profitability doesn’t matter when compared to the loss of social licence to operate, in addition to the continued public perception of poor service and investors gaming the system.
Speaking of social licence to operate, are there any particular concerns for you in terms of industry practices?
For our fund, our members don’t like the idea of us making money for them by standing on the shoulders of workers. It’s off-topic, but with something like wage-theft in the hospitality sector, for example, you can only get away with underpaying people and dodging on, say, health and safety for so long. It’s the same for us in terms of infrastructure. It’s still a cost driver but we want to be assured that people are being paid properly and treated decently. That’s what our members want.
“You’re not going to get away with people not being paid decent money. That’s particularly an issue in Europe and North America, where you’ve got significant amounts of migrant labour”
We’ve got a very low appetite for risk in pay, welfare and labour issues more broadly. I think the focus on modern slavery will make people revisit how they deal with labour relations and supply chain issues. You’re not going to get away with people not being paid decent money. That’s particularly an issue in Europe and North America, where you’ve got significant amounts of migrant labour, both documented and undocumented, working on infrastructure assets.
Regulators are clamping down on investor returns. Are the return levels they are proposing more appropriate? And should they have been set this low all along?
In the UK, high returns have not only been due to infrastructure investor greed. They’re also due to favourable borrowing costs relative to what was allowed by the regulator, unanticipated reductions in company tax and inaccurate inflation forecasts. These could not have been anticipated.
Returns could have been significantly lower if any of these three factors moved in the wrong direction. Subsequent Ofwat and Ofgem determinations will produce lower investor returns because of downward revisions to these inputs.
We have seen similar determinations in Australia, which should lead to lower returns. The issue for infrastructure boards and investors is, if there is an unanticipated windfall gain – as there was in the past – should this be shared with customers? Failing to do so risks loss of social licence and regulatory clampdowns. On the other hand, if there are unanticipated losses, should customers pay up?
It comes down to infrastructure investors investing for the long term, rather than just mouthing this rhetoric as they take short-term windfall gains. This means telling infrastructure boards that lower returns are acceptable and infrastructure executives getting used to more modest short-term and long-term incentives.
Is private ownership more efficient than public ownership? And how can you prove either claim?
Certainly, private ownership, public-private partnerships and outsourced arrangements are more efficient at prioritising the interests of equity holders above stakeholders. Are reliability and customer service better than in the past? Probably. However, we do not know whether these outcomes would have been achieved under public ownership with a comparable regulatory regime.
Privatisation of many, but not all, regulated assets in Australia took place prior to the imposition of regulatory regimes. This has driven improvements in efficiency and prioritised consumer interests over the respective Australian state treasuries’ interests.
Within the Australian electricity distribution sector there is little differentiation in service reliability between the private and public sectors. Within the seaports sector, privatisation has not seen an improvement in efficiency or service. Rather, there has been an increase in tonnage traffic translating to upward asset revaluations and a steady dividend flow to investors. Shipowners and cargo interests would not agree that privatisation has provided any benefits.
In the UK, the experience of British commuters leaves them unconvinced that privatisation has had any benefits. Franchise failures, government bailouts, unreliable services and eye-watering travel costs are not the features of an efficient service. By contrast, the experience of Australian commuters in Perth, Brisbane, Sydney and in Adelaide, travelling on government-operated rail services, is superior to that in the UK.
Finally, should utilities be nationalised, as the Labour Party proposed during the UK’s recent election campaign?
Utilities should not be nationalised. Failures by these utilities are not so catastrophic as to justify nationalisation. They have not been enough to trigger franchise termination, which is the correct route to take in response to service failure. Nationalisation is not the correct policy response to failures to date.
Ofwat and Ofgem are making significant progress in improving service quality and reliability and they will continue to do so. Higher-than-expected profitability has been addressed in the current round of determinations.
As an asset owner, we would expect to have our interests addressed should government policy objectives change. We would not expect our members to suffer financial loss by way of valuation write-downs because government is not willing to pay market price for these assets, as it does when there is compulsory acquisition of real property.