Privatisation in Poland: Stranded

Date: 31/01/04

Another shocking mess

THERE are many good ways to do privatisation. The Polish government's long attempt to sell the “G8” cluster of power distributors in central and northern Poland is not one of them. After tempting some global heavyweights of the electricity business, such as Germany's E.ON, the treasury then scared them off by driving too hard a bargain. This left it with a solitary, meagre bid, from Jan Kulczyk, Poland's richest entrepreneur, who, according to some distrustful parliamentarians, may have leaned on Poland's prime minister to keep the auction alive. On January 27th, NIK, Poland's national auditor, called for the G8 sale to be suspended as part of its wholesale review of the restructuring of the electricity industry.

A series of botched privatisations over the past few years has tarnished the reform of Poland's investment-starved, largely state-owned power sector. True, the headwinds have been strong. A sharp economic slowdown in 2001-02 soured Poland's investment climate. The post-Enron woes of American utilities reduced the list of buyers. Moreover, the government has put three of its largest generators - now merging - off limits to investors even though the government itself is financially and administratively ill-equipped to restructure the ailing industry.

Yet as privatisation falters, competition is finally at hand - after years of promises to scrap the monopsony model under which the state grid, PSE, buys most of the country's electricity. The European Union, which Poland joins on May 1st, wants PSE's transmission network unbundled from its trading business, to ease third-party access to the grid. On January 6th, the government approved a scheme to cancel PSE's fixed-price long-term contracts with generators. The contracts - some of which do not expire for over a decade - were used by plants as collateral for hefty bank loans to pay for environmental upgrades. Now, though, the contracts have become the enemy of deregulation, as they dominate the market.

Poland is not alone in tackling the vexed issue of “stranded costs ” - investments that suddenly become uneconomic due to deregulation. But its plan for annulling the contracts has unnerved utilities and banks alike. The scheme would securitise the contracts, worth up to $5 billion, via a huge bond issue by a special company to be set up by PSE, backed by a levy on electricity sales. Even assuming the offering is successful, which is uncertain given that its size would be unprecedented in eastern Europe, generators would have to settle for arbitrary compensation payments for the termination of contracts.

Some prominent foreign investors in the Polish power industry are mulling legal action against the government - especially those that took on credit risk by doing contract-backed project-finance deals. PSEG, an American utility that has just finished the construction of a new $335m combined heat-and-power plant near Katowice, fears that the banks will call in their loans if its contract is scrapped, raising the spectre of creditors seizing control of the plant. Even giant state-owned Electricite de France (EdF) is alarmed. Two of its subsidiaries in Poland would be at risk were their contracts dissolved.

Yet the government is unmoved, claiming that its hands are tied by the ambitious timetable for liberalising European electricity. Once it phases out obstructive contracts, end-users should enjoy lower tariffs, and trading on the struggling Polish power exchange should soar. Foreign investors are unconvinced. They want to keep their contracts as insurance against likely delays or snags in deregulating Poland's energy market - not least those arising from the trade-union dominated coal industry, which supplies most of the fuel for generation. “Competition and contracts are not mutually exclusive,” insists Paul Amoravain, the head of EdF's operations in Poland. Some might consider that a bit rich coming from a state-owned monopolist, but most other disgruntled investors would agree.