The Risk of Liberalizing the Energy Sector
A Summary of the Case Study ENDESA
Myriam Vander Stichele
SOMO (1), March 2002
See also: Privatisering energiesector houdt ongekende risico's in. Terugtrekking Endesa: Ramp vermeden? Somo, 1 March 2002
When privatizing and liberalizing the energy sector, the theoretical arguments assume that more competition will lead to better service to the clients and lower prices. In order to analyze what happens in practice, SOMO did research about a large and internationally operating Spanish energy company, Endesa, which had signed contracts with options to take over two locally privatized energy companies in the Netherlands, namely in Eindhoven en Utrecht. Endesa operates around of 45% of the electricity distribution in Spain and has operations in Latin America, mainly in Argentine, Brazil, Chili and Colombia. A summary of the research results follows. Detailed information can be obtained at SOMO.
Lack of information by authorities
In the discussion about privatization of the energy sector, the Dutch parliament and local authorities are not aware that when energy is not any more a "service supplied in the exercise of governmental authority" the sector becomes subject to certain rules of the WTO agreement on trade in services (GATS), such as the Most-Favoured-Nation treatment whereby no distinction may be made between the bidders and acquirers who are based in member states of the WTO. The Dutch Ministry of Economic Affairs decided not to privatize the lines and pipes of the distribution network. If a WTO member finds that this decision affects the operation of GATS, it can be raised at the WTO.
The Dutch local authorities that allowed the privatization by Endesa were not well informed either. They also included the sale of the lines and pipes of the distribution network while the ministry had not yet decided that this should not be the case. Endesa now wants to backtrack and cancel its option to take over the two Dutch local energy companies.
The City Council members in Eindhoven had just one week to decide whether to agree on the contract with Endesa while they had hardly any information about Endesa and the privatization process. There was no company profile available and the alderman of the City Council responsible for the deal said he assumed prices would go down and no jobs would be cut. However, Endesa clearly had a strategy to cut the total number of its employees by by 13,6% between 2001 and 2003 and had already diminished employment in her operations in Latin America by 6.8% between September 2000 and September 2001.
No garantees for consumers and workers
In the contract with Endesa, the city of Eindhoven did not include guarantees about its former employees nor about the service to, and prices to be paid by, the customers.
Endesa, however, saw the acquisition of the local energy companies in Eindhoven and Utrecht as a first step to expand into Europe and clearly stated it hoped to get good ideas from the experience! Moreover, Endesa's strategy was to get as much money as possible out of its Dutch operations by extracting value from (!) customers trough keeping the high margins and the low switching of customers to other energy companies, and by "locking in" clients in combined services contracts. Moreover, Endesa has already submitted in 2001-2002a dubious claim to compensate EUR 28.6 for a financially harmful decision that was taken before the contract was signed and which actually followed advise from Endesa. In the end, Endesa might not be interested to take over the energy companies in Netherlands as it would not be allowed to take over the distribution network, which provides most value to the company.
Enron-like characteristics
The risks of a take-over by Endesa are visible in its financial strategies. In order to pay its expansion strategy, Endesa accumulated an increasing debt of 25.01 billion dollar at the end of December 2001. In 2000, the debt ratio was already 69%. The long term debt was 13 times the annual income of 2000. The financing is done trough banks (33%) and 67% through the financial markets, which in risky in times that the stock market is showing a downward trend. Moreover, the income of Endesa's operations in Latin America is subject to heavy fluctuations due to the risks of devaluation and economic problems such as in Argentina.
As Enron, Endesa had high ambitions in energy trading, which is amongst others visible in its participation in the Amsterdam Power Exchange.
The transparency is Endesa's financial construction is not clear. It was beyond the scope of this case study to find whether some debt was hidden in unknown companies. Endesa however uses for its expansion 111 companies (December 2000) in which it participates for 100% or less. Forty two percent of these companies are portfolio companies while some others are used for financing and management. Five of these portfolio companies are based in the Cayman Islands, a tax heaven, and many of these portfolio companies were audited by Arthur Andersen, the much criticized accountant of Enron, and one of the two accountants of the Endesa company.
Unfair competition
For small energy companies in the Netherlands that is still in the process of fully commercializing energy distribution, it is very difficult to compete against companies like Endesa in order to acquire Dutch privatized energy companies:
- Endesa was able to benefit from the (critized) politics of privatization in Spain which started already years ago.
- Endesa is able to charge high energy prices in Spain which, according to the OECD, is due to Endesa's dominant position in the Spanish energy market (around 45%) and lack of competition. In November 2001, the Spanish authorities intended to look at allegations of price fixing by Endesa with its Spanish competitor.
- Endesa's main sources of energy on the mainland in 2001 were coal (45%) and nucleair energy (34.2%). The authorities in the Netherlands require more and more Energy from gaz because it is cleaner, but it is also more expensive. How can Dutch companies compete with a company that gets most of its profit from cheaper and dirtier energy?
Negative effects on the environment and local culture
Endesa claims it wants to take environmental aspects into account. This is amongst others included in the contracts with suppliers and some initiatives for sustainable energy. Endesa strives to reduce loss of energy by 3% between 2001 and 2003.
On the other hand, Endesa pariticipates in the French Soprilof, a company whose main objective is to produce nuclear energy.
Endesa's operations have already had negative environmental effects in Latin America and the Canary Islands. For instance in Chili, the use of the water of the Chapo lake to produce electricity lead to high fluctuations of the lake's water level, with the shores collapsing as a result. Worse, there were heavy protests against Endesa's construction of a dam on the Bio Bio river because of environmental damage. The local Indian population also sounded the alarm bell around the world because the dam would cover its houses, burial grounds and forest by water, which would destroy the Mapeche culture. On the Canary Islands, Endesa used political favouritism to build electricity distribution nets in rare nature areas against which the population and environmental groups protested heavily.
This case study indicates that is necessary to carefully assess (a) the real impact of allowing foreign companies to take over local energy distribution and (b) the room of maneuver for authorities to regulate a privatized sector or to reverse privatization after bad experiences. These aspects are not enough taken into account in the current GATS negotiations.
References
1. The Centre for Research on Multinationals (SOMO) is based in The Netherlands and does research for non-governmental organisations and trade unions on the behaviour of transnational corporations, the trade and investment agreements in which they operate, and the implementation of codes of conduct. For more information about this case study, please contact:
Myriam Vander Stichele
SOMO (Centre for Research on Multinational Corporations)
Keizersgracht 132, 1015 CW Amsterdam
Tel. +31/20-639.12.91;
Fax +31/20-639.13.21.;
e-mail: m.vander.stichele@somo.nl
This case study research was financed by NCDO and Hivos but the contents of the study are Somo's responsibility.
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