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Title Page

Name: Adam Burke

ID Number: 10112545

Project Title: Privatisation in Ireland: The Divestiture of Bord Gis Energy

Internal Supervisor: Dr. Donal Palcic

Degree Title: Bachelor of Arts in Economics and Sociology

Date: 20 February 2014

Word Count: 12,983

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Abstract

A new round of divestiture in the Irish public enterprise portfolio appears imminent.

Government is pursuing privatisation as a means of raising revenue to service the countrys

debt and part-finance its NewERA economic stimulus package in the wake of Irelands

financial crisis. This paper contends that this privatisation policy is a manifestation of lead

coalition government member Fine Gaels neo-liberal economic agenda that seeks to reduce

the role of the state in the provision of goods and services previously provided by state owned

enterprises (SOEs). The theoretical and empirical case for privatisation as a means of

improving enterprise performance is demonstrated to be ambiguous. A case study of the

ongoing divestiture of Bord Gis Energy (BGE) is undertaken which finds that BGE is being

solid amidst significant regulatory and governance shortcomings and via a method of sale

widely criticised in the failed divestiture of Telecom ireann. In conclusion, a

recommendation is made that calls for the immediate postponement of any future

privatisation of Irelands SOEs.

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Contents

Acknowledgements 5

Declaration 6

List of Abbreviations 7

List of Figures and Tables 8

Introduction 9

Chapter 1 Literature Review 11

1.0 Introduction 11

1.1 Defining Economic Efficiency 11

1.2 Theoretical Literature Review 11

1.3 Methodological Issues 13

1.4 Empirical Literature Review 13

1.5 Conclusion 16

Chapter 2 Public Enterprise and Privatisation in Ireland 17

2.0 The History of Irelands Public Enterprise Formation 17

2.0.1 Introduction 17

2.0.2 Public Enterprise Formation in Ireland: 1927-1957 17

2.0.3 Public Enterprise Formation in Ireland: 1957- 1989 19

2.1 Privatisation in Ireland 19

2.1.1 Introduction 19

2.1.2 Privatisation in Ireland: 1991-1996 20

2.1.3 The Privatisation of Telecom ireann 21

2.1.4 Privatisation in Ireland: 2001-2006 22

Chapter 3 A New Round of Divestitures 24

3.0 Introduction 24

3.1 The Economic Crisis in Ireland 24

3.2 Fine Gaels New Economy Recovery Authority 26

3.3 Memoranda of Understandings 28

3.4 Report of the Review Group on State Assets and Liabilities 29

Chapter 4 The Privatisation of Bord Gis Energy 31

4.0 Introduction 31

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4.1 The Economics of Natural Gas 32

4.2 The European Gas Market 33

4.3 Bord Gis ireann 34

4.3.1 The Development of Bord Gis ireann 34

4.3.2 The Structure of Bord Gis ireann 35

4.4 Bord Gis Energy 36

4.4.1 Introduction 36

4.4.2 Market Share: Electricity 37

4.4.3 Market Share: Natural Gas 37

4.4.4 Price Regulation in the Residential Supply Sector 38

4.4.5 Business Performance 40

4.5 The Sale Process to Date 42

Chapter 5 Future of Privatisation Policy in Ireland 45

5.0 Introduction 45

5.1 A Critique of the Imminent Privatisation of Bord Gis Energy 45

5.2 Recommendations in Conclusion 47

Bibliography 48

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Acknowledgements

Firstly, I would like to thank my supervisor Dr. Donal Palcic whose guidance and expertise

were invaluable throughout the development of this project.

I would also would like to thank Shelby, for being a beautiful distraction and infinitely

patient throughout.

Finally, I would like to thank my parents Ger and David. Your sacrifice, love and

encouragement have enabled me to thrive during my four years at the University of Limerick.

One day I will be able to repay the debt I owe you.

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Declaration

I hereby declare that this project is entirely my own work, in my own words, and that all

sources used in researching it are fully acknowledged and all quotations properly identified. It

has not been submitted, in whole or in part, by me or another person, for the purpose of

obtaining any other credit / grade. I understand the ethical implications of my research, and

this work meets the requirements of the Faculty of Arts, Humanities and Social Sciences

Research Ethics Committee.

_____________________

Adam Burke

20/02/2014

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List of Abbreviations

UK United Kingdom

SOE State Owned Enterprise

BGE Bord Gis Energy

NewERA Ltd. New Economy Recovery Authority Limited

EC European Council

EU European Union

IMF International Monetary Fund

ECB European Central Banl

TFP Total Factor Productivity

ROCE Return on Capital Employed

VA Value Added

DEA Data Envelopment Analysis

ACC Agricultural Credit Corporation

ICC Industrial Credit Corporation

TSB Trustee Savings Bank

ESOP Employee Share Ownership Plan

MoU Memoranda of Understanding

GDP Gross Domestic Product

GJ Gigajoule

US United States

VAT Value Added Tax

USSR Union of Soviet Socialist Republics

NAM Nederlandse Aardolie Maatschappij

OPEC Organisation of the Petroleum Exporting Countries

KM Kilometre

CER Commission for Energy Regulation

NDM Non-daily metered

IC Industrial and Commercial

FVT Fuel Variation Tariff

RTF Regulated Tariff Formula

TD Teachta Dla

RBC Royal Bank of Canada

OECD Organisation for Economic Co-Operation and Development

ICTU Irish Congress of Trade Unions

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List of Figures and Tables

Table 1 Commercial State-Owned Enterprises in Ireland

by the 1980s

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Table 2 Privatised SOEs in Ireland and Exchequer

Proceeds

20

Fig. 1 The Structure of Bord Gis ireann and its

Subsidiaries

35

Table 3 Table 3: Market Share of Electricity Suppliers as a

Percentage of Customer Numbers Across Market

Segments

37

Table 4 Table 4: Market Share of Natural Gas Suppliers as

a Percentage of Customer Numbers across Market

Segments

38

Fig. 2 Market Share of Residential Natural Gas Supply 39

Table 5 Irish Residential Gas Prices to Residential

Consumers at Purchasing Power Parity (all

taxes included) (1st Semester 2013) EU Comparison

40

Fig. 3 Fig. 3 BGE Operating Profit before Depreciation

and Amortisation (EBITDA) 2009-2012

41

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Introduction

Since being brought into vogue by Margaret Thatchers UK conservative government in the

late 1970s, privatisation has prevailed as the most popular means of improving public sector

performance. This prevalence is largely due to a global swing towards a hegemonic neo-

liberal economic ideology which seeks to minimise government control of the economy by

establishing a liberal and competitive private sector market economy. Privatisation has thus

become a divisive issue in a wider ideological debate about the role of government in the

economy. It is often presented by proponents as the common sense approach to modern

economics, while those in opposition tout it as a malicious method of undermining public

welfare in the pursuit of maximised profits (Palcic and Reeves 2011).

The term privatisation has been used loosely to describe a variety of public sector reforms

including liberalisation, deregulation and contraction out of public sector activities. Thus,

Starr (1988) defines privatisation as any transfer in the production of goods and services from

the public to the private sector. Starr (1988: 16-17) refines this definition in the following

sub-categorisation:

Governments ending public programmes and disengaging from specific

responsibilities.

The sale or lease of public assets (public land, infrastructure or state owned

enterprises) by the state to transfer ownership to the private sector.

Government withdrawal from the production of services while remaining financier.

For example, this can occur by contracting out or through some forms of public

private partnerships.

The deregulation of entry into former state monopolistic markets.

For the purpose of this study, privatisation will hereafter refer exclusively to the transfer of

state owned enterprises (SOEs) to the private sector by sale. SOEs are to be understood as per

Palcic and Reeves (2011) explanation as commercial enterprises owned by the state, who

earn the majority of their income in selling goods and services.

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As the pioneers of privatisation policies in Europe, empirical research of the European

privatisation experience has typically focused on the experience of the UK. There exists a

small but growing trend of country specific studies which seek to illuminate the motivations,

rationale, methods and outcomes of the privatisation of state owned companies (Palcic and

Reeves 2011). This study seeks to contribute to the existing literature on the Irish

privatisation experience by providing an analysis of the ongoing divestiture of Bord

Gis Energy (BGE), the retail arm of Irelands state-owned utilities company Bord

Gis ireann.

This study is structured as follows; a review of the theoretical and empirical literature of

privatisation to date is undertaken. This theory is then applied to an analysis of Irish SOE

formation and privatisation activity to date. Irelands current economic crisis is then

identified and explained as a driving force and rationale for a renewed interest in privatisation

in the context of a structured bailout programme. A number of documents are then analysed;

the governments NewERA economic stimulus plan, the various Memoranda of

Understanding agreed in return for Irelands bailout between the Irish government and the

EC/IMF/ECB and a Report of the Review Group on State Assets and Liabilities. This

analysis will identify the trajectory of recent privatisation policy formation and demonstrate

the key role played by the Troika in the decision making process. A case study of the ongoing

divestiture of Bord Gis Energy follows.

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Chapter 1: Literature Review

1.0 Introduction

A thorough review of the theoretical and empirical literature of privatisation policy is

essential in moving beyond a discourse all too often hijacked by vested interests. This

literature largely developed in parallel with the implementation of privatisation policies in the

UK in the early 1980s and has advanced substantially since. A period of stagflation with

sustained unemployment, decreasing growth and rising inflation in the 1970s undermined

Keynsian economic theory and paved the way for neo-liberal reforms in the British economy.

Deregulation, liberalisation and privatisation were the order of the day as the British

government sought to emerge from economic crisis (Palcic and Reeves 2011).

1.1 Defining Economic Efficiency

The economic argument for the sale of SOEs to the private sector is generally premised on

the supposition that enterprises under private ownership will achieve superior efficiency. It is

imperative to distinguish between different concepts of efficiency. Parker (2000: xv) offers

this distinction; Technical efficiency, a supply side concept, occurs when firms minimise

costs by maximising output at a given level of resources. Allocative efficiency, on the other

hand, is conceptualised from the demand side. Firms are allocatively efficient when they

when they set prices equal to the marginal economic cost of supply. In doing so, societal

economic well being is maximised through an optimal distribution of resources.

1.2 Theoretical Literature Review

The initial theoretical rationale for employing privatisation as a means of improving

economic efficiency came from theories of government failure; public choice perspectives

and property rights. Principal-agent theory was subsequently developed as a contractual

approach to the theoretical analysis of privatisation, and has influenced much of the

theoretical developments in the area thereafter (Palcic and Reeves 2011).

Public choice theory as developed by Buchanan and Tullock (1962) focuses on the motives of

elected representatives and bureaucrats as a source of inefficiency. Chicagoan public choice

theory asserts that decision making will always be based on individuals financial self-

interest. Thus, public sector workers and politicians will always forsake maximised profits

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and efficiency in pursuit of personal financial gain. It is argued that privatisation can put in

place an incentive structure that allows for the alignment of financial self-interests and

corporate goals. Virginian public choice theory on the other hand, identifies non-economic,

political motivations for privatisation such as a reduction in state power. This leads Boycko et

al (1996) to claim that democratic elections, rather than ownership per se, are the primary

source of inefficiencies in state owned enterprises.

Parker and Willner (2007) have developed a considerable rebuttal to public choice theory in

which they question the very assumption on which the literature is built, that of the individual

as homo economicus. They assert that the concept of an economically rational, financially

driven individual is not useful in all situations, pointing to the examples of non-commercial

activity and social institutions. Furthermore, they argue there to be a bias in the preposition

that public sector managers are inherently more disposed to being self-serving and wasteful.

They go on to question whether state owned enterprises operate more efficiently in a

dictatorship as implied by Boyckos (1996) rationale and find the opposite to be empirically

true.

De Alesi (1987) concedes that state intervention in the provision of goods and services is

useful in so far as it allows for the correction of allocative and distributive market failures.

However, he employs a property rights argument to justify privatisation. He sees public

servants as pursuing their own self-interest and those of lobbying groups. They do not

maximise profit or efficiency, nor do they operate in the publics best interest. Thus public

ownership is easily corrupted, bent to political will and unaccountable. However, it can be

argued that the incentive to maximise efficiency for governments is large, as state owned

enterprises directly influence government finances and that the democratic process is such

that the pressure of future elections makes governments accountable for the performance of

those enterprises under their control (TASC 2012).

Principal-agent theory examines the relationship between a principal who delegates work to

an agent. Objective and information asymmetries characterise this relationship under public

ownership; the principal and agents objectives can become misaligned, and the principal

strains to see what the agent is doing through a thick layer of organizational bureaucracy. Bs

(1991: 92) argues that privatisation alters the context of this relationship. The layer of

bureaucracy is reduced, and ownership is diversified amongst a multitude of parties, such as

financial organizations, individual shareholders and employees. It is argued that these

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organizational and ownership changes induce an environment where incentives can be re-

aligned, monitoring increased and information can flow more freely. The struggle to design

appropriate incentive structures and contracts is overcome, thereby leading to greater

efficiency.

1.3 Methodological Issues

Prior to a review of empirical studies of privatisation, it is important to highlight the key

methodological issues that inevitably compromise any comparative study of public versus

private enterprises. As mentioned previously, state owned enterprises often operate with

motives beyond profit. These enterprises can become vehicles of government policy. Thus,

standard performance indicators used to measure performance in the private sector such as

financial, productivity and cost measures may not be appropriate for publicly owned

companies thereby undermining comparative studies. Furthermore, price as a basis of most

indicators may not be appropriate as many state owned enterprises operate in non-competitive

markets (Palcic and Reeves 2011).

The effect of ownership change is but one of a host of factors such as the regulatory

environment, size, market and incentive structures that affect performance. This is further

complicated when looking at performance over time, where one must also control for

technological variation and sector trends. The task of controlling for such a vast set of

interdependent and non-mutually exclusive variables so as to isolate the effect of ownership

on performance is a daunting one, and something that a lot of studies fail to achieve. The

following will review the empirical literature of privatisation in light of these methodological

challenges (Palcic and Reeves 2011).

1.4 Empirical Literature Review

A nominal division of the numerous empirical studies of the effect of privatisation on

financial and operating performance can be made along the lines of broad based international

studies and in-depth country specific studies. The methods, limitations and conclusions of a

selection of prominent studies from both categories are discussed and their collective results

demonstrated to be ambiguous.

Much of the early empirical research on privatisation was conducted in the UK, as academics

clamored to understand the effects of its governments pioneering public sector reforms.

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Yarrow (1986) used financial performance indicators to study productive efficiency. It was

found that private ownership was preferential over public ownership in competitive markets.

However, where there existed a market failure, no evidence of improved performance could

be observed following divestiture

Bishop and Kay (1989) used similar performance indicators to assess the productive

efficiency of a sample of UK public and privately owned enterprises in a comparative study.

A total factor productivity analysis was also undertaken. This study found that growth and

profitability can cause privatisation, and that the very threat of privatisation can improve

performance through increasing commercialisation. Bishop and Thompson (1992) studied the

performance of British utilities between 1970-1980 and 1980-90. Labour productivity gains

were found, as privatisations took hold at the end of the 1970s. Productivity gains measured

with a total factor productivity analysis were identified to be higher in the 1980s than the

1970s but the researchers suggest that changes in the regulatory environment were more

influential than ownership changes in bringing about these gains.

These studies are not without methodological problems. Both studies by Yarrow (1986) and

Bishop and Thompson (1992) were undertaken immediately after privatisation thus

precluding the longer term effects of these divestitures from their analysis. Bishop and Kays

1989 study failed to control for national productivity which may have had a significant

bearing on their findings. Furthermore, the time periods analysed in Bishop and Thomsons

1992 study did not coincide with the times of privatisations occurring thereby rendering it

very difficult to identify the effect of privatisation on the observed productivity gains. In

general, such studies fail to account for the effect of organisational and management changes

that tend to arise with an ownership change. If the effect of these changes has a significant

bearing on performance gains, a case might be made for corporate restructuring over

privatisation as a means of achieving economic efficiency (Palcic and Reeves 2011).

Three broad based empirical studies conducted by Meggison et al (1994), Boubakri and

Cosset (1998) and DSouza and Meggison (1999) collectively analysed the effect of

privatisation on the performance of 211 firms, across 42 countries and 56 industries. Using

largely the same methodology, the studies tested whether privatisation led to increased

profitability, operating efficiency, capital investment spending output, dividend payments,

decreased employment and leverage. These performance indicators were measured for the

three years prior to and following divestiture.

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Meggison et al (1994) found performance to be superior following privatisation. Profitability,

dividend payments and capital investment increased while employment remained constant.

These performance indicators were not market adjusted; however they concluded that their

results were not influenced by the macroeconomic environment by computing the average

Gross National Product growth rate, inflation rate and change in countries industrial

production index. Boubakri and Cosset (1998) found similar gains in performance while

exclusively studying privatisation in developing countries. They sought to isolate the effect of

privatisation from economy wide factors by calculating performance indicators with both raw

and market adjusted data. DSouza and Meggison (1999) made no such allowance for the

business cycle. However, their findings correspond with those of the two aforementioned

studies, as well as measuring an increase in post-divestiture employment.

These studies do not overcome the methodological issues as outlined previous. The

performance measures employed cannot accommodate the non-profit motive of state owned

enterprises, nor can the effect of divestiture be isolated from the wide array of determinants

of performance. Further problems arise when one analyses the composition of the companies

studied in these broad based studies. Boubakri and Cosset (1998) dealt exclusively with

divestitures in developing countries. The relevance of their experience could be questioned

for a study of a small open economy such as Irelands. Furthermore, DSouza and Meggison

(1999) used a sample with a high proportion of electricity and telecom companies. Such

companies experiences have been unique, with a global policy preference towards

privatisation as a means of funding the capital investment needed for a rapid technological

advancement in the sector. Thus, their findings are limited in their application to other sectors

at different stages of development (Palcic and reeves 2011).

While the methodological difficulties in studying privatisation are such that the academic

literature is unavoidably imperfect, Martin and Parkers (1997) study of 11 privatised

companies in the UK represents one of the most comprehensive to date. Throughout, national

productivity trends were accounted for and averages figures used for periods before and after

divestiture. The researchers employed several methods to establish the impact of privatisation

on performance:

Martin and Parker (1997) began by studying the effect of the change from public to private

ownership had on labour productivity, finding it increased in most cases. However, a Total

Factor Productivity (TFP) analysis saw TFP increase in only 2 cases. The researchers

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concluded that overstaffing occurred in public enterprises through managerial slackness and

inefficiencies arising from political intervention. Repeating the study using the accountancy

ratios Return on Capital Employed (ROCE) and Value-Added (VA), the researchers could

not support the hypothesis that private enterprises performed better than their public

counterparts on efficiency grounds.

In looking at the affect of privatization on technical efficiency, Martin and Parker (1997)

employed a Data Envelopment Analysis (DEA). This linear programming method derives the

relative efficiencies of decision making units. Using 3 different models, no systemic evidence

of technical efficiency gains following divestiture were found, despite 3 of the 11 privatised

companies demonstrating technical efficiency gains. Finally, the effect of business

restructuring on performance was analysed in the context of privatisaion and a change in the

competitive environment. This highlighted the importance of internal factors on performance,

as privatisation and a more competitive market were found to bring about several positive

changes internally, such as an increased focus on profits and consumer needs, flexible

working practices, a flattening of organisational structures and an increase in disposals and

acquisitions.

1.5 Conclusion

The theoretical literature of privatisation is inconclusive. Even if we agree that in theory,

privatisation can lead to improved efficiency and profitability, the effect of privatisation on

wider society must be considered. One must acknowledge that economic efficiency is not

always the primary motive of a state owned enterprise. The deliverance of a good quality

product or service at an affordable price, with universal access may not be a technically

efficient strategy, but is equitable and beneficial to the wider society. Nobel Prize laureate

Joseph Stiglitz (1994) describes privatisation as a trade off between Technical and Allocative

efficiency, the result of which is ambiguous at best:

We cannot, in general, be assured that private production is necessarily "better" than

public production. Privatization involves costs and benefits, which, as always, must

be weighed against each other.

(Stiglitz 1994: 194)

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Chapter 2: Public Enterprise and Privatisation in Ireland

2.0 The History of Irelands Public Enterprise Formation

2.0.1 Introduction

An analysis of the rationale for the formation of SOEs in Ireland is necessary to contextualise

subsequent privatisation policies, and understand the key role SOEs continue to play in

important sectors of the Irish economy. The following explores the history of Irelands public

enterprise formation up until the 1980s, as underpinned by factors both common to SOE

formation in Europe and unique to Irelands experience.

Parris et al (1987: 14-21) explains why Post-World War Two European governments sought

the establishments of a strong public enterprise sector. A socialist political ideology

prevailed, which advocated for public ownership. Countries saw SOEs as necessary to

developing national wealth in the absence of private sector initiative. Such SOEs could be

used as a vehicle for regional development. Sectors characterised by duplication were being

rationalised with the establishment of state mandated monopolies. Although many of these

factors which underpinned European SOE formation are relevant to Ireland at particular

points in time, the chronology of Irelands SOE formation is somewhat different. Having

gained independence in 1922 and exercised neutrality throughout World War One and Two,

Ireland did not develop its SOEs in accordance with wide European trends (see Table 1 for

chronology).

2.0.2 Public Enterprise Formation in Ireland: 1927-1957

Protectionist policies were pursued in Ireland following independence from British rule in

1922. The state sought to break neo-colonial ties with Britain by vying for self-sufficiency

with an extensive import-substitution program. The successful establishment of the

Electricity Supply Board in 1927 set a precedent for public enterprise as a means of achieving

economic development (Palcic and Reeves 2011). Sweeney (1990) explains that SOEs were

subsequently established to meet the extraordinary needs of the fledging state. The

Agricultural Credit Corporation was also established in 1927, and the Industrial Credit

Corporation in 1933, to provide much needed funding to Irelands agricultural and industrial

sectors respectively. The Irish Sugar company was established in 1933 as a prototype of a

commercial SOE. As government continued to strive towards self-sufficiency, Ceimici Teo

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was established in 1939, initially as a producer of industrial alcohol, but then extending to

produce a multitude of chemicals. In 1936 Ireland established Aer Lingus as the state airline,

while Aer Rianta took control of Dublin Airport.

Table 1: Commercial State-Owned Enterprises in Ireland by the 1980s

Company Established Sector

Agricultural Credit Corporation 1927 Banking & Finance

Electricity Supply Board 1927 Electricity

Industrial Credit Corporation 1933 Banking & Finance

Irish Sugar 1933 Sugar Production

Aer LIngus 1936 Air Transport

Aer Rianta 1937 Airports

Ceimici Teo 1939 Chemicals

Irish Life 1939 Insurance

Irish Shipping 1941 Sea Transport

Cras Iompair ireann 1944 Rail & Road

Transport

Bord na Mna 1946 Peat Production

Irish Steel 1946 Steel Production

Arramara Teo 1949 Seaweed Processing

Voluntary Health Insurance 1957 Health Insurance

Raidi Teilifs ireann 1960 Broadcasting

Ntrigin ireann Teo- IFI 1961 Fertiliser Production

B&I Line 1965 Sea Transport

Foir Teo 1972 Banking

Bord Gis ireann 1976 Gas Distribution

Irish National Petroleum Corporation 1979 Oil Refining & Supply

Telecom ireann 1984 Telecommunications

An Post 1984 Postal Services

Coillte Teo 1989 Forestry

Source: Palcic and Reeves 2011

The outbreak of World War Two in 1939 provided an additional impetus for Ireland to

operate self-sufficiently. Irish Shipping was founded in 1941 to secure service between

Ireland and Britain during the war. The transport company Cras Iompair ireann, Irish Steel

and a seaweed processing company Arramara Teo were established throughout the 1940s

following nationalisations and mergers (see Table 1). The state established itself in the

financial services sector with the formation of Irish Life Assurance Company in 1939

following the nationalisation of 5 British companies the state had invested in, and formed the

Voluntary Health Insurance company in 1957 to insure those not covered by the Health Acts

(Palcic and Reeves 2011).

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2.0.3 Public Enterprise Formation in Ireland: 1957-1989

SOEs now existed across many sectors, and were essential in implementing broad

government policies as Ireland began to embark upon an era of outward looking economic

planning from 1958. Governments emphasis shifted from self sufficiency to establishing an

export orientated economy which was attractive to foreign direct investment. Agencies such

as Cras Trchtl and the Irish Export Board were formed to service the needs of this private

capital by offering advice and information (OMalley 1989:86). Other agencies were

established such as Gaeltarra ireann in 1959 to develop Irish speaking areas and Bord

Iascaigh Mhara in 1952 to develop Irelands fishing industry. Commercial SOEs continued

to be established; the state broadcasting agency Raidi Teilifs ireann in 1960, the fertiliser

company Ntrigin ireann Teo in 1961 and B&I Line, a ferry company formed in 1965

following the nationalisation of a failing British company (Palcic and Reeves 2011).

SOE formation continued into the 1970s, with the establishment of the state rescue bank Foir

Teo in 1972. Of particular interest to this study is the establishment of Bord Gis ireann in

1976 as the monopoly distributor of natural gas in Ireland. Telecom ireann and An Post

(1984) and the state forestrys company Coillte Teo in 1989 were corporatized from the civil

service to become commercial SOEs. At the beginning of the 1980s, 23 SOEs were

categorized as commercial entities engaging in the production of goods and services (Palcic

and Reeves 2011).

In sum, the rationale for establishing SOEs in Ireland was largely due to the need for the

creation of national wealth in a newly independent state without basic industries or the means

of attracting private enterprise. The formation of SOEs provided state autonomy and the

means to pursue state goals (Palcic and Reeves 2011).

2.1 Privatisation in Ireland

2.1.1 Introduction

The Irish state has to date raised 8.36 billion in privatisation revenues, significantly

changing the structure and composition in several key sectors of the Irish economy (Palcic

and Reeves 2011). This section explores these divestitures by applying the aforementioned

theoretical rationales of principal agent and public choice theories. Furthermore, it is

explained that European integration influenced government to privatise SOEs; the Single

Common Market necessitating liberalisation incompatible with certain public monopolies, the

20

Maastricht Treaty asserting a pressure to quickly reduce government debt and deficits to meet

its criteria and the issuing of EU directives banning state aid to failing SOEs (Palcic and

Reeves 2011). In conclusion, it will be demonstrated that decisions to privatise in the Irish

case have been made pragmatically, and not based on any single rationale.

Table 2: Privatised SOEs in Ireland and Exchequer Proceeds

Company Year of sale Exchequer proceeds

(000s)

Irish Sugar Apr. 1991 210,650.8

Irish Life Jul. 1991 601,930.8

B&I Line Jan. 1992 10,792.8

Irish Steel Apr. 1996 0

Telecom ireann Jul. 1999 6,399,907.9

Industrial Credit Corporation Feb. 2001 322,274.8

Trustee Savings Bank Apr. 2001 408,350.3

Irish National Petroleum Corporation Jul. 2001 20,000.0

Agricultural Credit Corporation Feb. 2002 154,603.0

Aer Lingus Oct. 2006 240,902.3

Total 8,369,412.7

Source: Palcic and Reeves 2011

2.1.2 Privatisation in Ireland: 1991-1996

Throughout the 1980s, Ireland opted to commercialise its SOEs rather than follow a growing

trend of privatisation in the UK and Europe, despite facing a severe financial crisis.

Government promises to trade unionists to avoid privatisations were eventually broken

however, as the pro-privatisation Progressive Democrats came into power as a minority

coalition member in 1989. The dual divestiture of Irish Sugar Company and Irish Life

Assurance in 1991 set a precedent for further divestitures in Ireland. These privatisations can

largely be explained with Chicagoan public choice theory, which demonstrates internal

actors ability to lobby relevant government ministries and officials. The privatisation of Irish

Sugar Company and Irish Life Assurance was driven by decision makers within the

companies, who pushed their privatisation agendas through to IPOs in 1991 (Palcic and

Reeves 2011).

Government continued to proceed cautiously and pragmatically following these divestitures.

Increasing the commercial performance of SOEs took priority over changing ownership.

Government took a hard line on loss makers, as evidenced by the liquidation of Irish

Shipping and Ceimici Teo in 1984 and 1986 respectively. It can be noted that the hard line

21

taken at this time was partly due to increasing European integration, with the conditions of

the Maastricht Treaty necessitating stricter fiscal discipline. By 1991, shipping company B&I

Line had accumulated losses of 170.71 million, relying on exchequer funding to service its

debt. Irish steels performance was similarly weak. Between 1980 and 1993, the steel

company received 234.9 million funding from government, but remained unprofitable, with

a net loss of 16.48 million in 1993. Rather than opt for liquidation, government choose to

sell the companies as going concerns. B&I Line was sold in 1992 to Irish Continental Group

for 10.79 million, with government agreeing to pay 44.4 million of its debt. Irish Steel was

sold in 1996 to ISPAT International (Palcic and Reeves 2011).

2.1.3 The Privatisation of Telecom ireann

By far the most significant divestiture in the history of the Irish state is that of Telecom

ireann (T); the national telecommunications operator. From its establishment in 1984, T

operated as a monopoly in the Irish telecommunications market. EU legislation saw T

facing full market liberalisation in 1998. To adapt to this impending competitive market,

internal management sought large capital investment. It was argued that such an investment

could only come from private sources thus management instigated a partial strategic

privatisation, eventually leading to full privatisation. In 1996 Comsource consortium

purchased a 20% stake in T, with an option to increase this holding to 35%. The

Communications Workers Union, the final hurdle in the full divestiture, agreed on the basis

of a generous 5% employee share ownership plan, with a further 9.9% stake bought at a fair

price (Palcic and Reeves 2011: 155-177).

T, rebranded as Eircom, was fully privatised in 1999 with the remaining 50.1% stock

flotation generating sales revenue of approximately 6.4 Billion. To put this in the context,

this represents 76.47% of total exchequer proceeds from privatised SOEs in Ireland.

Government promoted Ts flotation as a means promoting popular capitalism. Its goal of

widening share ownership seemed successful initially, with 575,000 people purchasing stock.

However as stock prices deteriorated, many thousands of these small shareholders were

burned, curbing the publics appetite for future privatisations (Palcic and Reeves 2011: 155-

177).

The privatisation of T has become known to be an example of failure in privatisation. The

lessons learned from this should be applied in future privatisations. Central to this failure was

governments decision to sell T as a vertically integrated business, not keeping the network

22

element of the business in state control. Also, selling T in one go as opposed to gradually

reducing ownership and keeping a golden share, which would have allowed the state to

prevent undesirable changes in ownership has been a source of much criticism (Palcic and

Reeves 2011: 155-177).

Eircom, was split up, with its fixed line business sold to private equity consortium Valentia.

In 2006, Australian investment firm Babcock and Brown bought Eircom in a leveraged

buyout and subsequently sold it to Singapore Technologies Telemedia in 2010. Eircom now

holds over 4 billion in debt, which has hampered its ability to invest in capital infrastructure

and contributed significantly to the slow roll out of broadband services in Ireland. This

infrastructural deficit persists in Ireland today, and has necessitated government intervention

(Palcic and Reeves 2011: 155-177).

2.1.4 Privatisation in Ireland: 2001-2006

Between 2001 and 2002, the 3 state owned commercial banks were privatised; the

Agricultural Credit Corporation (ACC), Industrial Credit Corporation (ICC) and Trustee

Savings Bank (TSB). Government policy sought to foster competition in Irelands banking

sector and considered a number of options for the 3 publicly owned banks including a

merger of the three or the sale of TSB to recapitalise a merged ACC and ICC. With

privatisations initially mooted in 1992, it was 2001 before the ICC was sold to Bank of

Scotland (Ireland) for 349 million. TSB was sold later that year to Irish Life and Permanent

for 430 million to form Permanent TSB. In 2002, the ACC was sold to Rabobank for 165

million. In all three cases, ESOPs of 14.9 % were agreed which ensured worker cooperation.

Successive governments were in agreement that government should exit the banking sector,

selling 3 small players to aid competition. This rationale guided the privatisations through a

protracted period of practical difficulties in finding an appropriate buyer for each (Palcic and

Reeves 2011).

In July 2001, the Irish National Petroleum Company was sold to Tosco Corporation for 116

million. The cost of capital investment necessary to upgrade its refinery facilities was deemed

too high to be paid from the exchequer and the sale proceeded with a number of conditions;

Tosco agreed to commercially operate the refinery and terminal operations for 15 years while

maintaining existing jobs and employment conditions. Also, they agreed to undertake any

capital investment necessary to adhere to future EU regulations (Palcic and Reeves 2011).

23

The state-owned airline Aer Lingus had struggled to remain commercially viable through a

volatile 25 year period which included the Gulf War of 1990-91, the outbreak of foot and

mouth disease in 2000 and the terrorist attacks on New York and Washington in September

2001. 2 rationalisation plans saw injections of state capital, sale of non-core assets, a pay

freeze, redundancies and a granting of a 14.9% ESOP. As the state made it clear it would not

provide any further capital injections, management sought to mobilise private capital to meet

the cost of funding necessary fleet renewal. Government opted to retain a 25% stake in the

company, and floated the remainder on the stock exchange in 2006. The decision to privatise

was initially made in 1999; however a lack of political impetus for privatisation following the

failed privatisation of T among other political considerations protracted the process (Palcic

and Reeves 2011).

24

Chapter 3: A New Round of Divestitures

3.0 Introduction

A new round of divestitures in the Irish public enterprise portfolio is imminent. The historical

context of Irelands public enterprise development has been explained. This chapter will go

on to locate Irelands return to privatisation in its economic and political context. The Irish

government is making privatisation decisions in a situation unprecedented in an Irish context;

public finances have been decimated and economic sovereignty surrendered. The potential

for an economically ill-advised fire sale of state assets is large. Bord Gis Energy, the retail

arm of the state owned utilities company and network operator Bord Gis ireann, has been

identified by government as a non-strategic asset and a suitable candidate for privatisation.

To evaluate the economic case for this planned privatisation, this chapter analyses the

evolution of this policy through a number of influential documents; Fine Gaels New

Economy Recovery Authority (NewERA) plan, Memoranda of Understandings (MoUs)

between the Irish government and the Troika of global institutions over seeing their bailout

program and a Fianna Fil requested Report of the Review Group on State Assets and

Liabilities published in 2011. These documents have shaped recent Irish privatisation policy.

3.1 The Economic Crisis in Ireland

It can be noted that since 2002, there had been a general lack of appetite for privatisation. The

state had withdrawn from several key sectors of the economy, and those commercial SOEs

that remained were large utility companies or companies not appropriate for private

ownership because they held considerable market power (Palcic and Reeves 2011). The

following section explains the national economic crisis that has emerged since 2008 which

has seen the state re-enter the banking sector and return to privatisation as a means of raising

revenue for the exchequer.

Between 1994 and 2007, the Irish economy experienced an unprecedented period of

sustained real economic growth. During the period, the Irish economy expanded at an

average rate of 9%, had average unemployment of just 3.6%, and experienced low inflation at

1.4%. Commentators dubbed it The Celtic Tiger economy. Donovan and Murphy (2013)

argue that up until 2002 this growth was sustainable. Ireland was established as a springboard

to Europe for investors. Boasting favourable corporate tax rates of 12% and as the only

English speaking country in the Euro currency zone, Ireland was well positioned to take

25

advantage of a global technological boom. Good macro-economic policies underpinned this

growth, as evidenced by an ability to reduce its debt to GDP ratio to 25% (Central Statistics

Office 2012).

Donovan and Murphy (2013) note the global economy began to contract in 2002. Equity

markets in the US and Europe fell due to unrealistic profit expectations largely in the

technology sector. Terrorist attacks in the US on September 11th 2001, and the foot and

mouth crisis of the same year saw a downturn in the US and European economies. They

suggest that Ireland resisted this contraction by pursuing policies to grow its construction

sector. Where in the 1990s increasing property prices were arguably justifiable by real

economic growth, an artificial property bubble was created. This second phase of economic

activity was fuelled by cheap access to European wholesale credit from an Irish financial

sector under light regulation from government, the financial regulator and the central bank.

The Irish government received windfall revenue through stamp duty, capital gains tax and

construction sector related VAT. Government pursued pro-cyclical policies by increasing

budget expenditure and balancing it against unsustainable property related tax revenue. By

2007, the property bubble had developed to the extent that residential property prices had

quadrupled since 1996 (Palcic and Reeves 2013).

This property bubble inevitably burst after 2007. Prices of residential properties in Ireland in

September 2013 have fallen 62.2% from their peak in August 2007 (Central Statistics Office

2014a). This collapse in construction activity saw a sharp rise in unemployment, from 4.5%

in 2007 to 12% in 2009 (Central Statistics Office 2014b) which squeezed public finances

already reeling from the loss of property related revenue such as stamp duty, on which the

exchequer had become overly reliant on. As the economy contracted, it became apparent that

the Irish banking sector was overly exposed to the property sector. At the end of 2007, bank

loans and advances to customers were over twice the size of the countrys GDP, at almost

400 billion (Nyberg 2011).

By late September 2009, the Irish banking sector was on the brink of collapse. The Irish

government took the decision to guarantee the deposits and most liabilities of all Irish banks,

a gross liability guarantee of 375 billion, 33% of which was senior unsecured debt.

Government decided that it would prevent any Irish bank from defaulting on its maturing

obligations, thereby avoiding a crisis of confidence in the Irish banking sector and preventing

a run on Irish banks. This decision has proven to be an extremely costly one. Government did

26

not foresee the extent of Irish banks bad debts, largely arising from property related loans.

To date, the recapitalisation of Irish banks has cost the state 64 billion (Nyberg 2011).

Ireland faced a dual dilemma; the true cost of recapitalising its banks was becoming apparent

and a massive structural deficit was developing. International financial markets were in a

liquidity crisis, and the global economy had begun to slip into recession. International money

markets became increasingly reluctant to lend to Ireland. By late 2010, Ireland was unable to

access credit and government was forced to enter into an EC/IMF/ECB bailout program on

29 November 2010. Ireland secured 85 billion in funding composed of 45 billion in

bilateral loans and funding from the European Stability Fund, 22.5 billion from the

International Monetary Fund and 17.5 Billion from Irish contributions via the National

Pension Reserve Fund (Donovan and Murphy 2013).

The effects of Irelands economic collapse are made stark by key indicators; Unemployment

rose from a low of 3.7% in the first 5 months of 2011, and peaked at 15.1% in February 2012.

This figure has improved somewhat to 12.3% in January 2014, although economic emigration

accounts for some of this reduction (Central Statistics 2014b). Real GDP for the second

quarter of 2013 was 9.8% lower than its peak in the fourth quarter of 2007. Irelands Debt to

GDP ratio averaged 71.3% between 1980 and 2012, and fell to a low of 24.8% in December

2006 (Central Statistics Office 2014c). At year end 2013, Irelands Debt to GDP was 124.1%

(Irish Fiscal Advisory Council 2013). Government policy in response to this crisis, and the

stipulations of the bailout program with the EC/IMF/ECB has significantly altered the

composition and function of Irelands public sector; with a raft of nationalisations, new SOE

formations and planned privatisations occurring (Palcic and Reeves 2011). Although Ireland

left this structured bailout program in December 2013, the decision making process around

public enterprise appears to have been altered indefinitely.

3.2 Fine Gaels New Economy Recovery Authority

In November 2009, Fine Gael was the opposition political party in the Irish government when

they released the New Economy Recovery Authority (NewERA) plan; an economic stimulus

plan that sought to create 105,000 new jobs with a 18.2 Billion investment in Irish

infrastructure over a four year period. Fine Gaels NewERA plan aimed to increase long term

competitiveness, increase energy security, eliminate the digital divide that has developed

27

between Ireland and Europe and create a new governance structure for the public sector (Fine

Gael 2009).

This stimulus was to be financed from a number of sources; The European Investment Bank,

The National Pension Reserve Fund, commercial borrowings of SOEs, a NewERA recovery

bond to be offered to the Irish people and, of primary interest to this study, from revenues

accruing from the sale of non-strategic state assets. The non-network elements of both major

state utilities companies, Bord Gis ireann and the Electricity Supply Board, were

earmarked for sale (Fine Gael 2009).

The governance of the state sector would be restructured with the establishment of NewERA

Ltd. as the states holding company. 100 professionals would be employed at NewERA to

commercially manage 5 new SOEs in a consolidated public portfolio. Smart Grid and

Gaslink would become owners and operators of Irelands electricity and gas networks

respectively. Furthermore, a National Recovery Wholesale Bank would be established to

facilitate commercial borrowings of SOEs (Fine Gael 2009).

Fine Gael came into power as the majority party in a coalition government with Labour in

September 2011 on the back of an economic mandate largely represented by NewERA. It

must be noted that Fine Gaels neo-liberal economic policies, which seek to minimise the

states role in the provision of services, is at odds with Labours policies. In their pre-election

manifesto in 2011, Labour stated its commitment to public enterprise:

Labour is committed to the concept of public enterprise, and is determined to ensure

that semi-state companies play a full role in the recovery of the Irish economy.

Labour is opposed to short-termist privatisation of key state assets, such as Coillte or

the energy networks.

(Labour 2011)

As Taft (2012) observes, Labour failed to protect this commitment in negotiations for the

program for government, which when published contained Fine Gaels commitment to

raising 2 Billion in revenue from the sale of state assets (Fine Gael and Labour 2011).

At the time of writing, much of this program has not been implemented. The NewERA Ltd.

holding company to manage public enterprise has not been established. NewERA has instead

developed as a non-statutory body within the National Treasury Management Agency tasked

with overseeing the financial performance, corporate strategy, capital and investment plans of

the five commercial semi-state companies within its remit; ESB, Bord Gis ireann, EirGrid,

Bord na Mna and Coillte (NTMA 2013). Planned divestitures of ESB and Coillte have been

28

rowed back on due to union resistance and popular protest respectively. To date, the

establishment of Irish Water as a subsidiary of Bord Gis ireann, a new SOE to take over

the operation of the Irish water infrastructure, has been the only full implementation of the

plan.

3.3 Memoranda of Understandings

Upon receiving bailout funding from the Troika of global institutions, Ireland signed a bailout

agreement renouncing its economic sovereignty. Both the political decision making process

and economic landscape were altered from that in which NewERA was developed.

Government now had to operate within the parameters of a Troika specified program for

government which was to be communicated in a series of Memoranda of Understandings

(MoUs) between the government and the Troika. Of interest to this paper is the

conditionality for the sale of sale assets prescribed (Palcic and Reeves 2013).

Privatisation as a condition of financial support has been a staple of IMF/World Bank

bailouts since the 1980s (Bennell 1997, Martin 1993). Where NewERA sought revenue from

the sale of non-strategic assets for investment in a stimulus plan aimed to restore growth and

finance national investment programs, Troika bailout agreements have prioritised the paying

down of national debt. However, Ireland has received somewhat favourable terms in

comparison to bailouts in Greece and Portugal (Palcic and Reeves 2013). Indeed, the first

MoU signed in November 2010 contained no specifics regarding privatisation. Updated six

times since, targets for revenue from divestments have emerged. Although there is significant

pressure being exerted from the Troika outside of these MoUs, the Irish government has

been afforded independence in deciding which SOEs are to be privatised and some

flexibility in the spending of revenues accrued as a result (Palcic and Reeves 2013).

Fine Fil ordered a report from the Review Group on State Assets and Liabilities. 5 billion

in revenues from recommended divestitures were identified in this report which was endorsed

in an IMF country report in September 2011 (IMF 2011a). However, upon coming into power

as the majority party in a coalition government with Labour in September 2011, Fine Gael

indicated it would seek only 2 billion in privatisation revenues. By January 2012, the

Troikas Quarterly Review sought specifics from government who scaled this target up to 3

billion (IMF 2011b).

This revenue would come from a sale of a minority stake in ESB, a full divestment of the

state forestry company Coillte, sale of the states majority stake in the semi-state owned

29

airline Aerlingus and the privatisation of the non-network elements of Bord Gis ireann.

However, mass public protests saw a reversal of the planned divestment of Coillte.

Furthermore, government reversed its decision to sell a minority stake in ESB. The sale of

Aerlingus will be delayed until market conditions become favourable. Thus, the only planned

privatisation to date is that of Bord Gis Energy, the retail arm of Bord Gis ireann. The use

of the proceeds of any privatisation is much debated, and again the Troika have been flexible

in this regard. The latest indication resulting from negotiations in March 2011 is that 50% of

revenues will be used to pay down government debt with the remainder available for state

investment as per NewEra (IMF 2012).

3.4 Report of the Review Group on State Assets and Liabilities

A report by The Review Group on State Assets and Liabilities as requested by Fine Gael

exists as the principle document directing privatisation policy in Ireland. In it, McCarthy et al

(2011) recommend 5 billion of revenues to be garnered from the sale of non-strategic state

assets. Unfortunately, this report does not contextualise its recommendations in Irelands

bailout program and the subsequent changes to the decision making landscape that resulted. It

was undertaken amidst a dynamic situation of bargaining between the Irish government and

the Troika, who had not yet set specific revenue targets. However, the flexibility afforded to

the Irish government as discussed previously means that this does not completely undermine

its recommendations. The Review Group recommends sales revenues from privatisation be

used to pay down government debt and decrease the burden of necessary spending cuts. They

do not advocate for the reinvestment of revenues in infrastructure development as per

NewERA (McCarthy et al 2011).

As a prelude, the Review Group stresses that there should not be an accelerated sale process,

and that sales should only be undertaken after state companies have been restructured and the

regulatory environment strengthened. Recommendation 4 calls for a comprehensive review

of legislation governing economic regulatory agencies, and necessary legislative amendments

made prior to any disposals (McCarthy et al 2011). However, in light of Irelands bailout

program, the time needed to undertake this may not be available and the sale process could be

inevitably accelerated.

The report warns that without significant regulation, there may be a subsequent under

investment in infrastructure as occurred in Irish telecoms networks following the sale of T

to a private equity fund with little interest in investment (Palcic and Reeves 2011: 155-177).

30

As revenues are recommended to be diverted from infrastructural investment to offset

spending cuts, such a situation could undo any short term gains to the exchequer made

through revenue realisation.

Bord Gis Energy is dominant across all market sectors in the supply of natural gas,

especially in the residential sector. Thus, regulation must be stringent to protect competition

and avoid a situation whereby a privately owned BGE could influence market price.

Acknowledging this, McCarthy calls for a full review of the system of energy regulation in

Ireland prior to any divestiture; which has not been done. The Review Group does ultimately

recommend the privatisation of all Bord Gis ireanns operations except its transmission

and interconnector assets (McCarthy et al 2011). Government has acted on this

recommendation, but this paper contends they have done so while ignoring concerns and

recommendations regarding the adequacy of Irelands energy regulatory regime.

31

Chapter 4: The Privatisation of Bord Gis Energy

4.0 Introduction

Despite a near blanket failure to implement their public enterprise policy, Fine Gael-Labour

government has persisted with the planned divestiture of the non-network elements of Bord

Gis ireann. In July 2013, the government brought before the Dil the Gas Regulation Bill,

which creates the legal basis for the divestiture of Bord Gis ireann (Gas Regulation Bill

2013). This followed a press release by BGEs Financial Director, Michael G OSullivan in

May 2013 which stated that the sale process had commenced and that the sale was expected

to be concluded by the end of that year (Bord Gis ireann 2012a). This bill faced significant

legal challenges for government as they worked to comply with the full ownership

unbundling requirements of the EU Gas Directive 2009 (Council Directive 2009/73/EC). In

consequence, both the Minister for Communications, Energy and Natural Resources and the

Minister for Public Expenditure may not retain any decision making role in the new Bord

Gis Network business as they are shareholders in other state energy companies.

Despite regulatory reform being a staple prerequisite of divestiture in the NewEra document,

The Report of The Review Group on State Assets and Liabilities and Fine Gaels program for

government, none such reform has been delivered. Despite this, the sale of BGE has

commenced. Fine Gaels 2011 election manifesto offered the only clear indication from

government of the potential composition of this reform. In it, it committed to establishing the

Competition, Consumer, Utilities Commission as one supra-regulator of the Irish economy.

This commission has not been established. The Commission for Energy Regulation regulates

the Irish electricity and natural gas sectors largely unchanged from its establishment in 1999

(Fine Gael 2011). Thus, BGE is being sold amid significant regulatory shortcomings that this

paper contends could lead to an economically harmful situation post-divestiture.

This chapter undertakes a case study of the ongoing divestiture of Bord Gis Energy. The

study begins by outlining the economic theory of natural gas supply, both as a network and a

natural resource industry. The development of Bord Gis ireann in the context of the

European gas market is then described. An overview of Bord Gis ireann follows, which

distinguishes the network and non-network elements of the business. An overview of Bord

Gis Energy is then provided, describing BGEs place in the Irish retail gas market. A

summary of the sale process will explain that a consortium led by a British multinational

utility company, Centrica, is poised to purchase BGE. In conclusion, recommendations are

32

made that call for reform of Irelands system of energy regulation and SOE governance

structure prior to any future privatisations, and that these privatisations are undertaken in a

series of tranches.

4.1 The Economics of Natural Gas

The market for natural gas combines a network industry and a natural resource industry. With

network industries, economies of scale are essesntial. The domestic transport and distribution

system services of natural gas in Ireland are made up of a high pressure long distance

pipeline, with a low pressure distribution grid connecting it and end-consumers. There is a

high fixed cost associated with the construction of such a network, with a relatively low

marginal cost of extending it. In Ireland, it is not feasible or efficient for different natural gas

suppliers to operate via duplicated parallel pipelines thus the countrys gas network is a

natural monopoly (CPB 2006).

In Monopoly and the Rate of Extraction of Exhaustible Resources (1976), Stiglitz explains

that in exhaustible resource markets such as that of natural gas, the total stock of resource is

fixed. Total production for a monopolist or a firm in a competitive market cannot change.

However, a monopolist does have the power to change the pattern of production over time to

influence price. Assuming constant elasticity of demand and zero extraction costs, Stiglitz

demonstrates that the rate of extraction for a monopolist and a firm in competition will be the

same. However, in reality price and elasticity of demand are positively linked, thus

monopolists tend to produce less than a competitive firm and welfare is not optimized.

Resource rents occur when there is a difference between market price and marginal cost of

extraction.

Both characteristics have regulatory implications. The Irish government has seemingly

learned from the failure arising from the privatisation of Ts network, and has committed to

keeping the network element of Bord Gis ireann in state control. Government can thereby

guard against rent seeking and ensure the integrity and safety of the system if regulation is

adequate. Of strategic importance to the state is security of supply. By controlling the gas

network and the interconnectors to the UK, from which Ireland imports 93% of its natural

gas, government can effectively manage our energy security, an issue particularly important

to Ireland as a small island country with a high reliance on imported gas (TASC 2012). The

EU mandated that European gas markets be liberalised in 2003 and forced ownership

unbundling in 2009 (Council Directive 2003/55/EC, Council Directive 2009/73/EC). These

33

policies are an endorsement of neo-classical economic theory which advocates for the welfare

optimality of competitive equilibrium, however as will be demonstrated, such perfect

competition does not exist across all sectors of Irelands natural gas supply market which

remains price regulated in one sector.

4.2 The European Gas Market

The strategic importance of SOEs in post-war Europe, as explained, is particularly relevant

to the utilities sectors. Governments undertook extensive reconstruction efforts and faced

very real threats to energy supply (Palcic and Reeves 2011). The oil and gas sector was

therefore tightly controlled. In 1959 the European natural gas business was mainly confined

to Northern Italy and South West France, with additional imports from parts of the USSR. At

the time, energy multinational ExxonMobil had acquired a 50% share in NAM as a balancing

item in a global asset swap. NAM, operated by Royal Dutch Shell, was the exploration

company working at Groningen, in the northeast of the Netherlands. This exploration

established the European gas business proper. The joint venture uncovered a giant natural gas

field, 2.8 trillion cubic meters in size with 2,800 BCM of recoverable gas. NV Nederlandse

Gasunie was established as the monopoly producer and transmitter of Groningen gas for 30

years, 50% owned by the Dutch government and a 25% stake owned by Shell and Exxon

respectively (Heren 1999).

Exxon insisted on the controlled supply of this gas, pegging its value to that of other fuels,

and guarding against an over-supply of cheap natural gas. Further discoveries followed;

onshore in Germany, offshore in the UK and Norway, with supply further supplemented with

imports from Algeria and Russia. ). Ireland was no exception. In 1971, natural gas was

discovered off the coast of Kinsale, in southern Ireland. Deemed commercially viable, Bord

Gis ireann was established by the Gas Act 1976 as the state gas development agency (Bord

Gis ireann 2013a).

OPEC had traditionally been the primary supplier of oil to Europe. However, having suffered

an OPEC induced oil price shock in the 1970s that rattled the European economy,

governments sought to move away from an over-reliance on OPEC oil. Suppliers pushed out

by OPEC began to find an outlet in these new reservoirs (Heren 1999).

Governments generally opted for a hands on approach in managing their nations new found

natural wealth. With the exception of a liberalised British market in the late 1980s, the

European gas market is traditionally characterised by an absence of rights to transmission and

34

distribution pipes, the prevalence of state monopolies, and prices pegged to those of

competing fuels (Heren 1999). EU directives have sought to correct this by creating a single

internal market for natural gas. In doing so, they liberalised European gas markets in 2003

and forced ownership unbundling in 2009. The EUs objectives are to increase service

quality, achieve universal service, increase consumer protection and achieve security of

supply with a competitive internal market with appropriate regulation. It seeks to achieve this

by removing government from the European gas market and relying on competition between

profit maximising private enterprises to achieve their objectives (Council Directive

2009/73/EC, Council Directive 2003/55/EC). However as we have seen, privatisation

literature does not definitively support this approach.

4.3 Bord Gis ireann

4.3.1 The Development of Bord Gis ireann

In 1971, natural gas discovered off the coast of Kinsale, Co. Cork was confirmed as

commercially viable. With the approval of the Gas Act by the Oireachtas in 1976, Bord Gis

ireann was established as the State Gas Development Agency. The beginning of natural gas

production in Ireland was marked by the first delivery of natural gas, received on-shore by

then Taoiseach Jack Lynch, in 1978. Throughout the 1980s pipelines were built, first in the

Cork area, then to Dublin with a series of spurs ever broadening the availability of natural gas

in Ireland. By 1995, 35% of Irelands dwellings were connected to the network. In 1985 Bord

Gis ireann was ordered to acquire Cork Gas, who found themselves in a perilous financial

position. In 1987 Bord Gis ireann took over the assets of Dublin Gas Company, whom

government had placed in receivership (Bord Gis ireann 2012).

In 1994 an inter-connector came into operation, completed with 35% funding from the EU,

which connected Irelands gas network with the UK and the European Gas networks,

securing a supply of gas beyond the exhaustion of gas in the Kinsale field. 1999 saw the

beginning of the opening up of 80% Irelands natural gas market. By 2002, any consumer

consuming 500,000 standard cubic meters of natural gas was free to choose from any

supplier. In 2001, Bord Gis ireann began to diversify its portfolio by entering the Irish

electricity supply market. This diversification has proven successful, evidenced by BGEs

ability to construct a gas-fired power plant at White-Gate, Co. Cork which became

operational in 2008 and acquire a 30 megawatt wind farm development in the West of Ireland

in the same year. BGE now operates as an all-island natural gas supplier with its subsidiary

35

Firmus in Northern Ireland, having entered the Northern Irish market in 2003 via network

connections from Belfast to Dublin and Carrickfergus (Co. Antrim) to Derry city (Bord

Gis ireann 2012).

4.3.2 The Structure of Bord Gis ireann

Today, Bord Gis ireann operates as a commercial enterprise owned by the Irish state. Bord

Gis ireann has evolved from a gas transmission company to become a major energy

provider. Recently, government has created a subsidiary, Irish Water, which is being

established as Irelands new public water utility (Bord Gis ireann 2013b). The firms

business structure is illustrated in Fig. 1. This study focuses solely on the divestiture of Bord

Gis ireanns retail arm, Bord Gis Energy. As such, an understanding of the parent

companys structure is essential.

Fig 1. The Structure of Bord Gis ireann and its Subsidiaries

Source: Bord Gis irean Annual Report and Financial Statements 2012

Gaslink is the independent gas system operator, created as per the unbundling requirements

of the EU. Gaslink is responsible for the maintenance and operation of the gas distribution

and transmission networks. Bord Gis ireann owns the networks, and in practice Gaslink

uses Bord Gis Networks as a service provider to carry out the majority of this work. It is

thought in the future much of Bord Gis Networks work will be transferred to Gaslink (Bord

Gis ireann 2013b).

Bord Gis ireann

Bord Gis Networks

Bord Gis Energy

Firmus

Irish Water Gaslink

36

Bord Gis Networks work on behalf of Gaslink to develop and maintain Irelands natural gas

transmission and distribution network, as well as providing gas transportation services to

suppliers and shippers. This network now consists of over 14,000 km of pipes and 2 sub-sea

interconnectors to the UK (Bord Gis ireann 2013b).

Irish Water has been established as per NewERA to take over the public water services from

34 local authorities. Irish Water will deliver services to public water uses and are responsible

for the installation and of water meters and subsequent billing of water users. As a subsidiary

of Bord Gis ireann it is thought they will better be able to raise finance on international

markets to fund capital investment projects necessary to maintain and upgrade Irelands

public water infrastructure, and will benefit from the groups experience in network

operations (Bord Gis ireann 2013b).

Firmus is Bord Gis Energys subsidiary in Northern Ireland, where it is licensed to supply

natural gas and electricity in 10 towns and cities including the greater Belfast area, Derry,

Newry and Ballymena. It is also responsible for developing and connecting the gas network

in licensed areas to that of the Republic of Ireland. As Bord Gis Energys subsidiary, Firmus

will also be privatised (Bord Gis ireann 2013b).

4.4 Bord Gis Energy

4.4.1 Introduction

Bord Gis Energy is the retail arm of Bord Gis ireann. It is a dual-fuel, all island supplier

of electricity and natural gas to residential, commercial and industrial customers in the

Republic of Ireland and Northern Ireland (via Firmus). BGEs trading arm procures natural

gas, electricity and carbon on international wholesale markets and works to optimise its

portfolio with hedging and trading strategies, risk management and market modelling. Its

assets arm manages BGEs existing assets, develops new assets to meet the companys needs

and invests in emerging energy technologies. In 2012, the latest year for which full market

data is available, BGE supplied electricity to 327,000 residential customers and 21,000

businesses. BGE supplied natural gas to 416,000 residential customers and 11,096

businesses. Residential natural gas supply persists as the only market in which BGE is price

regulated by the Commission for Energy Regulation (CER), Irelands independent energy

regulator (Bord Gis ireann 2013b).

37

At the end of 2012, BGE employed 453 people in the Republic of Ireland. The following

outlines BGEs position across all market segments in the electricity and natural gas supply

markets as per the data of the Commission for Energy Regulations annual report 2012 (CER

2013). An overview of BGEs financial performance is then given.

4.4.2 Market Share: Electricity

All market segments in Irelands electricity supply market have been deregulated, however

Irelands state owned electricity company the Electrical Supply Boards retail arm Electric

Ireland remains dominant across all market segments. In 2012, BGE saw a decline in its

market share in electricity supply. Table 3 details BGEs market share across the 4 market

segments as per year end 2012. Total customer numbers for all suppliers for the year were

2,237,203. BGE supplied 328,617 of these in the domestic market, and 19,030 in the business

and large energy users segments (CER 2013).

Table 3: Market Share of Electricity Suppliers as a Percentage of Customer Numbers across Market

Segments

Domestic Small Business Medium

Business

Large Energy

User

Electric Ireland 64.55% 45.88% 55.97% 42.13%

Airtricity 18.06% 21.29% 15.98% 26.20%

Bord Gis

Energy

16.26% 9.33% 4.85% 9.38%

Vayu - - - 4.51%

Energia - 23.41% 22.49% 15.63%

Others 1.14% 0.09% 0.72% 2.16%

Total 100% 100% 100% 100%

Source: CER Electricity and Gas Retail Markets Annual Report 2012

4.4.3 Market Share: Natural Gas

BGE remains dominant across all market segments in the supply of natural gas, however

competition is driving their market share down year on year. The CER (2013) divides the

natural gas market into segments as per the following:

Domestic: non-daily metered (NDM) residential customers.

Industrial and Commercial (IC): businesses with a supply point capacity of below

3,750kWh and consumption level below 73,000kWh.

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Fuel Variation Tariff (FVT) : NDM gas customers with a supply point capacity of

above 3,750kWh and consumption level above 73,000kWh.

Regulated tariff formula (RTF): annual consumption of between 5.5GWhs and 264

GWhs.

8 suppliers compete across 4 market segments in the supply of natural gas in Ireland. In

the domestic market in 2012, BGE had a very large market share. This share is falling in

line with CER targets however, and was significantly lower at year end 2013 as discussed

in detail below. In the IC market of 22,949 customers, BGE supplied 10,677. In the FVT

market BGE supplied 589 of 1,750. Although Vayu and Energia hold a larger market

share in the RTF market as a percentage of the 246 customers, BGE supplied the largest

volume of natural gas (1,194 GWhs or 21.09% of total volume). Across all deregulated

market segments BGE faces ever increasing competition and declining market share

however it remains dominant as the markets largest supplier (CER 2013).

Table 4: Market Share of Natural Gas Suppliers as a Percentage of Customer Numbers across Market

Segments

Domestic IC FVT RTF

Bord Gis

Energy 65.65% 46.52% 33.66% 19.51%

Airtricity 17.14% 5.29% 2.63% 9.76%

Electric Ireland 12.38% 2.92% - 4.07%

Flogas 4.83% 25.65% 22.34% -

Energia - 17.14% 19.77% 21.54%

Vayu - 2.46% 21.20% 31.71%

Phoenix - - - 7.72%

Gazprom - - - 5.69%

Others - 0.01% 0.40% -

Total 100% 100% 100% 100%

Source: CER Electricity and Gas Retail Markets Annual Report 2012

4.4.4 Price Regulation in the Residential Supply Sector

Policies which have liberalised and deregulated areas of Irelands market for natural gas aim

to maximise social welfare through competition. These policies are premised on the

assumption that the firms operate within a perfectly competitive market. The following

section analyses the residential market for the supply of natural gas in Ireland, detailing the

suppliers in operation, their market share as of December 2013 and the switching rate

39

between them to assess if there exists an appropriate level of competition for the successful

divestiture of Bord Gis Energy into a deregulated market (CER 2014).

The Irish natural gas market was fully liberalised in 2007, however new entrants had existed

since 2004. All areas of the market are now deregulated except residential supply. The

Commission for Energy Regulation (2014) has outlined three criteria that must be met before

it ceases to regulate prices set by BGE in this market:

BGE must hold less than 55% of the market share of residential gas supply.

There must be 3 (2 non-BGE) suppliers in the market with more than 10% of the

market share of residential gas supply.

Consumer switching rates between natural gas suppliers should be greater than 10%

per year.

Source: CER Review of the Regulatory Framework for the Domestic NDM Retail Gas Market Competition

Review December 2013

As illustrated in Fig. 2, 2 of the CERs criteria for full deregulation of the natural gas sector

in Ireland have been met. There are 3 suppliers, BGE, Electric Ireland and Airtricity, with a

market share in excess of 10%. Furthermore, the consumer switching rate for the year 2013

was 17.33%. However, BGE hold a market share of 57.23% at year end 2013, in excess of

the 55% threshold for deregulation. As such, BGEs decisions of supply and price setting are

57.23%

20.32%

17.33%

5.12%

Fig. 2 Market Share of Residential Natural Gas Supply

BGE

Electric Ireland

Airtricty

Flogas

40

non-negligible. It holds market power in an imperfectly competitive market for residential

supply.

Table 5: Irish Residential Gas Prices to Residential Consumers at Purchasing Power Parity (all taxes

included) (1st Semester 2013) EU Comparison

Residential Consumption Bands Price /kWh Relative to EU average

2013 Semester 1

Consumption < 20 GJ 6.58 75%

20 GJ < Consumption < 200 GJ 6.04 93%

Consumption > 200 GJ 5.77 93%

Source: Eurostat 2014

Currently, BGEs residential gas prices are competitive relative to the EU average as

evidenced in Table 5. Privatising BGE in such a scenario will require stringent regulation to

guard against BGE abusing this market power (CER 2014) and increasing prices across the

market. However, the effectiveness of Irelands current regulatory agencies has been

questioned, notably in the Report of the Review Group on State Assets and Liabilities;

The Review Group recommends that a comprehensive review of the legislation

governing economic regulatory agencies be undertaken and that necessary legislative

amendments be enacted prior to any state disposals.

(McCarthy et al 2011)

4.4.5 Business Performance

Bord Gis Energy is a profitable, commercially viable SOE. Fig. 3 graphs BGEs EBITDA

growth from 2009-2012. BGE have performed strongly throughout Irelands economic

downturn, despite facing volatile markets for wholesale gas and electricity and decreasing

consumer demand. BGE successfully entered the electricity supply market in 2009 (Bord

Gis ireann 2010), pioneering the dual-fuel supply model in Ireland. Although they have

faced significant competition in both markets, BGE has consolidated its market share in

electricity supply and remain dominant in the supply of gas as discussed previously. BGE

experienced a large increase in EBITDA in 2012, up to 79.4 million from 44.3 million in

2011. This increase is largely attributed to increased retail performance as a result of a

reduction in costs, a lowering of discounts having established themselves in the electricity

supply market and an increase in residential gas tariffs of 8.5%. BGEs strong financial

performance has made a significant contribution to Bord Gis ireanns ability to pay a

dividend of 23.8 million to the exchequer in 2012, bringing the total dividends paid since its

41

inception in 1976 to 854 million. BGE employed 453 individuals in 2012 (Bord Gis

ireann 2013b).

Fig. 3 BGE Operating Profit before Depreciation and Amortisation (EBITDA) 2009-2012

Source: Bord Gis ireann Annual Reports (2009-2012)

Beyond being a source of dividend and employment for the exchequer and economy

respectively, BGE fulfils wider social aims. Throughout the economic downturn, BGE has

worked closely with government agencies and non-profits such as Saint Vincent de Paul,

ALONE and MABS to ensure energy is supplied to vulnerable customers who struggle to

meet their payments. It has facilitated flexible payment plans and deems cessation of supply a

very last resort, only to be undertaken when all other avenues have been exhausted (Bord

Gis ireann 2010, 2011). Also, BGE plays an important role in the development of new

energy technologies. It has committed capital and resources to the Irish Energy Research

Centre and the Irish Maritime and Energy Resource Centre, contributing 1.5 million to the

latter for the construction of new premises (Bord Gis ireann 2013b).

In the absence of a full cost-benefit analysis of the divestiture, this paper can only observe

that BGE will cease to contribute to Bord Gis ireanns dividend to the state and that no

commitment has been made to retain BGEs staff. These employees however, will benefit in

the short-run from the sale of their employee share ownership plan which sees them hold a

stake of 3.27% of the company (Bord Gis ireann 2013b). Uncertainty prevails over a

20

30

40

50

60

70

80

90

2009 2010 2011 2012

EB

ITD

A

'mil

lion

Year

42

privately owned BGEs policy regarding universal access, consumer debts and BGEs

commitment to the research and development of new technologies.

4.5 The Sale Process to Date

Labours pre-election opposition to privatization has waned, and two Labour Party TDs now

preside over the sale; Minster for Public Expenditure and Reform Brendan Howlin and

Minister for Communications, Energy and Natural Resources Pat Rabitte. Management of

Bord Gis ireann have co-operated with the sale of BGE, as acknowledged in Chairperson

Rose Hynes statements in Bord Gis ireanns annual reports in 2011 and 2012 Bord Gis

ireann 2012b, 2013b). However, it does not appear that the sale was advocated for by

management as it was, for example, in the case of T and Aer Lingus.

The timeline of the sale process to date is as follows:

22 Febraury 2012: Government initially announces its plans to sell BGE, indicating

that the sale would only take place