Regulation in a context of limited competition: A port case

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Transportation Research Part A 42 (2008) 762–773

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Regulation in a context of limited competition: A port case

Enzo Defilippi a,*, Lincoln Flor b

a Instituto del Peru, Av. Javier Prado Oeste 580, Lima, Peru; and Center for Maritime Economics & Logistics (MEL),

Erasmus University Rotterdam, P.O. Box 1738, 3000 DR Rotterdam, The Netherlandsb Organismo Supervisor de la Inversion en Infraestructura de Transporte de Uso Publico (Ositran), Av. Republica de Panama 3659,

San Isidro, Lima, Peru; and Pontificia Universidad Catolica del Peru, Av. Universitaria 1801, San Miguel, Lima, Peru

Received 14 November 2005; accepted 1 January 2008

Abstract

This paper explains the rationale of the regulatory framework developed by the Peruvian regulator for transport infra-structure, using the 2004 Price Review at Matarani port as an illustration. This framework is worth analyzing for severalreasons: (i) it ensures that prices are regulated only where competition cannot be introduced; (ii) the regulatory frameworkis common to all transport infrastructures; (iii) experience in port regulation using RPI-X methodology is scarce; and (iv),the market is characterized by low levels of demand and limited competition. In addition, he results of the price reviewsuggest that in contexts characterized by institutional limitations and limited competition, estimation of a retrospectiveX factor using the TFP technique is recommendable. Likewise, if the industry is dominated by state-owned firms, the X

factor should be estimated using data from the concessionaire rather than from the industry. Other recommendationsare also formulated.� 2008 Published by Elsevier Ltd.

Keywords: Port economics; Regulation; Concessions; Access; RPI-X; Limited competition

1. Introduction

Over the last two decades, many developing countries have implemented structural reforms resulting inincreased private participation in the supply of public services, especially in energy and telecommunications.Private involvement in other infrastructure industries such as transport and water has been, however, lesscommon.

During the 1990s, motivated by the scarcity of public funds and the urgency of upgrading the country’stransport infrastructure, the Peruvian government decided to concession the most important ports, airports,railroads, and highways to the private sector. In parallel, a regulatory agency, (Ositran) was created with themission of regulating remaining monopolies in the sector.

0965-8564/$ - see front matter � 2008 Published by Elsevier Ltd.

doi:10.1016/j.tra.2008.01.009

* Corresponding author. Tel.: +511 221 8722.E-mail addresses: [email protected] (E. Defilippi), [email protected] (L. Flor).

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mailto:[email protected]

E. Defilippi, L. Flor / Transportation Research Part A 42 (2008) 762–773 763

Although the Peruvian concession program has been almost completely stopped since 2001, Ositran havebeen able to develop a regulatory framework which has the aim of facilitating further private investment byimproving the predictability of its decisions. In 2004, the regulator used the new framework to review regu-lated prices charged at Matarani port, the second most important in the country and the only one conces-sioned to the private sector.

The goal of this paper is to explain the rationale of the regulatory framework developed by Ositran, usingthe 2004 Price Review at Matarani port as illustration. Both the framework and the review are worth analyz-ing for several reasons: (i) Ositran uses a sequential regulatory process, aimed at ensuring that the prices beingregulated correspond only to markets where competition cannot be introduced; (ii) the regulatory process iscommon to all transport infrastructures; (iii) experience elsewhere of port regulation using the RPI-X meth-odology is limited to three cases in Australia; and (iv), the price review was carried out in the context of lowlevels of demand and limited competition, common to many developing countries. Given the trend of increas-ing private provision of port services, the authors consider that this rationale may provide guidelines for reg-ulators facing similar problems.

The remainder of the paper is structured as follows. The next section presents the rationale for regulationand explains the mechanisms used to intervene in monopolistic markets. The third section describes the pro-cess used to regulate port services in Peru, while the fourth analyzes the 2004 price review and the dilemmas itposed to the regulator. The last section contains the conclusions of the paper.

2. Regulatory rationale and options

2.1. Regulatory rationale

According to the two fundamental theorems of welfare economics, competitive markets lead to an efficientallocation of resources. However, market failures such as externalities, natural monopolies and informationasymmetries may impede the achievement of efficiency through competitive mechanisms. From a normativeperspective, these cases call for government intervention (Lasheras, 1999; Guasch and Spiller, 1998).

The presence of natural monopolies is one of the failures that warrant economic regulation in some trans-portation markets. If left unregulated, monopolists have incentives to maximize benefits by restricting thequantity of the services sold, causing negative consequences to the rest of society.

According to Baumol et al. (1982) natural monopolies occur in industries where cost functions are sub-additive, i.e., for a relevant demand interval, production is cheaper with only one firm in the market. Thischaracteristic is produced by the presence of economies of scale, scope or density, and constitutes a sufficientcondition for the existence of a natural monopoly.

Ports, therefore, may become natural monopolies when demand is insufficient to exhaust the large econo-mies of scale present in their cost functions, as often occurs in developing economies. In these circumstances,competition from a second port or terminal may be undesirable, since it would increase costs for both firmsand the users.1 But just as intervention is required in the presence of markets failures, regulation may also fail,due principally to three causes: (i) information asymmetries between regulators and the regulated firms aboutthe characteristics of demand, technology and costs; (ii) lack of regulatory commitment that may result in theexpropriation of assets due, for example, to politically-motivated pricing; and (iii), regulatory capture that mayresult in decisions biased towards the interests of the regulated firm or a determined lobbying group. Becauseof these failures, plus the additional costs of implementing regulations, government intervention may result inhigher economic costs than those caused by market failures themselves.

For these reasons, the guiding principle when designing regulatory processes is that regulation is only war-ranted when competition is impossible or undesired and the benefits of regulation are higher than its costs.

1 For example, analyzing the viability of concessioning Callao port in Peru, Defilippi (2004) found that although preferable, a multi-operator scheme was not possible without incurring a subsidy.

764 E. Defilippi, L. Flor / Transportation Research Part A 42 (2008) 762–773

2.2. Regulatory mechanisms

When regulation is warranted, its aim should be to eliminate the barriers that impede the functioning ofcompetitive markets; or, if this is not possible, to replicate the discipline that market forces would imposeon the regulated firm if they were present. To achieve these goals, regulation is based on two mechanisms:(i) regulation of how firms access the facilities they need to compete in the market (access regulation); and(ii), regulation of prices and quality of service (price regulation). Both mechanisms have the objective of inter-nalizing negative externalities and maximizing the sum of producer and consumer surpluses, but price regu-lation is more costly. It requires unbiased decision-making processes that are difficult to implement, andlarge amounts of information that is hard to collect. In developing countries, the weak institutional contextunder which many regulators operate may make price regulation even more costly.

Acknowledging that price regulation is more prone to spawn market distortions than access regulation, anormative analysis suggests that regulators should implement disciplined processes aimed at promoting com-petition in as many markets as possible, enforcing price regulation only in the residual ones.

2.2.1. Access regulation

Even when a port or terminal constitutes a natural monopoly, it is possible to introduce competition in themarkets for complementary services: pilotage, towage, mooring, warehousing, etc. However, since the monop-olist that controls the port has incentives to restrict competition to recover the rents foregone as a consequenceof price regulation, access regulation is required to set the conditions under which competing firms may use thefacilities controlled by the monopolist. Efficient prices would then be set by market forces.

Access regulation is preferred to price regulation because it promotes competition among the operators andhas lower intervention costs. A theoretical principle commonly used to regulate access is the ‘‘Essential Facil-ities Doctrine”, under which a firm with substantial market power must grant access to its facilities to theircompetitors under ‘‘reasonable” conditions. In the United States and the European Union, this doctrine isapplied in court-based Antitrust Law. In Australia, however, the National Access Regime restricts the useof this principle to monopolies within industries of national importance, and is applied not by the courtsbut by administrative bodies. Under the Australian regime, monopolists and potential entrants negotiateaccess conditions directly. The regulator only intervenes when the parties are unable or unwilling to reachan agreement or to settle disputes.

2.2.2. Price regulation

The second and most common mechanism for market intervention is price regulation. Although the last 20years have witnessed an evolution of price regulation methodologies, two remain the most used: rate-of-returnand price-caps. The rate-of-return methodology consists of the regulator setting prices so that the regulatedfirm earns a fair return on its capital investments. Prices must satisfy the following condition:

XN

i¼1

piyi ¼ CðY Þ þ gI

where ‘‘g” is the permitted return on investments and ‘‘I” represents the investments which will earn such areturn. It has three components: (i) the rate base, (ii) the rate level and (iii), its structure. The rate base com-prises those investments that will be allowed to earn a return, the rate level refers to the relation of overallrevenues to costs and the rate structure refers to the individual prices charged for different services to differentconsumers. Guasch and Spiller (1998) argue that rate-of-return regulation suffers from three major problems:

(a) It provides little incentive for productive efficiency, since it allows firms to pass increased productioncosts on to consumers in the form of higher prices.

(b) Since the firm is assured a return on its capital investments, it leads to excessive investment and use ofcapital (the ‘‘Averch–Johnson Effect”).

(c) The regulator needs a high degree of discretion to implement it. This facilitates regulatory capture byregulated firms, thus inducing rent-seeking behavior from monopolists.


Furthermore, these problems are exacerbated in an environment characterized by high inflation. Since theuse of this methodology requires time-consuming asset revaluations, prices will tend to lag behind costincreases unless regulated prices are reviewed frequently or mechanisms for building in expected future infla-tion are incorporated into the formula.

Under the second price-regulation methodology price-caps are calculated according to the RPI-X method-ology. This methodology consists on setting maximum prices for a period, allowing monopolists to raise theirprices in future periods at the rate of the inflation minus some amount (the ‘‘X factor”) chosen to reflect pro-ductivity gains of the industry over the economy as a whole. The X factor is calculated according to the nextequation (Bernstein and Sappington, 1998):

X ¼ ðdW � dWEÞ þ ðIPE� IPÞ
where dW is the change in the price of the inputs used in an industry; dWE is the change in the price of all ofthe inputs used in the economy; IPE is the change in productivity of the economy, and IP is the change inproductivity of the industry.
Price-cap regulation provides incentives for cost-cutting, since the firm may keep cost savings until the endof the review period. In this way, a profit-maximizing monopolist will have an incentive to operate efficientlyand the benefit will be passed on to consumers in the form of price reductions at the next review period. Theperiod is set according to the technological nature of the industry. For example, price reviews in technolog-ically dynamic industries such as telecommunications are expected to occur more often than in the transportindustry, where technological change is slower.

It is worth noting that unlike rate-of-return regulation, the price-cap methodology usually sets prices togenerate enough revenues to cover expected costs, not to recover actual ones. In this way, it provides incen-tives to reduce costs and achieve productive efficiency. Its main disadvantage, however, is the so-called‘‘ratchet effect”, i.e., the lack of incentives to obtain productive efficiencies when the period between pricereviews is too short.

A variation of this methodology is the use of a global price-cap, which consists of setting a price ceiling inthe form of a weighted average for the services produced by the monopoly. Given that the monopolist pos-sesses better information about the characteristics of demand than the regulator, it is allowed to chooseany combination of prices that matches the needs of its customers, as long as the weighted average doesnot exceed the global price-cap. This approach has the advantage that when operating properly, the regulatedfirm has an incentive to choose Ramsey prices without the need for the regulator to estimate demand functions(Laffont and Tirole, 2000). However, it may facilitate predatory pricing when some of the markets supplied bythe monopolist are contestable ones.

Price-caps are the most common form of regulation in Europe for privatized gas, telephone, electricity andwater industries, and are also the methodology used in Australia, Puerto Rico, Singapore and several coun-tries in Latin America. In the United States, price-caps have been used by the Federal Communications Com-mission to replace rate-of-return regulation in telecommunication markets. In the port sector, however, RPI-Xregulation has been limited to only three cases in Australia.

A less common regulation methodology is the so-called regulation by the efficient firm, used in Chile in thetelecommunications, electricity and water industries. Under this methodology, prices are set according to thecosts that a hypothetical firm would have if it were operating efficiently. The problem with this methodology isthat in theory, the regulator should have enough information to estimate efficient costs avoiding the use ofdata supplied by the regulated firm. In practice, however, prices cannot be set without information providedby the regulated firm, so there is always a risk that the hypothetical firm will end up with a cost structure verysimilar to the real one, thus reducing the incentive to operate efficiently.

3. Economic regulation of Peruvian ports

3.1. Institutional background

During the early nineties, the Peruvian government began a series of market-oriented reforms aimed atimproving economic efficiency and liberating public funds by promoting private provision of some public ser-


vices. Along with a program of economic liberalization and institutional reform, the government embarked ona large-scale privatization program. Although it was successively delayed and eventually stopped, the govern-ment was able to transfer most of its entrepreneurial activities to private firms. Among others, all state-ownedfirms in the telecommunications sector and most of the key assets in the electricity industry were privatized by1995.

The process of institutional reform also aimed to change the role of the government in the economy, fromdirect service provider to regulator of economic activities. Consequently, a strong antitrust agency was cre-ated, along with regulatory bodies for the industries where monopolies remained: telecommunications, energy,water and transport. In the port sector, a privatization committee was created as early as 1992. The first stepwas to concession two ports (Matarani and Ilo) located in the south of the country, but given the low tradevolumes that regional economies can sustain, common-user ports constitute natural monopolies. Therefore,their concessioning could not be carried out until an appropriate legal framework had been created to regulatethem.

This legal framework was finally created in 1998, when Ositran was established. Since then, the agency hasgradually developed a regulatory framework aimed at improving the predictability of its decisions and reduc-ing the risks of taking a concession. Two legal tools are worth noting: the ‘‘Methodological Guidelines for theReview of Regulated Prices” (Ositran, 2002); and the ‘‘Access Regulation” (Ositran, 2003). These complemen-tary regulations apply to all transport infrastructures and favor the use of market mechanisms over adminis-trative decisions wherever possible.

The Methodological Guidelines make explicit the exceptional nature of price regulation and establishthe regulatory principles to be used to set regulated prices.2 They also explain the alternative pricingmethodologies that can be used3 and the criteria to decide the context in which different methodologieswill be used.

The Access Regulation uses the Essential Facilities Doctrine as a criterion for deciding which servicesrequire regulation, and gives preference to market mechanisms (through negotiation or auction) to setthe price and conditions upon which access will be granted. According to Flor and Defilippi (2003), thisRegulation is based on the theoretical contributions of Coase (1960) and Demsetz (1968). The ‘Coase The-orem’ indicates that if property rights are well defined and transaction costs sufficiently low, direct negoti-ations between the parties will lead to a better resource allocation than government intervention. As in theAustralian regime, Ositran acts as an arbitrator when the parties are unable or unwilling to reach anagreement.

In exceptional cases where access has to be limited to one or a few service providers (because of physicalspace, safety, or other reasons) and there are more interested parties than available infrastructure, access isgranted through an auction. According to Demsetz (1968), with symmetric information among the biddersand the absence of collusion, an auction would make access charges approach the average cost of the mostefficient firm, thus minimizing productive and allocative inefficiencies simultaneously.

3.2. The regulatory process

The logical process used to regulate transport infrastructure in Peru is aimed at reducing regulatory risks byintroducing a discipline which ensures that the markets being regulated are only those where competition can-not be introduced. It follows the sequential order illustrated by Fig. 1.

The process to determine which services will be regulated and under which mechanism is based on asequence of options. If a port service has been declared essential, the regulatory option to be exercised isthe access regulation. Once this option has been selected, the mechanism for granting access (negotiationor auction) will depend on the criteria described earlier.

2 The regulatory principles established in the guidelines are: sustainability of the supply, efficiency, equity, non-discrimination,transparency and cost-benefit.

3 The alternative pricing methodologies are: marginal cost pricing, rate-of-return regulation, Ramsey pricing, incremental costs, price-caps and benchmarking.

Direct Negotiation

Yes Access Regulation is applied

Auction

Is the port service an "essential service?

Yes Market is deregulated

NoDoes the service face effective competition?

No Price regulation

Phase IIIPhase I Phase II

Fig. 1. Selection of the regulatory mechanism.


According to the Access Regulation the following port activities are considered essential services, sinceessential facilities have to be used to provide them and they are necessary to complete the transport chain4:

(a) Maritime transport of cargo and passengers;(b) Pilotage;(c) Towage;(d) Mooring;(e) Stevedoring;(f) Cargo transfer (within the port);(g) Fuel supply;

The second regulatory option corresponds to activities not declared essential services because are eithercompetitive without the safeguards of the Access Regulation or plainly monopolistic. The criterion to differ-entiate among them is the question: does the service face effective competition? If the answer is no, the serviceis regulated according to the principles and methodologies contained in the Methodological Guidelines. If theanswer is yes, the market is deregulated.

The administrative procedure has been designed to reduce information asymmetries and to legitimate reg-ulatory decisions. The concessionaire first submits a proposal, which is used as an input to the regulator’sdraft. This draft is published to obtain comments from interested parties. After a final decision is made, a briefcontaining the essence of the comments and the reasons why they were not taken into account must bepublished.

4. The Matarani port concession and the 2004 price review

4.1. The Matarani port concession

The port of Matarani was concessioned in 1999 to the Romero Group, the most important Peruvian busi-ness conglomerate, which founded the firm TISUR to operate the port. All other common-user ports remainstate-operated, including Callao, the most important one.

The port of Matarani, although small, is the second most important in Peru. It consists of a multi-purposeterminal with three berths. It was concessioned for a period of 30 years under a Build-Operate-Transferscheme. The concession contract specified price-caps for a number of services and established procedures

4 The Access Regulation considers the following as port’s essential facilities: wharfs, berths, cranes, conveyor belts, pipelines andmaneuvering areas, among others.


for their review after five years. The contract explicitly forbids cross-subsidies and establishes the principles ofnon-discrimination and neutrality for commercial activities.

The development plan to be implemented by the concessionaire reflected the common belief that a special-ized container terminal had to be developed in the port. However, two events changed the nature of demandand forced a renegotiation of the contract in 2001. The first was the acquisition of the main manufacturerslocated in the hinterland by firms which decided to consolidate operations in another region. This event almosteliminated the forecast demand for container-related services.

The second event was the development of the Bolivian grain market by TISUR. When the port was con-cessioned, its hinterland was limited to the region of Arequipa and immediate surroundings, and almost all ofthe grain transferred to and from Bolivia was handled through Chilean ports. However as a result of aggres-sive commercial marketing the amount of Bolivian grain handled at Matarani grew from 160,000 tonnes 1999to 522,000 tonnes in 2003 (Ositran, 2004b).

The development of the Bolivian market also had consequences for the port’s regulated commercial regime.To be able to compete with the Chilean port of Arica, TISUR had to offer rates which were lower than thosecharged to captive local customers (the maximum specified in the concession contract). Since this could beinterpreted as discriminatory treatment of customers, the opinion of the regulator was required. Ositran ruledthat this differentiated treatment did not constitute discrimination, basing its decision on two criteria: (i)Southern Peru and Bolivia constitute two different markets; and (ii) increased use of the port’s facilities wouldbenefit Peruvian consumers by diluting fixed costs.

4.2. The 2004 price review

The concession contract specified the maximum prices that could be charged for the provision of servicesand the use of the infrastructure listed in Table 1.

It is worth noting that as is common in many developing countries, the regulatory framework reflected inthe Matarani concession contract was different to the one later developed by the regulator. This fact further

Table 1Prices regulated by the concession contract

Marine services

PilotageTowageMooring (berthing/unberthing)BerthageComplementary services (energy, water, etc.)

Ancillary services

Special services to REEFER containersSurcharge for handling dangerous goods

Warehousing

Grain storage in silos (from 11th to 20th day)

Wharfage

Break bulk – generalBreak bulk – food, fertilizer and fishmealRolling cargoDry bulk – grains > 400 MT/hrDry bulk – grains < 400 MT/hrDry bulk – mineral oreLiquid bulk40 in. full containers20 in. full containers40 in. empty containers20 in. empty containers


complicated the price review, as concession contracts in Peru have higher legal status than Ositran’s regula-tions; a measure intended to avoid the problem of regulatory commitment.

The first phase of the regulatory process consisted of assessing which of the activities listed in Table 1 hadbeen declared essential services. They were pilotage, towage and mooring, for which they had to be subject toaccess regulation. However, since the concession contract granted the concessionaire the exclusive right to sup-ply mooring services, this activity was subjected to price regulation instead.

To assess which of the remaining services were to be further regulated or deregulated it was necessary toanalyze if they were subject to effective competition from other ports or modes of transport. It was found thatthe only cargo for which the port faced effective competition was containerized cargo, so wharfage and ancil-lary services for this freight were deregulated (Ositran, 2004a).

Using the criteria established in the Methodological Guidelines, Ositran selected the RPI-X methodology toset the new maximum prices for the services for which the port did not face competition. There were, however,two exceptions worth mentioning.

The first related to differences in the maximum wharfage rates to be charged for downloading grain. Thesewere set at US$ 4.20 or US$ 2.50 per ton depending on whether the port’s equipment resulted in a handlingrate higher or lower than 400 tonnes/h, respectively. This mechanism was intended to give the concessionairean incentive to invest in elevators and related equipment; given that the handling rate was well below 400 ton-nes/h at the time the port was concessioned. As the port had started to operate above the higher threshold onlysome months before the price review, Ositran decided not to modify it, subjecting to regulation only the lowerrate.

The second exception was the wharfage rate for handling break bulk cargo. The rate for this service was setat US$ 7.00 per ton, with the exception of food products, fertilizers and fishmeal for which the maximum pricewas set at US$ 3.50 per ton, an inexplicable difference of 50%. Ositran decided to correct this distortion byeliminating all exceptions, and to set a new price using benchmarking.

Table 2Results of the 2004 price review at Matarani port

Services Regulation Mechanism

Ship services

Pilotage Access regulationTowage

Mooring/unmooring RPI-XBerthing

Complementary services Deregulation

Wharfage

Break bulk – general cargo Price SettingBreak bulk – food, fertilizer and fishmeal

Rolling cargo RPI-X

Dry bulk – grains > 400 MT/hr Concession contract

Dry bulk – grains < 400 MT/hr RPI-XDry bulk – mineral oreLiquid bulk

4000 full containers Deregulation2000 full containers4000 empty containers2000 empty containers

Warehousing for grains (11th–20th day) RPI-X

Ancillary services

Special services to REEFER containers DeregulationSurcharge for dangerous goods


The analysis carried out by Ositran found that comparable ports in the area charged an average price ofUS$ 3.12 per ton of break bulk (Ositran, 2004a). It also showed that the average price received by TISURduring the first 5 years of the concession was US$ 3.83 per tonne. Paradoxically, most of the break bulk han-dled corresponded to products considered exceptions. Using this information, the regulator decided to set themaximum price of wharfage for break bulk cargo at US$ 3.50 per tonne.

Table 2 provides a summary of the new regulatory regime that resulted from the 2004 Price Review.

4.3. Methodological dilemmas of applying RPI-X

RPI-X is a well known methodology, but international experience of applying it to transport infrastructureis scarce and mainly focused on airports (Abbot and Wu, 2002). Moreover, calculation of the X factor is notstraightforward, and the result is affected by the instruments chosen by the regulator to estimate it.

The characteristics of the Peruvian economy, the context of limited competition under which the regulatedfirm operates, and the regulator’s own financial and institutional limitations forced Ositran to face the follow-ing methodological dilemmas to estimate the X factor for Matarani port:

4.3.1. Retrospective or prospective X

The X factor can be estimated either retrospectively or prospectively. In the first variation, known as theAmerican method, the factor is estimated using data from previous years and is set for a pre-announced period(4 or 5 years, depending on the rate of technological change of the industry). It implicitly supposes that pastdemand and cost trends will be continued into the future.

The prospective variation, called the English method, requires future changes in demand and productiontechnology to be forecasted, calling for more frequent price reviews. This can cause moral hazard, lack of cred-ibility and loss of predictability, resulting in higher regulatory risks. The information asymmetry about thefuture behavior of the regulated firm may reduce the efficacy of regulation, and may facilitate regulatory cap-ture in weak institutional contexts. Considering these arguments Ositran favored retrospective estimation ofthe X factor.

4.3.2. Choosing the estimation technique for the productivity index

To determine the productivity index for the port industry, three measurement techniques were evaluated: (i)total factor productivity (TFP); (ii) data envelope analysis (DEA); and (iii) stochastic frontier analysis (SFA).DEA and SFA are more sophisticated than TFP. DEA allows productivity to be disaggregated into its compo-nents, whilst SFA allows recognizing environmental variables, but TFP is a transparent technique that can alsobe audited. Another desirable element of TFP is that it requires less data to operate. As the data available werelimited to five years, the use of average variations to estimate trends reduced the number of observations to four.

Ositran considered that in a context of weak institutional development, simplicity and credibility consti-tuted more desirable features that complexity or precision, for which it decided to use TFP. This is definedas the ratio between the weighted sum of the outputs (Q), and the weighted sum of inputs (Y):

TFP ¼P

aiQiPbiY i

The coefficients ai and bi are the weighted values of the outputs Qi and inputs Yi.The rate of growth is given by the follow equation:

DTFP ¼ D ln Q� D ln Y

Q and Y are the aggregated output and input respectively. Logarithms were introduced to calculate the ratesof variation.

4.3.3. X factor for the industry or the firm

The standard RPI-X mechanism is based on estimating the X factor for the industry. However, in Peru allcommon-user ports but Matarani are operated by a state-owned firm, whose incentives for efficiency are notcomparable with those of a private firm.

Table 3TPF and X factor under different initial capital stock definitions

Definition Initial capital stock TPF (%) X-factor (%)

Book value in 1999 US$ 6.3 MM �1.64 1.47Present value of the concession rights US$ 13.5 MM �0.02 3.30Replacement value US$ 17.5 MM 0.69 4.16


In this context, estimating the average increase in productivity for the Peruvian port industry as a wholemay lead to an underestimation of the X factor. This would allow the concessionaire to preserve monopolisticrents, since not all productivity gains would be passed on to the consumers. For these reasons, Ositran favoredestimation of the X factor for the firm.

4.3.4. Determination of the initial stock of capital

One of the most controversial inputs in the determination of the TFP is the change in the aggregateinput of capital. This index requires knowledge of the stock of capital the port had when it was initiallyconcessioned. Accurate estimation of the initial figure is critical, since its underestimation leads to an over-estimation of the increase of capital, and thus to an underestimation of TFP and the X factor. However,the determination of the initial stock of capital is very sensitive to the methodology used, as shown in theTable 3.

The main problem of using books values to estimate initial capital stock is that they are based on account-ing methods which do not reflect the revenue-earning potential of the assets, especially when they are long-lived. As seen in Table 3, the use of book values would lead to a negative TFP, which is inconsistent withthe efficiency improvements introduced by the concessionaire and shown in the port’s productivity indicators.

A more market-based approach to calculating the initial capital stock is to discount and sum the paymentsfor concession rights the concessionaire has to disburse during the life of the concession. This figure effectivelyreflects the commercial value the assets had when the port was concessioned, but since concession rights arecalculated as a percentage of the concessionaire’s revenues, this option requires forecasting traffic, costs anddemand for at least 25 more years. The likelihood of an error is thus very high.

A third way to estimate the initial capital stock is through an appraisal of the replacement value of theassets made by a specialized independent firm.5 It can be argued that the results would probably vary accord-ing to the appraiser, but this methodology would yield a narrower range of outcomes. For these reasons, thiswas the method accepted by the regulator.

4.3.5. The opportunity cost of capital

A measure called ‘‘the implicit price of capital” (kpi) is used to determine the implicit value of each asset inperiod t. The implicit prices of assets and stocks are then used to determine the variation of the capital factorthrough the Tornqvist Index.

To estimate the kpi, Ositran used the formula developed by Christensen (2001) for the Peruvian telecom-munications regulator, which is a function of income tax (t), the price of the asset when it was acquired (q), thedepreciation (d) and the firm’s opportunity cost of capital (r):

5 Ta

kpi ¼ ½1=ð1� tÞðqtdþ qt�1 � r � DqÞ�
The weighted average cost of capital (WACC) was used as a proxy for r. The formula for the WACC is:
WACC ¼ rE �E

E þ D

� �þ rD � ð1� teÞ �

DE þ D

� �

where E is equity, D is the debt, rE is the opportunity cost of equity, rD is the cost of the debt and te is thecorporate tax rate. In the absence of market values, the capital structure reported in financial statements isused to calculate the WACC.

mayo and Barrantes (2004) suggest using this figure in absence of a more precise one.


In turn, the capital asset pricing model (CAPM) is used to calculate rE:

rE ¼ rf þ b � bðEðrmÞÞ � rfc
where rf is the risk-free rate, E(rm) is the expected yield of the market; r[(E(rm)) � rf] is the risk premium and bthe systematic risk of the capital. This formula was chosen because it constitutes a standard methodology ininternational finance.
The WACC for the port of Matarani was calculated for each year between 1999 and 2003 and averaged12.1%. The 30-year United States Treasury bond was used as a proxy for rf; and the yield of the S&P 500as the risk premium. Since Matarani port is not listed in the capital markets, the leverage betas were obtainedfrom a sample of ports located in New Zealand and the United Kingdom and later adjusted for long-termconvergence. The betas were also adjusted to reflect the scale of operations of the ports used as benchmarks,given that small ports generally bear higher risks (Ositran, 2004a).

At the end, the X factor for the 2004 price review was estimated at 4.16% per annum.

5. Conclusions

The regulatory framework used in Peru applies to all transport infrastructures and favors the use of marketmechanisms over administrative decisions. The process used to determine how services will be regulated issequential. Those declared essential services are subject to the access regulation, while those not facing effectivecompetition are regulated using one of the methodologies established in the Methodological Guidelines.

The results obtained from the 2004 Price Review at the Matarani port suggest that in contexts characterizedby institutional limitations and limited competition, estimation of a retrospective X factor using the TFP tech-nique is feasible. In addition, if the industry is dominated by firms facing an incentive structure not consistentwith that of a private firm, the X factor should be estimated using data from the concessionaire rather thanfrom the industry.

This experience shows that it is recommendable for governments to determine the value of the assets to beconcessioned beforehand, and that the estimation of the cost of capital is done using known methodologies todiminish the likelihood of future controversies.

Acknowledgements

This paper is a revised version of the paper that was presented at the International Association of MaritimeEconomists XII Annual Conference held in Limassol, Cyprus on June 2005. The authors would like to expresstheir gratitude to the referees and other colleagues for their useful comments made on the earlier draft of thispaper.

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Regulation in a context of limited competition: A port case

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