How to privatise ports, the Australian way

How to privatise ports, the Australian way

Every country in the world views their ports as critical to their ability to trade with other nations. This is especially true of Australia, an island country with no land bridges to other nations. Port infrastructure was always considered to be of utmost strategic importance to the wellbeing of the nation. However, building and maintaining large strategic assets like ports has a downside – it is expensive, and unlike the roads, hospitals, schools, airports, or even rail, the value of ports investments doesn’t register highly with the voters.

Lo and behold, as pressure on the government budgets increased, the state governments chose various paths to monetise their port assets. What is currently happening in many Australian ports provides some interesting lessons on port privatisation strategies, port regulation, port authority landlord models, terminal concessions, and service pricing strategies.

How much money did they offer?

No government will debate an offer of money in exchange for an asset that it isn’t their priority. In the bidding frenzy for Australian port assets, nobody considered why the bidders were offering unreal sums of money. Every additional billion dollars above the “estimated” value of the asset was seen as a bonus to the state treasuries. Instead of looking at the overall logistics situation of getting goods in and out of the country, each port sale or concession was viewed only in the context of each particular port. The port privatization scenarios described below will play out in many countries considering getting out of public ownership of port assets. It is worthwhile to know what could happen if the details of those deals are not thought through.

After you sell it, can the new owners behave any way they want?

There is nuance to every decision that a government takes to privatising public assets. That nuance lies in the balance between too much or too little regulation after the deal has been signed. The most likely area of regulation or oversight is the pricing of access to that asset to prevent the new owner from potentially gouging the market for the benefit of its shareholders. Regulate too much, and you disincentivise the owner from investing into properly maintaining and/or improving the asset. Regulate too little or not at all, and you risk monopolistic market behaviour from the new owner.

Whose channel is it after all?

One look at the map of eastern Australia shows two principal centers of economic activity benefiting from ports – Sydney (state of New South Wales) and Brisbane (state of Queensland). Between the two lies the city of Newcastle (state of New South Wales). The Newcastle port is primarily a bulk port serving coal exporters located in the region to the west of the port. Container ship calls produce an annual volume 40,000 TEUs, mostly serving break bulk agricultural exports. Unlike the container trade, there is no other viable bulk port alternative to Newcastle. Not viewed as strategically important as the container ports of Sydney and Brisbane, the port was offered for sale in 2014. The price of AUD 1.75 billion (over 20 P/E) offered for the port was breathtaking. Whoever estimated the ROI from operating this port, probably assumed that any increase of prices to use the port would be borne by the rich mining companies, not by the consumer population of Newcastle and surroundings. Just in case the new owners wanted to expand the container operations, a little trick in the contract ensured that they would have to pay a penalty for “loss of business” to the owners of container terminals in … Sydney, 160 km to the south.

Fast forward to 2018-2019. The need for financial returns from the excessive investment drove the new owners to announce plans to remake Newcastle into a 1 mln TEU p.a. port, theoretically to handle volume spillover from Sydney, but practically, a competitor with lower lift charges than those demanded by the Sydney terminal operators. Along with the announcement came a request to the government to change the terms of the contract to eliminate the penalty of about AUD 100 that Newcastle port would have to pay to the port of Sydney for every container above the 30,000 p.a. threshold.

The government had none of it, so it was coal exporters turn to improve the owner’s rate of return. For every ship sailing between coal terminals and the open sea, the port established new “channel access” fees to recoup the cost of maintaining the channel. One regulator, and there are many, deemed the channel access fees to be fair at AUD 0.61 per gross tonne. Another regulator believes AUD 1.04 is fairer. The port believes in the price north of AUD 1.2. Who is to say that port owners are making too much money to operate and maintain the port to the highest standards?

Lesson for other governments privatising their ports? Be very clear in the sale contract on the regulatory regime you will apply, so that the owner can’t play one regulator against another when disputes, like that of price for port access, arise.

My costs are up, and so are yours

Most port landlords opt for competition when it comes to selling terminal operating concessions. Sometimes, not all concessions are as viable as others, but the higher good of ‘competition’ will always take the precedence. In the case of port of Melbourne, having 3 concessionaires was viewed as more competitive than having 2 concessionaires. Presumably, the government performed detailed analysis of the demand from the container carriers calling on Melbourne and decided that there would be enough volume to make all three terminals financially viable. With the successful auctioning of the first two concessions, the price fetched by the third concession didn’t raise any eyebrows.

If only the carriers were as cooperative. Facing three terminals vying for their business, the carriers gained incredible leverage in price negotiations effectively restricting the terminals in their ability to generate sufficient profits to pay the rent, the dividends to their shareholders, and to invest into much needed terminal modernisation. Interestingly, with the larger ships cascading down and calling on ports the size of Melbourne, the carriers also gained the flexibility of calling less frequently, one more factor that would play in lift and service rate negotiations with the terminals.

Hemmed in by the carriers, the three terminal operators turned their attention to other ways of increasing their revenues and margins. One by one, they discovered an “infrastructure access charge” which they promptly applied to trucking and rail companies delivering and evacuating containers in port of Melbourne. The terms of the concessions are most likely too vague to allow the government to intervene. The operators can easily explain that the surcharges will be used to fund some major capital works in a few years, so who is it to tell them that they can’t charge for it now and save the money for later projects.

The process of annual increases of that charge is quite familiar to observers of some other industries where the number of competitors in the market is constrained by the government. Every year, one of the competitors jacks up the price attracting the wrath of the logistics companies. The other two then follow saying that they have no choice, but to cover their increasing costs. The following year, another operator takes the heat, and the whole process repeats itself. Interestingly, it appears that all three operators have the same cost base, similarly efficient infrastructure, and the same productivity, as their infrastructure charges are more or less in line with each other. Understandingly, the logistics companies operating in port of Melbourne are not amused. On one hand, they are appealing to the state government for regulation of the prices the terminal operators can pass on to them in lieu of negotiating them with the sea carriers. On the other hand, no doubt, they are working hard to figure out the way to push that surcharge down the supply chain, where ultimately it will be picked up by consumers and exporters.

Lesson for other governments privatizing their terminals? Think about the form of competition you want to have in your port and how you expect all terminal operators to make money on the assets they paid well in excess of what’s rational.

A few parting words

This article is not judging whether privatisation of maritime ports and terminals is right or wrong. It merely points out some consequences of focusing on maximising the price of those assets without consideration to the excess or deficit of regulatory levers that can be applied for the life of the concessions.

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1 Comment

  1. Avatar
    Bruce Coatta
    December 20, 2019 at 11:57 pm

    Well said Kris Kosmala …