Policy Studies
No. 38 March
1999
ISRAEL’S ELECTRICITY MARKET
by
Yossi
Borochov
Introduction
The
overall loss to the Israeli economy resulting from the present structure of the
local electricity sector is estimated at
$524 million (1.853 billion NIS) per annum. This is mainly due to inefficiency
and high prices. According to Professor Daniel Tchimensky who headed a
committee examining the Israel Electric Corporation (IEC) monopoly, Israel’s
electricity monopoly does not operate efficiently,[1]
contains hidden unemployment of around 3,000 workers and should prepare for
privatization. David Milgrom, the budget director at the Finance Ministry also
stated that electricity distribution should be opened to competition.[2]
With respect to electricity, at least, there is a consensus among professionals
in the field that the IEC is both inefficient and a burden on the economy. The
time is ripe for comprehensive reform. The Israeli electricity sector is a
monopoly that controls production, transmission and the supply of electricity
to the public.
But
anyone who knows Israel’s socialist economy and its hidebound political system
realizes this is easier said than done. A brief review of IEC’s history, a
story much like that of all of Israel’s economy, explains why.
Electricity
was an integral component of the Yishuv economy from its first beginnings at
the end of the nineteenth century. Pinhas Rottenberg, a hydrological engineer
from Russia, together with Chaim Weizmann and Herbert Samuel, were the
principal movers behind the idea of electrification of the Jewish homeland.
Upon emigrating to Israel in 1919, Rottenberg began pressuring the British
Mandate government to obtain the concession for producing electricity and was
finally successful in 1925 (in fact two concessions were granted).[3]
During
the formative years of the then privately-owned Electric Corporation, it
encountered competition from private producers (mainly industrial factories).[4]
As the electric company developed it succeeded in overpowering all its
competitors, the last of which was the Jerusalem Electric Corporation. It
ceased to exist in 1987. How did the company become powerful enough to
overwhelm all its competitors and maintain its exclusive control of the sector?
The
answer can be found in the use to which the Electric Corporation’s employees
― over 13,000 of them ― have been put. Their power derives from
control over an essential source of energy. This power has been fully exploited
ever since the IEC became a government monopoly in 1953.
Like
other of Israel’s pre-State undertakings, the IEC passed from its stages of
private ownership into Histadrut (meaning Labour Party) control. In due course,
indeed five years after statehood, IEC became a State-owned enterprise (SOE).
It remains one today, boasting annual revenues in each of the last three years
(1995-1997) over $2 billion.
This Policy
Studies paper consists of six sections which include the historical
development of the electricity sector, a description of the electricity system
and a comparison of the electricity sector in Israel with that of other
countries, noting comparisons of structure and prices. The study also includes
a comparative financial analysis of the IEC. The last section offers some
recommendations for reform.
General Description of the Electricity Sector in Israel
The
electricity sector is one of the largest and most prominent segments of the
Israeli economy. Electricity is a factor of production necessary for the
operation of all sectors of the economy, including households, industry, agriculture
and financial concerns. Also, in security matters critical to the State, the
electricity sector is of paramount importance.
In 1923,
Pinchas Rottenberg established The Electric Corporation of the Land of Israel,
Ltd. He received two concessions from the British for a period of 70 years to
utilize water to produce electricity. Rottenberg was not asked to pay for the
concessions, which were issued as part of British policy to allow local market
forces to develop the region’s economy. The company grew over the years and was
usually profitable. In 1953, the fate of the electric company was the same as
the fate of other institutions — they were subsumed by the State, which
effectively nationalized resources it considered essential. The electric
corporation became a State owned enterprise.
The
company, defined as a monopoly by the Electricity Sector Act, is licensed by
the State to control 100 percent of electricity production in the country as
well as its transmission, distribution, supply and sale. This control is
certified under the Electricity Act (March 3, 1996) which replaced the
original electricity concession. The law extends this power to the year 2006.
But for certain sections there is no final date.
In
addition, the government decided on August 1994 and May 1995 (Decisions 3880,
5484),[5]
to open up electricity production to limited competition from private producers
of up to 10 percent of IEC’s total production, and to the purchase of up to 10
percent from foreign producers such as Egypt. These Decisions were made in the
wake of pressure from private producers, some of whom produce electricity by
various methods abroad, as well as pressure from the regulatory body of the
Ministry of National Infrastructures and the Electricity Sector Authority who
saw a danger in IEC’s broad vertical monopoly. Despite these Decisions,
production of electricity by private bodies has not actually started and the
import of electricity has not progressed. IEC’s total power is secure. The
question is if this total power is good for Israel.
Over the
years, the IEC has accumulated a great deal of political power as a result of
its control over an essential product. Moreover, its vast number of employees
(approximately 10,000 regular workers at the end of 1997) makes IEC an
electoral power not to be trifled with. The influence of the IEC can perhaps
best be measured by the number of committees which have examined the structure
of the electricity sector and whose recommendations were never implemented.
Moreover, the recommendations of these committees fell far short of calling for
IEC’s breakup to be replaced by free markets. In 1989 the Fisher Committee
recommended a limited and gradual privatization of the IEC to the ministers of
finance and energy. For example, it called for the creation of clearly-defined
profit centers in the structure of the Corporation. In 1991, the Fogel
Committee presented its recommendations for determining electricity rates
according to the Price Cap, a modified subsidy system rather than Cost+. Two
additional committees, Vardi[6]
and Tchimensky,[7] were
established. Their recommendations were also never implemented. Among the
conclusions of the Vardi Committee (December 1992) were a number of recommendations that would have given more
operating power to the State while retaining IEC’s cartelistic form:
a)
To grant licenses, rather than
concessions, for the various activities of the IEC without any guarantee of
exclusivity.
b) To encourage independent producers.
Three)
To establish a statutory body, the “Authority for Public
Services — Electricity”.
The
Tchimensky committee presented its recommendation to the Ministry of Energy and
Infrastructure in July 1994. It outlined several guidelines for the
reorganization of the electricity sector including the separation of
production, transmission, supply and sale in preparation for the establishment
of subsidiary companies and finally their privatization. The committee
recommended that private producers should be allowed to supply up to 40 percent
of the electricity in Israel. In addition, it was recommended to leave only
transmission in government hands as a natural monopoly. This assumption would
later be reexamined. The rest of the components of the electricity system would
be privatized. Among the other recommendations of the committee was one to
allow for a period of preparation to last four years prior to privatization.
Despite
the unambiguous conclusions of the committees, the Electricity Sector Act was
passed in a quite different format. Dr. Ilan Maoz, who was involved in the work
of the committees, commented tersely as follows: “The new legislation does not make possible the process of
preparing for privatization.”[8]
According to Maoz, the legislation preserves the IEC’s monopoly since it
obligates independent producers to sell their electricity to the IEC which
enjoys a monopoly in transmission and distribution. This transforms the IEC
from a monopoly into a monopsony (single buyer) on the order of the Tnuva milk
monopoly. It leaves the company in an exclusive position.
The Electricity Sector Act[9]
The
Electricity Sector Act which came into effect in March 1996, allowed the IEC to
continue operating as a monopoly. The law grants the IEC licenses for the
exclusive production, distribution, supply and sale of electricity within
Israel for the next 10 years. It also allowed for up to 20 percent of total
electricity output to be produced by independent producers (10 percent from
local producers and 10 percent from imported electricity). As noted, this has
so far not been implemented. The obligation to buy 20 percent from independent
producers is not competition in the full sense. As IEC is the only buyer, it
can determine the final price. Furthermore, it still controls the transmission
and distribution of electricity. It should also be mentioned that until the
first half of 1998, tenders for the private production of electricity required the
IEC’s approval. Since then this function has moved to the Ministry of National
Infrastructures and the Authority for Public Services — Electricity. This
Authority was established by the 1996 law, and is a statutory body whose
function is to set rates for each service separately and to regulate the
quality and level of service of each license holder. Rates are to be determined
according to an equation which includes expenses, a reasonable return on
capital and a coefficient for improvements in efficiency (a non-permanent
parameter).[10] This is an
operating definition of the corporativist state.
Note as well that pension expenses
would be included in recognized expenses, according to law. This has an
important implication in that it creates a regressive tax. This is because
pension expenses are loaded onto each kilowatt hour in the form of a fixed
cost. In other words, this raises the price of electricity, and poorer people
pay a higher share of their income in utility charges than wealthier people.
With regard to salaries (including pension expenses), Voice of Israel radio
reporter Levi Morav made the following comment on the salaries of
vice-presidents at IEC:
It seems that vice-presidents, and
there are more than a few, earn more than $14,000 per month. If we take into
account that their salaries during 1996 increased by at least as much as
inflation, then they are now receiving close to $17,000 per month.[11]
Morav
points out that these salaries are paid directly from the citizen’s pocket since
the price of a kilowatt hour includes all the IEC’s expense. The IEC exploits
its status as a monopoly to pass on to consumers all its expenses, instead of
having to economize or become more efficient, as it would have to do if it were
competing with other companies. In effect the cost of statism is borne by the
poorer classes.
The
actions of the electricity workers union, led by Yoram Oberkovitz, prior to the
end of the IEC concession in 1996, resulted in the replacement of the
Electricity Concessions Order by the Electricity Sector Act, which in essence
preserved the existing situation. The Electricity Sector Act of 1996 became law
in March 1997 following a long battle. One of the results of the act was the
establishment of an independent body which will regulate electricity
rates. The setting of electricity rates
by non-market factors preserves IEC’s monopoly but weakens Israel economically
and politically.
The Authority for Public Services — Electricity
Beginning
in 1996, electricity rates in Israel have been determined by a statutory body,
the Authority for Public Services — Electricity.[12]
Rates are set by the Price Cap method.[13]
In contrast to the Cost+ method, the Price Cap sets a maximum price which is
updated annually according to the Consumers Price Index and the required
increase in efficiency. Despite the advantages of this method, which doesn’t
allow for immediate recognition of any expense claimed by the IEC, the determination of the maximum price is
problematic. This rate is determined on the basis of data reported by the IEC.
But, exploiting its monopoly status, these rates reflect IEC’s overcharging
consumers. This means IEC’s revenues are a function of regulation beyond what
it would receive in a competitive market. Too, the Electric Corporation reports
its expenses in ways to make difficult determination of rates. In practice,
production costs are rolled over onto transmission and supply. Lack of
information regarding the operational division of the company is a result of
the workers’ committee’s refusal to supply information on the company to
exterior bodies without authorization from the committee.[14]
Despite high revenues, amounting to
$2.3 billion in 1997, the government as sole shareholder of the company
receives a very low rate of return on capital. This apparent dilemma is
explained by the company’s salary expense clause. From 1995-1997 salary
expenses fluctuated between $675-727 million, a rate amounting to 17 percent of
total revenues. The salary expense per worker is $7,678 per month. This figure
is literally hundreds of percent more than the average salary in Israel. And
the bulk of IEC’s labor force is clerks.
The
words of Mr. Hagai Golan, editor of Globes, Israel’s financial newspaper
:
The Electricity Act is nothing but a
total sellout to the Electric Corporation’s workers’ committee; the law does
not allow direct sale of electricity to the final customer, but obligates the
private producer to transfer manufactured electricity through the Electric
Corporation infrastructure.[15]
It
seems, according to this, that the Electric Corporation is still acting as a
monopoly in the field of electricity production, transmission, distribution,
supply and trade. How did IEC’s clerks get so much power?
Organization of Electric Corporation Employees
Electric
Corporation employees, numbering 13,000 (including pensioners), operate within
an active and uncompromising workers’ committee. The committee is composed of
two sub-committees; the north and south workers’ committees. Over the years the
committees have cleverly exploited their power during negotiations over wage
agreements and social benefits, this despite the fact that their wages are
significantly higher than the average wage in the country and, in particular,
the average industrial wage. But more than wage conditions have been won by the
committees. Other powers have been achieved which in normal corporations are
held by the management such as the appointment of workers, and policy
determination. The power of the Electric Corporation’s workers’ committee may
be deduced from the comments of workers’ chairman Yoram Oberkovitz during a
labor dispute:
The Electric Corporation will
continue to exist; the [government’s] clerks and the minister of finance are
temporary phenomena.[16]
The
committee is considered to be one of the largest and most powerful among the
Histadrut organized committees.
The Power of IEC Labor and Histadrut
With the
establishment of the State of Israel the power of workers’ organizations grew,
in particular that of the Electric Corporation, not only because of the number
of unionized employees, but also because of its control of the electricity
market. Electricity, to repeat, is crucial to the existence of the State and
its residents. Each day that the electricity sector strikes costs Israel
$600,000.[17] Due to its
ability to shut down the economy at a moment’s notice, the electricity workers’
union has become one of the leading unions in the Histadrut, and has even
exploited its power to interrupt the supply of electricity on behalf of other
unions involved in disputes. For example, the electricity employees interrupted
electricity supply in 1991 and 1994 in support of the Histadrut, when the
Histradrut was making demands on behalf of other sectors (Bezek and El Al).[18]
The
management of the IEC has tried to change the balance of power at the
Corporation although with limited success. In theory, the function of the
management is to achieve the objectives of the shareholders (i.e. the State of
Israel) but in practice the opposite has occurred. The workers have in general
received all of their demands despite the opposition of the management. This
was seen most clearly during the early 1980s when the workers signed agreements
with the Finance Ministry without the involvement of the management.[19]
The conflict of interest between the workers and management has at times
resulted in direct confrontation, in which one of the sides (in general, the
management) has had to give in and in extreme cases the general manager was
forced to resign. For example, in 1980, the chairman of the board was forced to
resign on the issue of unlimited free electricity for the workers.[20]
Description of the Electricity System
The electricity sector is generally
divided into three components: production, transmission and supply. Supply is
often further divided into distribution, supply and commerce. The concept of a
natural monopoly in the electricity sector arises from the large investments
which are required for the establishment of power stations and the power grid.
In addition, in most countries electricity is considered an essential good and
should thus be under government control. This was also the case in the U.S.
where the electricity sector was under the direct regulation of the government
until the early 1980s. Only after the passing of the PURPA legislation (Public
Policies Act) did signs of privatization begin to appear.[21]
In Israel, the IEC has carried out all three stages of electricity production
since its establishment. Only recently has electricity production by
independent producers been considered, and even then on a very small scale.
Production
Production
involves the conversion of organic raw material (oil, coal, shale) into
electricity at a power station. This stage has been recognized by many
countries as not requiring the existence of a natural monopoly since there are
no increasing returns to scale beyond a certain level of production. In Israel,
the IEC began operations in the early 1930s and developed together with the
rest of the economy. Production has gone from 2,250 kilowatt hours in 1929, to
309 million kilowatt hours in 1948, and to 33,500 million kilowatt hours in
1997. This increase in production capacity was required for the needs of a
growing population and for agricultural and industrial development. By the end
of 1997, the IEC had six power stations containing 27 independent production
units (the energy for electricity production is self-produced). Increasing
returns to scale do not exist in production because each unit is independent
and the amount of production is adjusted to the unit’s location. In the area of
raw materials, there are no clear increasing returns to scale since raw
material is purchased by the coal company (64 percent owned by the government
with the rest owned by the IEC) according to commodity prices which are
determined on world commodity exchanges. On these exchanges quantity has a
negligible significance with respect to price. The recent tenders for the
private production of electricity in Israel have revealed a great interest on
the part of producers, including foreign companies such as Siemens.
Siemens’
bid, among other evidence, suggests that increasing returns to scale do not
exist in the production stage. Today, following the Israeli growth in
population and national product, the existence of a monopoly as opposed to
several competing companies is not easily justified. Until 1948 the IEC, as
well as its sister company, The Jerusalem Electric Corporation, were in private
hands and both companies prospered, except during World War II.
Transmission
The
transmission system in Israel is composed of 2,653 kilometers of high tension
overhead lines (high tension lines with high capacities of between 110-400 kilowatts),
and 4,251 kilometers of high tension circuits. One can imagine the transmission
system as a main avenue with smaller side streets branching off it which
constitute the distribution system. The function of the transmission system is
to transport the electricity from the various power units to the switching and
transformer stations which pass the current onto the end user. Putting the
transmission system under the jurisdiction of the distribution system is liable
to create extra costs since in many areas it is possible to hook up consumers
directly to the transmission system. This would be possible, for example, with
factories or large offices that would be able to be hooked up directly to the
high tension wires.
Distribution and Supply
This is
the stage in which the electricity finally reaches the consumer. It is the
final stage following production and transmission. In this stage the
electricity is transformed from high to low voltage which is delivered to
households, industry (principally light) and to businesses through a
multi-branched network of lines. It is worth mentioning that it is this network
of lines, whose length is 32,000 kilometers (18,000 kilometers of high voltage
line and 14,000 kilometers of low voltage), which is used as a justification
for the existence of a monopoly. The reason is the shortage of land resources
for electricity lines. But on this point it is significant that overhead cables
are not the only way to transport electricity. For example, underground cables
are possible. The Ramat Ephal area receives electricity by means of a system of
internal underground cables without electricity lines. This advantage
eliminates the problem of availability of land and, in some cases, it is even
possible to utilize existing underground infrastructures such as those of Bezek
and the cable companies.
Tenders
The IEC
also invests large amounts of money in the development of the electricity grid
and power stations. This development is considered essential to the economy and
therefore much of the IEC’s investments are done with a government guarantee,
easy government credit or through direct government financing. But the giant
tenders issued by the IEC for transformers, development of electricity lines
and investment in power stations are granted solely at the discretion of the
IEC without any direct involvement of the regulatory bodies. While there is no
doubt as to the professionalism of the IEC employees, the company’s power is so
great that it can grant tenders without the involvement of oversight from its
cash sources. Thus, the IEC may choose large and well-known contractors rather
than small and medium-sized contractors.
With
regard to independent producers, the IEC was able to exercise a veto up until
the end of 1997, making IEC a self-regulating “regulated” company. The
situation was rectified as a result of the efforts of Dan Shilo, a
representative of the Finance Ministry.[22]
Now tenders are published by the Ministry of National Infrastructures[23]
in cooperation with the Electricity Authority.
Today
the question is, are there increasing returns to scale, supposing it was this
that originally justified establishment of the electricity system embodies in
IEC?
The
Vardi Committee answered this question as follows: “It is not possible to
reduce the costs of a coal-burning power station by increasing its size beyond
550 MW.”[24]
Increasing returns to scale, which are the justification for a so-called
natural monopoly, exist only in the case where the costs of a single producer
are lower than those of numerous producers in a competitive environment.
Increasing returns to scale should result in a lower price to the consumer[25]
and the monopolistic firm’s rate of profit should be at least that of a
competitive situation and in general should be higher. If we examine the cost
structure of the IEC and its financial reports, we find that its return on
capital is very low: 0.2 percent in 1997 and 1.2 percent in 1996. This
contrasts with rates of return of 7-10 percent which typify the business
sector. The reason for this difference can only come from two possible sources:
low prices or high costs.
An
international comparison shows that electricity rates in Israel are neither the
cheapest nor the most expensive (see below). Thus, the only explanation for
this suspicious situation is high costs. Most investment in the electricity
system has already been made. New investments are marginal to the operation of
the electricity system. The production, transmission and distribution systems
already exist and represent an investment of $9 billion made over several
decades. This means that the majority of the IEC’s costs are variable (i.e.
labor costs). Thus, the IEC’s electricity rates do not accurately reflect
actual costs and include a subsidy to the Corporation. If the IEC were
operating under conditions of competition, its efficiency would have to be
significantly improved in order to achieve a reasonable rate of return on
capital. This does not happen because the IEC does not operate under conditions
of competition and neither does it feel a threat to its monopoly status.
Therefore,
increasing returns to scale have not been achieved and in fact the opposite has
occurred. Instead of the monopoly earning a rate of return above that of the
competitive situation,[26]
it is earning a much lower rate of return as its profits are squandered on
waste or on behalf of political interests. The low return on capital reflects
the high level of costs which the public subsidizes. Let’s look at the costs.
In order
to estimate the cost to the economy of the IEC electric monopoly we examined
financial data from the IEC’s financial reports.
It
should be noted that though the IEC is a State-owned enterprise (SOE), it is
not funded by the State. It is funded by foreign capital, based on bank credit
and bonds issued abroad. Because it is not merely an SOE but also a publicly
traded company, whose shares (bonds) are traded on the bourse, its financial
reports have to meet the standards set by the bourse. It can therefore be
compared to companies in other countries. Until 1986, the IEC’s shares were
traded directly on the local exchange which obligated the IEC to issue
quarterly reports to its shareholders. This allowed the company’s worth to be
evaluated in terms of market value. Thus, the IEC can be compared with
companies abroad even though it is an SOE.
General
The IEC,
which is rated 17 in size among electric companies in Europe,[27]
is the largest company in Israel. Its revenues total $2.3 billion per year, it
employs more than 10,000 people; its net worth totaled $2.7 billion at the end
of 1997. IEC is one of the oldest companies in Israel. By the end of 1998, the
Corporation had invested approximately $10 billion in power stations, the
transmission and distribution system, and in inventories of raw materials.
Profit and Loss: Labor Costs
The
number of workers employed at the IEC (not including temporary workers) totaled
10,075 in December 1997 (including pensioners, the total exceeded 13,500).[28]
Total expenditure on salaries in 1997 came to $731 million while the average
cost per worker came to $7,678 per month. In comparison, the monthly cost per
salaried worker (not including Arab labor from the territories)[29]
for the whole economy was only $2,938. In other words, employee costs per
individual at IEC are 2.6 times that of average costs. In comparison to
industrial workers (monthly cost of $4,792 dollars in 1997), the cost of an IEC
worker is 160 percent higher.[30]
Here lies the source of IEC’s low return on capital. But there is more.
The high
salaries enjoyed by IEC workers suggest a labor force at IEC of highly skilled
people. But this is not so. Instead IEC’s costs for labor (subsidized by the
State) are 160 percent higher than the rest of the economy is for clerks! In
fact, clerks and semi-skilled workers comprise 73 percent of the Corporation’s
labor force.[31] In this IEC
over-represents these categories of labor in the economy as a whole. Clearly
the composition of the IEC labor force does not justify such high salary
levels. Furthermore, the IEC’s workers enjoy a budgetary pension like those of
a government corporation which significantly reduces the cost per worker but at
the same time increases the financial obligations of the State.
Table
1
IEC Salaries
|
Salaries
(in thousands of dollars) |
||
|
|
1997 |
1996 |
|
Pension deductions |
167,075 |
65,445 |
|
Salaries |
195,878 |
203,190 |
|
Salaries - Selling and Marketing |
151,364 |
162,796 |
|
Salaries - General and Administrative |
59,621 |
68,338 |
|
Total |
563,938 |
499,770 |
|
Percent of Revenues |
24% |
23% |
Source: Israel Electric Corporation, Annual Report
75 (1997), p. 47. [Hebrew]
The IEC
is also generous with its pensioners who receive extensive pension benefits. The
pensioner continues to climb the wage ladder so that his pension grows by 2
percent annually above and beyond inflation every year. These benefits are not
enjoyed by workers in any other sector. Consider what this means. A department
head can advance to the position of section head and improve his benefits…while
he is a pensioner. This practice is unique to IEC. In addition, the pension
rates of the IEC are 2.5 percent during the first ten years of retirement
beginning at age 55 in contrast to 2 percent and age 55. Beginning in 1997 and
for ten years consumers are charged extra for the electricity they use. This is
due to these excessive pension benefits. To cover the company’s pension
liability, the cost to taxpayers is estimated at $167 million dollars per year
and $1.3 billion for the whole period.[32]
In sum,
the monopolistic structure of the electricity sector costs the economy $516
million in excess labor costs. This is, of course, passed on to the final
consumer, the Israeli citizen.
This situation has existed for
years and is a result of both the Corporation’s success and the ability of its
workers to translate their numbers and monopolistic power into influential
electoral power within the Histadrut and the central committees of the
political parties. This power has allowed the Corporation to influence
policymakers and to preserve its monopoly status. But there is still more. All
IEC employees are given free electricity!
To
salary expenditures must be added the well-known (in Israel) benefit of free
electricity. The IEC is one of the few public or private businesses which
allows employees to consume their product at no cost. It is true that many
Israeli companies allow employees to buy their products at a discount or at
cost. However, the IEC’s people receive electricity free. If the owners of the
IEC were private individuals, then this situation would be of no interest.
However, since the IEC is owned by the government and thus indirectly by the
public, a situation is created in which the IEC employees are receiving a
benefit which the company’s “owners” can only “dream” about. This is an absurd
situation. The average consumption of electricity stood at 6,000 kilowatt hours
(kwh) at the end of 1997 at a price of 10.85 cents per kwh.[33]
Thus, the annual cost to the economy of this benefit (including the fixed
payment) is estimated at $8.5 million. In fact the actual amount of electricity
consumed by the IEC employees is unknown so that this estimate is a minimum and
the actual figure is certainly much higher. For example, the Finance Ministry
has estimated that the IEC workers consume between twice and five times the
national average.[34]
The
total annual cost to the economy resulting from salary expenses totals $524
million. This is 24 percent of IEC’s revenues. The high cost to the economy in
a distorted price for electricity and a distorted level of salaries in the
electricity sector also hinders the development of the company. This can be
seen in the structure of IEC’s balance sheet.
Profit and Loss: Company Structure
At IEC
44 percent of total labor costs are discounted as fixed assets. This amount is
recognized as an expense for the determination of electricity prices and for
calculating depreciation for tax break purposes. It would appear that this
percentage is unusually high in view of the fact that other infrastructure
companies discount up to 25 percent of their labor costs. This practice is
especially outlandish in that the makeup of the IEC’s labor force does not
justify such a move, since thousands of IEC employees are clerks or are
involved in maintenance or service which have nothing to do with the
development of the electricity system or with an investment in fixed assets. By
discounting some of its labor costs, the IEC shows increased profits. It may
also cause an over-evaluation of fixed assets, for example, a power station.
As for
financing expenses, IEC had income of $211 million in 1997, in contrast to a
loss of nearly $1.7 million the previous year. These expenses are the result of
the raising of $425 million in financial markets abroad and the issue of bonds
under the guarantee of the State of Israel. The raising of foreign capital
reflects the Corporation’s inability to finance its development from its own
profits despite the relatively low rate of interest on the bond issues (about
7.1 percent). Furthermore, the Corporation might raise funds through the
issuing of shares without having to put up its assets as collateral and without
having to incur such high financial expenses.
The
entire balance sheet totaled $10.8 billion at the end of 1997. Of this amount,
25 percent ($2.7 billion) was net worth and the rest various liabilities. At
first glance, it appears that the percentage of net worth in total liabilities
is low. This could have made it difficult for IEC to borrow funds from banks
and to issue bonds. In reality, the situation is exactly the opposite. IEC
raised $425 million worth of bonds in the U.S. in 1997 at low rates of interest
(7.75 percent on 30 year bonds and 7.1 percent on 10 year bonds). The IEC
received a rating of AAA from Standard & Poor’s, which is similar to that
of the State of Israel.[35]
This rating was granted despite the relatively low level of net worth, since it
is a government owned company, has a monopoly position and enjoys a stable and
healthy cash flow. In addition, the actual net worth of the company is
different from that on its books. Many of its assets, such as the Reading power
station in north Tel Aviv, were written in the IEC’s books at very low values.
The value of many assets has not been marked up to market value until now,
because of technical difficulties stemming from the way land is registered in
Israel, and also because there is no law obligating the company to do so.
According to the valuation of Standard & Poor’s, the net worth of the IEC
totaled $4.4 billion at the end of 1997, which represents 37 percent of the
total balance sheet.[36]
Of
course, the ability of IEC to raise capital at low interest rates in local and
foreign capital markets is made possible by government guarantees for a large
proportion of IEC’s loans. For example, in 1996, 68 percent of the IEC’s loans
were guaranteed by the government. In 1997 the figure was 66 percent. In addition,
the government has granted numerous development loans to the IEC under
convenient terms of payback and linkage to inflation, and has purchased
perpetual bonds from the IEC which do not bear interest.[37]
The
various ways in which the IEC finances its activities, such as “easy” loans
(development loans), perpetual bonds with only partial linkage to inflation and
the issue of bonds abroad reflect the main fact about IEC: it is subsidized by
the government. Corporations that raise money abroad without a government
guarantee pay rates of interest which are 1-1.5 percent higher than those paid
by IEC. Thus, the government is taking on the risk that IEC will be unable to
service its debt. This represents an annual subsidy of $4.5 million for the
life of IEC’s bonds (from 10-30 years). Subsidization of the electricity system
exists in many states on the assumption that only the State can supply it. The
recent changes in the degree of government involvement in the private sector
and in the electricity sector in particular, have brought about a change in
thinking. Today many governments are allowing electricity sectors to operate
freely without direct state involvement. How does IEC compare to other electric
companies?
Comparison to Electric Companies Abroad
The IEC
has a monopoly over all aspects of electricity production and supply in Israel.
In order to examine the efficiency of its operations, one must compare it to
similar companies abroad. The countries
chosen were based on their size and population, which were relatively small,
since these factors have a significant influence on electric companies.
But
there are similarities among electric companies worldwide. For example, all
need large initial investments for continuing operations, and older companies
were (and to some extent still are) controlled by the government. The following
table presents a comparison done by UNIPEDE, the Union of Electricity Suppliers
in Europe.[38] The
companies in the table are also mentioned in the IEC’s financial reports.
Table 2
Comparison
of Electric Companies 1997
|
|
CEZ a.s.(a) |
VERBUND(b) |
N. POWER(c) |
BAYERNWERK(b) |
ENDESA(c) |
IEC(d) |
|
State |
Czech Republic |
Austria |
Britain |
Germany |
Spain |
Israel |
|
Type
of control |
Public |
Public |
Public |
Public |
Public |
Government |
|
Type
of Operations |
Production
Transmission |
Production
Transmission Distribution |
Production |
Production
Transmission |
Production
Transmission Distribution |
Production
TransmissionDistribution |
|
Production
in gwh |
48,008 |
24,153 |
60,300 |
62,700 |
64,646 |
33,500 |
|
Revenues
in $ millions |
2,332 |
2,583 |
5,643 |
5,700 |
1,936 |
2,365 |
Sources:
(a) Czech
Power Company CEZ. a.s., http://www.cez.cz/default.asp
(b) The following companies were compared on
the basis of their local activities, not including their activities abroad:
Verbund
www.verbund.co.at
Bayernwerk,
www.viag.co.gr
(c) The data for the following companies are
for 1995:
National Power,
www.national-power.com
Endesa,
www.endesa.es/english
(d) Israel
Electric Corporation, Statistical Report 1997 (March 1998), p. 4. [Hebrew]
Table 2
shows that IEC is one of the last electric companies still owned by the
government. All others in the table operate freely, and, except for the Czech
company, they all operate in other countries. The companies have taken
advantage of the opening up of electricity markets in Europe and Asia to create
partnerships and to operate where they have comparative advantage. The focus of
the companies has been on Europe and Asia in view of the accelerated growth in
these regions during the past few years and the fact that foreign investors
have been allowed to operate in sectors which were previously closed to them,
including the electricity sector, due to their national importance. The
possibility of operating abroad, including on other continents and not just in
neighboring countries, has allowed these companies to utilize their surplus
productive capacity and the knowledge they have accumulated over time. In
contrast, IEC is not capable of these types of operations.
Comparative Efficiency
Table
3
Electric
Company Employee Efficiency in 1995
(millions of kwh per employee)
|
Israel |
Denmark |
Holland |
Belgium |
|
2.65 |
2.86 |
3.98 |
4.45 |
Source: Israel Electric Corporation, Statistical
Report 1997 (March 1998), p. 73 [Hebrew]
Table 3 shows Israel is on the
extreme low end of employee efficiency. In IEC’s financial reports, this ratio is
presented somewhat differently and is reported at 3.55 rather than 2.65 as in
the table. The difference arises from IEC’s use of a number that shows only
operational workers. This total is 7,592. But other countries include all
workers. By means of this deception, IEC attempts to give the impression of a
higher rate of return on capital, and to hide its extraordinary high costs per
worker.
Table
4
Return
on Capital (percent)
|
|
CEZ a.s.(a) |
VERBUND(b) |
N. POWER(c) |
BAYERNWERK(d) |
ENDESA(e) |
IEC(f) |
|
Return on capital |
11.5 |
26 |
30 |
16.2 |
9.3 |
0.23 |
Sources:
(a) www.cez.cz/default.asp
(b) www.verbund.co.at
(c) www.national-power.com
(d) www.viag.co.gr ; Data for 1995
(e) www.endesa.es/english
(f) Israel
Electric Corporation, Annual Report 75 (1997), p. 3. [Hebrew]
Of
course the ratio of labor costs to capital is one of the most important
measures of the efficiency of any corporation. The return on capital is in
essence the profit to the company’s shareholders.
But IEC’s
return on capital is low, as noted. Considering the fact that the price of
electricity in Israel is in the same range as that in the countries that appear
in the table, the return on capital of less than 1 percent unambiguously
reinforces the claim that the IEC operates inefficiently. In addition, the
IEC’s profit derives from its financial activities rather than its current
operations.
Typical
of the classic SOE, IEC serves political needs often in conflict with economic
ones. It can be, for example, a receptacle for political appointments, or a
source of employment for thousands, thus “workfare.”
Table
5
Ratio
of Labor Costs to Total Revenues (percent)
|
IEC(a) |
VERBUND(b) |
CEZ a.s.(c) |
ENDESA(d) |
|
24 |
27.3 |
6.3 |
10.5 |
Sources:
(a) Israel Electric Corporation,
Statistical Report 1997 (March 1998), p. 83. [Hebrew]
(b) www.verbund.co.at
(c) www.cez.cz/default.asp
(d) www.endesa.es/english
The
ratio of labor costs to revenues is much higher for IEC than for the other countries
except for Austria, a socialist state, which has an explicit welfare policy of
setting wages at high levels.
Table
6
Rate
of Depreciation (percent)
|
|
IEC (a) |
VERBUND(b) |
CEZ a.s.(c) |
N.POWER(d) |
|
Power
Lines |
27.5 |
30 |
30 |
- |
|
Power Stations |
23 |
36 |
37.5 |
25 |
Sources:
(a) Israel Electric Corporation,
Statistical Report 1997 (March 1998), p. 82. [Hebrew]
(b) www.verbund.co.at
(c) www.cez.cz/default.asp
(d) www.national-power.com
Electric companies worldwide invest hundreds
of millions of dollars in development, depreciating these investments over
time. Depreciation represents the decrease in economic value in an asset which
is calculated each year according to the expected life of the asset.
Depreciation is a recognized expense for income tax purposes. It is essentially
a tax break.
In IEC’s
case, the rate of depreciation is notably higher than in the countries
appearing in the table. This is an additional benefit enjoyed by IEC. It has an
accelerated depreciation. Essentially what is taking place is this: IEC is
getting money out of taxpayers, thus a subsidy for itself. This allows IEC to
pay less taxes and to report a higher level of expenses relative to companies
abroad. Since this expense is recognized by the regulatory authorities, it is
passed on to the consumer. For example, the recognized annual depreciation on
power plants totals $215 million in contrast to an expense of $150 million
(according to an average life of 33.28 years in the other three companies).
Thus, accelerated depreciation contributed $23.4 million to IEC’s net profit
(after the deduction of 36 percent corporate income tax).
IEC in International Perspective
Technological
advances, globalization and the decrease in government intervention in economic
activity have all come together to challenge the idea of a justification for
the “natural monopoly.” In many countries (principally socialist states and the
industrialized nations) the central government saw itself as supplier of last
resort for electricity, this justifying government monopoly. Through direct
ownership of corporations, mostly of monopolies, governments fulfilled what the
intellectuals and bureaucrats thought was the government’s obligation.
In many
countries, especially the democratic ones, the power of the electric companies
also derived from their workers who were organized into unions. These unions,
which controlled a product (and service) essential to the state and its
residents, succeeded in making the elected government system dependent on their
electoral power. For reasons already mentioned, many governments began to
reexamine the necessity of maintaining the electric company as a natural
monopoly enjoying statutory protection. The leading countries in the
privatization of the energy and electricity sector are the UK, Eastern Europe
(principally the Czech Republic and Hungary) and Chile.
Comparison: Privatization
Comparisons
between countries with different levels of industrialization or different
geographic locations is problematic. This research paper will focus on
countries which have already been through the process of privatization despite
the differences between them.[39]
In
northern countries, for example, electricity is used extensively for
transportation due to the difficulty in using gasoline in the winter. The raw
material for producing electricity also varies from country to country
depending on the local availability of each type of raw material. The
electricity system is also affected by the type of industry predominant in a
country. Thus, heavy industry needs more electricity than light industry.
The
electricity sector in a country is a very large economic system and constitutes
an integral component in a country’s development. The main users of electricity
are: households, industry and transportation. The division among these three
uses is dependent upon the country’s geographic location, its natural resources
and the distance from those natural resources.
Table 7
shows that per capita production of electricity is highest in Israel
even though per capita consumption is among the lowest. The result is
unexpected since countries such as the Czech Republic and Britain have
extensive heavy industry and transportation systems which run on electricity.
One of the possible explanations is low efficiency and less than optimal
utilization of the electricity system in Israel. Although a technical analysis
of the system’s efficiency is beyond the scope of this study, it can be said
that during the early 1980s numerous inefficient links were found in the
production and distribution systems which were responsible for losses estimated
in the tens of million of dollars.[40]
These inefficiencies were made known to the management of IEC. Nothing was done
to eliminate them.
Table
7
The
Electricity Sectors in Selected Countries, 1995
|
|
Population (millions) |
Electricity Generation (millions of watt hours, mwh) |
Per Capita
Electricity Generation (kwh) |
Gross Inland Consumption per capita (toe/inhabitant) |
|
Israel |
5.62 |
32.8 |
6,048 |
2.79 |
|
Czech
Republic |
10.31 |
58.4 |
5,672* |
3.89 |
|
Chile |
14.24 |
25.3 |
1,800* |
1.27 |
|
Britain |
58.5 |
334.39 |
5,715 |
3.76 |
Source: ESAP sa, Energy in Europe 1997 ─
Annual Energy Review (Brussels: European Commission, September 1997), p.
13.
*
Data for 1994.
In order
to examine the possible effect of the privatization of IEC, a description
follows of the results of privatization of electricity monopolies in selected
countries.
Great Britain
Great Britain, under Mrs. Thatcher,
was one of the pioneers of privatization in the electricity sector. The
privatization was begun in the 1980s and actually completed in the 1990s. Until
the early 1990s the electricity sector had been controlled by CEGB (The Central
Electricity Generating Board) which was responsible for the production and
distribution of electricity throughout Great Britain. During the first stage,
the shares of 12 councils responsible for distribution (which were converted
into limited corporations) were offered to the public. (These corporations were
given a license to produce up to 15 percent of the power which they distribute
as part of the effort to increase competition). During the second stage the two
corporations, Powergen and National Power, which together produced all the
electricity in Britain, were sold. The control of supply was transferred to the
12 distribution companies and not to the public in order to prevent exclusive
control of the company.
Results of the Reform
Following
the reform there was no significant change in the price of electricity.
However, there were significant changes in rates according to marginal cost and
the type of consumption.[41]
The main beneficiaries of this change were the large consumers who enjoyed
lower rates. An additional effect was the doubling of productivity per worker
and the decrease in air pollution as a result of the switch to natural gas from
coal. Two important conclusions drawn after the privatization[42]
were that part of the funds generated by privatization were taken out of Great
Britain by investors from abroad, and that more electricity producers should
have been created in order to further bring down prices.
The Czech Republic
The
Czech Republic has gone over to a market economy during the past few years. The
electricity sector was completely privatized. The new structure is composed of
production and transmission companies and local distribution companies.[43]
The Czech Republic has privatized its publicly owned assets in two ways. First
of all, in January 1991, was the “little privatization.” This involved selling
the government corporations for the highest price. Second, in 1993-1994, the
Czech government used coupons to privatize the electricity sector. Citizens
were issued coupons who then chose which government corporations to invest in.
One of the positive aspects of this method was the wide distribution of the
shares among the population such that financial bodies constituted only 4-8
percent of shareholders. Compare this with privatization attempts in Israel.
Here the objective has been maximization of selling price, (thus government
revenue and continued control) with the result that ownership was transferred
to a small “core” of private investors. The “privatization” of the banks, Bezek
and the refinery was carried out in this manner.
Chile
Chile
has a population of 14.24 million and produces 25.3 million gwh (gigawatts, or
billions of watt hours) of electricity with a per capita consumption of 1800
kwh.[44]
Privatization in Chile began in the 1980s with the principal goal of financing
the country’s external debt. From the time of the depression in the 1930s until
the early 1970s, numerous companies had been in private hands. However, in 1973
following the military coup, companies were taken over by the government.[45]
The
Chilean electric company, Endesa (owned by Enersis) was established in 1943 to
produce, transmit and distribute electricity. In the late 1970s the company
began to operate according to the system of profit centers with the goal of
profit maximization. Already during this period, the company was no longer
given instructions by the government and neither did it receive any subsidy. In
the early 1980s the company switched methods for setting rates from Cost+ or
Price Cap to the method of marginal cost. The former methods had guaranteed the
company a return on capital of 10 percent. The distribution branch was later
made into a separate independent company and sold to the public on the local
stock exchange.
Endesa
itself was completely privatized by the end of 1989. A portion of the shares
was sold to its workers which brought an end to a longstanding dispute between
the workers and the shareholders.
The
privatization of the electricity sector achieved a number of goals. It
increased efficiency, extended wider distribution of ownership and changed
employment policy. The return on capital, which is a measure of efficiency,
rose from 2 to 9 percent following privatization. The distribution of shares
was also increased, reflecting a reduction in the control of State assets. At
the same time, the takeover of the company by a small group of investors was
prevented. In addition, the
privatization process took place over many years, and by the time privatization
was complete the electric companies were operating on business principles.
There was no significant change in employment policy following privatization.
Employment policy had already been put on a sound business basis during the
long process. An additional objective, also achieved, was a lower price for
electricity to consumers as a result of increased efficiency. Usage was also
reduced by consumers who now had to pay for electricity.[46]
Electricity Prices
One of
the principal objectives of this paper has been to quantify the costs to the
economy resulting from the present situation. The price of a kilowatt hour to
the household consumer in Israel ranges from 10.6-11.1 cents while the price to
industry ranges from 5.9-9.7 cents. These prices reflect an accumulated decline
of 10 percent during the years 1991-1996. This in contrast to the 10 percent
decline in world gasoline prices,[47]
and the 15 percent decline in the price of coal during this same period.
Furthermore, IEC has continually requested price increases from the regulatory
authorities, something which has not been widely publicized.
Table
8
Prices
of a Kilowatt Hour in Various Countries, 1997
|
|
Price
per kwh for Industry (Dollars) |
Price
per kwh for Households (Dollars) |
|
Israel |
0.086 |
0.108 |
|
Czech Republic |
0.059 |
0.081 |
|
Chile |
0.047 |
0.106 |
|
Austria |
0.081 |
0.136 |
|
Great Britain |
0.065 |
0.12 |
Source: ESAP sa, Energy in Europe 1997 ─
Annual Energy Review (Brussels: European Commission, September 1997), p. 7.
Table 8
shows that the price of electricity in Israel is high. The difference in price
is most pronounced for industrial users.
How are electricity
prices set? They are usually determined by one of three methods: First, Cost+.
This means the price covers all the company’s expenses, plus a set rate of
profit. Second, “Price cap.” This means the price partially covers the
company’s expenses in producing the product, minus a regular “efficiency
promoting” amount cut off the price to encourage or acknowledge improved
efficiency. Third, marginal cost. This is used mainly in market economies, in
which an item’s price is based on the cost of producing the last unit of that
item, and taking into consideration demand for the product. In this method,
with price and competition so important, the consumers usually benefit.
These
three methods reflect degrees of State intervention. The third applies to a
firm which operates under market conditions. The Cost+ method was used for many
years in Israel. Accordingly, the expenses of the company together with a
reasonable rate of profit are covered by the price of electricity. This method
does not encourage efficiency, control or supervision. It allowed IEC to load
its costs onto its electricity rates without any effort at increasing
efficiency.
The
second system, Price Cap, is presently used in Israel. The price of electricity
is meant to cover a basket of costs. The basket is determined by the regulatory
body. Furthermore, this method assumes an annual increase in IEC’s efficiency.
This is intended to create an incentive for the IEC to increase efficiency in
order to preserve its level of profitability.
The
third method is that of marginal cost which sets electricity rates according to
the load at the time of usage. This system has been used in Israel since 1982
for large consumers. The rates are based on the marginal cost to the system and
are intended to strengthen the link between the cost imposed on the system by
the consumer, according to time of usage, and his payment.[48]
In 1997
time of usage consumers constituted 50.9 percent of the total number of
consumers which revenues from them represented 46 percent of IEC’s total
revenues. In other words, these consumers (who are mainly industrial users)
paid less than their share in total consumption and were thus subsidized by
household consumers in the amount of $100 million. The IEC is thus able to
discourage large industrial concerns from competing with it through the use of
small independent power stations at their factories.
Conclusions
The
structure of the electricity sector in Israel, which has not changed since the
1950s, results in a serious misallocation of resources. This distortion arises
from the disproportionately high level of wages and number of workers at IEC.
This distortion is related to state subsidization of a large proportion of
IEC’s investments by government guaranteed financing.
In
addition, time of use consumers (mainly industrial concerns who can write off
the cost of electricity as an expense) are subsidized at the expense of private
consumers. In many countries the price of electricity to industry is cheaper
than the rate for households. But this is because the industrial sector’s
consumption is significantly higher than the household sector, (a result of the
operation of the principle of equilibrium in a truly competitive market). It
must be remembered that though industrial bulk use of electricity may merit
discounts, industry also causes more wear on the system than private households
do.
The lack
of efficiency characterizing the operations of IEC diminishes the company’s
ability to operate in a competitive environment whether at home or abroad. The
company has not tried to exploit the expertise it has accumulated in order to
compete for tenders in Eastern Europe, Asia and Africa. Avoiding the risk
involved in operating in only one country and in only one sector is a result of
IEC’s protected, monopoly status.
Renewal
of the IEC’s license to operate as a monopoly extinguished any spark of
independent initiative, and was not in the best interest of the electricity
sector or the country. The structure of the electricity sector, in which
politicians and unions have disproportionate influence, makes it impossible for
the sector to operate independently and in accordance with economic criteria of
operational efficiency and profit maximization. The structure of the
electricity sector is dictated by inflexible legislation, which clearly favors
a single company and quashes any potential for initiative.
Technology
is presently in a very rapid process of development in all areas of life and
each innovation quickly becomes outdated. Therefore the question must be asked
whether the development of a very large economic sector should be in the hands
of a single firm and whether the Israeli electricity sector should be dependent
on a single firm using only one method of producing electricity.
The
answer to these questions is clearly no. The IEC is investing millions of
dollars in the development of its traditional means of producing energy using
various types of fuel and technologically state-of-the-art power plants and
turbines. There is no guarantee that these will be the preferred technologies
of the future. The production of electricity does not necessarily require the
construction of huge power plants. There are already available household
generators and batteries which can supply a house with power for a reasonable
period of time. An additional example of energy technology, which has
successfully been applied here in Israel, is solar energy. In Israel solar
energy is used to heat water for household use but there are additional applications
as well. An additional method of producing energy, including electricity, is
nuclear power which is characterized by a very quick and powerful production
capacity. This technology is not presently in wide use in Israel but it can be
assumed that under the right conditions, nuclear power would be worthwhile in
view of the knowledge and expertise in this field which is available in Israel.
The
method of transporting electricity by way of overhead lines is also not the
only available technology. It is possible to transport electricity through
underground cables and even to use the existing infrastructure of the cable and
telephone companies. This would introduce competition into electricity
transmission and distribution as well.
Recommendations
An
analysis of the electricity sector in Israel makes it clear that the rules of
the game have been determined by the Knesset and the Supreme Court[49]
by way of statutory legitimization of the exclusive status of IEC for an
additional ten years. Enactment of the Electricity Sector Act of 1996 on the
eve of the Labor Party primaries (Labor was the ruling party that year)
extended the status quo for ten more years in return for the electoral support
of IEC employees. The result is higher costs which distort the allocation of
resources in the electricity sector.
Changing
the structure of the Israeli electricity industry requires an end to State
ownership. Vickers and Yarrow state that: “Public ownership is one of the main
solutions to the problems of market failure that arise where competition is
impossible or undesirable, where major externalities exist.”[50]
If the
objectives of a government corporation are not fully achieved due to exogenous
and other types of changes, the shareholders (the government in this case)
should privatize the factory or public service. The main objectives of
privatization are: the reduction and elimination of State control as a means to
enhance growth and freedom. In accordance with these aims, and in order to
minimize the cost imposed by the present structure of the electricity sector,
several steps should be taken.
Strategic Change
Change
in Concept — Minimizing government involvement in the electricity sector. The
State does not possess the ability to manage businesses and therefore the
involvement of the State should be reduced to a minimum. This should be done
through the sale of the government’s shares in IEC and by reduction of the
regulation of the electricity sector which at present is complex and irksome.
Increasing
returns to scale do not exist and thus it is possible to privatize all the
components of the electricity system. The claim that entry into the electricity
sector requires a huge investment which can only be made by the government is
not correct. For example, compare the case of international telephone calls and
the market for cellular phones. Both sectors were entered by private companies
who invested billion of dollars, without any government funding. It is likely
that full privatization of the electricity sector will spur the entry of
numerous private companies each specializing in some area, whether it be
production, transmission or distribution. This will lead to the allocation of
resources found in markets (through the equalization of marginal cost to price).[51]
The public will enjoy lower electricity rates and the electricity sector will
be stimulated by the creation of small, efficient and flexible firms as an
alternative to the existing monopolist.
Objectives of the Change
1)
Wider distribution of public assets among the population.
2) Increased efficiency and reduced costs in the
electricity sector.
3) The possibility of competition among the firms in the
electricity sector.
4) Preparedness for expected and unexpected developments
in the energy and electricity sectors.
Let us consider each of these points.
Wider distribution of public assets among the
population. The IEC which is owned by
the State essentially belongs to all taxpayers and not to the IEC workers or
managers. Therefore, privatization should be for taxpayer benefit.
Increased efficiency and reduced costs in the
electricity sector. The results of
this research have shown the waste and inefficiency inherent in the present structure
of the electricity sector. Privatization will make possible the operation of
IEC according to economic criteria alone which will benefit the whole economy,
for example by reducing the price per kwh. It can also be assumed that in a
competitive environment, companies will try to minimize air pollution in order
to appear “green,” which will also benefit the economy as a whole.[52]
The possibility of competition among the firms in the
electricity sector. The domination of
the electricity sector by a single gigantic firm does not allow for competitors
of any kind. The cancellation of concessions will allow others to compete with
the IEC, reducing the price of electricity to the consumer.[53]
Preparedness for expected and unexpected developments in
the energy and electricity sectors.
The operation of an old company using means of production based on oil/gas,
makes it difficult for the electricity sector to adjust to changes. Thus,
changes are liable to occur in the relative prices of raw materials and a company
which has invested a large amount of capital in power plants which use outdated
raw material is liable to find itself in difficulties. For example, it is
estimated that it takes 50 years for an economy to switch from one type of fuel
to another.[54] In
contrast, an electricity sector with numerous producers, each trying to stay
ahead of the next, will be characterized by initiative and development in
various directions. In this situation, there is more likelihood that in the
future, one or more of these companies will be prepared for a change which
occurs. An analogy to this situation can be found in the communications sector.
The veteran firms, Bezek and Pelephone, still operate on an analog system while
newer competitors began using the more advanced technology immediately upon
their entry into the market. The new firms have thus succeeded in competing
with and outperforming the veteran companies.
Tactical Aspects of the Change
The
withdrawal of the State from the electricity sector can be done in a number of
ways, all of which are based on the sale of its share holdings. Though the
privatization in Chile[55]
and the Czech Republic demonstrated that selling government holdings to a small
“core” of investors is relatively easy, it is not recommended, as it means the
transfer of exclusive control from the State to exclusive control by a small
group of private investors.
Recently,
the outgoing director of the IEC, Gad Yaacobi, announced the possibility of the
sale of 20 percent of the IEC’s shares to the public.[56]
This opportunity should be exploited to the maximum in order to bring about a
change in the ownership of the IEC. But privatization means the process must go
all the way. Furthermore, the sale of shares will require a process of Due
Diligence, in which the Corporation presents itself to potential investors. The
process will provide an indication of the worth of the Corporation and will
make it easier for the government to sell off its shares in the future. And
where privatization is concerned the “correct price” is what the market will
offer, not what the government will set.
In
summary, the structure of the electricity sector is not prepared to deal with
the numerous changes which are expected in the world energy market in general
and in the local market in particular. There is no doubt that the electricity
sector is essential to Israel’s economy and therefore we should prepare now for
expected and unexpected changes and not be dragged into hasty, unplanned
decisions at a later stage when there will be insufficient time to do
otherwise.
Mr.
Yossi Borochov is a Policy Analyst at the Institute for Advanced Strategic and
Political Studies in Jerusalem and Washington, D.C.
Appendix
|
IEC Balance Sheet (thousands of dollars) |
|||||
|
|
1997 |
1996 |
|
1997 |
1996 |
|
Current
assets |
867,871 |
1,089,557 |
Current
liabilities |
880,019 |
937,270 |
|
Net
fixed assets |
9,855,740 |
9,039,374 |
Long-run
liabilities |
7,186,014 |
6,515,809 |
|
Other
assets, Net |
63,333 |
49,792 |
|
|
|
|
Investments |
12,891 |
14,544 |
Net
worth |
2,765,621 |
2,750,863 |
|
Other |
31,820 |
20,674 |
|
|
|
|
Total |
10,831,654 |
10,213,941 |
|
10,831,654 |
10,213,941 |
|
|
|||||
Source: Israel Electric Corporation, Annual
Report 75, pp. 1, 2. [Hebrew]
Note: Dollar = NIS 3.536
Profit and Loss
Statement
(thousands of
dollars) |
||||
|
|
1997 |
|
1996 |
|
|
Revenues |
2,365,883 |
100.0% |
2,184,230 |
100.0% |
|
Pension
deductions |
167,075 |
2.0% |
65,445 |
0.8% |
|
Net
revenues |
2,192,736 |
26.2% |
2,131,395 |
25.5% |
|
Cost
of goods sold |
1,295,355 |
15.5% |
1,243,920 |
14.9% |
|
Gross
profit |
1,070,527 |
12.8% |
887,475 |
10.6% |
|
Selling
and marketing expenses |
407,742 |
4.9% |
400,180 |
4.8% |
|
General
and administrative expenses |
184,526 |
2.2% |
185,181 |
2.2% |
|
Operating
profit |
307,570 |
3.7% |
275,513 |
3.3% |
|
Financing
expenses (income) |
211,068 |
2.5% |
-1,669 |
0.0% |
|
Other
expenses (income) |
46,885 |
0.6% |
77,899 |
2.4% |
|
Net
profit before taxes |
49,617 |
0.6% |
199,283 |
2.4% |
|
Taxes |
24,984 |
0.3% |
80,193 |
1.0% |
|
Profit
after taxes |
24,633 |
0.3% |
119,090 |
1.4% |
|
Share
of subsidiary companies’ profits |
611 |
0.0% |
298 |
0.0% |
|
Net
profit |
25,244 |
0.3% |
119,388 |
1.4% |
Source: Israel Electric Corporation, Annual
Report 75, p. 3. [Hebrew]
NOTES