Market announcement

Title

Disclosure of the Competition Authority's decision regarding Tallinna Vesi's tariff application

Message

Contract and Tariff application

ASTV believes it is the responsibility of government authorities in any EU
member state to ensure that any changes in law, or implementation of such laws
must be done in such a way as to ensure that complies with EU legislation and
basic legal principles. This is especially the case when an investor has signed
a long term contract in good faith, and in return for the increase in quality
of services and capital it has invested, has a justified expectation of the
returns permitted over the period of the contract 

Shareholders of AS Tallinna Vesi (ASTV) have written to the Competition
Authority (CA) requesting the publication of the CA's decision to reject ASTV's
tariff application. The Competition Authority has asked AS Tallinna Vesi if it
is willing to disclose their decision as they are constrained by the law from
doing this without ASTV's permission. As a fully responsible utility company
ASTV believes that all utilities that are natural monopolies should fully
disclose the key aspects of their tariff application that are material to their
customers, investors, but also are important from environmental perspectives.
Such disclosure should include the price, the detailed reasoning for the
increase, the quality standards that customers should expect to receive for the
tariff, and as importantly an audited review of the company's past performance
against those standards. 

Customers expect high standards of service from utilities as it does the buyer
no good to pay a lower price if the quality or quantity he/she gets for his/her
money is lowered in the same proportion. It is for these reasons ASTV has
already publicised all aspects of the service in its 2011 tariff application,
including proposed tariffs, reasons for the increase, the quality standards
customers can expect from the company, and an independent audited report of
company's operational performance in the previous year. 

AS Tallinna Vesi hereby reiterates that the Company applied for a contractual
3.5% tariff increase for 2011, submitting all necessary documents in accordance
with the law, including a cost-based analysis in order to comply with the
Public Water Supply and Sewerage Act. All agreements contained within our
contract were in accordance with Estonian and EU law at the time of
privatisation and have been ever since. At the time of the privatisation the
contractual terms were agreed for a period of 15 years. 

The objective of the 2001 privatisation was the rapid improvement of the
quality of water services. The Company was privatised according to the terms
and conditions of a market led tender to the investor who offered the lowest
real tariff increases to achieve the significant improvement in standards and
the highest price for the shares. In the privatisation process documentation it
is clearly stated that the quickest and most efficient way to achieve these
improved standards was via a privatisation process that offered a long term
contract. Before the privatisation went ahead, the national government of
Estonia granted a 15-year concession. To date the company and its owners have
fulfilled all their contractual obligations. 

The Competition Authorities Analysis of ASTV's tariff application

The Competition Authority did not perform an actual analysis of the agreements
signed during the privatisation and claimed that "agreements between any party
and ASTV do not have greater legal strength than the PWSSA". In addition, the
Estonian Authorities have not made an economic analysis of the ASTV's financial
performance since 2001. Such an analysis would demonstrate that the average
real rate of return made by ASTV for the period 2001 to 2010 is 6.5%. 

Furthermore, the CA has not analysed nor commented on the independent
confirmation given by Oxera to the return the investors have had since
privatisation despite of the fact that such analysis was part of the tariff
application submitted to the CA together with the full set of the privatization
documents on 9 November 2011. It should also be pointed out that this analysis
was made using the methodologies recommended by the World Bank in their
guidelines for tariff setting for privatised utilities. To take such an
approach is to make a unilateral decision which is unproven, unsupported and
ignores the contractual agreements in place for the last 10 years thus
overturning the legal and economic framework of the privatisation. 

Tallinna Vesi welcomes the opportunity to once again disclose its tariff
application together with the key discussion documents the company has sent to
CA as response to their preliminary analysis. 

The company has disclosed the following set of documents on its web-page:

·         09.11.2010 contractual tariff application appended with a company
review, cost analysis, the privatization contract and an independent analyses
by Oxera 

·         28.02.2011 CA's preliminary analysis of ASTV's tariff application

·         29.03.2011 ASTV's response, insisting that the contract should be
applied, appended with the commentaries to the CA's statements 

·         02.05.2011 CA's decision re tariffs

In extra we have disclosed the correspondence about the WACC debate held in
parallel to the discussion of the tariff application. 

Points of Dispute with the Competition Authorities Methodology

Whilst ASTV believes in total transparency the company does not believe that
disagreements on technical issues should be discussed in public. However on
this occasion the CA announced that it would not consider any aspect of our
privatisation contract and had made an analysis and publicly rejected the 2011
tariff application using only its own internally developed recommended
methodology, comparing this to the supplementary information sent by ASTV.
Throughout the process ASTV has always cooperated with the CA commenting on the
problems it sees in the CA's recommended methodology and its application, using
examples and references to present our questions as professionally as possible.
 ASTV believes technical disputes such as these raised below should be resolved
through open dialogue with expert analysis used when and where necessary, with
publication made only once all points raised have been thoroughly analysed.
Therefore it is with some reluctance that we make the comments below, however
in the interests of balance and fairness for our customers and investors we
detail the following points. 

AS Tallinna Vesi would like to explain the key flaws of the analyses made by
the Competition Authority: 

·         The methodology applied by the Competition Authority makes no
reference whatsoever to service aspects of the PWSSA (water quality etc).  This
omission is completely inconsistent with regulatory practice across the world. 

·         The methodology applied by the Competition Authority does not allow
the investor to earn returns on capital paid by the investor for the shares
sold by the City of Tallinn at the time of the privatisation. Thereby assigning
no value to the premium paid for the equity or the improvements in service made
since privatisation. 

·         The CA's methodology for the treatment of inflation is entirely
unclear. The CA declares that their WACC is nominal. However the risk free rate
is based on German inflation and thus does not include Estonian inflation or a
factor to clearly reflect the variance between Estonian and German inflations
into WACC calculation. This is inconsistent with best regulatory practice and
fundamental finance principles. 

·         According to the CA equity investors should receive returns from post
tax earnings whilst debt investors should receive returns from pre tax
earnings.. Such an approach clearly prejudices equity investors and is
inconsistent with the CA's own regulatory objectives (see No 4 below), and
regulatory best practice (see World Bank guidelines). According to the CA ‘s
logic dividend payments are voluntary however in reality would anyone invest in
a stable utility business without the opportunity to earn dividends. 

·         The CA's analysis of pollution tax does not include any attempt to
understand the most efficient balance from a customer and environmental
perspective. The CA does not recognise that in order to be 100% certain of
avoiding pollution taxes  it would require the company to make a huge
investment which would be charged to the tariffs, and could be many times
higher than the disallowed pollution tax dependant on exceptional weather
conditions. To illustrate the question, should the company construct an asset
to avoid a 1 in 20 year weather event? 

·        The CA prohibits the inclusion of any minimum provision for bad debts
costs. As an alternative for an allowance for bad debts the CA proposes that
the water companies ask the customers to prepay for water services. Such a
proposal is unheard of for utility services in Estonia, both from a business
and cultural perspective. Moreover, such an approach is not in accordance with
the payment term recommended by the PWS prescription of the City of Tallinn. A
more sensible approach would be to understand the collection rates of all
companies and then motivate the companies to improve by setting stretching
collection targets. 

The company would like to point out that it did not include pollution tax
penalties or bad debt costs separately in its application. Under the terms of
the current contract all pollution tax and debt collection risks are taken by
the company. 

Regulatory Objectives and Legal Obligations

In their 2009 analysis of ASTV's tariffs the CA has indicated the following
objectives of the regulation that have also been included to the regulatory
methodologies of other sectors: 

  1. Protecting the consumers;
  2. Using the regulation methods, which enable the company to remain
     economically and financially viable, i.e. to cover current business
     expenses and finance the required investments from equity capital and loan
     capital;
  3. Establishing sufficient motivation for the company for a more efficient
     organisation of its activity;
  4. Ensuring an revenue acceptable for investors from the assets invested by
     them or at least revenue of equal value, which they could get from other
     investments with the same risk level.

Unfortunately in practice the CA has completely ignored their own regulatory
objectives and the only objective of the CA's analysis seems to be “to limit
the profitability” by unilaterally breaking the privatisation contract, and
without any evidence to suggest that this long term contract was inefficient.
For example, despite the CA's regulatory objective to guarantee a justified
return to the investors the CA has decided that they do not need to include the
capital paid by the investor during the privatization into the calculation of
the justified return. 

Finally all good regulation takes time to develop and evolve and takes account
of best practice elsewhere. It should recognise existing contractual
obligations, differentiate between privatised and non-privatised entities and
provide a balance between price, investor return and service provided. In this
manner a regulatory regime fit for purpose and respected by all parties can be
put in place. Unfortunately the CA has not allowed this to take place.  In this
case the CA wants  to impose its recommended methodology on AS Tallinna Vesi
and the rest of the water industry without being able to prove its statements
or methods are correct. In spite of the thoroughness and challenge contained in
ASTV's responses the CA has either been unwilling to answer our questions or
provide independent examples to demonstrate that the practices it uses are
sound 

The Company would like to reiterate that ASTV is fully committed to honour the
Contract to continuously offer high quality services to the Citizens of Tallinn
and having the achievement of these standards independently verified in
accordance with good regulatory practice. In a situation where these standards
have been attained, the company will strive to ensure that its owners receive
an acceptable return on invested capital that corresponds to at least the
equivalent return that they would obtain on investments with the same degree of
risk, over the lifetime of the contract. 

The regulation correspondence is available at
http://tallinnavesi.ee/?op=body&id=728 

Ian Plenderleith

CEO

AS Tallinna Vesi


         Priit Koff
         Head of Public Relations
         AS Tallinna Vesi
         +372 62 62 209
         [email protected]