Electricity company vertical backward integration into regasification facilities: A transaction cost explanation

10th IAEE EUROPEAN CONFERENCE 7-10 September 2009 Vienna - Austria Electricity company vertical backward integration into regasification facilities: A transaction cost explanation

Enrique Loredo University of Oviedo Spain José Alberto Goicochea Thames Valley University United Kingdom Nuria López-Mielgo University of Oviedo - Spain

1. Background information 2. The regasification war 3. Some theory 4. Method 5. Results 6. Conclusions

1. Background information a) Liberalisation of Spanish electricity and gas industries b) Electricity-gas convergence c) Long term supply contracts d) Regasification investments

1. Background information d) Regasification investments Existing regasification plants Capacity m 3 /h Barcelona 1.650.000 Cartagena 1.350.000 Huelva 1.350.000

1. Background information d) Regasification investments Existing regasification plants Capacity m 3 /h Barcelona 1.650.000 Cartagena 1.350.000 Huelva 1.350.000 New regasification plants Capacity m 3 /h Sagunto 750.000 Bilbao 800.000 Mugardos 322.500

1. Background information 2. The regasification war 3. Some theory 4. Method 5. Results 6. Conclusions

2. The regasification war Production Liquefaction Shipping Regasification Transmission Storage Distribution Supply

2. The regasification war Production Liquefaction Shipping Regasification Transmission Storage Gas supply CCGT Electricity company

2. The regasification war Production Liquefaction Shipping Regasification Regulated businesses Gas TSO: Enagas Transmission Storage Gas supply CCGT Electricity company

2. The regasification war Production Liquefaction Shipping Regasification Gas TSO: Enagas Transmission Storage Gas supply CCGT Electricity company

2. The regasification war Regasification plant Electricity company Capital stake Unión 42,5% Sagunto Fenosa Iberdrola 30% Endesa 20% Bilbao Iberdrola 25% Unión 21% Mugardos Fenosa Endesa 21%

2. The regasification war Production Liquefaction Shipping Regasification Regulated investment TPA Regulated tariffs Transmission Storage Gas supply CCGT Electricity company

2. The regasification war Production Liquefaction Shipping Regasification Regulated investment TPA Regulated tariffs Transmission Storage Gas supply CCGT Electricity company Economies of scope Economies of scale

2. The regasification war Production Liquefaction Shipping Regasification Transmission Gas supply CCGT Storage Electricity company Research question: Why Spanish electricity companies simultaneously expanded into a particular regulated gas asset of the LNG chain?

1. Background information 2. The regasification war 3. Some theory 4. Method 5. Results 6. Conclusions

3. Some theory Research question: Why Spanish electricity companies simultaneously expanded into a particular regulated gas asset of the LNG chain? Irrational behaviour?

3. Some theory Research tradition: Vertical limits of the firm Agency Theory Property Rights Theory Resource-Based View Transaction Cost Economics

3. Some theory

3. Some theory Bounded rationality Farsightedness Opportunism Transaction Governance mechanism Frequency Uncertainty Asset specificity

3. Some theory TCE review papers: Joskow (1988). Shelanski & Klein (1995), Williamson (2000), Boerner & Macher (2002), Klein (2004), David & Han (2004), Carter & Hodgson (2006), Macher & Richman (2008) TCE and vertical relations in the electricity and gas industries: Coal Electricity: Joskow (1985, 1987, 1988, 1990) Natural gas producers-buyers: Masten & Crocker (1985). Crocker & Masten (1988, 1991 LNG chain: EE2 (Dresden) /DIW (Berlin) Ruester, Neumann, Hirschhausen Coal transportation Electricity: Saussier (1999) Gas-Electricity: Russo (1992)

3. Some theory Research question: Why Spanish electricity companies simultaneously expanded into a particular regulated gas asset of the LNG chain? Irrational behaviour? If firms are persistently irrational, perhaps their behaviour is not irrational (Kay, 2008): Core hypothesis: Asset specificity favours vertical integration, as internal organisation attenuates opportunism relative to market exchange

1. Background information 2. The regasification war 3. Some theory 4. Method 5. Results 6. Conclusions

4. Method Transaction Cost Economics heavily relies in case studies. They are an important, indeed necessary, complement to econometric analysis

4. Method Transaction Cost Economics heavily relies in case studies. They are an important, indeed necessary, complement to econometric analysis Qualitative case study: a) Public secondary information (official reports, annual accounts, news ) b) Six in-depth interviews to senior managers of the electricity companies. Heads of Strategy/Regulation or Fuel Purchasing Departments c) Three in-depth interviews to industry experts (energy regulator, electricity TSO and gas TSO) Average time of each interview > 1 hour Standard techniques for strengthening validity and reliability were applied

1. Background information 2. The regasification war 3. Some theory 4. Method 5. Results 6. Conclusions

5. Results Bounded rationality Farsightedness Opportunism Transaction Governance mechanism Frequency Uncertainty Asset specificity Asset specificity - Electricity companies accomplished huge investments in CCGT and gas retailing -The value of these investments critically depended on the timely entry of external gas to the Spanish national system: a particular case of asset specificity

5. Results Bounded rationality Farsightedness Opportunism Transaction Governance mechanism Frequency Uncertainty Asset specificity Uncertainty - Although the gas TSO could develop equivalent regasification facilities, electricity companies would not have the guarantee that the plants were going to be operational in time

5. Results Bounded rationality Farsightedness Opportunism Transaction Governance mechanism Frequency Uncertainty Asset specificity - Electricity companies did not trust the gas TSO impartiality because: Opportunism (i) previously to restructuring, the gas TSO was a subsidiary of the gas incumbent and both companies kept close links at the operational level; (ii) the gas incumbent retained a minority stake in the capital of the gas TSO

5. Results Bounded rationality Farsightedness Opportunism Transaction Governance mechanism Frequency Uncertainty Asset specificity Farsightedness and governance - The observed vertical backward integration into regasification facilities was a farsighted governance solution to prevent opportunism in the presence of large specific investments in CCGT and gas retailing

1. Background information 2. The regasification war 3. Some theory 4. Method 5. Results 6. Conclusions

6. Conclusions Uncertainty and opportunism exist, even under regulated environments. Therefore, transaction costs matter Electricity company vertical integration into regasification facilities was a defensive strategy for protecting the value of other downstream investments The optimal scope of firms can be distorted by imperfect regulation and imperfect restructuring Case studies rooted intransaction Cost Economics are useful for explaining how firms choose from the set of feasible institutional alternatives, the arrangement that offers better protection for their relationship specific investments at the lowest cost

01/07/2009 IBERDROLA AGREES SALE OF STAKES IN REGASIFICATION PLANTS The company owned 25% of BBG and 30% of Saggas The company agrees sale of shareholdings to RREEF Infrastructure for 200 million, representing a gross capital gain of 27 million. IBERDROLA has agreed to sell its shareholdings in the Sagunto (Saggas) and Bahia Bizkaia Gas (BBG) regasification plants to RREF Infraestructure, in line with the Group s asset divestment plan. The transaction is subject to the relevant regulatory aauthorizations and other third party approvals. Specifically, the company has closed the sale of 25% of BBG and 30% of Saggas valued at 200 million, including debt, generating a gross capital gain of approximately 27 million. In the case of Saggas, the transaction has been implemented via the sale of 60% of Iniciativas de Gas, a company that owns 50% of the plant and in which Endesa had a 40% stake. IBERDROLA acquired its stake in Saggas in July 2002. The plant is located in the port of Sagunto and has been in commercial operation since April 2006. It has a storage capacity of 450,000 m3 and a regasification capacity of 1,000,000 m3 per hour. IBERDROLA s stake in the BBG regasification company BBG, located n the town of Zierbana, Vizcaya, dates back to 1998.

Enagas in talks to buy BP's 25 pct of Basque plant Fri Aug 7, 2009 4:27pm IST MADRID, Aug 7 (Reuters) - Spanish gas grid operator Enagas aid on Friday it is in talks to buy BP PLC's 25 percent stake in a 264-millioneuro ($379 million) regasifification terminal in the Spanish Basque Country, the company said on Friday. Bahia de Bizkaia Gas (BBG), the company which owns the plant, gave its support to the gas network operator's negotiations with BP on Thursday at an extraordinary shareholders meeting, an Enagas spokeswoman said. Spanish press reported on Friday that Thursday's meeting also approved the sale of Basque power group Iberdrola's 25 percent stake in BBG to German infrastructure fund Rreff, although no-one at BBG was availible to commment. Enagas owns three of Spain's six working regasification plants, which convert super-cooled liquid natural gas (LNG) from container ships back into gas and pump it into the gas network, and recently won approval to build a fourth.