Labor Toolkit

Port Regulation: Overseeing the Economic Public Interest in Ports

Regulatory Concerns When Formulating a Port Reform Strategy

The decisions about reform strategy, industry structure, and regulatory frameworks are closely linked. Therefore, regulatory issues, options, and their consequences should be considered at the early stages of the reform process, and not left until other key decisions about reform strategy have been made. As demonstrated by the reform experience in other sectors, to do so can increase the regulatory burden and cost, restrict the range of options that may be available to the regulator, and risk incongruity between regulatory requirements and institutional capacity.

Governments do not need to undertake detailed design of the regulatory framework when they are first considering private sector participation. However, they should take regulatory needs and costs—and their own regulatory capacity—into account when making choices about private sector participation. And when embarking on the first private sector participation in ports, it is important to consider whether the regulatory system proposed for the first transaction will preclude the regulatory options that might be most appropriate as private sector arrangements become more common. A government that fails to get the structural and regulatory package right from the outset can face an immensely costly, time-consuming, and acrimonious process to rectify matters later.

Considering regulatory issues before formulating the framework of the contract has a number of important purposes:

All of these purposes are closely related. For example, as was shown in the Malaysian experience at Port Klang, the failure to have an adequate legal framework in place prior to the privatization effort can impose substantial delays as legislators debate legislative actions to facilitate the privatization process. The continuing refusal of the Sri Lankan government to corporatize or privatize its publicly owned container terminal in Colombo has delayed the necessary port expansion for years. And Colombia’s failure to properly define anticompetitive behavior beforehand led to the need for the regulator to constantly solicit legal opinions before intervening.

In many countries, the broad regulatory framework may not adequately support a private sector arrangement. Private sector ownership of port assets may be prohibited by the legal system. Tariff setting responsibility may reside within an operating port authority that would compete with the private operator. But governments can still make private sector participation in ports work by taking one or both of the following actions1:

Prior to undertaking port sector reform, the public interest in ports has typically been vested in a public port authority. In a traditional port, the public port authority provided all basic port services and functions (for details see Module 3). There was no need for a separate regulatory agency as the public port authority was the institution charged with operating the port as a public monopoly consistent with the public interest.

Under port sector reforms, many ports have evolved into landlord port authorities where facilities are leased to private operators, who in turn directly provide their services to carriers and shippers. In this situation, private operators may provide services previously provided by the public port authority, such as pilotage, tug assist, vessel stevedoring, cargo handling, storage, and yard services. Private operators will be motivated by profit maximization objectives. They may not necessarily provide facilities or services that are of economic, environmental, or social value if doing so would conflict with profit maximization. This creates the need for regulatory oversight to ensure that the public interest is upheld.

How Ports Compete

Generally, port-related competition can be defined as one of three types: interport, intraport, and intraterminal. Interport competition arises when two or more ports or their terminals are competing for the same trades (for example, New York and Halifax; Hong Kong and Singapore; Los Angeles, Long Beach, and Oakland; or Rotterdam, Hamburg, Bremerhaven, and Antwerp). Interport competition may be for origin-destination traffic or for transit traffic. Intraport competition refers to a situation where two or more different terminal operators within the same port are vying for the same markets (for example, Stevedoring Services of America, Evergreen, and Hutchison International Terminals in Manzanillo- Cristobal, Panama). In this case, the terminal operator has jurisdiction over an entire terminal area, from berth to gate, and competes with other terminal operators in the port. See Box 1 for a similar example of intraport competition in Buenos Aires, Argentina. Intraterminal competition refers to companies competing to provide the same services within the same terminal (for example, the stevedoring companies Estibadora Caribe and COOPEUNITRAP in Port Limon, Costa Rica). However, this type of competition, applied within the framework of the tool port system, in general does not result in stable labor relations and optimum port development (see Module 3).

Competition also helps ensure that the private sector passes savings on to users and reduces opportunities for monopolistic abuses. A private terminal operator can be presumed to be more tempted than a public port authority to exploit any market power that it may have. But one should not forget that experience has shown that public sector monopolies are often stronger, more authoritarian, and noncompromising than private sector monopolies. Moreover, they are often more difficult to fight as they are either claimed not to exist or to be justified for the public good. As long as a market is competitive, private operators cannot price much above their long-run marginal costs; they may be able to do so in the short run if demand temporarily outstrips supply, but only for as long as it takes to provide additional capacity. If the markets are noncompetitive, however, public port or terminal operators are often able to sustain prices well in excess of marginal costs whether they are located in developed or developing countries. In practice, governments consider such ports as “cash cows” and are often reluctant to limit or lower port tariffs and terminal handling charges. Private terminal operators will equally be tempted to raise their tariffs above the level that is economically reasonable. In such a case, tariff regulation by an independent regulator is the answer, although the history of government regulation attests to difficulties in preventing misuse of the dominant position of such operators.

When effective competition can be established and maintained in the relevant markets and activities, privatization has proven to have great potential for reducing costs and improving service quality. Without competition, privatization can still bring some improvements, but the gains are relatively limited.

Assessing Port Sector Competition

This section presents a conceptual framework for assessing the extent of competition within a port sector. The conceptual framework may be used when deciding the optimal form and scope of port modernization or in determining whether regulatory intervention may be warranted after modernization. The framework is not intended to determine definitively that a particular port or terminal operator is engaged in anticompetitive behavior. Instead, it indicates conditions where anticompetitive behavior may occur. When these conditions exist, the framework serves effectively as a red flag to indicate to the regulatory authority that the situation should be closely monitored. Alternatively, the framework could be applied when complaints are received to determine if in fact there may exist sufficient grounds for the complaint. Factors indicative of the extent of market competitiveness include:

Box 2 presents an overview of the key elements of a conceptual framework for considering these factors. Each of the framework’s salient features is described below.

Transport Options

The most important indicator of competition is the degree to which a shipper has transport options (substitutes). The choices or options available to a shipper or consignee largely determine the extent of competition within the port sector. In examining options, one should analyze a specific cargo flow as defined by cargo type, shipping characteristics, inland point, and direction (import or export). The number of options is defined according to the technical capabilities of the ports and their available inland connections. For example, there may be situations in which one port has already captured a large share of the cargo market. One might, therefore, label this as a noncompetitive market. However, the market power of this port (or its capability to increase the price) would be limited if other ports could provide an attractive alternative and keep competitive pressure on the other port’s prices.

The availability of competitive options is based not just on the existence of a physical service alternative, but on overall transport system costs (land and port). Thus, the first step in assessing the competitiveness of the port and transport system is to identify the lowest cost option. Then, the competitiveness of each option is determined by comparing it to the lowest cost option, defined here as cost proximity. A cargo flow that moves through a system with many options and possessing close cost proximity (small cost differentials) faces a highly competitive market setting. Conversely, if there are few options and the cost differentials among the options are large, the market setting is defined as noncompetitive.

Operational Performance

Operational performance indicators can be used to assess the relationship between supply and demand for port services in a particular country. Presumably, a chronic shortage in supply indicates a possible tendency toward monopolistic practices by a port or terminal operator. However, using the supply-demand relationship itself as an indicator may be inadequate because of difficulties in direct estimation of these two market factors.

Instead of the throughput-capacity (supplydemand) ratio, two measures that can indicate a potential shortage in supply of port services can be used: berth occupancy and ship waiting for berth. Both measures are, in fact, two different aspects of one phenomenon, port congestion. Berth occupancy has a direct relationship to capacity utilization in ports where the berthage is the limiting factor of terminal capacity. This, however, is usually not the case in container terminals, where the limiting factor is often the container storage capacity of the yard. Nevertheless, even in container terminals, berth occupancy provides a good indicator for capacity utilization. To provide a more telling picture of a port’s operational performance, berth occupancy should be complemented with the berth utilization ratio, which compares the amount of time ships are worked at berth to the total time that the berth is occupied, and with the berth productivity ratio, relating berth occupancy time and berth throughput.

Ship waiting has a direct relationship with berth occupancy. When occupancy is low, there is usually no (or minimal) ship waiting. However, at a certain occupancy level, waiting begins to increase very rapidly. Thereafter, a small increase in the level of berth occupancy results in congestion and long waiting times for ships. Although these two indicators are closely related, both can be examined to obtain a more comprehensive assessment of port congestion.

The input data for berth occupancy are typically readily available from operational reports generated by the ports or terminal operators. The occupancy indicator should be calculated separately for container, general cargo, and bulk ships. For vessel waiting time, the input data are also typically available from port (usually the harbormaster’s office) or terminal operator operational reports. The ship waiting indicator is calculated as the average waiting hours per ship, by type of commodity. Average waiting time is also sometimes compared to average time at berth to produce the ship-waiting rate. The various elements contributing to the waiting time should be analyzed to allow the port authority to precisely identify cases whereby it was the result of nonavailability of port facilities or equipment. Practitioners should be aware that terminal operators are increasingly seeking to acquire the ability from port authorities to offer guaranteed priority berthing windows to secure long term contracts with some of the larger main line vessel operators.

Berth occupancy and utilization and wait time are strong indicators of undercapacity, which in turn may indicate the absence of significant competition.

TARIFF COMPARISONS

The objective in examining tariffs is to determine if the tariff level of a port is within a reasonable range. Presumably, abnormally high tariff levels in a port indicate a tendency to exert market power and employ unfair trade practices. This inflates total port costs, which include charges to shipping lines and cargo. The calculation of port costs should be based on a representative basket of basic services and their respective charges.

An indication of whether tariff levels are within a reasonable range can be based on three comparisons. The current rates of the port under consideration are compared with: (1) historical rates of the same port, (2) rates (tariff differentials) at other ports in the same country, and (3) theoretical rates based on model port costs. Historic rates measure the difference in port costs between the time of analysis and the past, either in the previous year or before a recent rate increase. Differences in port costs (tariff differentials) are examined by comparing a specific port with the average of the country’s ports that handle the same cargo (including the port under consideration). Model port costs measure the difference between the actual and theoretical costs of a specific port based on a port cost model that generates the model costs for a country’s ports in general.

FINANCIAL PERFORMANCE

A variety of financial performance measures can be used to examine whether a port has been earning abnormally high profits. The assumption here is that abnormal profits may indicate a noncompetitive market setting and the possibility that a port is engaged in anticompetitive behavior (taking advantage of dominant market power). Economic theory maintains that suppliers possessing monopoly power tend to charge prices that exceed marginal and average costs.

Ideally, a competitive assessment should be based on the comparison of price and marginal cost. However, direct measurement of the difference between price and marginal cost is impractical. The financial profit (net income and earnings) of a port is used as a proxy for the difference between market price and marginal cost. Presumably, abnormally high profits indicate a noncompetitive setting that, in turn, suggests the possibility of anticompetitive behavior. The level of profit is usually compared to some measure of investment. Two common indicators that relate profit to investment are return on equity and return on assets, and both are typically found in port financial statements or can be calculated from data readily available from the port.

COSTS OF AN INADEQUATE REGULATORY FRAMEWORK

Failure to provide an adequate economic regulatory framework can be very costly in terms of inefficient and high-cost port services. In many countries, excessive port costs function like an additional import duty on all goods entering the country and a tax on exports. Excessive port costs reduce the competitiveness of a nation’s products in world markets and can stifle economic growth and development. In fact, shipping lines or conferences may further compound the unfavorable effects inefficient ports have on a nation’s economy by imposing penalty surcharges to offset the carrier’s operating costs and disruptions to its service rotation or itinerary. Unfortunately, the anticipated benefits of free trade associated with reduction of import duties and removal of trade barriers may be offset by the inefficiencies of an improperly regulated and noncompetitive port sector.

In some instances, port reform efforts have transferred public ports to single private operators, thereby creating private monopolies for local port services. This type of transfer does nothing to lessen the vigilance governments must maintain if abuses of market dominance are to be avoided. Box 3 presents the experience of Israel, which dissolved its national port authority in favor of individual port operating companies for its three ports. Similarly, in Mexico terminal operations at the ports of Veracruz and Manzanillo were transferred to private operators. However, due to the lack of interport or intraport competition, port users have repeatedly complained about high tariffs and have requested that a regulatory institution be established to limit the monopolistic position of terminal operators.

Due to the nature of the sector, it is common that even when competition for port services is strong, there may be only two or three direct competitors. Thus, market shares and concentration ratios measured by traditional antitrust techniques would typically be high. In most circumstances, a high industry concentration indicates that conditions are such that they may encourage anticompetitive practices (see Box 4). For example, having few competitors invites pricing collusion, agreements to allocate customers or geographic territories, or the establishment of cartels or boycotts, all of which are typically prohibited in a country’s antitrust legislation. Having one dominant firm may also encourage predatory pricing, another practice that is typically prohibited.

After pressure from the European Union, Maersk Line (APM Terminals) and P&O Nedlloyd were allowed to operate two competing terminals. The take-over of P&O Nedlloyd by Maersk Line however, has created the next problem, as these large terminals are now owned by one common shareholder which, again, might violate EU competition rules. In Antwerp, competition between the original three major container operators (Hessenatie, Noord Natie and Seaport/Katoennatie) has always existed, but because of the need to gain in scope and scale, the two main operators have merged into Hesse-Noord Natie. To cope with growth, Antwerp has built a new tidal container port, the Deurganck dock, on the left bank, doubling its handling capacity. On the west side of the Deurganck is Antwerp International Terminal – operated by PSA Hesse-Noord Natie – which started operations in December 2005 and will be fully completed by 2007. To the east is the Antwerp Gateway Terminal – operated by DPW-owned P&O Ports, Cosco Pacific, P&O Nedlloyd (now owned by Maersk), CMA-CGM and Duisport – which started work in September 2005. All in all, major global terminal operators and shipping lines acquired a substantial stake in Antwerp’s container terminal business, thus enhancing intraport competition.

It is the growing scale of the users that makes larger scale operations in ports imperative. With this pressure for increased size, one might ask whether any regulatory framework can ensure the continued existence of more than one container terminal operator. One should keep in mind that in the early years of 2000, the top two Antwerp terminal operator consortiums mentioned above, Hesse-Noord Natie and Seaport/Katoennatie, handled more than 1,000,000 and more than 2,000,000 TEU per year respectively. Thus, the nominal size of their throughput does not explain the merger in itself.

In an unregulated market, profit may be sought through the creation of a stevedoring company cartel to exclude competitors from access to facilities. Controlling anticompetitive commercial behavior requires a regulatory institution to prevent the acquisition and exploitation of excessive market power. Even without cartelization, wherever there is a financially strong incumbent in a market, there is a danger that anticompetitive behavior will occur (see Box 5).



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How To Use The Toolkit

Overview

Framework for Port Reform

The Evolution of Ports in a Competitive World

Alternative Port Management Structures and Ownership Models

Legal Tools for Port Reform

Financial Implications of Port Reform

Port Regulation:
Overseeing the Economic Public Interest in Ports

Introduction

Regulatory Concerns When Formulating a Port Reform Strategy

Strategies to Enhance Port Sector Competition

Designing a Port Regulatory System

Summary and Conclusions

Annex

Endnotes

Labor Reform and Related Social Issues

Implementing Port Reform

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