The Scottish Government

« Previous | Contents | Next »

Listen

6. Risk Management and Contract Procurement

6.1 Our case studies reveal a variety of contractual arrangements and risk allocation mechanisms in the procurement of island ferry services in Europe and abroad. In this report, we have chosen to concentrate on the most common risks, as well as widely adopted mechanisms designed to manage them.

Revenue and Cost Risk Management

6.2 Cost fluctuations are considered to be a big risk by the governments surveyed. A popular response amongst countries is to include clawback clauses, and make provisions for fuel price adjustments within the PSCs.

6.3 In response to revenue risks and fluctuations in demand, contracts may include revisions to the subsidy amount up to a ceiling, or may include revised fares.

6.4 Inclement weather conditions not only lead to non-sailings, but can also increase the operating costs of the shipping company. PSCs may detail what happens and who bears the costs in case of unsafe sailing weather.

Service Requirements and Quality

6.5 Public Service Contracts should not be so onerous in terms of contract structure or over-optimistic prices that it drives operators into default.

6.6 PSCs should incentivise operators to provide good service, and should penalise for failures. This would require close monitoring of the operations and the penalties may be subject to challenge and negotiations.

6.7 The incentivised gross-cost contract is a potential solution to ensuring service quality while protecting the contracted operator.

Innovation

6.8 The definition of the subsidised network should be market-driven. Economic benefits and commercial interests ought to be taken into account when designing the tender.

6.9 The design of the contract should incentivise service improvements and efficiency.

6.10 As such, we recommend that PSCs should be of:

• Limited tenure to allow for changes to be incorporated;
• Sufficiently long duration to allow for recuperation of any capital investment.

Safety

6.11 Incentives built into the contract must not conflict with safety.

6.12 Sailing in bad weather conditions is a big risk. In response, PSCs may want to detail what happens in case of inclement weather.

Tendering

6.13 The tendering of public service contracts must not be so onerous that competitive bids are not received.

6.14 The transfer of risks should be balanced and managed in order that a tendered service is possible.

6.15 Access to required capital equipment, such as vessels, harbour facilities, and marketing/distribution channels are pre-requisites for private operators to compete and operate in the subsidised ferry market.

The Maritime Cabotage Regulation

6.16 Council Regulation ( EEC) 3577/92 (the Regulation) applies the principle of freedom to provide services to maritime transport within European Union Member States. The goal of the EC directive aims to promote competition and non-discrimination amongst Member States.

6.17 There are, however, three derogations specified in the Regulation. Firstly, Members States have the power to impose manning rules on board vessels performing island cabotage services between two ports in the territory. Secondly, Members States may impose public service obligations on ship-owners in order to ensure an adequate level of services. Lastly, Member States may ask the EC to adopt safeguard measures to remedy a serious disturbance of the internal market. Articles 3 and 4 of the Regulation are most relevant to the purpose of this study.

6.18 In 2003, the Commission adopted a communication on maritime cabotage with a view to simplifying the rules concerning small islands. The Communication provided for an exemption for small islands from the legislation EC 3577/92, which applied the cabotage rules indiscriminately to islands irrespective of size. The unique situation of small islands led the Commission to consider that public service contracts for maritime services to small islands should be awarded simply on the basis of a call for expressions of interest, rather than the full tender process. "Small islands" are understood to be islands where the total annual number of passengers carried by sea to and from the island is around 100,000 or fewer. Where the same operator services several small islands, the total number of passengers carried by that operator in the context of the public service is taken into account when determining whether the threshold is reached. The European Commission believes that 40% of the islands in the European Union will, in the future, fall into this category.

6.19 On 22 ^nd December 2003, a communication from the Commission to the European Parliament ( COM(2003) of 22/12/2003) was presented, for information only, about the interpretation of Regulation 3577/92, however, no alteration to the Regulation has been proposed.

6.20 Steer Davies Gleave consultants met with administrators from the European Commission's Directorate-General for Energy and Transport in Brussels during the course of this research study. The objectives of the meeting were to:

• Understand how the rules regarding maritime cabotage and Public Service Obligations/ Contracts have changed, and to confirm and clarify our understanding of regulation 3577/92 and the subsequent communications (especially the most recently published Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions on the interpretation of Council Regulation ( EEC) No 3577/92 applying the principle of freedom to provide services to maritime transport within Member States (maritime cabotage) COM/2003/0595) ; and
• Gauge the Commission's data and understanding of the situations in the member states, so as to identify issues that researchers should pay particular attention to in the course of our research. Our conversations concentrated heavily on the Commission's stance on the bundling of routes, exclusivity, manning and vessel ownership.

Bundling
6.21 Member States are free to decide on whether to tender the subsidised services as individual routes, or as a bundle(s). Recently, Greece was denied the ability to bundle popular services with non commercially viable ones on the grounds of cross-subsidy.

Exclusivity
6.22 The Commission believes that exclusivity should be applied as a last resort. Other means should be considered first to mitigate the competition risks confronting the Public Service Contract ( PSC) operator. For example, if skimming activities do take place, where operators enter the market during the peak season, the government can then also impose a PSO on that particular route. The PSC would then run alongside the PSO. The PSO must be a light one.

Crew
6.23 In general, manning rules of the Member States apply. These rules, however, cannot distort the goal of the EC directive, which aims to promote competition and non-discrimination. Member States can prohibit non-European Union crew from bidding or manning the PSO routes, but cannot extend it to other Member States (including the EEA countries, such as Norway). While a country can impose a language and nationality requirement out of safety reasons, it must be deemed reasonable by the Commission.

6.24 EEC No 3577/92 prohibits Member States from obligating an operator to take over crew from its predecessor.

Vessels
6.25 As Members States liberalise their cabotage and privatise / tender formerly government-run operations, the fleets are usually owned by private operators. Based on our research to date, almost none of the governments directly own the vessels that service the PSO routes (with the exception of Ireland, where the government is currently in the process of selling its last remaining vessel and Scotland where the Clyde and Hebrides fleet is owned by a limited company which is, in turn, owned by the Scottish Executive). Regarding the taking over of vessels, Article 5.3.2.1 of the Communication COM/2003/0595 specifically addresses the situation in Scotland. The Commission reiterated that where serving an island requires the use of a vessel with a unique design, the vessel could in this case be leased under very clear conditions set out in the tender documents. It is also possible for the new operator to take over the vessel(s) directly from its predecessor. This condition, however, does not extend to the crew on the vessel.

Ports
6.26 The Commission indicated that the proposal for a directive on freedom to provide services to ports has been adopted by the Directorate-General, but still needs to go through proceedings. Until then, the Commission's stance on staffing, pilotage, towage and mooring at ports has not yet been clarified.

Freight
6.27 Member States have different provisions in their PSCs in relation to freight transport. For example, in Portugal, the subsidised ferries between the mainland and the Azores only carry freight, whereas in Spain, the Public Interest Services routes only pertain to passenger transport and no freight transport is subsidised. In Greece, an operator can be contracted to transport both freight and passengers on the thin routes. In Ireland, there is a trend towards separating contracts for freight from those for passengers for reasons related to health and safety, and flexibility. In some cases, such as in Ireland and Malta, the PSC operator has separate contracts with the government to carry mail and garbage.

6.28 There is no separate treatment of freight from passenger PSOs according to the European Commission. Other contracted services with the government, such as mail and garbage collection, also have to be tendered openly.

Procurement and Tendering

6.29 Countries where private operators provide lifeline services under public service contracts are moving towards competitive tenders.

6.30 The early joiners, such as France, Italy, Portugal and Spain, had an earlier start in their market liberalisation process. As a result, they have managed to openly tender and procure their domestic lifeline services in compliance with the EC regulation.

6.31 In Sicily (Italy) slow ferry services to the minor islands are undertaken by a state-private joint venture, Siremar (it is partly owned by private company Tirrenia). These contracts are still in operation, and provide a public service that is stipulated directly by the Ministry. These contracts will expire in 2005, at which point they will be substituted by standard PSO contracts let by the Region, as was done for the fast passenger and freight services.

6.32 Greece enjoyed a derogation until early 2004, and, along with Scotland and Malta, is currently drafting new tenders and contracts. The Maltese PSO services will be tendered openly by 2010. There is currently no plan in place to prepare for the tender. As the first contract only began in 2004, the Maltese Government is going to observe the current contract and see what the problems and difficulties may be before drafting the new tender and contract.

6.33 The more recently ascended countries, such as Finland and the Baltic Countries, have started re-shaping their markets. It may be another 3 to 6 years before an open tender will happen.

6.34 The degree of competition, however, differs amongst the surveyed countries. The degree of competition is influenced by the nature of the routes and the capabilities of local operators. For example, in Malta, the government predicts that the contract for the Gozo services will go to a foreign operator due to lack of domestic capabilities. In the case of the Netherlands, the unique design of the vessels highly increases the costs of market entry for new operators, therefore minimising the degree of competition in the market.

6.35 Amongst the countries that have successfully tendered their PSCs to date, almost all of the final contracts were awarded to domestic operators. A prevalent reason for this is that the islands are so remote and the sunk costs of setting up operations are so high that foreign ships are unlikely to be able to compete.

6.36 Table 6.1 summarises the status of the PSC tendering process in the surveyed EU countries.

Table 6.1 PSC and Tendering Status for Surveyed EU Countries

« Previous | Contents | Next »