Privatisation derailed in Estonia

By bne IntelliNews January 9, 2007

Steven Roman in Tallinn -

The process of privatisation may be unstoppable elsewhere in the EU, but on Tuesday the Estonian government will re-privatise its rail network by taking back a 66% stake in Baltic Rail Services (BRS), the majority owner of Estonian Railways, in a controversial cash-for-stocks deal that will end up costing the taxpayer about €150m.

Some officials in Estonia will no doubt breathe a sigh of relief this strategic national asset (Estonian Railways owns the tracks that provide a key link from the Russian border to Estonia's ports as well as the main rail cargo carrier) is back in government hands after effectively reversing the privatisation deal struck in 2001. Business leaders are more likely to be scratching their heads and wondering what went wrong.

The break-up was an ugly one. The unravelling of the biggest privatisation project in Estonia's history was the culmination of five years of increasingly intense disputes between BRS – a consortium of domestic and foreign firms – and the Estonian government.

It was accompanied by a large dose of infighting between political parties, some of whom have continued to oppose the privatisation. Even more contentious were the accusations by BRS' chairman, Edward Burkhardt, that Russian business interests had colluded with members of the Estonian government to kill off BRS' chances of turning a profit, eventually forcing it to sell.

"Right from the start there was a strategy to basically bring us down," said Burkhardt.

In earlier remarks to the press, he pointed the finger squarely at Estonia's Centre Party, which he said is being covertly influenced to favour the Russian railway giant Severstaltrans. It's the Centre Party's outspoken chairman, Minister of Economic Affairs and Communications Edgar Savisaar who has been leading the drive to renationalise Estonian Railways since he took his post in 2005. The same ministry will take control of the company on Tuesday.

BRS, currently a consortium of RailWorld Estonia LLC (US), the Railroad Development Corporation (US), Ganiger Invest (Estonia) and the Emerging Europe Infrastructure Fund (Netherlands), had initially bought the ailing Estonian Railways for EEK1bn (€63.9m) with the plan to revamp the company and bring it to the point where it could carry out an IPO.

Since the company controlled both the rail infrastructure and rail transport services on the two lines heavily used by Russian exporters, notably oil exporters in need of access to European markets, it seemed in a good position to do that. Burkhardt said that during the first two years, the business was growing as expected.

"We greatly improved our efficiency, cut costs, improved service – we did all these things and had a pretty strong financial performance," he said.

But in 2003 Estonian Railways hit a wall when the government passed a new Railways Act that gave Russian companies the right to use the rail lines at a price that was half what Estonian Railways wanted to charge.

"We lost €25m of cash flow each year as a result of the government's action," he said. "It came out of our hide."

The government, for its part, complained that BRS was not meeting its obligation to invest €22.4m per year in Estonian Railways infrastructure, as stipulated in the privatisation contract.

It was a claim BRS denied. This spat apparently stemmed from different interpretations of which kinds of investments could be counted under the agreement.

As tension between the two sides grew, they took each other to court in Washington and Stockholm. Soon BRS had had enough and was ready to sell.

"Divorce was inevitable," Savisaar said in a ministry statement. "We absolutely could not agree to BRS' interpretation of the privatisation agreement, their understanding of tariffs, investment principles and many other issues."

The end of the line

Savisaar, who had been a leading critic of the Estonian Railways privatisation from the outset, appears to have finally gotten his way. But with so much bad blood and speculation surrounding the issue, it's easy to question whether there was anything more behind the affair than simple differences in contract interpretations.

If indeed successive governments who disagreed with the privatisation deliberately took steps meant to interfere with Estonian Railways' prospects, as Burkhardt and some opposition politicians have alleged, or if Severstaltrans is controlling the Ministry of Economic Affairs' actions from behind the scenes, as Burkhardt also alleges, then the Estonian government has serious problems.

But Heido Vitsur, advisor to Savisaar and head of the commission that negotiated the buyback, said that the dispute was much more straightforward.

"In the last two years, BRS and the state have had very a different understanding about the railway law of railways in Estonia. …Maybe BRS in the very beginning didn't understand what implications this would bring for BRS and its profits," said Vitsur.

He also denied Burkhard's accusation that the ministry had sold out to Russian business forces.

"Maybe he has more information than we do, but …we were not interested that Russian companies would own Estonian Railways," he said, going on to explain that the motivation for the buyback was in fact to prevent BRS itself from selling to Russian interests.

"Actually we know that they had negotiations with some Russian companies who wanted and were interested to buy, and as I understand Mr Burkhardt was agreed to sell them, but it was good for us that they couldn't make a deal and the state could buy back the shares," he said.

Given Estonia's 50-year occupation by the former Soviet Union and continuing pressure by its neighbour to the east, it's understandable that Estonians are jittery about anything that smacks of a covert Russian power play to gain control of Estonian Railways.

But what may seem like paranoia doesn't seem so far-fetched when you see who's involved.

Though a popular political figure, Savisaar has more than once found himself in the midst of corruption scandals, and he has also sent shockwaves through Estonia's political establishment by signing a cooperation agreement with Russian President Vladmir Putin's United Russia Party.

Edgar Savisaar

Martin Hanson, a journalist who has been following the story for Estonia's business daily Äripäev, said that just exactly what kind of sway, if any, Russia has over the Estonian government in this matter is impossible to tell. Covert deals of the type Burkhardt alleges, he points out, are never put on paper.

"Looking at …the geographical position of Estonia, and the historical position, it would be stupid to say there's no interest from Russia," he says.

Knowing how Savisaar operates, Hanson says, it's likely that the minister was pressured from the Russian side, but doesn't think that was his main motivation. It could simply be that the minister wants Estonia to be in a position to offer a better export route than competing ports.

It's possible the full story will never be known. What's also unclear is the long-term future of Estonian Railways now that it's back in government hands.

Vitsur said the current business plan will go ahead, and there's an agreement not to sell any part of the company for at least another five years. But with an election looming in March, he wouldn't speculate further.

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