A simple formula worth keeping in mind has become of increasing importance to utilities around the world. It is called RPI-X. The idea is that all utilities, and we shall include railways here, are to some extent monopolies. You may introduce competition, but it is always pointless, for instance, to have three gas companies lay pipes along a street when one will do. So if they are to be held in private hands you want some regulation of tariffs to avoid overcharging of customers through their monopoly positions. The traditional way in Hong Kong, and one employed in the United States, is to limit their profits to a set percentage of investment in plant and equipment. This has some failings. It can encourage them to invest more than they have to as a way of boosting profits. We have an example in accusations that CLP Holdings has over-invested in recent years and has thus taken too much money from power users. The RPI-X approach is from a different angle. It says you take retail price inflation (RPI) minus some small figure (X) regularly reviewed by government and this is the maximum by which you allow utilities to raise charges. The Mass Transit Railway (MTR) does not like RPI-X or any other regulatory scheme of that nature. It wants what it calls 'fare autonomy'. You can understand the MTR's difficulty. A figure of $30 billion is still being bandied about for the 49 per cent of its equity that the Government intends to sell through privatisation. That would value the whole corporation at near $60 billion. But last year it only made about $865 million from railways operations (leaving the property smokescreen out of the picture here) and that was without a full year's depreciation charge on the Airport Express and Tung Chung lines, an investment as big as the rest of the railway assets put together. Nor can it get the depreciation charges lower. It already reduced them by lengthening depreciation periods last year. There is no way that investors will value the stock at $60 billion with only $865 million in earnings. That would give you a price earnings ratio of almost 70 times, a ludicrously high figure. Remember also that the number of passenger journeys has fallen over the past two years and that the new depreciation charges this year will take a further bite out of earnings. The point of all this is that we had MTR chairman Jack So Chak-kwong warning this week that staff would become lazy if fare autonomy was taken away and that overseas experience had shown that pegging fare adjustments to inflation would discourage productivity gains. Well . . . ahem . . . not quite, according to the most recent authoritative study on the subject by Richard Dobbs and Matthew Elson of McKinsey and Co. 'The RPI-X forumula, which is used to set the prices that UK privatised utilities charge their customers, has driven gains in efficiency so successfully that it is becoming the method of choice in countries from Argentina to Australia,' they say. However, if Mr So loses his pricing power and has only the thin reed of expected revenues from a Tseung Kwan O extension to boost profit estimates, then that $60 billion market value figure for the MTR is a dead letter. He needs control of fare levels if he is to promise investors that they can get a better return in the future and should pay for it now. But you can also understand why Democrat legislator Andrew Cheng Kar-foo is sceptical. The Government built the MTR as a service to the people of Hong Kong and he wants to adopt RPI-X to protect passengers if the MTR is now to become answerable to private shareholders instead. He is right too and Mr So is wrong about the overseas experience. RPI-X has been proven to work. It won't make the MTR lazy or discourage productivity gains. Stick to your guns, Mr Cheng.
