MAY 2013 DANISH MARITIME PILOTS ASSOCIATION

SCENARIO ANALYSIS OF THE DANISH PILOTING SERVICE FINAL REPORT

MAY 2013 DANISH MARITIME PILOTS ASSOCIATION

SCENARIO ANALYSIS OF THE DANISH PILOTING SERVICE FINAL REPORT

CONTENTS 1 Introduction 2 Background 2.1 The current model 3 International experience with liberalization of piloting services 4 Scenario analysis 4.1 Scenario A – status quo 4.2 One state-owned company 4.3 Free competition - liberalization of transit pilotage 4.4 Pure concessionary model 4.5 General outline 5 Conclusions and recommendations 5.1 Recommendations APPENDIX Appendix A Interview list

4 6 7 9 10 11 14 16 19 22 24 25

1 Introduction A scenario study of the Danish piloting service in Danish waters is a complex task. The organization of piloting services in Denmark can be compared to a circuit with many communicating vessels where adjustments in one place create changes in many other places in the system. It does not fall within the scope of this study to investigate all options and models in detail and therefore this study will focus on a description of the most likely advantages and disadvantages of four possible models for organisation of the Danish pilotage service. The purpose of the study is to contribute with varied reflections to the current discussion on a future sustainable and effective model for the Danish piloting service. Prerequisites To simplify our analyses a little we have had to establish some permanent prerequisites, which may form a kind of basis on which to analyse the models. The chosen prerequisites will hopefully reflect the most unambiguous priorities in the political system with respect to pilotage. These are: o A high level of safety must always be the top priority o It is important that Denmark is able to live up to its obligations to the shipping industry and thus live up to its supply obligation o The government will still have a self-financed and user-financed piloting model and therefore a reform must be "free" for the tax payers. o There is still a wish to support regional pilotage in outer ports through the price policy for piloting services conducted within a state-controlled framework. o It is a requirement that efficiency and optimisation potentials are identified and realised on an ongoing basis o It is an explicit goal - without consideration for the above - that prices for piloting services must be reduced Perspective The study will be carried out at a relatively general level and there will be no detailed business economic analyses. We will focus on the overall consequences of different models for the pilotage area. In this context, efforts are made to avoid making changes that may increase the risk of accidents and environmental disasters based on the simple logic that short-term marginal streamlining measures are only acceptable if the risk of environmental disasters does not increase. It follows from this logic that the costs of cleaning up after a potential accident are so far-reaching for many years after the accident that just a small reduction in safety is often untenable from a political as well as socio-economic perspective. Four scenarios In the report we set up four scenarios with an analysis of advantages and disadvantages: › The 'status quo' model › Free competition › State-owned company › Pure concessionary models

Naturally, the scenarios are fictitious (except the first scenario) and it will no doubt be possible to imagine other specifications of the scenarios than the ones we have included. The study includes 2 types of data collection: › Interviews with stakeholders in all corners of the business1 › Desk studies of available national and international texts on the experience of other countries General consequences As it appears from the above, the study is based primarily on qualitative data, which guide the reflections and conclusions of the analysis. These attempt to identify the overall consequences of different models by describing the causalities that affect prices of piloting services and the safety level in the specific case. So, the analyses will not include any exact quantitative data and descriptions of the detailed economic consequences of the different models. Their primary purpose is to outline to the reader the conditions that should be considered when reflecting on the relevance of one or several models for future organisation of the piloting service in Denmark. This study has been prepared by Nis Vilhelm Benn and Carsten Bondo Ellegaard from COWI. The study is financed by the Danish Maritime Pilots Association. The Danish Maritime Pilots Association has contacted COWI with a request for a clarification of the advantages and disadvantages of different scenarios to ensure that these are included in the reflections that take place at a political level in the spring and summer of 2013. COWI has concluded a contract with the Association with the understanding that, as always, COWI's report is based on impartial professionalism. Due to the size and budget of the project we have not been able to analyse all potentially relevant details for the individual scenarios.

1

See appendix A

2 Background Pilotage is a traditional maritime profession for the prevention of accidents. The pilots' task has been to navigate ships safely into port or safely from point A to point B. Subsequently, the pilot's work has developed so that it now comprises an assessment of the safe condition of ships and the maritime competencies of the crew. The Danish pilot's self-knowledge Danish pilots view themselves as an integrated part of the Danish maritime tradition with emphasis on quality, a high degree of professionalism and good maritime skills. Today, Danish pilots are highly specialised navigators with many years' experience as master or senior officer2. The job as pilot has traditionally been associated with a highly independent and impartial identity. There is a self-knowledge that maritime pilots have been put on this earth to create as much safety as possible, primarily through preventive and impartial advisory services. The general view is that today the pilots provide piloting services of a very high quality. In many places, the Danish pilots are seen as a very important element in the preventive preparedness in case of accidents and oil pollution in Denmark. Pilotage in Danish waters From an international perspective, Danish waters are some of the most crowded areas. Navigation in Danish waters is associated with several challenges. In most places, the sea bed is quite close to the ships, which means that even the slightest deviation from the channel may result in grounding. At the same time, the narrower straits in Denmark present a special challenge in the form of a very small passage distance. In these places - and not least considering the increasing amount of traffic it only takes a very small deviation to cause a collision. Danish piloting operations are particularly important for safety around the many tankers that pass through Danish waters3. From a safety point of view it is of special interest that each day large volumes of oil are transported through Denmark from the Baltic Sea to the North Sea - and these volumes should be rising as a result of an increase in particularly Russian tankers with oil. Prices for piloting services In an EU benchmarking study of prices for piloting services in other countries Denmark ended up in the middle among EU countries and our prices were lower than those in a number of countries such as Norway, Sweden, the Netherlands and Germany, which we resemble the most based on numerous cost parameters. Figure 1 Average price for piloting service: Non-specified cargo ship4 Figure 2 Average price for piloting service: Container ship5 2 3

This strong professional culture is clearly discernable during interviews and conversations with pilots.

Interview sources have assessed that half a million tons of oil is transported annually through Danish waters - however, we have not been able to find statistical data on this.

4

Study on Pilotage Exemption Certificates, PWC 2012: http://ec.europa.eu/transport/modes/maritime/studies/doc/2012-09-18-pec.pdf

5

Ibid

2.1 The current model In 2006, the Danish parliament adopted a new pilotage act which exposed the state-owned pilotage service to competition within certain types of pilotage, so-called regional pilotage in Danish waters to and from Danish ports, while transit pilotage of tankers and other large ships through Danish waters remained a task for the state-owned pilotage provider DanPilot. Two primary players on the market Today, there are two primary players within the Danish pilotage service - DanPilot and Danish Pilot Service. In addition, a few ports have their own pilots, including Aarhus harbour, Rønne, Hirtshals, Skagen and Frederikshavn (private player). DanPilot Danpilot was founded in 2007 as a merger between the former local pilotage services and it is now an independent unit under the Danish Ministry of Business and Growth but there are plans to establish a state-owned company with a professional board.6 DanPilot carries out the statecontrolled pilotage through Danish water to and from any destination in Denmark and to destinations in the Baltic Sea. It is one of DanPilot's responsibilities to ensure that the government's supply obligation is fulfilled. As a result of the pilotage act from 2006, DanPilot competes with Danish Pilot Service for regional piloting tasks whereas transit pilotage is still not subject to competition. DanPilot is in the process of becoming a public service organisation as part of an effort to increase transparency and in this way the possibility for increased cost efficiency.

6

At the moment, a bill is in the consultation process.

Danish Pilot Service Danish Pilot Service (DPS) is a limited partnership, which was established as the first private pilotage company in Denmark in October 2007. Thus, the company broke the monopoly held by the state-owned pilotage service up until then. The company is based in Fredericia and its pilots carry out pilotage to and from major Danish ports as well as port pilotage, mainly from Fredericia, Kalundborg, Aabenraa, Copenhagen and in Limfjorden. Size of the pilotage market Today, various conditions trigger a recommendation7 for transit pilotage. These may be the ship's draught. All ships with a draught of more than 11 metres are recommended to use a pilot through the Great Belt. In Oresund, there are recommendations that apply to loaded tankers with a draught of more than 7 metres and all loaded chemical tankers, gas tankers and ships loaded with INF. In case of regional pilotage, such cargos trigger an obligation to use a pilot for pilotage to and from a port. (inner territorial boundary). Pilotage generates an estimated total turnover of approx. DKK 450 million per year. Table 1 Approximate number of pilotage operations broken down on regional pilotage and transit pilotage as well as approximate prices Annual number of pilotage operations Approximate price per pilotage operation

Regional pilotage8 8,000

Transit pilotage9 10,000

6,000-8,000

30,000-50,000

In the Danish model, the costs of the Danish pilotage service, whether through DPS or DanPilot, are 100 % user-financed. Therefore, from a government perspective, the model may be regarded as a cost-neutral public service. Our discussions with the interview subjects during this study indicate that today some of the large income from transit pilotage is used to ensure lower prices for regional pilotage (where the supply obligation is quite expensive to maintain). Users of transit pilotage services pay an unknown additional price for this. In chapter 4.1 we will discuss the consequences of the current scenario.

7 8

IMO sn1 / 263

These pilotage operations do not only cover port pilotage but also pilotage for example from Skagen to Kalundborg. "Pure" port pilotage operations are less expensive than the amount stated in this document.

9

DanPilot's turnover distribution on regional pilotage and transit pilotage?

3 International experience with liberalisation of piloting services Today, the large majority of countries have a state-controlled pilotage service. However, a number of countries have experimented with different variations of liberalisation or deregulation of piloting services. The general picture from this international experience is that it is not a given to expose this area to competition. Australia is one of the countries that has changed the organisation of the piloting service and has gained some experience in the process. In 1993, a reorganisation of the supply of piloting services was adopted and for all ports this meant that a model with "serial competition exposure" was elaborated. Only one supplier wins the contract in each port but bids must be invited for the piloting service from time to time. For the piloting service at Great Barrier Reef and the Torres Strait a model was introduced that allowed continuous competition between several suppliers (two at first, but subsequently several suppliers). At first, this resulted in price reductions but also more accidents. This scheme has been assessed quite critically following these accidents and regulation within the area has been tightened.10 At the same time, it is being considered to replace continuous competition with the same "serial" model that is used for the ports. The possible advantages of not having competition exposure involve safety as well as efficiency.11 However, such models require what the completed analyses call "comprehensive transition planning", when it may be necessary to change supplier. In the United States, they have also experimented with exposing piloting services to competition in, for example, Alaska and Florida. In Alaska, a report in 1994 concluded that ‘Competition… severely compromised the… ability to maintain high professional standards’.12 Therefore, it was no great surprise when it was concluded in 1997 following the grounding of ’Nieuw Amsterdam’ - that competition (in the model used in Alaska) had been detrimental to the public safety.13 Florida has also attempted to introduce a brief competition exposure of piloting services. However, this attempt was terminated and the state laws revised. Today, the following is stated in the Florida Statutes: ’Because safety is the primary objective in the regulation of pilotage by the state and because of significant economies of scale in delivering the service, the requirement of a large capital investment in order to provide required services and the fact that are supplying services that are considered to be essential to the economy and the public welfare, it is determined that economic regulation, rather than competition in the market place, will better serve to protect the public health, safety and welfare’.14

10 11 12

http://www.atsb.gov.au/media/4018189/MI2010011_FINAL.pdf http://www.amsa.gov.au/shipping_safety/coastal_pilotage/Coastal_Pilotage_Services.pdf

”Alaska’s Marine Pilotage System Revisited”, to which we have not been able to find specific references. Our source is “The Impact of Competition on Pilotage,” Canadian Marine Pilots’ Association.

13 14

http://www.marinepilots.ca/en/articles/competition.html 2005 Florida Statutes, article 2

In many American states they have and have traditionally had a system where several pilotage associations share a market based on a principle of rotation. Thus, there is no competition for the individual customer. In Hawaii, the efficiency of the organisation of pilotage services was investigated in 1993 where there were two suppliers in competition with each other. The conclusion was: "The existence of two pilot organizations results in a very inefficient pilotage system in Hawaii .... Since they do not share information or resources, there is necessarily a duplication of staffing requirements and an inefficient use of resources."15 In England, the legislation was amended in the late 1980s so that responsibility for piloting services was transferred to the individual port authorities. In this way, it was not a matter of competition exposure but rather of deregulation. Subsequently, the ports had full responsibility for the supply of pilotage services and the quality of the services. The accident with Sea Empress in 1996 had legal consequences which revealed some of the weaknesses of this organisation of pilotage services. The judge in the case states: ’The port authority imposes a charge for pilotage but in the same breath has the added advantage of the pilot being treated for purposes of civil liability as an employee of the shipowner’. So, it may be problematic when private operators (such as a port) do not really have the legal liability for the ship but still receive payment for the service. In general, the British deregulation did not manage to assign sufficiently clear responsibility for the qualifications of the pilots since the responsibility for setting standards was also decentralised. This situation is still relevant16 but the British parliament is now once more considering revising the pilotage legislation. Argentina has also implemented liberalisations within pilotage back in 1997. During the first three years, there were 18 serious accidents compared to zero in the preceding twenty years.17 At that time, the government presented a reform proposal which would roll back the liberalisation. However, it was not adopted. In the introduction to the bill, the following was stated (translated) ”competition leads pilots to do things they would refuse to do for safety reasons in a noncompetitive setting.”18 4 Scenario analysis In the following chapter we will review a number of scenarios for future organisation of piloting services in Denmark. For each of these, we will point out the most likely advantages and disadvantages. However, it is of course difficult to predict the consequences of a chosen model in practice since a lot of specific legal and contractual conditions would come into play and affect the 15

"Division of Consumer Advocacy's Statement of Position With Respect to the Hawaii Pilot Association's Amended Petition for Change of Pilotage Rates," Hawaii Department of Commerce and Consumer Affairs, 1993. See also ”Competition in Pilotage: The US Experience.” Michael R. Watson (president of International Maritime Pilots’ Association), 2007.

16 17 18

www.publications.parliament.uk/pa/cm201213/cmselect/cmtran/writev/marine/m16.htm “The Impact of Competition on Pilotage,” Canadian Marine Pilots’ Association “The Impact of Competition on Pilotage,” Canadian Marine Pilots’ Association. Unfortunately, we have not been able to find the original bill.

advantages and disadvantages of the model. However, it can be expected that specific legislation will always try to counter the most obvious negative consequences of a scenario. We will examine the economic and safety-related consequences of four scenarios: › Status quo › Free competition › State-owned company › Concessionary models Economic aspects Basically, five parameters will impact on the economic aspects of all scenarios: › Degree of utilization of pilots › Optimization of use of equipment › Remuneration of pilots › Administrative costs of support functions › Expected price policy and market behaviour of the players Safety We will assess safety on the basis of parameters such as: › The quality of pilots determined by their education and experience › Incentive structures for safety, including maintenance of impartiality › Handling of the supply obligation so that everyone who requests a pilot is assigned a pilot In all scenarios, we assume that the government will maintain a reasonable, high level of qualification requirements and thorough supervision of pilotage services. 4.1 Scenario A – status quo Description The current model can very briefly be described as a model with monopoly on transit pilotage and free competition within regional pilotage. As already mentioned, the model has resulted in the establishment of Danish Pilot Service, which is now acting as a competitor of DanPilot in certain ports. Economic aspects For the shipowners, this model has the obvious advantage that in these ports (primarily Fredericia, Copenhagen, Aabenraa and Kalundborg) they are able to choose between various suppliers of piloting services. This may be regarded as a benefit in itself but it only creates real advantages for the shipowners if the competition leads to innovation/improved service and lower prices. Today, Danish Pilot Service has the same price level as DanPilot for the individual pilotage operation. However, the company is planning to grant discounts to shipping companies that choose to conclude agreements on a large number of pilotage operations within a given period. It is our

impression that the discounts can amount to 5-15 per cent of the original price per pilotage operation. Sometimes, DPS offers an introductory discount to new customers. Thus, competition exposure has resulted in limited advantages with respect to price since a price reduction requires the conclusion of a major contract between the shipowner and the supplier. As already mentioned, the price for individual pilotage operations is the same as the price charged by DanPilot. For the majority of the shipping companies, the current scenario does not contribute to lower prices. As already mentioned, one of the primary elements in the costs of pilotage is the remuneration of the pilots. There are indications that Danish Pilot Service is able to conclude remuneration agreements with some of their pilots under which the remuneration level is lower than it would have been if the pilot had been employed by DanPilot. To a certain extent, the competition situation has resulted in a more varied remuneration determination for pilots. This is an advantage since it makes it possible, in the long term, to reduce the price of pilotage but it also involves a small risk of having less qualified labour, which we will revert to later. The current model represents several challenges with respect to the price of piloting operations and the costs of maintaining security of supply. With respect to the price, we can see that the price of a single piloting operation has not been reduced. This is not surprising in any way. Any rationally acting private enterprise that is in competition with a state-owned company which has a supply obligation (DanPilot) will choose to offer its services at a price that is only marginally lower than the price fixed by the government. This is all it takes to be more attractive with respect to price than the state monopoly and therefore there is no incentive to lower the price further since this does not create any additional competitive advantages. In fact, the current model generally results in higher prices. The logic is as follows: 1 The government has the supply obligation, which is expensive to maintain, especially when a private supplier can take all the easy customers/piloting operations (so-called ’cherry picking’) 2 The government's price for pilotage to the relevant ports rises (or must be subsidized elsewhere) 3 The private player just needs to be a little bit less expensive than the government player, which will enable it to set a price that is marginally lower than the government's relative high price. That is the disadvantage of having a model like this where the supply obligation only affects one of the players so that the price set by one player becomes high whereas the other player(s) is able to fix the prices at the same high level.19 If the market for regions was larger and there was more money to compete for there might be more private companies that would be able to compete more on price and thus avoid the above situation completely or partly. In this situation, rational companies would be expected to share the still relatively small market between them or conclude agreements on prices to ensure the largest possible earnings. Alternatively, they would compete until there was only one player left. This player would then be able to fix its price as outlined above, i.e. at a high level. The result would most likely be the same: The same prices as today or high prices for pilotage.20 19 20

This will also apply to the model with free competition

In addition to these market-related logics there is at least one formal reason why DPS' pilotage operations will be a little more expensive than those carried out by DanPilot, all other things being equal. The loan conditions according to which Danish Pilot Service is able to finance its ships include depreciation requirements that are much stricter, in relative terms, than those applying to DanPilot. DanPilot depreciates a ship over 20 years while Danish Pilot Service must depreciate a ship over fewer years. It requires a higher income to be able to cover this depreciation and it contributes to explain the higher prices and why it has historically been difficult to find a longterm company structure for Danish Pilot Service. If this situation was different Danish Pilot Service would probably have a somewhat stronger business but would still not have an incentive to fix lower prices.

It has already been indicated that the supply obligation is expensive to maintain. It is especially expensive to maintain in the current scenario where "cherry picking" takes place. At the moment, Danish Pilot Service can conclude predictable contracts with these players involving large volumes and make plans accordingly. At the same time, they are able to decline piloting tasks which DanPilot is obligated to carry out. The situation has the following consequences: › Both DanPilot and Danish Pilot Service have two vessels in the port of Kalundborg, which means double capacity. This is also the case to some extent in other ports such as Fredericia, Aabenraa, Limfjorden and Grenå. › A total of 7 pilots are needed to guarantee the supply obligation in the port of Kalundborg. It is relatively easier for Danish Pilot Service to utilize its part of these 7 pilots whereas it is more difficult for DanPilot to use its pilots as efficiently as it could if it had all 7 pilots. This is a loss of efficiency. › DanPilot must maintain certificates for ports where they do not navigate as often as before (Fredericia and Aabenraa) and DanPilot does not generate the corresponding income. The pilots who are needed to maintain the day-to-day preparedness at these locations also reduce DanPilot's general pilotage efficiency. › All in all, more persons have to be remunerated since both companies must have people on call and DanPilot must have as many as before to be able to guarantee that it can handle the order volume. This generates more costs for the same number of piloting operations. Safety A common concern which doubtlessly must be addressed when trying to deregulate piloting services is whether commercial suppliers are able to deliver the same quality as state-owned suppliers. There are several interacting elements. The Danish Maritime Authority has established the same formal qualification requirements for pilots irrespective of where they are employed and the supervision by the Danish Maritime Authority is also the same. Therefore, the regulation by the authorities formally ensures that the qualifications are adequate. However, in theory and in practice there are potential challenges with respect to quality. One of the challenges has to do with experience. If a new player wants to carry out pilotage to a new port it may have to train its employees for this purpose. This is expensive and the result is less experienced - but still formally qualified pilots. It is very difficult to describe the difference in quality between a very experienced and a little less experienced pilot but, to mention an example, Statoil has recently chosen always to use DanPilot pilots for their refinery at Kalundborg. Ostensibly, they do this because they find that DanPilot's pilots have more experience navigating the port of Kalundborg than pilots from Danish Pilot Service. Since any increased risk in connection with safe navigation from the refinery is much more costly than the price of a slightly more expensive pilot in the foreseeable future Statoil rejects the possibility of obtaining lower prices at Danish Pilot Service.21

21

Please note that Statoil uses Danish Pilot Service in several other contexts where they find that they can obtain adequate quality in relation to their requirements..

The other challenge involves the independence of the pilot. As mentioned in the section on international experience, there is concern in several countries as to whether the government's and the public's interest in a safe maritime sector is compromised by the commercial relation between a supplier of pilotage services and a buyer of such services. It is not possible to say whether this is a problem in a Danish context but there is no reason to believe that Danish Pilot Service does not live up to the expectations in this field. On the other hand, it is logical that a pilot from a company which has concluded a major contract with a customer cannot be expected to be as zelous with respect to, for example, reporting as a commercially independent colleague would be.22 In this field, any model which includes private players which conclude contracts directly with shipping companies will involve a slightly large risk than a model without such interdependence. Other conditions Market introduction may have triggered a development with respect to service and flexibility that has come about as a result of pressure on the market. With respect to improved service, it is our impression based on data collection that there have been several instances where DanPilot has been forced into a more offensive dialogue with its customers. This has contributed, to a certain extent, to a generally closer co-ordination and an experience of improved service at DanPilot. However, it is not clear whether this increased customer focus applies to the entire DanPilot organisation or only to the ports which have been exposed to competition. 4.2 One state-owned company Description One way of creating a framework for further development of pilotage in Denmark is by recreating the situation where a state-owned unit offers pilotage in Danish waters. In this case, the government (or a state-owned company) owns all equipment, employs all pilots, guarantees their education and training and negotiates their working conditions. In a state-owned company, the management will be responsible to a professional board, which should include different parties from the sector. In addition, the state-owned company will be generally responsible for the continuous development and streamlining of pilotage in Denmark. The specific control mechanisms (the legislation and possibly a result contract), which establish the more detailed framework of a strong model with strong incentives and as few disadvantages as possible, are not discussed in this document. Economic aspects It is obvious that a state monopoly does not in itself involve any strong incentive to work on improvement of efficiency or stimulate innovation in general. There are indications from customers that DanPilot has become a more dynamic and open organisation after being exposed to competition and this would not necessarily have been the case without it. Also, it might not be possible to preserve this in a new future state monopoly model. In connection with monopolies, it is a relevant concern how to ensure focus on promotion of a performance culture where operational improvements and cost reduction are constantly on the agenda.

22

This is worth elaborating on. A liberalization of piloting services that turns pilotage service providers into sellers which must sell services to the shipowners fundamentally changes the purpose of having piloting services. Suddenly, the purpose becomes primarily commercial: To contribute as consultant to a safe and commercially viable operation at the individual shipping company (with primary focus on safety, however). This differs from the primary purpose today: to ensure an overall efficient maritime sector with few accidents and - most importantly - prevention of environmental disasters resulting in gigantic clean-up costs. This remark is not included in the analyses since this choice is primarily political: should piloting services be regarded as a service for the individual shipping company or as a way for the government to ensure a safe and proper shipping sector? As initially presented, our entire analysis assumes that the government's safety-related priorities take precedence because it has always been that way.

Another disadvantage of a state monopoly would be an upward pressure on prices from the salary level. As is the case with other highly educated professional groups with an exclusive right to perform certain tasks it can be difficult as an employer to put pressure on working conditions and salaries. Not least because pilots are "only" employed on terms resembling those of public employees and therefore are entitled to terminate the collective agreement. In a situation with demands for streamlining, a monopoly with strongly unionized employees will find it difficult to obtain cost reduction by means of a reduced growth in salaries. However, there are also several price advantages of a scenario with a state-owned company where the control framework is reasonable and dynamic. This scenario will enable a higher degree of efficiency than the current model. We have discussed how the current model seems to result in "double housekeeping" in several areas: There is double staffing of certain staff functions (for example submanagers), more equipment must be available (no sharing of vessels and boatmen) and there is no possibility of synergies between training efforts. An adapted calculation from the current scenario may illustrate the problem. Today, Danish Pilot Service has a turnover of approx. DKK 30 million but obtains a relatively small profit from this turnover.23 For example, they have operating costs of DKK 30 million. DanPilot estimates that they would be able to carry out DPS' tasks with an increase in operating costs of not more than DKK 10 million, and with the same turnover. Thus, the current scenario costs DanPilot a potential profit of up to DKK 20 million (which could be used to reduce the prices in general). The reliability of this figure is difficult to determine but there is no doubt that DanPilot, which already has the supply obligation in the relevant ports, would be able to supply the piloting services carried out by Danish Pilot Service today at relatively modest additional costs. At the same time, the current restrictions on the possibility of navigating transits limit Danish Pilot Service' ability to use its pilots efficiently. It is no secret that regionally located pilots cannot be used fully if they cannot be used to navigate transits. The challenge for Danish Pilot Service is not very big since they provide piloting services in ports with adequate traffic to employ full-time pilots. DanPilot also works in a more inefficient manner since they have to maintain preparedness in ports where Danish Pilot Service also provides pilotage as they do not know whether there will be piloting tasks that DPS is not able to carry out. The overall productivity of the pilotage service is determined by the efficiency of the pilot utilization, which could no doubt be more efficient in a monopoly than in the current model. Here, we assume that a state monopoly would make a targeted effort to optimize the utilization of pilots. The sum of the above indicates that a state-owned company would be able to offer prices that would be at least as low as in a scenario with competition exposure, as is the case today. The primary reason for this is that it is assessed that the possibility for economies of scale, synergies and high utilization of pilots is highest in this model, as are control and quality, which we will discuss in the next section. This should also be reflected in the socio-economic considerations, since this is the primary goal.

23

This is not to criticize Danish Pilot Service but merely to state a fact. We acknowledge that there are also conditions on the market that make it difficult for Danish Pilot Service to carry on business. So far unmentioned, there are the costs of training pilots, several of which subsequently obtain employment with DanPilot because the salary is higher. For a small company which cannot offer an equally high salary, this is difficult to guard against. It can make it difficult for DPS or other private players to develop a strong core of experienced pilots.

Safety With a state-owned company the safety level would be guaranteed, one of the reasons being that pilots would be neutral and impartial in the performance of their work. This would mean that safety conditions would take precedence over commercial considerations. This model is assessed to provide a high degree of supply security in respect of the long-term considerations on minimization of accidents rather than short-term benefits with a higher risk profile. Other conditions In principle, a state-owned company could support other political goals such as a wish to keep small ports in fringe areas alive by ensuring pilotage services at reasonable prices. The fulfilment of such a goal would, to a certain extent, compromise the possibility for lower prices in very commercialised ports, as is the case today where transit pilotage co-finances regional pilotage to a large extent.

4.3 Free competition - liberalization of transit pilotage Description In this scenario, there is free competition between all players wanting to be on the market. The primary difference compared to the situation today is that transit pilotage is liberalised with the same requirements with respect to pilot qualifications as apply today. In this model, there will still be a need for at state-controlled player such as DanPilot to fulfil and maintain the supply obligation. Price There are elements in a complete liberalisation that point in the direction of lower as well as higher prices. The possibility of lower prices of transit pilotage arises as soon as a private operator offers transit pilotage. Since there is a large predictable traffic volume for transit pilotage it is possible a) to use the pilots very efficiently, b) to invest in relatively little equipment compared to the volume and length of piloting operations and c) conclude long-term agreements with shipowners wanting to buy many piloting operations. The business activities are thus characterized by relatively lower risks than in the current scenario. This makes it possible to act with lower prices than those charged by DanPilot today for transit pilotage. If a private operator would want to provide regional pilotage at the same time as transit pilotage this would be more profitable than in the current scenario. Again, the reason for this is that it is possible to utilize the pilots more efficiently when providing both types of piloting. In other words, the private operator would obtain the advantages that DanPilot has today with respect to creation of synergies between regional pilotage and transit pilotage within staffing and equipment. For the part of the regional piloting operations that are commercially interesting, prices could potentially be lower. It provides an independent contribution to the private operators' bottom line - or possibility of price reductions - that their income does not have to be used to cover costs for maintenance of the supply obligation in commercially unprofitable contexts. This is probably the element that contributes the most to a private supplier's ability to offer lower prices than those offered by the state monopoly today.

All in all, this scenario will make it easier for one or several private operators to carry on a coherent business and there are indications that the prices paid by the shipowners could be reduced. However, there are also a number of conditions that indicate a rise in prices of piloting in general. DanPilot will still be forced to maintain and cover the costs of the supply obligation in all waters and especially where the private operators do not wish to carry out piloting. In this respect, the liberalisation scenario corresponds to the current scenario only with a worsened situation and even more expensive maintenance of the supply obligation. When DanPilot loses income because many customers will naturally choose the private supplier, which probably offers lower prices, DanPilot will be forced to increase its prices if it is to maintain a financial position without need for government subsidy. This will enable the private player(s) to raise its prices as well. As long as they are lower than DanPilot's prices they are the best alternative. Any rational private market player would do this and increase its profit in this way. This indicates that the private operators will not lower their prices even if their operating costs would actually allow this. However, one could also imagine a situation with several private players wanting to offer piloting services. In principle, this could end the mechanism just described where a private player can just raise its prices concurrently with DanPilot. However, in practice it would be quite difficult to ensure that the market is not divided between a few suppliers or that price agreements are concluded. In a small market that requires major investments in equipment and training, it is usually risky to compete on price and therefore most rational market players will try to avoid this. Thus, there is no guarantee that a majority of private players will automatically create a healthy competitive situation on a small market like this. Safety With respect to safety, there is no doubt that the level of safety can only deteriorate compared to the current situation. This is especially true in case of a real competitive situation on the market where prices are truly varied and there is a plurality of players. In this situation, a combination of mechanisms will be triggered. › The private companies which carry out pilotage will have no interest in reporting criticizable conditions on board the customers' ships since this compromises their own turnover. There may even be a situation where not only price but also "easy conditions" are competition parameters, which is neither in the public interest nor socio-economically expedient. It will be particularly difficult for a pilotage service provider to oppose a large customer because it will be logical to conclude exclusive agreements between a shipowner and a pilotage service provider. › As we have seen in the Torres Strait in Australia, it may become reality that private competing operators put pressure on the employees with respect to observance of resting time. The pilot's "fitness for work" is one of the most central parameters for the quality of the piloting service in addition to his competence level, so non-observance of resting time may be quite risky. › If the market becomes characterized by strong price competition the result may be less qualified pilots. Very experienced pilots will be too expensive and the private piloting operators may force each other to employ pilots who are just barely able to live up to the certificate requirements.

Therefore, it is not certain that there will be a market for experienced pilots but only for "certified" pilots. › One last challenge in this area is that it will be problematic if a private player obtains a large market share but subsequently goes into liquidation. In this situation, there is no guarantee that DanPilot and other private players will have the necessary capacity to carry out the piloting operations of the player in liquidation. This could mean that ships requesting a pilot will have to navigate without one, which would be potentially problematic from a safety point of view. Other conditions There are a number of other conditions that are positively and negatively affected in a scenario with liberalization of transit pilotage. On the positive side, there will quite naturally be more freedom of choice for shipowners with respect to piloting service providers since it will no doubt be attractive to carry out transit pilotage. This freedom of choice will trigger a need for all providers, including DanPilot, to ensure a high service level, possibly create new supplementary services for the market and invent new agreement and contract types that may be used to offer the customers an overall good service. In other words, there will be pressure on the companies, which requires innovation and new development initiatives for the benefit of the customers. On the negative side, there will be some fundamental political issues that must be addressed in this scenario. The most important issue is DanPilot's loss of turnover, which means that it will not have enough funds to fulfil the supply obligation for regional pilotage without a major loss. As mentioned above, prices could be raised or DanPilot could be granted a government contribution towards operating expenses. A price increase would affect the small ports since it will be unprofitable to navigate some of these. This would probably lead to the closure of several small ports as commercial ports. In other words, this will have local political consequences. The other option of granting a government contribution towards operating expenses does not seem very attractive since the government would now have to pay extra to ensure pilotage to the smallest ports in Denmark instead of having a cost-neutral pilotage service. In a situation where the government lacks money, this is probably not feasible.

4.4 Pure concessionary model Description For example in Australia, they have established a model within port pilotage that can best be described as "serial competition". In this model, one or several private players make an offer for the right to pilot one or several port for a number of years according to agreed and predictable conditions. In Denmark, such a model could be a possibility where private players could win the right to perform piloting services in certain regions or geographical areas. Such a model could be called a "concessionary model". One of the advantages of this model is that some of the inexpediencies of pilotage with competition exposure are avoided and at the same time the supply obligation is unambiguously assigned to the winner of the concession. There is also an advantage compared to the competition models where the government must always be the final guarantor of the supply obligation. There would be many variants of a concessionary model. In order to describe the advantages and disadvantages of such a model we have to decide on a general framework in this document. The model which we will describe is characterized by the following: › A concession will be accompanied by a supply obligation › The concession applies to a geographically delimited area and there may be several of these in Denmark (the exact number is not important) › The concession will be effective for an extended period of time of 3-5 years › The winner of the concession must itself provide crew and equipment to carry out the task We do not consider a concessionary model to be realistic for transit pilotage since no private players can be expected to accumulate capacity to carry out this part of the pilotage task. At the same time, it would be a disaster if a private player had to withdraw from this and there was no longer a statecontrolled player to reassume the piloting task. Price This is the scenario that comes closest to a guarantee of lower prices. The primary reason is that it creates a clear market situation where a private player would be guaranteed a contract period of, for example, 3-5 years and a reasonably predictable number of piloting operations. It will create the basis of employment of a number of pilots corresponding to the work volume and conclusion of better agreements with banks (than is possible today) since they can be sure that the customer has a stable income. The time-limited monopoly which is won may make it feasible for a company to overcome the high start-up costs with respect to ships and training of crew. However, the utilization efficiency will probably not be as high as is seen at DanPilot today since it will not be possible in a concession area to utilize the capacity to the fullest and to use pilots across geographical areas in the same way.24

24

In principle, this could be done but technically it would be very difficult to handle a bidding process where private players commit themselves to sharing their resources with others.

In concession areas with relatively heavy traffic it will be possible to obtain lower price than today based on the above conditions. The only concession area that is guaranteed to have enough traffic for private players to be willing to make a bid, with reasonable certainty, is the area Aabenraa/Kalundborg/ Fredericia and the other local ports in that area. It is also possible that concessions may be established for Copenhagen, Aarhus, Stigsnæs and Esbjerg, which all have a certain traffic volume. In concession areas with less traffic there will either be no bidders for the pilotage task or they will offer a price that is higher than the price paid today (because today the price can be kept down by DanPilot as a result of income from transit pilotage). This means that only the busiest ports will have a lower price while the rest will have a higher price. There are also several conditions that indicate an increase in prices after the first bidding round. The reason for this is that after a period with only one supplier there will actually be a monopoly on qualifications at this supplier. The other companies offering piloting services will not have qualified pilots since they have not piloted the relevant ports for 3-5 years. This means that the old operator will be in a very strong position in respect to raising it prices again. Consequently, any concessionary model must have an elegantly elaborated model for transitions between suppliers in order to minimize costs. If nothing else, then because it is inexpedient for the customers of piloting services to have to pay the start-up costs of a new supplier every third or fifth year. Safety The concessionary model described will probably result in poorer overall safety than would be the case with an operative state-owned company. Once a contract is concluded with a supplier it will be its commercial duty to create the largest possible profit under the given contract terms. This may be accomplished for example by putting pressure on the pilots' resting time or by employing less experienced pilots rather than more experienced pilots to save remuneration costs. We consider the former to be a larger risk than the latter. The reason for this is that it involves considerable costs to train a competent pilot and the amount saved for a new pilot does not necessarily balance the additional training expenses. There is a special problem associated with the risk of the chosen private supplier going into liquidation (perhaps due to overly optimistic pricing). It may have to withdraw from the concession and a situation may arise where it is not possible to guarantee pilot service for the relevant ports. It would be irresponsible from a safety point of view to allow such a situation to arise.25 Other conditions The most positive element in a concessionary model is that it is the only model, except for the monopoly model, that solves the challenge of the supply obligation. In this model, the concession is accompanied by a supply obligation. The great advantage of this is that there is no need for several suppliers maintaining parallel organisations and functions. In other words, it allows a more efficient

25

A similar situation occurred in connection with a bidding process for ambulance service in Region Sjælland a few years ago where the chosen supplier had to withdraw at the last minute and had to be replaced. In the specific case, it was still possible to go back to the original supplier but that might not have been the case if the new supplier had carried out the operation for a year.

operation by the concessionary and, not least, it ensures efficient utilization of pilots within the concession since all pilots are employed by the same supplier. On the negative side, there are three elements pulling in the opposite direction. One element is that more expensive piloting services within some of the regional concessions will probably force some small ports to close.26 The second element is that a concessionary which must try to optimise its profit and is guaranteed an influx of new customers does not have any incentive to maintain a high service level. Costs will be reduced where possible. If concessions provide poor service this may give Denmark a bad reputation within the shipping sector. The third element that pulls in a negative direction is that a concessionary model will require a very detailed and thorough bidding process where legal tug-of-war (for example on transitional schemes) and administration may become very costly.

26

Socio-economically this is probably a positive consequence. However, in relation to the goals so far for the pilotage service where low prices for regional pilotage have been important it should be regarded as a negative consequence.

4.5 General outline Figure 3 General outline of the advantages and disadvantages of the four scenarios

Primary advantages

The status quo model

Free competition

- Competition has contributed to innovation/streamlining

- Less expensive transit

State-owned company - Focus on quality, neutrality and safety

- Greater flexibility and more options (until the formation of monopolies)

- Possibilities of economies of scale, synergies and high pilot utilization

- Lower pilot salaries

- Better able to regulate and support other political goals (safety, environment, fringe ports)

- Conditional flexibility and possibility of slightly lower prices according to volume agreements in individual ports - Salary differentiation among pilots

Primary disadvantages

- Expensive double capacity for equipment and crew in individual ports - Inefficient pilot utilization and extensive utilization administration - Risk of loss of independence as a result of commercialisation

- The market is not large enough - over time there will be monopolies, shared markets and higher prices - The player with the supply obligation will lose shares on the favourable markets and be left with the unfavourable ones

- Supply obligation firmly anchored - Risk of lack of flexibility, dynamics and innovation - Gives the employer an unhealthy negotiation position in connection with salary negotiations

- Possibility for high pilot utilization within the individual concession

- Ports with few piloting operations become expensive - Will in reality lead to monopolies since it will be expensive for new players to develop capacities for new bids - High transaction costs for start-up, bidding processes, authorisation and supervision

- Pilotage in small ports in fringe areas will be markedly more expensive

Overall evaluation (1-3 score, 1= relatively best, 3 = relatively worst)

Pure concessionary model - Supply obligation is guaranteed and firmly anchored

Economic aspect: 3

- Risk that competition will affect independence, quality and safety Economic aspect: 3

Economic aspect: 1

Economic aspect: 2

Safety: 2

Safety: 3

Safety: 1

Safety: 2

The overall evaluations, which are described in the table above, will be explained briefly below. The details of the individual scenarios have already been presented. Primarily, we will clarify why we end up concluding that a state-owned company as sole supplier of pilotage services is the best scenario. One argument concerns safety. Pilotage is not carried out primarily as a commercial service but rather as a preventive way of safeguarding the environment and maintaining safety at sea. Even the slightest weakening in general safety can become very expensive. Just one accident of the wrong type can easily become many times more expensive than the benefit of all kinds of future cost reductions in piloting services combined.27 To this should be added that there are no strong indications that the other models that we have discussed (including the present) are able to create a framework for real or lasting price reductions. When at the same time, public costs of supervision and/or transition (for example invitation for bids) can only be expected to rise it is difficult to see that the other models represent an attractive alternative. All in all, it is so uncertain whether the other models represent a practicable method that in our assessment it would be most sensible to continue to develop and streamline a state-owned company within a framework where a state-owned company is still predominant. See the section on recommendations for further information on this. Seen in isolation, the above conclusion may be surprising in respect of the economic aspect of the case: How is it possible that the competition scenarios cannot generate better prices than a stateowned company: Again, all of the most important explanations have been reviewed above. However, the two decisive factors are the following: 1) That private companies' possible ability to lower salaries is not reflected in the prices since the state-owned company with the supply obligation will create a high price level, just below which they will fixed their prices. 2) That the market for these piloting services is so relatively small and associated with high entry barriers in the form of equipment and training that there is a great risk of unhealthy markets with market division and/or agreed prices. As previously noted, the elaboration of these scenarios is more an attempt to expose possible advantages and disadvantages of different models than stating that these advantages and disadvantages are a natural consequence of the individual model. In practice, it depends on the specific implementation, as mentioned previously.

27

In a few areas the safety level may even be too high and it may be possible to reduce this. However, these possibilities will be the same across all scenarios. See the section on recommendations.

5 Conclusions and recommendations The report concludes that pilotage in Danish waters is today characterized by a high quality and safety level compared to other EU countries. The Danish pilots are highly educated and generally have extensive experience across geographical areas and vessel types etc. Our data show that the rates for pilotage within the EU are approximately average - i.e. generally higher than in most Southern European countries and generally lower than in other North European countries. In this international context there is no obvious potential for major streamlining benefits. Below, we will make conclusions on the advantages and disadvantages of different scenarios and we will state which scenario we believe will create most safety and prevention of accidents for the money. International experience and our study reveal a number of inexpediencies of a liberalized pilotage service. The primary arguments are: › All in all, the market is not large enough for healthy and sustainable competition with many players. This should be seen in relation to very high establishment costs in the form of provision of equipment and training for players on the market. It is our assessment that, on a free market, there will be market-based monopolies or more or less illegal agreements on shared markets after a period of time in order to be able to generate sustainable profits that may cover high depreciation of equipment, relatively high salaries and other expenses. › In addition, pilotage is first and foremost a question of preventing accidents. In this context, we find that clear coordination, regulation and distribution of roles are strong points. In a marketbased scenario, there is a risk that the pilot's obligations as accident preventer clash with the pilot's incentive to make money. In addition, it will be difficult to find a good solution to the supply obligation and especially the pilotage services that generate major losses. It is the consultant's overall assessment that liberalization will be more expensive or will at least involve the same cost level and that it will probably result in poorer safety due to less regulation, coordination and the risk of unhealthy incentive structures. In our assessment, to reach the goal of streamlining and maintenance of a high safety level a stateowned company should be maintained based on the existing DanPilot with a view to coordination of activities, attainment of synergies and realisation of streamlining benefits for the entire pilotage service in Denmark. The state-owned company must continuously and annually be exposed to pressure for realistic annual streamlining initiatives and production improvements in line with other comparable organisations. The state-owned company may offer and invite bids for individual areas where analyses show that quality and streamlining benefits may be obtained. COWI recommends the model with a state-owned company, which may, however, incorporate some of the mechanisms from the concessionary model on parts of the market. In addition, COWI finds that there may be a number of other methods that may lead to streamlining without compromising safety, which have not yet been examined.

5.1 Recommendations To the best of our knowledge, there are no "quick fixes" that may solve all problems in a jiffy. However, there are a number of promising ideas for streamlining the Danish pilotage service but at present there is no exact outline of the costs or safety level of these ideas. On this basis, COWI proposes the elaboration of a number of pilot projects to clarify streamlining benefits without compromising safety through a number of alternative ways of handling pilotage in Danish waters. Land-based pilotage Due to the technological development land-based pilotage is being mentioned more and more often as an alternative to traditional pilotage. However, there is significant uncertainty with respect to quality, costs and the types of piloting operations and geographical areas that may be suitable for this type of pilotage. In order to identify the potential for land-based pilotage and provide a varied and sustainable decision-making basis a 2-3-year pilot study is proposed to collect relevant domestic and international experience. It would be important to collect experience from, for example, similar initiatives in Norway and the Netherlands if pilot projects are to be considered further. Port pilots/boatmen in regional ports Some ports may employ a pilot without formal qualifications to carry out piloting to ports with very few pilotage operations and where it is not environmentally irresponsible to risk grounding (sand bank etc.). Many ports already have such a pilot part-time or full-time, which may represent good synergies for the ports. COWI proposes a pilot project with 2-3 ports to obtain experience with a view to a more nationwide rollout of this model. Analysis of synergies with other services There are other state-owned maritime services with which synergies may be sought. For example, the Danish coast guard has vessels located throughout Denmark. These vessels are almost always located in ports where there are also pilot vessels. Could the pilot vessels in fact replace the coast guard vessels? Could DanPilot carry out maintenance on behalf of the coast guard - or vice versa? As with the coast guard, Denmark also has a maritime environmental preparedness. Could DanPilot's ships be used for environmental preparedness in order to save money overall? COWI suggests that an analysis is carried out to clarify the potential for synergies and co-operation between the mentioned services. This could contribute to a reduction in public costs or improvements of the preparedness within the existing economic framework. Invitation for bids under a state-owned company In the review of the different models we described the possibility of a geographical concession. There may also be other models that resemble the concession model a little. One possibility could be that DanPilot (in its new form as a state-owned company) offers pilotage within a delimited geographical area or a number of transit pilotage operations. DanPilot could still provide equipment and then experiment with buying pilotage hours and pilotage operations through a bidding model to be clarified further. Perhaps DanPilot could submit a control bid. The scope of such bids should probably not exceed 15-30 per cent of the total number of pilotage operations since there must be state-controlled capacity that can take over if the private supplier goes into liquidation or does not live up to the safety requirements.

Reduction in costs of regional pilotage The greatest potential for reduction of pilotage costs lies within the regional area. This will lower the contribution that transit pilotage must make to the regional area to maintain artificially low prices. One example of this could be that pilotage services to small ports are no longer offered during weekends or outside the working hours of the other port facilities. Another possibility could be to reduce the scope of the pilotage obligation within port pilotage. The risk profile for certain port pilotage operations is not especially alarming and another COWI analysis shows that groundings are not particularly risky from an environmental perspective when the ground consists of sand or silt. It could be considered to examine whether it is possible to reduce the pilotage requirements for distances where the risk of collision is non-existent and where the ground conditions are not dangerous. This will reduce the number of expensive regional pilotage operations to be carried out. Streamlining at DanPilot In our opinion, the obvious way to lower prices is to further increase attention on DanPilot's internal processes and administration costs. We consider the transformation to a state-owned company to be an advantage since it makes it possible as owner to further clarify and tighten the requirements for DanPilot's performance. There are clearly streamlining benefits that have not yet been reaped. The data collected for this task have also indicated that DanPilot could create streamlining and controlrelated benefits by increased digitalization. However, this potential has not been further analysed.

Appendix A Interview list Person interviewed Nete Herskind, deputy head of division Tom Elmer Christensen, head of division Lars S. Ahrendtsen, manager Henning Mørk Jørgensen, marine biologisk Jan Fritz Hansen, deputy director general Michael Wengel-Nielsen Jan Bonfils, chairman of the board Fritz Ganzhorn Jan Merling-Petersen Nick Cutmore, secretary general Carsten Greve Claus Andersen Steffen Dalgaard

Organisation Danish Ports Danish Ports DanPilot Danish Society for Nature Conservation Danish Shipowners' Association Rederiforeningen af 2010 - part of Danish Shipowners' Association targeting the small and medium size shipping sector Danish Pilot Service Danish Maritime Officers Schulz Shipping International Maritime Pilot Association IMPA Professor, CBS Fredericia Shipping Shipping DK