How did Tallinn Utilitas enter deal that led to sale of its shares?

The city's decision to build a district heating company in partnership with Utilitas and to sell two-thirds of Tallinn Soojus to Utilitas raises doubts, as the city appears to have no objections. The city's decision is based on a 22-year-old contract that includes a compensation obligation that would otherwise require the payment of hundreds of millions.

The City of Tallinn is the sole proprietor of 1996-founded AS Tallinna Soojus, whose mission is to supply the city's heat. However, the capital announced on Wednesday that it will form a joint venture with Utilitas, Utilitas Tallinna Soojus, in which Utilitas, will own two-thirds, while the capital will own one-third.

The contract is supported by the fact that the city signed a contract with the predecessor of Utilitas, Tallinn Heating, in 2001, stipulating that Tallinn must purchase the heat lines at investment prices after 30 years. This deadline is rapidly approaching and Mayor Mihhail Kõlvart believes that paying such a sum would plunge the capital into a financial crisis.

On October 31, 2001, Tõnis Palts, the then-mayor of Tallinn, and Toomas Sepp, the then-city secretary, signed the lease and operator agreement with Tallinn Heating.

A committee was established in the summer of the same year to lease the city-owned Tallinn Soojus. According to the agreement signed by the at the Enterprise service of Tallinn Strategic Management Office, Charlie Viikberg, there were two interested parties.

In addition to AS Tallinn Heating, a subsidiary of Dalkia International SA, which won the bid, Tallinn district heating services also wished to enter into a lease agreement with the capital, but offered a quarterly lease payment that was less than the winning bid of 10.5 million Estonian kroons (EEK).

In addition, the owner company of Tallinna Kütte made a better offer for the start-up fee, and so on 25 October 2001, Tallinna Kütte was selected to lease the entire city-owned assets of Tallinna Soojus, although the city of Tallinn retained ownership of all shares.

The lessee was required to pay Tallinn Soojus a fee for the use of the property, while the City of Tallinn, as the sole shareholder, retained the right to appoint the members of the company's supervisory board, who in turn elect the management board of Tallinn Soojus, and the city also retained the right to determine the payment of dividends.

The contract between Tallinna Soojus and Tallinna Kütte, which is now Utilitas, stipulated a 30-year lease period, and Tallinna Kütte paid a contract charge of 210 million kroons when the contract was signed. Tallinna Soojus leased all of its networks, production units and land, and agreed to guarantee any loans taken out by Tallinna Kütte, particularly for the improvement of assets.

In terms of contract termination, the lease required the lessee to return the assets to the lessor for free after 30 years.

But here is the clarification that has led the city of Tallinn to its current predicament: "By way of exception, at the end of the term of the contract, investments shall be compensated, the contract says." When entering into such an agreement, it must be kept in mind that the amortization of the investment cannot be less than four percent per year and that 275 million of Estonian kroons (the pipeline's current remaining value) will be deducted from the compensation amount."

The justification for such remuneration was also highlighted in a contract addendum: it was meant to encourage the lessee to continue investing in the route during the contract's final years.

Former city official: this is clear privatization

One of the city officials involved in the 2001 decision told ERR, on the condition of anonymity, that he did not believe such a clause was included in the original contract with Tallinn Heating. Upon learning that the clause was present, he stated that it sounded awful.

"This is blatant privatization, which was not the intention of the agreement," the former official acknowledged. "We transferred the assets to the corporation, the rent was paid for each period, and the assets were to be returned at the conclusion of the 30-year lease. In this sense, it is a very bad story. All of us who authorized this are responsible."

He said that Tallinn should not form a joint venture with Utilitas and transfer two-thirds of its stake to them at this time, as the contract was still several years away.

"I do not think there is an urgency. There is no purpose in attempting to completely max out the company's capacity at this time as it can manage the investments. Eight years is quite a time away. And the city of Tallinn can obviously influence the residue amount so that it is not so high," he said. "Tallinn should take a more aggressive stance regarding which investments require immediate attention and which do not."

Even though a clause regarding compensation for investments is included in the contract, the official said that the newly disclosed method of dividing the stake is lopsided. In addition, he pointed out that Utilitas is a monopoly.

"Because the competition authority calculates a return based on the quantity of assets, there is no reason to merely hand over assets. There should be a tender, not a backdoor agreement, at the very least. This is simply absurd!" he said. "Is Utilitas the only purchaser? The contract is so old and I don't remember exactly what it says, but even if that clause is there, there is no reason to transfer the assets to Utilitas."

The former municipal employee said Tallinn's inability to pay Utilitas is understandable, but there are still eight years remaining. "If interest rates are high now and there are few interested buyers, the situation will change in a few years and there will certainly be some," he said.

Tõnis Palts, who served as mayor of Tallinn in 2001 when the agreement was signed, declined to speak to ERR regarding the agreement. He said that the issue is so old that it would take hours to look into it.

Mihhail Kõlvart said on Wednesday that the creation of the joint venture and the transfer of two-thirds of Tallinn Soojus to Utilitas was justified by the fact that at the time the lease agreement was signed, Tallinn wanted to lease out all city-owned heat lines because the city's financial situation prevented it from making the necessary investments.

If the city were to purchase the heat pipes in Tallinn after 30 years, in 2031, the compensation obligation for interim investments would reach €250 million, Kõlvart said. As a result of the joint venture's formation, the obligation to provide compensation will be eliminated.

Kõlvart said that paying such a sum would lead to a financial crisis for the city in seven to eight years, which was one of the primary reasons for the city's two-year negotiations with Utilitas to find an alternative solution.

Former Supervisory Board Chair Kalle Klandorf has been the leader of Tallinn Soojus since June 1 of last year. Jevgeni Ossinovski, a member of the company's board, said when he was appointed a year ago the contract with Utilitas would expire in 2031 and that Tallinn Soojus had to create a new organizational model as soon as possible.

According to the financial report for the previous fiscal year, which was concluded in the summer of last year, the revenue from capital leases for Tallinn Soojus was nearly €3,130 million, while its profit was €2,237 million. The report indicates that Utilitas has maintained the service level throughout the lease term. The permitted average age of pipelines is 30 years, but at the end of 2021, their actual average age was only 23,4 years.

Utilitas invested 30.27 million in 2021.

As of December 31, 2021, the share capital of Tallinna Soojus was €3.25 million.


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Editor: Kristina Kersa

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