National Audit Office: Nordica example of state's indecision in managing its company

Nordica planes at Tallinn airport. Photo: Erik Prozes

According to the Estonian National Audit Office, state-owned airline Nordica’s course suggests that the state has not been a sufficiently skilled or interested owner in such a complex business area as aviation and arguments in favor of keeping both Nordica and OU Transpordi Varahaldus in state ownership were lacking before the serious financial difficulties faced by Nordica that appeared in July and are still scarce.

Following the results of the ongoing special audit of Nordica, it would be reasonable to sell both Nordica and Transpordi Varahaldus, the National Audit Office notes.

The National Audit Office published an overview of the activities of the national airline Nordica. During the audit, the National Audit Office did not find any significant arguments confirming that Nordica and Transpordi Varahaldus in their current state were strategically necessary for the state before the serious financial difficulties revealed in July or are so now, or that there is understandable public interest for the state’s participation in those companies. The audit also did not reveal any understandable need to bear the risks of the company’s economic activity as the owner.

The National Audit Office recommends the Government of the Republic to decide after the results of the special audit of Nordica are revealed and the economic activity is stabilized which method of sale best suits the state’s interests -- either to privatize Nordica and Transpordi Varahaldus together or separately, partially or in full.

If the government still decides to continue as the owner of Nordica and Transpordi Varahaldus, the National Audit Office recommends clearly defining why the companies are strategically necessary for the state and which public interest function they fulfil. In the event of a failure of the aviation market, which the officials of the Ministry of Economic Affairs and Communications consider highly unlikely, the state would have other options besides owning Nordica to ensure the necessary air service.

"For many years, people have been asking the same question that the National Audit Office is repeating in its latest report -- 'Should the state own an air company in order to ensure flights to and from Estonia?'," Auditor General Janar Holm said. "Life itself has provided an answer to this -- the dream of flying under one’s own flag might not be possible in the tight competition of the aviation market without continuous financial support from the state and without violating the European Union rules for granting state aid."

The National Audit Office found that there were attempts to stop unprofitable flights from Tallinn, but the necessary agreements were not reached at the owner level, and the representative of the owner did not respond to serious problems pointed out by the company. Nordica was founded in autumn 2015 for 40.7 million euros in order to ensure necessary air service for Estonia and service a route network similar to that of AS Estonian Air, but three years later, the funds provided by the state had essentially ran out.

Since its foundation, Nordica’s management board had been looking for other earning opportunities to cover the loss of flying from Tallinn and started wet lease of its aircrafts and crews to other airlines. The management board repeatedly raised the issue of updating the strategy with the company’s supervisory board because it was economically difficult to meet the owner’s expectation of flying from Tallinn while profitably competing with international airlines.

However, neither Nordica’s supervisory board nor the minister of economic affairs and communications in charge of the holding went along with the request to consider the sustainability of flying from Tallinn, until the economic reality forced the closure of routes from Tallinn. Nordica’s management board had requested a review of the business plan nearly ten times to no avail by the time the minister of economic affairs and communications finally agreed to end regular flights from Tallinn in 2019, preventing the company from collapsing.

"This is an example of a situation where a politically established goal, which turned out to be unsuitable due to the changes in the environment, does not allow responding to the actual situation. Time and money was lost," Holm said.

Following the termination of regular flights, a legitimate question what the public task performed by Nordica is after transitioning from scheduled flights to outsourcing services and why should the state bear the risks of the company’s economic activity. It was an airline whose business model worked at the time and which the state had no clear reason to own.

From summer 2019, the question as to whether the state needs an airline that does not fly from Estonia was repeatedly raised in the Government of the Republic, but the discussion died down. From August 2019 to July 2021, two different ministers of finance asked the government to consider whether owning Nordica is justified a total of four times. No visible actions followed these appeals.

Just like the entire world’s aviation, the coronavirus crisis also hit Nordica. By fall 2020, Nordica was practically insolvent. In October 2020, the airline received 22 million euros from the state and the opportunity to borrow an additional 8 million euros from the state foundation Kredex. The European Commission approved state aid granted to Nordica on the condition that the company must not operate unprofitable routes. However, it was difficult for Nordica even before the coronavirus pandemic. Liquidity problems had increased after the failed cooperation with the Adria Airline, which ended with a 4.6-million-euro write-off for Nordica.

The National Audit Office is pointing out that Nordica is an example of how the state should not govern a company it owns. The company’s activities and the management’s decisions cannot be permanently monitored because a lot of documents are either missing or have not been preserved. The owner’s guidelines have been contradictory. Nordica was tasked by the minister of economic affairs and infrastructure with ensuring necessary air service for Estonia even after the termination of flights from Tallinn, but it was unclear what was meant by air service necessary for Estonia.

Because the minister of economic affairs and communications as the representative of the owner did not determine what is the situation or market failure in which case Nordica should have started operating on the Estonian aviation market again, it is also not clear with which delay period, costs and under which conditions Nordica would be able to open fights from Tallinn again alongside other existing obligations. Nordica’s aircrafts were then and are still busy with wet lease to other airlines. Finding new ones would probably take months or cost an unreasonable amount. According to Nordica’s representatives, the competitive situation would have to change a lot for the company to have the need and opportunity to start flights from Tallinn again. It should also be taken into account that the state aid permission of the European Commission does not permit flying at a loss.

In July 2023, it became apparent that Nordica’s economic situation had deteriorated sharply since May of this year. The chairman of the company’s management board resigned, and international experts were hired to restructure Nordica’s economic activities. In addition, the minister of climate decided to carry out a special audit at Nordica. According to the minister, the results of the special audit should be revealed within three months, and half a year has been given to stabilize the company.

Nordica barely made a profit in 2021 and 2022, and although from August 2019, various ministers of finance repeatedly raised concerns about the expediency of owning Nordica, discussions stalled and died down and the Government of the Republic has not reached a decision on the privatisation of Nordica. Now, due to the deterioration of Nordica’s economic situation, the circumstances have changed drastically.

According to Auditor General Janar Holm, Nordica’s story is an example of a situation where the political risk of making a decision is high, but letting it go seems safe, at least initially.

"A decision is finally made only when the crisis has become extremely serious," Holm said. "By then the political and economic price is already very high. We can see that Nordica has increasingly moved away from its original goal -- to ensure air service for Estonia --, this goal has not been achievable neither commercially nor due to the European Union’s rules for state aid, which is why public interest -- to keep the company in state ownership following the termination of regular flights from Estonia -- was questionable."

The National Audit Office analyzed whether the state as the owner for more than seven years has directed the activities of AS Nordic Aviation Group and OU Transpordi Varahaldus and what has been expected of the companies, whether Nordica and Transpordi Varahaldus have succeeded in meeting the goals established by the owner, and whether the state operating in the aviation business is justified.

The National Audit Office prepared a report based on written materials as at January 2023 and oral explanations of the auditees as at April 2023. The report refers to information and events revealed in July only in individual, most critical places for readability.