Balkan power problems

By bne IntelliNews March 9, 2007

Nicholas Watson in Belgrade -

Elektroprivreda Srbije's general manager, Vladimir Djordjevic, is a hard man to meet. bne knows this, because sitting opposite in the director's restaurant on the top floor of the state utility's communist-era headquarters in Belgrade is not the famously media-shy head of the state power company as had been arranged, but Dejan Jovanovic, the grandly titled chief of the Cabinet of general manager.

Mr. Djordjevic is apparently tied up with the minister of energy, it's politely explained. And well he might be, because EPS finds itself at the centre of what is turning into a major worry for the future development of Southeast Europe – namely, the failure of electricity production to keep pace with the huge surge in demand. This will inevitably lead to a rise in prices over the coming years, which, European policymakers fear, could choke off the economic boom that is doing so much to stabilize the region after the chaos of the 1990s.

EPS' recent admission that it is forecasting a 15% fall in its electricity output this year, to 33.45bn kilowatt hours (kWh), hasn't done much to soothe such fears.

EPS claims much of this fall can be attributed to the unexpectedly favourable weather conditions in 2006, which resulted in very high hydropower output that lifted total output 3.0bn kWh above the plan – a level it couldn't expect to match this year. Also, EPS stresses it's planning a major investment programme that will see some €3.1bn ploughed into raising capacity by 2010, which will include €700m to complete the thermal power plant Kolubara B and €250m to open a new pit at the lignite mine Rudarski Basen Kolubara. The company also expects to finish the reconstruction and upgrade of the country's hydro and thermal power plants.

Coal in Kolubara

In any case, "EPS is planning to import electricity to cover this gap. We are now more active in the trading area since we began trading directly, not only using middlemen as before," Djordjevic says in a hastily arranged interview later.

Importing this power means another area must be exporting. And on paper at least, say experts, there appears to be enough power projects to satisfy the region's growing demand for power.

South of Serbia proper in the UN-administered province of Kosovo, which holds plentiful reserves of lignite, the government there is planning to build several thermal units with a total capacity of 1,200-1,300 megawatt (MW) over the next four to five years.

In Bosnia Hercegovina, the Czech power company CEZ is putting the finishing touches to a deal announced in December in which it will acquire an existing plant in the Bosnian Serb Republic with a 300 MW capacity and coal mines with 400m tonnes of reserves in return for investing €1.5bn to construct a 660-MW coal power plant in Gacko. CEZ is looking at a similar opportunity at the Ugljevik plant in the Bosnian Serb Republic, where CEZ is competing against Slovenia's EPS and an unnamed Greek investor. All in all, CEZ's chief executive, Martin Roman, says his firm is planning to spend around €10bn on acquisitions by 2009, with the company looking to close deals soon further east in Ukraine and Russia.

Nuclear power is also making a comeback in the region, just as it is elsewhere in the world. On February 13, Romanian Economy Minister Varujan Vosganian announced the government would be putting in place a three-stage strategy for the energy sector to run through until 2030, which will include increasing the country’s nuclear energy capacity. The state is already committed to opening a second reactor at the Cernavoda power station by the end of this year. Under the new strategy, two new nuclear power plants would come online by 2014.

Energy ministers from Southeast Europe agreed in December 2004 to establish a $30bn special fund to spend on electricity and other energy projects by 2012.

All this capacity is desperately needed because the region's economies are performing so well. Not only is the gross domestic product of the two new entrants to the Europe Union, Bulgaria and Romania, growing at over 6%, but the economies of the former Yugoslavia and Turkey are also increasing at around that rate too. UniCredit Group expects Turkey's economy to grow 5.4% in 2007 and Serbia's to grow about 6.0%.

In broad terms, the World Bank has forecast that the economic growth of the countries in Southeast Europe will remain at higher levels than the 2-3% for the EU as a whole over the next decade as these economies converge with their Western counterparts. Assuming growth rates of 3-5%, therefore, growth in demand for electricity would average 2.3% per year through to 2020, bringing gross demand to roughly 235,200 GWh.

The trouble with the power industry, though, is the time lag associated with building a plant and it actually coming online. It takes at least three years to build a gas-fired power station and over five years to build a coal-fired one. There is a 10-year minimum lead-time for the development of a nuclear plant from initial concept to power flowing onto the grid.

"The problem is we're dealing with decisions about power that were made 10, 20 years ago," says one Belgrade-based senior executive of an international utility.

With virtually no new power plants expected to come online before 2012, the big question is what will happen over the medium term.

"I don’t expect any more units to begin operations until 2012, so the only problem is how to survive until then," says Mirko Ivkovic, the director of long-term sales at the region's largest power trader Energy Financing Team.

Political delays

On the plus side, the region has just enjoyed one of the mildest winters on record. This meant that while consumption was expected to rise by 2-3% in 2006, in reality it actually fell by around 10% instead.

On the flip side, the dry winter will mean falling production at the region's hydroelectric plants. This problem is especially acute in Albania, a country that relies on such plants for over 90% of its power. This winter saw the worst power-cuts in decades, which peaked at 20.5 hours a day in the first week of December as the drought reduced water levels in dams that feed the power plants along the Drin river in the north of the country. This comes at a time when electricity demand in the country is growing at almost three times the European average as more Albanians move to the cities and furnish their homes with all the modcons associated with urban life.

On March 5, the government fired the head of its power utility KESH, Andi Beli, and appointed Gjergji Bojaxhi as the new chief executive of the state-run company. "The overall performance of the enterprise has been inadequate when compared to its goals, particularly regarding the improvement of its revenue, the cutting of losses and the timely averting of crises, which required higher dynamics and responsibility from its managers," SeeNews reported the Economy Ministry as saying in a statement.

However, the problems at KESH, which used to export power to neighbouring Greece and the former Yugoslavia in better times, run much deeper than an incompetent chief executive.

One foreign banker in Belgrade says blaming the weather is convenient, but doesn't explain the whole story. Given that hydropower in Serbia and Croatia enjoyed a bumper year in 2006, he accuses KESH of overstating the case about the weather and reckons a bigger problem is the decrepit state of the transmission lines and other infrastructure.

"The only solution is to privatise KESH immediately – there would be a lot of interest from EPS and other international utilities in buying KESH," he says.

The World Bank has also come up with a series of proposals to modernise hydro-power plants, reduce transmission losses and build new power stations near the fast-growing towns in the centre and south of the country. Yet apart from a €92m contract signed in February with Italy's Maire Engineering to build a 100-MW oil-based thermo-power plant in Vlora, 140 kilometres southwest of the capital Tirana, the government has dragged its feet over other proposals.

Politics is also hindering the building of new capacity elsewhere in the region. A source close to the Czech utility CEZ says that together with its partner AES Corporation it has submitted a bid to help Serbia's EPS complete the building of the thermal power plant Kolubara B, which was begun in 1988 but frozen in the early 1990s due to the wars in former Yugoslavia. So far, Serbia has invested $400m in the Kolubara B project and some 40% of the plant has been built; it would cost around €600m to complete it, experts estimate.

However, the CEZ source says that no movement on this project is possible until a new government is formed in Belgrade following January's elections. Hopes of a new government being formed by the April deadline, after which new elections must be held, remain in the balance, because no party wishes to be in power when a formal decision is made to send Kosovo along the road to independence - a development vehemently opposed by virtually all Serbs.

Even if a new government is formed, it's unlikely to undertake the wholesale privatisation of EPS that the European Commission would like.

Djordjevic says the privatization of EPS is unlikely. A more probable scenario is increasing the capital of the company through joint projects with strategic partners, where these strategic partners take minority stakes in EPS' capital structure. The state is also planning this year to distribute a certain number of shares, probably 15%, at the holding level to public sector employees, while another 15% will go into the State Fund. The majority of the shares will remain in the hands of the government.

"There are discussions that EPS could be privatized by offering [the state's majority] shares on the Belgrade Stock Exchange, but it is still too early to predict. All options are still open," says Djordjevic.

The unresolved status of Kosovo is also creating uncertainty in the power sector of the province. Kosovo has large lignite reserves and was responsible for 15% of EPS' annual power output before the UN took over the running of the province following the 1999 conflict with Nato. EPS still claims those assets as its own, though UN special envoy Martti Ahtisaari's plan for Kosovo issued in February was vague on this thorny issue.

"EPS is waiting for the final political resolution of this problem. We are a state-owned company, and all of our actions will be in line with the government's activites regarding the Kosovo issue," Djordjevic says, diplomatically.

Serb or Kosovan?

The EU has also been caught between a desire to see the region develop economically and its environmental obligations. As part of Bulgaria's accession to the EU this year, it was required to close reactors 3 and 4 at its Soviet-era Kozloduy nuclear power plant. Bulgaria used to be a key electricity exporter in Southeast Europe, but the closure of these two reactors will cut its net exports from around 7.8bn kWh in 2006 to close to zero this year.

Bulgaria and Albania, which relied on exports from the plant, formally requested in January that the European Commission suspend the closure of the reactors due to the dire consequences on the region's power deficit, arguing the reactors do not pose any kind of safety risk and citing three reports from international nuclear agencies as supporting this. However, this request was given short-shrift by the Commission.

"There was a legal obligation to close down the reactors for safety reasons. To come back to the issue now is like driving down a one-way street in the opposite direction," Piebalgs told a press conference on 30 January.

Geographically speaking, Serbia would be an ideal place to site nuclear power plants as it lies in the centre of the Balkans. However, a law in 1989 banned the construction of nuclear power plants and there is little appetite among the general population for a revival of the programme. "Nuclear power is far off," says EPS' Jovanovic.

Powerful prices

The result of this will inevitably mean much higher prices for electricity in the region, though to what extent will depend upon factors such as the weather, oil and gas prices, and the ability of governments to organise the projects that are on the drawing board. "I can't imagine prices being lower than nowadays," says EFT's Ivkovic.

EFT says that Serbia's retail prices, which are some of the lowest price in the region, stand at around 4 euro cents/kWh compared with 10 cents/kWh in Hungary – an effective subsidy from the state-owned EPS. However, with prices in the region already starting to rise and approaching levels seen in Greece and Italy, the ability to sustain such subsidies becomes harder.

"As traders, we were exporting electricity to Greece and Italy but now we are seeing the situation reversed; in total we are in deficit in this region," says Ivkovic.

A direct result of this is that capacity at plants and planned projects in Italy and Greece that were uneconomical now look less so. Italy's largest utility Enel said on February 28 it plans to invest up to €1bn in the Greek power market. The Greek regulator reckons the country needs to build one new 400-MW power plant a year in order to meet growing demand. Enel said it will look to invest between €500m and €1bn between 2007 and 2011. It is already bidding to build a 450-MW combined cycle gas turbine plant at Livadia.

Matthew Hall of the consultancy Global Insight says the closure of the two reactors at the Kozloduy nuclear power plant in Bulgaria means the plant is now reportedly running at a loss and "the government will be pressing for a 24% electricity price increase from July."

Economists say such price hikes and possible power shortages will inevitably start affecting the region's economies. Already, it is reported, Albania's electricity shortage is showing up in slower economic growth and less foreign investment than elsewhere in the western Balkans.

There are steps the EU can take though to help the region over this five-year "hump." Analysts say the European Commission needs to organise better the transmission connections linking the countries of Europe so that new capacity can be brought efficiently to regions in deficit. For example, it would help if more transmission lines were built between Slovenia and Hungary and Slovakia and Hungary. Also Ukraine, which is big power producer, could be incorporated into the European market by building transmission lines with Slovenia and Romania.

Finally, sometime after 2009 there are plans to link Turkey's grid to Greece and Bulgaria, allowing the possibility of exports from a potentially enormous power producer. However, successive Turkish governments have behaved little different from their counterparts elsewhere in the rest of the region in dragging their feet over the restructuring and reform of the sector. The IMF and World Bank have been badgering Turkey for years to step up the privatization of the power sector in order to increase efficiency and cut the huge subsidies that are hurting the country's fiscal situation.

Progress was being made until the government postponed in January tenders for the first three of the 20 electricity distribution companies due to be privatised until after November's parliamentary elections – a delay seen as blatant pandering to the electorate. Ultimately, though, the biggest loser will be Turkish consumers. In a report released in January, the World Bank said the shortage of investment in Turkey's generating capacity means blackouts are likely from 2009 onwards.

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