Nicholas Watson in Prague -

When the Bosnian Serb Republic and Czech utility CEZ signed a €1.5bn deal in December 2006 to build a new coal power plant and upgrade an existing power plant, it seemed a great opportunity at an ideal time: the region is facing a huge power deficit at the same time the republic desperately needs investment. So the news on January 28 that CEZ has pulled out of deal sends a terrible signal to investors at a critical juncture in the country and region's development.

CEZ said it has decided to exercise a put option to sell back its 51% stake in the joint venture Nove Elektrane RS (NERS) to the state power company Elektroprivreda RS (ERS) for the reputed €4m it had spent capitalising the venture, because the Bosnian Serb side had simply not lived up to its side of the bargain.

Under the terms of the deal, CEZ was supposed to have stumped up €200m in initial investment in return for 51% of NERS, while the state would contribute existing assets such as the 300 MW Gacko 1 power plant and adjoining coal mine to the venture in return for 49%. The construction of the Gacko 2 power plant and the modernisation of the existing Gacko 1 power station were scheduled to begin this year and to be completed by 2013. CEZ put its total future investment in the project at €1.5bn.

However, according to Aleksandar Obradovic, NERS general manager, the Bosnian Serb government didn't fulfil its pledges despite continual prodding over the past year and a half, putting the timetable for the project's development in jeopardy. Bohdan Urban, the project manager of the Gacko power plant, was quoted as saying the government failed to register property in a timely manner, issue concessions, expropriate land for the mine and put forward to parliament a 2006 feasibility study. Thus, a few days before the expiry of the put option at the end of January, CEZ decided to exercise it.

Obradovic was careful to stress that this move does not signal the end of CEZ's interest in the project, just that it became clear to the Czech utility that the structure of the deal was ultimately not to the liking of the government. "The ball is in their court," he said.

Lack of power

What went wrong? The deal was signed back in December 2006 by Bosnian Serb Prime Minister Milorad Dodik, whose party campaigned during the 2005 elections under the slogan, "Republic of Srpska, the better part of BiH", a dig at the Muslim-Croat half of the war-divided Bosnia-Herzegovina. The Gacko project was the largest piece of foreign investment ever in Bosnia-Herzegovina and was regarded as an important step in showing that the Serb-run half of the country could get things done better than its neighbour and was well and truly open for business. Such foreign investment is vital to help rebuild the state after the Balkan wars in the 1990s and further its aim to eventually join the EU.

However, the project immediately attracted public criticism, with some complaining about the price the government got for Gacko 1 (essentially that initial €200m investment from CEZ when the stock market value of the firm was about €390m) as well as the murky way the negotiations were handled. Some sources close to the deal attribute the collapse of the agreement to the inability of the prime minister to give it a high-enough priority, as well as the naiveté and inexperience of the Bosnian Serb government and, particularly, ERS management in running large projects such as this.

Whatever the reason, the collapse of the deal is, say analysts, a terrible signal for investors, especially when investment is in such short supply at this time of crisis in the world. Sources say that the attractiveness of Gacko as a foreign investment opportunity has decreased significantly since Serbia proper next door announced in January that it is launching a huge €1.4bn tender for the construction of three power generation units with a combined capacity of 1,400 MW. CEZ is a leading contender for that.

The collapse of the deal is also harmful for the Balkans as a whole, since the region is facing a power deficit at the same time as its economies need more power from projects like Gacko to grow. Bosnia, along with Bulgaria and Romania, are the only power exporters in the region. "Only several countries in the region have a surplus of energy, while all others have energy deficits, which means that energy is now imported into the region from western markets," says Dr. Svetislav Bulatovic, one of the founders of the regional power firm Energy Financing Team.

Bulatovic estimates that the overall demand for energy in the region is growing at about 4% annually. In 2008, the overall energy deficit in the region was estimated at about 15 terawatt hours (TWh), which compares with overall demand of over 240 TWh. However, this deficit is set to worsen as Bulgaria has been forced to close down four Soviet-made reactors of 440 MW each at its sole nuclear power plant Kozloduy under pressure from the EU, which it joined in 2007. According to estimates of the energy ministry, Bulgaria will only be able to cover just 13% of the power deficits in Southeast Europe, down from 37% in 2007. Bulgaria is now talking about restarting two of the reactors.

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