Bulgaria's state energy regulator (SEWRC) launched last week proceedings to revoke the operating licences of the country's three foreign-owned power distributors (Austrian EVN, and Czech CEZ and Energo-Pro) because of some BGN 318mn (EUR 163mn) dues they allegedly owe to electricity utility NEK. The regulator also imposed a BGN 1mn fine on each of the distributors.

The structure of the electricity sector

The sector of Bulgaria's economy that generates, transmits and distributes electricity is heavily regulated by the state. Almost all of the entities comprising the sector's current structure are owned by the Bulgarian state, with the exception of the distribution, which is managed by the three foreign companies. Generation is handled almost exclusively by state-owned power plants.

The installed production capacity stood at 13.8 GWh in 2012, the share of nuclear, fossil fuel and renewable energy sources being 14.5%, 50% and 35.5%, respectively. In that year, Bulgaria's net electricity production equalled 42.9 TWh, of which the local economy consumed 34.6 TWh. In 2013, net electricity generation declined 6.6% to 40 TWh and consumption fell 2.1% to 33.8 TWh.

The Bulgarian electricity market is divided into regulated and unregulated segments, with the size of the former ranging from 75% to 90%, according to different estimates. State-owned NEK has a central position in the transmission chain of the market structure, acting as a single buyer from power generators on the high-voltage grid in the regulated segment. Furthermore, NEK is the single supplier of electricity at regulated prices for the distribution operators.

Public distrust in the sector is growing as the perception of deep-rooted corruption has increased. The independence of the regulator is insufficient as its decisions are considered to be heavily influenced by the government. Rent-seeking for political or economic purposes is possible because the regulator's role as a central planner in the sector (setting prices and recognising costs). This role hampers the competitive pricing process of the market and instead creates imbalances between supply and demand, which show up on the companies' balances as loss of income and growing debt.

The financial condition of the electricity sector

NEK is on the brink of collapse. The company had a liquidity ratio of 0.38% as of end-September 2013 and BGN 2.15bn (EUR 1.1bn) worth of short-term dues, which NEK has said is a direct result of the regulator's pricing policy. In February, Standard & Poor's lowered its long-term corporate credit rating on NEK to 'B+' from 'BB-'/negative outlook. The downgrade followed the steep deterioration in NEK's credit metrics in 2013, which resulted mainly from the adverse regulatory tariff decisions, the S&P explained.

Meanwhile, the earning before interest and taxes of the Bulgarian Energy Holding (BEH), which groups Bulgaria's largest state energy utilities (NEK included), tumbled 55.3% y/y to BGN 244.8mn in the first nine months of 2013, latest data has shown. BEH itself tapped foreign markets in October 2013 to raise EUR 500mn in a debut eurobond issues in order to cover one of NEK's maturing loans.

Czech electricity conglomerate CEZ Group said that its electricity production and distribution units in Bulgaria turned to a combined negative EBITDA of CZK 300mn (EUR 11mn) in 2013 from a positive EBITDA of CZK 400mn a year earlier. The other two power distributors have not yet made available their results for 2013 but there have been media reports that Energo-Pro has been in technical bankruptcy since mid-2013.

The origins of the latest debacle

The creation of wind farms and photovoltaic parks speeded up rapidly in the first half of 2012 and a lot of new capacities were connected to the power grid from April to June. Investors hurried to complete their projects as government officials (including representatives of the regulator) were saying publicly at the time that they consider decreasing the feed-in tariff (a preferential price) for new projects as of July 1. These events largely took place after the March annual submission of the power distributors' forecast on the amount of installed green energy capacities for 2012.

Obviously, their forecast turned out to be wrong. The turning point was in July, when the regulator decided not to reimburse the distributors for the amount of surplus green electricity bought by them, i.e. that portion which exceeds their forecast (applied retroactively to all such purchases from March onward). The distributors challenged the decision in court and the Supreme Administrative Court ruled it illegal in November 2013. In the meantime, the obligation to pay for the surplus (above the forecast) electricity from renewable sources from their own pocket drained their finances and threatened to bankrupt them.

The distributors tried to persuade the regulator to raise the price of electricity as a form of compensation but SEWRC instead introduced a grid access fee with the intention of making the power generation from renewable sources relatively less attractive. This decision was also ruled as illegal by the courts, which said that NEK should reimburse the fees it has been collecting.

All in all, NEK became indebted to the power distributors for hundreds of millions. Facing the threat of bankruptcy, the distributors started withholding payments to NEK as a method to improve their financial situation. However, NEK is in worse shape and even though it is likely the wrong one in this case, legal-wise, it enjoys a favourable regulatory bias because of which the regulator took upon its claims that the distributors owe it BGN 318mn from payments withholding.

Conclusion

The law does not put limits on the time a licence revocation procedure should last. It is reasonable to assume that the results of the regulator's investigation will become public before the May elections for members of European Parliament. The sector has become a preferred tool for politicians to consolidate their electorate. However, even if this is just another pre-election fiasco, the sector's problems must be addressed or the whole economy will suffer. We note that the regulator remains the biggest source of instability because of its central planning functions and insufficient independence.