Ian Bancroft in Belgrade -

Serbia's energy sector - which currently accounts for 10% of GDP - is one of the key planks of future growth, particularly with regards to cross-border energy trading. Realising and diversifying this potential, however, will require sizable investments in infrastructure, and the success of attracting investment and securing market competitiveness will have important implications not only for the country's economic development, but for its overall strategic orientation.

Numerous possibilities abound. As Vladimir Markovic, an energy consultant with Primus GBS Energy Consultants, tells bne, the biggest opportunity is the forthcoming energy market liberalisation and unbundling. "The outsourcing of production from Europe has raised demand for electricity, yet already Serbia imports certain quantities in peak consumption months," he says.

Sizeable investments will be needed to modernise Serbia's energy infrastructure, including grid extensions and decentralised energy technologies. "Investment and modernisation cycles every year are valued at €100m-200m, as Serbia is trying to achieve different European efficiency and environmental standards," Markovic notes.

Financing such improvements, though, is constrained by artificially low energy prices, which have persistently failed to reflect actual production costs. Yet any dramatic change in electricity prices in the current climate is likely to provoke significant political and public opposition.

Furthermore, there is the challenge of realising cooperation between the state-owned power utility Elektroprivreda Srbije (EPS) and private actors. The European Bank for Reconstruction and Development (EBRD) is currently considering providing some €400m of financing to construct the new 750-megawatt (MW) Kolubara B lignite-fired power plant in central Serbia, some 40 kilometres from Belgrade. A joint venture was signed between Italy's Edison and EPS back in June 2011 - the first sizable private sector investment in the power generation sector and a test-case for future agreements.

Russia's grip

In the oil and gas sphere, Russia plays a pivotal role after Gazprom Neft acquired a 51% stake in the state-owned Naftna Industrija Srbije (NIS) back in 2008, with an undertaking to invest some €550m. A new gas delivery agreement with Srbijagas, finalized in mid-April, is expected to bring gas price reductions, whilst construction of the South Stream gas pipeline section through Serbia is expected to begin in November or December this year. An underground gas storage facility at Banatski Dvor was opened at the end of 2011, whilst investments into local oil refining capacity have also been made. Russia's influence in this domain of Serbia's energy sector remains unrivalled.

Even though Serbia's renewable energy alternatives are there, only a small percentage of the sector's potential is being exploited. As Rene Jensen, an independent expert on Balkan affairs, points out, the potential is around 4,3 mio TOE, of which more than half is biomass from agriculture and forestry. Also hydroelectric, wind and photovoltaic all have good potential, at least theoretically. However, "The challenges related to using these resources are many, and in most cases systemic... the subsidies needed to attract private investors are big, and can only come from the consumers or the state budget."

Markovic highlights major obstacles in a lack of understanding about the local business and legal environment. "Foreign investors don't lack financing for renewable energy projects, they just need reliable partners in Serbia," he says. "The government is trying to prepare everyone for market liberalisation, which will allow new competitors and actors to enter the Serbian energy market which - in the eyes of many foreign companies - is a regional hub for expansion."

Significant challenges also persist on the demand side, with the excessive use of electricity for heating, outdated and energy inefficient manufacturing technologies, and ageing municipal energy supply services. Given that Serbia is a very energy inefficient country, Jensen questions whether money would be better spent investing in highly needed improvements in the energy efficiency in production and among households. "Even though this is only part of the 20-20-20 criteria set by the EU, both the environmental and economic gains will probably be much higher by focusing the scarce resources on reducing energy consumption than investing in new and relatively more expensive energy resources."

How Serbia copes with the challenges of market liberalisation, different models of co-operation - particularly public-private partnerships - and pervasive Russian influence will have a significant bearing on the country's future energy balance. Overly focusing on power generation - particularly from traditional fossil fuel sources - threatens to impede the development and implementation of a comprehensive policy to improve both energy efficiency and the utilisation of renewable energy sources.

With Russia exerting a tight grip over oil and gas, securing a sustainable and diverse energy future will go a long way to determining Serbia's overall strategic orientation.