Double trouble in Romania

By bne IntelliNews January 28, 2011

Nicholas Watson in Prague -

In the early 1990s, Romanian coal miners marched on Bucharest, stormed parliament and toppled the prime minister of the time. And it's to prevent a repeat of this, not to boost electricity output or increase energy security, that the current Romanian government is pushing a misguided plan to create two huge energy holding companies, according to research from the Bucharest- and Prague-based advisory firm Candole Partners.

As the country shivered under a thick blanket of snow early last year, the Romanian government announced a radical restructuring of the struggling state-owned power and heat generation sector, which would involve bundling assets into two new, vertically integrated energy giants that will rival the Czech Republic's CEZ, the region's largest utility.

One of the companies, to be named Electra, would take control of the Cernavoda nuclear power plant, the largest coal-fired power plants, a brown coalmine and three Hidroelectrica subsidiaries operating hydroelectric power plants, giving it a market share of about 48%; the other, to be called Hidroenergetica, would consist of Hidroelectrica's remaining hydro plants, the mine in Petrosani (CNH), and heat and power plants in the central part of the country, giving it a 44% market share. Ministers say stakes of about 15% in each of the two firms would eventually be listed on the stock exchange.

Romania's centrist coalition government says it's looking to get the plan approved at a cabinet meeting in the coming weeks, arguing that the new market structure would increase security of supply; increase domestic competition; create domestic energy firms strong enough to compete with their European counterparts and to become market leaders in Southeast Europe; give job security to the ailing coal-fired generation and coal mining sectors; and provide much-needed investment for modernising the generation (particularly coal-fired) sector. And all that without an increase in wholesale electricity prices.

Certainly, the country's sclerotic power sector is in desperate need of investment and an overhaul. According to Alexandru Sandulescu, the head of the ministry's energy policies department, Romania will need to shut down aging power production units totalling 5,544 megawatts (MW), or 28% of overall capacity by 2020, at the same time as energy consumption is predicted to rise by more than 2% a year.

However, Candole says the reforms as they stand will achieve none of the objectives outlined by the government.

Short-circuiting competition

First, the consultancy argues this restructuring will increase anti-competitive behaviour known as capacity withholding as the merged entities use it as a way to enable inefficient coal-fired generators with high marginal costs to continue producing electricity. This will end up raising, not lowering, prices. According to Candole, daily load curves suggest that this capacity withholding is already happening. At times when one would expect Hidroelectrica, the profitable hydropower generator, to produce electricity because the demand situation makes it profitable to do so, the firm doesn't, allowing prices to rise and enabling those inefficient coal-fired plants to sell their electricity. "And this is happening when those firms are nominally independent entities in a relatively competitive market, so imagine what would happen when they are merged into one juggernaut?" says Razvan Grecu, the author of Candole's report.

These market distortions would inevitably increase prices for consumers, because the difference in marginal costs in Romania between hydro and coal-fired producers is enormous, with the former costing around €20 MW per hour and coal around €47 MW.

The argument that this restructuring would lead to an increase in investment is also false, argues Candole. On the contrary, it will discourage investment, a view backed up by the World Bank, which claims that financing for Romania's energy sector would become scarcer and the market would become dysfunctional.

Based on market concentration measures, Candole argues that Romania would go from having one of the most competitive electricity markets in Europe to one of the most concentrated, and this market concentration will discourage foreign investment in Romania's obsolete gas and coal-fired generation fleet, thus leading to higher prices. The government claims that rising demand will take care of this market concentration - as demand increases, new capacity will be required to meet this demand. However, Candole says the government is using old data that doesn't take into account the effect on demand from the economic crisis. "The grid operator Transelectrica's own forecasts for electricity demand are about a third lower than the government's," points out Grecu.

Short fuse

The real motives behind the government's restructuring plan aren't hard to discern: for several years, the European Commission has been working on a directive that would halt government subsidies to member states' coal industries; in December, EU industry ministers agreed that the continent's coal industry will be allowed to receive state subsidies until 2018, but money-losing mines will have to close after that. Without state subsidies, much of Romania's coal industry is likely to prove uncompetitive, particularly that in the Jiu Valley region, once the industrial heartland of Romania. "The government is facing the problem of tens of thousands of coalminers marching on Bucharest if they close these mines and coal-fired plants, which have such high marginal costs of production they would be uncompetitive in Germany, so politicians think they can avoid the problem by creating these vertically integrated groups so that efficient assets will subsidise the inefficient ones from their profits," says Grecu.

But this is typically short-termist political thinking applied to a long-term structural problem. Rather than integrating all those assets, Candole argues the government needs to allow those inefficient power plants to fail, because no investor will likely want to buy them. If the government would agree to pay for an environmental clean-up of those sites, then investors might be persuaded to build new, modern power plants to replace the old ones. At the same time, those coal mines should also go through bankruptcy procedures, enabling their balance sheets to be cleaned up through the sale of assets. "Those coal mines are huge infrastructure companies with real estate, generation assets, transport, and they could be broken up and sold piece by piece," says Grecu.

On the other side, the profitable and efficient generators like Hidroelectrica should have controlling stakes sold on the stock exchange, not minority 15% stakes, to avoid a similar situation to what's happened in the Czech Republic, where a "pseudo-privatisation" of 30% of CEZ means the state still protects the state-controlled utility and ignores the alleged abuses of its dominant position.

The irony is that the Romanian power market was actually on the right track, albeit with some problems. It was moving in the right direction and the government had taken some steps that would make it function even better - for example, calling for the cancellation of dodgy long-term contracts to electricity trading firms and drawing up plans to increase interconnection capacity with neighbours such as Hungary and Serbia. The restructuring currently on the table will do nothing to take that process forward.

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