Nicholas Watson in Belgrade -

Serbia in September signed a multi-billion-euro energy deal with Germany's RWE, part of the new government's drive to kick start investment in the sector and head off a looming energy crisis. However, a drought-stricken summer that cut electricity production by about a third means it has the more immediate problem of dealing with a severe energy shortfall this coming winter.

On September 10, the new head of state-owned Elektroprivreda Srbije (EPS), Aleksandar Obradovic, accompanied by Deputy Premier Aleksandar Vucic and Minister of Energy Zorana Mihajlovic, travelled to Berlin to sign a memorandum of understanding and strategic partnership with RWE, the projects for which could add as much as 3,000 megawatts (MW) of hydroelectric power capacity in the Balkan country and, the government hopes, "ensure stable and continued growth of the energy sector in Serbia."

RWE's total investment through the joint venture with EPS could amount to €2.2bn, which will include €1.2bn to add a third unit to the 1.240-MW lignite-fired Termoelektrana Nikola Tesla B3 plant, and about €1bn in hydropower plants on the rivers Drina and Danube, including the construction of the Djerdap 3 hydro plant on the Danube River.

Mihajlovic tells bne such deals are crucial for Serbia because for 27 years the country hasn't built any significant new energy infrastructure to add to the 8,359 MW of installed capacity, most of it ageing communist-era coal-fired plants, even though consumption of electricity has risen by an average 2-3% per year. "This is a problem for us, because we now have a deficit of electricity of about 25-30%, so we are in an energy crisis I think," says Mihajlovic. "By building Tesla B and other smaller hydropower plants on the river Drina we could solve our problems in five to eight years."

A river runs through it

The RWE deal is an acknowledgement of the huge, untapped potential that the country's renewable energy sector has. Rene Jensen, an independent expert on Balkan affairs, has told bne that its potential is around 4.3m tonnes of oil equivalent a year, of which more than half is biomass from agriculture and forestry, while hydroelectric, wind and photovoltaic all have good potential, at least theoretically.

The coalition government, led by the Progressive and Socialist parties, has already taken some steps toward this since it came to power in late July.

In moves it hopes will stimulate the country's renewable energy sector, the government has said it intends to bring in public tenders for renewable energy permits, while also establishing rules on a time limit within which the investor will have to finish the project, or at least build it to a certain level. If the investor fails to do so, the permit will be revoked. "This way we shall make sure that we do not have the same persons extending the permit every two years, or investors who after eight years still have not finished the power plants they began constructing," Mihajlovic says.

The government also wants to cut red tape, which it believes is fostering corruption and stifling investment. Today, to build a small hydropower plant an investor must get 27 permits from a variety of ministries. "This is a problem because it opens the way for corruption and an investor hasn't two or three years to get all of these permits. From 27 permits, I think we should bring it down to three or four and the investor will get all of them from the energy ministry," Mihajlovic says.

"There have been a lot of investors who came to Serbia over the years, but the result is we don't have any big investment in the energy sector, so something is wrong - I think what's wrong is corruption," she says.

Elephant in the room

Crucial to turning around Serbia's energy sector will be the restructuring of the lumbering, loss-making EPS - the vertically integrated state utility that in 2010 generated 35,855 gigawatt hours (GWh) of electricity and produced 37m tonnes of lignite.

The new general manager, Aleksandar Obradovic, has been tasked by the government with preparing the company for the liberalised energy market along EU lines that Serbia will develop over the next few years. A key part of this will be the "unbundling" of EPS, splitting off the distribution from the generating bits of the business.

The first step is stabilising the financial situation of the company, which was loss-making in the four years to 2010 (the 2011 figures appear to show a profit though have not been analysed sufficiently by the company for public release). "We have to make sure our liquidity and financial stability is there, so I'm now working on renegotiating some financial packages," says Obradovic.

This is particularly crucial in regards to this upcoming winter when demand traditionally surges, because the terrible drought suffered this summer reduced production of hydropower, which accounts for about a third of EPS' production, by around 30%. "All missing electricity we need to import, but if we're not financially stable, then we could have a problem," says Obradovic. "I'm confident in our technical ability to handle this winter, but I want to be sure we are financial stable to cover all the needs that may arise from importing electricity."

This view is backed by Mihajlovic. "Our biggest problem is to get through this winter and how to have enough energy, electricity and gas, for households and industry in November, December and January - it is the biggest problem right now," she says.

Returning the utility to profitability, which will also involve rooting out corruption (several EPS officials were arrested last year in connection with the misuse of funds in procurement) and raising electricity prices for households and industry to nearer market prices, will allow the state to eventually privatise the country's biggest employer. "We don't want to privatise EPS yet - we need to make EPS like a modern European company first," says Mihajlovic.

That will take time, as Obradovic sums up. "I took this responsibility at a very difficult time, when EPS' financial situation is still not so stable, when our usage of electricity is not efficient - we use two- to three-times more electricity to GDP per capita than the EU average because we are not efficient and use too much for heating - and we're expecting a liberalised market," he says. "We have a lot of short-term, medium-term and long-term issues that I have to work on resolving at the same time."