Central and Eastern Europe must add new capacity to grow economically

Although there is a need for new capacity, some power projects are not feasible and financing will be difficult

By Kevin Dodman

European Editor

The Central and Eastern European Power Industry Forum (CEEPIF)–the annual conference organized to provide an opportunity for key representatives from utilities, governmental bodies and industry to meet to discuss practical issues associated with energy sector restructuring–was held this year at the Anichkov Congress Hall, St. Petersburg, Russia, on April 3 and 4.

Now in its third year, CEEPIF has gained a reputation for attracting the highest quality delegates and speakers, and the St. Petersburg event was no exception. Attendees to the conference heard first-hand from some of the major players in the Central and Eastern European markets.

Opening the conference, Peter Goldscheider, the European Finance and Investment Corp. managing director, commented that total global power financing requirements for the period from 1995 to 2004 are likely to be more than (US)$900 billion, with around 10 percent of this needed for power projects in Central and Eastern Europe. He went on to stress, however, that there is a significant imbalance between needs and feasible projects.

Feasibility often hinges upon putting together a financing package. According to the European Bank for Reconstruction and Development (EBRD), some countries in Central Europe–notably Poland, the Czech Republic and Hungary–have now made sufficient economic progress to be able to raise finance from commercial banks and international capital markets. This has enabled the EBRD, which was set up to foster transition toward open market-oriented economies in Central and Eastern Europe, to move its focus further to the east, where its preferred creditor status can give other lenders the confidence to invest.

In his keynote address, Professor A.F. Djakov–president of the utility that runs Russia`s united power system, RAO EES Rossii–commented that the Russian system needs around (US)$21-26 billion of new investment through the year 2000. This would be used to build 44 new thermal and hydroelectric power stations with a total capacity of 45 GW, 50 substations and more than 9,500 km of power lines.

He said that RAO EES Rossii, which is a 60-percent state-owned, joint-stock company, would be able to fund between 35 and 40 percent of the investment, with around one-third of the total being sought from direct foreign investments and loans. He went on to say that the present legal environment hinders investment, but a new tax system is being introduced to encourage foreign participation.

The total capacity of Russian power stations in 1995 was 217 GW, of which 10 percent was nuclear-based and 20 percent was hydro-power. The power stations working within the united power system accounted for about 90 percent of this, making RAO EES Rossii one of the world`s largest utilities.

In 1995, its power output was 852 TWh, which was around 80 percent of the 1990 level. Hydro-power and nuclear accounted for one-third of the total, with the balance from thermal stations. Natural gas made up around 62 percent of the fuel used in the thermal power stations, oil 11 percent and coal 26 percent.

The decline in power consumption and consumers` inability or unwillingness to pay for the power they use are major problems for the utility. Power consumption is forecast to reach 1,050 TWh (the same level as 1991) in 2005 and rise to 1,200 TWh in 2010; although these figures will depend on the rate of general economic growth, which is hard to forecast reliably.

A law passed by the State Duma in 1995 requires that the power industry be self-financing, so local administrations and regional power commissions are taking steps to set appropriate tariffs for domestic and industrial users. According to Professor Djakov, the average electricity price in Russia today is (US)$.04 cents per kWh, which is comparable with Western European levels.

Increased cooperation

In Russia, as in most of the Central and Eastern European countries, power consumption declined during the early 1990s, and the main priorities were environmental clean-up and refurbishment of existing power plants. Typically, new power stations are being built to replace old plants, rather than to increase total installed capacity; although that situation is set to change in faster-growing countries such as Poland, the Czech Republic and Hungary, where power consumption is now close to pre-1990 levels.

The issue of the Chernobyl nuclear plant in the Ukraine was addressed by Theodorich Schon of Siemens, who presented a concept for replacement of the Chernobyl capacity by rehabilitation of coal-fired power plants.

Closure and decommissioning of Chernobyl is dependent upon financial assistance from the West, and recent reports indicate that such financing will be made available as Western governments become increasingly concerned about the long-term safety of the site.

However, for the Ukraine, a major priority is the replacement of the 2,000 MW of generating capacity provided by the remaining Chernobyl units, which is regarded as being vital for the country`s economy and would be lost if the plant is closed. Annual output from these units is 12 TWh.

The coal-fired rehabilitation option would involve upgrading existing 200-MW and 300-MW units and installing fluidized-bed boilers in a number of 100-MW units that have already been decommissioned.

According to Schon, investigations to date indicate that specific boiler and turbine-generator upgrading measures could increase power output by the requisite 12 TWh within 3-to-4 years by recovering installed capacity totaling around 6,000 MW. Efforts would be focused on enhancing general availability and improving overall efficiency, and it is estimated that the service lives of the rehabilitated units would be extended by between 15 and 20 years.

An additional benefit would be that Ukrainian companies would be expected to provide a substantial share of the necessary supplies and services, which would give a useful boost to the local power engineering sector, particularly the boilermaking industry.

Initial estimates are that a rehabilitation option of this sort would cost about (US)$1.5 billion. To test its feasibility, the Ukrainian Energy Ministry has given the go-ahead for a short-term pilot project to refurbish a 300-MW unit at the Smiyev power station.

Successful privatization

Elsewhere in the region, there has been rapid progress toward a competitive energy market. In Hungary, which has a total installed capacity of ,7070 MW, privatization of the utility MVM started in 1994 when a new Electricity Act was passed. The subsequent privatization process, which included the sale of 47 percent of six supply companies, 34 to 49 percent of seven power generation companies and 24 percent of the grid was achieved over a period of six months in 1995.

Dominic Freely, Schroders director of who led the team advising the Hungarian government on the privatization of the electricity industry, commented that the process was successful and provides a good model for the rest of the region. The second round of sell-offs will soon be under way in Hungary, with five power generation companies on offer that between them own 14 power stations and four coal mines.

Douglas Wardle–a partner in London-based law firm Watson, Farley and Williams–gave a hard-hitting presentation on risk management. He pointed out that the Central and Eastern European market is one that remains most attractive to “strategic” investors able to take a long-term view. Good evidence for this is given by the Hungarian privatization, where all the buyers were partly or wholly state-owned, such as Electricite de France, or part municipality-owned, such as RWE and Bayernwerk of Germany.

Where the potential investor is a public company with shareholders, viability has to be measured in terms of the contribution the project can make to profitability, he said. Assessment is thus made on the basis of estimated future cash flows. Discounting to take account of risks can be so great that required levels of return are not achievable.

Douglas Wardle`s paper concluded, “Given the nature of energy infrastructure projects, it is not surprising that investments are particularly susceptible to the full gamut of risk issues–in most instances more than conventional corporate investment; and it is surprising that governments do not wake up to the fact that private investment in energy infrastructure has to be distinguished from donation to charity.”

“The question that remains is whether the particular investment opportunity makes any sense at a time when there are so many energy sector opportunities elsewhere in the world.”

He suggested that if, in energy terms, governments try to “run before they can walk,” there is a risk of selling out to an investor who has the backing of a foreign state to compensate for what are otherwise unfinancable risks. Then, the question is whether it is really privatization at all.

Lively debate

These and other issues around risk management and specific business opportunities were widely debated at CEEPIF, and it was noticeable that there was ample scope for informal discussion among speakers and delegates. The event, which has become one of the major events where views can be exchanged at the senior level, once again attracted some of the most senior people in the European market.

Today, Central and Eastern Europe is emerging from the decline of the early 1990s, with economic growth now evident across the region, and grant aid giving way to strategic investment. That trend is likely to continue, offering enormous potential for both investors and equipment suppliers.

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CEEPIF`s format gives ample opportunity for informal discussions between delegates and speakers.

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Istvan Bakacs, MVM director of development, explained that privatization has been an instrument for the introduction of market conditions in Hungary.

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Professor Djakov, RAO EES Rossii president, commented that electric power has a key role to play in Russian economic development.