The Key to the Future

Poland is moving towards the creation of a traded electricity market, while privatizing the electricity sector. The outlook for competition in this market is very positive, providing the government can create the right regulatory environment.

Ten years after embarking on an ambitious programme of economic transformation, Poland has established itself as one of the most successful transition economies”. So concludes the OECD in its latest survey of the Polish economy. It goes on to note that to achieve sustained high growth, a key requirement is that “it makes rapid progress to privatize state-owned enterprises so as to maximise the economy-wide benefits of increased efficiency”. This applies to enterprises in a number of sectors. It includes firms at all levels of the electricity sector: production, transmission, supply and distribution.

Electricity is rapidly becoming an actively traded commodity in much of western Europe. Similar potential to create a traded electricity market clearly exists in Poland. The ability of the government to lead and implement the necessary structural and regulatory reform will determine to what extent this potential is fulfilled.

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Many economic indicators in Poland are currently pointing in the right direction. The European Commission has forecast gross domestic product (GDP) growth to hit 5.1 per cent this year. However, the government is now seeking to bring the public sector deficit to under three per cent of GDP and the current account gap back to 6.0-6.5 per cent of GDP. Spending on European Union accession (which is planned for 2003) and other budgetary commitments imply that the governmentss ability to attract enough money in privatization revenues may determine whether or not it meets its fiscal targets. Since the electricity sector is one of the key potential sources of privatization revenue, there will be major repercussions if the government does not succeed in establishing a functioning electricity market in 2000.

A basis for competition

Given its size, location and disaggregated structure, the Polish electricity market is ideally placed to play a leading role in the development of an integrated wholesale energy market in Europe. Traders and marketers are excited by the prospect of the competitive, liquid electricity market that promises to emerge if the government puts in place the building blocks on which the market can be based.

The focal point of the industry has in recent years been the state-owned transmission company, Polskie Sieci Elektroenergetyczne SA (PSE). PSE performs many more roles than most transmission companies in liberalized markets. It has been to a large extent the “single buyer” of all power produced in Poland and it remains a major electricity trader in its own right. Ultimately this trading role is at odds with the requirement for the transmission system to be operated on an independent basis, separate from the commercial interests of market participants to whom it will provide transmission services.

The generation sector consists of around 30 generation companies. Installed capacity is approximately 33 GW and peak demand about 24 GW. While there is significant overcapacity in generation, much of the plant is close to retirement. Furthermore, the heavy reliance on coal-fired production raises questions of environmental sustainability in the long term.

Some new plant is coming on line, including Enron’s Nowa Sarzyna project. This is a gas-fired combined heat and power station with a total capacity of 116 MWe and 70 MWth. Enron won a power purchase agreement for the facility through a competitive tender process in 1998. It is due to enter full commercial operation early in 2000. It is the first greenfield private project-financed entity established on the basis of concluded contracts, rather than government guarantees. In addition to supplying power to the grid, Enron plans to distribute the high and low pressure steam produced by its steam turbine generators to the Organika-Sarzyna chemical company and to the City of Nowa Sarzyna. A 4.5 km local gas pipeline connects the facility to the nearby Polish Oil and Gas Company (POGC) gas transmission pipeline.

In distribution there are 33 joint stock, 100 per cent state-owned distribution companies. In the emerging liberalized market these companies will explicitly become suppliers as well as distributors to customers in their territories that do not have the right, or do not choose, to switch supplier.

Some consolidation in generation and distribution is likely in the coming years as liberalization becomes effective. Nevertheless this level of disaggregration on both the demand and supply sides of the market augurs well for competition and competitive prices to consumers. The potential exists for prices to be driven primarily by supply and demand fundamentals, rather than the market power of one or two key participants, provided the government can create an appropriate regulatory climate.

Privatization programme

From 2000-2002 the government has committed to a large-scale electricity privatization programme. Apart from the few shareholdings in generation that have already been sold, the sector remains entirely state-owned. In principle, whether ownership is public or private is unrelated to the issues involved in establishing a market. However, a by-product of privatization is likely to be a significant sharpening of economic incentives in the sector. This will reinforce the transition to a market.

Shareholdings in generation at the Bedzin, Rybnik, Wybrzeze, Zielona Gora, Wroclaw, Bialystok and Polaniec power plants are among those that the government plans to sell in 2000. The main PSE transmission business is scheduled to be privatized in 2002. In late 1999 the government announced plans to privatize all 33 distribution companies by 2002. The tender for at least ten per cent of the shares in Gàƒ³rnoslaski Zaklad Elektroenergetyczny (GZE), the first of the distribution companies on the list, was published in November. However, it now appears that GZE may be the only distribution company to be privatized in 2000, with a group of adjacent distribution companies in the north of Poland following in 2001.

Minority stakes in each distribution company will be sold off initially. Trade unions will be awarded up to 15 per cent of the shares, while the State Treasury will keep the remaining shares. The government’s unwillingness to sell off majority stakes in generation and distribution companies raises the spectre of continuing state intervention even when private investors have been brought on board. This reluctance to cede control is indicative of the resistance the government is facing from trade unions and the distribution companies themselves to the privatization programme. Union demands typically include job guarantees for employees of a minimum of five years and certain guaranteed wage increases.

To the extent that the government accepts job guarantees as part of privatization transactions, these should at least be financial, rather than physical, guarantees. Physical guarantees interfere with the new investor’s freedom to run the company as it sees fit. Moreover, they discourage workers from seeking employment elsewhere in the economy and in so doing, counter the objective of creating a more flexible labour force.

While the government may wish to retain some portion of the shares in the companies in order to be sure that the State Treasury benefits should the company valuations subsequently rise dramatically, the refusal to sell majority shareholdings from the outset can only undermine the credibility of the programme.

Regulatory uncertainty

The absence of an electricity market creates a major problem for the State Treasury in seeking to maximise the privatization revenues from the sector. Electricity trading has not yet begun, in spite of the entry into force of a progressive Energy Law in December 1997. This means that investors have no wholesale electricity reference price against which to make asset valuations. The existing “prices” are numbers that are administratively set to allocate costs across the sector. They are no use to an investor seeking to value assets that will be earning all or part of their financial returns.

Even if investors do invest, they are likely to charge significant discounts to take on risks, if the rules of the market have not been sufficiently defined to enable the investors to manage those risks. In the case of Elektrim’s purchase of the generation at Patàƒ³w-Adamàƒ³w-Konin (PAK) last year, it is rumoured that Elektrim only agreed to the acquisition on the basis of a discount, in the absence of a power purchase agreement being in place. Vattenfall’s acquisition in January 2000 of a stake in the Warsaw CHP plant confirms the trend of low sales prices (when measured on an adjusted $/kW basis). Meanwhile, the recent tender for the Bialystok CHP did not attract any bids from investors.

Exchange and market

The lack of development of a traded wholesale power market to date can be explained by the absence of any clearly-defined electricity trading arrangements and the failure of URE (the Energy Regulatory Authority) to meet its statutory duty to promote competition.

If these regulatory failings are not addressed, more than 200 customers (with consumption of more than 40 GWh per annum) who are legally entitled to choose their supplier from 1 January 2000 will be frustrated in their attempts to source cheaper power supplies from alternative providers.

A consortium led by Endesa of Spain and Elektrim has been given the task of setting up a power exchange by the end of June 2000, following a Ministry of State Treasury tender last year. However, a power exchange is not by itself the answer to the structural and regulatory reforms that the sector requires. Indeed, the power exchange will not be able to function properly if the regulatory climate does not inspire the confidence of market participants.

But if the power exchange can be a catalyst for the establishment of a set of workable trading arrangements, then it will have made a major contribution to the cause of reform.

The power exchange should be voluntary in that market participants will be free to conclude their own bilateral trades in addition to trading on the exchange. However, rules will have to be agreed by Gielda Energii S.A (the power exchange company established by the consortium) with PSE (as the system operator) on the details of the trading arrangements.

Definition and monitoring of rules addressing these issues lie at the heart of any electricity market. These are the rules that every market participant must agree to accept if they wish to trade in the market. The government and URE must therefore become more pro-active in enforcing and interpreting any rules that are agreed than they have been until now.

As part of the development of the electricity trading arrangements, the government must assess the impact of the draft Commodity Exchange Law being considered by the Sejm (the Polish Parliament) this year. As proposed, it would prevent market players entering into their own privately-negotiated, individual electricity derivative contracts in order to better manage their risks. Such a rule is completely unnecessary and would simply stifle the development of a liquid traded market in electricity.

The draft law also provides that brokerage houses (as parties which have been admitted to conduct exchange transactions) will have exclusive rights to trade on power exchanges. There is no reason for intermediaries such as brokerage houses to be given this exclusive role. Over 150 entities have been granted a licence to trade electricity since 1997 and the requirements that these entities had to meet to obtain licences should be sufficient to permit them to trade in their own right on the exchange.

The government and Gielda Energii should therefore consult widely on the proposals before they are finally agreed. The authorities will not know how effectively the new trading arrangements will work if they do not explicitly and openly ask for the input of all possible market participants.

Gielda Energii should nevertheless be able to keep to its commitment to establish the exchange, with the new trading arrangements, by the end of June. Should it fail to do so, the consequences could be serious not just for the electricity sector, but also for the government

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