Albanian Power Distribution Privatization

1
Albanian Power Distribution Privatization Transact
ion Issues and Risks Assessment and Allocation
Investors Roundtable Tirana, April 8,
2008 Private Enterprise Partnership Southeast
Europe Infrastructure
2
Agenda
Project Background and Status
Transaction Risks Assessment
Supply Risk Retail Tariff Level Distribution
Technical and Non-technical Losses Protection of
Vulnerable Consumers Regulatory Risk Other Risks
3
Project Background and StatusMilestones Achieved
(1)

• January 22, 2007 IFC appointed as Lead Advisor
  by Albanias Ministry of Economy, Trade and
  Energy (METE).
• Projects main objectives
• Unbundling of Albanian Electricity Company
  (KESH) distribution business
• Structuring of a PSP transaction
• Executing an open, transparent and competitive
  bidding process
• IFC has contracted for this project the following
  specialized consultants
• Technical consultant SNC Lavalin
• Accounting consultant Ernst Young
• Legal consultant Gide Loyrette Nouel
• Efforts towards the privatization of Power
  Distribution in Albania are integrated with all
  parties involved Work is closely coordinated
  with other activities undertaken by the GoA with
  the assistance of donors community.
• September 07 Technical, legal and accounting Due
  Diligence review was completed . Preliminary key
  findings were presented to the government on July
  18.

4
Project Background and StatusMilestones Achieved
(2)

• A number of regulatory reports and comments were
  delivered during the Due Diligence review
• Electricity Market Functioning
• Distribution and Public Supplier Organization
• Tariff Regulatory Framework
• The Strategic Options, as identified by IFC, were
  presented to the GoA in December. Final draft of
  Strategic Options Report delivered in January,
  and included appendices on
• Public Supplier Organization
• Accounting Issues and Pro-Forma BS and PL
• Legal Due Diligence Report
• Corporate Due Diligence Report
• Draft of the Distribution Privatization Law
• Distribution and Public Supplier Organizational
  Arrangements
• An Invitation for Expression of Interest was
  published in the Economist issue of March 1st,
  2008.

5
The Wholesale-Retail Public Supply Model
Schematics
TSO
KESH Gen
Distribution Company

Wholesale Public
Retail Public Supplier
Wholesale Public Supplier


Supplier
Tariff Customers
Imports
Eligible Customers
Other Sources
Distribution Company covers distribution losses
at import market prices
A separate Public Supplier legal entity must be
created after a short transition period
NOTE DIAGRAM FOCUSES ON THE REGULATED MARKET FOR
TARIFF CUSTOMERS ONLY
6
Wholesale/Retail Public Supply ModelRoles and
Responsibilities

• Wholesale Public Supply license holder will
  remain with KESH, but will be organized under a
  separate management structure within a transitory
  period and eventually as a separate legal entity
• Retail Public Supply license will be granted to
  the DSO, but RPS will have to be organized under
  a separate management structure within a
  transitory period and eventually perhaps as a
  separate legal entity
• Retail Public Supplier (RPS) is responsible for
  
• buying energy from WPS and reselling it to the
  tariff customers. Price to Tariff Customers is
  pass-through plus a RPS margin
• tariff Customer load forecast
• billing and collection
• Distribution System Operator (DSO) will be
  responsible for
• operating, maintaining and expanding the
  distribution system throughout Albania
• buying energy in the open market to cover the
  losses in the distribution system (technical and
  non-technical)

7
Risk Assessment and Allocation Main Risks

• Supply Risk
• Retail Tariff Level
• Distribution Technical and Non-technical Losses
• Protection of Vulnerable Consumers
• Legal, Regulatory and Contractual Risk
• Other Risks

8
Risk Assessment and AllocationSupply Risks

• The risk that supply may not meet demand because
  of low production and interconnection capacities
• Table 1 Power generated and purchased

9
Risk Assessment and AllocationSupply Risk
Mitigation

• The physical constraints are expected to be
  largely eliminated for one or more years by
• the commissioning of the Vlore thermal power
  plant in 2009, which will add about 800 GWh of
  annual production, and
• the completion of a 400 kV transmission
  interconnection to Podgorica in the same year
• Ongoing Concession transactions in power
  generation
• Fieri TPP, Ashta HPP and Devoll River HPPs
• The removal of the financial constraint will be
  largely achieved by
• requiring DSO to buy energy for losses at market
  prices with a pass through of quantities and
  prices to tariff customers
• implementing a fully adequate mechanism to allow
  the Wholesale Public Supplier to pay for
  additional supply expenses in poor hydrological
  periods

10
Risk Assessment and AllocationObligation to
Supply Risk

• The Obligation-to-supply risk has been allocated
  to the Wholesale Public Supplier by adopting the
  Wholesale - Retail Supply Model
• Wholesale Public Supplier (WPS) has the
  obligation to provide sufficient supply to Retail
  Public Ssupplier (RPS) to satisfy Tariff
  Customers demand
• The DSO companys failure to supply caused by its
  own actions (e.g. poor transformer maintenance)

11
Risk Assessment and AllocationObligation to
Supply Mitigation

• ERE will monitor the process and assess the
  adequacy of supply from Wholesale Public
  Supplier. Also the public supply tariff will be
  set to provide the WPS with sufficient revenue to
  cover reasonable levels of costs and profits
• Distribution and retail tariffs will be set to
  provide DSO and RPS with
• sufficient revenue to cover reasonable levels of
  operating costs and justified and prudent
  investments realized and reasonable profits and
• incentives to reduce costs and operate
  efficiently
• Incentives to ensure the reduction in non-payment
  of bills by tariff customers.

12
Risk Assessment and Allocation Retail Tariff
Level Risks

• The risk that electricity revenue do not cover
  for power purchase costs
• Table 2 Cost and Revenue for MWh produced and
  purchased

13
Risk Assessment and Allocation Retail Tariff
Level Mitigation

• Tariffs will be set at cost-recovery level and
  power purchase costs will be fully passed through
  to tariff customers.
• Distribution and retail tariffs will be set to
  provide DSO and RPS with sufficient revenue to
  cover reasonable levels of costs and profits
• The tariff that Wholesale Public Supplier will
  charge the Retail Public Supplier will be
  determined in the regulated contract between WPS
  and RPS and will be monitored by ERE
• The RPS will be allowed to pass through to tariff
  customers the cost of power purchased from WPS
• DSO will be allowed to pass through to tariff
  customers the cost of power purchased to cover
  losses

14
Risk Assessment and Allocation Distribution
Losses

• Risk DSO will fail to reduce technical and
  non-technical losses.
• Presently the losses in the Distribution System
  are high. Total losses in 2007 are estimated at
  36.4, of which 35.4 are distribution losses
• Table 3 Total energy produced and purchased
  compared with total energy billed

15
Risk Assessment and Allocation Distribution
Losses Mitigation

• The Distribution Operator will have full
  responsibility to reduce technical and
  non-technical losses
• The effectiveness of the Distribution Operator to
  reduce losses will be benchmarked
• The amount of power purchased by the DSO to cover
  losses will be allowed to recover in Distribution
  tariffs
• Price of power purchased by the DSO to cover
  losses will be allowed to recover in Distribution
  tariffs

16
Risk Assessment and Allocation Collection Risk

• Risk that the company will be unable to will be
  unable to meet its revenue targets. This might
  occur for one or more of the following reasons
• customers refuse to pay their bills,
• customers tamper or disconnect meters,
• company employees receive bribes to make illegal
  connections or under collect metered or billed
  amounts,
• and government officials or courts are unable or
  unwilling to support disconnections or other
  actions against non-paying customers
• Table 4 Percentage of Collections

17
Risk Assessment and Allocation Government
Support for Reduction of Non-technical Losses and
Increase in Collections

• The most important support has been the complete
  elimination of arrears of government budgetary
  and non-budgetary entities (as of end of 2006) to
  KESH by mid-2007
• The Government will continue to
• support in strengthening the state and
  governments institutions role in prosecuting
  illegal consumers of electricity and persistent
  non-payers
• ensure that all electricity bills of budgetary
  and non-budgetary entities are paid, if necessary
  through payments by the Ministry of Finance
• The Government together with its lead advisor
  will engage in public information activities that
  will
• Inform the Albanian consumers on the transaction
  structure role of Wholesale and Retail Public
  Supplier and all the privatization process
• Be organized in parallel with the privatization
  transaction

18
Risk Assessment and Allocation Protection of
vulnerable consumers

• WPS, RPS and vulnerable consumers would bear the
  adverse effect of any failure to implement a
  satisfactory mechanism to protect vulnerable
  consumers.
• The draft ERE Regulations for Captive Customers
  provide for a two-block tariff structure for all
  tariff customers, including households, with the
  first block enjoying the hydro benefit and the
  second block having a price based on the cost of
  marginal energy
• For 2008 ERE has established a first block for
  household consumption with a width of 300 kWh and
  a price of 7 lek/KWh. The second block is
  established at above 300 kWh with a price of 12
  lek/kWh.

19
Risk Assessment and Allocation Regulatory Risks

• Risk that the regulator will reinterpret existing
  regulations or create new ones that will increase
  costs or reduce revenues.
• The regulator disallows the prices paid or the
  quantities purchased.
• Operating Cost Risk Risk that the company will
  not be able to recover the costs of operating its
  distribution system (i.e. the wires function)
  or the costs of retailing electricity (i.e. the
  supply function) either because the regulator
  disallows certain operating costs or sets
  unrealistic performance targets.
• Capital Cost Risk Risk that the company will not
  be able to recover its capital costs because the
  regulator sets a low allowed capital base,
  disallows costs of certain capital expenditures,
  or sets low rates of return.

20
Risk Assessment and Allocation Regulatory Risks
Mitigation

• Solid and Transparent Regulatory Framework
• Potential investors will have an opportunity to
  comment and give feed-back on the final draft of
  the ERE regulatory documents
• World Bank Partial Risk Guarantees (PRG), which
  are designed to help mitigate government-related
  performance and policy risks associated with
  privatizations
• PRG can ensure that the regulatory framework
  committed to in the pre-privatization phase will
  be adhered to and not changed unilaterally
  following privatization
• It is a transitional instrument to be used until
  the country has developed sufficient regulatory
  track record and has built up confidence in its
  sector policies
• IBRD would require a counter-guarantee for the
  PRG from GOA as well as compliance with the
  Banks policies

21
Risk Assessment and Allocation Other Potential
Risks

• Political Risks Risk of expropriation,
  nationalization, war, civil, disturbances and
  breach of contracts
• Government Subsidy Risk Risk that the government
  does not pay promised subsidies or pays with
  considerable delay.
• Inflation Risk Risk that the companys tariff
  will not be adjusted for general inflation.
• Foreign Exchange Convertibility Risk Risk that
  the government will not give the company access
  to sufficient foreign exchange to repatriate
  earnings and to pay for costs incurred in other
  currencies.

22
Risk Assessment and Allocation
Note MDB Multilateral Development Bank, ECA
Export Credit Agency