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E N E R G Y & N AT U R A L R E S O U R C E S

Prospects for the


Central and Eastern European
Electricity Market
In light of the present economic environment

A DV I S O RY
Authors:
KPMG Energy & Utilities Centre of
Excellence Team, Budapest, Hungary

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Foreword 3

Foreword

The history of harnessing electricity, spanning only two centuries, is much shorter
than that of other technologies – for instance agriculture or mining – which have
been exploited since prehistoric times. Yet electricity has become a crucial form
of energy in modern societies; it is a unique resource which cannot be readily
substituted. The importance of electricity is soaring, since Western-type lifestyles
and industrial societies require unprecedented quantities. Meanwhile, developing
economies are catching up in terms of industrial production and are also
experiencing a massive expansion in residential consumption.

This document focuses on the development of the electricity industry in Central


Péter Kiss and Eastern Europe (CEE), a region which has gone through major restructuring
Partner, KPMG Global in the last two decades. Yet while much progress has been made, considerable
Head of Power & Utilities challenges still await most countries in the region, including liberalization,
privatization, synchronization, efficiency and climate change issues.

Compared to Western Europe, the CEE region also has a substantial backlog of
tasks regarding economic development, which include social, industrial and
environmental challenges. Nonetheless, this delay also offers great potential,
allowing the possibility of a “quantum leap” in the industry. Thus, instead of
following a drawn-out learning curve, CEE could reap the rewards of the
immediate introduction of state-of-the-art technologies, even potentially
overtaking western electricity industries in the coming decades.

This publication identifies the key characteristics the region’s electricity sectors,
assesses issues such as sustainability and the development needs and evaluates
the effect of the present economic circumstances on the investment
environment. I trust that you will find the contents of this report valuable for your
business.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Table of contents 5

Table of contents
Methodology 7

Executive summary 11

1. Introduction 17
1.1. Macroeconomic development in the region since 1990 17
1.2. Development of the electricity sector since 1990 18
1.3. Development of CEE electricity generation 19

2. Restructuring the CEE electricity sector 23


2.1. Privatization and market development 23
2.2. Efficiency in electricity generation 27
2.3. Sustainable generation 28
2.4. Infrastructure 31
2.5. Diversification of supply sources 33

3. CEE electricity generation: forecast 39


3.1. UCTE forecast 40

4. Financing investments in the energy and power sectors 53


4.1. Conditions of the current financial crisis 53
4.2. Effects of the crisis on the economy and energy sector 54
4.3. Effects of the financial crisis on financing conditions 58
4.4. Financing needs of electricity sector development in CEE region 68

5. Conclusions and future prospects 75


5.1. Economic environment: crisis, consumption and recovery 75
5.2. Financing in the future 77

Acronyms 81

What can KPMG firms offer to the electricity sector? 83

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Methodology 7

Methodology

This publication has been compiled by KPMG’s Global Power & Utilities
Knowledge & Resource Center, based in Budapest, Hungary, to frame the
prospects of the Central and Eastern European electricity market in light of the
present economic environment.

KPMG conducted comprehensive research to frame the prospects of


development in the CEE region’s electricity sector. The report is based in part on
statistical databases and forecasts of the Union for the Co-ordination of
Transmission of Electricity (UCTE), EUROSTAT, Economist Intelligence Unit,
Dealogic, and on interviews conducted with key market participants. Based on
these interviews, databases, evaluations and forecasts, KPMG analyzed the
development trends of the electricity sector of the CEE region up to 2020.

The report also analyzes the assumptions of the System Adequacy Forecast
2009–2020 prepared by UCTE 1 which differentiates two scenarios, a
Conservative and a Best Estimate Scenario for generation capacity development
in the region.

The main questions surrounding energy sector development were also raised and
assessed by the sector’s main market players. KPMG conducted a survey to map
out the expectations of market players. During the survey period May–October
2009, KPMG conducted semi-structured, face-to-face and phone interviews with
top-level executives who are considered key stakeholders within the CEE region’s
electricity sector. The target groups for the interviews comprised:

1) Transmission System Operators

2) Regulatory authorities

3) Financial institutions: domestic and international commercial and investment


banks present in the CEE region that have experience in loan syndication and
project financing and have already financed energy-related projects.

4) Equipment suppliers, equipment manufacturers

1 The European Network of Transmission System Operators for Electricity (ENTSO-E) took over
all operational tasks of UCTE from July 2009.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
8 Methodology

The following companies and their representatives contributed to


our survey:

Company Contact person

MAVIR, Hungarian Transmission Zoltán Tihanyi


System Operator Company Ltd Director of System
Operation
Transmission System Operators

CEPS, joint-stock company Miroslav Vrba


operating Transmission System Board member and
(TS) of the Czech Republic Executive Director of
Dispatch Management and
ICT

Miroslav Šula
Director of Dispatch
Management
Regulatory

Hungarian Energy Office Péter Simig


authority

Electricity sector expert

OTP Bank Balázs Balogh


Head of Division
Project Finance and
Acquisition Directorate
Financial institutions

MKB Bank Attila Erhardt


Senior Manager; Project,
Structured and Corporate
Finance II

Oliver Gulyás
Head of Department;
Project, Structured and
Corporate Finance II

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Methodology 9

Company Contact person

BNP Paribas Pierre Bonin


Head of Corporate and
Transaction Group for the
Financial institutions Region (Hungary, Croatia,
Slovenia and Serbia)

European Bank for Nandita Parshad


Reconstruction and Director of Power and
Development (EBRD) Utilities Department

Grzegorz Peszko
Senior Energy/
Environmental Economist

GE Energy Rod Christie


Equipment suppliers

President of GE Energy,
Central & Eastern Europe,
Russia & CIS

Siemens Andreas Mueller


General Manager, Sales
GT Power Plant Solutions
Central Eastern Europe,
Russia, Central Asia

KPMG would like to thank the numerous sector experts for their participation in
this report, and for their contributions in terms of insights and valuable
information. These contributions have enabled the authors to identify the sector’s
needs and opportunities.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Executive summary 11

Executive summary

The electricity systems of the Central and Eastern European countries have
undergone considerable development since the fall of communism in 1989–90.
Nonetheless, as this study highlights, huge challenges remain across the region.
Almost all economic data, including electricity consumption, which on a per
capita basis is only 57 percent that of Western Europe, indicate that the region
still has some way to go before living standards catch-up with those in the
developed world.

These challenges include investment into transmission and distribution systems,


cross-border links, and most especially, renewal and expansion of generation
capacity.

Meanwhile, planners have to take into account increasing concerns regarding


security of supply, ever more stringent environmental regulations, political
worries over the cost of electricity and last but not least, the problem of long-
term finance for projects in the current global economic turbulence.

The ever more complex matrix of factors to be considered when planning


electricity investments makes it a daunting prospect for both business and
governments, and one which the latter might easily be tempted to put off.

Yet this report, compiled from official data and detailed interviews with
professionals in the electricity and banking sectors, argues that in many ways
political leaders must understand that the economic downturn makes reform and
the creation of well-thought out policies for their electricity sectors an
increasingly urgent task, assuming they want to establish a basis for sustainable
economic growth in the future.

Indeed, given the increasingly long lead-times and pay-back periods associated
with new power projects – most especially large hydro, coal and nuclear facilities
– the future planning of CEE electricity sectors requires focused and responsible
governments at all levels.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
12 Executive summary

Regionally, the requirements are substantial; the Union for the Co-ordination for
the Transmission of Electricity (UCTE) estimates electricity consumption in the
region will jump by an average of 25 percent in the next decade, with above
average growth in Romania, Hungary and most states of the former Yugoslavia.
And while Poland is expected to see only 17–18 percent growth in consumption,
the size of the Polish market means even this translates into 25,000 GWh, not far
short of the current net consumption of Slovakia. (With a net production of
143,000 GWh, Poland consumes approximately 30 percent of total electricity in
CEE.)

To meet this increased demand, the UCTE estimates that the region requires
between 21 GW (Conservative Scenario) and 42 GW (Best Estimate Scenario) of
new generation capacity by the end of the decade.

In addition, based on KPMG estimates, 53 GW of obsolete capacity needs


replacement or at least retrofitting over the same time period.

All of which will take huge amounts of finance. Depending on which scenario
proves more realistic – and on the modes of generation the countries employ –
the UCTE scenarios will require a capital expenditure of between EUR 40–70 bn,
while replacement of the obsolete capacity could take up to EUR 76 bn.
Combined, this means the generation segment across the region could soak up
anything between EUR 114–144 bn in investment by 2020.

What kind of new developments can be expected? Inevitably, as in the past, this
to a large extent will depend upon the kind of fuel is available in each country.
Many CEE countries boast coal deposits (albeit of differing quality), so it is no
surprise that coal fired plant currently makes up about 50 percent of installed
capacity across the region and accounts for up to 48 percent of electricity
generated.

The readily-available supply of coal (or lignite) is excellent in terms of security of


supply, but of course the high emissions, coupled with low efficiencies
associated with older plant, make coal less attractive from an environmental
viewpoint. While coal’s future in the region will depend partly on the development
of CO2 trading and storage schemes, efforts to develop clean-burn technology are
expected to keep coal well in contention in the race for new investment in the
next decade.

As a result, the percentage of coal fired capacity is expected to fall to 38–39


percent of the total. However, should the UCTE’s Best Estimate Scenario prove
realistic, this could still mean an increase in absolute numbers of up to 750 MW.
On the other hand, if the future follows the Conservative Scenario, total coal-fired
plant could drop by some 10,000 MW across the region.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Executive summary 13

In contrast to the relative decline in coal usage, renewables are expected to be a


“focus of attention” in the coming decade as a result of EU regulations, public
concern over the environment and the desire to reduce dependence on imported
energy sources. Some CEE countries, notably Latvia, Romania, Albania and most
former Yugoslavian states can already boast that a significant proportion of their
power derives from renewables – typically in the 15–20 percent range – primarily
hydro sources.

But for countries lacking significant hydro capacity, such as the Czech Republic,
Hungary and Poland, the proportion of renewable electricity is typically in the
range of 5.0–7.5 percent of the total, meaning these countries hold out the
prospects of considerable investment in the renewable energy segment.

The UCTE Best Estimate Scenario suggests the share of renewables in the
installed generation capacity will reach 31 percent, i.e., 50 GW by 2020, and
though hydro capacity is predicted to expand by about 20 percent across the
region, wind energy is expected to be the star performer. As the report notes,
almost every CEE state intends to progress with wind energy, most significantly
Poland, Romania, Estonia and Albania. According to the UCTE’s Best Estimate
Scenario wind-generation capacity in the region will expand to 12 GW by 2020,
6.5 times current levels.

However, KPMG notes that development of both wind and solar energy is highly
dependent on the regulatory framework, feed-in price levels and the system-
balancing potential of the various national transmission system operators.

Nuclear generation is a very significant source of electricity for seven countries in


the region, and with the priority given to CO2 emission reduction, the pressure is
on to once again expand nuclear facilities.

Plans are going ahead in several countries, including two reactors in Slovakia with
a capacity of 840 MW, two in Bulgaria with 1,900 MW and two in Romania
totaling 1,310 MW based on the World Nuclear Association’s database.
In addition, 14 more reactors have been proposed across the region, which if
completed would total 21,655 MW – roughly double the total current capacity.

Finally natural gas, which currently accounts for only 9 percent of total CEE
generation capacity, is likely to see its share of the electricity production cake
more than double in the next decade. And this is despite concerns regarding
dependence on Russia as the primary source for most countries in the region.

Indeed, even Latvia and Hungary, where gas-fired plant makes up more than
30 percent of generation capacity, are expected to opt for more, such are the
attractions in terms of efficiency, relatively short lead times, low emissions and
low capital expenditure.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
14 Executive summary

In addition, development of gas-fired generation should be advanced by the


realization of new supply routes to Europe, such as the Nabucco and South
Stream projects.

Poland, in particular, expects to build up to 8,000 MW of gas-fired plant, with


other developments in Croatia, Macedonia and Hungary according to the Best
Estimate Scenario.

In light of all these needed investments (and CEE is not alone – huge
investments are also required in western European electricity systems), the
question arises: where the money comes from, particularly in these troubled
times?

Perhaps surprisingly respondents to this study were cautiously optimistic that,


with confidence slowly returning to the markets, financing would be made
available for well-thought out energy-sector projects, although with more
stringent conditions than have been applied in the past decade. However, the
need is such that the required developments will need financial assistance from
beyond the region.

In terms of the investment costs, governments and national authorities within


CEE can help themselves by ensuring a transparent and robust regulatory
framework is in place in their jurisdictions. They must also make all possible
efforts to streamline and unify regulation among the respective countries.
This will reduce risk and encourage external investors and operators into their
markets, thereby maintaining a strong inflow of best practices and modern
technology into their respective power industries, to the ultimate benefit of all
concerned, including their economies, industries and peoples.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Executive summary 15

Central and Eastern European EU member states


region’s countries Bulgaria
Area: 110,879 km2 Population: 7.2 m GDP: USD 93.8 b Electricity consumption: 34,453 GWh
 EU member
states EE Czech Republic
Area: 78,867 km2 Population: 10.2 m GDP: USD 217.1 b Electricity consumption: 65,141 GWh
 Non-EU LV

member states Estonia


LT Area: 45,228 km2 Population: 1.3 m GDP: USD 27.4 b Electricity consumption: 8,036 GWh

Hungary
Area: 93,028 km2 Population: 9.9 m GDP: USD 196.6 b Electricity consumption: 41,284 GWh
PL
Latvia
Area: 64,589 km2 Population: 2.2 m GDP: USD 38.9 b Electricity consumption: 7,573 GWh
CZ
Lithuania
SK Area: 65,300 km2 Population: 3.6 m GDP: USD 63.3 b Electricity consumption: 11,491 GWh

HU Poland
SI Area: 312,685 km2 Population: 38.5 m GDP: USD 667.9 b Electricity consumption: 142,852 GWh
HR RO

Romania
BA RS Area: 238,391 km2 Population: 22.2 m GDP: USD 271.4 b Electricity consumption: 55,206 GWh
ME
KO BG Slovakia
MK
Area: 49,035 km2 Population: 5.5 m GDP: USD 119.5 b Electricity consumption: 27,635 GWh
AL
Slovenia
Area: 20,273 km2 Population: 2.0 m GDP: USD 59.3 b Electricity consumption: 12,686 GWh

Non-EU member states


Albania
Area: 28,748 km2 Population: 3.6 m GDP: USD 21.8 b Electricity consumption*: 3,603 GWh

Bosnia & Herzegovina


Area: 51,197 km2 Population: 4.6 m GDP: USD 29.7 b Electricity consumption: 11,575 GWh

Croatia
Area: 56,594 km2 Population: 5.0 m GDP: USD 82.4 b Electricity consumption: 17,861 GWh

Kosovo
Area: 10,887 km2 Population: 1.8 m GDP: USD 5 b Electricity consumption*: 4,281 GWh

Macedonia
Area: 25,713 km2 Population: 2.2 m GDP: USD 18.8 b Electricity consumption: 8,643 GWh

Serbia
Area: 77,474 km2 Population: 7.5 m GDP: USD 80.3 b Electricity consumption: 38,982 GWh

Montenegro
The databases utilized in this publication do not Area: 13,812 km2 Population: 0.7 m GDP: USD 6.8 b Electricity consumption: 4,583 GWh
include information for some of the CEE countries.
The following list summarizes those countries that Central and Eastern Europe Total 2008
have been left out of the statistics: Area: 1,342,700 km2 Population: 128 m GDP: USD 2,000 b Electricity consumption:495,885 GWh
EUROSTAT databases do not contain information
for Albania (AL), Bosnia Herzegovina (BA), Kosovo Western Europe Total 2008
(KO), Montenegro (ME) or Serbia (RS). Area: 3,605,717 km2 Population: 407 m GDP: USD 13,372 b Electricity consumption: 2,785,321 GWh
World Bank databases do not contain information
for Kosovo (KO) or Montenegro (ME).
UCTE databases do not contain information for
Albania (AL), Estonia (EE), Kosovo (KO), Latvia (LV)
or Lithuania (LT). Although in the cases of System
Adequacy Forecasts only Albania (AL) and Kosovo
(KO) are excluded.
Energy Information Administration databases do
not contain information for Kosovo (KO), Sources: Area, population, GDP: CIA – The World Factbook,
Montenegro (ME) or Serbia (RS). Electricity consumption 2008 (net consumption with system losses): UCTE,
BP and International Monetary Fund databases do http://www.entsoe.eu/resources/publications/ce/ms/
not contain information for Kosovo (KO). * 2007: CIA – The World Factbook, https://www.cia.gov/library/publications/the-world-factbook/

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
CEE Renewable Electricity Outlook
Introduction
2008 17

1. Introduction

1.1. Macroeconomic development in the region since 1990

The Central and Eastern European (CEE) region was part of the broad Socialist
Bloc, predominantly within the Soviet sphere of interest, until political transition
eventually began in 1989. With the political and economic changes of the 1990s
the region embarked on the path towards a free-market economy based on
competition and demand for goods and services. The first years of the transition
were generally accompanied by recession, high levels of inflation and escalating
unemployment. Initial government measures were only partially successful in
combating these problems, until key reforms brought on economic recovery.
However at the end of 1990s, many CEE countries again experienced an
economic slowdown due to the slow pace of structural transformation.
The decline was also seen in local national crises, which, alongside other factors,
halted the escalation of growth in the region. Stabilization occurred at the
beginning of the 21st century, with annual national growth rates ranging from
3–12 percent (compared to 1–4 percent in the EU15).

Figure 1: GDP in EU-27 and CEE (1990–2008), 1990=100%

CEE 700 %


EU-27 600

500

400

300

200

100

0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Source: International Monetary Fund, World Economic Outlook Database, April 2009

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
18 Introduction

GDP has increased in recent years, the sectors producing the largest portion –
roughly 20 percent of total GDP – have been industry and commerce.

Figure 2: Distribution of GDP by sectors in the CEE region

 Agriculture 1995 2008


 Industry 6.1% 15.2% 3.9%
14.4%
(excluding construction)
23.6% 21.5%
 Manufacturing
13.1%
 Construction
 Trade & Commerce 16.5%

 Financial intermediation 13.4%


& business
20.0% 17.8%
 Services 22.5% 7.0%
5.0%

Source: EUROSTAT

1.2. Development of the electricity sector since 1990

The economic changes of the mid-1990s resulted in a significant decrease in


electricity demand after many heavy industries, the main consumers, were shut
down. The restructuring of these economies proved to be successful; setbacks
occurring on local and national levels were remedied with relative ease through
government intervention. Since the political transition, the region has experienced
increasing electricity production as a consequence of a general improvement in
economic performance, as can be seen in Figure 3.

Figure 3: Development of electricity consumption in EU-27 and


CEE (1990–2008), 1990=100

CEE 135 %


EU-27 125

115

105

95

85

75

65
1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Source: World Bank

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
CEE Renewable Electricity Outlook
Introduction
2008 19

Due to the restructuring of the CEE economies, the present electricity


consumption of the region has just returned to the level of the early 90s,
although its usage among the different sectors has changed significantly.
In particular, as a result of steady economic growth, the proportion of residential
consumption has increased by six percentage points, reaching 26 percent of total
consumption by 2007. The share of commercial consumption has also grown,
while industrial consumption has fallen back. As a result, the current distribution
of electricity consumption in the CEE and in the EU-27 are nearly identical, as
shown in Figure 4.

Figure 4: Distribution of electricity consumption in CEE and EU 27 by sectors


(1990, 2007)

 Industry EU-27
 Transport 3,000,000

 Households 2,500,000
 4%  2%
 Services 2,000,000
GWh

 20%  27%
 Other 1,500,000
 27%  28%
sectors* 1,000,000
 3%  3%
500,000
 46%  40%
0
1990 2007

CEE
400,000
350,000
300,000
 9%  3%
250,000
GWh

 13%  27%
200,000
150,000  20%  26%
100,000  5%  3%
50,000  53%  41%
0
1990 2007

* including Fisheries and Agriculture

Source: EUROSTAT

1.3. Development of CEE electricity generation

The generation mix of the CEE region has been stable and the proportions of
different generation types have not changed significantly in the last two decades,
despite the enforced closure of some nuclear facilities. The evolution of the
generation mix, shown in Figure 5, highlights a strong and continuous
dependence on fossil-fired generation, comprising altogether 57–60 percent of
total generation.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
20 Introduction

Figure 5: Development of generation by fuel types in CEE, 1990–2006

600

16% 16% 15% 15%


500 18% 15%
17% 19% 18% 18% 16% 3% 4% 5% 6%
18% 17% 17% 2% 3%
14% 15% 17% 1% 1% 1%
400 1% 17% 18% 17% 17%
16%
15% 15% 16% 16% 16% 18%
15% 15% 15% 15% 15% 16%
9% 9% 10% 10% 10% 10%
TWh
10%
300 10% 10% 9% 9% 9% 9% 8% 8% 8% 9% 4% 4% 3% 3%
7% 6% 6% 7% 7% 6% 5% 5% 4%
5% 7% 7% 6%

200
50% 49% 50% 49%
52% 50% 55% 54% 53% 53% 50% 51% 50% 52% 53% 50% 50%
100

0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

 Coal  Oil  Natural Gas


 Nuclear  Renewables excluding hydro  Hydro

Source: UCTE, European Commission, EU Energy in figures, 2009

Figure 6: Generation capacities by Nuclear-based generation is the second most important component of the
fuel type in the CEE region, 2009 generation mix, providing almost 20 percent of total generation. Reliance on oil
has been steadily diminishing, while at the same time, gas is gradually gaining
importance. The use of renewable energy sources, although showing a slight
increase, remains low in comparison to current EU targets.

In 2009, the total installed capacity in the region was 124 GW, while the total
peak load was 80 GW, thus overall capacity was sufficient to meet demand.
While the generation mix in the region is relatively diverse, the use of specific
 Nuclear 10% fuel sources in individual countries depends on a number of factors, including the
 Coal 49% availability of natural resources, cost structures of the different generation types
 Oil 1% and the particular national strategy, as many countries are aiming for increasing
 Natural Gas 9% security of supply and decreasing dependency on foreign fuel sources.
 Mixed/Other Fuel 6%
 Renewables 2%
 Hydro 23%
Figure 7: CEE electricity generation mix (GWh) by country, 2008
Source: UCTE, System Adequacy Forecast
2009–2020  Nuclear 160,000

 Coal 140,000
 Oil 120,000
 Natural Gas 100,000

GWh

Mixed/Other Fuel 80,000


 Renewables
60,000
 Hydro
40,000

20,000

0
BA BG CZ HR HU ME MK PL RO RS SI SK

Source: UCTE

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Introduction 21

Although the generation mix is heterogeneous, it does show a strong


dependence on thermal sources. This results from the large-scale utilization of
coal, especially in Poland, the Czech Republic and Serbia, a result of historical
developments in those countries.

Some CEE states, notably in the Balkans, are experiencing a shortage of


capacity, while others, like the Czech Republic and Poland are net exporters.

Due to rising environmental concerns, EU regulations and security of supply


issues, an extensive and comprehensive restructuring of the region’s electricity
generation units is expected to begin in the short term. In accordance with
EU Energy Policy, three main pillars underpin this transformation (see Table 1).

Table 1: The three pillars of EU Energy Policy

Competitiveness Sustainability Security of Supply

1. Liberalization, privatization 3. Developing sustainable 4. New investments to meet


and unbundling generation policy the expected energy demand
2. Efficiency in electricity and replace aging
l Competitive renewable infrastructure
generation, securing and sources of energy and other
diversifying energy supplies low carbon energy sources 5. Diversifying sources and
technology development and routes of imported energy to
R&D l Curbing energy demand
within Europe compensate the rising import
dependency with
l Reduction of the CO2 infrastructure development
emission (decreasing the
environmental impact and
controlling climate change)

Source: Green Paper on the European Strategy for Sustainable, Competitive and Secure Energy
(SEC(2006) 317)

Over the years there has been a certain change of emphasis, with a shift away
from competitiveness towards sustainability and more recently to security of
supply as a result of the high dependency on imported fuels. In addition, the
transformation of the energy sector into an open and competitive market has
given way to concerns regarding environmental impacts, especially CO2
emissions.

This KPMG overview assesses the factors which must be taken into
consideration when defining the development plans of the region’s electricity
sector. For example, the importance of modern technology and infrastructure
development is apparent, as these are the essential foundations upon which
commercial and operational development can be established.

In the following chapters the three pillars of the EU Energy Policy are examined,
along with their resultant implications for the Central and Eastern European
region.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Restructuring the CEE electricity sector 23

2. Restructuring the
CEE electricity sector
2.1. Privatization and market development

Electricity sector privatization began in the 1990s, and has made considerable
headway in some of CEE countries. In many cases privatization of the distribution
and generation sectors is at an advanced stage. However in the case of the
transmission grids, these are typically regarded as strategic assets and hence are
owned directly or indirectly by the states concerned.

Figure 8: Privatization of the CEE electricity market

Overview of DSO privatization in the Overview of generation privatization


CEE region 2007, 2008 in the CEE region 2007, 2008

EE  In final phase EE

LV  Underway LV

 In initial phase
LT LT

PL PL

CZ CZ

SK SK

HU HU

SI SI
HR RO HR RO

BA BA
RS RS

ME BG ME BG
KO KO

MK MK
AL AL

Source: International Energy Regulation Network, Country Factsheets 2007, 2008

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firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
24 Restructuring the CEE electricity sector

In Hungary, the Czech Republic, Slovakia, Bulgaria and Macedonia, the


Distribution System Operators (DSOs) have been privatized, sold mostly to
foreign investors. In Romania, Slovenia and Albania, privatization is well
underway, while in Estonia and Lithuania, the DSO privatization has begun but
privatization of generation is still in the initial phase. As a result of delayed
restructuring, Poland, Croatia, Serbia, Montenegro, Bosnia and Latvia are still in
the early stages of the process.

The relevant new EU regulations regarding unbundling, summarized in the so-


called 3rd Energy Package, are set to speed up these processes.

What are the main questions arising in relation to the 3rd Energy Package?
The 3rd Energy Package details further steps to be taken in the process of
unbundling, prescribing a higher level of independence for the entities already at
least partly unbundled, and stipulating the inclusion of the previously omitted
TSOs into the process.

It provides a choice between three solutions: creating an Independent System


Operator (ISO) (i.e., a transmission system operator (TSO) with the
responsibilities of operating and managing the electricity network but without the
ownership of said network); full ownership unbundling (requiring the separation
and sale of the integrated transmission business); or the independent
transmission operator (ITO) model – where ownership and operation can remain
within an integrated utility.

In order to facilitate the integration of the EU electricity system, in July 2009, the
six European TSO associations – ATSOI, BALTSO, Nordel, UCTE and UKTSOA –
merged into one organization, the European Network of Transmission System
Operators for Electricity (ENTSO-E). ENTSO-E comprises all TSOs in the
European Union, as well as others connected to their networks.

Will the new organization ENTSO-E become a super TSO over the national
TSOs in the long term?
Respondents do not deem this realistic, mentioning that legal, technical and
commercial feasibility could be problematic. The main concept is that the use of
local primary energy is more efficient than the delivery of electricity over long
distances. In the light of this fact, a totally integrated system requiring robust
infrastructure does not seem advantageous economically. Currently, the
responsibility of ENTSO-E is coordination, lobbying and gently pushing market
players towards cooperation.

What kind of difficulties could the unbundling represent (regarding


competition, transparency, etc.)?
In accordance with the 3rd Energy package, the shares of the Czech TSO (CEPS)
have been transferred from the Ministry of Finance of the Czech Republic to the

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Restructuring the CEE electricity sector 25

Ministry of Industry and Trade at the end of August 2009. By this act the
condition for unbundling in ownership was completed; however, as the
representative of the Czech TSO pointed out, this change is not going to
significantly affect market transparency or competition requirements.

Competition on the Hungarian market, where liberalization has already occurred


and privatization is also advanced, is also not considered to be genuinely
complete. In addition, the operation costs of the Hungarian transmission system
are probably higher than that of the old centralized system, due to the costs of
administration, coordination of the market players, etc.

A power exchange has also been mentioned as a potential tool to both


incorporate renewables into the competitive market and to increase competition.
This is an important issue in Hungary for example, where a large number of
plants currently operate under long-term contracts, and therefore are little
affected by market forces. If market prices were transparent, power producers
would be more constrained by market prices to produce only when their plant is
competitive for the system load.

This state of affairs is far from unique: indeed, liberalization has not really
succeeded anywhere in CEE to create a genuine free market in electricity.

Partly as a consequence of privatization (and in order to give investors reasonable


security for their efforts), long-term power purchase agreements (PPAs) were
introduced into the region, particularly in Hungary and Poland, where they covered
80 percent and 50 percent of the power markets respectively. Such agreements
were signed in the 1990s, with some valid until 2030. The European Commission
requested the termination of these agreements, considering them one of the main
obstacles against market development and liberalization because of their effects on
competition and the transparency of electricity pricing. As a result most PPAs have
been eliminated and substituted with market-based contracts.

Price convergence within CEE is expected to occur as part of the integration


process of the European electricity markets, with the EEX in Germany and
NordPool in Scandinavia playing major price-setting roles. The rate of convergence
will depend on the following:
• establishment of local power exchange spot markets
• efficient cross-border interconnections
• elimination of PPAs and
• market liberalization.

Nevertheless, a number of smaller, national power exchanges have started


operations in Europe, including Poland, Slovenia, Romania and the Czech
Republic, each proving to be a great success in supporting the liberalization
process.

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firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
26 Restructuring the CEE electricity sector

2.1.1. Energy community


Although the western Balkan countries are not members of the EU, the
acceptance of the Treaty Establishing the Energy Community is a definite step
towards their integration into a single energy market. The overall principle of the
Treaty, which entered into force on 1 July 2006, is to create a common regulatory
framework for trading energy across South East Europe and the EU on equal and
transparent terms. It was signed by the European Community and by the
Contracting Parties, viz. Albania, Bosnia and Herzegovina, Croatia, Republic of
Macedonia, Montenegro and Serbia, as well as UNMIK2.

These states agreed to the adoption and implementation of the acquis


communautaire3 on energy, environment, and renewable energy sources.
In addition, the main principles of EU competition policy are also applicable.
Following Treaty procedures, the Contracting Parties have also taken up the
commitment to implement a set of security of supply-related regulations.
Attracting investment, enabling cross-border trade, enhancing security of supply
along with improving the environmental situation is among the goals of the
Treaty. Meanwhile, a common regional approach concerning oil, energy efficiency
and the social dimension of energy reforms is also being worked on.

The distinctive characteristics of the Contracting Parties illustrate the significance


of the Treaty. The region has a relatively low level of gas-dependent generation,

2 United Nations Interim Administration Mission in Kosovo (as Kosovo representative under Security
Council resolution 1244)

3 EU law, in this case EU single market regulations

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Restructuring the CEE electricity sector 27

combined with few nuclear power generation facilities, while some countries rely
heavily on hydro electric generation. Hence the security of supply and efficient
allocation of resources are issues of paramount importance. Stronger regional
trade in electricity would certainly help exploit the opportunities created by
differences in natural resources available between individual states, enabling
power stations based on various fuels to supply demand as appropriate.
Furthermore, unhindered cross-border trading – as an alternative to nationally-
independent energy policies – could reduce the total (indeed substantial)
investment in generation facilities that the Balkan countries would otherwise
need to prevent supply shortages.

2.2. Efficiency in electricity generation

Along with the political changes of the 1990s, a gradual shift in the structure of
the region’s economic system also came about. With the evolution of competitive
markets, heavy industries, previously the backbone of the command economies,
lost their dominance. In turn, less energy-dependent sectors, notably services
and trade, gained predominance. These tendencies resulted in a general decline
in electricity consumption. At the same time, the gradual substitution of outdated
equipment and infrastructure with modern and efficient technology began.
Consequently, the region’s production efficiency and energy intensity4 improved
significantly, as seen in Figure 9.

Figure 9: Energy intensity of the CEE and EU-15 region economy, 1992–2006

CEE Total 4.5 %


GWh/ million USD (2000 PPP)

EU-15 4.0

3.5

3.0

2.5

2.0

1.5
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Source: Energy Information Administration

The CEE region’s energy intensity has decreased by 78 percent since 1990.
Lower energy intensity indicates a lower price or cost of converting energy into
GDP, suggesting a more efficient use of resources. Despite such progress, the
region still has room for improvement in this respect.

4 The energy intensity indicator highlights the necessary energy input of an economy to produce one
unit of GDP.

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firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
28 Restructuring the CEE electricity sector

2.3. Sustainable generation


2.3.1. Emission policy
A reduction in emission levels and enhanced environmental protection in Europe
are governed under the Kyoto Agreement and the associated European Union
Emission Trading Scheme (EU ETS).

The Kyoto Protocol is an international treaty on climate change linked to the


United Nations Framework Convention on Climate Change (UNFCCC). It is a
commitment from the signatory nations to reduce greenhouse gas emissions.
As of February 2009, the Protocol has been signed and ratified by 183 countries
and the European Union. However, the target levels for the reduction of
emissions are binding for only 37 industrialized countries and the European
Community. The majority of CEE countries have shown their commitment to the
Protocol and undertaken a target of 8 percent (6 percent for Hungary and Poland)
greenhouse gas emissions compared to the base year.

The EU ETS was founded in order to make the CO2 market, the so-called carbon
market, operational. Involving all 27 EU and also the 10 CEE countries, it is the
world’s largest multinational greenhouse gas emissions trading scheme. Its main
objective is to create a price for carbon dioxide emissions that includes the so-
called “external” environmental costs of energy production, thereby showing the
genuine, total costs of generation.

2.3.2. EU climate and energy package


In December 2008, the EU approved the so-called “energy-climate” package,
which incorporates the world’s main energy and climate issues. The motive
behind the package includes concerns regarding climate change and European
dependence on imports of foreign oil and gas. Its main targets, to be achieved by
the year 2020, are:
• 20 percent reduction of green house gas emission
• 20 percent improvement in energy efficiency
• 20 percent share of renewable energy in primary energy consumption.

The legislative package includes:


1) a directive improving and extending the greenhouse gas emission allowance
trading system of the Community
2) a decision on the effort of member states to reduce their greenhouse gas
emissions
3) a directive on the promotion of the use of energy from renewable sources
4) a directive on the geological storage of carbon dioxide
5) regulation setting emission performance standards for new cars and
6) a directive on the quality specification of petrol, diesel and gas-oil.

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firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Restructuring the CEE electricity sector 29

Implementation of the EU energy and climate strategies also aims to enhance


the competitiveness of the region through innovation in the energy sector.
Countries, on their way to becoming low carbon economies, must encourage
innovation in the existing energy sources, with an emphasis on increasing the
effectiveness of energy production and on increasing the share of renewable
energy in the generation mix.

Power plant emissions are to be cut by 21 percent by 2020 in comparison to


2005 levels. Granting fewer emission allowances under the EU ETS is one way to
achieve this goal. A large share of these allowances will be dispensed by auction.
From 2013, full auctioning of CO2 emissions are also planned for electricity
generators.

However, technical developments could alleviate many concerns over the


skyrocketing costs of fossil based power generation, since the promotion of the
safe use of carbon capture and storage (CCS) methods shall eventually remove
most carbon emissions.

Are the planned renewable capacities sufficient to meet national targets?


What actions are necessary in order to achieve the EU requirements?
Respondents indicated that it would be difficult to meet the targets set by the
EU. Compliance with previous regulations was achieved by most states, but
reaching this new set of goals may not be as straightforward. Challenges and
opportunities are different for every country, depending among others on national
resources and market pressures (available financing, subsidized prices, etc.) One
representative remarked that in all probability not all countries would succeed in
fulfilling the targets on their own. The representative of the Czech TSO
underlined that meeting the EU target (13 percent by 2020) seems challenging
even with the current massive state subsidies available.

Increases in electricity tariffs have not succeeded in moderating electricity


demand significantly. Thus, reaching the target of improving energy efficiency
(through reducing electricity consumption) calls for more direct energy saving
initiatives. Simple measures which can easily fit into the everyday lives of the
population are being widely promoted. Among these, the renovation and
replacement of large residential buildings holds great potential, as does a
program to replace incandescent light bulbs with fluorescent lamps. Although
these steps may not succeed in curbing consumption in absolute terms, they
are certain to improve living standards and to slow down consumption growth.
It should be noted that seasonal use of electric appliances, such as air
conditioning, increasingly influences network load. It is clear that changes in
lifestyles affect energy efficiency as much as large-scale developments and
state policies.

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firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
30 Restructuring the CEE electricity sector

Finance is a ubiquitous factor in all respects regarding future development.


Meeting the targets requires investment in the present, which will in turn result
in more expensive electricity in the future. This means that tax rates must either
be decreased or electricity tariffs raised. Thus, to create a business environment
attractive to potential developers, governments must create a reliable regulatory
regime, alongside an investment-friendly tariff, tax and licensing system.
A majority of respondents agree that the targets are feasible from a technical
point of view, but will only be met satisfactorily if renewables-related initiatives
are well-structured and the potential return underpins projects. It was mentioned
that the level of utilization of biofuels would be a key factor in reaching the
Hungarian national target of 13 percent.

Which form of generation is the most cost-effective in reducing carbon


emissions?
Respondents are in agreement that diversity in the development of the
generation mix is not only the most efficient way to cut emissions, but it is a
necessity of itself. Certainly renewables are seen as only part of the solution, not
least because they are very expensive, which raises objection from the
population because of subsequent higher electricity prices. Furthermore, they
require additional balancing capacities, and do not provide a constant and
dependable source of power.

Combined cycle gas turbine plants (CCGTs) have the lowest emission level of all
fossil fuel generation systems.

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Restructuring the CEE electricity sector 31

Ideally, however, pan-European legislation is needed to recognize and subsidize


new technologies if carbon capture systems are to become cost effective and
more widespread.

Sustainability and security of supply are two crucial issues that must be
addressed simultaneously. Building new, modern and efficient power plants to
replace old, inefficient units is therefore inevitable. A mix of renewables and new
power plants equipped with cutting-edge, clean technologies are needed, as are
nuclear plants.

2.4. Infrastructure

In addition to the need for new investments, extended modernization and retrofit
work on existing power infrastructure is also necessary in the region. Power
plants in CEE are steadily aging, as shown in Figure 10. and more than 60
percent of installed capacity, amounting to more than 67GW, is over 30 years old.

Figure 10: Power Plant Infrastructure in the CEE region, 2009

 Nuclear 80,000

 Coal 70,000

 Natural Gas 60,000

 Oil 50,000
MW

 Renewable 40,000
 Hydro 30,000
20,000
10,000
0
<10 years 11–20 years 21–30 years >30 years

Source: DATAMONITOR; Statement of Security of Supply, Republic of Macedonia, 2007; Statement of


Security of Supply for Kosovo – Electricity and Gas, May 2007; Security of Supply Statement of the
Republic of Albania, Ministry of the Economy, Trade and Energy, 2007; Security of Supply Statement of
the Republic of Croatia, Ministry of the Economy, Labor and Entrepreneurship, 2007.

The typical lifetime of large hydro power plants varies between 90 and 120 years,
therefore most of the current units in CEE are likely to be in operation over the
next few decades. However, lifetimes of fossil fuelled plants are much shorter,
amounting to approximately 40–50 years for conventional coal, gas and oil-fired
plant, and 25–30 years in the case of CCGT plant. Capacities older than the
theoretical life-span for a given technology may be considered inefficient
generation sources. The majority of current plants deemed obsolete are coal
fired, and they must either be decommissioned or retrofitted in the short or
medium term.

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32 Restructuring the CEE electricity sector

In total some 54 GW of CEE generation capacity (including 42 GW coal-fired,


7.5 GW gas-fired and 3.5 GW oil-fired) is considered life-expired, or close to it.
It is therefore abundantly clear that significant investment will be needed now or
in the near term to address this issue.

What level of efficiency improvements can be expected from new


technologies? What types of generation units are required?
The average efficiency of conventional coal, gas, and oil-fired power plants built
20–24 years ago in Europe is around 30 percent.

Older coal-fired units can be modernized to achieve efficiencies of 38–39 percent,


but newly-built coal-fired plant can attain efficiencies of up to 47 percent.
Designers hope that in the medium term, a figure of 50 percent may be
achieved.

CCGT technology has seen efficiency levels climb from around 50 percent and is
expected to reach 60 percent in the near future.

CHP plant is typically 85–88 percent efficient, though in the case of well-sized
units it can reach 91 percent.

Further efficiency improvements are expected to depend mainly on the


development of new, heat and pressure resistant materials, such as advanced
ceramics.

One respondent believes that CCGT units will be the most popular option to
replace obsolete capacity in the short term, primarily because of the relatively
short lead times of 5–6 years. This is pertinent because investors are still nervous
regarding both the electricity and financial market conditions.

To meet load fluctuations, modern transmission systems need faster reaction


times from generators than in the past to maintain the balance of supply. Hence
the response time of new capacity is another crucial factor to be taken into
account by systems designers.

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Restructuring the CEE electricity sector 33

2.5. Diversification of supply sources


Many CEE states are concerned about their dependency on imported primary
energy and are seeking to diversify both sources and the delivery routes in order
to improve their security of supply.

The electricity systems in the CEE region are at threat from three principal risks:
weather conditions, technical outages and any interruption of supply from primary
sources. Weather conditions affect changes in demand, which can be relatively
sudden. Moreover, a sudden interruption of wind in the countries with wind-
dependent electricity generation can also cause shortage of supply.

The question of the security of natural gas supply has also become an issue in
Europe recently after Russian-Ukrainian gas crises broke out in 2006 and 2009.
As a consequence, several European countries suffered a shutdown in supplies
of gas from Russia. Natural gas imports are a critical source of primary energy in
many CEE countries, with 11.3 GW of installed capacity in the region reliant on
gas. In addition, a considerable increase in the use of natural gas for electricity
generation is also forecasted, taking its share in generation from 9 percent today
to 17 percent by 2020 that is 28 GW of installed capacity5.

Figure 11: CEE natural gas imports by origin in 2008

 Russia 14

 Germany 12
Billion cubic meters

 Norway 10
 Other 8
Europe
6
& Eurasia
4

0
Albania
Bosnia and
Herzegovina
Bulgaria

Croatia

Republic
Hungary

Lithuania

Poland

Romania

Serbia

Montenegro
Czech

Slovakia

Macedonia

Latvia

Estonia

Slovenia

Source: British Petrol

Gas plays a crucial role as a primary energy source in Hungary, Romania,


Slovakia, Croatia and the Baltic countries. With limited or no domestic sources,
these countries are therefore all highly dependent on Russian supplies, which
currently use one pipeline through Ukraine.

5 According to the Best Estimate Scenario of the UCTE Forecast

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34 Restructuring the CEE electricity sector

Figure 12: Natural gas reserves of CEE countries (2007)

Legend  Production (bcm)


EE

 no reserves  Dem and (bcm)


 1–50 bcm
LV

18 12.5/17
6/16.3
 >50 bcm LT
16

14 2.5/13.3

PL 12

10
0.1/8.6
CZ
8
SK 0.1/6.2
6
HU
4 0/3.5 2.8/3.3 0/3.4
SI 0.6/2.5
HR RO 0/2.04
2 0.03/ 0/1.1 0/1
0.03 0/0.1 0/0.4
BA
RS
0
AL BG HR CZ HU PL RO Sl SK LT LV EE MK ME RS BA
ME BG
KO

MK
AL

Several new transit routes are proposed to improve the natural gas supply of the
Source: CIA The World Factbook region, notably Nabucco, South Stream and Krk LNG. To ensure energy
independence, individual countries also developing a more diverse generation
portfolio, including renewable energy sources and nuclear power.

Nabucco

Austria Hungary

Romania

Bulgaria

Turkey

The construction of the Nabucco pipeline was scheduled to start in 2010,


however, neither the financing nor the sources of the natural gas have yet
been finalized.

The 3,300 km Nabucco pipeline, which aims to bring gas from the Caspian Sea
region to Central Europe, has a planned maximum capacity of 31 bcm/year.

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Restructuring the CEE electricity sector 35

South Stream

Russia
Austria Hungary

Romania

Serbia
Italy
Bulgaria

Turkey
Greece

Operations were planned to commence in 2013. However, the project has been
delayed due to the financial crisis and disagreement among the potential
parties involved, and the pipeline is expected to be commissioned in 2015.

Based on recent news the north-western part of the pipeline will run
through Serbia and Hungary to Austria’s Baumgarten gas storage.

KRK LNG terminal

Slovakia

Austria Hungary

Slovenia Romania
Croatia
Bosnia and
Herzegovina
Serbia

The proposed capacity of the new LNG terminal at Krk is approximately


10 bcm/year. The start-up is planned for 2014.

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36 Restructuring the CEE electricity sector

Figure 13: Main electricity flows in Ensuring the security of supply is certainly a matter of great concern for CEE
2008 and planned new cross-border countries. They are expected to seek ways to reduce dependence on natural gas
transmission lines in the CEE region (or at least diversify their sources) in the future to offset the potential risks.
Additionally, the CEE region has expressed a great interest to participate in and
finance alternative supply routes, which is beneficial for both the region and
exporters.

The security of the electricity supply is also an especially significant factor in


certain parts of the CEE region. The Baltic countries still belong to the IPS/UPS
synchronous zone integrating the transmission networks of the ex-Soviet
countries, and this is directed by the Russian Federal Grid Company. Although
one inter-connection with the Finnish electrical system was established in 2006
(EstLink), this is not sufficient, and the Baltic countries remain largely isolated
from the European electricity system.

What should policy makers do to achieve a secure and sustainable power


sector in the CEE region?
TSOs and equipment suppliers agreed that providing long-term security of fuel
supply is of critical importance. The most straightforward solution is the
construction of new gas pipelines. The need for new LNG terminals, gas and oil
storage facilities were also mentioned as partial solutions. The maintenance and
development of the electricity networks themselves is also considered very
significant by respondents.

 Net exporter countries


In this respect, there are two areas where systems suppliers could see much
 Net importer countries
potential, namely those with so-called “smart grid” technology that improves the
 Electricity flow in 2008 balance between demand and supply. Secondly, those with the systems capable
 400 kV line to be commissioned of providing the flexibility to enable grids to respond effectively in times of fast
before 2013
load or supply changes. This is of particular importance with the introduction of
 400 kV line to be commissioned
before 2016 significant volumes of wind and solar generation into the network. In addition,
network modernization can also be highly successful in improving certain security
 400 kV line to be commissioned
before 2020 of supply indicators.

2.5.1. Cross-border capacities within the CEE region


Source: UCTE statistical database and the UCTE The primary focus of energy policy in the European Union lies in creating a
System Adequacy Forecast 2009–2020
unified and integrated European energy market. Alongside those factors which
influence the individual national markets, the steps towards this unification also
play an important role in the development of the electricity sector in the CEE.

Cross-border electricity trading systems are a key component of this process.


The Cross-Border Trading Mechanism (CBT Mechanism) promotes trading
possibilities between countries, while the newly established ENTSO-E, operating
the European high voltage grid, synchronizes the countries’ electricity systems
and makes direct trading possible. Consequently, TSOs are now able to utilize
their unused capacities through auctions, leading to the standardization of rules
and regulations in the region. This is much improved on the 1990s, when surplus
cross-border capacity was more scarce.

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Restructuring the CEE electricity sector 37

In addition, construction of new cross-border transmission lines is also planned.


According to the UCTE System Adequacy Forecast, over the next 12 years,
several cross-border links will be developed in the CEE region.

What are the main factors behind import and export capacity
developments? Are the new capacities considered sufficient to ensure
security of supply?
As a general rule, electricity system planners believe cross-border capacities
should be about 10 percent of peak load. In fact, many countries in the region
comply with this at present, but while this would appear acceptable on paper, in
fact from a market point of view it is inadequate, and if cross-border trading is to
work efficiently more capacity must be built.

Regarding to Northern Europe, the Baltic States will benefit from interconnection
development to Scandinavia by reducing dependence on Russian power imports.
Apart from reducing the Baltics’ isolation from the European grid, such
interconnections also enable power systems to be operated more economically.

Generally, respondents agreed that the development of cross-border capacities


would improve system efficiencies, e.g., by helping to diversify supply routes,
enabling competition and eventual procurement from the most economical
sources.

However the Czech TSO representative noted that, rather than building
expensive cross-border links, other, more cost-efficient measures might boost
export-import capacities, such as modernization of the internal grids, high voltage
transmission lines and substations.

Figure 14: Net Transfer Capacities (NTC) in the CEE region

1,000
1,000
 No existing determinant procedure 750

 Proportionally 1,300
750
600 400
 Auction 1,500
0
60 680 680
 <500 MW 2,200
1,400

0
10
 500–1,000 MW
1,100
1,200
 1,000–1,500 MW
1,
 >1,500 MW 75
0
2,250 8 500
800 00
0 0

700
0
1, 2

500 400 400


1,0

1,200 400
600 800
300
500

650 350 800 400


400 600
600
160 0 650 400 1,000
900 630
600
430 420
900 500 450
600 430 350 750
500
400 450
400 450 250 750
250
480
250 60 70 500
20 0 100
300 300
30 300
Source: ETSO – NTC values winter 2008–2009

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
CEE electricity generation: forecast 39

3. CEE electricity
generation: forecast
Increasing demand is another key factor driving change and expansion in the CEE
electricity sectors, and naturally needs to be taken into account in any future
modeling of systems, particularly of generation.

Figure 15: Growth forecast of electricity consumption in CEE 2009–2020

CEE 45%
Average 40%
35%
30%
25%
20%
15%
10%
5%
0%
Montenegro
Baltic
States

Bosnia

Bulgaria

Croatia

Republic

Hungary

Poland

Romania

Serbia
Czech

Macedonia

Slovakia

Slovenia
Source: UCTE, System Adequacy Forecast 2009–2020

Since 1993, the annual growth of electricity consumption per capita in the region
has been around 2.2 percent CAGR (compound annual growth rate), with
consumption finally reaching the 1990 level by 2005. According to the forecast,
this growth will now slow to about 1.7 percent CAGR, which is very close to the
Western European rate.

Do you consider the UCTE’s forecast average annual consumption growth


until 2020 as realistic?
The Hungarian representatives pointed out that the forecast national
consumption growth rate of 2.1 percent is not in line with their projections.
A decrease is expected in the immediate future, and afterwards the annual
change anticipated in the long-term strategic plan of MAVIR, according to two
separate scenarios (in the medium and long term) is anticipated to be either
0.5 percent or 1.5 percent.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
40 CEE electricity generation: forecast

3.1. UCTE forecast


Figures for future developments are based on the System Adequacy Forecast
2009–2020 prepared by the Union for the Co-ordination of Transmission of
Electricity (UCTE) and KPMG analysis regarding the Baltic countries and Albania.
This presents two scenarios (“Conservative” and “Best Estimate”) for the
development of the electricity sector. The Conservative Scenario takes into
account the commissioning of new power plants considered as certain and the
expected shutdown of power plants during the given time period. The Best
Estimate Scenario also contains future power plants where commissioning can
be considered as reasonably credible according to the information available to the
national TSOs. Additional information regarding EU regulations and data pertaining
to non-UCTE member states has also been examined in order to ensure a
comprehensive review of the evolution of the regional generation mix.

According to the Best Estimate Scenario, the CEE generation capacity mix will
develop significantly by 2020, with total regional capacity reaching 163.3 GW, and
an average system load at 97.3 GW.

Renewable energy together with nuclear sources and new gas-fired power plants
will form the primary focus of sector development.

Figure 16: CEE generation capacity forecast, 2020

 Nuclear 180

 Coal 160

 Oil 140
 23%  25%  22%
 Natural Gas 120
 1%  2%  2%
 Mixed/Other 100  2%  6%  7%
GW

Fossil Fuel 80  6%  3%  3%
 Wind 60  9%  13%  17%
 Other 40  1%  1%  1%
Renewable  49%  39%  38%
20
 Hydro  10%  12%  11%
0
2009 2020/Conservative 2020/Best Estimate
Scenario Scenario

Source: UCTE, System Adequacy Forecast 2009–2020, KPMG analysis regarding the Baltic countries
and Albania

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
CEE electricity generation: forecast 41

However there is a significant difference between the Conservative and Best


Estimate Scenarios. Based on the assumptions of the Best Estimate Scenario
and KPMG analysis the installed capacity is estimated to be 34 GW higher than in
the case of the Conservative Scenario. In the case of the Best Estimate Scenario
the ratio of coal-fired capacities is expected to shrink to 38 percent of the total.
The proportion of renewables will increase to 31 percent, with the continuing
dominance of hydro representing above 22 percent of the total. The proportion of
gas-fired plants, expected to account for 13–17 percent in 2020, is expected to
largely replace defunct coal-fired capacity.

In order to identify the investment possibilities for each kind of fuel, generation
sources will be outlined separately in the following section.

Coal
Currently, coal generation accounts for 48 percent of total electricity generation in
the CEE region. It also plays an important role in the security of supply, as the
resources are local. However, since coal-based generation produces high levels of
CO2 emissions, it is not favored by the European Union. Nonetheless, in the long
term, the emergence of “clean” coal generation technology is expected to boost
the attractiveness of coal as a primary fuel.

Several CEE countries hold significant coal reserves, including Poland, Bulgaria,
Hungary, the Czech Republic, Romania and also Kosovo.

A number of new coal and lignite-based generation units are also planned in
Albania, Bosnia, Bulgaria, Croatia, Macedonia, Montenegro, Romania, Kosovo and
the Baltic countries. Meanwhile Poland, Slovakia and the Czech Republic will
decrease their coal-fired capacity. In Hungary, and most of the CEE countries, the
future of coal depends on the development of the European Union’s Emission
Trading Scheme (ETS) after 2013.

Generally, the share of coal in total generation capacity is expected to dip below
40 percent according to both scenarios. However, in absolute terms, there is a
significant difference between the two, as in the Best Estimate Scenario, the
total coal generation capacity will be increased by 750 MW, while conservative
estimations suggest a decrease of more than 10 GW.

What are the current trends in coal-fired capacity expansion?


After falling out of favor in recent years, coal-fired power plants are once again
under construction (or at least being considered) in many countries, primarily due
to the relative abundance of domestic reserves and despite public objections.
The future, however, will depend, among other factors, on the new European
Trading Scheme for CO2, the price of CO2 and permit processes.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
42 CEE electricity generation: forecast

The carbon capture and storage (CCS) question would appear to be of crucial
importance, and if successfully developed could well boost the opportunities for
future coal-fired plant. Yet one respondent indicated that the development of this
technology is highly questionable in the near term.

Renewable generation
Renewable energy is a focus of attention for future investment and development,
as it is a strategic energy source due to EU regulations, growing environmental
concerns and the desire to reduce dependence on imported energy.
The renewable energy targets of individual countries have generally been set in
line with their potential resources.

The level of development in the renewable sector varies across the region.
Significant proportions of electricity generation in Bosnia and Herzegovina,
Croatia, Montenegro, Latvia and Albania is based on renewable sources,
principally hydro, its share being over 50 percent in these countries’ installed
capacities. In contrast, in countries such as Czech Republic, Hungary, Poland and
Estonia, which all lack cheap hydro resources, the share of renewables is below
20 percent.

Figure 17: Share of renewables in final consumption of energy

25%
40% 16.6%
31.4%
 EU member CEE countries EE

 EU member candidate LV 23%


CEE countries 14.6%

 EU member potential candidate LT

CEE countries
15%
Target for share of energy from PL
7.5%
renewable sources in gross final
consumption of energy, 2020 13%
6.4%
CZ 14%
Share of energy from renewable 6.8%
sources in gross final consumption SK

of energy, 2006 13%


5.1% 24%
HU 17.1%
SI
HR RO
25%
Non-EU member Balkan 15.6%
countries have no targets BA
RS
16%
yet, but have high share of 9%
ME BG
hydro electricity. KO

MK
AL

Source: DIRECTIVE 2009/28/EC on the promotion of the use of energy from renewable sources

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firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
CEE electricity generation: forecast 43

According to the UCTE’s Best Estimate Scenario, the share of renewables in


total generation capacity will reach 31 percent, i.e., 50 GW, by 2020.

Wind-generation is expected to advance significantly, with capacity in the region


increasing more than six-fold to some 12 GW by the end of the forecast period.
Indeed, almost every CEE state is going forward with wind energy plans, with
Poland, Romania, Estonia and Albania at the forefront.

Nonetheless, the realization of these investments is highly dependent on the


availability of finance and the system-balancing ability of the national
transmission systems. As exceptions, Montenegro and Serbia have no wind
generation plans in the forecast period, focusing instead mostly on hydro
schemes.

Across the region, hydro capacity is expected to increase to some 35 GW, 20


percent up on current levels, with Montenegro, Macedonia, Romania, Slovenia
and Albania leading developments. Of the countries studied, Estonia is the sole
exception in not planning any new hydro capacity.

How attractive are renewable energy investments?


Even without the financial crisis, there were already growing concerns about the
economic viability of EU targets, both in Western and Eastern Europe.
Renewable energy generation also involves certain time-consuming permitting
procedures. Therefore, the reality is that some countries might not reach their
goals – despite striving to do so.

Interestingly, the financial crisis arguably hit energy investments in Western


Europe harder than in the east, due to the large number of ongoing projects
(many of which are now delayed due to lack of funds). On the other hand, in the
CEE countries, similar projects had just been started, and there is still a long way
to go until most feasible projects get off the ground. Hence in CEE the focus of
attention should be on the regulatory frameworks, the licensing regimes and
getting projects going, rather than merely on the lack of financing. Indeed, the
EBRD pointed out that there is more finance available than actual projects
underway. A Siemens representative concurred, adding that given the right
policy incentives, renewable projects were often easier to finance as the
presence of political support and subsidies clinched the case for investors.

Not all agree, however. A representative of OTP, the Hungarian-based bank, said
that bank was skeptical of renewables both pre- and post-crisis. OTP pointed to
the vital influence of favorable regulations and subsidies, noting that the
modification of the Hungarian feed-in tariff system was a development which
could boost the future appeal of renewable projects. In Romania, where

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
44 CEE electricity generation: forecast

legislation is in force that promotes renewables, there are numerous projects in


these sectors. MKB Bank is one that anticipates a change for the better in this
field, and plans on expanding its renewable portfolio.

What are the most significant technical constraints that hamper the
expansion of renewable technologies and threaten compliance with the
renewable energy target?
Many respondents insisted that favorable financial and regulatory measures are
indispensable for widespread promotion of renewables, including, for example,
the feed-in tariff. However such incentives also introduce certain technical and
commercial challenges to electricity systems. Monitoring plants generating
power under this tariff arrangement poses difficulties for the TSO, especially
related to balancing. For example there may be surplus electricity generated,
during periods of low demand. This in turn causes prices to fall, and reduced
loads at larger plants which do not benefit from the tariff system. All of which
causes disturbances in the market which must be properly managed, both
technically and commercially.

One solution is to build more balancing power plants. For example, the Siemens
representative mentioned that the company currently sees more than 3–4 GW of
renewable power plants in development, which will of necessity be accompanied
by a similar amount of stand-by generation, most likely CCGT. This is a new
challenge, as currently system balancing capacity is primarily a function of
fluctuations in consumer demand, and back-up for the largest generation units.
Hence the spread of renewable technologies is a new factor for system
designers to grapple with in coming years.

In response to this challenge, the representative of the Hungarian TSO


suggested that the system operator should be granted more direct control over
subsidized plants. For example, in the case of wind plant, due to the volatility
and simultaneity of generation, the volume of production permitted should
depend on whether the TSO is able to directly influence generation. Without a
central solution, investments will become more costly as some form of remote
control with an accompanying IT system must be implemented individually for
each unit.

The biggest issue in respect to the preparation of such common regulation


(setting aside political dealings) is the fact that the plants affected are diverse and
usually quite small, but must be controlled uniformly. One possible remedy to
this would be grouping these plants, either on a geographic basis, or according to
generation type, and creating one sizeable “virtual plant” comprising each group,
which could in turn be operated more effectively.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
CEE electricity generation: forecast 45

Nuclear generation
Nuclear is a priority issue, due to the EU regulations on CO2 emissions,
competitive pricing and security of supply.

Seven CEE countries currently run nuclear plants, viz. Bulgaria, the Czech
Republic, Hungary, Lithuania, Romania, Slovakia and Slovenia (which operates a
nuclear plant together with Croatia).

Table 2: Nuclear electricity generation

Nuclear electricity Capacity


generation, 2007 Apr 2009
TWh % No. MW
Bulgaria 13.7 32 2 1,906
Czech Republic 24.6 30.3 6 3,472
Hungary 13.9 37 4 1,826
Lithuania* 9.1 64.4 1 1,185
Romania 7.1 13 2 1,310
Slovakia 14.2 54 4 1,688
Slovenia/Croatia** 5.4 42 1 696

* The Lithuanian reactor was decommissioned in December 2009


** Slovenia and Croatia jointly operate Krsko NPP.

Source: Reactor data: WNA to 1/5/09, IAEA- for nuclear electricity production & percentage of electricity
(% e) 5/08., WNA: Global Nuclear Fuel Market (reference scenario) – for U, IEA

In recent years, Bulgaria, Slovakia and Lithuania have been forced to close a
number of nuclear generation units on safety grounds.

According to the World Nuclear Association, currently Slovakia is building two


reactors, with a total capacity of 840 MW, another two are planned in Bulgaria
(total capacity 1,900 MW) and two more in Romania (total capacity 1,310 MW).

In addition, 14 more reactors have been proposed across the region, involving a
total capacity of about 21.5 GW.

According to the UCTE’s Best Estimate Scenario, nuclear generation capacity in


the region will grow by 42 percent by 2020 to total 17.4 GW. And as an indication
of the optimistic outlook for the nuclear industry, the Conservative Scenario is
little different. It takes into account Slovenian and Lithuanian forecasts, and
predicts 2.1 GW less nuclear capacity in total.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
46 CEE electricity generation: forecast

What are the current trends in nuclear capacity expansion?


Two respondents remarked that nuclear generation might be seeing a comeback.
New nuclear projects are underway or being considered in the Czech Republic,
Lithuania, Poland, Romania, and Bulgaria, and are being studied in Hungary and
Slovenia. With the exception of a nuclear power plant extension initiated by CEZ,
however, none of the projects in the region are showing substantive progress.
The volume of investment involved, the socio-political implications and the
extremely long commissioning period all mean that nuclear facilities are a long-
term prospect, when they will surely be a significant factor.

Nuclear plants also create system balancing issues, although this is far from
insoluble. In France, for instance, where nuclear generation is substantial,
negative balancing is technically feasible and therefore available.

Natural gas
Natural gas generation currently represents only 9 percent of total capacity in the
region, although in Latvia and Hungary gas makes up more than 30 percent of
total capacity, and Croatia, Lithuania and Romania also have significant gas-fired
plant infrastructure.

Further development of gas-based generation is expected due to its high


efficiency, the short lead times for new plant, low capital expenditure, and low
CO2 emissions. Moreover, development of natural gas usage in electricity
generation might be advanced by the realization of new supply routes to Europe,
such as Nabucco, Blue Stream and Nord Stream.

According to the estimates of national TSOs, gas-fired capacity in the region will
jump to 28 GW, i.e., 2.5 times current levels in the Best Estimate Scenario.

Poland leads the CEE “dash for gas”, with around 8 GW of new capacity to be
installed by 2020 (primarily as an alternative to coal). Hungary and Croatia plan a
total of 1.4 GW of new plant, while Macedonia, currently dependent only on coal,
oil and hydro, is mulling up to 500 MW.

With these and other developments, the total share of gas capacity in CEE is
forecast to rise to 17 percent of the total by 2020.

What are the current trends in gas-fired capacity expansion?


The majority of projects in recent years have been Combined Cycle Gas Turbine
(CCGT) plants built by large utility companies, although small cogeneration units
(for heat and power) have also become popular, both for district heating and
industrial projects. Again, the attractions of gas – the low CO2 emissions, high
efficiency (especially for small cogeneration units) and short commissioning

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
CEE electricity generation: forecast 47

times – underpin the popularity of gas. On the other hand, Russia is the primary
fuel source, which raises questions about the security of supply.

3.1.1. Analysis of the UCTE Scenarios for CEE countries


According to the UCTE’s Conservative Scenario, the total capacity in the CEE
region will grow by only 3.4 percent in the next decade, hitting 130 GW by 2020,
with some differences in the proportions of primary energy sources.

Figure 18: CEE Generation capacity change from 2009 to 2020

 Other Fossil Fuels


 Nuclear
 Coal B

 Natural Gas CEE


 Renewables
 Hydro
A

-20 -10 0 10 20 30 40 50
GW

Note: A – Conservative Scenario; B – Best Estimate Scenario

Source: UCTE, System Adequacy Forecast 2009–2020

Overall, both scenarios forecast similar trends regarding capacity development,


with nuclear, gas, wind, and hydro capacities presenting the best opportunities
for investment. A moderate decrease is foreseeable in the use of oil and other
fossil fuel-fueled capacity, although in the case of coal the outlook is more
difficult to predict.

How accurate are the forecast figures in the UCTE System Adequacy
Forecast 2009–2020?
Most respondents indicated that some of the forecast figures were not entirely
consistent with their own projections. Firstly, the economic crisis might affect the
implementation and the timing of implementation of the project plans that have
been incorporated in the Best Estimate Scenario, while the crisis might act as an
incentive for taking old, inefficient power plants out of service that cannot compete
effectively in the current situation (with low demand and cheap imports). Two
strategic options can be considered for ageing units: utilities might wait for demand
to recover to a competitive, or they might invest in replacement plant. The biggest
challenge appears to be finding investors for such a long pay-back period. Other
issues include who will provide the replacement units (the current utility companies
or new investors) and which type of generation to choose.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
48 CEE electricity generation: forecast

Respondents agreed that the Best Estimate Scenario is questionable, and


indicated that although ensuring security of supply needed substantial
investment, the projects already in place or in the planning phase (and thus
included in the Conservative Scenario) would probably be adequate to cover
future demand.

Respondents expressed strong doubts regarding greenfield investment


predictions and meeting renewable targets. The representative of the Czech TSO
also mentioned that the UCTE forecasts were based on earlier studies that had
not considered the advances in photovoltaic technology and only counted on
conservative development of wind power generators. Although several wind park
projects have been postponed or cancelled due to either the financial crisis or
local public opposition, some of these projects had been replaced by a boom in
photovoltaic installations. Indeed, in the Czech Republic some 55 MW of new
photovoltaic capacity was installed in 2009.

Note: A – Conservative Scenario; B – Best Estimate Scenario


Source: UCTE, System Adequacy Forecast 2009–2020

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Figure 19: CEE Generation capacity change from 2009 to 2020 (GW)

EE
2009 2020
2.47 4.06

LV
2009 2020
2.18 3.81

LT EE

2009 2020
4.65 5.51
LV

PL
2009 2020
LT
33.25 38.98

CZ
2009 2020
15.85 16.85
PL

SK
2009 2020
6.73 8.30 CZ

SK
HU
2009 2020
8.83 11.12 HU

SI RO
RO
2009 2020
HR
16.68 23.15
BA
RS

SI
2009 2020 BG
ME
3.04 6.52
AL MK

HR
2009 2020
4.00 6.10

BA
2009 2020
3.74 6.22

RS
2009 2020
8.31 9.88

Legend
ME
2009 2020  Nuclear
0.85 1.82  Coal
 Oil
AL  Natural Gas
2009 2020
1.50 4.10  Mixed/Other Fossil Fuel
 Wind
MK  Other Renewable
2009 2020
 Hydro
1.45 3.19

BG AL Total installed capacity


2009 2020
2009 2020 in 2009 and 2020
11.32 15.59 1.50 4.10
(Best Estimate)

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
50 CEE electricity generation: forecast

Assessment of both generation forecast scenarios by country


Balkan Countries
Albania plans major developments in its electricity generation sector. Overall
growth is predicted to be 170 percent, with installed capacity reaching 4.1 GW by
2020. New fuels will be introduced, such as coal, wind and other renewables,
which will help in diversifying the country’s generation mix.

Bosnia and Herzegovina is planning to introduce wind generation and


developing its coal-fired capacities

Bulgaria aims to meet its future electricity demand mainly with the help of new
nuclear, wind and hydro capacities (4 GW), accompanied by moderate
investments in coal.

The Croatian generation mix is already quite diversified; considerable


development is expected in gas-fired generation.

The increase in fossil fuels in Macedonia mainly comprises new gas-fired


capacity. Development of 1 GW of new hydro units is also planned, which would
raise the renewable share of the generation mix in the country to 46 percent.

The generation mix of Montenegro is based on just hydro and coal, both of
which will form the basis for new projects, with no further diversification of
primary energy sources. Serbian development plans include investment in new
thermal plants. No renewable development is expected, and the share of
renewables is expected to decline to 29 percent.

The energy system of Kosovo is under severe strain, with peak demands well
above total capacity. Kosovo intends to build new lignite-fired capacity based on
domestically available resources.

Baltic states
In Lithuania, the existing nuclear facility has been decommissioned by the end
of 2009, which will create capacity and a need for imported electricity. However,
the Best Estimate Scenario suggests that 1 GW of new nuclear generation will
be built by 2020.

In Estonia the development of 1 GW of new wind capacity is forecast, which


may be too optimistic. New gas and wind capacity will be developed in Latvia in
order to meet growing demand.

Central Europe
The Czech Republic is focusing on replacing coal-fired plant with gas and wind
capacity.

Hungary’s future generation mix implies investment into further gas units totaling
1.4 GW and a large hydro facility of 1.2 GW. KPMG assesses this unrealistic as there
are no concrete information available on the initiation of such hydro investments, and
as these developments take several years of planning and construction it is doubtful
that significant capacities would be deployed until 2020.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
CEE electricity generation: forecast 51

Controversial forecasts have been made for Poland, where owing to EU


environmental regulations, some major coal-based generation facilities may have
to be closed. Poland will probably be able to replace some of the existing coal
plant by investing heavily into gas-fired units. Further development of wind
generation can also be viewed as a promising investment prospect.

Romania’s plans lie predominantly in developing its existing nuclear and hydro
generation capacities. In Slovakia, new nuclear generation facilities and a
reduction in coal generation are expected. Slovenia is also planning to invest in
new nuclear capacities.

Overall, opportunities in the region vary according to existing plant, know-how


and available resources in each country. According to the UCTE forecasts,
certain countries will experience shortages in capacities even if all plans are
fulfilled. These countries will need to import electricity in order to meet rising
demand.

In particular, both Poland and Macedonia are likely to suffer from capacity
shortages which, in case of the Conservative Scenario, amount to a peak load 21
percent higher than the generation capacities by 2020 in both countries. Similarly,
in Bosnia and Herzegovina, the Czech Republic, Hungary and Serbia, the increase
in electricity demand is expected to be higher than the development of
generation capacities. These countries should therefore be given special attention
when assessing investment opportunities.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Financing investments in the energy and power sectors 53

4. Financing investments in
the energy and power sectors
Energy industry investments, be they in generation, transmission or distribution,
require a large amount of money and generally entail moderate risks. Such
projects are considered long-term investments associated with mid- and long-
term payback periods. However, even in a stagnating economic environment
energy sector investments can prove worthwhile, as infrastructure is aging and
efficiency improvements are continually being made. Hence new investment can
both increase corporate profitability and reduce environmental damage.

According to KPMG estimates, industry statistics and respondents’ opinions, the


financing of energy sector development projects has changed considerably due to
the economic crisis. The following sections analyze the challenges of the new
environment for energy sector investment financing in the CEE region.

4.1. Conditions of the current financial crisis

The current financial and economic crisis was triggered by the collapse of the US
mortgage-backed securities market in 2007; however, it later escalated into a
global financial crisis with significant impact on the global economy, including the
energy sectors and the CEE region.

In the period 2002–2007, world economies experienced significant and almost


continuous GDP growth, which in the emerging countries, such as China, India
and the CEE region, was higher than in the developed world. The CEE region in
particular relied on large inflows of foreign direct investment (FDI) from
multinational companies to create significant industrial production capacities.

This process began from the mid-1990s, as the implementation of political and
economic reforms created favorable market conditions. An increasing portion of
the FDI flowed into the electricity, gas and water sectors also benefited from
this trend, and the share of FDI in these sectors rose from 18 percent in 1995 to
27 percent in 2006.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
54 Financing investments in the energy and power sectors

Figure 20: FDI Inflows in CEE

80,000
70,000
60,000

USD million
50,000
40,000
30,000
20,000
10,000
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: UN, World Investment Report, 2008

Due to the liberalization, integration and globalization of financial and capital


markets, incomes generated mainly by the export of multinational companies
have been transferred to the capital markets of the developed countries,
financing further investments and consumption. But low base rates, high levels
of liquid capital and decreasing yields led to a persistent rise in risk taking and
high financial leverage.

New financial instruments such as the Collateralized Debt Obligation (CDO)


became common on the financial markets, providing the illusion of well-managed
financial risks, and resulting in financial institutions retaining highly-leveraged
positions.

4.2. Effects of the crisis on the economy and energy sector

The economic downturn can be seen as a major restructuring of the risk


assessment of market participants. Investors came to terms with the misleading
low-risk perception of the sophisticated financial products and thus intended to
get rid of those as soon as possible. This generated a massive wave of global
sell-offs, bankruptcies and liquidations.

Banks moved to modify their highly-leveraged positions, and therefore credit


conditions became stricter and interest levels increased, entailing negative
consequences for the real economy. A lack of financial liquidity, the credit crunch,
and a growing number of bad loans has affected all segments of the global
economy. Market players took the following steps in the face of the new
challenges:

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Financing investments in the energy and power sectors 55

• Introduction of cost reduction programs


• Revision of next years’ budgets
• Implementation of tightened cost management
• Hiring freeze
• Investment freeze
• Reduction in production capacities

In addition, the lack of financial liquidity caused a reduction in consumption that


further worsened the situation, leading to diminished production levels, unutilized
capacities and the shutdown of production sites, ultimately resulting in an
increase in global unemployment.

4.2.1. Effects of the financial crisis on the CEE economy


The financial crisis also hit the CEE region, since most of the CEE economies
were built on FDI, foreign borrowing and additional funds from the European
Union. Governments borrowed massively to finance the modernization of their
industries, service and public sectors, with the aim of producing lower-cost
industrial goods, commodities and to increase domestic social well-being.

The reduced demand accompanying the financial crisis afflicted the highly-
leveraged state budgets and industrial plants in Central and Eastern Europe.

In addition to the difficulties in the industrial sector, in some countries consumers


were encouraged to borrow money for housing and consumer durables in euro
and other foreign currencies at low interest rates. Therefore, when the financial
crisis hit Europe, indebted borrowers were devastated by the collapse of their
national currencies and increasing interest rates. The financial crisis led to a
housing crisis in several CEE countries such as Hungary, Bulgaria and Romania,
resulting in a high level of non-performing assets on banks’ balance sheets.

4.2.2. Effects of the financial crisis on the electricity sector


The crisis has hit the power sector less than others, since electricity is a
necessity good that is less dependent on income than many consumer items.
However, the decrease in industrial production and overall residential
cautiousness regarding energy consumption has resulted in falling electricity
demand. As shown in Figure 21, monthly electricity consumption in the region
has been lower than the previous year’s since October 2008, and the average
year-on-year decrease between October 2008 and September 2009 was
5 percent.

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56 Financing investments in the energy and power sectors

Figure 21: Monthly electricity consumption in the CEE region

 2007 46 000 8%

 2008 44000 6%
4%
 2009 42000

P erc entage c hange


2%
40000


 2008/2007 0%

GWh
3 8 000


 2009/2008 -2%
3 6 000
-4%
3 4000
-6 %
3 2000
-8 %
3 0000 -10%
28 000 -12%
26 000 -14%
J an Feb M ar Apr M ay J une J uly Aug S ept Oc t N ov D ec

Source: UCTE

How does the current economic crisis affect electricity consumption?


Until late 2008 electricity consumption had shown a stable growth rate in the
CEE region. TSOs agree that the current decrease in consumption is mainly
caused by the global economic and financial crisis. According to the Hungarian
and Czech TSOs the decrease is mainly due to reduced consumption by large
industrial consumers, with only a marginal decline in the residential sector.

It should also be noted that the monthly consumption data presented in Figure 21
shows gross electricity consumption which includes self consumption of the
generation units, plus network losses. Total self consumption depends significantly
on the generation mix of the country and the age of power plants. (Self consumption
of old, inefficient plants is high, so any decrease in the use of such plants affects the
final figures disproportionally more than switching out an efficient unit.).

The decreasing demand has resulted in a modified supply-demand equilibrium,


followed by lower electricity prices. The spot price of the Prague Electricity
Exchange presented in Figure 22 is a good indicator of electricity price trends in
the region. The Prague Energy Exchange (PXE) showed a significant decline in
January 2009 and spot electricity prices were under the 2008 level throughout
the year. However, it should also be kept in mind that the majority of electricity
trading happens on the OTC market in the CEE countries.

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Financing investments in the energy and power sectors 57

Figure 22: Czech electricity spot price development on PXE

Peak load 120

Base load 100

80

EUR/MWh
60

40

20

2009.07.04
2008.06.04

2008.07.04

2008.08.04

2008.09.04

2008.10.04

2008.11.04

2008.12.04

2009.01.04

2009.02.04

2009.03.04

2009.04.04

2009.05.04

2009.06.04

2009.08.04

2009.09.04
Source: Prague Energy Exchange

Falling electricity prices have a major effect on the profitability of the electricity
industry, which in turn throws into question the viability of several planned and
on-going investment projects. Furthermore, decreasing prices have resulted in a
worsening credit outlook for major European utilities.

What are the main effects of the financial crisis on the Transmission System
Operators in the CEE region?
The extensive investment costs of TSOs are mainly financed from external
sources, especially bank loans.

Due to the economic crisis, the costs of these loans have increased significantly,
which in turn reduces the profitability of TSOs.

Furthermore the credit ratings of CEE countries have significantly worsened,


which affects the state-owned TSOs’ ability to access loans.

The Czech TSO respondent emphasized this point, saying that currently the high
interest rates make financing the modernization of existing infrastructure more
difficult and expensive.

The Hungarian TSO representative also mentioned that the lower electricity
consumption means reduced revenues for TSOs. In general, the costs of system
operation services are built in the tariff prices proportionately to the estimated
annual electricity consumption. Since the tariff levels defined for 2009 were
calculated based on a higher electricity consumption level therefore the revenue
realized by the TSO does not cover the system operation costs, which must be
compensated in next year’s tariffs.

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58 Financing investments in the energy and power sectors

4.3. Effects of the financial crisis on financing conditions

4.3.1. Introduction of the main financing structures


Financing has always been one of the most difficult and most complex exercises
of the project realization process, since all stakeholders shall make their final
“go” decision considering the benefits they expect and the risks they are ready
to take in connection with the specific project.

The applied financing structure is always project specific and reflects the risk
bearing capability of the involved parties.

The utilization of equity is a straightforward choice for financing electricity


industry projects however in most cases; substantial external resources are also
required due to their extensive investment need.

Investors must pay careful attention to the utilization of own and external financial
sources when assessing the profitability of a planned investment, as high
leverage can increase the returns.

Joint ventures are frequently formed if the equity need of the project exceeds
the resource of a single project sponsor. In this structure the project sponsors
create a partnership for the financing of a specific project. The parties, known as
co-venturers, share costs, risks, and liabilities associated with raising funds for a
project. By participating in joint venture financing, the investors can spread risks,
minimize credit exposure, and often share in asset ownership. In the traditional

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Financing investments in the energy and power sectors 59

form of joint venture, each co-venturer raises its share of the funds on the basis
of its own direct credit and its ownership interest in project assets.

There are various types of financing structures used to raise external financing for
large infrastructure projects. However the two most commonly used ones are:
1. Traditional Corporate Lending (full recourse to the sponsor)
2. Project financing (non- or limited-recourse financing)

Traditional Corporate Lending (full recourse to the sponsor)


The main feature of this type of financing is that the financing is linked to the
project sponsors’ balance sheet and most of the risks are absorbed on the side
of the project sponsors. This means that if the project is delayed, stops or goes
bankrupt, the borrower must take the responsibility and meet all liabilities.

Banks typically provide different types of loans according to the specific


circumstances of the borrower. The main characteristics of bank loans are
amount, currency, maturity, interest rate and fees.

Project financing (non- or limited recourse financing)


Generally, project financing is used when sufficient conventional assets are not
available to secure the loan as collateral. Rather, the project itself is considered as
the main asset, and thus the lending bank executes a thorough examination of
the project plan, including key aspects such as market analysis, the business plan
and the expected cash flow. In addition, several covenants and conditional
obligations are required by the lending banks to secure the loans and they
continuously monitor the advancement of a project.

Syndicated project financing is often used and involves a large sum of funds lent
to a single borrower by a group of banks that teams up in an alliance to share the
risk of financing. The project is usually pursued in a separate special purpose
vehicle (SPV) created to execute the project and to be “bankruptcy remote” from
the project sponsors.

Many times the project financing in practice turns to limited recourse direction,
meaning that the sponsors give certain direct securities to lenders but those are
only for covering limited areas of risks (one typical example is project cost
overrun risk).

The main characteristics of project financing are amount, currency, maturity,


covenants, interest rate and fees.

Main considerations of financing from the banks’ perspective


The banks assess carefully the background of the project sponsors, especially of
the lead sponsor including their financial resources, technical knowledge, past
experience, etc. Furthermore the shareholder structure between the project
sponsors including their role in the management, their potential exit options and
their relationship are also examined in detail. The financing is usually priced based

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60 Financing investments in the energy and power sectors

on the risks involved in the project such as country risk, technology risk, licensing
risk, construction risks, off-take risk etc.

What are the types of preferred financing structures commonly used to


finance energy sector-related projects?
Respondents agreed that project financing is the most common form for
financing energy sector projects, since the cash flow generated through these
projects can be relatively well quantified and estimated. The experience and
credentials of project sponsors are also key factors to consider when opting for
this method of finance.

Lending is also substantial but it is mainly used when large international


companies or utilities finance several investment projects from the same pool of
credit. The amount of loans usually depends on the creditworthiness of the
investor and it is based on a deep and long-lasting relationship between the bank
and the borrower.

In general, most greenfield investments are implemented in project financing


form while modernization and retrofit projects are usually financed through
lending. Private equity and mezzanine financing are not commonly used in energy
sector investment projects. However, some banks (such as BNP Paribas) actively
use these financing forms, and focus on the fees that these smaller investment
deals can generate. The interviews also revealed that MKB Bank intends to apply
some non-conventional financing forms in energy sector financing such as
leasing or factoring.

Overall, survey respondents agreed that prior to the crisis it was relatively
easy to find financial resources for a well-structured energy sector investment,
while in the last year it has become more challenging due to tighter capital
resources.

How does the size of the investment influence the financing model applied?
Project financing is usually applied for medium or large deals, since small projects
are not able to finance the extra costs derived from project financing (such as
consultancy fees or the cost of permanent monitoring of the project). Large
investment projects are usually realized in a well-structured form, which includes
senior and junior tranches. Large transnational development banks, such as EIB
or EBRD, are typically also involved in such projects.

The thresholds mentioned by the banks participating in our survey differed


significantly: in the case of OTP, project financing is commonly used for projects
in a range of EUR 20–60 million or above, while BNP Paribas concentrates its
resources on deals that are over EUR 100 million.

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Financing investments in the energy and power sectors 61

The present financial and economic crisis has affected the willingness of banks
to take risk; therefore, syndicated financing currently starts at a lower level to
spread the risks among numerous banks. Documentation has become more
complex and the decision making and lead time of investments has lengthened.

It was also concluded that in the recent past the CEE region has only seen
limited refinancing or medium-sized investments, with no new large-scale power
plant investments taking place since the crisis hit. In Hungary, the largest deals in
the energy sector have been in connection with bio-fuel investments.

How do equipment suppliers participate in the financing of new generation


capacity development?
The study revealed that there are several practices regarding the financing of
energy projects. GE has a separate business unit within GE Capital which
provides financial services for the energy sector by seeking out financial
resources and viable projects. Siemens provides limited financing for projects' in
terms of giving loans, and additionally it does assist clients by advising them on
financing-related questions, e.g., by optimizing the involvement of Export Credit
Agencies and by facilitating investors’ involvement through their connections
with banks and lenders. Siemens also participates in several projects as an IPP
and helps to bring equity to the project and provide the technology. Siemens
intends to expand further in this business area, especially under the present
financial and economic circumstances, when the financing of such projects is
getting more difficult.

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62 Financing investments in the energy and power sectors

What are the preferences and priorities for banks regarding project financing
in different sectors and industries? What is the share of energy-related
projects in the portfolio of the banks surveyed?
Respondents identified real estate, automobile, energy, telecommunications and
pharmaceuticals sectors as the most common sectors to employ project financing
structures for development projects. The share of energy sector-related deals within
the project financing portfolio of the banks varied between 10–40 percent, depending
on the strategy of the particular bank. With the exception of the EBRD, banks
mentioned that prioritization among the different sectors has recently changed due to
the financial crisis. MKB’s strategy aims to shift its priorities from the construction,
automotive industry and real estate sectors (which had previously provided the
backbone of their project financing portfolio) to other sectors that were less impacted
by the crisis, such as energy and pharmaceuticals. For OTP the share of energy-
related projects was expected to decrease slightly from the level of 35–40 percent in
2009, as these projects are usually low risk, consequently their pricing and profitability
are lower compared to other sectors. Nevertheless, in the beginning of 2010 a
substantial shift in OTP's strategy resulted in considerable growth of energy sector
lending and financing. In contrast, the EBRD’s strategy, as a development bank,
differs from the commercial banks, and no industry preferences are specified, as
financial decisions are based on the principles of sound banking, additionality and
transition impact that can be achieved through the implementation of the project.

Are there any preferences for renewable energy among the different
investment projects?
The Equator principles provide a benchmark for financial institutions regarding the
management of the social and environmental issues encountered in project
finance. Among the interviewed banks, only BNP Paribas has adopted these
principles, although the others also have some policy on renewable energy
investment projects.

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Financing investments in the energy and power sectors 63

The EBRD places high priority on energy efficiency improvements and


sustainable energy projects, including renewables and projects which improve
energy security. Any project financed by the EBRD has to meet both local and
international environmental regulations, or even go beyond them and apply best
available techniques in order to score better in terms of transition impact.
Similarly, Bayerische Landesbank, the owner of MKB, also promotes the
importance of “clean energy”, which also includes efficiency improvement and
CO2 emissions-reducing projects.

OTP Bank has no specific priorities for renewables, and although it considers the
environmental impacts of a project during the evaluation process (it requires full
compliance with the applicable environmental rules and regulations), its financial
decisions are based solely on financial viability.

Despite the stated strategy of banks to support renewable projects, such


projects comprise less than 20 percent of the portfolios of respondent banks.
However, all agreed that there is huge potential in renewable energy, as the
growth rate in this sector is expected to be higher than the average in the region.
Furthermore, the feed-in tariff system provides good predictability and profitability
for investments, making such projects attractive for banks. Wind energy and
biogas were mentioned as the key development areas within the Hungarian
renewable market, but other innovative projects such as agricultural waste, pellet
or sewage mud, etc. also have potential.

4.3.2. Changes in the financing conditions of energy sector projects


Most banks present in the CEE region (with the principal exceptions of OTP in
Hungary, PKO in Poland and most banks in Slovenia) are majority owned by
institutions headquartered in Western Europe.

However, the majority of these banks had only insignificant direct investments in
such problematic financial innovations as the American CDOs. Therefore, they
were not directly impacted by the downturn of the American mortgage market
although they were heavily affected by the spill-over effect of the financial crisis.
In order to control the negative consequences of the crisis the following
measures were enacted:
• Restructuring and refinancing their problematic debts
• Providing fresh loans to the government, industry and consumers
• Cutting back operating costs and
• Accumulating a substantial amount of liquidity as a precautionary measure.

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64 Financing investments in the energy and power sectors

How have the financial requirements and the assessment of project plans
been modified due to the financial crisis? What are the minimum financial
requirements and prerequisites for an eligible project?
Respondents agreed that project financing has become considerably more
difficult during recent years. Prior to the crisis, commercial banks became very
liberal in the boom years in terms of financing requirements due to the extensive
amount of liquid and cheap financial resources available. As a consequence of
the crisis however, banks had to face deteriorating loan portfolios and a lack of
trust in the financial market, which eventually led to liquidity problems. Therefore,
the following changes occurred in the conditions and prerequisites for project
financing:
1) The expected ratio of own equity increased to 30 percent, compared to the
previous 10–15 percent levels. This has had a huge impact on, for example,
wind park projects, which in the past, had the most aggressive project
structures. But now, with the banks demanding higher equity ratios, project
sponsors have to demonstrate more trust and commitment towards projects.
Furthermore, government and EU subsidies are usually not included in own
equity (since these can suffer delay or cancellation), and thus the project has
to be profitable without these subsidies, although they can later be used for
early repayment.
2) The interest surcharge level has also drastically increased as a result of the
growing cost of bank funding. Depending on the currency, the interest rate
surcharge has jumped from 0.8 percent to 3.8–5.0 percent. However
resources in local currency have generally stayed relatively cheap compared to
credit in foreign currencies and long-term financial resources, which became
extremely expensive. Although the interest surcharge has increased
significantly, the lower base rates have to some extent compensated for this.
3) The one-time fees linked to project financing have also significantly increased,
typically from a level of 0.15 percent to 1–1.5 percent.
4) The Debt Service Coverage Ratio (DSCR) currently required from eligible
projects has risen from 1 percent to 1.2–1.25 percent.
5) The collaterals and covenants required from the project sponsors have
become more tough and more regular and thorough monitoring is conducted.
6) The fact that banks refuse to take currency risks and the borrower has to
possess incomes in foreign currency in the case of foreign debts is a further
disadvantage.
7) More attention is paid to the assessment of assumptions in a project plan
such as the contractual background, ownership structure, and cash-flow
projections.
8) Banks have also introduced some new indicators to assess the efficiency of
their internal operation, based on the risks and profitability associated with
different financial products.

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firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Financing investments in the energy and power sectors 65

The interviews conducted for this survey confirmed that most commercial banks
have had to make the aforementioned changes, which have all led to a more
tedious and time-consuming process, and often resulted in delays or even the
cancellation of projects. However, the new conditions for project financing have
proved to be a good filter, since only truly profitable projects pass the stricter
hurdles.

In the meantime the financing principles of the EBRD have not changed to this
extent since they followed a more conservative approach than the commercial
banks prior to the crisis as well.

4.3.3. Changes in project financing volumes


The impact of the financial crisis appears in recent project-financing trends.
Most particularly, the global project finance volume in Q1 2009 (USD 41 billion)
was barely half the average quarterly volume in 2007 and 2008 (USD 79 billion).
In the first half of 2009 the number of large projects valued at over USD 1 billion
reaching financial close also dropped significantly. However, the Q2 2009 data
shows some recovery, with volumes approaching previous levels, both in terms
of total project volume and number of deals*.

Figure 23: Recent trends in project financing

 Loan 140 250

 Bond 120
200

Number of deals
100
 Equity
150
USD bn

80


Number
of deals 60 100
40
50
20

0 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
2007 2008 2009

Source: Dealogic Global Project Finance Review – 1H 2009 – July 13, 2009

Figure 24 reveals that the CEE region, followed by Australia and Africa, suffered
the largest slump in project financing deals. The energy sector accounted for
40 percent of the total volume, reaching USD 45.4 billion, a significant decline
compared to the H1 2008 (USD 64 billion). However, in H1 2009, five of the
10 largest project finance deals were energy sector-related.

*Source: Dealogic Global Project Finance Review – H1 2009 – July 13, 2009

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firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
66 Financing investments in the energy and power sectors

Figure 24: Regional analysis of recent project-financing trends

-41% -85%

6%
-37%

24,667
43,390
3,700

20,635

36,000
13,000

33,962
25,600
Eastern Europe
North America

Western Europe Asia


39% -68%

21,300
15,324

40,000
-83%
Latin America/
% change

15,294
Caribbean

12,800
Project financing 2,600
H1 H1
2008 2009
volume in USD Middle East/Africa Australasia
million

Source: Dealogic Global Project Finance Review – 1H 2009 – 13 July 2009

What are the main reasons for the decline in project financing? What are the
main differences in concluding financing decisions in view of the present
economic climate?
All respondents agreed that project-financing trends reflect the effects of the
global economic and financial crisis. However, they are convinced that banks will
continue financing in the long term since it is their core activity, and inevitably the
energy sector needs significant financial resources.

There was a clear distinction between the new investment policies applied by
commercial banks compared to development banks, as while commercial banks
were suffering from a lack of available financial resources, EBRD global financing
volume has almost doubled last year. This is mainly due to the EBRD’s stated
mission, namely to provide financing for justifiable projects in times when
commercial banks can not do so.

However, the drop of project financing volume in CEE was nonetheless


proportionally deeper than in Western Europe, where the European Central Bank
provided cheap financial resources to revive the credit markets.

After the crisis struck most commercial banks in CEE faced serious liquidity
problems, mainly due to a lack of financial resources and the temporary reallocation

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Financing investments in the energy and power sectors 67

of limited assets to residential business lines where higher profitability was


achievable. However, respondents emphasized that their liquidity has significantly
improved in recent months, though due to the increased interest rates immediate
development is not anticipated in the volume of project financing.

A major setback in project financing volume was caused by the real estate
sector, where a price bubble collapsed worldwide. In the energy sector the
decline was not as serious as there had been no bubble and no urgent need for
new investments. Therefore, only minor delays were experienced in energy-
related projects, and if contracts had already been signed, delays are less likely
still since the licenses expire within a certain timeframe. Typically, generation
investment projects which have a feed-in tariff system were not affected by the
financial crisis to the extent experienced by other investments.

Respondents mentioned that the reduced demand for electricity came at a time
when many countries were reaching their capacity limits, reducing the urgency
for new investment. Indeed, the current situation provides time for decision
makers to rethink their long-term investment plans, potentially making them
more rational and efficient.

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firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
68 Financing investments in the energy and power sectors

4.4. Financing needs for electricity sector development in


the CEE region

4.4.1. Urgency of electricity sector development in the CEE region


Declining electricity demand coupled with falling electricity prices has
worsened the outlook for the power industry. The present investment
environment is not promising, although there is an extensive need for
refurbishment of old plant and for the deployment of new or modernized,
efficient generation capacity. These investments cannot be delayed since the
development of new capacity needs time-consuming licensing, permitting and
construction processes.

What are the general time constraints for generation capacity development
projects by generation type? What is the general ratio between the needs of
the preparation and construction phases?
Equipment suppliers emphasized that the time requirements for investments
depend on the type of generation selected and on the country in which the
project takes place, but as a rule of thumb the preparation and construction
phases are roughly of equal duration.

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Financing investments in the energy and power sectors 69

Nuclear power requires the longest lead times since there are numerous political
and social questions to be addressed before it can get to the construction phase.
In a best case scenario, if a very well-developed nuclear program started today, it
would take 10 years before power could be fed into the grid. The split between
the planning (pre-selection, licensing and political issues, legislation) and the
construction phases for nuclear plant is typically around 40:60. According to GE,
the process, from breaking ground to first fuel takes 39 months, followed by
another 23 months before final commissioning, though GE has on occasion
completed the whole process within 49 months.

Coal-fired power plant projects are also difficult in terms of obtaining permits and
licenses. However, the length of the construction phase, depending on the
complexity of the project, is typically around 36 months.

The development of gas-fired power plant projects is slightly easier from the
licensing and permitting point of view, while construction time is significantly
shorter, usually taking 24–28 months.

In the case of wind power, measurements to show that a site is suitable for
wind generation purposes take at least one year. The time needed for
licensing depends on the country’s regulations, which varies within the CEE
region from 12 months to 2–3 years. Construction time is highly dependent
on market demand and the installation capacities of the suppliers, but in
general, wind power plants have a construction cycle taking less than six
months.

4.4.2. Capital expenditure costs of electricity sector development in


the CEE region
The capital expenditure costs of power plant investments, according to the
latest study of the Royal Bank of Scotland, vary between EUR 800 – EUR
5,000/MW depending on the generation system employed. Currently, CCGT
technology and coal-fired thermal power plants have the lowest CAPEX cost,
while solar and nuclear–based plant are the most expensive. In November
2008, the Commission of European Communities published a communique on
capital investment costs and generation costs (SEC(2008) 2872). The ranges
indicated by the report covered the cost levels published by RBS, except in the
case of nuclear fission generation, which was priced at a significantly lower
level of EUR 2,700/kW.

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70 Financing investments in the energy and power sectors

Table 3: Estimated investment needs for additional capacity development in


the CEE region by 20206

Conservative Scenario – Best Estimate Scenario –


Capex Investment need of Investment need of
GW additional capacities additional capacities
EUR/kW
GW Million EUR GW Million EUR
Nuclear 3,600* 4.2 15,286 5.3 19,246

Lignite 1,725** 3.1 5,426 4.6 7,945

Hard Coal 1,400* 0.7 977 0.9 1,325

Gas 800* 5.0 4,009 15.8 12,655


Oil 800* 0 – 0 –
Mixed/Other
n/a 0 – 0 –
Fossil Fuel

Wind 1,400* 4.2 5,908 8.8 12,387

Solar 5,000* 0.2 1,000 0.3 1,550

Other
n/a 0.6 – 0.7 –
Renewable

Other Hydro 2,500** 2.5 6,265 5.2 13,065

Run-of-River
2,500** 0.5 1,194 0.9 2,187
Hydro

Total 21.1 40,064 42.7 70,360

* Royal Bank of Scotland – Equity and Debt Market Perspectives on Nuclear Investments

** Nuclear Energy Agency – Projected costs of generating electricity

Source: KPMG analysis based on UCTE System Adequacy forecast and presentation of the RBS –
Equity and Debt Market Perspectives on Nuclear Investment

Are the CAPEX costs presented in Table 3 realistic? Have the CAPEX costs
changed significantly following the financial crisis?
In the last three years a significant increase of CAPEX costs has been
experienced, mainly due to the large number of power plant projects and
extensive steel consumption of China. The prices provided by RBS indicate the
price levels for 2008.

According to Siemens, market prices have been decreasing recently but it would
be hard to predict at what level they will stabilize. Most probably they will not
reach the lower price levels experienced four years ago, but they are anticipated
to be lower in the next 1–3 years than the prices in the table. Hopefully investors
who postponed projects due to economic and financial factors will not all return
to the market simultaneously because that would result in high CAPEX prices, as
has happened in the past. Thus customers are highly recommended to take
advantage of low asset prices and buy equipment before other players return to
the market and push up prices.

6 The table above only shows the investment costs of additional generation capacity investments and
does not contain information about the estimated costs of replacing inefficient and the
decommissioned power plants.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Financing investments in the energy and power sectors 71

Table 4: Capital expenditure costs by Generation Type

Capex EUR/kW

Nuclear III+ 3,500–4,500


CCGT 766
Lignite 2,074
Offshore wind 1,400
Solar CSP 4,500
Solar PV 5,700
Biomass 2,700
Hydro 2,000

Source: GE Energy

The CAPEX costs provided by General Electric are fairly similar to the investment
costs published by RBS, although GE has higher costs for lignite-fired plant, while
hydro power is priced considerably lower. The variations are due to differences in
equipment and the characteristics of the location (especially in case of hydro
power generation).

Have the equipment suppliers changed their supply or sales strategies due
to the global financial crisis?
As a consequence of the financial crisis some suppliers have become more
flexible and willing to adjust their services more to clients’ needs. However, no
substantial changes have been noted in the sales strategies of either Siemens or
GE since both provided a wide range of services prior to the crisis. Siemens
mentioned that, depending on the market situation and customer needs, the
company is willing to participate in product delivery and turn-key projects.
In the midst of the current economic turmoil, GE is busy helping clients to
develop their future strategies by assessing the market, available technologies
and future trends. GE has also made considerable efforts helping costumers
to develop financing structures for projects and enhancing reliability among
market players.

Are the present capacities of equipment suppliers sufficient to fulfill the


extensive demands presented in the forecast? What are the planned
capacity improvements?
According to respondents interviewed, suppliers to the power sector have
sufficient capacity to fulfill the new generation needs as presented in the Best
Estimate Scenario. The 42 GW mentioned in the forecast equates to
approximately 4 GW per annum, which would normally be shared among three
major suppliers of hardware. While the suppliers should be capable of meeting
such orders, they admit that if all regions revive simultaneously it could result in
longer delivery times and higher prices.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
72 Financing investments in the energy and power sectors

Nuclear power is a special case, since in the past 10–15 years no nuclear
development has taken place in the region. However GE has indicated that there
are many nuclear initiatives under consideration, and if just a few of these were
implemented simultaneously both the supply chain for materials and availability
of skilled manpower could soon be under stress. Siemens also pointed out that
in the area of renewable energy, equipment suppliers are currently facing delivery
problems due to increasing demand. As a result, Siemens has almost tripled its
production capacities of wind generation equipment over the last 2–3 years.

4.4.3. Total investment needs of the energy sector development program


in CEE
Taking into consideration the UCTE forecasts and the estimated CAPEX costs,
significant capital investments will be required to implement the electricity sector
development plans in Central and Eastern Europe by 2020. The additional
capacity requirement is estimated to be around 21 GW (according to the
Conservative Scenario), which represents about EUR 40 billion of total
investment. For the Best Estimate Scenario, more than 42 GW are required,
amounting to investments of more than EUR 70 billion.

In addition, the decommissioning and replacement of obsolete power plants will


also be required. Based on the analysis presented in the Infrastructure section of
this report, a total of 53 GW of generation plant (mainly coal, gas and oil fired)
over 30 years old should be replaced or retrofitted by 2020. The total investment
needs for replacement can be calculated based on a weighted average of
individual CAPEX costs and the Conservative Scenario of the UCTE System
Adequacy forecast. The estimated investment cost could reach EUR 74 billion by
2020, depending on the extent of substitution of old generation units.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Financing investments in the energy and power sectors 73

Table 5: Estimated investment replacement needs in the CEE region by 20207

Investment need Capex Total investment


GW
of replacements EUR/kW need (million)

Coal fired 42* 1,600** 67,200

Gas fired and mixed fossil fuel 7.5 800 6,000

Oil fired and mixed fossil fuel 3.5 800 2,800

Total replacement investment 53 76,000

* Based on KPMG assessment, coal fired power plants, taking into account several exceptions, will not
be obviously replaced with coal fired ones. In this respect, the future of the Kyoto Protocol and the
related European Union Emission Trading Scheme will be a decisive factor. Nevertheless, the foreseen
total investment cost of 67.2 billion for the replacement of coal with coal and other fuel types provides a
good basis for assessing the total average financing needs of generation capacities.

** Average CAPEX cost of lignite and hard coal

Source: KPMG analysis based on UCTE System Adequacy forecast and presentation of the RBS –
Equity and Debt Market Perspectives on Nuclear Investment

Based on an optimistic timeline the total replacement and new investment in the
region’s power plant infrastructure may result in a total financing of EUR 114–144
billion over the next decade.

Are there sufficient funds available in the banking system to meet the
sector’s extensive financing demand?
Based on market knowledge from banks participating in our survey,
the Conservative Scenario of the UCTE forecast seems more realizable.
The respondents all agree that the investment needs of the Best Estimate
Scenario are slightly overestimated and in the time of financial and economic
crisis priorities must be reviewed. Therefore, a realignment of resources and
needs is inevitable, resulting in a downward adjustment of required capacities.

Two banks, OTP and the EBRD do not believe that there will be sufficient
financial resources available in the region to fund the required investments.
However, this is not considered a real constraint, since Western European banks
would also participate in any deals, with a pricing level adjusted to country risk.
As discussed, the risk taking attitude of banks has changed due to the crisis and
they prefer more limited participation in projects.

Two banks, MKB and OTP, indicated that the biggest concern relating to the
realization of these investments is the lack of credible, committed project
sponsors and sufficient equity. Therefore, state participation in investments and
the development of robust regulatory frameworks will play an important role in
attracting financial resources to such projects.

7 The table presented above only shows the investment costs of additional generation capacity
investments and does not contain information about the estimated cost of replacing inefficient and
decommissioned power plants.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Conclusions and future prospects 75

5. Conclusions
and future prospects
5.1. Economic environment: crisis, consumption and recovery

The effects of the financial crisis on the present state and future development of
the CEE electricity sector are many and diverse: among the most significant, the
drop in consumption and the various changes in the terms of financing.

From other aspects however, much is unchanged. The temporary slowdown in


demand of certain industrial sectors or entire national economies cannot detract
from the fact that modern societies are based upon an abundant supply of
electricity. Whatever the effects of the crisis on the immediate future, electricity
developments cannot be postponed for long, especially considering that the lead-
times for these investments are particularly long.

What are the foreseeable effects of the crisis on electricity generation


development projects on a longer term basis (a period of 3–5–10 years)?
Respondents are in agreement that recovery is on the way. The representative
from Siemens is convinced that power plant sales will recover within a few years
out of necessity. The Hungarian TSO, while indicating that investment decisions
and timing do not belong to its responsibilities, highlighted its commitment to
development and its intention to reassure investors whose cooperation is vital.

A less favorable turn of events could theoretically come to pass with a further
downturn in the economy, resulting in populations having to give up current living
standards. However, this is considered unlikely, as CEE has the potential to drive
the production of multinational companies to a fast recovery. On the other hand,
electricity is likely to become more expensive, a difficult task for politicians to
explain to electorates. This is yet another reason for adjusting regulations and
government policies to counteract the adverse effects of the current economic
situation.

The GE respondent remarked that the market for energy infrastructure


developments was currently quite slow, and the only projects moving forward were
those with owners determined to complete the ventures regardless of the crisis.
However, it must be added that GE envisages more projects starting in 2010.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
76 Conclusions and future prospects

The promptness of any recovery depends on the timeframe required for the
industry to return to full production, according to respondents’ views. Steps
taken by decision makers everywhere significantly influence this time need –
while also having a lasting effect on the years following financial restoration.
The EBRD stressed that if the required investments are not made in time,
economies slow to react could face new problems in the future. Indeed, the
development of the energy sector should be understood as fundamental to the
future success of post-crisis economies.

Aging power plants combined with the necessity for capacity expansion to
provide for the needs of millions mean that finding solutions for renewal is
imperative. It is not likely that the downturn in consumption will continue in the
medium or long term. It is equally improbable that any rise in the price in
electricity, be it due to compensation for costs incurred complying with
environmental regulations or to any capacity shortage, will be capable of
substantially altering the expectations, wants and perceived needs of the region’s
population.

How long will the drop in electricity consumption last? Will it have a
permanent effect on the sector’s development needs?
The current downturn in electricity demand will not prove to be an enduring
trend, respondents say, and while many production sites have been shut due to
the crisis, in most cases this can be considered a temporary state of affairs.
Additionally, the decommissioning of power plants reaching the end of their life
span in itself necessitates steps to be taken for the development of the sector.
If environmental obligations and security of supply issues are also factored into
the situation, it becomes increasingly clear that the drop in consumption alone
should not impede the restructuring of the electricity sector.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Conclusions and future prospects 77

The share of electricity within total energy consumption is anticipated to increase


steadily in the medium and long terms. Therefore, all other factors remaining the
same, electricity consumption is still expected to increase steadily in the future,
although this future growth is forecast to be somewhat lower than that
experienced in the last 15 years. True, energy efficiency is predicted to increase:
however, with the proliferation of environmentally-conscious consumer
appliances and industrial developments this will still mean a growth in total
electricity consumption for the future.

5.2. Financing in the future

In view of the course of expected economic trends and the steady increase in
household consumption, the development of the electricity sector can be
considered indispensable. However, the issue of financing these investments in an
altered economic climate remains an open question. Financial institutions and large-
scale investors, reeling from the setbacks of the crisis, have adjusted not only their
expectations, but also their affinity to risk and exposure. Yet decision makers cannot
deliberate for long, as the restoration of a sustainable level of financing is strongly
dependent on timely reactions, dedication and competence on their part.

Can it be anticipated that the financing of large infrastructure investments


will return to the pre-crisis level? How much time will this recovery take and
what are the main factors affecting it?
Respondents agreed that prospects were currently encouraging. The shortage in
financing is seen as temporary, ending as soon as within 12 months (according to
BNP Paribas), although the time and degree of this recovery will depend on various
factors, including the confidence of market players and the commitment of decision
makers.

Recent circumstances have resulted in a slowdown of the evaluation processes


related to financing, a trend which is anticipated to reverse in the near future.
This is inevitable, says OTP Bank, as a lasting scarcity of investment financing
hampers production and economic growth – which is not sustainable in the long
term. Therefore, governments and national financial institutions are under
pressure to take steps to improve conditions. Consequently, infrastructure
investment will be among the fields that receive substantial volumes of financing
(due also to characteristic risks that are easier to monitor).

Energy sector developments should have the highest priority among these
preferred developments. The sector has not seen many large-scale investments
recently, and as funds once again become available, the issue of obsolete,
inefficient and inadequate capacities must be resolved. As a result the OTP
representative argued that the energy sector will see an investment surge on a
timeline ranging from 4–5 to 10 years.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
78 Conclusions and future prospects

Another sign of the future expansion of financing in the CEE region is the fact
that more interest and demand can be seen regarding EBRD financing than
previously. While earlier, projects were mostly financed by commercial banks,
with the EBRD often absent from the deal, since the onset of the crisis investors
have been turning to the EBRD to compensate for the lack of private funds. In
response, the EBRD is cooperating closely with the EIB (European Investment
Bank), which controls a larger volume of resources and generally invests more in
the region. The EBRD has indicated that it would be glad to see more funds in
the CEE region but not necessarily originating from banks.

What do banks require to accelerate financing decisions relating to energy


projects? What are the banks’ recommendations to policy makers and
market players?
As the OTP Bank respondent remarked, it is government’s responsibility to
ensure investors get adequate returns on renewable electricity generation.
Without clear regulatory measures to ensure a transparent market, investors will
be few and far between. The banks interviewed agreed that there was no need
for major legal or other action, except a clearly-understandable and transparent
regulatory framework is essential.

Project developers are not unwilling to invest. Nonetheless, in terms of the


financing structure, investors have to realize that the financing climate of the last
years has passed. As the EBRD remarked, debt/equity ratios of 90:10 are simply
no longer compatible with the business environment. Yet according to BNP
Paribas, financing is rather a question of capital allocation, since there is no real
constraint in the credit process itself. However, money is more expensive due to
higher rates, thus robust project structures are required.

Investors must put more equity in their projects in order to make banks and other
lenders comfortable. Credibility and trustworthiness, critical attributes of
investors, are more important now than ever. Consolidation and branding are
underway in the sector and projects very much depend on the sponsors behind
them.

Both the EBRD and MKB stressed the same prime message for policy makers:
development of a predictable regulatory regime is indispensable to attract
investors into energy projects. What already exists must be strengthened to
provide better assurances, namely the security and predictability of cash-flow.
MKB highlighted that long-term contract structures must be present on both the
input and sales sides. In the case of smaller projects, although it is theoretically
possible that the electricity generated could be sold strictly on a market basis,
this is not typical yet.

What are the recommendations for project owners to enable the


establishment of an eligible project structure?
Project financing entails a strictly individual, case by case approach, and thus it is
difficult to formulate general advice. The main question for lenders is the
allocation of capital that has become less abundant than it was in the past.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Conclusions and future prospects 79

Clearly, this means that it will be awarded to those projects that are found to
have the stronger business cases. It is imperative to meet the expectations of
financial institutions and meanwhile demonstrate commitment from the part of
the project owners.

The banks interviewed for this report all had suggestions and comments
regarding the opportunities they had to offer and the steps project owners
should take.
• OTP indicated it considered terms and conditions flexible and negotiable.
New, long-term, market-based contracts are expected, both on the input side
and also for the sale of electricity, taking the place of PPAs.
• Concepts and ideas are not sufficient; a well-grounded business plan is
absolutely necessary. OTP normally requires a potential project developer to
have a business plan put together by a financial advisor before negotiations
commence.
• The EBRD remarked that leverage ratios had to be re-aligned, and project
sponsors needed to step up and cover more of the risks than earlier (for
example by giving some guarantees on pricing).
• MKB underlined the importance of the project developers contacting the bank
before all contracts were signed, giving the financial institution the opportunity
to influence or modify relevant aspects of the project.
• However, as at least 20–30 percent own equity must be collected under all
circumstances, and project owners have more time for EBRD
administrative processes, they can thus secure cheaper financing.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
80 Conclusions and future prospects

How do banks see their involvement in energy project financing in the


future?
In the current financial environment, when available funds are scarce, MKB plans
to turn towards stable energy sector investments, as these can provide the level
of profitability desired by the bank.

OTP indicated the growth of the project financing portfolio of the Bank, however,
shall be basically energy sector driven.

BNP Paribas, on the other hand, stated firmly that utilities featured among its
priorities. As for expectations, the bank is looking for the transparency of data
and predictability. The bank has developed a deep understanding of the local
markets in the past years, which it plans to utilize in the financing of energy
projects. BNP Paribas, aside from its internal knowledge, has a project financing
team in place which is responsible for the entire region.

The financing of well-structured, carefully-planned energy project developments in


the CEE region will clearly be possible in the years to come. The stable nature
and expected steady growth in the sector, combined with its huge influence
throughout the economy, society and industry mean that its development must
be considered crucial even in difficult times.

The various factors determining progress in the sector – environmental concerns,


security of supply, the need for modernization, to name a few – and the colorful
diversity of the region itself offer an exceptionally wide scope for development.
The resources are largely in place, policy makers and market participants are
generally open minded and committed to development.

The fundamental task is to synchronize the opportunities offered by the various


players: technological solutions from the suppliers in the region, financing
opportunities offered by banks and the needs and requirements of the local
decision makers must be brought together. This requires a circumspect overview
of all aspects of the sector and the participants, alongside a viable and realistic
financial plan. Once these efforts have been made, the possibilities in the region
are numerous and far-reaching.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Acronyms 81

Acronyms

CAGR Compound Annual Growth Rate


CAPEX Capital Expenditure
CCGT Combined Cycle Gas Turbine
CCS Carbon Capture Storage
CDO Collateralized Debt Obligation
CEE Central and Eastern Europe
DSCR Debt Service Coverage Ratio
DSO Distribution System Operator
EBRD European Bank for Reconstruction and Development
EEX European Energy Exchange
EIB European Investment Bank
ENTSO-E European Network of Transmission System Operators for Electricity
EPC Engineering, Procurement and Construction
EU European Union
EU ETS European Union Emission Trading Scheme
FDI Foreign Direct Investment
GDP Gross Domestic Product
IPO Initial Public Offering
ISO Independent System Operator
ITO Independent Transmission Operator
LNG Liquefied Natural Gas
NTC Net Transfer Capacities
PPA Power Purchase Agreement
PXE Prague Energy Exchange
SPE Special Purpose Entity
SPO Secondary Public Offering
TSO Transmission System Operator
UCTE Union for the Co-ordination of Transmission of Electricity
UNFCCC United Nation Framework Convention on Climate Change
UNMIK United Nations Interim Administration Mission in Kosovo

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
What can KPMG firms offer to the electricity sector? 83

What can KPMG firms


offer to the electricity sector?
KPMG is a global network of professional firms providing audit, tax and advisory
services. We operate in 146 countries and have more than 140,000 professionals
working in member firms around the world.

KPMG’s ENR practice overview

KPMG’s Global Energy and Natural Resources (ENR) practice is dedicated to


helping our firms’ clients tackle the issues affecting them in today’s operating
environment. From global super majors to next-generation leaders, KPMG
member firms strive to tailor our service offerings to specific client needs and
deliver the highest standards.

KPMG’s Global ENR practice is organized through a global leadership team


aligned with member firms’ ENR practices. The global leadership team focuses
on our strategic framework, reputation and performance, supported by an
executive group dedicated to driving their implementation, and measuring and
communicating our performance. Our management team focuses on providing
account management, proposals, marketing, knowledge management, and
administrative support to KPMG client service teams operating in the ENR
industries.

KPMG’s ENR professionals help our member firms’ clients address the
complexities and challenges that affect their businesses by creating industry
groups that tackle different areas of the global energy marketplace. The industry
groupings – Oil & Gas, Power & Utilities, Mining & Forestry – facilitate
outstanding coverage of this vast industry.

KPMG firms have Centers of Excellence (CoE) throughout the globe, dedicated to
the Oil & Gas, Power & Utilities, Mining, and Forestry sectors. These centers are
strategically located near major hubs of activity within the industry. CoE teams of
experienced KPMG energy professionals provide high quality advisory services to
clients based in those specific areas.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
84 What can KPMG firms offer to the electricity sector?

Energy and Natural Resources Centers of Excellence


Key
• Oil and gas
• Forestry
• Power and
utilities
• Mining
• Oslo
•• Moscow
•• Calgary Rotterdam
Vancouver •• London • • Essen
Portland • Paris •• •Budapest
• Denver
•• Beijing
Phonenix • • Dallas
Houston •
Al Khobar • • Hong Kong
• Muscat

• Rio de Janeiro
Sao Paulo •
Johannesburg
Santiago • Perth •• • Adelaide
•• Melbourne

KPMG’s Global Power & Utilities Knowledge and


Resource Center – Budapest, Hungary

The Power & Utilities market has been developing at an extremely rapid pace
globally in recent years. This fast development is characterized by large scale
infrastructure projects that require a global base of experience and a high level of
specialized industry knowledge.

As a focal point of Power & Utilities, KPMG’s Global Power & Utilities Knowledge
& Resource Center based in Budapest, Hungary (Central and Eastern Europe)
consolidates global know-how and knowledge in a single location and takes a
hands-on approach to match client needs with KPMG’s Centers of Excellence
(CoE) across the globe that are best suited to providing professional advice and
support that addresses clients’ strategic and transactional activities.

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
What can KPMG firms offer to the electricity sector? 85

Throughout the globe, KPMG member firms provide clients with offerings in relation to the following services:

KPMG Services

Infra- Implemen-
New Transaction Procurement Negotiate Implement Monitor Renew/
structure tation
Investments Strategy and Close and Control Dispose
Strategy Plan

Strategy planning / support, financial Support vendor / partner


modelling / model integrity review evaluation and selection process, Support to subsequent contract
Corporate (demand planning / financial forecasts), finalise business case, support changes, dispute resolution,
Finance assess delivery options / funding / pricing developing negotiating positions, annual investment valuation /
/ risk sharing, develop procurement / support fulfilling closing review and refinancing
transaction strategy, initial transaction conditions
valuation support

Transaction Restructuring: On-going contract


Initial financial / commercial / Detailed due diligence, compliance and performance
Services/ counterparty solvency due investigation of negotiating
Restructuring monitoring (covenants, financial
diligence issues metrics / gain sharing, capex)

Strategic
Commercial Commercial due diligence,
Intelligence market assessment feasibility

Upfront corporate intelligence, Counterparty risk assessment Contract compliance and


Forensic counterparty integrity due diligence, (fraud / criminal risk) governance –royalty review
conflict of interest management

Risk analysis and assessment, retained risk / Information management /


Risk technical risk analysis, advice on risk-sharing security assessment,
Monitoring of major
Management issues, advice on valuing risk for inclusion in privacy protection issues
programmes
pricing mechanism options, regulatory / advice, risk mitigation /
legislative compliance assessment monitoring

Project management support, Project management and change Analysis in support of


Business transaction impact analysis management support, operational due contract compliance and
Performance (stakeholders, etc.), organisational diligence support, organisational design dispute resolution, analysis
Services impact assessment, change / restructuring, contract management in support of renew /
management, public sector and process design, performance metrics dispose decisions
infrastructure sector knowledge

Creation of tax- Post transaction Tax


Tax efficient deal Tax due diligence efficient
integration
structures exit

Accounting / Transaction-related accounting


Audit reporting issues standards, understanding /
identification interpretation (international)

PROGRAM MANAGEMENT

Modelling

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
86 What can KPMG firms offer to the electricity sector?

Throughout the globe, KPMG member firms provide clients with offerings in relation to the following services:

KPMG Services

Opportunity Deal
Acquisition Identification Hypothesis/ Bid Due Negotiate Enhance/ Renew/
Acquisitions Strategy /Assessment Transaction Preparation Diligence and Close Operate Dispose
Structuring

Deal hypothesis, transaction


Strategy planning / support, Support bid analysis, Support for
structuring, detailed financial
deal criteria / objectives, investigate / model issues, subsequent
Corporate modelling / model integrity review,
initial opportunity incorporate risk analysis / contract changes,
Finance demand planning / financial
identification / assessment, mitigations, develop dispute resolution,
forecasts, initial transaction
pre-deal evaluation, financial negotiating positions, annual investment
valuation, bid strategy, bid
modelling fulfill closing conditions valuation / review
preparation

Transaction Restructuring: ongoing contract


Detailed due diligence,
Services / Initial financial / commercial / compliance and performance
investigation of negotiating
Restructuring counterparty solvency due diligence monitoring (covenants, financial
issues metrics / gain sharing, capex)

Strategic
Commercial Pre-deal strategy Commercial due diligence
Intelligence

Upfront corporate intelligence, Counterparty risk


Forensic counterparty integrity due diligence, assessment (fraud / Contract compliance and
conflict of interest management criminal risk) governance – royalty review

Risk analysis and assessment, retained risk / Information management /


Risk technical risk analysis, advice on risk-sharing issues, security assessment, Design of governance,
Management advice on valuing risk for inclusion in pricing privacy protection issues compliance and controls
mechanism options, regulatory / legislative advice, risk mitigation /
compliance assessment monitoring

Project management support, transaction Project management and change Performance improvement /
Business management support, operational value realisation, merger
impact analysis (stakeholders, etc.),
Performance due diligence support, organisational integration, ongoing
organisational change management,
Services design / restructuring, contract performance monitoring,
public sector and infrastructure sector management process design, analysis in support of renew
knowledge performance metrics / dispose decisions

Creation of tax-
Tax Post transaction
efficient Tax due diligence
integration
deal structures

Accounting / Transaction-related accounting


Audit reporting issues standards, understanding /
identification interpretation (international)

Information Systems
Risk optimisation,
Management IT governance

PROGRAM MANAGEMENT

Modelling

© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
© 2010 KPMG Tanácsadó Kft., a Hungarian limited liability company and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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KPMG’s Energy & Utilities Advisory Services


contact in Central and Eastern Europe

Péter Kiss
KPMG’s Global Head of Power & Utilities
Head of Sector, Energy, KPMG in Central and Eastern Europe
Tel.: +36 1 887 7384
E-mail: energy@kpmg.hu

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