CC BY
17
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Russia’s NIKoil, long present in our market, intends to open branches in all economically developing regions of the republic in view of a shortage of banking services in rural areas. In accordance with Azerbaijan’s regional development strategy, it plans to open 6 branches and 38 offices in the next two years. Apart from financing farmers, the bank is to focus on the development of manufacturing enterprises and land reclamation infrastructure. Today this policy is being successfully implemented by NIKoil’s Gabala Branch,17 which provides loans for winegrowing, production of wines and brandies, and cotton production and processing.
Russia is Azerbaijan’s major trading partner. Historical and economic ties, a single transportation network, a common infrastructure and widespread knowledge of the Russian language facilitate cooperation between the two countries. In our opinion, further development of the banking system in both countries is a prerequisite for accelerating integration processes. Close economic integration with Russia meets Azerbaijan’s strategic interests.
C o n c l u s i o n
We believe it is time to think about creating within the CIS framework a system of mutual preferences for establishing subsidiary banks and branches. The Commonwealth countries do not make full use of their potential for trade operations and mutual investment. As for the use of national currencies in trade between CIS countries, only 20% of their mutual trade turnover is settled in these currencies. That is why it is necessary to create a single payment system in the CIS for settlements in national currencies. So, further development of the CIS countries’ banking system can pave the way for accelerating integration processes in the post-Soviet space.
17 See: Z.F. Mamedov, “O nekotorykh voprosakh azerbaidzhano-rossiiskogo sotrudnichestva v finansovo-kreditnoi
sfere.”
Vagif NASIBOV
Ph.D. (Technology), director of the Department of Reforms and Economic Problems of the Electric Power Industry, Azerbaijani Research and Development Institute of the Power Industry, OAO Azerenergy
(Baku, Azerbaijan).
THE FORMATION OF AN EFFICIENT INTERNAL ENERGY MARKET UNDER GLOBALIZATION CONDITIONS (AZERBAIJANI CASE STUDY)
Abstract
T
his article looks at the situation that has developed in the country’s electric power industry, studies the prin-
ciples and special features of forming an internal energy market in the Azerbaijan Republic, and justifies the need for reform-
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ing the economy’s power industry and creating new independent market entities
that meet the demands of the globalizing world.
I n t r o d u c t i o n
After the collapse of the U.S.S.R., Azerbaijan experienced an abrupt drop in its industrial production, including in energy generation and consumption. Due to the social situation that developed in the country, the price of electric energy consumed reached a critical level. Due to insufficient financing and lack of spare parts, electricity-generating installations, which were in need of modernization anyway, experienced a rapid drop in capacity. This resulted in its shortage and upset the balance between energy supply and demand. In order to find a solution to this situation, the government launched several programs aimed at developing the power industry. Their successful implementation requires creating an efficient internal energy market based on the experience of advanced countries, particularly the European Union states.
The Current Situation on the Energy Market in Azerbaijan
In 2007, the overall capacity of the Azerbaijani energy system comprised 5,569 MW, of which thermal power stations accounted for 4,540 MW, and hydropower stations for 1,029 MW. Two types of fuel are used at thermal power stations—natural gas and fuel oil. According to the 2007 data, natural gas comprises 78.87% of the total amount of combustible fuel, and fuel oil accounts for 21.1%.1 This shows that, compared with many other countries of the world, Azerbaijan produces electric power that is cleaner in environmental terms.
Due to the fact that most of the energy installations are morally and technically outmoded, they cannot operate at full capacity, particularly at peak hours. This, in turn, is leading to certain restrictions in energy consumption: for example, in the winter, the capacity could be raised to only 4,100 MW.
At present, although there exist the problems of the transition period in the economy, the electric power system continues to develop at an accelerated rate. Over the past few years, state-of-the-art combined cycle electric generating plants with a total capacity of approximately 1,000 MW have been put into operation in Azerbaijan, which is the first of the former Soviet republics to do this. They include the Shimal State District Power Station with a capacity of 400 MW (in operation since 2002) and the Sumgait State District Power Station with a capacity of 517 MW, which should go into operation in 2008. In order to resolve the problem of insufficient electric power at peak hours and create reserve capacities, five module gas piston power plants with a total capacity of 452 MW have been put into operation, and new ones are being built.
Beginning in 2008, in addition to those already in operation, newly built power plants with a total capacity of 2,500 MW are being launched, and this comprises approximately 50% of the capacity of the country’s entire energy system. These power plants, which cost several billions of dollars, are being built by the state. In addition, large-capacity thermal power plants are being built (one with a capacity of 760 MW in Alibairamly and another with a 712 MW capacity in the settlement of Aliat),
1 See: Report of OAO Azerenergy for 2007.
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and a project is underway to build a network of small hydro- and wind power stations. Corresponding state programs, both in the above-mentioned and in other spheres of the electric power industry (alternative sources of energy, transmission and distribution networks, an automatic-control system, electricity-supplying networks, building-assembly and other organizations, and so on), are being carried out.
An important aspect of state policy in the fuel and energy sphere is creating the necessary conditions for building so-called independent power plants, using state-of-the-art technology, based on private property and with the incorporation of foreign investments. This should help the country’s energy industry to successfully compete with the world producers of electric power and bring in high dividends. The need for building independent power plants and its legal aspects were set forth in the Law of the Azerbaijan Republic on Power and Thermal Stations adopted in 2000. When building such power installations, the investor (usually foreign) assumes responsibility for all the planning, construction, financing, and management issues. The client country, which issues the license for building an independent power plant, is not responsible for financing the power plant, but creates equal conditions for it with respect to use of the country’s fuel and infrastructure.2
When independent power plants go into operation, real competition is generated and monopoly is eliminated in electric power generation, and not only do electric power plants operate more reliably, but other economic indices are also raised. As a result, the country’s energy security is strengthened.
But when building such power plants, it is very important to keep in mind world experience and the opinion of well-known specialists in this sphere. This is because in debt contracts that regulate the settlement of a certain amount of the country’s debt in dollars and euros, the loan interest is defined on market conditions (particularly with respect to short-term debts). Since the loan interest rate and inflation rate can change, a developing country that borrows money is taking a great risk. And another negative fact should be taken into account: the International Monetary Fund and World Bank encourage entering such contracts, despite the fact that the client country assumes the entire risk perpetrated by a change in the level of energy consumption. Under the conditions of a contract signed on the take-or-pay principle, if electric power is not produced (for reasons beyond the plant’s competence) or there is no demand for it, the government of the client state guarantees return of the loan. So when drawing up contracts for building independent power plants, particular attention should be paid to measures aimed at minimizing the said risks.
According to the State Statistics Board’s data for 2007, Azerbaijan is at the bottom of the list of 50 countries of the world in terms of per capita electric power generation.3 Due to this and taking into account the potential of the country’s fuel resources, there is an urgent need to build power stations based on private and mixed types of ownership in order to eliminate the shortage of electric power and ensure its export.
In addition to the above, specific and quite effective measures have been carried out recently to eliminate monopoly in the distribution and supply of electric power. For example, the vertical monopoly state management system in effect during the 20th century has undergone some changes and economically, organizationally, and legally independent electricity-supplying enterprises (electric power networks) have been created in the regions; for example—the Baku, Sumgait, and Sheki power networks, as well as the distribution and power supply networks of other regions that are still part of the OAO Azerenergy State Power Company.
There can be no doubt that the accelerated construction of contemporary power plants, the development of high-voltage power networks, the use of precise and reliable metric systems, and the formation of a national dispatcher system that meets international standards have led to a significant
; See: J.E. Stiglitz, Making Globalization Work, New York, 2007.
2 <
3 Website of the State Statistics Board of the Azerbaijan Republic [www.azstat.org]—International comparison.
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reduction in the electric power shortage and to elimination of the imbalance, which has been observed for many years, between the amount of electric power produced and consumed.
Along with the accelerated development of technical generation capacities and the increase in other opportunities in the electric power industry, lowering the net cost (price) of electric power, carrying out measures to increase the security and reliability of the energy system, eliminating the wastefulness existing in energy supply (losses of electric power, unreusable reserve capacities, and so on), and taking into account the social status of clients when collecting payments for the electric power consumed are just as important. An internal energy market must be formed to carry out these measures, otherwise purely technical development of the industry without economic reform will not produce the anticipated results.
The efforts exerted at this stage to create an energy market can be assessed as initial steps. For example, the Law of the Azerbaijan Republic on Electric Power envisages large-scale changes in the structure of the country’s energy system, the main ones of which are ensuring legal and economic independence and choice of forms of ownership by the main electricity-supplying entities: producers, transmission and distribution networks, and enterprises supplying customers with energy and functioning as independent market entities.
The diagram below presents the approximate structure of the existing market status of the energy system and shows the entities of the internal energy market and simplified relations among them. The existing structural elements (power stations, transmission and distribution networks, etc.) and their relations are shown by solid lines, and the necessary enterprises and their relations under market conditions by dotted lines.
As is seen from the diagram, despite the fact that there are already several electricity-supplying enterprises, general standards have still not been adopted. Moreover, a corresponding regulatory authority has not been formed that would ensure the functioning of market relations within the main entities of the energy market and between them (between producers and transmission networks, between transmission and distribution networks, and between distribution networks and electricity-supplying enterprises).
Advance of the country’s economy requires accelerated development of the electric power industry in order to cover the growing demand for electric energy. This means that reforms must be conducted relying on international experience to create an efficient internal energy market based on a special state program. This program, which should take the country’s specifics into account, must define the orientation of the reforms, the model for forming an internal energy market, the principles for creating a regulatory authority, and the drawing up of corresponding standards.
The model of the energy market being created should include the following principles:
■ Ensuring correspondence of the new legislative acts, regulations, and instructions regarding operation of the energy industry to the principles of the European Union’s directives.
■ Putting operation of the energy industry on a competitive basis.
■ Creating a tariff system that reflects the expenses. New tariffs for energy and its capacity should be multi-rate and take into account the objective expenses, making it possible to regulate the activity of groups of producers and customers.
■ Eliminating cross-subsidizing by means of direct targeted financing.
■ Providing access to the energy market based on licenses issued by the regulatory authority.
■ Regulating market relations by an administratively and financially independent regulatory authority.
■ Defining the state’s role in control and management.
■ Ensuring that market participants assume all market-related risks.
M a r k e t C o
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Power
Stations
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NDC*—National Dispatcher Center MFPC*—Market Financial Payment Center RES**—District Power Station GorES**—City Power Station
Transmission System and Operator
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Distribution System and Operator
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AZERENERGY RES**
Baku GorES**
Sumgait GorES
Sheki RES
Electricity-Supplying
Enterprises
Customers
110-220-330-500 kV W h o l e s a l e M a r k e t
35-110 kV
0.4-35 kV Retail Market
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Existing Structure of the Country’s Energy Market
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■ Privatizing state energy property.
■ Ensuring an efficient management system.
The implementation of these principles is inevitably encountering difficulties and requires adequate political decisions, the carrying out of large-scale restructuring of the existing structures, the creation of new subdivisions, constant consideration of the country’s specifics, and public support.
The following entities should take part in forming an internal energy market and in regulating its activity: the state and government, the regulatory authority, transmission system operators, distribution system operators, electricity-generating companies, electricity-supplying and retail sale companies, service companies, electric power merchants, and a wholesale market.
The Special Features of Forming an Internal Energy Market
The transition to a free energy market (independent of the country or region) must be carried out on the basis of a substantiated market model. In so doing, it is very important to determine the role and specialization of each participant (i.e. to determine whether the electric power entities are monopolistic, competitive, etc.).
As in all spheres of state economic policy, the experience of developed states, primarily the European Union countries and Turkey, in the electric power industry was used when drawing up legislative acts.
In compliance with the decision adopted by the Ministry of Industry and Power Engineering and OAO Azerenergy, the Azerbaijani Research and Developing Institute drew up an initial list of legal acts, regulations, and instructions for ensuring the creation of an internal energy market.
At present, the following laws on energy are in effect in the Azerbaijan Republic: On the Use of Energy Resources (30 May, 1996), On the Subsurface (13 February, 1998), On Electric Power (13 April, 1998), On Gas Supply (30 June, 1998), On Power Engineering (24 November, 1998), and On Power and Thermal Stations (6 March, 2000).4
These legislative acts contain numerous binding political decisions generated by the transition period (for example, the long-term transfer to a single operator of a monopoly distribution system consisting of 110-kV power transmission lines and competitive electricity-generating and electricity-supplying systems) and encompass only the general principles of market relations relating to alternative forms of ownership: anti-monopolistic, competitive, and other new operating entities. So it is imperative that a new law be adopted that ensures the regulation of activity on the energy market. In our opinion, the following factors, which are not taken into account in current legislation, should be set forth in it:
■ Types of activity of legal entities on the energy market that carry out generation, transmission and distribution, wholesale and retail sale of electric power, retail sale services, and import-export.
■ Types, conditions, principles, and general license requirements issued for carrying out activity on the energy market.
■ Creation of a regulatory authority and its management apparatus, determination of its status, rights and obligations, ownership and income, sanctions and legal proceedings, working procedures, and so on.
4
See: V.A. Nasibov, A.A. Alizade, Energy Legislation and the Development of the Power Industry, Baku, 2000 (in
Azeri).
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■ New tariffs (tariffs for hooking up to and using networks, electric power transmission tariffs, wholesale tariffs, electric power distribution tariffs, retail sale prices) must be drawn up by a corresponding legal entity based on the new regulations and presented to the regulatory authority before the fourth quarter of the current year for their use the following year.
In order to bring the regulatory legal base of the internal energy market into harmony with contemporary international requirements, the following laws of the Azerbaijan Republic must be adopted: on regulation of utilities (a draft is ready) and on electric power, natural gas, and petroleum product markets. Provisions (Regulations) on Tariffs should be drawn up: on servicing electric power users; on users with special authorities; on regulating operation of the energy system; on balancing the capacity of the energy system and on calculating conditions; on distributing electric power; on licensing; on the reliability and quality of the transmission system; on the import and export of electric power; and on auditing and research, as well as the corresponding instructions.
When drawing up regulations for operation of the energy system on the internal market, the Electricity Directive 2003/54/EC and Regulation 1228/2003/EC should be used as a basis. The main principles of these regulations were adopted in Turkey, in many developed countries of Asia, and in the republics of the former U.S.S.R. This directive says:
—despite the fact that electricity companies in the country are fully owned by the state, in keeping with the new rules, the state’s participation in the management of electricity companies is limited as is the case in European states;
—in the energy sector, regulatory functions and state management functions shall be kept separate from each other.
According to the requirements of the electricity directive, Azerbaijan, as any other country (and naturally keeping in mind its special features), shall create a regulatory authority of the energy market that is independent of the interests of the energy industry.
In our opinion, certain changes must first be made in the structure of the energy industry and the independent bodies and market entities indicated below formed.
The regulatory authority directly determines and approves the network tariffs for electricity transmission and distribution, is responsible for drawing up a tariff calculation method, and provides access and hook-up to the networks. In rare cases, these tariffs can be approved by the government. Under the new market conditions, the government (or any state agency) cannot as a rule interfere in market activity, particularly in wholesale and retail trade price formation.
Regulatory legal acts drawn up with the participation of the regulatory authority create full-fledged conditions for the activity of an integrated and competitive internal energy market. These acts define the general provisions for the generation, transmission, distribution, and supply of electric energy. Rules are thus established for the organization and functioning of the electric power industry under the new conditions: access to the market, tender criteria and procedures, and licensing.
The transmission system with a current of 110- 220- 330- 500 kV acts as the center of the energy market. Since it encompasses the whole country and includes the National Dispatcher Center (NDC) and Market Financial Payment Center (MFPC), it performs the function of technical and financial operator.
According to the new regulations, electricity transmission and distribution is a monopolistic activity, whereas energy generation and supply are carried out on a competitive basis. The operators of transmission and distribution systems should not allow discrimination with respect to producers, energy suppliers, and merchants, or final customers, particularly when hooking up to networks and establishing tariff rates.
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According to the legislation, the internal energy market being formed at present with the government’s participation should be built on the principle of competition. Monopoly will ultimately be eliminated in vertically integrated undertakings and there will no longer be a need for the state’s direct participation on the energy market. In the future, the internal market will gradually turn into an open market. So network operators will also be responsible for ensuring the right of all producers and energy suppliers to hook up to their networks and the right of customers to purchase electricity from the supplier of their choice. Customers can be free to choose their supplier if all industrial and household customers have reached the level of a highly qualified user.
One of the main demands of the internal energy market is the fact that transmission and distribution must be absolutely separate from generation, supply, and sale of electric power. In keeping with the new requirements, the operators of transmission and distribution networks should function separately, both from the viewpoint of rights and with respect to management and accounting. Transmission system operators are founded as independent legal entities. If they function as subsidiary enterprises of vertically integrated undertakings (the shareholders of Azerenergy, for example), they are granted the right to make independent decisions.
Distribution systems with a current of 35-110 kV ensure the distribution of electricity to final customers in their region. Since electricity distribution is a monopoly activity, it should be separate from competitive activity. The operators of monopoly distribution networks must hook up all the customers in their area of service. The independence of transmission and distribution network operators is the main element of the internal energy market.
Electricity-generating companies. Energy generation is a competitive activity. Since electricity-generating companies do not have the rights of monopolist for providing customers with electric power, they operate on a competitive basis and sell their goods at a price that is set based on the balance between supply and demand on the market. These companies, both in the legal and functional respect, do not depend on transmission and distribution networks, which are monopolistic entities. In keeping with the requirements of the European Council Directive on liberalization of the energy market, competition must be created in Azerbaijan among electricity manufacturers across the entire market. The regulatory authority and other corresponding government structures engaged in market regulation are responsible for applying the regulations that ensure the objectivity of competition based on unified principles.
Electricity-supplying companies with a current of 0.4-10-35 kV provide final customers with electric power. As a rule, these enterprises buy electricity on the market, but they can also produce it themselves if they own power plants. Electricity-supplying companies function on retail markets, their clients are household customers, small and medium-sized industrial enterprises, services, stores, and so on. They should be both legally and functionally independent of transmission and distribution networks, but can operate jointly with energy producers.
Along with the aforesaid, in world practice special types of energy servicing based on contracts are also widely used. Extensive use of these regulations is also considered expedient under Azerbaijani conditions. Research-and-development and construction work, the issuing of licenses for investments, technical servicing, communication and telecommunication, and so on are also included in these types of activity.
C o n c l u s i o n
In order to create competitive energy market in Azerbaijan and taking into account the experience of the European Union countries, reforms should be primarily carried out in some areas.
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The existing energy laws contain many binding political decisions generated by the transition period and encompass only general principles of market relations. For example, for many years monopolistic distribution systems and competitive generation and electricity-supplying systems have been managed by one operator. So the following is necessary in order to regulate market relations between the newly created and fully independent legal entities of energy activity.
1. A new law on electric power must be drafted and adopted (based on the principles of the European Council Directive (2003/54/EC). During the discussion and adoption of the new law, keeping in mind the principles of the regulatory legal acts of the European Union energy market (EC Regulation 1228/2003), a code of rules and provisions must be prepared for regulating the operation of all participants of the energy market (those doing the regulating and those being regulated).
2. An independent body must be created for regulating the energy market (including natural gas, water, and other energy resources) which will be responsible for the efficient operation of the energy market, honest competition, establishment of generation and network tariffs, non-discriminatory hook-up of customers to the network, and so on. In 2005, a draft Law on Regulation of the Energy Market drawn up by the commission for natural resources, energy and environmental issues of the Milli Mejlis of the Azerbaijan Republic and the Azerbaijani Research and Development Institute of Power Industry of OAO Azerenergy was submitted to the government for discussion. It envisaged complete independence of the regulatory authority from executive power. This authority was entrusted with the following functions: issuing licenses to energy market entities, regulating electricity tariffs, and reviewing complaints by market participants.
3. Transition of the electric power industry to market relations must be ensured, whereby it is primarily necessary to create new organizations functioning autonomously and on the principles of competition and natural monopoly. At the moment, the country’s electricity producers and transmission and distribution systems are completely subordinate to OAO Azerenergy. In order to eliminate this monopoly, electricity producers, the transmission system and its operator (dispatcher service), the distribution systems and their operators, and electricity-supplying companies should be separate from each other from the legal, managerial, and financial viewpoint and act as independent legal entities.
4. The formation of an internal energy market in our country should be carried out in two stages. At the first stage, Azerenergy, while remaining the main shareholder of state property, should make the power plants and electricity-supplying companies under its subordination independent and create a competitive mechanism between them. At this stage, transmission and distribution systems and their operators should begin to function as subsidiary enterprises of Azerenergy. The energy system functioning in this structure will eventually gain experience and, along with Azerenergy, draw up a program for privatizing the electric power industry and ensuring the transition to the next stage of the energy market.
So, since the lion’s share of the energy resources are exported to countries actively undergoing globalization, the creation of an internal energy market will make it possible to determine the most optimal strategies of energy balance. And this in turn makes it possible to raise the country’s energy security and lower the risks of its energy vulnerability.
