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This publication was produced for review by the United States Agency for International Development. It was prepared by Deloitte Consulting LLP. The author’s views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government.
REGULATORY IMPACT ASSESSMENT ON THE ELECTRICITY TRADING MECHANISM
USAID GOVERNING FOR GROWTH (G4G) IN GEORGIA
USAID | GOVERNING FOR GROWTH (G4G) IN GEORGIA REGULATORY IMPACT ASSESSMENT ON THE ELECTRICITY TRADING MECHANISM i
REGULATORY IMPACT ASSESSMENT ON THE ELECTRICITY TRADING MECHANISM
USAID GOVERNING FOR GROWTH (G4G) IN GEORGIA
CONTRACT NUMBER: AID-114-C-14-00007
DELOITTE CONSULTING LLP
USAID | GEORGIA
USAID CONTRACTING OFFICER’S REPRESENTATIVE: REVAZ ORMOTSADZE
AUTHOR(S): LEPL ILIA STATE UNIVERSITY
ELECTRICITY TRADING MECHANISM: 4000
LANGUAGE: ENGLISH
25 APRIL 2018
DISCLAIMER:
This publication was produced for review by the United States Agency for International Development. It was prepared by Deloitte Consulting LLP. The author’s views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government.
USAID | GOVERNING FOR GROWTH (G4G) IN GEORGIA REGULATORY IMPACT ASSESSMENT ON THE ELECTRICITY TRADING MECHANISM ii
DATA
Reviewed by: Giorgi Giorgobiani, David Gvenetadze, Michael Martley, Ana Jejelava
Project Component: Energy Trade Policy Improvement Component
Practice Area: Electricity Trading Mechanism
Key Words: Electricity, Power, Market
USAID | GOVERNING FOR GROWTH (G4G) IN GEORGIA REGULATORY IMPACT ASSESSMENT ON THE ELECTRICITY TRADING MECHANISM iii
ACRONYMS CAPEX Capital Expenditures
CBA Cost-Benefit Analysis
DisCos Distribution Companies
DSO Distribution System Operator
EMRA Energy Market Regulatory (Republic of Turkey)
ENTSO-E European Network of Transmission System Operators
EPIAS Energy Exchange Istanbul
ESCO Electricity Market Operator
ESMAP Energy Sector Management Assistance Program
ETM Electricity Trading Mechanism
G4G Governing for Growth in Georgia
GNEWRC Georgian National Energy and Water Supply Regulatory Commission
GSE Georgian State Electrosystem
GWh Giga Watt Hours
HHI Herfindahl-Hirschman Index
KWh Kilo Watt Hours
MoE Ministry of Energy
MoESD Ministry of Economy and Sustainable Development
OGP Open Government Partnership
PPA Power Purchase Agreement
RIA Regulatory Impact Assessment
SDG Sustainable Development Goals
TEIAS Turkish Grid Operator
TPP Thermal Power Plant
TSO Transmission System Operator
USAID United States Agency for International Development
VPP Virtual-Power Plant
USAID | GOVERNING FOR GROWTH (G4G) IN GEORGIA REGULATORY IMPACT ASSESSMENT ON THE ELECTRICITY TRADING MECHANISM iv
CONTENTS 1. EXECUTIVE SUMMARY .............................................................................................................. 1
2. PROCEDURAL ISSUES AND CONSULTATION OF INTERESTED PARTIES ......................... 6
3. PROBLEM DEFINITION ............................................................................................................... 4
4. OBJECTIVES .............................................................................................................................. 14
5. POLICY OPTIONS ...................................................................................................................... 17
6. ANALYSIS OF IMPACTS ........................................................................................................... 28
7. COMPARING THE OPTIONS .................................................................................................... 36
8. MONITORING AND EVALUATION PLAN ................................................................................. 38
REFERENCES ...................................................................................................................................... 40
APPENDIX A: TURKISH POWER MARKET LIBERALIZATION .......................................................... 1
APPENDIX B: ALTERNATIVE OPTIONS ............................................................................................. 6
APPENDIX C: LIST OF LITERATURE COMPUTING PRICE ELASTICITY OF DEMAND FOR
ELECTRICITY ............................................................................................................................. 10
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1. EXECUTIVE SUMMARY Since 2005, Georgia has been implementing extensive reforms in its electricity sector, including its restructuring, privatization and deregulation. As a result of accession to the Energy Community in October 2016, Georgia undertook an obligation to harmonize its legislation with the European Union (EU) Energy acquis. The agreement between the EU and the Government of Georgia (GoG) stipulates the completion of the development and implementation of a power exchange platform by the end of 2018. Also, the Association Agreement (AA) obliges Georgia to address key issues in the energy sector, including:
• Development of competitive, transparent and efficient energy markets allowing third parties non-discriminatory access to networks and to consumers, following EU standards, including the development of the relevant regulatory framework;
• Development of an attractive and stable investment climate by addressing institutional, legal, fiscal and other conditions;
• Development of energy infrastructures of common interest, in order to diversify energy sources, suppliers and transportation routes in an economic and environmentally sound manner;
• Enhancement of security of energy supply, increasing market integration and gradual regulatory approximation towards key elements of the EU acquis;
• Enhancement and strengthening of long-term stability and security of energy trade, transit and transport, and pricing policies, including a general cost-based system for the transmission of energy resources, on a mutually beneficial and non-discriminatory basis in accordance with international rules, including the Energy Charter Treaty; etc.
The current system (Baseline Scenario) is largely managed by policy makers. The current electricity market model is a partially deregulated electricity trading system. Around 90% of electricity is generated by the regulated generators or power plants with power purchase agreements (PPA) with a fixed price. The participants of the power market, customers and the generators, make short term and long term direct contracts on sales and purchases. Balancing electricity is traded exclusively through the Electricity Sector Commercial Operator (ESCO) and the management and clearing function of the balancing market is carried out by the same entity. Third party access is ensured and any consumer with more than 1 kWh of annual consumption may become a direct customer of a generation plant. However, excessively high tariffs on the transmission through the distribution network does not allow efficient application of this function. Direct contracts are allowed, and capacity charge is collected from the market participants.
An eligible enterprise, which has not signed and duly registered the direct contract on purchase or sale of electricity according to the applicable law, shall be automatically linked to the Standard Conditions of Direct Contract on Purchase and Sale of Balancing Electricity. Georgian National Energy and Water Supply Regulatory Commission (GNEWRC - the regulator), approves the Standard Conditions of Direct Contract on Sale and Purchase of Balancing Electricity, based on the market operator’s proposal. According to the current market rules, vertical integration is allowed. This means the distribution companies can own generating units as well.
Over the past six years, the country’s annual net trading surplus of electricity generation changed into a net trading deficit. This is largely due to the growth of the consumption at the higher rate than the growth of total generation. In 2017, the negative trading gap reached 806 GWh.
The biggest challenge of the country over the years remains the seasonality in generation and consumption. Electricity consumption peaks from October through March, while the highest point of generation is achieved from April to August. Seasonality in power consumption is primarily due to
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relatively underdeveloped industrial electricity consumption1 and to the low use of cooling appliances in the summer. Industrial consumption doesn’t have major seasonable fluctuations. From the power generation perspective, the cause of seasonality is a large portion (roughly 80%) of hydropower plants (HPPs) in total power generation of the country. The large decrease of power generation in winter is primarily filled by thermal power plants, working on imported natural gas and electricity imports. Seasonality of the Georgian electricity market defines electricity trading patterns of the country. Risks and Risk Mitigation (Baseline “Do Nothing” Scenario)
• The current market scenario bears several risk factors that can affect market participants and the final consumers in the short and long term: it is not harmonized with the EU Directives and with the Treaty of Energy Community, therefore, it doesn’t answer to the obligations that have to be fulfilled by the country in the years to come;
• It doesn’t answer to the strategy and policy of the GoG, as Georgia tries to harmonize its regulations with EU energy community;
• It can negatively affect price stability; increased share of imports or newly built HPPs have higher than average tariff. Also, both of their prices are fixed in USD and Forex fluctuations may have its own effect;
• Vertical integration and low level of unbundling strangles competition. Vertically integrated companies have an overwhelming market share and impose their own terms on others;
• As power-purchase agreements (PPAs) are abolished, the energy sector may not be able to attract enough investments in the short and medium term because the funding of HPPs is largely done by financial institutions (banks). Neither international financial institutions nor local Georgian banks are ready to provide project financing for HPPs without long term power purchase agreement. This eventually will cause growth of the deficit, worsen the trading balance and reduce energy independence.
In such a case, the long-term confidence in the energy sector can be supported only by reducing the regulation and allowing market participants to compete fairly among each other. However, for the purpose of this work, it is assumed that no regulatory change is taking place.
A major constraint to the full liberalization of the market is the existence of several categories of producers of electricity with different backgrounds and ongoing situation:
1) Enguri and Vardnili HPPs;
2) Privatized HPPs (most of the were privatized in 2007-2008);
3) Newly built HPPs (with PPAs from ESCO);
4) Small HPPs (below 40 MW);
5) Thermal power plants.
Enguri and Vardnili HPPs are partially located in Abkhazia, and more than half of the produced electricity is supplied to the population in the region. It is unclear how much more electricity will be taken from these power plants if the consumption in Abkhazia increases. Also, their tariffs do not reflect the full cost of capital of the plants. This means that they are subsidized (to keep final consumer tariffs low) and would have a competitive advantage over other plants. In case the
1 The share of industrial electricity consumption in total electricity consumption is relatively low (less than 30%) relative to more industrialized economies (in Germany, for example, the share is between 40 and 50%). This means demand is more affected by the seasonal fluctuations in electricity consumption characterizing the commercial sector and the residential consumers.
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Abkhazian side takes a larger proportion of the generated power, Enguri and Vardnili HPPs would suffer as compared to other market participants.2
Privatized HPPs have been sold at the price that would not reflect full replacement costs of these plants. This was done in order to keep the final consumer prices low. This means that they will also have an advantage over potential competitors.
The third category of generators have long term power purchase agreements with the state owned ESCO to sell large part of their electricity at a fixed price. This means that they cannot change their price to electricity with changing market conditions. As long as private investors expect to fully recover their investment competing against the power plants, which have recovered a large part of their capital costs during Soviet times, and were privatized below their replacement value, will be almost impossible.
Small HPPs (below 40 MW) are fully deregulated and they can sell electricity freely with no constraints or obligations.
Thermal power plants have two-tier tariffs: a capacity fee and tariff that covers variable costs (price of the fuel). Due to the low operating leverage as compared to HPPs, they would not be as flexible as HPPs in free competition.
Therefore, until December 2019, partial deregulation is suggested for the electricity market in Georgia. At this stage, full-scale liberalization of the electricity trading mechanism will be a difficult task for the abovementioned reasons.
From December 2018, Partial deregulation will affect all non-household customers, and later all customers (from December 2019). Partial deregulation, followed by full-scale liberalization in defined time-frames, is consistent with the obligations before the EU.
After several meetings with the stakeholders, most importantly with the Ministry of Economy and Sustainable Development (MoESD), and considering the range of regulatory and non-regulatory options, based on the agreement with G4G, a modified electricity trading mechanism (ETM) was chosen as the only feasible option to be analyzed. The project team also analyzed two more options: the Nord Pool (adjusted version to Georgian Market) and Free Market scenarios. After thorough analysis and meetings with the relevant stakeholders, it was decided to put these options in annexes (Appendix C), as they are not feasible due to the present constraints and challenges, but at the same time, it can give political decision makers the possibility to discuss these options after elimination of the current constraints and full-scale liberalization of the market.
The modernized version of the current ETM will introduce the following features and mechanisms:
a) Day-Ahead Market
Bids and offers for the next day are made every day until 12:00 (or any other time in the first half of the day), on an hourly basis. Market participants either directly participate in the trade or via traders.
All market generators (including thermal-power plants (TPPs), trading companies and consumers may participate in the trades. In order to avoid price spikes during the peak hours or congestion, the prices can be capped by the price of the most expensive imported electricity (the MoESD wanted to impose such a limit).
Electricity generated by Enguri and Vardnili HPPs can be distributed evenly to all consumers. Socially vulnerable households will be the major target for distribution of the electricity.
Newly built HPPs who have entered PPAs with ESCO shall also participate in the trades. The difference between the market price and PPA price shall be offset by the TSO or by the market
2 During the workshops one of the participant raised the issue to include Enguri & Vardnili HPPs in Electricity Trading Mechanism, so they will have opportunity to trade on market. However, this feature is not included in the report as part of ETM for several reasons, first of all, it is unclear how much electricity will be taken by Abkhazia; secondly, the tariffs don’t reflect full cost of the plants; thirdly, participation of Enguri & Vardnili HPPs will increase government participation on the Market, as these HPPs are owned by the government; lastly, during the meetings and workshops representatives of the government underlined that the Enguri & Vardnili HPPs will not be market participants in Modified ETM. But at the same time, we can also argue that involvement of Enguri and Vardnili HPPs in ETM, will help to decrease the electricity tariffs at the first stage.
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operator. However, offsetting formula for PPA holders to avoid price fixing is suggested. The funds for such an offset can be collected from all consumers via the end-user tariffs. However, in order to avoid inefficient bidding from such generators, they should be restricted to bid below the weighted average price of all bids made on the market.
b) Transmission System Operator (TSO) – including a Balancing Function
Balancing of supply and demand is provided by TSO. TSO also determines the market clearing price. This market model includes capacity pricing. Every market participant (consumer) pays a capacity charge to the TSO. The capacity fee is set by GNEWRC.
Distribution system operators (DSOs) can be split into two categories, low voltage transmission and suppliers/traders (billing).
In addition, this model requires:
c) Balancing Mechanism
The balancing on the market shall be implemented by the TSO, including imports of the electricity.
d) Clearing House
The clearing function can be implemented by a seasoned financial institution, which will be able to take risks and offer trading margins to market participants.
Required Changes in the Current ETM in the Short and Long-Term Periods
Short-Term - until 2020:
- Split of vertically integrated companies at the level of beneficial owners;
- Creation of TSO with balancing functions;
- Introduction of congestion management and balancing group structures;
- Introducing wholesale/trading companies;
- Start of bi-directional flows on the interconnectors;
- Conversion of ESCO to hourly settled day-ahead market or establishing a private entity as the market operator;
- Set-up of clearing and hedging mechanisms (hedging does not necessarily only mean complex financial instruments).
Long-Term (by 2024):
- Elimination of end user tariffs and introduction of social and last resort tariffs;
- Introduction of aggregator business models including virtual-power plant (VPP) and demand side management.
After the indicated period, it is assumed that the validity of the PPAs and contractual obligations with distribution companies will be expired, and the system can move to the free market model.
While comparing the alternatives to identify the preferred one, a number of criteria in addition to net present value (NPV) were considered. These criteria are:
Effectiveness: the capability to produce the desired results. In this case, the capability to:
1. Enhance the efficiency, competitiveness, resilience, sustainability and accessibility of the electricity market on a mutually beneficial and non-discriminatory basis, in accordance with the European Community Treaty and other international rules, including the Energy Charter Treaty.
2. Support cross-border trade in accordance with the European Community Treaty and other international rules, including the Energy Charter Treaty.
Feasibility: possible to realize/easiness of realization.
Minimization of risks associated with the options:
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• Risks related to the technology (glitches, hacking, etc.);
• Price volatility;
• Risks of default.
Maximization of potential benefits associated with the options:
• Market competition;
• Market efficiency;
• Attractiveness to investors.
Policy Option 1, the Modified ETM, is superior to the baseline scenario in terms of quantified expected NPV, the effectiveness criteria and the maximization of potential benefits. On the downside, it is substantially harder to implement and presents slightly higher risks (especially in terms of technological reliability).
Figure 1.1: Comparison of options using cost-benefit and multi-criteria analysis
EVALUATION CRITERIA Baseline Scenario Modified ETM
Incremental Benefits – Incremental costs (NPV)
2019-2028
- 56 mil GEL
PV of incremental Benefits 2019-2028
- 436 mil GEL
PV of incremental Costs 2019-2028
- -380 mil GEL
Effectiveness 1 0 +++
Effectiveness 2 0 +++
Feasibility / Ease to comply 0 ---
Minimization of Potential Risks
0 -
Maximization of Potential Benefits
0 +++
According to the analysis, the expected outcomes of the Modified ETM appear to be much more in line with the goals of the reform than those for the baseline scenario. For this reason, it is recommended to move forward with the reform.
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2. PROCEDURAL ISSUES AND CONSULTATION OF INTERESTED PARTIES
2.1. CONSULTATION AND EXPERTISE
Meetings and consultations with stakeholders were conducted throughout the project implementation phase. Data collection took place throughout the project.
The first step of the project and consultation process was the identification and categorization of the main stakeholders in an influence-interest matrix format. Table 2.1 presents this matrix.
Table 2.1: Influence-interest matrix
INFLUENCE / INTEREST LOW INFLUENCE HIGH INFLUENCE
Low Interest Citizens and residential consumers
Parliament
High Interest Ltd PERI, JSC “Khramhesi – I”, JSC “Khramhesi – II; Georgian Stock Exchange direct consumers, non-governmental organizations (NGOs); civil society organizations (CSOs) dealing with environment, social assistance; local self-governments
MoESD, GNEWRC, GSE, ESCO, Parliamentary Committee on Sector Economy and Economic Policy, mass-media
The project team met with the most important stakeholders of the energy sector and conducted in-depth interviews. Each meeting lasted approximately from one to three hours. Though, most meetings and conference calls were conducted at the beginning of the project. The project team continued active collaboration with all major stakeholders throughout the RIA implementation period.
To create a successful RIA document, a number of research methods were used, such as: data collection, analyses of official data, face to face consultations and in-depth interviews. Table 2.2 summarizes the information collected and the methods used.
Table 2.2: Description of data and research methods
DATA AND INFORMATION METHODS USED/SOURCE
International experience on ETM and the Energy Sector
Desk research; requesting data and information from international consultant
Current situation on the power market in Georgia
Desk research and information from relevant stakeholders
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Analyzing United Nations (UN) relevant Sustainable Development Goals (SDGs) and Strategic Objectives of GoG and MoESD
Desk research
EU Directives Desk research
Information and experience gathered from relevant stakeholders
Requesting data and information from relevant stakeholders
During the in-depth interviews and consultations, topics that were discussed included but were not limited to: possible effects of the deregulation and the new energy market model; effective functioning of the thermal and hydro-power plants in Georgia; opportunities for investors for further investing money in energy system; the short-term and long-term perspective of electricity tariffs in Georgia; the role of current state owned entities and organizations/commissions in the new energy market model; potential local and foreign organizations willing to invest in water recourses of Georgia; etc.
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Table 2.3: Summary of the consultation process (summarizes the consultation process (detailed description of the meetings and interviews is given in APPENDIX A).
STAKEHOLDER/ GROUP OF STAKEHOLDERS
TIMING OF CONSULTATION
CONSULTATION METHOD
CONSULTATION OUTPUT/SUMMARY OF RESPONSES COMMENT
G4G Preliminary meeting, July 26, August 10, August 25, October 4, October 24, 2017
Meetings During the meetings following issues were discussed: - Compliance of Georgian energy system to EU Competitive Market Principles; - Harmonization with the Turkey’s power market; - Objectives of the GoG and MoESD; - The importance of maintaining low electricity prices for socially vulnerable citizens; - Other relevant and important issues (direct consumers, competitive trading, etc)
Responses taken into consideration
Meeting with the relevant stakeholders with participation of project international experts
• GNEWRC
• GSE
• ESCO
• JSC “Khramhesi I” and “Khramhesi II”
• Gardabani Thermal Power Plant (unit 9 &10)
• Dariali HPP
• MoE
• MoESD
• Georgian Stock Exchange
• RIA Experts
Meetings took place from July 19, 2017, to January 30, 2018.
Meetings, interviews, conference calls
During the meetings, the following issues were discussed: - Deregulation of electricity prices; - Fair competition for all involved parties; - Opportunities for export; - Sustainability of the energy system; - Bi-directional flows with Turkey and their constraints; - Direct consumers; - Clearing house. All stakeholders support the deregulation of the market and establishment of ETM; their expectation is that after the deregulation the electricity prices will rise; overall, they are skeptical of the possibility of selling electricity in Turkey due to low prices, uncertainty and bureaucracy. Stakeholders also think that the main challenges are: deregulation of system with no opportunities for monopolistic dominance (unbundling is of crucial importance where the generation, supply and the ownership of the grid will be separated at least regarding the ownership and control); government measures of trying to lower the tariffs (tariffs are reflecting the social policy of the government and not the expectation of the investors); stability of GEL. The responses also included the following: deregulation should cover not only newly built HPPs but also thermal power plants
Responses taken into consideration
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(TPP) and HPPs that were built before 2008 (those that were built before 2008 should be deregulated gradually with exception of Enguri HPP); in the deregulated market a transmission system operator (TSO) should be formed; the role of GNEWRC will gradually transform from regulating tariffs to regulating competition on power market; in the deregulated market, ESCO’s role should be transformed to the market operator; taxation and customs procedure prevent bi-directional flows with Turkey; according to the agreement with the International Energy Community, customers that are users of 6-10 kV, 35-110 kV transmission voltage will be considered as eligible customers and will begin trading as direct consumers.
Workshop was held with participation of donor community and state agencies. The following stakeholders participated in the meeting:
• MoESD
• USAID
• G4G
• Ilia State University
• ISET Policy Institute
• GNEWRC
• GSE
• ESCO
Workshop took place at Ilia State University, April 11.
Workshop 1 G4G and its grantee Ilia State University, implementing the “RIA on ETM” presented the RIA findings to the officials and representatives of the MoESD and other state agencies. Deputy Minister, Giorgi Chikovani, was also present at the meeting. He gave opening remarks for the workshop. During the meeting, speakers presented various legal and economic aspects of ETM and validity of the basic assumptions behind the RIA were discussed.
The topics of the discussion included – general RIA findings; CBA; objectives of RIA; policy analysis; qualitative and quantitative analysis of selected policy options.
Responses taken into consideration
Workshop was held with the participation of representatives from private legal entities, NGOs, and academia.
Workshop took place at Ilia State University, April 19.
Workshop 2 G4G and its grantee ILIAUNI, implementing “RIA on ETM,” presented the RIA findings to the representatives of the private legal entities, NGOs and lecturers. During the meeting, speakers presented various legal and economic aspects of ETM and validity of the basic assumptions behind the RIA were discussed.
Responses taken into consideration.
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Following stakeholders participated in the meeting:
• USAID
• G4G
• Ilia State University
• ISET Policy Institute
• GREDA
• Galt & Taggart
• Phazisi Group
• Georgian Stock Exchange
• WEG
• SGI Frontier Capital
The topics of the discussion included – general RIA findings; CBA analysis; objectives of RIA; policy analysis; qualitative and quantitative analysis of selected policy options.
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3. PROBLEM DEFINITION
3.1 POLICY CONTEXT
Since 2005, Georgia has been implementing extensive reforms in its electricity sector, including in terms of its restructuring, privatization and partial deregulation. Capacity and output of the industry has significantly increased due to growing investments.
As a result of accession to the Energy Community in October 2016, Georgia undertook an obligation to harmonize its legislation with the EU Energy acquis. The agreement between the EU and the GoG stipulates the completion of development and implementation of a power exchange platform by the end of 2018. The AA obliges Georgia to address key issues in the energy sector, including:
- Development of competitive, transparent and efficient energy markets allowing third parties a non-discriminatory access to networks and to consumers, following EU standards, including the development of the relevant regulatory framework;
- Development of an attractive and stable investment climate by addressing institutional, legal, fiscal and other conditions;
- Development of energy infrastructures of common interest, in order to diversify energy sources, suppliers and transportation routes in an economic and environmentally sound manner;
- Enhancement of security of energy supply, increasing market integration and gradual regulatory approximation towards key elements of the EU acquis;
- Enhancement and strengthening of long-term stability and security of energy trade, transit and transport, and pricing policies, including a general cost-based system for the transmission of energy resources, on a mutually beneficial and non-discriminatory basis in accordance with international rules, including the Energy Charter Treaty;
- Promotion of energy efficiency and energy savings in economic and environmentally sound manner;
- Development and support of renewable energies with a primary focus on hydro resources and promotion of bilateral and regional integration in this field.
A number of policy level documents adopted by Parliament of Georgia, GoG and MoESD as well as international agreements and declarations outline the general developmental strategy of Georgia in the power sector. These can be generalized under the following objectives per respective policy document:
1. Socio-Economic Development Strategy of Georgia “Georgia-2020” and associated activities, Government of Georgia, Resolution No 400, June 17, 2014. This strategy underlines the importance of the energy sector for economic development of Georgia and the recent spike in consumption of electricity. According to the Strategy, the two main guidelines of GoG action are the following: the increasing level of electricity consumption should not inhibit the development of businesses; the state must ensure a steady supply of electricity. The main objectives of the GoG, based on this strategy, are: development of sources of local power generation, improved energy efficiency, reduction of electricity imports and increase of electricity exports. The GoG expects the achievement of these objectives will lead to a reduction in the dependency from electricity imports, to a reduction of electricity prices, and to the creation of an environment of steady power supply. The strategy also addresses the issues of grid development and access to the distribution network, which are instead expected to lead to an increase in the price of electricity. The Strategy predicted that total annual production of electricity by 2017 would have been 12.0 TWh (in reality total generation for 2017 amounted to 11.531 TWh), and 14.0 TWh by 2020. At the same time, the Strategy prognosticated that by 2017 Georgia would have ranked #45, and by 2020 #35, in the World Bank (WB) Doing Business (DB) ranking of “Getting Electricity” (in reality, Georgia’s rank in the 2018 DB ranking for “Getting Electricity” – referring to the year 2017 – was 30).
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2. Main Directions of the State Policy in the Power Sector, Parliament of Georgia, Resolution No. 3758, June 24, 2015. Under this resolution, the main objective of the energy policy is to enhance the country’s energy security, which shall ensure protection of national interests through uninterrupted supply of various energy products of acceptable quantity, quality and price. Directions for the energy policy include: diversification of the sources of supply, optimal utilization of local resources and reserves; utilization of Georgia’s renewable energy sources; gradual approximation of Georgia’s legislative and regulatory framework with the EU Energy acquis; development of the energy market and improvement of the energy trading mechanism; strengthening Georgia’s regional transit role; positioning Georgia as a regional platform for generation and trading in clean energy; development and implementation of an integrated approach to energy efficiency in Georgia; taking into consideration environmental components in the course of implementing energy projects; improving ensuring service quality and protection of consumer interests.
3. Strategy of Development of Energy Sector of Georgia (2016-2025).3 This strategy has been elaborated by the MoE with the assistance of field experts and is consistent with the above listed two policy documents. MoESD’s strategy envisages three basic tasks: (1) ensuring energy security of Georgia; (2) creating a competitive investment environment; (3) developing the energy sector in line with the principles of sustainable development.
The priorities of this strategy include, but are not limited to, the following: harmonization of energy sector legislation with the EU energy acquis; improving the investment environment in the power sector via transparency, competition and self-regulation; decreasing dependency on imports; implementing social policy, etc. The Strategy predicts that during 2016-2026 the consumption of electricity by sector of economic activity will be the following: households will utilize 34%, industries – 32%, commercial entities – 30%, transportation – 4%, agriculture – 0.4%.
4. Ten Year Network Development Plan (TYNDP) of Georgia for 2017-2027. The Ten Year Network Development Plan of Georgia is elaborated according to Article 32 of the Law of Georgia “On Electricity and Natural Gas” by GSE with agreement of transmission licenses Energotrans LTD and JSC Sakrusenergo. The TYNDP was agreed by the GoG on December 9, 2016. The TYNDP was approved by the Minister of Energy on December 15, 2016 by # Order 103. The Plan highlights the development of the Georgian power system, a predominantly grid development, for the years of 2017-2027. According to the Plan, the total installed capacity of electric power plants operating in Georgia by the end of 2016 amounts to 4,106 MW. Based on signed contracts, the total installed capacity in the Georgian power system is expected to grow to 7,595 MW in 2027. According to the Plan, the total Generation in 2017 would have been 12.9 TWh, of which 1.26 TWh would have been exported (in reality only 0.686 TWh). By 2020, the generation is expected to grow to 17.61 TWh, of which 4.71 is planned to be exported. By 2027, the generation is expected to be 26.3, of which 9.9 is planned to be exported.
The TYNDP also highlights that the Georgian transmission network could be used for energy transit among Turkey, Russia, Armenia, Azerbaijan and Iran. The document defines the main drivers of the Georgian transmission network development: uninterruptable transmission of the existing generation; improvement of reliability; reclamation of the new energy resources; integration of new HPPs into the network; increasing network potential with respect to power transit; establishment of reliable power supply centers for promoting development of potential production/tourist centers; responding to the naturally growing demand in the power system; replacement of aged thermal units with flexible and cost-effective combined cycle thermal power plants; provision of sufficient operating reserves; improvement of the power quality.
5. Agreement between the Government of the Republic of Turkey and the GoG on the Cooperation in the Field of Energy. This Agreement was signed on April 9, 2015, by the Minister of Energy of Georgia and by the Minister of Energy and Natural Resources of Turkey to be in effect for 20 years. According to this agreement, parties have declared their will to “promote the development of bilateral scientific, technical, technological, legal, administrative and commercial cooperation between the parties in the field of energy, particularly in the areas of energy resources, green energies and energy efficiency, electricity trading, cooperation in the development of the new transmission infrastructure
3 For the purposes of the RIA on ETM only Electricity Part of the Strategy was analyzed. This document is not approved by the Ministry, and therefore, it is a project not an official source.
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and in the field of electricity transmission, cooperation in knowledge/experience sharing on European Network of Transmission System Operators (ENTSO-E) integration process and electricity within the framework of their National Legislators.”4 At the same time, according to this agreement, parties have declared that they shall cooperate in the areas of developing necessary infrastructure and facilitation of the trade through the trade instruments such as long term power purchase agreements in compliance with ENTSO-E rules. Regarding the electricity trade, parties agree to develop intercommunication between capacity auction platforms in both countries based on the same software that is used in Turkey. Under the same agreement, common and non-discriminatory rules established by international agreements and national legislations shall be applied to the operation of the interconnection lines between the Republic of Turkey and Georgia. Capacity allocation for the interconnection lines shall be utilized by application of “year ahead,” “month ahead” and “day ahead” basis. The agreement also provides that after the Government of the Republic of Turkey becomes a member of ENTSO-E subject to Georgia’s request, the Government of the Republic of Turkey shall support the integration process of the Georgian Power System with ENTSO-E.5
6. EU Directives. As an Associate Member of the EU, Georgia, is committed to implement EU Directives in the energy sphere. Among other issues, these Directives support adequate balance between supply and demand; security and continuity of electricity supply; appropriate level of interconnection between Member States; importance of a transparent and stable regulatory framework; transparency of electricity prices; investments in transmission and distribution system; promotion of the use of energy from renewable sources; unbundling of transmission systems and transmission system operators; implementation of a system of third party access to the transmission and distribution systems based on published tariffs and applied objectively and without discrimination between system users; setting fair rules for cross-border exchanges in electricity, thus enhancing the competition within the internal market in electricity.
7. Protocol Concerning the Accession of Georgia to the Treaty Establishing the Energy Community. Protocol defines that Georgia accedes to the Treaty as a contracting party and undertakes obligations of implementing EU Directives and Regulations. According to the Protocol, from December 2018, all legal entities will be considered as eligible customers who will be free to purchase electricity from the supplier of his/her choice, and therefore, will be “forced” to trade as direct consumers, and from December 2019, all customers will be considered as eligible customers, including households. Protocol underlines the obligation of executing EU Directives with the abovementioned responsibilities, including unbundling of generation, supply and grid ownership.
8. UN Sustainable Development Goals (SDGs) – 2030 Agenda for Sustainable Development. The GoG as the member of Open Government Partnership (OGP) Steering Committee adopted the declaration on implementation of SDGs. Goal 7 of SDGs states that countries should: “ensure access to affordable, reliable, sustainable and modern energy for all”.
It should be noted that Resolution of the Parliament of Georgia on Main Direction of the State Policy in Power Sector and the Strategy of Development of Energy Sector of Georgia both underline the role of the state in supporting the vulnerable population and ensuring an uninterrupted supply of electricity.
3.2. PROBLEM DEFINITION
Historically, electricity sectors around the world evolved as vertically integrated monopolies controlling all segments of the power market: generation, high-voltage transmission lines and local distribution companies. This was due to the particular characteristics of the electricity sector, characterized by a high level of capital intensity and by a decreasing-cost structure. In this situation, a monopoly is expected to emerge.
4 Agreement, Article 3.1 5 Agreement, Article 10.
7
As monopolies lead to social losses, due to their maximization strategies that lead to excessively high prices and excessively low generation, government decided to intervene. This initially led to either government ownership or price regulation.
However, government regulators and owners may fail. Regulating the electricity sector requires expertise in a variety of areas, including engineering, economics, accounting and finance, which is not always available among politically appointed regulators. Moreover, regulators may be “captured” by powerful interest groups (producers, consumers, environmental groups, and even the executive and legislative branches of the government, using energy policy as a tool to gain popular support).
Beginning in the 1990’s, most developed markets and an increasing number of developing markets have evolved (or are evolving) towards some form of wholesale or retail liberalization. In the first model, there is competition in generation, accompanied by a common or contract of carriage of high-voltage transmission lines offered to all wholesale sellers and buyers and with distribution companies often owning the distribution wires and choosing their suppliers on the wholesale market. In the second model, retail customers can also choose their suppliers.
Currently, the potential advantages of competition, when combined with appropriate restructuring and incentive regulation, have been demonstrated6 and are the main reason for the EU’s commitment to a market approach to energy policy.
This market approach, however, still needs to deal with the obstacles that can prevent the achievement of efficient outcomes. Among them:
• Public goods;
• Market power;
• Presence of externalities.
Transmission and distribution networks have an element of excludable public goods (or club goods). For this type of goods, efficiency requires that the good is produced if the sum of marginal values attributed by agents to the good exceeds its marginal cost. For network expansions this suggests that beneficiaries should pay. The challenge resides in quantifying the identity of the beneficiaries and the entity of the benefits.
Transmission and distribution networks are also natural monopolies, requiring regulation both to prevent consumer exploitation and investment protection.
Finally, in the presence of externalities (greenhouse gas emissions, air pollutants, learning spillovers), in order to ensure efficiency, the value of these externalities should be properly charged (via pollution taxes) or compensated (via targeted subsidies).
Ultimately, the main challenge in ensuring an efficient functioning of the electricity market is to find a system that minimizes market and government failures.
Existing constraints and potential to overcome them The current system is largely managed by policy makers and conditions for investment and trade may change based on their political agenda. The proposed changes are first steps in the direction of achieving above mentioned objectives, by introducing market system for all market participants with the goal to eliminate all indirect subsidies within next 10 years and moving to fully-fledged free market system.
Shifting to a free market would require dealing with a number of challenges, such as endorsement of rules of competition, free third-party access, unbundling, development of the grid, electricity tariffs, awareness of the stakeholders, incentivization of investors and more. A major constraint to the full liberalization of the market is the existence of several categories of producers of electricity with different backgrounds and ongoing situation: 1) Enguri & Vardnili HPPs; 2) Privatized HPPs (most of these HPPs were privatized in 2007-2008);
6 Galal et. Al. (1994), Newbery and Pollitt (1997), Pollitt (2012), and references therein.
8
3) Newly built HPPs (with PPAs from ESCO)7; 4) Small HPPs (below 40 MW); 5) Thermal power plants. In addition to the strategic challenges, there are open technical issues. Transformation to the free electricity market may be unfair for 3rd and 4th category producers as these producers are disadvantaged vis-à-vis other producers. Enguri and Vardnili HPPs are partially located in Abkhazia, and almost half of the produced electricity is supplied to the population of Abkhazia. It is unclear how much more electricity will be taken from these plants if the consumption in Abkhazia increases. Besides, their tariffs do not reflect the full cost of capital of the plants. This means that they are subsidized (in order to keep final consumer tariffs low) and would have a competitive advantage over other plants. But, in case Abkhazia takes a larger proportion of the generated power, they would suffer as compared to other market participants. Privatized HPPs have been sold at the price that would not reflect full replacement costs of these plants. The reasons are the same as above. Hence, they also would have a competitive advantage over free players. The third category of generators has a long term power purchase agreement with the state owned ESCO to sell a large part their electricity at a fixed price. This means that they cannot change their price to electricity with changing market conditions. As long as private investors expect to fully recover their investment, competing against the plants, which have recovered large part of their capital costs during Soviet times and where privatized below their replacement value, will be almost impossible. Small HPPs are fully deregulated and they can sell electricity freely with no constraints or no obligations. Thermal power plants have two-tier tariffs: capacity fee and tariff that covers variable costs (price of the fuel). Due to the low operating leverage as compared to HPPs they could not be as flexible as HPPs in free competition. It is therefore clear that it would be hard to reach strategic goals without addressing technical issues for each particular case.
Further, to safeguard uninterrupted flow of investments to the sector, Georgia needs to ensure that its electricity market design enables fluidity of electricity trading with its neighboring countries. To facilitate further development of the sector Georgia needs to introduce and endorse such trading tools and risk management techniques which shall be aligned with the needs of the neighboring electricity markets and enable electricity cross-border and bidirectional trading on an hourly basis.
3.3. BASELINE SCENARIO
ELECTRICITY GENERATION, CONSUMPTION AND TRADE
Over the past six years, the country’s annual surplus of electricity generation changed into a deficit. During the period of 2007-2011, in annual terms, Georgia was producing more electricity than it was consuming. However, the gap between generation and consumption has been increasing since 2012 (with the minor exception of 2016), peaking in 2017 with 806 mln kWh of deficit.
7 Currently government has signed more than 180 PPAs and Memorandums of Understanding, some of them were never executed but this figure clearly shows the policy and obligations of the Government to attracting investors with taking a responsibility on buying the electricity at least for 10 years period mostly on winter season (October-March).
9
Figure 3.1: Generation-consumption gap
The reason behind this large deficit is a minor decline in generation, accompanied by a robust increase in consumption (+8% compared to 2016). Over the past 10 years, the electricity annual average growth rate of consumption was 4.17%, against 3.02% for generation (Figure 3.2).
Figure 3.2: Annual electricity consumption and generation
To cover its annual power deficit, Georgia imports (Figure 3.3) electricity primarily from Russia (30% in 2017 imports), Azerbaijan (61% in 2017 imports) and Armenia (9% in 2017 imports). As for the exports, Georgia exports power to Turkey (41% in 2017 exports), Russia (38% in 2017 exports) and Armenia (20% in 2017 Exports). Turkey has become the main market for Georgia’s electricity exports and the country’s energy policy is oriented on increasing its potential on this market.
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Figure 3.3: Electricity import and export for Georgia
The biggest challenge of the country over the years remains the seasonality in generation and consumption. Electricity consumption peaks from October to March, while the highest point of generation is achieved from April to August each year. Seasonality in power consumption is primarily due to a relatively underdeveloped industrial electricity consumption and to the low use of cooling appliances in the summer. From the power generation perspective, the cause of seasonality is a large portion (roughly 80%) of hydropower plants in total power generation of the country. The large decrease of power generation in winter is primarily filled by thermal power plants, working on imported natural gas and electricity imports. Seasonality of the Georgian electricity market defines electricity trading patterns of the country. Figure 3.4 shows the seasonality in electricity consumption and generation from the monthly perspective.
Figure 3.4: Monthly electricity generation and consumption
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TRENDS IN ELECTRICITY PRICES
Seasonality in power generation and consumption influences electricity prices at all levels. The prices for the balancing electricity provide a good proxy for this pattern. The balancing electricity prices fall during summer months, while increasing during the winter – Figure 3.5.
Figure 3.5: Weighted average prices for balancing electricity (US ¢/kWh)
Over the past four years, electricity import and export prices have been decreasing, however there is no clear long-term trend for these prices – Figure 3.6. One clear characteristic is that export prices are always below those for imports.
Figure 3.6: Weighted average annual prices for electricity import/export (US ¢/kWh)
The prices that “absorb” all annual trends of the Georgia’s electricity market are retail electricity tariffs set by GNWERC. Georgia has three separate tier block prices both for private households and industrial customers. Over the past 10 years, the trend of retail prices has been increasing – Figure 3.7 – 3.8.
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Figure 3.7: Retail electricity tariff for households (Tetri/kWh - w.o. VAT)
Figure 3.8: Retail electricity tariff for commercial costumers (Tetri/kWh - w.o. VAT)
GENERAL MARKET CHARACTERISTICS
Economic Growth and Electricity Consumption
In general, electricity consumption has been following overall patterns for economic growth in the country. As expected in most years, electricity consumption in Georgia has increased at a higher rate than the economy (Figure 3.9.) However, growth in electricity consumption is highly volatile and is largely dependent on specific sectors of the economy that have been growing.
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Figure 3.9: Annual electricity consumption and GDP growth
Competition on Electricity Market
As already discussed in subsection discussing the policy context, Georgia’s electricity market is highly regulated. However, after further steps of deregulation, the competition on the market is expected to increase and to play a fundamental role. At this stage, Georgia’s power market is highly concentrated. Around 40% of annual generation comes from government enterprises that represent 43% of total installed capacity in the country. Hirschman-Herfindahl index (HHI) for power generation in 2017 was 2,326 out of 10,000 (with a value of 10,000 corresponding to full concentration). More importantly, market concentration significantly increases in the summer months reaching up to 4,341, when large state owned HPPs are in their peak generation period – Figure 3.10.
Figure 3.10: Herfindahl-Hirschman Index (HHI) for 2017
If the current trends were to continue without modification, it would be plausible to expect an increase in the electricity gap, especially during the winter and early spring months, potentially leading to an increase in retail electricity prices and to a greater reliance on imports.
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4. OBJECTIVES
4.1. GENERAL OBJECTIVES
General objectives for creating the ETM are to:
1. Enhance the efficiency, competitiveness, resilience, sustainability and accessibility of the electricity market on a mutually beneficial and non-discriminatory basis, in accordance with the European Community Treaty and other international rules, including the Energy Charter Treaty.
2. Support cross-border trade, in accordance with the European Community Treaty and other international rules, including the Energy Charter Treaty.
4.2. SPECIFIC AND OPERATIONAL OBJECTIVES
A number of specific and operational objectives are associated with the general objectives listed above:
1. Enhance the efficiency, competitiveness, resilience, sustainability and accessibility of the electricity market on a mutually beneficial and non-discriminatory basis in accordance with international rules, including the Energy Charter Treaty.
1.1. Implementation of EU Competitive Market Principles, ensuring third party access to transmission and distribution systems within the Georgian market;
1.2. Addressing institutional, legal, fiscal and other issues preventing the development of an attractive and stable investment climate and of a competitive electricity market;
1.3. Ensure the uninterrupted access of consumers to the electricity market, at affordable prices (with a particular emphasis on vulnerable groups and strategic economic sectors);
1.4. Promotion of energy efficiency and energy savings in economic and environmentally sound manner;
1.5. Support the development of generation capacity utilizing renewable and environmentally friendly energy sources.
2. Support Cross Border Trade.
2.1. Implementation of EU Competitive Market Principles, ensuring third party access to transmission and distribution systems in the context of cross border trade;
2.2. Enabling neighboring countries to transit power through Georgia;
2.3. Harmonizing power market regulations in a way which allows fair trading with neighboring trading partners.
Table 4.5: Summary of objectives
General Objective Specific Objective Indicator Responsibility
1. Enhance the efficiency, competitiveness, resilience, sustainability and accessibility of the electricity market on a mutually
1.1. Implementation of EU Competitive Market Principles, ensuring third party access to transmission and distribution
100% of the EU Directives and requirements of EU Energy Community relative to cross-border trade implemented by the end of 2018.
Sustaining decreasing trend of Herfindahl-Hirschman
MoESD
GNEWRC
15
beneficial and non-discriminatory basis in accordance with international rules, including the Energy Charter Treaty.
systems within the Georgian market
Index (HHI) for market concentration
1.2. Addressing institutional, legal, fiscal and other issues preventing the development of an attractive and stable investment climate and of a competitive electricity market
MoESD engages relevant stakeholders to identify institutional, legal, fiscal and other issues preventing the development of an attractive and stable investment climate and of a competitive electricity market and produce a book of recommendations;
100% of institutional, legal, fiscal and other issues identified as preventing the development of an attractive and stable investment climate and of a competitive electricity market are addressed by ………….
MoESD
GNEWRC
1.3. Ensure the uninterrupted access of consumers to the electricity market, at affordable prices (with a particular emphasis on vulnerable groups and strategic economic sectors), growing in a predictable way
X% of consumers having access to electricity market by……
Improving the score on the index of “Getting Electricity” in Doing Business;
Reliability of the system fully within the parameters established by GNEWRC in the whole country by …….
Electricity prices in the regulated sector evolve in a predictable way and do not increase faster than necessary to cover generation (operational and investment) costs;
The cost of the consumption of a minimum monthly socially acceptable quantity of electricity for private consumption (to be defined) remains below a pre-defined threshold set by ……….
Presence of universal supplier on the market starting from….
MoESD
MoLHSA
1.4. Promotion of energy efficiency and energy savings in economic and
Tariffs and energy prices allow covering the true opportunity costs of generation (including
MoESD
GSE
ESCO (Market Operator)
16
environmentally sound manner
operational, investment and environmental costs).
1.5. Support the development of generation capacity utilizing renewable and environmentally friendly energy sources
The share of electricity generated by renewable and environmentally friendly energy sources grows with time. Goal: X% by…….
The MoESD sets a target in terms of maximum administrative burden for setting up new generation using renewable and environmentally friendly energy sources and the target has to be achieved by……
2. Support Export and Cross-Border Trade
2.1. Implementation of EU Competitive Market Principles, ensuring third party access to transmission and distribution systems in the context of cross border trade
100% of the EU Directives and requirements of EU Energy Community relative to Cross Border Trade implemented by end 2018;
Sustainable increase in electricity trade with neighboring countries (+X% per year);
Sustaining decreasing trend of HHI calculated looking at the market shares of exporter in total exports.
MoESD
GNEWRC
2.2. Enabling and facilitating neighboring countries to transit power through Georgia
100% of required legal amendments in legislation are implemented by end 2018;
All information about transit rules, capabilities and fees is transparently available and easy to access for electricity traders by ……..
Electricity transit capacity is increased to ……… by ……….
MoESD
GNEWRC
2.3. Harmonizing power market regulations in a way which allows fair trading with neighboring trading partners
100% of required legal amendments in legislation are implemented by 2018
MoESD
GNEWRC
17
5. POLICY OPTIONS The choice of the option and its features has to be largely aligned with the general and specific objectives of the state declared in the respective strategy documents, legal acts and international instruments.
After several meetings with stakeholders, most importantly with MoESD, and considering the range of regulatory and non-regulatory options, based on the agreement with G4G, project team decided to analyze the Business As Usual (“do nothing scenario”) and Modified ETM. The first option characterizes the ongoing scenario, status quo, and gives its impact analysis in the short and long-term periods.
The second option is the Modified ETM, which addresses the modification of the current market scenario and assesses cost-benefits in the short and long-term.
The project team also analyzed two more options: the Nord Pool (adjusted version to Georgia Market) and Free Market scenarios. After thorough analysis and meetings with relevant stakeholders, it was decided to put these options in annexes (Annex C), as they are not feasible in the nearest future but at the same time, can give political decision makers the possibility to discuss these options in the coming future.
The Nord Pool gives opportunity to market participants to receive electricity on more fair terms and increases competition but has different nodes to different regions, as the electricity price in the given region depends on the local generation. For example, according to Nord Pool Option, the electricity tariff in some rural parts of Georgia should be higher than in urban areas of our country. This model may be a good starting point if the opportunities arise for the Georgia to become regional energy/power hub. Therefore, we would advise to consider this option from the regional viewpoint (considering different rules may apply at different nodes, neighboring countries use different trading and transmission rules).
The differentiation of prices at different nodes for different consumers (especially if the rural population will have high tariffs as compared to more densely populated areas) would not be acceptable for the GoG for political reasons. In addition, increased investments in the grid will increase transmission costs, eventually increasing consumer tariff. In this case the GoG will also be opposing the growth of tariffs.
The fourth policy option is the Free Market Scenario, which envisages creation of free day-ahead and balancing markets by using the distributed ledged technology, eliminating the intermediaries and giving opportunity for peer-to-peer transactions. This option gives higher transparency and price reduction in the long-run, but quick introduction of this option may cause an increase of wholesale electricity prices by 15-20% (i.e. replacement cost of power production). Newly built HPPs, which have PPAs with the GoG, will suffer serious losses. Due to possible resistance to immediate liberalization of the market by the GoG, it is believed that this option may be utilized at a later stage (after expiration of PPAs and contracts with privatization participants).
Common assumptions
Before describing the assumptions that are specific to each of the two options analyzed, it is important to mention those that are common to all of them. All the variables mentioned below are exogenous (i.e. they are not affected by changes in the model output and/or by the reform option chosen).
The values of the main macroeconomic variables and their sources are displayed in Table 5.1.
Table 5.1: Variables and sources
Variables Value Source/Methodology
Discount rate 9.81% National Bank of Georgia (NBG)/nominal interest rate on 10-yr government bonds
Price elasticity of demand - 0.25 Average value for short-run price elasticity from 23 academic papers (see Appendix D)
Growth rate of electricity consumption
4.17% ESCO/growth rate calculated on total electricity supplied to customers excluding transportation losses and consumption of Abkhazia, 2007-2017
18
Growth rate of electricity supply (in baseline)
3.7% MoESD, author calculations / total generation is calculated based on increasing of current generation in 2017 by estimated annual generation of planned power plant projects that have specific commencement dates till 2028. The data of feasible projects was corrected by expert opinion.
Growth rate of electricity supply (in ETM)
5.807% MoESD and author calculations / total generation is calculated based on increasing of current generation in 2017 by estimated annual generation of planned power plant projects that have specific commencement dates till 2028. The commencement dates were increased by 5 years.
Retail price of electricity in 2017 (GEL)
0.1447 MoESD, GNEWRC / weighted average price of electricity for retail customers. Official tariffs of electricity in 2017 were weighted by share consumption of each price block in total consumption and share of each distribution company in total electricity supply excluding Abkhazia.
Retail price of electricity in 2025 (GEL)
0.1995 MoESD, GNEWRC / growth trend of electricity tariffs between 2006 and 2018, by the distribution companies. One tariff was calculated with same weighting rule as for retail price in 2017.
5.1. POLICY OPTION 0 (STATUS QUO – “DO NOTHING SCENARIO”)
The actors currently participating to the functioning of the Georgian power market (GPM) are the following:
• MoESD;
• GNEWRC;
• GSE;
• ESCO;
• Distribution companies:
o JSC “Energo-Pro Georgia
o JSC “Telasi”
o JSC “Kakheti Energy Distribution”8
• Generators:
o Regulated generators: these are all power plants built before 1 August 2008 and with installed capacity above 40 MW. In addition, regulated power plants include all thermal power generators that provide base load and are consequently subject to guaranteed capacity payments.
o Deregulated generators: under the Georgian Law on Electricity and Natural Gas, all electricity generators built since 1 August 2008 are deregulated. However, this does not include those thermal power plants that provide base load. In addition, all power plants that have installed capacity below 40 MW are also considered deregulated. Such power plants are not subject to the tariff setting by the national regulator. Among the newly built HPPs with installed capacity above 40 MW, only three are deregulated (Paravani HPP 86.54 MW, Dariali HPP 108 MW and Khelvachauri HPP (1) 47.48 MW).
8 Very recently JSC “Kakheti Energy Distribution” was bought by Energo-Pro Georgia” but it is still indicated separately in the document to highlight the importance of distribution system and difficulty to provide electricity to the regions.
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MoESD is responsible for policy and strategic development of the energy sector. MoESD prepares the Strategy, promotes the investments and, represents GoGs interests in Energy Sector, both locally and in international organizations.
GNEWRC is the independent regulator which is responsible for competitive environment of the market. GNEWRC sets tariffs, issues, renews and cancels licenses to market participants.
GSE is the system operator (transmission and dispatch is performed by GSE) and performs ancillary services as well.
ESCO is the market operator and it balances the difference between the consumption and the amount of the electricity specified by the contracts. ESCO is responsible for the purchase of electricity from newly constructed power plants. ESCO also buys electricity from small HPPs.
ESCO executes power trading in two ways. The first type of power trading is done when the customer purchases the electricity from ESCO. Another way for power trading is through a contract between ESCO and a customer where the amount and price of the electricity are not defined. In the latter version, the trading is performed as a power exchange after receiving requests from both sides. The power exchange does not affect the consumer tariff.
Three companies are carrying out the distribution of energy in Georgia: JSC “Energo-Pro Georgia” (which is the largest transmission company in Georgia and has several features: distribution, transit and production of electricity), JSC “Telasi” (distributes electricity in Tbilisi and to nearby areas), and JSC “Kakheti Energy Distribution” (distributes electricity in Kakheti region).9
There are several main categories of producers of electricity with different backgrounds and ongoing situation:
1) Enguri & Vardnili:
Enguri and Vardnili are partially located in Abkhazia, and more than half of the produced electricity is supplied to the region’s population. Their tariffs do not reflect the full cost of capital of the plants. This means that they are subsidized (in order to keep final consumer tariffs low) and would have a competitive advantage over other plants.
2) Privatized HPPs (most of the were privatized in 2007-2008):
HPPs have been sold at the price that would not reflect full replacement costs of these plants. This was done in order to keep the final consumer prices low.
3) Newly built HPPs (with PPAs from ESCO):
Newly built HPPs have long term PPAs with ESCO to sell a large part their electricity at a fixed price. This means that they cannot change their price of electricity with changing market conditions.
4) Small HPPs (below 40 MW):
Small HPPs are fully deregulated and they can sell electricity freely with no constraints or no obligations.
5) Thermal power plants:
Thermal power plants have two-tier tariffs: capacity fee and tariff that covers variable costs (price of the fuel). Due to the low operating leverage as compared to HPPs, they could not be as flexible as HPPs in free competition. The average price of TTP is higher than average price of HPP.
9 Ministry of Energy of Georgia, http://www.energy.gov.ge/energy.php?id_pages=63&lang=eng.
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Figure 5.2: The current functioning of the Georgian power market
Source: ESCO10
The current electricity market model is a partially deregulated electricity trading system. Around 90% of electricity is generated by the regulated generators. The participants of the power market – customers and the generators, make short-term and long-term direct contracts on sale and purchase. Balancing electricity is traded exclusively through ESCO. Balancing market management and clearing function is carried out by ESCO.
Third party access is ensured and any consumer with more than 1 kWh of annual consumption may become a direct customer of a generation plant.11 Direct contracts are allowed and the capacity charge12 is collected from the market participants.
An eligible enterprise that has not signed and duly registered the direct contract on purchase or sale of electricity according to the applicable law, shall be automatically linked to the Standard Conditions of Direct Contract on Purchase and Sale of Balancing Electricity. GNEWRC approves the Standard Conditions of Direct Contract on Sale and Purchase of Balancing Electricity, based on the market operator’s proposal.13
According to the current market rules, vertical integration is allowed. This means the distribution companies can own generating units as well.
Risks and Risk Mitigation
- The current market scenario bears several risk factors that can affect market participants and the final consumers in the short and long run: it is not harmonized with the EU Directives and with the Treaty of Energy Community, therefore it does not answer to the obligations that have to be fulfilled by the country in the years to come;
- It does not answer to the strategy and policy of the GoG, as Georgia tries to harmonize its regulations with the EU Energy Community;
10ESCO, http://esco.ge/en/electricity/trade-scheme.
11ESCO, http://esco.ge/en/kvalifitsiuri-satsarmoebi.
12 Capacity Charge is the same as the capacity fee. These fees are covering fixed costs. 13ESCO, http://esco.ge/en/electricity.
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- It can negatively affect price stability; Increased share of imports or newly build HPPs have higher than average tariff. Also, both of their prices are fixed in USD and forex fluctuations may have its own effect;
- Vertical integration and low level of unbundling strangles competition. Vertically integrated companies have huge market share and propose their own terms to others;
- As PPAs are abolished, the energy sector may not be able to attract investments, this eventually will cause the growth of the deficit of electricity, reduce energy independence.
In such a case, the long-term confidence in the energy sector can be supported only by reducing the regulation and allowing market participants to compete fairly among each other. However, for the purpose of this work, it is assumed that no regulatory change is taking place.
5.2. STRUCTURAL CHANGES REQUIRED FOR MARKET REFORM
By signing the EU-AA, and joining the European Energy Community, Georgia has acquired the obligation to adjust its regulations in compliance with EU directives. This gives Georgia the opportunity to modify its energy market model, concentrating on the goals mentioned in the objective section (enhance the efficiency, competitiveness, resilience, sustainability and accessibility of the electricity market and support cross border trade).
In order to avoid unfair competition, for the required reform and for the approaches that are analyzed below, it is suggested that the participants trade with a certain formulae during next 10 years.14
- Enguri & Vardnili HPPs can be excluded from the trade, and the generated electricity can be redistributed based on the current principles. This will meet one of the GoG’s intentions to keep electricity prices low.
- For the privatized HPPs, the cost of capital was not fully included in the privatization price and was redistributed over 10 years and added to their costs. Therefore, the discounted capital cost can be charged as a fee to this category of HPPs. The collected fee, by the TSO, can be charged on every kWh of electricity generated by such HPPs. The effect on the prices will be either none or negligible. However, HPPs of these categories would not be able to dump prices below their marginal cost plus the fee.15 The collected fee can be used by the TSO to fund difference between PPA prices and market prices for PPA holders.
- HPPs which have a PPA with ESCO shall trade at market prices. However, the difference can be covered by the TSO from the fund which can be collected from the final consumers (the difference can be both negative and positive). However, in order to reduce the incentive16 of these HPPs to dump prices, they can be obliged to pay a penalty to the TSO in the pro-rata range of the difference, if on average their offers have more than a10% lower price as compared to other market participants, during the month when trade was conducted.
- TPPs can be eligible of capacity/reserve fees from the TSO (if they provide reserve capacity). They will participate in the market based on their variable costs.
- GNEWRC will be strengthened as the independent regulator responsible for overseeing the ETM and ensuring fair competition rules among the market participants.
- The market operator (MO) will be created to operate the day ahead market. The MO will register market participants, receive and match bids and offers and calculate the market clearing price.
- Functions of the TSO will be performed by GSE. In the long-term, TSO can be formed as a separate entity. TSO will administer the security of the power system in real time. TSO will perform real time
14 After ten years all contractual obligations with current owners of Privatized HPPs, distribution companies as well as overwhelming majority of PPAs will be expired. 15 Though this is not part of our analysis but there are two alternatives regarding the HPPs that were privatized. First alternative is to allow them to trade freely on the market. But this option will give them superiority over other HPPs which have obligations according to the PPA and have a regulated price. If we allow them to trade on the market, GNEWRC should not give the opportunity for dumping pricing. According to second alternative, privatized HPPs can be precluded from Modified ETM but this might significantly reduce the trading. 16 This incentive will exist to take more profit from the trade. HPPs which have PPA receive fixed price for their electricity. Therefore the volume maters and they can dump prices.
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balancing, register bilateral contracts, organize the supply and demand of electricity in a way to avoid frequency fluctuations and supply interruptions.
- Harmonization of current legal framework with EU Directives and with protocol concerning the accession
of Georgia to the treaty establishing the Energy Community.
- Unbundling is one of the crucial aspects for effective functioning of ETM. Distribution system companies own generation plants and transit facilities in Georgia. In order to ensure the competitive principles of the market and harmonization with EU Directives, it is necessary to separate the supply functions from transmission and distribution.
- The clearing house is an entity for clearing electricity market transactions. This function should be performed by a financial institution with adequate risk capacity.
- Traders will be registered by GNEWRC to buy and sell electricity on ETM. Traders can enter into long-term and short-term transactions in the power market.
- Other participants of the ETM will be aggregators who are middlemen between groups of customers. Aggregator can offer a large customer pool to the suppliers and may be able to get competitive offers.
Risks
- Risk of financial insolvency can arise if a buyer of electricity does not have enough liquidity to keep the margin at the clearing house.
- Technological risks - as long as the system will be based on new technology, it would be important to ensure its proper maintenance. Every new technology contains additional risks, until tested, including glitches and hacking.
- Additional capital expenses may marginally increase the price of electricity, though the benefits of fair competition may overweigh the drawbacks of increased price.
5.3. MODIFIED ETM (POLICY OPTION 1)
This section describes the modernized and enhanced version of the current ETM model into which the following features and mechanisms are introduced:
a) Day-ahead market:
Bids and offers for the next day are made every day until 12:00 (or any other time in the first half of the day), on an hourly basis. Market participants either directly participate in the trade or via traders.
All market generators (including TPPs), trading companies and consumers may participate in the trades. In order to avoid price spikes during the peak hours or congestion, the prices can be capped by the price of the most expensive imported electricity (The MoE wanted to put up with such a limit).
Electricity generated by Enguri and Vardnili HPPs can be distributed evenly to all consumers17:
Newly built HPPs who have entered into PPAs with ESCO shall also participate in the trades. The difference between the market price and PPA price shall be offset by the TSO or by the market operator. However, it is suggested to use the offsetting formula for PPA holders to avoid price fixing. The funds for such an offset can be collected from all consumers via the end-user tariffs. However, in order to avoid inefficient bidding from such generators, they should be restricted to bid below the weighted average price of all bids made on the market.
b) Transmission system operator (TSO) – including a balancing function:
Balancing of supply and demand is provided by the TSO. The TSO also determines the market clearing price. This market model includes capacity pricing. Every market participant (consumer) pays a capacity charge to the TSO. The capacity fee is set by GNEWRC.
17 It means that regarding Enguri and Vardnili HPPs the current model of distribution energy will remain evenly to all consumers.
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DSOs can be split into two categories, low voltage transmission and suppliers/traders (billing).
In addition, this model requires:
c) Balancing mechanism:
The balancing on the market shall be implemented by the TSO, including imports of the electricity.
d) Clearing house:
Clearing function can be implemented by a seasoned financial institution, which will be able to take risks and offer trading margins to market participants.
The market system would also be able to register long term direct contracts through trading platforms. Full deregulation of generation plants and unbundling (high voltage transmission, supply and distribution) are prerequisites. Under this model, high voltage transmission and distribution activities are not deregulated. An overall and revolutionary discussion related to elimination of end user tariffs and introduction of social or last resort tariffs should be held.18 In addition, introduction of wholesale trading/supply companies will potentially improve the competitiveness on the market. GNEWRC and/or the MoESD can initiate this policy. As the generation pool is mainly composed of somewhat regulated plants (PPAs, mandatory dispatch etc.), it is crucial to design relevant structures that can help wholesale bilateral trading to emerge.19 From the security of supply perspective, certain quick-wins can be implemented immediately such as bi-directional flows on the Turkish border. Currently, there is no bi-directional flow from Turkey but negotiations have began to kick-off the process.
Given the ongoing digitalization movement in the energy business and applicability of low cost tools to integrate, it is of vital importance to introduce such structures to the Georgian power markets. These tools include digital platforms with automated online trading systems, smart metering systems, etc. This will allow the market to make a leapfrog move and to avoid spending time to fulfill and follow the traditional steps of market liberalization.20 After the expiration of contractual liabilities with distribution companies, privatized HPPs and power purchase agreements (which may happen within next 10 years), the market will be free of current imperfections and capable to set up equitable competitive environment. For example, this policy option introduces and recommends establishment of aggregators as a new category of a market player. These should mainly function as mini utilities which will carry out balancing, forecasting, scheduling, and demand management. The first three functions shall be provided with a VPP business model,21 while demand will be managed via demand side management business model. TSO will then be able to introduce congestion management tools/tariffs for better balancing of the system and that accumulated revenue can be used for TSO capital expenditures (CAPEX), which will further support the security of supply. Aggregators are introducing efficiency in the market by allowing small producers not to waste their resources (water for HPPs) and avoid influence of large consumers and distribution companies (DisCos).
This policy option also recommends further harmonization of the rules and regimes with the Turkish power market and by doing so utilizing the interconnector capacity to the full extent. Flow of power and know-how between the markets will support Georgian market liberalization in the long run. The level of harmonization can range from streamlining the rulebooks to a full-fledge market coupling of both markets.
This option suggests implementing partial deregulation of the electricity market in Georgia. At this stage, full-scale liberalization of electricity trading mechanism will be a difficult task for several reasons:
18 Social or last resort tariff is a tariff for socially unprotected customers who consume less than 100 kWh of electricity per month. 19 In order to create relevant market structure and support wholesale bilateral trading, it is important to abolish high fees that remain constraint for third party access. Bilateral trade won’t happen if there are no incentives for third party to access the market. Therefore, the current obstacles should be removed. 20 Traditional steps of market liberalization are: 1.Unbundling of vertically integrated companies; 2.Third party access, with competitive transmission costs; 3.Deregulation of all generating companies; 4. Access to purchase electricity from any generation unit for consumers, who consume more than 1kWh electricity per month; 5.Supplier of last resort appointed by the regulator; 6.Clearing and settlement risk managed by qualified financial institution/company; 7. Allow switching of the supplier on monthly basis. 21 VPP is group of generators and consumers who act as a single entity towards the power market. The plant is virtual because it doesn’t exist physically, but it is a method of managing the electricity and supplying it to interested stakeholders. The portfolio of generators and consumers is managed by ICT. Aggregator is typically an actor who mediates between consumers who are willing to modify their consumption and sell it other market participants.
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- Competitive advantage of HPPs built before 1990: these plants have been sold at the price that would not reflect full replacement costs of these plants in order to keep the final consumer prices low. Unlike newly built HPPs, they lack invested money in their construction, and they lack PPAs with ESCO, hence they would have a competitive advantage over free players.
- Island modes:
- Enguri & Vardnili HPPs related problems: Enguri & Vardnili HPPs are partially located in Abkhazia, and almost half of the produced electricity is taken by the region without payment. Their tariffs do not reflect the full cost of capital of the plants. This means that they are subsidized (in order to keep final consumer tariffs low) and would have a competitive advantage over other plants
- Low competitiveness of thermal power plants: thermal power plants have two-tier tariffs: capacity fee and tariff that covers variable costs (price of the fuel). Due to the low operating leverage as compared to HPPs, they could not be as flexible in terms of price setting as HPPs in free competition. The average price of a TTP is higher than the average price of an HPP.
- Vertical integration (legally they are owned by different companies but in some cases the generation and distribution companies have the same owners) of power generation and distribution companies (the latter may change in the near future): for example, JSC “Energo-Pro Georgia,” which is the largest distribution company in Georgia, has several features: distribution, transit and production of electricity.
- Sensitivity of the policy implementing institutions vis-à-vis the risk of climbing electricity prices in the short run.
Required Changes in the current ETM in short and long-term periods:
Short-Term - until 2020:
- Split of vertically integrated companies at the level of beneficial owners;22
- Creation of TSO with balancing functions;
- Introduction of congestion management and balancing group structures;
- Introducing wholesale/trading companies;
- Start of bi-directional flows on the interconnectors;
- Conversion of ESCO to hourly settled day-ahead market or establishing a private entity as the market operator;
- Set-up of clearing and hedging mechanisms (hedging does not necessarily and only mean complex financial instruments).
Long-Term (by 2024):
- Elimination of end user tariffs and introduction of social and last resort tariffs;
- Introduction of aggregator business models including VPP and Demand Side Management.
Description of Option 1
Under Option1 as an independent regulatory body, GNEWRC is regulating all market activities, including ancillary services. The services on the market are provided by the following entities:
i) TSO;
ii) DSO;
22According to the Directive 2009/72/EC neither of the persons who own undertaking that performs functions of transmission or distribution should own directly or indirectly or exercise control (where control means using decisive influence on an undertaking, ownership or the right to use all or part of the assets of an undertaking, including voting rights, contracts which confer decisive influence or influence on the decisions of organs of undertaking) on an undertaking that performs functions of generation or supply (vertically integrated undertaking).According to the Article 9th of the Directive 2009/72/EC, persons who are owning transmission system cannot own or control undertaking that performs function of generation and supply. This restriction also includes the power to exercise voting rights, the power to appoint members of the supervisory board, the administrative board or bodies legally representing the undertaking; the holding of a majority share. According to the agreement with the Energy Community, Georgia has to implement this regulation till the end of 2018.
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iii) Market/or market operator;
iv) Clearing house.
Market participants consist of:
i) Generation companies;
ii) Traders;
iii) Consumers;
iv) Suppliers;
v) Aggregators.
The desired market structure is a day-ahead market. However, participants are allowed to maintain direct contracts (over-the-counter market) and are encouraged to utilize bilateral trading. The balancing function will
be implemented by TSO which will be a state-owned public entity.
Further, parties will be able to register long-term direct contracts on the OTC market.
Main stakeholders affected
The implementation of ETM will have a positive impact on stakeholders. It is assumed that the liberalization of the market should attract more investors and will increase the reliability of the market. Harmonization with EU Directives will be another incentive for further approximation of the current market standards to the modernized electricity trading mechanism more adaptable to the requirement of Turkey and the EU. This effect enacts slowly, as the market converges to the new equilibrium, investors and consumers build up new expectations and alter their behavior. In the modeling of this option, it is assumed that the effect of the reforms (in terms of additional generation) will begin to be felt after five years.
In the long run, the modified ETM will increase the stability of supply of electricity to consumers. The ETM will be part of a new regulatory framework where the unbundling down to the beneficial ownership will be necessary for transmission systems and the transmission system operator, and separation of generation, supply and distribution.
Costs
Generators – training of the staff (with excluding Enguri & Vardnili HPPs, privatized HPPs, TPPs) will be necessary to acquire knowledge of new market rules;
Eligible Customers – installation of new metering system and trading technologies;
HPPs below 40MW – training of the staff will be necessary to acquire knowledge and new skills for modified market;
Consumers – no change in the short run. In the long run higher competition will increase efficiency and will reduce prices;
DSO – costs will be connected to implementation of new metering system and trading technologies.
Benefits
Generators – will have opportunity to trade freely (with excluding Enguri & Vardnili HPPs, privatized HPPs, HPPs built with PPAs, and TPPs, which cannot freely trade due to legal constraints discussed above);
Eligible Customers – no change;
HPPs below 40 MW – direct participation in the competition and reduced influence from large consumers;
Consumers – no change;
DSOs – no change.
Public service obligation
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Article 3 of EU’s Directive 2009/72/EC is obliging Georgia to ensure a public service obligation (PSO) to the customers. Based on the Directive, PSO means to provide customers with security of regular supply of electricity, its quality and price of supply from renewable sources, and the “supplier of last resort.”
The Directive instructs to provide access to the electricity to the vulnerable part of the population. Although it is not clearly defined which part of the population falls under this criterion, in this paper the project team took a number from the Social Service Agency of Georgia and at the end of 2016 the number of socially vulnerable households was 142,967, which is 13.4% of the total population.
The project team believes that under the new market model the rules for the quality and reliability of supply shall be defined by GWNERC and ancillary services and provision should be under the TSO. As for the vulnerable population, the GoG can allocate funds through a ministry to cover gaps for the most vulnerable part of the population. This can be done through the system of vouchers or donations.
TSO can assign or designate the supplier of last resort, based on its discretion.
Major risks associated with the reform:
- Lack of the knowledge of the new market system for trading participants;
- Risks related to the technology (glitches, hacking, etc.);
- High probability of price movements due to the reduction of regulated share of producers on the market;
- Risks of default;
- Growth of power consumption will cause the increase of the volatility of prices at higher rate than during current market system. At the current ETM, all market prices are either directly or indirectly controlled by GWNERC and ESCO. They try to level costs and avoid price fluctuations. There is no peak hour price. After the reform of the market, HPPs with reservoirs and TPPs will try to utilize new opportunity and may try to sell at higher prices during peak hours.
Best coping strategies:
- Trainings and seminars for the market participants;
- Media coverage for general public;
- Involve outsource professionals in the management process technology unit;
- Clearing risks should be managed by a seasoned financial institution.
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Figure 5.3: Modified ETM
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6. ANALYSIS OF IMPACTS
6.1. METHODOLOGICAL APPROACH
The methodology applied in the (efficiency-focused) analysis of the impacts is a CBA, coupled with a qualitative analysis for the components that were impossible to quantify given time and data constraints (qualitative CBA). The qualitative CBA will be complemented with a multi-criteria analysis to include in the comparative analysis for other components in addition to efficiency considerations.
The planned reform is likely to affect three main categories of stakeholders:
• Consumers;
• Producers;
• Government.
Data is used from the following sources:
• ESCO;
• GSE;
• GNWERC;
• GeoStat;
• Information collected through interviews and stakeholder consultations;
• MoESD;
• MoF;
• Statistical data from other countries and international organizations (including from existing reports about Georgia);
• Turkish Electricity Transmission Company (TEIAS);
• Other publicly accessible information.
The time horizon of the analysis will be 10 years.
The discount rate used is 9.81% (i.e. nominal return on 10-year government bonds). A sensitivity analysis will be performed at 7.03% and 12.6%23.
After quantifying the expected impacts in each area for each alternative, the expected NPV of all alternatives will be determined.
In all the cases in which the quantification of costs and benefits will not be possible, a qualitative evaluation of the incremental costs and benefits of different options with respect to the baseline scenario will be prepared, in the attempt to test whether this affects the ranking of the options from an efficiency-focused point of view.
The main assumptions used in the quantitative analysis have been discussed in the first part of Section V.
Discussion of sensitivity analysis
To test the robustness of the results to changes in the underlying assumptions, a partial sensitivity analysis is performed, inputting into the model the minimum (and, later, the maximum) values for each of the following six variables, keeping constant the expected values for all remaining variables in the
23Central value ± 1.96 Standard Deviations, corresponding to the boundaries of 95% confidence interval.
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model24. The net present values (NPVs) obtained are observed and the variables have the greatest influence (positive and/or negative) on the final results are recorded.
The ranges of the variables are indicated in tables 6.1 and 6.2:
Table 6.1: The ranges of the variables used in sensitivity analysis (normal distribution)
Variable Name Standard Deviation -1.96 SD Central Value
1.96 SD
Discount rate 1.42% 7.03% 9.81% 12.6%
Growth rate of Electricity Consumption
5.32% - 6.26% 4.17% 14.60%
Growth rate of Electricity Supply (in baseline)
4.48% - 5.08% 3.7% 12.48%
Growth rate of Electricity Supply (in ETM)
4.97% - 3.93% 5.81% 15.55%
Table 6.2: The ranges of the variables used in sensitivity analysis (uniform distribution)
Variable Name Central Value Minimum Value
Maximum Value
Price Elasticity of Demand
- 25% - 10% - 40%
Retail Electricity Price in 2028 (GEL)
0.1995 0.1395 0.2595
In the second stage, to develop a better understanding of the interactions among the different potential sources of uncertainty, a sensitivity analysis and Monte Carlo simulation25 are performed, to obtain a plausible representation of the potential range of outcomes.
24 When the variables have identical initial and final values we change both initial and final values. When initial and final values differ (to indicate a transition towards a different economic structure) we let the final (long-term) value unaltered and change only the initial one. 25 A simulation in which, defining a probability distribution associated to the values of each random variable, we let all the identified sources of uncertainty vary at the same time, generating a NPV value. We repeat the simulation (letting the variable values change randomly) a considerable number of times in order to generate a distribution of potential outcomes and be able to study the properties of such distribution, including the probability of particularly positive or negative outcomes.
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6.2. ANALYSIS OF IMPACTS
Table 6.3: Summary impact of selected options
IMPACT
OPTION 1
Administrative The administrative impact for the government will be substantial and mostly related to setting up the day-ahead market, starting from the day-ahead market platform. This will also require additional IT staff to operate it. For the state-owned ESCO and GSE, this means further restructuring to address the need of new market structure. Furthermore, the dispatch center at the GSE will require additional training and preparation of the staff to learn operations with a new day-ahead market in parallel to the regulated part. As demonstrated in the discussion of the baseline scenario, the power generation on Georgian market is highly concentrated. To ensure fair competition on the day-ahead market, the government will have to set very clear rules of participation on the market for the state owned generators that represent around 43% of the total installed capacity. The restructuring will be needed for the distribution system operators as well, as they will have to serve both as universal suppliers and distribute power on the day-ahead market. This will require additional staff and training to ensure adequate operations on both markets. Furthermore, under the Energy Community Membership Protocol, Directive 2009/72/EC entails vertical unbundling of distribution and generation. The unbundling of Telasi and Energo-pro from their respective generation will require substantial administrative costs. Both empirical and qualitative literature on power market states that unbundling is essential to drive the costs of the market down and ensure efficient operation of the market (Energy Sector Management Assistance Program (ESMAP) 2011, Jaskow 2008). For the private generators, administrative costs will increase to ensure training and/or hiring new staff to conduct day-ahead trading. Lastly, institution of power sellers will be created for the deregulated part of the market. The institution of the private electricity re-sellers will be created. The personnel operators will have to be trained to operate on the market and ensure proper billing of the deregulated clients.
Economic The expected economic impacts of the reform are significant. Among the most relevant to mention are:
• Increased competition and reduced market distortions in the electricity market;
• Reduction in excess profits of distributors and generators;
• Increase competitiveness in the economic sectors having electricity as a substantial input;
• Increased purchasing power for households. The impact of the Electricity Market Reform on the GDP growth is expected to be positive (Nepal and Jamasb 2012a; Carvalho et al. 2016). Some of the reasons will be increased investment in power generation that will have a spillover effect on other sectors of economy. If the ETM reform facilitates larger private ownership in the electricity market, the overall productivity of the sector is going to increase (Celen 2013). The results of Balza, Jimenez and Mercado (2013), estimating different impacts of Electricity Market Reform in 18 Latin American countries, confirms positive impacts of private investment and of improved regulatory quality on the performance of the electricity sector . In the case of cumulative private investment, an increase of one percent is statistically significantly associated with: (i) a 0.49 percent increase in electricity generation capacity; (ii) a -0.13 percent reduction in electricity losses; (iii) a 0.11 percent increase in access to electricity services; and (iv) a -0.015 percent reduction in electricity prices. Increases in regulatory quality are strongly associated with (i) increase in generation capacity, (ii) reduction in electricity prices (iii) increase in coverage. These effects, however, are not expected to occur immediately (especially in our setup) but to increase progressively, as the market develops and converges to a new equilibrium and the investors and consumers build up new expectations.
Electricity Prices
The impact on electricity prices is not obvious. According to Erdogdu (2011), which uses econometric analysis to capture the impact of electricity market reforms on the panel data of 63 developed and developing countries in the period 1982-2009, there is no uniform pattern for the impact of reforms process as a whole on price - cost margins and cross-subsidy levels.
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However, the existence of independent power producers (IPPs) has a decreasing effect on price cost margin for all countries. In developing countries (excluding ones from America), unbundling increases price cost margin by 53.3%, while in developed countries privatization and unbundling together decrease price cost margin by 28%. Energy Sector Management Assistance Program (ESMAP) (2011) uses panel data of 20 countries (for the period 1999-2009) with different system sizes and estimates that vertical unbundling reduced electricity tariffs by 10%. More disaggregation in distribution seems to drive electricity tariffs down. Partial unbundling, however, has no significant impact on tariffs. The share of private sector participation significantly raises the level of tariffs, while the presence of an autonomous regulator is also significantly and positively associated with higher tariffs. Finally, Nagayama (2007) uses panel data of 83 countries for the period 1985-2002, and his findings suggest that neither unbundling nor introduction of a wholesale pool market on their own necessarily reduces the electric power price. In fact, contrary to expectations, he documents a tendency for the price to rise. However, coexistent with an independent regulator, unbundling seems to be contributing to the reduction of electricity prices. Estimating the expected price impact of the reform on the Georgian market is also complicated by the fact that the regulated part of the market, in which end-user tariffs are set by the GNEWRC, will be maintained, next to the deregulated part of the market (where electricity will be negotiated at the competitive price, which will fluctuate based on the development of the demand and supply sides of the market and on the trends characterizing the import and export markets). In this structure of the market it is of paramount importance that any cross-subsidization between regulated and deregulated sectors are avoided.
Social The social impact of the reform will depend both on the market outcomes of the reform (i.e. change in customer prices), as well as from impact on the economic development of the country. The quantitative model suggests that, when electricity generation increases faster than consumption, the customers are going to benefit from the reduced electricity prices. In addition to the potentially beneficial effect on consumer prices, if the ETM facilitates the increase of investments in generation, this will create larger employment as these investments are realized26. The realization of new investments could strengthen the potentially positive effects on employment by allowing an expansion of the electricity-intensive sectors and, more generally, through faster growth. The extent of these impacts, however, is conditional to the specific market conditions. Galal et al. (1994) analyze before and after performance indicators data of public enterprises divestitures in UK, Chile, Malaysia and Mexico. Their findings are that privatization combined with regulation can enhance welfare, and private ownership improves efficiency of generation, promotes profit maximization and increases value of regulation. In contrast, Tishler et al. (2006) conducted a cost-benefit analysis exercise to find the impacts on the generation, transmission and distribution in accordance to the 2003 government announcement to undertake a functional unbundling of ESI in Israel. Their finding is in line with the expected total net benefit value of our quantitative model, however with a different impact on stakeholders. Specifically, the paper finds that the reform will only yield a small net benefit even when carried out flawlessly, will increase profits for producers and government tax receipts at the expense of customers, and incentive regulation of the sector thereby is desirable. In the Georgian case, the decision of the government to maintain a relatively large regulated part of the market should prevent sudden shocks negatively affecting the most vulnerable consumers. The final impact on the most vulnerable consumers will depend on the impact of the reform on prices.
Environmental The environmental impacts of the reform will primarily depend on its outcomes. For example, an increase in the amounts invested will create a greater pressure on the environment. It is currently expected that in the coming years most new generation capacity will be constituted of HPPs, WPPs, and TPPs. In order to minimize the environmental impact of the realization of the new power plants, it is vital that an accurate environmental impact assessment takes precedes
26 This effect takes place over the short/medium period and has two components: 1) direct increase in employment during construction; 2) indirect increase in employment through multiplier effects due to the increase in aggregate investment.
32
the concession of construction permits for power plants. In this case, the impact on the environment can be expected to be moderate. It has to be noted that, in addition to energy regulations, both the EU Association Agreement (AA) and Energy Community Membership Protocol require the implementation of additional environmental regulations. With regard to the utilization of Georgia’s hydropower potential, it is vital to implement the EU Water Framework Directive, in particular the part that requires the implementation of the incentive based economic instruments for the use of water resources. Furthermore, other EU directives also facilitate greater emphasis on sustainable resource use, promotion of biodiversity, decrease of pollution and increase of energy efficiency of the country. Thus, the process of implemented EU regulations will partially serve as a deterrent against the possible negative environmental impacts of the reform. In consideration of these developments, the impact of the reform on the environment to be either moderate or low is expected.
Public financing
Initial setup costs are expected to affect negatively the government budget, especially as the ETM trading platform is implemented. These costs, however, can be recovered in time through the payment of participation fees. Another negative impact of the reform on the public budget is associated with the reduction in profits of producers and distributors due to increased competition and reduced market power. A positive impact on the public finance is expected (and is not included in the quantitative analysis) in case, in order to facilitate more competition on the market, the government decides to privatize its generation capacity. These should positively affect both ETM performance and the state budget. However, the extent of these effects would probably be very limited as the privatization of some of the large HPPs (Enguri and Vardnili) is not feasible for security reasons. Overall, the impact of the reform on public financing is expected to be moderate.
High impact Medium impact Low impact
6.3. COST-BENEFIT ANALYSIS
OPTION 1: MODIFIED ETM
QUANTIFIED COSTS
Consumers (all categories)
Increased consumer costs are associated with the consumption of greater quantities of energy. The Modified ETM is expected to lead to higher generation levels and lower electricity prices with respect to the baseline scenario. For this reason, electricity demand from consumers is expected to increase.
Government
In this model, the GoG is going to incur two types of additional costs:
• Lower revenues whenever the profits of producers decline due to the increased level of competition in the market. These effects actually kick in slowly, as the market converges to the new equilibrium and investors and consumers build up new expectations and alter their behavior;
• Capital costs for the implementation of the modified ETM, that vary from 28 to 40 million USD within the period from 12 to 18 months. The costs depend on the decisions of the policy maker (GNEWRC and MoESD) regarding to its approach to installing the new system. They include:
o Creation of the digital platform (it can be developed independently, built on the open source, or linked to the existing platforms, like an operating exchange). (USD $4-7 mln);
33
o Create links of all energy companies/participants to this platform, including their own program facilities (USD $6-8 mln);
o Installation of electric equipment (i.e. smart meters, etc.) (USD $18-25 mln); o Training of the personnel.
Producers
In this model, producers are going to incur two types of additional costs:
• Generation costs associated with additional production27;
• Profit taxes on additional profits.
QUANTIFIED BENEFITS
Consumers (all categories)
Increased consumer benefits associated with the consumption of greater quantities of energy at lower prices.
Government
The government experiences an increase in profit tax revenues whenever the reform leads to an increase in producer profits. As mentioned above, this effect actually kick in slowly, as the market converges to the new equilibrium and investors and consumers build up new expectations and alter their behavior
Producers
In this model, producers are going to experience an increase in revenues associated with the higher level of investments and generation. Again, this effect actually kicks in slowly, as the market converges to the new equilibrium and investors build up new expectations and alter their behavior.
UNCERTAINTIES
The main uncertainties pertain to the following issues:
• Growth rate of internal demand – due to the complex relationship between variables and existence of seasonality of consumption and generation, changes in the growth rate of internal demand could either reduce, or increase NPV. This is because the relation between this variable and NPV is not linear;
• Growth rate of supply – increase in the growth rate of supply has a positive impact on NPV, while a decrease has an opposite impact;
• Price elasticity of demand – there is a nonlinear relationship between this variable and NPV. The maximum NPV achieved is at a 25% price elasticity of demand;
• Evolution of import prices – higher import prices are associated with larger NPV, as gains for local producers exceed losses from consumers;
• Evolution of spot market prices in Turkey (main export market) – higher spot market prices in Turkey are associated with a larger NPV, as gains for local producers exceed losses from consumers.
6.4. SUMMARY
The results, summarized in in Table 6.4 and in Figure 6.1, indicate that the reform is expected to lead to a small increase in NPV with respect to the Baseline Scenario, over the 10-year period. This is partially due to the delay with which the ETM is expected to stimulate additional investments in generation capacity, as the system is set in place and operators manage to
27 Under the ETM, investments in generation capacity will be larger. Therefore, more electricity will be generated, with an increase in the total generation costs.
34
assess more carefully the nature and the extent of the market risk. The increase in NPV for consumers is due to the greater availability of electricity at lower prices. The negative NPV of producers is due to the expected increase in generation capacity, which is not sufficient to offset the decline in margin per unit of electricity generated (as prices tend to be lower than without ETM). The negative NPV of the government is the consequence of the implementation costs and of the lower profit tax revenues.
Figure 6.1: NPV in million Lari (total and by group)
Table 6.4: Summary of incremental costs and benefits of the Modified ETM
OPTION 1
NPV +56 mil GEL
Qualitative impacts (if quantitative not possible)28
POSITIVE:
Economic gains associated with increased competition, efficiency and attractiveness to private investors
NEGATIVE:
Increased administrative burden on government and companies operating in the electricity market
Negative environmental impacts
It is important to emphasize that these quantitative results have been obtained under a precise set of assumptions (discussed in section 5) based on expert opinions and on simple projections based on the available data. Changes in the assumptions may lead to significant differences in the level and the distribution of NPV across actors.
28 List those items that have a significant impact on the decision making, but cannot be quantified
56
(152)
434
(226) (300)
(200)
(100)
-
100
200
300
400
500
NPV GOV CONS PROD
NP
V in M
illio
n L
ari
35
For this reason, it was decided decided to perform a Monte Carlo Simulation29 (with 1,000 repetitions) of the expected outcomes. The results of the exercise (Figure 6.2) confirm that, while the range of possible outcomes is quite large, the expected value is positive in 60% of the cases.
The sensitivity analysis has also confirmed that, ceteris paribus, several variables potentially have a strong impact on final NPV. Among them, in addition to the variables identified previously as potential sources of uncertainty, must be added the role of the discount rate (as benefits tend to grow later in time, a high discount rate has a negative impact on the expected NPV). From this point of view, a reduction in the domestic interest rates on the Georgian market would lead to an increase in the expected NPV of the reform.
Figure 6.2: Distribution of NPVs (Monte Carlo Simulation with 1,000 repetitions)
29 Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted due to the intervention of random variables. It is a technique used to understand the impact of risk and uncertainty in prediction and forecasting models. Definition from: https://www.investopedia.com/terms/m/montecarlosimulation.asp#ixzz56cAsvnas
0
50
100
150
200
250
Fre
quency
Total NPV
36
7. COMPARING THE OPTIONS While comparing the alternatives to identify the preferred one, a number of criteria in addition to NPV were considered. These criteria are:
Effectiveness: the capability to produce the desired results. In this case, the capability to:
1. Enhance the efficiency, competitiveness, resilience, sustainability and accessibility of the electricity market on a mutually beneficial and non-discriminatory basis, in accordance with the European Community Treaty and other international rules, including the Energy Charter Treaty.
2. Support Cross Border Trade, in accordance with the European Community Treaty and other international rules, including the Energy Charter Treaty.
Feasibility: possible to realize/easiness of realization.
Minimization of risks associated with the options:
• Risks related to the technology (glitches, hacking, etc.);
• Price volatility;
• Risks of default.
Maximization of potential benefits associated with the options:
• Market competition;
• Market efficiency;
• Attractiveness to investors.
7.1. SUMMARY OF OPTIONS
As observed in Table 7.1, the modified ETM is superior to the baseline scenario in terms of quantified expected NPV, the effectiveness criteria and the maximization of potential benefits. On the downside, it is substantially harder to implement and presents slightly higher risks (especially in terms of technological reliability).
The Baseline Scenario (Option 0) was assessed as a simple continuation of the status quo, without considering Georgia’s obligations to the European Energy Community.
Relative to Option 0, the Modified ETM option (Option 1) receives a very positive assessment (three pluses) for complying with all sub-objectives underlying the effectiveness criterion 1 (see table 4.5). The policy options ensures openness and competitiveness of electricity market, and complies with the EU competitive market principles. Furthermore, the Modified ETM option also received a very positive assessment (three pluses) in relation with the effectiveness criterion 2, as it complies with all its sub-objectives (see table 4.5). The Modified ETM option receives instead a low score (three minuses) for the feasibility of the option as its implementation is associated with substantial investment in the realization of the market infrastructure. In addition, the option entails restructuring of the whole electricity market – a process that requires very cautious implementation. From the point of view of minimization of potential risks, the Modified ETM option is accompanied by some risks associated with the policy implementation process. These risks are related to possible market concentration and technical implementation. Lastly, in case the Modified ETM option is properly implemented, it has substantial potential to ensure larger investments and more open cross-border trading on the Georgian electricity market.
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Figure 7.1: Comparison of options using cost-benefit and multi-criteria analysis
EVALUATION CRITERIA Baseline Scenario Modified ETM
Incremental Benefits – Incremental costs (NPV) 2019-2028
- 56 mil. GEL
PV of incremental Benefits 2019-2028
- 436 mil GEL
PV of incremental Costs 2019-2028
- - 380 mil. GEL
Effectiveness 1 0 +++
Effectiveness 2 0 +++
Feasibility / Ease to comply 0 ---
Minimization of Potential Risks
0 -
Maximization of Potential Benefits
0 +++
7.2. RECOMMENDATION
According to the analysis, the expected outcomes of the Modified ETM appear to be much more in line with the goals of the reform than those for the Baseline Scenario. For this reason, the project team’s recommendation is to move forward with the reform, proceeding with the implementation of the Modified ETM.
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8. MONITORING AND EVALUATION PLAN
In this section, a rough plan is suggested for the monitoring and evaluation of the ETM in Georgia. Table 8.1 summarizes a variety of data that could be collected and indicators that could be employed in order to make evaluating the success (or failure) of the selected policy option easier.
MoESD and GNEWRC should be able to track the implementation of ETM and evaluate the extent to which the selected policy is achieving its objectives. Monitoring should be conducted by the MoESD and GNEWRC to measure the progress of indicators on the country’s macroeconomic parameters and demonstrate accountability towards completion of general and specific goals. Quantitative data for monitoring should be collected by the MoESD through various sources, including with GSE. Qualitative evaluation should be conducted via consultations with state, commercial and non-governmental entities and other relevant stakeholders. Table 8.1 presents the proposed list for the progress indicators.
Table 8.1: Progress indicators to measure progress towards meeting the objectives
INDICATOR FREQUENCY OF EVALUATION
RESPONSIBILITY FOR MONITORING
100% of the EU Directives and requirements of EU Energy Community relative to cross-border trade implemented by the end of 2018
Yearly MoESD, GNEWRC
Sustaining decreasing trend of Herfindahl-Hirschman Index (HHI) for market concentration
Yearly MoESD, GNEWRC
MoE engages relevant stakeholders to identify institutional, legal, fiscal and other issues preventing the development of an attractive and stable investment climate and of a competitive electricity market and produce a book of recommendations
100% of institutional, legal, fiscal and other issues identified as preventing the development of an attractive and stable investment climate and of a competitive electricity market are addressed by ………….
Yearly MoESD, GNEWRC
X% of consumers having access to electricity market by……
Yearly MoESD, MoLHSA
Improving the score on the index of “Getting Electricity” in Doing Business
Yearly MoESD, MoLHSA
Reliability of the system (SAIDI and SAIFI indexes) fully within the parameters established by GNEWRC in the whole country by …….
Yearly MoESD, MoLHSA
Electricity prices in the regulated sector do not increase faster than necessary to cover generation (operational and investment) costs.
Yearly MoESD, MoLHSA
The cost of the consumption of a minimum monthly socially acceptable quantity of electricity for private consumption (to be
Yearly MoESD, MoLHSA
39
defined) remains below a pre-defined threshold set by …………….
Presence of universal supplier on the market starting from ……
Yearly MoESD, MoLHSA
Tariffs and energy prices allow covering the true opportunity costs of generation (including operational, investment and environmental costs)
Yearly
MoESD
GSE
ESCO (Market Operator)
The share of electricity generated by renewable and environmentally friendly energy sources grows with time
Yearly
MoESD
GNEWRC
GSE
The MoESD sets a target in terms of maximum administrative burden for setting up new generation using renewable and environmentally friendly energy sources and the target has to be reached by ………
Yearly
MoESD
GNEWRC
GSE
100% of the EU Directives and requirements of EU Energy Community relative to Cross Border Trade implemented by end 2018
Yearly MoESD, GNEWRC
Sustainable increase in electricity trade with neighboring countries (X% per year)
Yearly MoESD, GNEWRC
Sustaining decreasing trend of Herfindahl-Hirschman Index (HHI) calculated looking at the market shares of exporter in total exports
Yearly MoESD, GNEWRC
100% of required legal amendments in legislation are implemented by end 2018
Yearly MoESD, GNEWRC, GSE
All information about transit rules, capabilities and fees is transparently available and easy to access for electricity traders by …..
Yearly MoESD, GNEWRC, GSE
Electricity transit capacity is increased to……. By….
Yearly MoESD, GNEWRC, GSE
100% of required legal amendments in legislation are implemented by 2018
Yearly MoESD, GNEWRC
1
REFERENCES Balza, L., Jimenez, R., & Mercado, J. (2013). Privatization, Institutional Reform, and Performance in
the Latin American Electricity Sector. Inter-American Development Bank.
Carvalho, A. e. (2016). Economic Reforms and Human Development: Evidence fron Transition Economies. Applied Economics, 1330-1347.
Celen, A. (2013). Efficiency and Productivity (TFP) of Turkish Electricity Distribution Companies: An application of Two-Stage Analysis. Energy Policy, 300-310.
Erdogdu, E. (2013). The Impact of Power Market Reforms on Electricity Price-Cost Margins and Cross-Subsidy Levels: A Cross-Country Panel Data Analysis. Energy Policy, 110-118.
ESMAP. (2011). REVISITING POLICY OPTIONS ON THE MARKET STRUCTURE IN TH E POWER SECTOR. World Bank.
Galal, A. L., & et, a. (1994). Welfare Consequences of Selling Public Enterprises: An Empirical Analysis. Oxford: Oxford University Press.
Jamasb, T., Nepal, R., & Timilsina, G. R. (2017). A Quarter Century Effort Yet to come of Age: A Survey of Electricity Sector Reform in Developing Countries. The Energy Journal, 195-234.
Jaskow, P. L. (2008). Lessons Learned From Electricity Market Liberalization. The Energy Journal, 9-42.
Nagayama, H. (2007). Effects of Regulatory Reformsin the Electricity Supply Industry on Electricity Prices in Developing Countries . Energy Policy, 3440-3462.
Nepal, R. a. (2012a). Reforming the Power Sector in Transition: Do Institutions Matter? Energy Economics, 1675-1682.
Newberry, D., & Pollitt, M. (1997). The Restructuring and Privatization of the CEGB - Was it Worth It? Journal of Industrial Economics, 269-303.
Pollitt, M. (2012). The Role of the Policy in Energy Transition: Lessons from Energy Liberalization Era. Energy Policy, 128-137.
Tishler, A., & et, a. (2006). Cost-Benefit Analysis of Reforming Israel's Electricity Industry. Energy Policy, 2442-2454.
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APPENDIX A: TURKISH POWER MARKET LIBERALIZATION
(Summary)30
History
2001 – 2004
• Turkish Power market liberalization began when the “Electricity Market Law” in 2001 came into force and with the Law the Energy Market Regulatory Authority (EMRA) was settled.
• With new legislation, the only governmental body TEAŞ, which consists of all generation, transmission and wholesale operations, was separated into three bodies managing their area of expertise; EÜAŞ (Generation), TEİAŞ (Transmission) and TETAŞ (Wholesale). Besides this, TEDAŞ is responsible of all distribution operations in Turkey managing 21 different distribution regions.
2004 – 2009
• New balancing and settlement legislation came into force in 2004. This legislation leads the bilateral agreements and it is settled in daily on a three time basis; Day Time (06:00 – 17:00), Peak Time (17:00 – 22:00), Night Time (22:00 – 06:00).
• Balancing power market 1st phase started on a three time basis (Day – Peak – Night).
• In this period, the distribution company privatization process began for 21 DisCo’s.
2009 – 2011
• Updated balancing and settlement legislation came into force in 2009. This legislation leads hourly settlement in the market.
• This was a transition period which is called day ahead planning. It was not a real market but all participants are making their daily generation/consumption plans on a 24-hour basis.
2011 – 2015
• Day ahead market is settled with the responsibility of all participant to give their bids/offers on hourly basis for the next day’s 24 hours.
• Collateral and advance payment systems settled.
• Renewable Energy Resources Support Mechanism began which is actually a PPA mechanism for 10 years to support renewable investments in USD/MWh basis.
2015 - 2017
• Energy Exchange (EPİAŞ) is settled in 2015 as a private entity.
• The shareholder of EPİAŞ are: Transmission System Operator (30%), Istanbul Stock Exchange (34%) and 97 Private Energy Entity (36%).
• Intraday market settled.
• Local Coal (lignite) Support Mechanism started in 2016.
Although the Turkish power market is not a fully liberalized market, it is in a transition period and several solutions are created so sort out short term problems. So far the Turkish Power Market could be named as a partially liberalized market. Even though these liberalization activities are thought to increase the market prices, the reality shows that there is not a major change in terms of local currency and there is a 50% drop in terms of USD/MWh within the last eight years.
30 The Information in the Appendix B was collected based on the sources of EPIAS, TEIAS, EMRA and Ministry of Energy and Natural Resources of Turkey.
2
Power Markets in Turkey
The Turkish power market consists of several markets in which companies could sell/buy electricity. There are mainly seven different markets, considering the operational sequence of power trading:
• Day Ahead Market
• Intraday Market
• Balancing Power Market
• Over The Counter
• Bilateral Agreements
• Cross Border
• Power Derivatives / Financial Market
3
A. BEFORE DAY AHEAD 1. Bilateral Agreements: These are usually yearly, quarterly or monthly contracts. Both parties
sign a contract which is not disclosed. These contracts could be physical or financial contracts.
In case physical delivery is needed, the delivery is cleared through EPİAŞ (energy exchange). Both parties enter only the hourly energy amounts to bilateral agreement platform. In this platform the financial terms like price, payment terms, etc are not declared.
In case of a financial agreement, the reference price is the day-ahead market price, and only the difference between the contract price and reference price is paid.
After the day ahead market settled in late 2011, the volume of bilateral agreements (and day ahead market) is increasing steadily.
Years Bilateral Agreements (MWh)
Day Ahead Market (MWh)
2012 195.279.952 48.910.912
2013 248.271.800 60.194.511
2014 271.743.703 79.216.559
2015 280.565.937 99.294.908
2016 276.358.375 114.050.126
2017* 248.303.337 100.389.617
*Until October 2017.
2. Over the Counter (OTC): These contracts are mainly originated by brokers. There are several brokerage houses and platforms where trading companies could trade. The most liquid products are Monthly products. After a deal is concluded in OTC, a bilateral contract is signed between the buyer and the seller.
3. Cross-Border: Turkey has several cross-border trading partners and each border has its own procedures. It is possible to make trading from monthly up to yearly products.
4. Power Derivatives/Financial Market : Under the Istanbul Stock Exchange, it is possible to trade monthly power derivatives. The settlement and margining is done daily and operated by the Stock Exchange according to the day-ahead market prices.
B. DAY AHEAD MARKET
The day-ahead market is operated by EPİAŞ. Every licensed market participant has to send their BİDS/OFFERS on daily basis. After collection of all Bids/Offers until 12:30, according to the Merit Order rules , market clearing price for each hour is calculated and published at 13:00.
C. INTRADAY MARKET
After the day ahead market closes, at 18:00, the intraday market is opened for the next day’s 24 hours. Each hour is a separate market and participants could buy/sell energy from each hourly market. The gate closure time for each hourly market is 90 minutes before the related hour (e.g.
4
the market for 21:00 is closed at 19:30). This market is the last chance for the participants to clear their imbalances before real time balancing.
D. BALANCING POWER MARKET
After the day ahead market closes, the system operator (TEİAŞ) begins balancing of the system until the real time. This balancing authority is able to give orders to balancing responsible parties from the time day ahead market closed until 15 minutes prior to the real time.
The balancing responsible parties give their bids/offers for balancing power market after day ahead market closed between 14:00 - 16:00. The balancing price for each hour is called “System Marginal Prices” and it is published four hours after the related hour is closed (e.g. SMP for 15:00 is published at 19:00).
MERIT ORDER SYSTEM
The merit order system is a common price calculation methodology for power markets and it is used to calculate prices in the Turkish power market. According to this system, each buyer and seller nominates their bids and offers indicating:
i) The hour they are bidding/offering; ii) The price they are willing to buy/sell; iii) The amount they are willing to buy/sell at that price.
After each participant send their bids/offers, for each hour these bids and offer sorted from the best to worst. This means for buyers higher bid is the best bid and for the offers lower is the better.
Bids are sorted from the higher to lower one.
Offers are sorted from the lowest to highest one.
5
According to the double sided auction model, the price is settled where the demand and supply is matched. In this example it is 1200 MW where the price is 120/MWh.
According to the market results, the orders are sent to the sellers who are willing to sell their energy lower than market price (120). So, each participant (green ones) paid the same market Price (120). The red ones are not able to sell their electricity and they have to sell their electricity in intraday or balancing market.
On the other hand, buyers who were willing to pay more than the market price (green) are now able to purchase electricity for market price (120). The buyers who are willing to buy at a lower price (red) has to buy it from intraday or balancing market.
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APPENDIX B: ALTERNATIVE OPTIONS
A. Nord Pool
The proposed model is based on one of the most successful European electricity market models – Nord Pool.31 It offers trading, clearing, settlement and ancillary services in day-ahead markets. However, the model is adjusted for the current Georgian power market requirements and with the state of its development.
Nord Pool is one of the most successful power market models based on the supply and demand from different regions at different nodes. It has evolved gradually from a simple power trading model into a trading structure using complex financial instruments. Based on this model, regulators do not define the trading rules. The regulator defines the principles and the rules are agreed between market participants. The function of coordination between the market participants is implemented by the TSO.
Market Participants
Based on this model, GNEWRC regulates all market activities including ancillary services. The services on the market are provided by the following units: i) TSO; ii) DSO; iii) market/or market operator; and iv) clearing house.
Market participants consist of: i) generation companies; ii) traders; iii) consumers; and (iv) brokers.
Pre-Condition for the Nord Pool Model
- Unbundling of three segments: (i) TSO: owner of the main grid and also the national system operator. This needs to be regulated as a natural monopoly by the national energy regulatory authority; (ii) distribution companies (DSO): distribution end-consumers at a lower voltage level (DSOs are regulated); (iii) generation companies (generation sector should not be regulated);
- Principles based approach (there are no trading rules between participants. The rules are regulated by contracts. There are just general principals of trade;
- Coordination between market participants by TSO;
- Well-functioning metering system at every node of the grid
Market Components
Day-ahead market
This type of market is an electronic exchange which unites all market participants and trade is made only through the exchange. Direct contracts are only allowed for regulated generation units (like Enguri & Vardnili) to sell power pro-rata to their generation. This means that direct contracts in essence are not allowed.
Players, who trade power on the market, must send their purchase orders to the exchange noon the day before the power is delivered to the grid at the latest.
Participants may trade the power generated by their own facilities as well as of other generators or import.
Point tariff system
The idea of the system of point tariff is that the producers pay a fee to the grid owner for each kWh they put into the grid. Correspondingly, the end users pay a fee for each kWh they draw on from the grid.
This means, for example, that a retailer in Kakheti may buy electricity from a producer in Adjara. The principle is that electricity produced by a generator and put each hour into the grid by the producer corresponds to the volume of electricity the retailer’s customer taps from the grid.
31Nord Pool, [https://www.nordpoolgroup.com/]
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This system is based on nodal prices. At a particular node, the prices may defer depending on the congestion of the grid. The tariff at the node is also influenced by the capacity required at this node. The higher the required capacity the high the tariff.
- Dispatching tariff is the same for each participant;
- Capacity load fee may differ at different nodes, depending on the demand;
- Balancing is accomplished by the TSO. In case of misbalances, advantage is given to a lower price producer;
- Clearing house and reserve capacity are also needed for such a model.
Potential advantages of the option with respect to the modified ETM:
- Prices at different nodes are distributed based on supply costs, i.e. consumers at each node pay price based on the delivery costs of their section of the grid;
- Congestion is reduced at the grid;
- Rules are set between counterparties not by the regulator;
- Competition is improved between market participants at different nodes.
Potential risks of the option:
- Different consumers in different regions may have different prices;
- Grid quality may not always meet the model’s requirements at some nodes;32
- Large players (discos and large consumers) on the market may dictate their rules to small generators and push them to adapt their proposed rules;
- Longer implementation period, due to the bigger difference from current system as compared to modified ETM.
Recommendation
The differentiation of prices at different nodes for different consumers (especially if the rural population will have high tariffs as compared to more densely populated areas), would not be acceptable in the current situation for political reasons.
In addition, necessary additional investments in the grid associated with this model would increase transmission costs, eventually increasing consumer tariffs. This would also constitute a significant obstacle to the adoption of such a model.
Although the proposed model has several facets which may hinder its application, it may be a good starting point if the opportunities arise for Georgia to become a regional energy/power hub. Therefore, it is advised to consider this option from the regional viewpoint at a later stage (taking into account different rules may apply at different nodes. Neighboring countries use different trading and transmission rules).
B. Free Market
The proposed model has not been implemented in any other market, and this makes it difficult to make a strong reference to any existing market models but there are studies and several minor
32 For example, Kakheti is more sparsely populated area that requires longer TSs and respectively the price will be costlier. Nord Pool envisages the differentiation of prices at different nodes for different consumers. Hence, the rural population will have high tariffs as compared to more densely populated areas.
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examples that prove the superiority of this option.33 This model offers a peer-to-peer trading platform, smart contracts, the highest transparency, the lowest number of intermediaries and costs, and fastest way of carrying out trading procedures.
The system is based on the distributed ledger technology, where all participants confirm and see all transactions through the trading system. Furthermore, this model enables households to produce and sell electricity directly.34 Bilateral agreements are free and can be traded between market participants without regulation.
Market Participants
Based on this model, GNEWRC is regulating all market activities, including ancillary services. The services on the market are provided by the following units: i) TSO; ii) DSO and iii) clearing house.
Market participants consist of: i) generation companies and ii) consumers.
Pre-Condition for the Free Market
The market should be fully liberalized and based on transparency and competition. The distributed ledger technology should be applied to the market. Sensor technology, smart devices, smart meters and payment methods via crypto-currencies (in addition to traditional means of payment) should be established. Harmonization with EU electricity market standards should be already finalized. At the same time, it means that all market participants including newly built and old HPPs (with exception of Enguri & Vardnili), also TPPs, are deregulated and can trade freely. Thus, consumers can have access to various generators in real time.
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33 “Blockchain: What does it mean for Energy Markets in Africa?” [http://www.renewableenergyworld.com/ugc/articles/2017/11/10/blockchain-what-does-it-mean-for-energy-markets-in-africa.html]. 34 “Blockchain – an opportunity for energy producers and customers?” [https://www.pwc.com/gx/en/industries/assets/pwc-blockchain-opportunity-for-energy-producers-and-consumers.pdf]. 35 Financial Times, https://i.pinimg.com/736x/4f/24/a1/4f24a1ff21e790b9100a33fbf38f5c52--banking-industry-anil.jpg.
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Market Components
Day Ahead Market
Consumers and producers make bids and offers in the day ahead market and after the matching, they are cleared after every trading day. All transactions are seen by the participants. They do not need a central counterparty or market operator.
After the trading day, the cleared deals are transferred to the clearing and settlement unit for the settlement. Risk management of the settlement can be done by the clearing house. All participants shall have a trading license, as in all other cases.
The balancing function is carried out by TSO based on the same distributed ledger technology.
Blockchain technology can be applied only to the day-ahead market, as long as the balancing function may stay temporarily with the TSO.
Potential advantages of the Option with Respect to the Modified ETM
This option gives higher transparency and reduction of intermediaries during the trading process. In the short run, the model may cause a slight hike of the electricity prices, due to the capital of costs of new technologies, but in the long run due to the elimination of a market operator and intermediation costs, the prices will be reduced. Besides, transactions will be implemented faster with higher reliability due to the reduced intermediation links and automated transactions.
The biggest positive effect will be on old HPPs (built before 1990), which have artificially reduced power prices (due to the low privatization costs). Their revenues may increase by 25-28%.
This option will increase competition; it will be easy for consumers to trade with electricity; it will create a better investment climate. This option will support fairness, efficiency and price stability.
Potential Risks of the Option
Quick introduction of this option may increase wholesale electricity prices by 15-20% (i.e. replacement cost of power production). Therefore, the costs of the government will be also increased due to the support of the vulnerable population. The prices will rise due to increased costs.
Currently, existing contracts with distribution companies and regulation would not allow fair competition at the free market. Namely, third party access tariffs, grid access process, etc.
Newly built HPPs, which have PPAs with the government, may suffer serious losses. The losses can be contained by restructuring of the loans or default on them.
In the long run, this option can be the easiest and lowest cost approach.
Recommendation
Due to the possible resistance to immediate liberalization of the market by the government, this option may be utilized at later stage (after expiration of PPAs and contracts with privatization participants).
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APPENDIX C: LIST OF LITERATURE COMPUTING PRICE ELASTICITY OF DEMAND FOR ELECTRICITY
Author Country Period Method Sector Short-run Elasticity
Long-run Elasticity
Cuddington and Dogher (2015)
Minnesota, US
01/1998 - 2006:12
AR 1 Residential -0.07 -0.07
PAM Residential -0.04 -0.19
ECM/ADL Residential -0.16 -0.6
Arisoy and Ozturk (2014) Turkey 1960 - 2008 Kalman Filter Residential -0.014
Industrial -0.023
Inglesi-Lotz (2011) South Africa
1986 - 2005 Kalman Filter Aggregate -0.075
Matsukawa et al. (1993) Japan / Regional
1980 - 1988 Pooled regression Industrial -0.63
Tamechika (2014) Japan / Prefecture
1996 - 2009 GMM Residential From -0.26 to -0.35
From -0.49 to -0.4
Hosoe and Akiyama (2009) Japan / Regional
1976 - 2006 Partial Adjustment Industrial and Commercial
From -0.105 to -0.300
From -0.190 to -0.552
Okajima and Okajima (2013)
Japan / Regional
1990 - 2007 GMM Residential -0.397 -0.487
Otsuka (2015) Japan / Regional
1990 - 2010 Partial Adjustment Industrial and Commercial
-0.034 -0.146
Tanishita (2009) Japan / Regional
1986 - 2006 Partial Adjustment Residential -0.6 -0.92
Cabinet Office of Japan (2007)
Japan / Regional
1986 - 2005 OLS Residential -0.373
Houthakker and Taylor (1970) USA
-
Residential -0.13 -1.89
Anderson (1973) USA Residential -1.12
Houthakker et. Al (1974) USA Residential -0.9
Halvorsen (1975) USA Residential -1.52
Lyman (1978) USA Residential -2.1
Industrial -1.4
Baker et al. (1989) UK Residential -0.76
Beenstock et al. (1999) Israel Residential -0.58
Industrial -0.44
Bose and Shukla (1999) India Residential -0.65
Industrial -0.04
Filippini (1999) Switzerland Residential -0.3
Filippini and Pachauri (2004)
India Residential Winter
-0.452
11
Residential Summer
-0.29
Residential Monsoon
-0.51
Holtedahl and Joutz (2004) Taiwan Residential -0.16
Kamerschen and Porter (2004)
USA Residential -0.93
Industrial -0.35
Narayan and Smyth (2005) Australia
Residential -0.26 From -0.54 to 0.47
Labandeira et al. (2006) Spain Residential -0.78
Bjorner et al. (2001) Denmark Industrial -0.48
Dilaver and Hunt (2011) Turkey 1960 - 2008 Structural Time Series Model
Residential -0.38 -0.09
Industrial -0.16
Lee and Chiu (2011) 24 OECD
1978 - 2004 Panel Smooth Transition
Aggregate -0.229
Turkey Aggregate -0.228
Dergiades and Tsoulfidis (2011) Greece 1964 - 2006
ARDL Residential -0.092 -0.606
Nakajima and Hamori (2010) Japan 1993 - 2008
Panel Cointegration
Residential -1.127
Athukorala and Wilson (2010) Sri Lanka 1960 - 2007
Johansen Cointegration
Aggregate -0.58 -0.61
Amusa et al. (2009) South Africa 1960 - 2007
ARDL Aggregate 0.038 0.298
Sa'ad (2009) South Korea 1973 - 2007
Structural Time Series Model
Residential -0.14 -0.27
Dergiades and Tsoulfidis (2008) USA 1965 - 2006
ARDL Aggregate -0.386 -1.065
Ziramba (2008) South Africa 1978 - 2005
ARDL Residential -0.02 -0.04
Halicioglu (2007) Turkey 1968 - 2005 ARDL Residential -0.33 -0.52
Atakhanova nad Howie (2007)
Kazakhstan 1994 - 2003 Panel GMM
Aggregate 0
Industrial 0
Services -0.12
Residential From -0.22 to -1.1
De Vita et al. (2006) Namibia
1980 q1 - 2002 q4
ARDL Aggregate -0.298
Hondroyiannis (2004) Greece 1986 - 1999
Johansen Cointegration
Residential -0.41
Al Faris (2002)
Saudi Arabia
1970 - 1997 Johansen Cointegration
Aggregate
-0.04 -1.24
UAE -0.09 -2.43
Kuwait -0.08 -1.1
Oman -0.07 -0.82
Bahrain -0.06 -3.39
Qatar -0.18 -1.09
Dilaver and Hunt (2011) Turkey 1960 - 2008
Structural Time Series Model
Aggregate -0.11
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Amarawickrama and Hunt (2008) Sri Lanka 1970 - 2003
Time Series Analysis
Aggregate From 0 to -0.06
Ang et al. (1992) Singapore 1972 - 1990
Time Series Analysis
Residential -0.35
13
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