The Electricity Sector in FYR Macedonia

WP/11/30
The Electricity Sector in FYR Macedonia
Alexander F. Tieman
© 2010 International Monetary Fund
WP/11/30
IMF Working Paper
European Department
The Electricity Sector in FYR Macedonia
Prepared by Alexander F. Tieman1
Authorized for distribution by Wesley McGrew
February 2011
Abstract
This paper describes the current state of the Macedonian electricity sector. It looks at
ongoing structural changes, driven by the gradual adoption of the EU acquis on energy,
and comes up with estimates for electricity subsidies. It concludes by discussing the
longer term outlook and sketching policy options.
JEL Classification Numbers: I38, L3, L5, L94, L98, Q43, Q48
Keywords: Electricity, FYR Macedonia, Liberalization, Subsidies, EU acquis, ECT
Author’s E-Mail Address: atieman@imf.org
This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarily
represent those of the IMF or IMF policy. Working Papers describe research in progress by the
author(s) and are published to elicit comments and to further debate.
1
This work has benefitted from discussion with many stakeholders in Macedonia, as well as comments from World
Bank staff and Daniel-Alexander Schroth of the EU Delegation in Skopje. The author would like to thank them all.
2
Contents
Page
I. Introduction and Summary .....................................................................................................3 II. The Electricity Sector ............................................................................................................4 A. Demand and Supply ..................................................................................................4 B. Market Structure ........................................................................................................6 C. Plans for the Future ...................................................................................................7 III. European Integration is Driving Electricity Reform ............................................................8 IV. Subsidies are Declining .....................................................................................................11 V. Longer Term Outlook and Policy Options ..........................................................................15 References ................................................................................................................................19 Tables
1. Electricity Consumption and Generation, 2000–2010 ...........................................................5 2. Subsidies and Losses in the Electricity Sector, 2008–2010.................................................12 3. Subsidies and Losses in the Electricity Sector, Scenarios for 2015 ....................................14 Figures
1. Electricity Demand and Supply, 2000–2010 .........................................................................4 3
I. INTRODUCTION AND SUMMARY
The Macedonian energy sector is in a transitional phase from centrally planned and
managed to a decentralized regulated free market. Like in many of its peers in the region,
the energy sector is still working to overcome its collectivist legacy. On the demand side, the
key challenge is to improve efficiency of energy usage, which has been held back by below
market pricing for all but the largest users. On the supply side, challenges include the limited
range of options for energy supply, due to Macedonia’s lack of oil, gas or high quality coal
reserves, and ageing generation facilities. These factors have resulted in a shortage of
domestic generation capacity, as well as relatively inefficient and dirty facilities.
In order to sustain economic growth over the medium-to long-term, Macedonia would
have to address both demand and supply issues. New investment in generation should be
done based on least-cost analyses, taking into account environmental standards. The rise in
demand should be moderated by promoting energy efficiency measures, as well as market
liberalization and the concomitant price increases. In order to create the right incentives on
both sides of the market, establishing an efficient energy market is crucial. This will imply
further sector reform, including legislation and regulation.
Recent reforms are helping to address these issues, and the country is committed to
further reforms, that will bring about full liberalization of the energy market.
Macedonia has signed the Energy Community Treaty (ECT), which commits the signatories
to implement the relevant parts of the EU acquis communautaire. In particular, the
signatories aim to set up a single regional stable regulatory market framework capable of
attracting investment in transmission networks and generation capacity, and fostering
competition and interconnectivity, thus ensuring supply and realizing economies of scale.
The government has recently drafted a new Energy Law, which, once fully implemented
together with the necessary secondary legislation, is expected to bring the country in
compliance with its Treaty obligations.
Past structural reform of the electricity sector is already paying off. Implicit electricity
pricing subsidies have steadily decreased from 3.8 percent of GDP in 2008 to 0.7 percent of
GDP in 2010. This is mainly on the back of lower regional energy prices and increases in the
domestic price for subsidized end-users, and the full liberalization of the market for the
10 largest users. In addition, the privatization of distribution in 2006, and the subsequent
substantial investment by the new owner, has reduced distribution losses and collection
shortfalls.
Going forward, Macedonia’s challenge will be to implement fully its reform plans,
which are needed to boost supply while containing demand. Implementation of the new
Energy Law will result in full electricity market liberalization by 2015, which, together with
providing a stable and predictable legal and regulatory environment, is essential for attracting
large-scale long-term private sector investment in generation capacity. Market-based pricing,
the promotion of energy awareness among users, including attention for insulation of homes
and businesses, and further attention to collection enforcement, will contain increases in
demand. Gasification of the country can also contribute to lowering energy demand and
4
increasing supply, as natural gas provides a more efficient option for heating buildings, and a
denser gas network provides incentives to increase electricity supply by making relatively
environmentally-friendly cogeneration combined heat and power plants more attractive to
build. Taken together, these energy policies should ensure the security of supply, and hence
provide a necessary precondition for economic growth over the medium to long-term.
Energy reform will also have a favorable macroeconomic impact. Liberalized prices and
private investment will help ensure the sector does not become a fiscal burden or a source of
balance of payments pressures (as in 2008, when a spike in import prices coupled with a drop
in domestic output caused the value of imports to surge). Furthermore, in a liberalized
environment, subsidy outlays can be reduced and cover social assistance to the poorest
households only.
II. THE ELECTRICITY SECTOR
A. Demand and Supply
Over the past decade, supply has failed to keep up with demand, despite modest
improvements in energy efficiency. Between 2000 and 2008, energy consumption rose
34 percent, from 6,433 GWh to 8,609 GWh (Figure 1 and Table 1). In 2009, consumption
decreased to 7,597 GWh, on the back of a collapse of (electricity-intensive) exports from
heavy industry. Including this slump, demand growth averaged 1.9 percent per year between
2000 and 2009, below GDP growth of 2.7 percent on average over the period, indicating that
the energy intensity of
10,000
10,000
Figure 1. FYR Macedonia: Electricity Demand and Supply 2000-2010
production has
9,000
9,000
(GWh)
increased. While
8,000
8,000
demand has grown,
7,000
7,000
domestic supply
6,000
6,000
actually decreased from
5,000
5,000
Domestic consumption
Domestic supply
6,326 GWh in 2000 to
4,000
4,000
Imports
Domestic Consumption by Large Industry
6,152 GWh in 2009.
3,000
3,000
The remainder of
2,000
2,000
1,000
1,000
consumption, some
0
0
1,500 GWh annually on
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
average, was met from
Source: MEPSO
imports, which cost an
average of €95 million in the years 2003–09, and peaked at €235 million (or 3.6 percent of
GDP) in 2008, adding substantially to the country’s current account deficit.
5
Table 1. FYR Macedonia: Electricity Concumption and Generation 2000-2010
(Gw h)
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010 5/
6433
6283
6399
7216
7372
7955
8364
8581
8609
7597
7458
976
1198
1046
1531
1622
1937
2072
2281
2084
1284
1359
5246
4885
5170
5461
5571
5755
6062
6064
6251
6140
5913
820
870
1053
1083
1199
1316
211
200
183
224
179
263
231
236
224
172
191
301
121
212
99
44
37
153
109
38
80
441
Demand
Domestic consumption
Large Industry
Households and SMEs
of which: Techinical Losses and Theft 1/ 2/
Grid losses 3/
Exports
Supply
Domestic supply
6326
5863
5619
6273
6208
6474
6568
6071
5764
6152
7241
ELEM 4/
5973
5807
5468
6273
6208
6474
6334
5651
5586
5973
7241
Negotino
353
56
150
0
0
0
234
421
119
178
0
355
540
1010
1053
1228
1651
1950
2618
2757
1518
776
Imports
source: MEPSO
1/ information not available beyond 2005
2/ technical losses refer to transmission losses on the low -cvoltage distribution netw ork
3/ Grid losses refer to transmission losses on the high-voltage netw ork
4/ ESM before 2006, w hen the company w as split up into separate generation, transmisssion, and distribution companies.
5/ 2010 full-year estimate based on Jan-Jul data and 2009 monthly pattern
Electricity demand is dominated by large industrial users and households. The
10 largest industrial customers are mainly found in the metals and mining sectors. These
largest industrial users amounted for some 25 percent of total electricity consumption in
2005–08. Households, meanwhile, consumed around 50 percent of total, and together with
small industry and SMEs consumption of these regulated consumers reached around
72 percent of total (including over 15 percentage points in technical losses and theft).
Transmission (grid) losses accounted for the remainder. These percentages have shown a
gradual trend of an increasing share of electricity usage by heavy industry, and a concomitant
decrease in relative share of households. In 2009, however, the trend was reversed: as metal
exports collapsed, heavy industry used only 17 percent of total electricity in 2009, while
regulated consumers (households, small industry and SMEs) together consumed 80 percent.
Domestic electricity supply is mainly from thermal and hydro generation. The main
domestic generation facilities are the lignite-fired thermal power plants in Bitola and Oslomej
(together 800 MW), with the three generation blocks at Bitola alone representing 675MW.
Both these generation facilities are owned and operated by the state-owned ELEM
(ELEktrani na Makedonija, or Electric Power Stations of Macedonia). In addition, there is a
back-up thermal power plant fueled by heavy fuel oil in Negotino (210 MW capacity), which
is not owned by ELEM. Hydroelectric generation represents the other main domestic
electricity supply, with a total installed capacity amounting to 528 MW, out of which over
500MW is run by ELEM. As power plants, and in particular hydro power plants due to their
dependence on hydrological conditions, cannot continuously be run at peak capacity, overall
electricity generated by hydro facilities amounts to some 20 percent of total. Further modest
domestic generation capacity exists in geothermal, while there are plans for small wind farms
also.
Domestic generation capacity does not suffice to meet demand. Generation capacity has
to match peak demand plus a reasonable amount of spare capacity to ensure room for failure
and maintenance of equipment. With peak demand in Macedonia at some 1,500 MWh, and
hydro generation limited by water supply, it is clear that domestic generation capacity is
insufficient to supply the market. The difference between demand and supply is made up by
electricity imports through the high-voltage international transmission network. Total imports
6
averaged 20 percent of demand (1,468 GWh) between 2000 and 2009, and peaked at
32 percent of demand (2,757 GWh) in 2008, the year before the global crisis impacted
Macedonian power demand in earnest.
Electricity generation fall shorts of EU environmental standards and its output is used
inefficiently. The domestic thermal generation facilities heavily rely on dirty lignite for fuel,
and as a consequence they are dirty by international comparison. The main facility at Bitola,
for instance, operates on lignite, and emits much CO2 , as well as NOx (exceeding the limits
set in the EU Large Combustion Plants Directive about 4 times), and SOx (exceeding the
LCP Directive limits about 7–8 times).2 Total CO2 emission in Macedonia amount to some
14.4 Megaton CO2-equivalent (about 7.2 tons per capita), of which the thermal generation
accounts for some 70 percent.3 This implies emissions which are 60 percent higher per unit of
GDP than the OECD average.4 In turn, this is an indication of both inefficient usage and
inefficient generation facilities.
Both the dirty generation and the inefficient usage of electricity stem from past policy
choices, and will take time to change. The Bitola thermal power plant, as well as many of
the main industrial electricity-using factories, was built before Macedonia became an
independent country. Concerns about self-sufficiency and direct generation costs at the time
trumped environmental and efficiency considerations. Since then, the low, subsidized
electricity price has not provided the proper incentives to invest in energy conservation.
B. Market Structure
The Macedonia electricity market currently consists of three separate segments of endusers: The households, which are connected to the low-voltage grids, and pay a regulated
price; the companies which are on the low-voltage grid (small industry and SMEs) and pay
the same regulated price as the households; and the 10 largest electricity users in the country,
which are directly connected to the high-voltage grid and operate on a liberalized market as
of September 2008. The customers paying the regulated price are referred to as tariff
customers, while the customers on the liberalized market are referred to as eligible
customers.
The liberalized market for the largest users in effect drove these users to secure their
supply through electricity imports. After amendments to the Energy Law came in to effect
in September 2008, the 10 largest electricity users in the country have had to secure their
own electricity supply. They secure their supply through electricity traders. Most of the time,
there is a shortage of domestic supply, which is provided at below (regional) market rates to
2
Source: ELEM
3
Data for the year 2000, quoted from MANU (2010).
4
Source: IEA (2009), based on the amount of CO2 emissions per unit of GDP, measured at purchasing power
parity. When measured at market exchange rates, Macedonia emits 5 times as much as the OECD average per
unit of GDP.
7
tariff customers. In effect, this has forced the large users to start to import their own
electricity supply from the regional market. However, during time periods when domestic
supply exceeds demand by regulated customers, the traders also buy domestically produced
electricity. In addition to the price the large users agree with the traders, they pay a regulated
transmission fee to MEPSO (Makedonski Elektro Prenosen Sistem Operator, or Macedonian
Electricity Transmission System Operator), which operates the domestic transmission
network.5
The market for tariff customers has been partly unbundled, with generation,
transmission, and distribution split between three separate regulated monopolies.
ELEM is the regulated generator of electricity and monopoly wholesale supplier for retail
distributor EVN. In case ELEM itself does not generate enough electricity to supply all tariff
customers, it imports additional power. MEPSO is the sole operator of the electricity
transmission network.6 EVN is the retail distributor, i.e., the supplier of tariff customers.
EVN buys transmission services from MEPSO and power from ELEM. EVN concludes
individual contracts with retail end-users and collects payments. Prices of the services these
three market parties provide, as well as end-user prices for tariff customers, are regulated by
the Energy Regulatory Commission (ERC). While ELEM and MEPSO remain state-owned,
the retail distributor was privatized and subsequently sold to EVN Austria in April 2006.
C. Plans for the Future
In the medium to long term, the authorities are planning to expand hydro generation
capacity. According to the Strategy for Energy Development (MANU, 2010), existing and
new renewables could contribute up to 4,600 GWh by 2030, 90 percent of which would
come from hydro. The economics of some of the proposed hydro generation plants are not
always compelling. Based on a 7 percent return on investment, the Strategy calculates that
the cost per KWh for hydro would be in the range of 3.0–8.2 € cents, while lignite comes out
at 4.0 cents and gas-fired cogeneration combined heat and power (CHP) plants would
generate for 5.7 cents per KWh.7 A higher discount rate, which could be warranted given the
need for foreign investment and considering the country risk8, would result in higher costs for
5
The price the traders charge includes transmission fees to the Macedonian border (or another contractually
specified delivery point).
6
The transmission network consist of the high-voltage international interconnector lines and (mainly highvoltage) power lines connecting power generation facilities with substations. The network between the
substations and the end-users is called the distribution network, and is operated by EVN.
7
The range for hydro generation is particularly wide, as it represents different hydro power plants, facing
different hydrological and geological conditions. Within this range, only the smallest one (Lukovo Pole and
Crn Kamen, 8 MW) is estimated to generate at a cost below 4 cents, while only one additional medium-sized
plant (Boshkov Most, 68 MW) is estimated to be able to generate at a cost below 5.7 cents.
8
The country’s 2009 Eurobond carried an interest rate of 9.875 percent. This provides a benchmark rate for
foreign investment. While the bond trade at much lower yields in the secondary market, calculating with a
7 percent return seems to be on the low side.
8
all types of generation plants. But the costs for hydro plants would increase proportionally
more, because they are very capital intensive and take a long time to build. Hence, in
economic terms, hydro would be further disadvantaged vis-à-vis other sources. Note that
these calculations do not take account of a price for carbon emissions. A positive carbon
price, which will become reality once Macedonia joins the EU Emission Trading Scheme,
will benefit hydroelectricity vis-à-vis non-renewable source of generation, and in particular
compared to lignite. A further consideration that should be taken on board lies in the EU’s
renewable target of 20 percent of total consumption, and Macedonia’s own renewable energy
target of 21 percent of total consumption by 2020 (Ministry of Economy, 2010). Investment
in hydro generation could be justified on these grounds.
The largest hydro project currently under tender is for two dams at Cebren and
Galiste. This project would comprise a total investment of around €700 million, and would
add net generation capacity of 320–420 GWh.9 The tender is for investment in building,
maintaining, and exploiting the dams in a joint-venture with ELEM. While several large
European energy companies expressed preliminary interest in the tender, the fourth tender
closed without bids in November 2010. The authorities plan to re-launch the tender in early
2011. Apart from the pure economics of the project, attracting foreign investment on this
scale will also call for more general improvements in the business climate, including the
judiciary. Preparations for several other, smaller, hydro concessions are also under way,
including projects in Boskov Most (68 MW, €83 million), Lukovo Pole and Crn Kamen
(8 MW, €53 million), and Gradec (55 MW, €203 million).
The authorities are also seeking to lower cost and safeguard supply by improving
regional interconnections. The government is seeking to alleviate bottlenecks in the high
voltage transmission lines by building additional international interconnection capacity. This
could both reduce the cost of importing power, as well as play a role in safeguarding supply
in case of unexpected event or maintenance, as in a regionally connected network, one can to
some extent rely on spare capacity elsewhere in the network.
III. EUROPEAN INTEGRATION IS DRIVING ELECTRICITY REFORM
Macedonia has committed to gradual adoption of the EU energy policy. The goal of this
policy is to secure reliable and affordable supply of energy for countries in South Eastern
Europe (SEE), while safeguarding the environment. These goals and the steps toward it were
formalized in the Energy Community Treaty (ECT). The treaty set up the Energy
Community, which extends the EU internal energy market to South East Europe and beyond,
based on a legally binding framework.
The ECT commits the signatories to implement the relevant EU acquis communautaire
(the acquis). In particular, the contracting parties are to establish an integrated market in
9
The project would include pumping water back into the reservoir in off-peak periods to be used during peak
demand. While this entails an efficiency loss, it can make economic sense when the price difference between
peak and off-peak power is large enough. Nevertheless, it considerably reduces the plant’s net generation
capacity. The estimated total investment cost includes interest during construction.
9
natural gas and electricity. They aim to set up a single regional stable regulatory and market
framework capable of attracting investment in transmission networks and generation
capacity, and fostering competition and interconnectivity, thus ensuring supply and realizing
economies of scale. At the same time, the treaty parties strive to decrease the environmental
impact of natural gas and electricity provision, in particular through boosting efficiency and
using renewable sources of energy. A fixed time frame (2015) is set for the adoption of the
acquis, and the implementation process is backed up by a dispute settlement procedure, thus
contributing to the enforcement of the ECT legal framework.
Since signing the ECT, the authorities have advanced steadily towards meeting their
commitments. On the institutional side, an Energy Law was adopted in 2006, and amended
in 2008. This law is currently being comprehensively overhauled (see below). The energy
law lays out the framework for the unbundling of generation, transmission, and distribution.
This has led to the current market structure (described in Section II.B). The 2006 law also
provides the legal framework for the establishment and operation of the Energy Regulatory
Commission (ERC— the market regulator. The ERC has since been set up in accordance
with the law. It is a statutorily independent regulatory body that reports directly to
parliament, with authority to monitor the energy market operations; set regulated prices; be
the licensing authority; and participate in dispute resolution between market participants. The
2008 amendments to the Law created the liberalized market for the 10 largest industrial
electricity users.
The authorities are currently working to solve several outstanding treaty obligations.
Specifically, outstanding issues remain on market structure, cost reflectivity, and the deadline
for liberalization of the nonhousehold market.

Market structure. The main issue remains the dominant market position of ELEM
with respect to tariff customers. For these customers, ELEM remains the monopoly
wholesale generator and importer. The ECT requires imports and generation to be
fully liberalized.

Cost reflectivity. Currently, regulated prices are set in such a way that they do not
incorporate certain legitimate costs, such as full technical and commercial losses
(electricity theft), and certain collection shortfalls. According to the treaty
obligations, prices should reflect these costs.

Liberalization deadlines. While the government remains committed to the 2015
deadline for full liberalization of the entire market, it has missed the January 1, 2008
deadline for liberalization of the nonhousehold market. So far, it has only liberalized
the market for the 10 largest electricity consumers in the country (see above).
To remedy these shortcomings, the ministry of economy has prepared a new Energy
Law, together with secondary legislation. The law was approved by the government and
sent to parliament in October 2010, but was withdrawn in November. A new drafts of the
Law, including some of the numerous amendments filed in parliament and further changes, is
currently (December 2010) in parliament, which is expected to adopt it soon. A preliminary
analysis of the new proposed law, and discussions with the authorities, indicate that the law
10
would bring Macedonia into compliance with its treaty obligations. Specifically, the
legislative package will address the three outstanding issues of market structure, cost
reflectivity, and liberalization deadlines mentioned above:

Market structure. The law will abolish the monopoly position of ELEM on imports
for tariff customers. At the same time, the law will strengthen the monitoring and
enforcement role of the ERC. Such a strengthened role for the ERC would facilitate
its role in bringing together supply and demand.

Cost reflectivity. The amended rulebook for the energy market would set the rules in
this market structure, taking into account that the market will only be fully liberalized
by 2015. It would clarify the provisions on technical and commercial losses, as well
as collection shortfalls. The rulebook amendments have to be made by the ERC. It,
however, is awaiting the new energy law before proceeding with such amendments.

Deadlines. The law or secondary legislation would clarify the time line for
liberalization of the non-household sector (2012) and household sectors (2015).
Furthermore, together with the Energy law, the authorities have introduced measures
for social protection of vulnerable households in a liberalized market. Given the
relatively low electricity price, market liberalization will result in substantial price increases.
While desirable from the perspective of eliminating subsidized pricing for all customers,
poorer household would need to be partially protected against such price rises. Among the
several ways available to provide such support, the authorities have introduced a lump-sum
cash subsidy payment, targeted at the poorest households (for details, see Section IV).
The ongoing legal proceedings between EVN and ELEM and the Republic of
Macedonia present another outstanding issue. EVN entered the market by buying the
electricity distribution network ESM in 2006 for € 225 million.10 According to EVN, the
share purchase agreement specified that EVN would not be liable for uncollected receivables
from before the privatization.11 Shortly after the privatization, however, ELEM interpreted
the sale agreement differently, and claimed that EVN should pay the € 90 million of
outstanding receivables, which, including interest, led to a claim of € 160 million. In the
ensuing legal proceedings, the Skopje basic court found for ELEM. EVN has appealed, after
which the appeals court sent the case back to the court of first instance, citing substantial
procedural shortcomings in the original verdict. Meanwhile, EVN has sued the Republic of
Macedonia at the World Bank’s International Centre for Settlement of Investment Disputes
(ICSID) for breach of several investment treaties, as well as in the London court of
10
The sale price was later reduced by € 22.5 million, as the share purchase agreement specified that deviations
in the balance sheet prepared under IFRS would lead to adaptation in the sale price. Negative deviations,
leading to a lower equity value of the company, were indeed found by the independent auditor, leading to the
ex-post sale price reduction.
11
ESM had previously agreed with ELEM to aim to collect these debts. The proceeds would be split evenly
between ESM and ELEM.
11
arbitration for breach of the share purchase agreement. It reportedly claims damages of
€1 billion from the Government. Currently, efforts to come to a negotiated out-of-court
settlement continue. Such a solution would likely imply dropping ELEM’s claim and EVN’s
counter claim, and clearly specifying the market conditions under which EVN will operate
going forward. A solution along these lines will likely improve foreign investor perception
and interest in energy sector investment in the country.
IV. SUBSIDIES ARE DECLINING
The current market structure implies substantial implicit subsidization of electricity
supply. First, the electricity price for tariff customers is regulated at a level below the
regional market price, implying subsidization. Second, whenever tariff customers’ demand is
larger than supply, ELEM imports power for these customers, which is sold below the import
price.
The electricity price for tariff customers is subsidized. Since the regulated price lies above
the short-run marginal cost of generation, however, the subsidy is mostly implicit. For the
electricity produced domestically, the regional market price represents the foregone
opportunity benefits of selling the generated electricity at the regional market price. This
market price is used to calculate implicit subsidies. Only for the part of the electricity
consumption that is not generated domestically, and which hence has to be imported, does
the subsidy amount to a direct out-of-pocket expense. However, part of the implicit subsidy
for domestically produced electricity may still represents a true long-term cost, as the
marginal generation cost of generation does not properly reflect the long-run costs of mining
and depreciation. While current marginal mining cost is reflected, the main Suvudol coal
mine is almost exhausted. Replacement coal deposits, while plenty, are projected to be
considerably more expensive to mine. Furthermore, current generation facilities are valued at
below replacement cost, and hence depreciation costs of the existing generation facilities will
not suffice to replace aging facilities in the future.
These implicit subsidies are inefficient, and the authorities are committed to phasing
them out. By distorting incentives, electricity subsidies stimulate usage and hence an
inefficient use of scarce resources. As a social policy, electricity subsidies are inefficient,
since most electricity is used by the richer households, who hence benefit from the bulk of
the subsidies. In addition, keeping electricity tariffs below market clearing levels discourages
domestic and foreign investment in the sector. Through the ECT, the government has
committed to fully liberalize the market by 2015, implying a gradual phasing out of subsidies
and rising end-user prices. At current tariff and market prices, this would require an almost
40 percent tariff increase over the next five years. Rising prices should be accompanies by
increases in the targeted social assistance available to poorer households, in order to keep a
limited supply of electricity for basic and essential needs affordable for these households.
The total amounts involved in these subsidies is estimated at about 2.3 percent of GDP
in 2009, or €150 million. This estimate is based on a regional market price of €63 per MWh
(ELEM’s average weighted import price in 2009), while the price at which ELEM supplies
tariff customers is equivalent to some €30 per MWh. In addition, calculating the implicit
subsidy takes account of the average transmission price of €4 per MWh, which is included in
12
the import price of €63 per MWh but should not be included when calculating the
opportunity costs, as this revenue would not accrue to the generator. Multiplying the price
difference with volume consumed by tariff customers in 2009 yields the above cost estimate
(Table 2).12 Assuming that the regional market price includes the full cost of generation, i.e.,
including the full cost of mining and depreciation, this cost estimate reflects the full implicit
subsidy.
Out of this total subsidy, providing subsidized imports to tariff customers costs some
0.2 percent of GDP or €12 million in 2009.13 Whenever generation capacity falls short,
ELEM imports additional electricity, which is subsequently sold to tariff customers at the
regulated price. The cost involved can hence be calculated by multiplying the price
difference between the regulated price and the volume-weighted average import price with
the imported volume (Table 2). This subsidy shows up in state-owned ELEM’s accounts as a
loss, and is cross-subsidized with profits from other activities.
Table 2. FYR Macedonia: Subsidies and Losses in the Electricity Sector, 2008 - 2010
Quantity (MWh)
Price (euro per MWh) 4/
Cost (percent of GDP)
2009
2010
2009
2010
2008
2009
2010
5,230,050
370,166
5,334,651
-
63-30-4 = 29
63-30 = 33
46-33-4 = 9
46-33 = 13
3.8
n/a
2.3
0.2
0.7
0.0
Excess distribution losses 2/
754,334
583,842
30
33
0.3
0.4
0.3
Collection shortfall 3/
784,507
533,465
30
33
0.6
0.4
0.3
4.7
3.1
1.3
Pricing subsidies 1/
of which : subsidized imports
Total Losses
Sources: ELEM, MEPSO, Domestic Regulation, and Staff Estimates
1/ The import price differential is applied to distribution consumers and excess distribution losses.
The import price is ELEM's 2009 average import price, which is assumed to be representative for the regional market.
2/ Assumes a 24, 20, and 18 percent distribution loss for for 2008, 2009, and 2010 respectively, and 11 percent distribution
losses as the international standard (as per Regulatory Commission formula).
3/ Assuming EVN's collection rate improved from 75 percent in 2008 to 85 percent in 2009 and 90 percent in 2010.
4/ The regulated domestic price at which ELEM sells its production remained at €30/MWh in 2009 and increased to €33/MWh in 2010.
These estimates of subsidies are considerably lower than previous estimates based on
2008 prices, due to structural reform and lower energy prices. In IMF (2009), total
pricing subsidies were estimated at 3.8 percent of GDP in 2008, without distinguishing
between the direct and indirect subsidies. The estimate for 2009 is lower for several reasons.
First, as of September 2008, the government has obliged the largest 10 electricity customers
to secure their own supplies on the regional market. They hence pay the regional market
price (plus a transmission and service fee), and subsidies to these customers have been
eliminated.14 Second, the regional market price for electricity has decreased from an average
12
In the calculation, one need to correct for recognized losses (technical and commercial losses), which are
included in the generated amount of electricity but for which no payment is ever received. Recognized losses
stand at 11 percent per the ERC decision.
13
As this is not an opportunity cost but an actual expense, the full import price, including transmission cost, is
taken into account.
14
This move resulted in continuous complaints of the large consumers about an unlevel playing field due to a
cost disadvantage compared to their smaller competitors, who for the moment remain tariff (subsidized)
electricity consumers. Further market liberalization (see Section III) will deal with this issue by pushing all nonhousehold customers onto the liberalized market.
13
of €82 per MWh in 2008 to €63 per MWh in 2009.15 Third, tariff prices were raised
13 percent in late 2008 (and another 10 percent at the start of 2010).
In 2010, some of these effects have reduced the pricing subsidy further to an estimated
0.7 percent of GDP (Table 2). The main contributing factor to the lower estimate for
subsidies lies in the lower regional market price of €46 per MWh (the prevailing price at the
start of the year, when actual imports took place), and the 10 percent increase in the regulated
domestic electricity price on January 1, 2010. In addition, rainfall during the 2009–2010
winter has been plentiful, enabling ELEM to generate significantly more hydro electricity in
the winter months (when consumption is high) compared to the long-run average. This has
reduced the need for imports substantially, and the above estimate for 2010 assumes no
imports, and hence no subsidization outlays for imports. Unfortunately, as rainfall reverts to
historic averages, imports could increase again, and unless offset by price liberalization,
could increase subsidy outlays. In addition, climate change studies (see, e.g., Bergant, 2006)
suggest that, from a hydrological perspective, water-management and the directly associated
hydro generation of electricity will become more challenging in the future. Similarly, the
current low regional market price for electricity might increase again in the future when
demand picks up on the back of renewed economic growth. Still, in 2010 and beyond, the
large consumers will continue to operate without subsidization, which permanently lowers
the amount of subsidies involved.
In addition to these subsidies, there are further losses in the system, which, however, no
longer accrue (indirectly) to the state. Since the privatization of the distribution network,
the unrecognized distribution losses and the collection shortfalls accrue to EVN. These
unrecognized distribution and collection losses amounted to a further estimated 0.8 and
0.6 percent of GDP in 2009 and 2010 respectively (Table 2). These estimates assume
moderate improvement over time in distribution losses and collection shortfalls, as bringing
down these losses has been one of the main areas of focus and investment of EVN.16
Going forward, with unchanged policies, the pricing subsidies will remain roughly
constant as a share of GDP in the future while the excess distribution losses and
collection shortfalls will decrease moderately. Estimates for 2015, assuming no imports,
indicate that the quasi-fiscal subsidies will decrease to some 0.5 percent of GDP (Table 3,
Baseline). On unchanged policies, excess distribution losses and collection shortfalls will
decrease moderately to 0.6 percent of GDP.17 The estimates are based on the assumption of
15
During the year 2009, the price decreased almost continuously to about €46 per MWh in December.
However, the largest monthly volumes of imports were realized in the first few months of the year, when the
import prices were still considerably higher.
16
No recent data was made available by EVN. Based on discussion with industry experts, I assume 20 percent
total distribution loss and an 85 percent collection rate for 2009.
17
As above, these estimates are based on assumed improvements in distribution losses and collection shortfalls.
I calculate with distribution losses of 18 and 16 percent for 2010 and 2015 respectively, and collection rates of
90 percent for 2010 and beyond.
14
domestic price increases of 10 percent per year, increases in transmission costs in line with
inflation, regional market prices in line with the 2003–09 average (plus inflation), and
consumption increases equivalent to the real GDP growth rate.
Table 3. FYR Macedonia: Subsidies and Losses in the Electricity Sector, Scenarios for 2015
Quantity (MWh)
2010
2015
Price (euro per MWh)
2010
Baseline
Pricing Subsidies 1/
5,334,651 6,490,418
Cost (Percent of GDP)
2010
2015
Baseline
Scenario 1 Scenario 2
46-33-4 = 9
65-53-5= 7
65-42-5= 18 58-53-5= 0
2015
Baseline Scenario 1 Scenario 2
0.7
0.5
1.2
0.0
Excess distribution losses 2/
583,842
495,301
33
53
42
53
0.3
0.3
0.2
0.3
Collection shortfall 3/
533,465
649,042
33
53
42
53
0.3
0.4
0.3
0.4
1.3
1.1
1.8
0.7
Total Losses
Source: ELEM, MEPSO, Domestic Regulation, and Staff Estimates
1/ The import price differential applied to distribution consumers and excess distribution losses.
The import price for 2015 is based on the average import price 2003-09, increased by inflation.
2/ Assumes an 18 and 16 percent distribution loss for for 2010 and 2015 respectively, and 11 percent distribution
losses as the international standard (as per Regulatory Commission formula).
3/ Assuming EVN's collection rate remains at 90 percent after 2010.
The estimates are roughly linear in the assumptions on future price increases and
import prices. For instance, a 5 percent annual domestic price increase from 2011 to 2015
(instead of the assumed 10 percent), would increase the estimated pricing subsidization from
0.5 to 1.2 percent of GDP (2015 – Scenario 1), while a 10 percent lower average import price
would reduce the estimate to almost 0 percent of GDP (2015 – Scenario 2). Such a lower
average import price might be realized through the authorities’ plans to increase high-voltage
international transmission capacity. In the long-run, this wills presumable close some of the
price differential between the regional market price and the market price in Western Europe.
In addition to the pricing subsidies, the government introduced a targeted social
assistance package for poor households. From September 2010 onwards, an estimated
58,000 families became eligible for social assistance for heating in the amount of € 10 per
month per household, which would provide for about 200 KWh.18 While a lump-sum
subsidy, it is targeted at combating the effects of electricity price increases for poor
households. Electricity prices have increased by 10 percent this year, and future further
substantive increases are likely. The fact that many households use electricity as one of the
means to heat their home during winter makes this kind of social assistance all the more
necessary.19 The total maximum estimated cost of €7 million (€10 * 12 month * 58,000
households), or 0.1 percent of GDP, is modest, and the assistance is well-targeted.20 Going
18
Based on an average residential price of MKD 3.34/KWh (day) and MKD 1.67/KWh (night). Both rates do
not include the regular additional fee for transmission and spare capacity. This fee is, however, taken into
account in these calculations.
19
The subsidy, in fact, also applies to other expenditures for heating. I.e., a poor household can ask for payment
of the full subsidy in case its total heating bill (electricity + district heating + fuel oil + firewood) is above €
10 per month.
15
forward, this assistance might have to be increased in line with future price increases. Still,
the efficient targeting ensures that the social subsidy is kept at the minimum amount needed
to achieve its goal of assistance to poor households.
Reducing pricing subsidies over the coming years will require commitment to
implement fully the government’s target of full price liberalization. If prices are
liberalized fully by 2015, as called for under the new Energy Law, this will eliminate pricing
subsidies. Achieving this will require strong political will, in particular if international prices
rise from current levels, which would require higher domestic price increases. In this context,
the government’s new targeted lump-sum social benefit for heating expenses will cushion the
effects of electricity price increases for poor households and should increase social
acceptance of price increases.
V. LONGER TERM OUTLOOK AND POLICY OPTIONS
Several significant longer term risks are present in the outlook for the region. The
longer term outlook for the wider region of Central, Eastern, and Southeastern Europe
(CESE) together with Central Asia includes significant risks. On current policies, electricity
supply is likely to decline over the next two decades. Many electricity generation and district
heating facilities are ageing, which means that they will have to shut down or will at the very
least operate less efficiently. At the same time, on the back of economic growth, demand for
energy in the region is projected to increase significantly.
A regional mismatch between supply and demand is projected to create a squeeze in the
regional electricity market. As electricity does not lend itself well to long-distance export,
the market is of a regional nature, i.e., the western Balkans. On current trends, investment in
new generation facilities is not making up for the losses from ageing facilities, likely
resulting in decreased regional supply. At the same time, while the CESE economies recover
from the crisis and return to growth around potential, demand for electricity will increase
significantly. Even when incentives to increase energy efficiency are put in place, and hence
the energy intensity per unit of GDP will decrease, total electricity consumption is projected
to increase by 3.1 percent a year on average, or over 100 percent over 2005 levels by 2030
(World Bank, 2010).
Early and decisive policy action can diminish the effects of such a squeeze or possibly
even prevent it all together. Policy actions include options on the supply as well as on the
demand side. On the supply side, attracting large private sector energy firms to invest in
generation capacity is part of the solution. In addition, investment in the international highvoltage transmission network will ensure that Macedonia can also benefit to the full extent of
investment in generation made outside its borders. On the demand side, energy efficiency
20
Other options for social assistance, such as, e.g., a social tariff up to a usage threshold, are less efficient, in
the sense that they provide a subsidy to all households, rather than just the poor households. The cost estimate is
a maximum, as poor household will have to apply and show proof of payment before being eligible to receive
the subsidy.
16
needs to be promoted. At the same time, incentives need to be devised and implemented to
stimulate environmentally friendly solutions. Establishing a carbon price in line with the
European carbon trading scheme would provide a market-friendly way toward this goal.
On the supply side, authorities need to provide an enabling environment for private
sector investment. This applies to investment in new generation capacity, and could also
include the privatization of existing capacity. The public sector does not have the resources
to finance all the necessary investment in energy infrastructure. Moreover, private companies
can bring in valuable knowledge and expertise on how to run large generation facilities
profitably and efficiently. Hence, it is essential that countries in the region put in place
incentives for private sector investment. The main elements of such an investment
environment should be geared towards reducing uncertainty for investors, and would include:

Setting out a clear multi-year time frame for market liberalization, as envisaged
in the new Energy Law, and sticking to it. A clear time frame for market
liberalization reduces the uncertainty of potential returns on large, long-term
investments in generation capacity. Lower uncertainty makes investment more
attractive, and enlarges the pool of profitable investments.

Providing a stable and predictable legal and regulatory environment, as
perceived in the new Energy Law. Clear rules and regulation, and a regulator that is
independent both on paper and in practice, further reduce uncertainty. Full adoption
of the EU acquis on energy, as envisaged in the Energy Law, would go a long way
toward achieving such stability.

Improving the environment for collection and lower theft. Improved cooperation
between the energy suppliers, the judiciary, and in some cases the police, could lead
to better enforcement of payment discipline, and lower the amount of electricity theft.

Working with other countries in the region to strengthen regional security of
supply. Individual markets in the region are mostly small to realize the full
efficiencies of scale of large energy investments. The establishment of a transparent
regional market, including sufficient interconnection capacity (and nondiscriminatory access to such capacity), would ensure that such efficiencies can be
realized, and would hence enhance the scope for profitable investment. At the same
time, it would increase the security of supply, by providing a regional network of
backup facilities.
On the demand side, energy efficiency should become a policy priority. The
Government’s recent Energy Strategy (MANU, 2010) and Renewable Energy Strategy
(Ministry of Economy, 2010) clearly spell out these issues and set policy priorities to achieve
a higher level of energy efficiency. Several short and medium-term option come to mind in
particular:

Promoting better insulation of businesses and homes. Premises are often heated
using electricity. Better insulation will hence reduce electricity demand. Higher
electricity prices, in line with the regional market price, will provide an incentive.
17
Additionally, transparent marking of energy efficiency of products, mandating energy
efficiency standards, and promoting the most energy-efficient products could be part
of the policy mix.

Gasification of the country and the use of gas-fired cogeneration plants (which
produce both electricity and heat) could reduce electricity as a source of heating. Such
efforts should not be limited to electricity usage only. For instance, consumers should
be given better control over the amount of district heat they consume.21
Implementing these policy options, as envisaged by the authorities, will have further
positive effects beyond boosting supply and containing demand. Specifically, policy
measures can reduce both the import bill as well as the amount of subsidization.

First, full market liberalization will reduce subsidies. As a first step, all nonhousehold customers will be pushed onto the liberalized market in 2012, where they
would have to pay the full market price for power. This will be followed by
liberalization of the market for household customers by 2015. As this will likely go
hand in hand with increased subsidies to poorer households for basic electricity
usage, direct subsidies would not be totally eliminated, but reduced to a minimum. In
addition, the subsidies would be more visible, enhancing transparency.

Second, investment in generation capacity would reduce the import bill, benefit
the environment, and likely contribute to knowledge transfer. While reduction of
the import bill should not be a policy goal in itself, a lower current account deficit,
which would, ceteris paribus, be the result of lower imports, would reduce external
vulnerabilities. New investment in modern generation technology would also benefit
the environment. Modern facilities are more efficient and hence generate lower
emissions per unit of output. Switching from lignite to other, cleaner, fuels, such as
natural gas in co-generation plant, would yield further environmental benefits. In
addition, there is potential for investments in renewables, in particular in hydro
generation. To the extent that new investment will include sizeable FDI, foreign
investors would also bring in knowledge, both on the technical side, as well as on
project management.
Several of the policy directions outlined above are currently awaiting implementation.
As detailed above, the authorities are committed to adopt the EU acquis on energy under the
ECT, which implies fully liberalizing the electricity market. The new Energy Law, and
concomitant new rulebook for the energy market, which the regulatory commission is
expected to start preparing soon, will lay down the new market structure and the details of
the rules under which the market operates. Full and consistent implementation of these rules
will ensure the predictability of the regulatory environment.
21
At the moment, district heat is provided at a uniform temperature set by the provider, and can be either turned
on or off by the user. Thermostatic valves would enable consumers to heat to a specific individually chosen
preset temperature.
18
Going forward, implementation of these policies will improve the foundations for
sustained growth. The policies will bring regulation of the electricity sector up to European
standards, will contribute to reliable and safe energy supply at lower environmental costs,
with transparent and cost-effective social subsidies, and reduce risks to the balance of
payments and the budget. They will hence provide some of the necessary pre-conditions for
economic growth.
19
REFERENCES
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Framework Convention on Climate Change, University of Nova Gorica: Nova
Gorica, Slovenia.
Energy Community Secretariat, 2009, “Report on the Implementation of the Acquis under
the Treaty Establishing the Energy Community,” available from http://www.energycommunity.org/portal/page/portal/ENC_HOME/DOCUMENTS?library.category=15
7
European Commission, 2006, “Commission decision amending the Annex to Regulation
(EC) No 1228/2003 on conditions for access to the network for cross-border
exchanges in electricity,” Official Journal of the European Union L 312/59, Brussels.
EU Council, 2004, “Council directive 2004/67/EC concerning measures to safeguard security
of natural gas supply,” Official Journal of the European Union, L127/92, Brussels.
European Parliament and EU Council, 2003a, “Directive 2003/54/EC of the European
Parliament and of the Council concerning common rules for the internal market in
electricity and repealing Directive 96/92/EC,” Official Journal of the European Union
L176/23, Brussels.
European Parliament and EU Council, 2003b, “Regulation (EC) No 1228/2004 of the
European Parliament and of the Council on conditions for access to the network for
cross-border exchanges in electricity,” Official Journal of the European Union,
L176/1, Brussels.
European Parliament and EU Council, 2003c, “Directive 2003/55/EC of the European
Parliament and of the Council concerning common rules for the internal market in
natural gas and repealing Directive 98/30/EC,” Official Journal of the European
Union L176/57, Brussels.
European Parliament and EU Council, 2005, “Regulation No 1775/2005 of the European
Parliament and of the Council on conditions for access to the natural gas transmission
networks,” Official Journal of the European Union L289/1, Brussels.
European Parliament and EU Council, 2006a, “Directive 2005/89/EC of the European
Parliament and of the Council concerning measures to safeguard security of
electricity supply and infrastructure investment,” Official Journal of the European
Union L33/22, Brussels.
European Parliament and EU Council, 2009, “Proposal for a Regulation of the European
Parliament and of the Council concerning measures to safeguard security of gas
supply and repealing Directive 2004/67/EC,” mimeo.
International Energy Agency, 2009, “CO2 Emissions from Fuel Combustion – Highlights,”
2009 Edition, OECD/IEA: Paris.
20
International Monetary Fund, 2009, “Former Yugoslav Republic of Macedonia: Selected
Issues,” IMF Country Report 09/61, International Monetary Fund: Washington, D.C.
MANU, 2010, “Strategy for Energy Development in the Republic of Macedonia until 2030,”
Macedonian Academy of Sciences and Arts: Skopje, Macedonia.
Ministry of Economy, 2010, “Strategy for the Use of Renewable Energy in the Republic of
Macedonia by 2020,” Ministry of Economy: Skopje, Macedonia.
World Bank, 2010, “Lights Out? The Outlook for Energy in Eastern Europe and the Former
Soviet Union,” The World Bank: Washington, D.C.
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