power industry cee 2011

8/3/2019 Power Industry CEE 2011

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Power Industry CEE 2011

KEY CHARACTERISTICS OF THE ELECTRICITY INDUSTRY IN CENTRAL ANDEASTERN EUROPE

The electricity systems of the Central and Eastern European countries have undergone

considerable development since the fall of communism in 198990. Nonetheless, huge

challenges remain across the region. Almost all economic data, including electricityconsumption, which on a per capita basis is only 57 percent that of Western Europe,

indicate that the region still has some way to go before living standards catch-up with

those in the developed world.

Increasing demand is a key factor driving change and expansion in the CEE electricitysectors, and naturally needs to be taken into account in any future modeling of systems,

particularly of renewal and expansion of generation capacity.

Other challenges include investment into transmission and distribution systems and

crossborder links. Meanwhile, planners have to take into account increasing concernsregarding security of supply, ever more stringent environmental regulations, political

worries over the cost of electricity and last but not least, the problem of long term finance

for projects in the current global economic environment.

Given the increasingly long lead-times and pay-back periods associated with new powerprojects most especially large hydro, coal and nuclear facilities the future planning of

CEE electricity sectors requires focused and responsible governments at all levels.

Regionally, the requirements are substantial; the Union for the Co-ordination for theTransmission of Electricity (UCTE) estimates electricity consumption in the region willjump by an average of 25 percent in the next decade, with above average growth in

Romania, Hungary and most states of the former Yugoslavia.

To meet this increased demand, the UCTE estimates that the region requires between 21

GW (Conservative Scenario) and 42 GW (Best Estimate Scenario) of new generationcapacity by the end of the decade. In addition, based on KPMG estimates, 53 GW of

obsolete capacity needs replacement or at least retrofitting over the same time period.


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CEE ELECTRICITY GENERATION: UCTE FORECAST

Figures for future developments of the electricity sector are based on the System

Adequacy Forecast 20092020 prepared by the Union for the Co-ordination of

Transmission of Electricity (UCTE) and KPMG analysis regarding the Baltic countriesand Albania and presents two scenarios: Conservative and Best Estimate.

The Conservative Scenario takes into account the commissioning of new power plants

considered as certain and the expected shutdown of power plants during the given time

period. The Best Estimate Scenario also contains future power plants where

commissioning can be considered as reasonably credible according to the informationavailable to the national Transmission System Operators (TSOs). Additional information

regarding EU regulations and data pertaining to non-UCTE member states has also been

examined in order to ensure a comprehensive review of the evolution ofthe regionalgeneration mix.

According to the Best Estimate Scenario, the CEE generation capacity mix will develop

significantly by 2020, with total regional capacity reaching 163.3 GW, and an averagesystem load at 97.3 GW. Renewable energy together with nuclear sources and new gas-

fired power plants will form the primary focus of sector development.

There is a significant difference between the Conservative and Best Estimate Scenarios.Based on the assumptions of the Best Estimate Scenario and KPMG analysis the installedcapacity is estimated to be 34 GW higher than in the case of the Conservative Scenario.

In the case of the Best Estimate Scenario the ratio of coal-fired capacities is expected to

shrink to 38 percent of the total. The proportion of renewables will increase to 31 percent,

with the continuing dominance of hydro representing above 22 percent of the total. Theproportion of gas-fired plants, expected to account for 1317 percent in 2020, is expected

to largely replace defunct coalfired capacity.


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RENEWABLE GENERATION

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

attention in the coming decade as a result of EU regulations, public concern over theenvironment and the desire to reduce dependence on imported energy sources. Some

CEE countries, notably Romania, Latvia, Albania and most former Yugoslavian states

can already boast that a significant proportion of their power derives from renewables

typically in the 1520 percent range primarily hydro sources.

The UCTE Best Estimate Scenario suggests the share of renewables in the installed

generation capacity will reach 31 percent, i.e., 50 GW by 2020, and though hydro

capacity is predicted to expand by about 20 percent across the region, wind energy is

expected to be the star performer. Almost every CEE state intends to progress with windenergy, most significantly Poland, Romania, Estonia and Albania. According to the

UCTEs Best Estimate Scenario wind-generation capacity in the region will expand to 12

GW by 2020, 6.5 times current levels.


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Favorable financial and regulatory measures are indispensable for widespread promotion

of renewables, including, for example, the feed-in tariff or green certificates systems.

However such incentives also introduce certain technical and commercial challenges toelectricity systems. Monitoring plants generating power under these arrangements poses

difficulties for the TSO, especially related to balancing. For example there may be

surplus electricity generated, during periods of low demand. This in turn causes prices tofall, and reduced loads at larger plants which do not benefit from the tariff or green

certificates system. All of which causes disturbances in the market which must be

properly managed, both technically and commercially.

One solution is to build more balancing power plants, for example Combined Cycle GasTurbine (CCGT). This is a new challenge, as currently system balancing capacity is

primarily a function of fluctuations in consumer demand, and back-up for the largest

generation units. Hence the spread of renewable technologies is a new factor for systemdesigners to grapple with in coming years.

NUCLEAR GENERATION

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

region, and with the priority given to CO2 emission reduction, competitive pricing and

security of supply, the pressure is on to once again expand nuclear facilities. Plans aregoing ahead in several countries, including two reactors in Slovakia with a capacity of

840 MW, two in Bulgaria with 1,900 MW and two in Romania totaling 1,310 MW based

on the World Nuclear Associations database. In addition, 14 more reactors have beenproposed across the region, which if completed would total 21,655 MW roughly double

the total current capacity.

New nuclear projects are underway or being considered in the Czech Republic, Lithuania,Poland, Romania, and Bulgaria, and are being studied in Hungary and Slovenia. With theexception of a nuclear power plant extension initiated by CEZ, however, none of the

projects in the region are showing substantive progress. The volume of investment

involved, the socio-political implications, the recent events at the Fukushima NPP and theextremely long commissioning period all mean that nuclear facilities are a long term

prospect, when they will surely be a significant factor.

NATURAL GAS

Finally natural gas, which currently accounts for only 9 percent of total CEE generation

capacity, is likely to see its share of the electricity production more than double in thenext decade. And this is despite concerns regarding dependence on Russia as the primary

source for most countries in the region which raises questions about the security of

supply. Further development of gas-based generation is expected due to its highefficiency, the short lead times for new plant, low capital expenditure, and low CO2

emissions. Moreover, development of natural gas usage in electricity generation might be

advanced by the realization of new supply routes to Europe, such as Nabucco, BlueStream and Nord Stream. According to the estimates of national TSOs, gas-fired capacity


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in the region will jump to 28 GW, i.e., 2.5 times current levels in the Best Estimate

Scenario.

The majority of projects in recent years have been CCGT plants built by large utilitycompanies, although small cogeneration units (for heat and power) have also become

popular, both for district heating and industrial projects.

ANALYSIS OF THE UCTE SCENARIOS FOR THE CEE COUNTRIES

According to the UCTEs Conservative Scenario, the total capacity in the CEE region

will grow by only 3.4 percent in the next decade, hitting 130 GW by 2020, with somedifferences in the proportions of primary energy sources.

Overall, both scenarios forecast similar trends regarding capacity development, with

nuclear, gas, wind, and hydro capacities presenting the best opportunities for investment.

A moderate decrease is foreseeable in the use of oil and other fossil fuelfueled capacity,

although in the case of coal the outlook is more difficult to predict.

TOTAL IVESTMENT NEEDS OF THE ENERGY SECTOR DEVELOMPMENT

PROGRAM IN CEE

Taking into consideration the UCTE forecasts and the estimated CAPEX costs ofdifferent power plants, significant capital investments will be required to implement the

electricity sector development plans in Central and Eastern Europe by 2020. The

additional capacity requirement is estimated to be around 21 GW (according to theConservative Scenario), which represents about EUR 40 bn of total investment. For the

Best Estimate Scenario, more than 42 GW are required, amounting to investments of

more than EUR 70 bn.

In addition, the decommissioning and replacement of 53 GW of generation plant (mainlycoal, gas and oil fired) over 30 years old should be replaced or retrofitted by 2020. The

total investment needs for replacement can be calculated based on a weighted average of

individual CAPEX costs and the Conservative Scenario of the UCTE System Adequacy

forecast. The estimated investment cost could reach EUR 74 bn by 2020, depending onthe extent of substitution of old generation units.

Based on an optimistic timeline the total replacement and new investment in the regions

power plant infrastructure may result in a total financing of EUR 114-144 bn over the

next decade. In light of all these needed investments (and CEE is not alone hugeinvestments are also required in western European electricity systems), the question

arises: where the money comes from, particularly in these troubled times?

The need is such that the required developments will probably need financial assistancefrom beyond the region. However, this is not considered a real constraint, since Western

European banks would also participate in any deals, with a pricing level adjusted to

country risk.


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Several banks indicated that the biggest concern relating to the realization of these

investments is the lack of credible, committed project sponsors and sufficient equity.

Therefore, state participation in investments and the development of robust regulatoryframeworks will play an important role in attracting financial resources to such projects.

CEE generation capacity forecast, 2020


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WHAT ARE THE TYPES OF PREFERRED FINANCING STRUCTURES

COMMONLY USED TO FINANCE ENERGY SECTOR RELATED PROJECTS?


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Project financing is the most common form for financing energy sector projects, since the

cash flow generated through these projects can be relatively well quantified and

estimated. The experience and credentials of project sponsors are also key factors toconsider when opting for this method of finance. Lending is also substantial but it is

mainly used when large international companies or utilities finance several investment

projects from the same pool of credit.

In general, most green-field investments are implemented in project financing form whilemodernization and retrofit projects are usually financed through lending. Private equity

and mezzanine financing are not commonly used in energy sector investment projects.

Prior to the financial crisis it was relatively easy to find financial resources for a well-

structured energy sector investment, while in the last years it has become morechallenging due to tighter capital resources.

WHAT ARE THE MINIMUM FINANCIAL REQUIREMENTS AND

PREREQUISITES FOR AN ELIGIBLE PROJECT IN THE CURRENTENVIRONMENT?

Project financing has become considerably more difficult during recent years. Prior to the

crisis, commercial banks became very liberal in the boom years in terms of financing

requirements due to the extensive amount of liquid and cheap financial resourcesavailable. As a consequence of the crisis however, banks had to face deteriorating loan

portfolios and a lack of trust in the financial market, which eventually led to liquidity

problems. Therefore, the following changes (see the box on the right) occurred in the

conditions and prerequisites for project financing.

Prerequisites for project financing:

1. The expected ratio of own equity increased to 30 percent, compared to the previous

1015 percent levels. This has had a huge impact on, for example, wind park projects,

which in the past, had the most aggressive project structures. But now, with the banksdemanding higher equity ratios, project sponsors have to demonstrate more trust and

commitment towards projects. Furthermore, government and EU subsidies are usually not

included in own equity (since these can suffer delay or cancellation), and thus the projecthas to be profitable without these subsidies, although they can later be used for early

repayment.

2. The interest surcharge level has also drastically increased as a result of the growingcost of bank funding. Depending on the currency, the interest rate surcharge has jumpedfrom 0.8 percent to 3.85.0 percent. However resources in local currency have generally

stayed relatively cheap compared to credit in foreign currencies and long-term financial

resources, which became extremely expensive. Although the interest surcharge hasincreased significantly, the lower base rates have to some extent compensated for this.


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3. The one-time fees linked to project financing have also significantly increased,

typically from a level of 0.15 percent to 11.5 percent.

4. The Debt Service Coverage Ratio (DSCR) currently required from eligible projects hasrisen from 1 percent to 1.21.25 percent.

5. The collaterals and covenants required from the project sponsors have become more

tough and more regular and thorough monitoring is conducted.

6. The fact that banks refuse to take currency risks and the borrower has to possess

incomes in foreign currency in the case of foreign debts is a further disadvantage.

7. More attention is paid to the assessment of assumptions in a project plan such as the

contractual background, ownership structure, and cash-flow projections.

8. Banks have also introduced some new indicators to assess the efficiency of their

internal operation, based on the risks and profitability associated with different financialproducts.

FINANCING IN THE FUTURE

A lasting scarcity of investment financing hampers production and economic growth

which is not sustainable in the long term. The EBRD stressed that if the required

investments are not made in time, economies slow to react could face newproblems in thefuture.

Therefore, governments and national financial institutions are under pressure to take steps

to improve conditions. Consequently, infrastructure investment will be among the fieldsthat receive substantial volumes of financing (due also to characteristic risks that areeasier to monitor).

Energy sector developments should be understood as fundamental to the future success of

post-crisis economies and should have the highest priority among these preferreddevelopments. The sector has not seen many large-scale investments recently, and as

funds once again become available, the issue of obsolete, inefficient and inadequate

capacities must be resolved.

Another sign of the future expansion of financing in the CEE region is the fact that more

interest and demand can be seen regarding EBRD financing than previously. Whileearlier, projects were mostly financed by commercial banks, with the EBRD often absent

from the deal, since the onset of the crisis investors have been turning to the EBRD to

compensate for the lack of private funds. In response, the EBRD is cooperating closelywith the EIB (European Investment Bank), which controls a larger volume of resources

and generally invests more in the region.


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

CEE region will clearly be possible in the years to come. The stable nature and expected

steady growth in the sector, combined with its huge influence throughout the economy,society and industry mean that its development must be considered crucial even in

difficult times.

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

of supply, the need for modernization, to name a few and the colorful diversity of theregion itself offer an exceptionally wide scope for development.

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

technological solutions from the suppliers in the region, financing opportunities offered

by banks and the needs and requirements of the local decision makers must be broughttogether. This requires a circumspect overview of all aspects of the sector and the

participants, alongside a viable and realistic financial plan. Once these efforts have been

made, the possibilities in the region are numerous and far-reaching.

***

KPMG conducted a comprehensive research to frame the prospects of development in

the electricity industry in Central and Eastern Europe (CEE).

This article is prepared based on the Prospects for the Central and Eastern European

Electricity Market report that has been compiled by KPMGs Global Power & Utilities

Knowledge & Resource Center, locate.

The report is supported in part by statistical databases and forecasts of the Union for the

Co-ordination of Transmission of Electricity (UCTE), EUROSTAT, EconomistIntelligence Unit, Dealogic, and by interviews conducted with key market participants.

Based on these interviews, databases, evaluations and forecasts, KPMG analyzed the

development trends of the electricity sector of the CEE region up to 2020. The reportalso analyzes the assumptions of the System Adequacy Forecast 20092020 prepared by

UCTE which differentiates two scenarios, a Conservative and a Best Estimate Scenario

for generation capacity development in the region.

KPMG identified the key characteristics of the electricity industry in Central and Eastern

Europe (CEE), assessed issues such as sustainability and the development needs and

evaluated the effect of the present economic circumstances on the investment

environment.

power industry cee 2011

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