south east europe wholesale market opening, poyry and nord pool

8/10/2019 South East Europe Wholesale Market Opening, Poyry and Nord Pool

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SOUTH EAST EUROPEWHOLESALE MARKET OPENING

Final reportOctober 2009

FINAL DRAFT


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SOUTH EAST EUROPE WHOLESALE MARKET OPENING

PYRY ENERGY CONSULTING

ACKNOWLEDGEMENT

The South East Europe Wholesale Market Opening technical assistance project (theProject) is co-financed by two multi-donor trust funds, ESMAP and PPIAF.

The Energy Sector Management Assistance Program (ESMAP) is a global technicalassistance program which helps build consensus and provides policy advice onsustainable energy development to governments of developing countries and economies intransition. For more information on the program see the website:www.esmap.org

The Public-Private Infrastructure Advisory Facility (PPIAF) is a multi-donor technicalassistance facility aimed at helping developing countries improve the quality of theirinfrastructure through private sector involvement. For more information on the facility seethe website:www.ppiaf.org

The Word Bank is managing the Project as a part of its support to the development of theEnergy Community. For information about the World Bank's energy sector activities seethe website: www.worldbank.org/energy
http://www.esmap.org/http://www.esmap.org/http://www.esmap.org/http://www.ppiaf.org/http://www.ppiaf.org/http://www.ppiaf.org/http://www.worldbank.org/energyhttp://www.worldbank.org/energyhttp://www.worldbank.org/energyhttp://www.ppiaf.org/http://www.esmap.org/


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2PYRY ENERGY CONSULTING

NORD POOL CONSULTING

TABLE OF CONTENTS

EXECUTIVE SUMMARY 5

SECTION I: HIGH LEVEL RECOMMENDED MARKED DESIGN 7

1. SUMMARY OF RECOMMENDED MARKET DESIGN ANDIMPLEMENTATION 8

1.1 Prerequisites 8

1.2 High level recommended SEE Regional Power Market Design 12

1.3 High level SEE Regional Power Market business processes 12

1.4 CAO Coordinated Auction Office 15

1.5

Transition phase: From regulated prices to market prices 16

1.6 VPP auction 20

1.7 Action plan 20

SECTION II: BACKGROUND 25

2.

INTRODUCTION 26

2.1 The focus of the study 26

2.2 Designation of the Contracting Parties 27

2.3 Objective of a wholesale market reform 27

2.4

Regulatory framework 27

3. THE REGIONAL ELECTRICITY MARKET 29

3.1 Introduction 29

3.2 Electricity generation and demand 29

3.3 Regional trade in electricity 38

3.4 Market structure, market opening and market model 43

3.5 Prices and tariffs 49

4.

CURRENT REGIONAL MARKET OPERATIONS AND MECHANISMS 52

4.1

Current Balance Management in SEE 524.2 Congestion management and cross-border capacity allocation 53

4.3 Inter-TSO Compensation mechanism (ITC) 59

5.

EXPERIENCES FROM OTHER REGIONAL MARKETS 60

5.1 Selected national and regional markets 60

5.2

Review of Regional Markets 68

5.3 Conclusion 71

SECTION III: ANALYSIS 73

6.

POSSIBLE CAUSES FOR HIGH PRICES IN THE REGION 74


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7. RISKS AND OPPORTUNITIES FOR NON-HOUSEHOLD CUSTOMERS 80

7.1 Key risks 80

7.2 Opportunities 81

8.

BARRIERS TO MARKET OPENING 83

8.1

Prerequisites for market opening and current status 83

8.2 Barriers to market opening 89

8.3 Ways to overcome barriers to market opening 91

9. KEY PERFORMANCE INDICATORS 92

9.1 Prices, transparency and surveillance 93

9.2 Access to markets 94

9.3 Access to customers 95

9.4 Market structure and competition 96

9.5

Balance responsibility and balancing markets 97

9.6 Allocation of cross-border capacities 98

9.7 Network tariffs and grid access 99

9.8 Independent regulators and harmonization of regulations 100

10.

SEE WHOLESALE MARKET OPENING REQUIREMENTS 101

10.1 Introduction 101

10.2 Balance Responsibility, Regulated Prices and Market Price 102

10.3 Generation and consumption balancing 102

10.4 Market Structure 105

10.5 Regional market key decisions 106

SECTION IV: MARKET DESIGN AND IMPLEMENTATION 111

11. REGIONAL MARKET DESIGN 111

11.1 Introduction 111

11.2 Recommended Regional Market Design 112

11.3 Details in the SEE Regional Power Market design 121

11.4 Organization of the SEE Regional Power Market 143

12.

TRANSITION PHASE: FROM REGULATED PRICES TO MARKET PRICES 154

12.1 Transition towards a unified SEE Regional Power Market 154

12.2 Regulated Price 154

12.3

Traditional Full Supply Contracts with Regulated Price 155

12.4 Supply Contracts and Balance Responsibility 156

12.5

Transition Period 157

12.6 Stepwise implementation challenges 161

13. ACTION PLAN 163

13.1 Required decisions 163

13.2 Project team(s) 163


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13.3 Implementation Plan 164

ANNEX A LIST OF INTERVIEWS AND MEETINGS 174

ANNEX B LIST OF REFERENCES 175

ANNEX C GLOSSARY 176

ANNEX D ACTION PLAN FILES 181


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EXECUTIVE SUMMARY

Pyry Energy Consulting and Nord Pool Consulting have been commissioned by the World

Bank to develop a study on Wholesale Market Opening for the electricity market in SouthEast Europe. The key outputs of the study are a Regional Market Design (RMD) and anaction plan for implementation.

The geographical focus of the report is the seven Contracting Parties to the Treaty thatestablished the Energy Community, i.e., Serbia, Croatia, Albania, Bosnia and Herzegovina,FYR of Macedonia, Montenegro and Kosovo1

The recommendations as set out in this report are founded on the decisions andrecommendations found in various European organizations like EU, EuroPEX, ERGEG,ENTSO-E, and UCTE. A full reference for these documents is part of the

. However, the creation of a regional wholesaleelectricity market may span a broader geographical scope than this.

Annex B List ofreferences found at the end of this document.

The Consultants recommendations are based on the following key elements and can besummarized as:

The establishment of a flexible regional cooperation enabling competitive wholesaletrading of electricity between the involved participants in the SEE region is based on thesuccessful experiences from other European markets.

A regional market founded on a Day-Ahead Market with implicit auction and cross-border capacities allocated to the DAM

A step by step approach: Serbia and Romania (Hungary) mandatory in phase I

Bulgaria, Croatia and Slovenia optional in phase I

Others to follow as soon as they comply with requirements;

Implementation of Balance responsibility for wholesale market participants;

Harmonisation of rules and regulations between the SEE Contracting Parties;

Generator Supplier unbundling, at least removal of traditional Full Supply Contractsbetween Generators and Suppliers/Eligible Customers

Transparency of relevant market information and prices;

Equal market access to all;

Co-existence of bilateral and exchange trading; The deadline for implementation of the complete SEE Regional Power Market is 2015.

To be able to meet this target, political willingness and support for the required changes andcommitment to the action plan(s) from all the stakeholders in the region are vital.

A prioritized task is to set up a market simulation environment for the SEE region to be ableto perform dry runs and various market trials.

1

The Republic of Kosovo became a member World Bank Group (and the IMF) on June29, 2009 and is therefore named Kosovo throughout this document. Kosovo willhowever remain UNMIK under the Treaty that established the Energy Community.


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Reading instruction

The report consists of four main sections as well as three annexes.

Section I(chapter 1) is a high level summary of the recommended market design and actionplan. These are the key recommendations from the Consultants and are based on thepresentation given at the ECRB meetings and workshop in Vienna in September 2009.

Section II (chapter 2-5) contains background information such as the foundation for theproject, the current situation in SEE and experiences from other regional electricity markets.A reader with good insights to the region and the subject may want to skip this section.

Section III(chapter 6-10) contains analysis of the current situation, descriptions of differentpossible solutions for a wholesale market in SEE and key performance indicators to monitor

the progress of the wholesale market opening.Section IV(chapter 11-13) contains the market design recommended by the Consultant andthe action plan to implement the solution. This section provides more details regarding therecommended market design and offers more details and insight to the high level summaryin section I.


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SECTION I: HIGH LEVEL RECOMMENDED MARKED DESIGN


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1. SUMMARY OF RECOMMENDED MARKET DESIGN ANDIMPLEMENTATION

1.1 Prerequisites

The framework for the SEE Wholesale Market Opening is set by the EC Treaty, ref [3].

The recommended market design is based on the following basic requirements:

SEE, an integrated part of European Internal Energy Market

Technical operation of the SEE grid system spans 4 control areas within ENTSO-E. Tradeacross national borders is currently based on bilateral contracts and explicit auctions. SEEWholesale Market Opening should streamline with European trends with price couplinglinking national and regional markets in order to enhance efficiency and transparency.

Regional approaches that choose incompatible solutions would obstruct the process ofcreating an integrated pan-European power market (ref [2]).

National control, regional cooperation

The recommended market design aims at having national responsibility of all the tradingprocesses, procedures and trading platforms including the market opening process itself.Regional cooperation and efficient cross-border utilisation will be secured through coupling ofnational DAMs. TSOs must allocate cross border capacity to DAMs.

Controlled transition from regulated prices to open market

The process of abandoning regulated prices/tariffs is progressing at different speedthroughout the SEE region. The recommended design allows for national preferences withrespect to further development of this process. Schemes for vulnerable customer sustain.

Quick establishment of incentives to invest

Generator/supplier unbundling will secure DAM-liquidity and a reliable and trustworthy pricereference will soon be established. As soon as the reference price(s) for the SEE market isestablished, investors will find it more favourable to come forward. Publishing SEE DAMprices through EuroPEX daily info systems will be a strong indication of market integration.

Co-existence of bilateral trade and market operators

Until financial instruments are developed, market participants will need bilateral trade (mid.term and long term contract) to supplement DAM trade to handle price risk.


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The following figures illustrate how the recommended design complies with current TSOscheduling and ongoing efforts to co-ordinate power trade across Europe.

1. No change to ENTSO-Es Scheduling and Accounting when introducing DAM. DAMwill replace some bilateral contracts.

Figure 1 Information exchange for the scheduling process in the UCTE pyramid(ref UCTE)


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2. Implicit auctioning fits with EuroPEX-ENTSO-Es preferred market couplingmechanisms, ref [2].

Figure 2 European power market integration, ref. EuroPEX-ENTSO-E, FinalReport January 2009


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3. Existing PXs across Europe bring transparency and predictability to marketparticipants and investors. SEE countries will benefit from harmonization andintegration with these markets.

Figure 3 European spot prices, ref EuroPEX


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1.2 High level recommended SEE Regional Power Market Design

The Consultants recommendations are based on the following key elements and can besummarized as:

The establishment of a flexible regional cooperation enabling competitive wholesaletrading of electricity between the involved participants in the SEE region is based on thesuccessful experiences from other European markets.

A regional market founded on a Day-Ahead Market with implicit auction and cross-border capacities allocated to the DAM

A step by step approach: Serbia and Romania (Hungary) mandatory in phase I

Bulgaria, Croatia and Slovenia optional in phase I

Others to follow as soon as they comply with requirements;

Implementation of Balance responsibility for wholesale market participants; Harmonisation of rules and regulations between the SEE Contracting Parties;

Generator Supplier unbundling, at least removal of traditional Full Supply Contractsbetween Generators and Suppliers/Eligible Customers

Transparency of relevant market information and prices;

Equal market access to all;

Co-existence of bilateral and exchange trading;

1.3 High level SEE Regional Power Market business processes

The Consultant recommends a decentralized design.

Each Contracting Party (CP) has its own National Market Operator (NMO);

Each market participant has an agreement with his NMO;

All bidding, settlement, collateral and participant agreements are made between themarket participant and the NMO;

NMO will collect and validate all bids from its participants and creates one Net ExportCurve (NEC) combining all the bids from its market participants into one aggregated bid

curve (thereby anonymous) that is sent to the SEE Market Service Provider (SEESP)acting on behalf of the Regional PX;

SEESP will collect NECs from all NMOs, and will get ATCs for all interconnections fromthe CAO. Based on these data, SEESP will calculate a common price index for all areasand price for all individual areas as well as the flow on each interconnection. Thesevalues will be returned to the NMOs;

NMOs will have a service agreement with the SEESP for the price calculation as well aswith the CAO for the allocation of ATCs to be utilized for DAM;

Prices and volumes for each market participant are calculated by the NMOs.

This design is based on Price Market Coupling.


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The business process overview is illustrated in the following 2 figures and discussed indetails in chapter11:

Figure 4 Business process overview


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The proposal is based on three (chronological) processes:

1. ATC publication the publication of ATC from CAO (as representatives for the TSOs)to the SEESP, the national market operators and the participants

2. Bidding process the process where participants submit individual portfolio bids totheir NMOs, the NMOs create NEC curves and submit these to SEESP

3. Results where SEESP calculates area prices and flows based on the received NECsand ATCs, sends the results to the NMOs and then the NMOs check results andcalculate and send the individual results to the market participants.

Figure 5 High-level recommended solut ion National control regionalcooperation


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1.4 CAO Coordinated Auct ion Office

As described in chapter4.2,when a well-functioning DAM for the whole region is in place, allavailable transmission capacity should be made available for the implicit auction. This implies

that in the final solution, long-term transmission capacity auctions will not be needed. For theSEE Regional Power Market the main function of the CAO is to provide correct transmissioncapacities to the market independent of the market concept.

The following simplified diagram is an illustration of the co-existence of CAO and a SEERegional Power Market:

Figure 6 CAO funct ions in the Regional PX

Dedicating cross border capacity to the SEE Regional Power Market is an essential policydecision in order to establish a Regional PX. The CAO will be responsible for determiningtradable cross border capacities, performing explicit auctions and providing the Regional PXwith daily capacities for the implicit auction. In this way the two concepts mutually supporteach other.


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1.5 Transit ion phase: From regulated prices to market prices

Exposing eligible customers 100% to market prices from day one of the wholesale marketopening process will meet hindrance in most countries due to uncertain market prices and

their volatility. For this reason transitional schemes should be considered. The need for suchschemes will vary across the region, because each country has a different starting point.

Some countries have already taken steps to expose eligible customers to market prices. Ingeneral a transition period with steadily decreasing contract volumes supplied at regulatedprices is recommended to gain acceptance among market participants. This solution isillustrated in the figure below.

Figure 7 Transit ional period market and regulated prices Eligible Consumers

Incentive contracts should be established prior to market opening as an offer to eligiblecustomers. This will give them the necessary predictability and they will respond to marketprices from day one. They can profit from reducing consumption during peak prices.

During the transition phase or in general from market opening - the challenge is toestablish sufficient volumes (liquidity) on the DAM. It is therefore important that the demandside bid for volumes themselves.

Full Supply Contracts - meaning that the customer can consume whatever he likes and payscontract (tariff) price anyhow - between Generators and customers are the greatest obstacleto DAM liquidity. In this situation the Generator will give a net bid on the DAM and purchasingvolumes will be very low.

Full Supply Contracts between Public Suppliers and customers, on the other hand, can beaccepted as long as the Supplier purchases additional volumes on the market andconsequently pays market price for marginal volumes.


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Base load contracts between Generators and Public Suppliers to serve Tariff Customers willbring remaining volumes from the demand side on the market.

The following figures illustrate how this design works.

Figure 8 Recommended transitional design per country

Bilateral trade will focus on mid- and long term agreements while DAM will offer marketparticipants an instrument to fine-tune their hourly supply/demand balance (contractportfolio).

If incentives are necessary to motivate eligible customers to exercise their eligibility from dayone of market opening, base load contracts with Generators declining over time - can be asolution, in line with the arrangement proposed for serve tariff customers.

In order to increase liquidity, TSOs should buy grid losses from DAM.


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A simple contract portfolio for a Public Supplier serving Tariff Customers is shown below.Base load contract between Public Supplier and Generators (incumbents) and hourlycontracts from DAM filling the gap between the base load contract and estimatedconsumption.

Pass-through mechanisms or hedging of market volumes are required to avoid setting PublicSupplier at risks.

Figure 9 Public Supplier with trading portfolio for Tariff Customers


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Traders, Eligible Customers and Suppliers will in general have a more complex contractportfolio, established over time in order to minimize cost, but the principles are the same.Hourly contracts from DAM fill the gap between contracted volumes and estimated load.They trade into balance.

Deviations from expected load will be handled on the imbalance market or later whenimplemented on the intraday market. The structure of such a contract portfolio is illustratedbelow.

Figure 10 Trading portfolio for Eligible Consumers & Suppliers

Generators, Suppliers and Eligible Customers will in this way be exposed to market prices onmarginal volumes, increasing over time as volumes for eligible customers and tariff

customers are scaled down. These volumes, together with export/import volumes will giveDAM liquidity. Market prices will therefore be established from day one of market openingwith sufficient liquidity.


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1.6 VPP auct ion

VPP (Virtual Power Plant) is a mandatory auction of generation capacity in order to mitigateincumbents dominant market position. The buyer gets a contract (base or peak) at auction

price, but the owner of the VPP operates the plant independently of how the buyer nominatescapacity from the plant.

The proposed market solution implies that incumbents serve tariff customers through a baseload contract with the public suppliers.

Such a contract reduces incumbents dominant market position in the same way as VPPauctions. The only difference is that prices are set differently.

For this reason, the Consultant does not see the need for VPP auctions from day one ofmarket opening. VPP auctions might be considered later when downsizing of volumes fortariff customers has strengthened incumbents potential dominant market position.

1.7 Action plan

1.7.1 Required decisions

Approval of the Ministerial Council to proceed with the SEE Wholesale market openingprocess by establishing a SEE Regional Power Market based on a Day-ahead market inline with the proposal from this Consultant Report.

TSOs to take the principle decision to dedicate all or part of ATCs to the SEE RegionalPower Market, increasing over time

All wholesale market participants to be Balancing Responsible Parties But customers can buy this service from Suppliers & Traders

Incentives to Eligible Customers to exercise their eligibility

Unbundling of Generators and Suppliers. Tariff Customers secured through separate contracts between Generators and

Suppliers

No Full Supply Contracts between Generators and Suppliers/Traders/EC

Downsizing of volumes based on regulated (low) tariffs to meet the open market

Establishment of an efficient market surveillance function

Basic harmonization of codes, rules and regulations among SEE countries


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1.7.2 Step by step approach

The Contracting Parties enter the wholesale market opening process from different startingpoints. For this reason the required decisions (from1.7.1)will be taken at different points intime. To give the process momentum from the start, connection to an existing functioningmarket is important.

Serbia is a natural hub in the region, in order of size, number of interconnections and bylocation. At the same time Serbia is well prepared for a national DAM. Romania is alreadyoperating a DAM and will provide access to market participants and liquidity from day one.

The Consultant suggests the following stepwise establishment of the SEE Regional PowerMarket:

Figure 11 SEE Wholesale Market opening - Action plan


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Figure 12 SEE Wholesale Market opening Initial setup

1.7.3 Dry run

Dry run serves different purposes:

simulate a regional competitive market;

train market participants;

simulate different market setup scenarios.

Prior to market opening such exercises will prepare market participants and facilitate asmooth market opening. The idea is to simulate a DAM through bids and offers fromGenerators, Suppliers, Traders and Eligible Customers.

Cross border capacities and base load contracts to serve tariff customers have to beallocated. In order to simulate the effect of power exchange with neighbouring countries,existing bilateral contracts may be represented by price independent bids in the relevantbidding areas (countries). The DAM simulator will calculate area prices and flows oninterconnections.

Training of market participants can go on until real market opening takes place and evenbeyond to familiarize new market entrants. Simulations of future market development will beongoing activities.


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1.7.4 National and regional action plans

The Wholesale market opening process must have a regional foundation in line with twosimilar projects already established, CAO and BETSEE. Support from national authorities ismandatory. Unbundling of generation and supplier functions, cancellation of full supplycontracts between Generators and tariff customers, incentives to eligible customers anddedication of cross border capacity to DAM all require top political attention and decisions.

An overview of the substance in national action plans is as follows: (The details are found inchapter13.3.4)

Figure 13 SEE Wholesale Market opening high level action plan overview

Phase 1 Phase 3

Balancing Mechanisms 2010 2013

Establishment of market council 2010 2012 Cross Border Capacity to DAM 2011 2014 Supplier Unbundling 2011 2014

Replacing Full Supply Contracts to TC withBase Load Contracts to PS

Market Surveillance 2011 2014 National units ECRB

Agreements 2011 2013 TSO-TSO TSO-Regional PX Regional PX-NMO NMO - Market participants

Transparency 2011 2012

Procedures for reporting relevant market information Publication of maintenance plans Reporting on outages Hydro power plant reservoir level

TSO reporting on Total Consumption & Production (hourly) Available & Metered exchange (cross border)

Start up of Financial Forward 2012 2015

These national plans may seem very ambitious. But judging from experience in Romania and

India, the Consultant concludes that they are realistic.1.7.5 Action plans market participants

Generators, Suppliers, Traders and Eligible Customers all have to establish new operationalworking routines in order to handle new market opportunities and challenges. Long and shortterm power price variations call for hedging strategies. This will be core business forTraders, Generators and Suppliers. Eligible Customers will choose different solutions. Bigindustry could develop their own trading skill (figure below) while small enterprises could buyportfolio management services including imbalance management - or stay at a marketbased contract price (fixed or variable).


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Illustration of a big industrial customers possible organization of power sourcing afterestablishment of a DAM:

Figure 14 Power sourc ing on a liberalized market example for Industry

A condensed overview of new tasks for market participants is given below.

Figure 15 Action Plans for different types of Wholesale Market Participants

Generators and big Suppliers will need this competence in-house. Eligible Customers canoutsource power procurement, balancing and trading in different ways as discussed above.


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SECTION II: BACKGROUND


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2. INTRODUCTION

The conflicts of the 1990s led to the disintegration of a unified energy system stretching from

the Adriatic to the Black and Aegean Seas, changing it from a single system into a patchworkof systems. However, the separate entities still rely on each other for the smooth functioningof their power supplies.

In 2005, the European Community and then nine Contracting Parties signed the Treatyestablishing the Energy Community of South East Europe. The Treaty aims at establishingan internal market for network energy in the energy and is based on binding legalcommitments governed by a set of institutions. The Treaty extents and applies andsynchronized application of the EC acquis communautaire and thus ensures homogeneitybetween the EC and the Contracting Parties.

The 11thAthens Forum Meeting requested the World Bank to develop a study on WholesaleMarket Opening in South East Europe for the benefit of all Contracting Parties to the Treatyestablishing the Energy Community. Pyry Energy Consulting and Nord Pool Consultingwere subsequently commissioned to develop the study.

The overall aim of the study is to develop a proposal for a Regional Market Design (RMD)and an Action Plan (AP) for its implementation. The full project covers eight tasks:

Task 1: Review of the current state of market opening in SEE, ref chapter3;

Task 2: Examine barriers to advancing market opening and liberalisation, ref chapter8;

Task 3: Identify risks and opportunities posed by market opening in electricity supply tonon-household customers, ref chapter7;

Task 4: Review lessons learned from other regional markets ref chapter5;

Task 5: Define indicators to measure and monitor progress in opening the electricitymarket in SEE, ref chapter9;

Task 6: Developing the SEE Regional Power Market Design (RMD) and Action Plan forImplementation, ref chapter1 and11;

Task 7: Workshops for non-household consumers and other market participants onelectricity market opening arranged in Vienna 17thof September 2009; and

Task 8: Implementation Support to be carried out after the acceptance of this report.

This report covers task 1 to 6.

A large number of reports have previously been developed covering these or closely relatedissues. Within this project the project team is to interact closely with the regional institutionsand stakeholders in the development of a RMD and AP, rather than developing lengthyreports. This report is thus focused on establishing the current situation and identifying keyissues for the future work.

2.1 The focus of the study

Currently there are seven Contracting Parties to the Treaty establishing the EnergyCommunity. These seven Contracting Parties are Albania, Bosnia and Herzegovina,Croatia, Former Yugoslav Republic of Macedonia (FYR of Macedonia/FYROM), Montenegro,Serbia and Kosovo. These seven entities are the prime beneficiaries of this study and itsprime focus, but also Bulgaria and Romania are partially covered.


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The relevant region for the creation of a regional electricity market in South East Europe ishowever larger. In addition to the seven entities listed above; Austria, Bulgaria, Greece,Hungary, Italy, Romania and Slovenia are important for a regional market. The relevant areacould be further extended to countries such as Turkey, Moldova, Ukraine and others.

2.2 Designation of the Contracting PartiesIn the region there are disputes regarding the status and/or denomination of the ContractingParties in two cases. In this report we use the official designation of the Contracting Partiesaccording to the World Banks definitions. This should not be interpreted as reflecting anyposition taken by Pyry Energy Consulting or Nord Pool Consulting.

2.3 Objective of a wholesale market reform

Under earlier assignments various options for regional market integration have beendeveloped. One question is whether or not a regional power exchange should be establishedor whether there should be continued reliance on purely bilateral contracts. Furthermore, the

market model currently under development relies on explicit auctioning of cross-bordertransmission capacities. An alternative option would be the use of implicit auctioning. Thiswould require a liquid market place under a market splitting approach, or market couplingbetween several liquid markets.

According to the Terms of Reference for this study, these options should be reviewed, andbased on this review a Regional Market Design should be developed, taking into account thepossibility of a staged implementation. We thus foresee that the proposal developed underthis study will entail such a staged approach starting with simple arrangements and latermoving to more complex mechanisms. Furthermore, the Terms of Reference states that theongoing work on coordinated auctions and regional balancing mechanism seems torepresent a good base for wholesale market opening.

At this point the proposal for the long-run solution has not been finalized. Several objectivescould be considered with different levels of ambitions, such as:

coordinated interconnector allocations day-ahead;

coordinated interconnector allocations day-ahead with well developed national energymarkets

fully coordinated day-ahead wholesale scheduling using implicit auctions:

Market coupling, or

Joint market with market splitting; and

additional development, e.g., a completely seamless retail and wholesale market.

A common (seamless) retail market is not covered under this assignment, although theorganization and opening of retail markets is likely to affect the functionality of the wholesalemarket.

2.4 Regulatory framework

The Contracting Parties to the Energy Community Treaty have legally binding commitmentsto the creation of an internal market for network energy. The regional market provided for bythe Treaty is to be connected to the EC internal market. Through the Energy CommunityTreaty the Contracting Parties are bound to implement the acquis communautaire on


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energy2, the acquis communautaire on environment and also follow the principles laid outin the acquis on competition insofar as it may affect the trade of network energy between theParties. According to the Treaty the Parties shall also implement the renewables Directive2001/77/EC (promotion of electricity produced from renewable sources) and Directive2003/30/EC (promotion of the use of biofuels or other renewable fuels for transport).3

Under the Treaty the regulators are cooperating within the Energy Community RegulatoryBoard (ECRB). The ECRB advises the Ministerial Council and Permanent High Level Group(PHLG) on details of statutory, technical and regulatory rules and make recommendations inthe case of cross-border disputes between the regulators.

2 Directive 2003/54/EC of the European Parliament and of the Council of 26 June 20003concerning common rules for the internal market in electricity, Directive 2003/55/EC ofthe European Parliament and of the Council of 26 June 2003 concerning common rulesfor the internal market in natural gas, Regulation 1228/2003/EC of the EuropeanParliament and of the Council of 26 June 2003 on conditions for access to the networkfor cross-border exchanges in electricity.

3 The Treaty establishes that the Parties shall present a plan to implement the directiveswithin one year of the date of entry into force of the Treaty.


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3. THE REGIONAL ELECTRICITY MARKET

3.1 Introduction

The following sections set out a quantitative summary of the regional electricity sector underthe following topics:

electricity generation and demand;

electricity imports and exports;

market structure and market model; and

prices and tariffs.

Pyry makes long range electricity and gas market price projections for the region as part ofits pan-European market modelling, designed for use by investors inproject evaluation, and

updated quarterly. Data items with a source labelled "Pyry EurECa4

The statistical information in this section sets out a background which emphasises the needfor:

analysis" are based onthis modelling work. No modelling work has been made explicitly for this project, but we havedrawn on results from other studies.

efficient dispatch and cross-border trading arrangements between the Parties and withthe surrounding countries;

increases in consumer tariffs to economically efficient levels, which will lead to areduction in inefficient patterns of electricity consumption,

improved levels of payment for electricity; and

very high levels of investment in generation and network infrastructure.

The necessary investment, reduction in inefficient consumption and improvements in theefficiency of generation production can only realistically take place with a move to market-based (marginal) wholesale pricing and regional coordination.

3.2 Electricity generation and demand

Small, but growing, national markets

Figure 16 shows that the size of the markets, in terms of final energy consumption, varies

widely, but also that most of the markets are small. The smallest market in energy terms isKosovo with a final electricity consumption of 3.2 TWh (2005), closely followed by Albaniaand Montenegro. The largest is Serbia with a final electricity consumption of 25.6 TWh(2005). Network losses5

4 EurECa is the name given to Pyrys pan-European electricity model.

are generally quite large ranging from 14% in Croatia, up to 37% inKosovo, with an average of 23%. The electricity consumption is expected to grow rapidlyover the coming years, which implies significant requirements on new generationinvestments.

5 Including transmission and distribution technical losses and commercial losses.


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Figure 16. Final electrici ty consumption and network losses (2005) and expectedconsumption year 2015, TWh

3,2 3,6 3,8 6,27,7 14,4

25,6

10,2

22,8

1,2 1,3

2,0

1,1 1,4

5,4

2,24,9

6.6

7,1

9,5 10,4

37,540,5

63,7

5,5

13,2

22,1

0

10

20

30

40

50

60

70

Kosovo

Alba

nia

Montene

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FYR

ofMaced

onia

Bosnia

and

Herzego

vina

Croatia

Serbia

Bulga

ria

Romania

0

10

20

30

40

50

60

70

Network losses, TWh

Final electricity consumption, TWh

Expected energy consumption (2015)

Source: Energy in the Western Balkans, IEA 2008; Eurostat; Pyry EurECa analysis

High energy intensities low energy effic iency

The economies in the region generally have high energy intensities. As is displayed inFigure17 below, energy intensities are considerably higher than the average OECD level (IEA(2008)6

Figure 17

. This is explained by the degraded state of energy infrastructure, high energy lossesin transformation, transmission and distribution and inefficiency in the end-use sector. Thehigh network losses shown in are an illustration of this.

Croatia has relatively high energy efficiency, but according to IEA (2008) the country still hasan energy savings potential of around 25% of the total primary energy supply. The region asa whole could save 5 TWh annually by bringing losses down to the level of Croatia. At the

same time high energy prices and high energy consumption put a significant pressure onhousehold budgets, and it is estimated that 16% of the people are exposed to energypoverty. It is reasonable to believe that the current high energy intensities/low energyefficiency are likely to be affected by changes in prices that a market opening could result infor some of the countries. Given the starting point, increased energy efficiency can alsomitigate the economic impact of possible increases in electricity prices.

Figure 17 does also display that the Parties have high carbon intensities compared to OECDaverages. Serbia has the highest level of carbon intensity (1.2) which corresponds to its highdependency on coal and Albania the lowest (0.3) due to its high usage of hydropowerresources.

6 IEA (2008), Energy in the Western Balkan


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Figure 17. GDP per capita, electricity and carbon intensity, 2005

0,3

0,7

1,0

0,7

0,1 0,2

0,6 0,7

1,2

0,7

0,5

0,40,50,4

0,20,3

0,6

0,3

0,8

0,4

0

5 000

10 000

15 000

20 000

25 000

30 000

35 000

Alba

nia

Bosnia

andHe

rzeg

ovina

Croatia

Kosovo

FYR

ofMaced

onia

Montene

gro

Serbia

Bulga

ria

Romania

OECD

average

USD(

PPP)

0

0,2

0,4

0,6

0,8

1

1,2

1,4

kWh/GDP(USD,PPP);CO2Mt/GDP(USD,

PPP)

GDP PPP per capita Electricity intensity CO2 intensity

Source: Energy in the Western Balkans, 2008; CO2 emissions from fuel combustion 2008 ed, IEA, 2008

A mixed generation structure but with import dependencyThe region is dependent on imported energy, primarily oil and natural gas. Several of thecountries are also heavily dependent on import of electricity. Lack of reliable electricitysupply is generally a serious problem in the region. IEA (2008) 7

The total electricity generation in the region

mentions the erraticelectricity consumption pattern of the poorer parts of the population as a key factor forconcern. This is driven by the fact that fuel wood is used for heating needs by the poor, butduring the heating season electric heaters are often used when fuel wood demand spikes.This then exacerbate seasonal and weather related peaks in electricity demand. Extremepeaks can then cause black-outs or require rationing. The utilities are forced to maintainconsiderable reserve requirements, which then reduce potentials for exports and revenues.Low tariffs and payment discipline also limit the revenues.

8

Figure 18 is a mix between conventional thermal

generation, hydro plants and nuclear power, as shown in . Other renewablesources, besides hydro, have played a very limited role so far.

7 IEA (2008), Energy in the Western Balkans8 Also including Romania and Bulgaria


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Figure 18. Regional electricity generation by fuel 2008, %

26%

14%

27%

2%

1%

30%

0%

Hydro Nuclear Coal and Lignite Gas Oil Mixed fossil fuels Other renewables

Source: UCTE, OST

The generation structure is however very different in the different countries, seeFigure 19.Albania gets almost all of its domestic generation from hydro power, but is also to a highdegree import dependent. This is in particular the case in drought years. Other countriessuch as Bosnia and Herzegovina, Croatia and Serbia also get a third or more of theirgeneration from hydro power. On the other extreme of the scale is Kosovo, which getsalmost all of its domestic generation from thermal plants (lignite) and which is also importdependent. Many of the countries in the region are import dependent, and some of thecountries are heavily dependent on import of electricity.

The regional generation mix highlights the importance of trade and the potentially significantbenefits that can be achieved through improved regional trade. Hydro and thermal basedsystems are excellent complements due to the regulation possibilities connected with hydro(with storage), but also the increased security of supply that can be expected. The needs forregional trade is furthermore emphasised by the clear import dependency of some of thecountries in the region.


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Figure 19. Country level electricity generation by fuel 2008, %

0%

10%

20%

30%

40%

50%

60%

70%

80%90%

100%

Alba

nia

Bosnia

andHe

rzeg

ovina

Bulga

ria

Croatia

Kosovo

Monte

negro

FYR

ofMaced

onia

Romania

Serbia.

excl.K

osovo

Hydro Nuclear Fossil fuels Other renewables Net import

Source: UCTE, KOSTT, OST

Figure 20 shows the peak electricity load in 2008 and expected peak load in 2015 incomparison to the generation capacities in 2008 and 2015 (expected), respectively. Thisshows that in along with the growth in electricity consumption the peak demand will alsogrow in most of the countries in the region.

The capacity margins vary considerable throughout the region. Some countries have verysmall capacity margins, while others most notably Romania have a very substantialcapacity margin. A similar structure can also be expected to remain in the near future.


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Figure 20. Peak electr ici ty load 2008 and 2015 (expected); Generation capacity 2008and 2015

0.0

5.0

10.0

15.0

20.0

25.0

Alba

nia

Bosnia

andHe

rzegovin

a

Croatia

Kosovo

FYR

ofMace

donia

Monte

negro

S

erbia

Bulga

ria

Roma

nia

GW

Peak Electric ity Consumpt ion 2008 GW Generat ion Capacity 2008 GW

Expected Peak Electricity Consumption 2015 GW Expected Generation Capacity 2015 GW

Source: Pyry EurECa analysis, OST, KOSTT, UCTE

Table 1 below provides some summary comments on the demand and supply balance for

each of the nine original Contracting Parties.


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Table 1. Comments on demand and supply balance

Demand and supply Comments

Albania Hydro dominated (approx.

98%). Highly import dependent (24-

40% over the last years).

Load shedding required since1997.

One river system generates

88% of the electricity. Importdependent during droughts.

Bosnia andHerzegovina

Approx. 60% thermal, 40%hydro of domestic generation.

In recent years a surpluscountry.

Consumption expected toincrease considerable over thecoming years and by 2014 behigher than the domesticgeneration.

Bulgaria Approx. 7 % hydro, nuclear 35% and conventional thermalclose to 60 %.

Net export amounted to 5.4TWh of electricity in 2008.

Construction of a new nuclearpower plant possible.

Croatia Mix between thermal andhydro generation.

Import dependent.

Deficit is expected to grow inthe future to a level ofapproximately 9.5 TWh by2020.

Hydro and nuclear generation

reduced during droughts.FYR ofMacedonia

Approx. 75% thermal, 25%hydro of domestic generation.

About 2.5 TWh import of 8.5TWh consumption.

ELEM has sufficient generationto cover the demand of EVN interms of energy, but notsufficient capacity to meetwinter peak.

Of import of 2.5 TWh about 800GWh is for tariff customers.

Montenegro Approx. 60% hydro, 40%thermal (lignite).

1/3 or more of supplyimported (in 2008 about 40%).

Considerable unused hydropotential.

Romania Almost 30 % hydro, 15 %nuclear and 55 %conventional thermal.

Net export amounted to 4.4TWh of electricity in 2008.

Significant unused hydropotential.

RES-E is promoted through amarket based green certificatesystem.


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Demand and supply Comments

Serbia Approx. 75% thermal (mostlycoal) and 25% hydro.

Relatively well balance

between supply and demand.Previous deficit turned into asmall surplus.

Kosovo 97% thermal (lignite).

Import dependent (number).

Load shedding applied.

Only 52% of the deliveredelectricity billed and of this only2/3 was collected.

Low availability of existingplants.

High demand growth.Source: Team analysis

The current generation capacity in the region is about 54 GW according to UCTE and Plattsdata. However, taking the expected availability into account the firm capacity in the regionwould be approximately 40 GW.9 Figure 22 shows the hourly load in the region for the 3rdWednesday of each month during 2008. Based on this data the regional peak (in January)was slightly below 30 GW, which is somewhat below the peaks reported in Figure 20.Nevertheless, while the capacity margins are limited for some countries, on a regional levelthere seems to be a substantial margin between the peak load and the installed generationcapacity.

In order to look further into the capacity margin an approximation has been done of the

regional generation capacity split into base load and peak load. As has been noted beforethe regional capacity margin is rather substantial. This is evident in figures below. However,some capacity is currently not producing or is used very sparsely due to the lack ofmaintenance. Furthermore, a substantial part of the generation fleet will have to be replacedin the future due to old age. The latter is especially true for old lignite capacity. Together withan increasing demand for electricity, regional capacity margin should decrease in the future.Figure 21 below suggests that even the base load generation should be close to sufficient tocover also the peaks, provided that the capacity is available.

9 Pyry Energy Consulting analysis


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Figure 21. Regional generation capacity sp lit on type of capacity, percent and GW

BaseloadHydro; 6

BaseloadNuclear; 3

BaseloadFossil; 27

PeakHydro; 12

PeakFossil; 5

BaseloadRenewables; 0

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

BaseloadHydro BaseloadNuclear BaseloadRenewables BaseloadFossi l PeakHydro PeakFossil

Source: UCTE and Platts

Figure 22. Hourly load, 3d Wednesday in each month 2008

0

5 000

10 000

15 000

20 000

25 000

30 000

35 000

January February March April May June July August September October November December

Hourly

load,

MW

KosovoSerbia, excl. Kosovo

AlbaniaRomaniaFYR of MacedoniaMontenegroCroatiaBulgariaBosnia and Herzegoviina

Source: UCTE; KOSTT, OST. NOTE: For Albania data we only have data for January and July.


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Old coal and ligni te fired plants in the region

There are 4 000 MW of coal and lignite fired plant in the region with an age of more than 30years, see Figure 23. Old generation units and an increasing demand in the region willrequire more generation capacity

Figure 23 Age dist ribut ion of Coal and Lignite fired plants

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Croa

tia BiH

Alba

nia

FYRO

M

Mon

tene

gro

Serbia

%ofinstalledcapacity

Coal and Lignite before 1980 Coal and Lignite 1980-1989

Coal and Lignite 1990-1999 Coal and Lignite 2000-2005

Source: Platts

3.3 Regional trade in electricity

The former Yugoslavian transmission system was a 400 kV system spanning about 800 kmconnected to the UCTE synchronous system. In 1991 it was split in two separate parts.Croatia and the Federation of Bosnia and Herzegovina (within Bosnia and Herzegovina)became part of the UCTE zone 1, while Republika Srpska (within Bosnia and Herzegovina),Serbia, FYRO, Bulgaria, Romania and Greece formed UCTE zone 2. In October 2004 thesewere again reconnected. The total interconnection capacity (net transfer capacity) in theregion was in beginning of 2007 about 5800 MW, which is about 35% of total peak demandin the region.

The region in total is dependent on imported energy, primarily oil and natural gas. In general,cross-border electricity exchanges in SEE are somewhat lower compared to other regions inEurope.10 Figure 24However, the total trade flows between the countries included in was in

10 ECRB 2008 Market Development Report.


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2008 above 65 TWh. Looking only at the original contracting party 11of the Energy Treatywas in 2008 about 37 TWh. The total electricity consumption in the nine original contractingparties was in 2008 about 177 TWh.12

The main trading pattern in the region is a flow of electricity from the north to the south, asillustrated in

Thus, about 20 per cent of the regional electricityconsumption was subject to trade between these countries.

Figure 24). Import is mainly provided from Hungary, Romania and Bulgaria andwith Serbia being the main transit country.

Figure 24. Net electricity flows, 2008

0-999

1000-1999

2000-2999

3000-4999

5000-

0-999

1000-1999

2000-2999

3000-4999

5000-

Bulgaria

Aust ria Hungary

Slovenia

Macedonia

Greece

BiH

Croatia

Italy

Serbia

Alban ia

Monte-

negro

Romania

Kosovo

Bulgaria

Source: UCTE, KOSTT

NOTE! Detailed data and explanatory note available inTable 2

11 The current seven contracting parties plus Bulgaria and Romania.12 Source: UCTE


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Table 2. Electric ity exchanges in South East Europe 2008, TWh

Importer

AL AU BA BG GR HR HU IT KO ME MK RO RS SL SUM

Exporter

AL 0 0.2 0 0.2 0.3

AU 0.8 1.4 1.2 3.4

BA 2.7 2.1 0.3 5.0

BG 4.6 1.1 0.3 2.4 8.4

GR 1.7 0 0.2 0.1 1.9

HR 0.7 0 0 4.9 5.7

HU 0.7 5.3 0.1 2.7 8.8

IT 0 1.8 0.1 1.8

KO 0.2 0.7 2.7 0 3.6

ME 0.8 0.2 0.1 0.4 1.6

MK 0 1.2 0 1.2

RO 3.1 0.7 3.2 7.0

RS 2.4 0 2.1 0 3.7 0.6 0 0 8.8

SL 0.9 2.2 4.7 7.8

SUM 2.6 1.6 3.4 3.1 7.6 12.2 1.6 6.3 4.0 3.4 3.9 0.4 9.2 6.2 65.4

Source UCTE, KOSTT

NOTE! Separate data for Kosovo is not available from UCTE, but are included under the Serbian control area (EMS). We havereceived data from KOSTT and deducted those flows from the flows for Serbia according to UCTE. All numbers are rounded tothe closest 0.1 TWh.

AsTable 2 (andFigure 19)illustrates, there are some countries which are import dependentto a very high degree:

Albania is a net importer (2.1 TWh) with large imports from mainly Greece, but also fromMontenegro and to some extent from Kosovo.

Croatia is a net importer (6.6 TWh) with large net imports from Serbia, Hungary andBosnia and Herzegovina. The country also has considerable trade with Slovenia (being

a net exporter to Slovenia). Kosovo is a net importer (0.6 TWh) with large net imports from Serbia, but also net

export to Montenegro and FYR of Macedonia (transit trade).

Montenegro is a net importer (1.8 TWh) with large import mainly from Bosnia andHerzegovina, but also from e.g. Kosovo. Montenegro has a relatively balanced trade (ona yearly level) with Serbia, and is a net exporter to Albania.

FYR of Macedonia is a net importer (2.7 TWh) with large import mainly from/throughKosovo, but also from Bulgaria. At the same time, FYR of Macedonia has a net export toGreece.

Three countries are net exporters:


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Bosnia and Herzegovina exports mainly to Croatia and Montenegro, but has a net importfrom Serbia.

Bulgaria exports to Greece, Serbia and FYR of Macedonia, but has a net import fromSerbia.

Romania exports to Serbia and Bulgaria, but also to Hungary.Serbia has a relative balanced trade.

3.3.1 Trading licenses13

Various licensing regimes can create barriers for traders to enter into the market.Requirements for trading licenses exist (or are foreseen) in all participating countries in therelevant region. The licensing regimes often require a registered seat in the country whichcreates an additional burden for international traders.

The licenses are typically issued by the relevant regulatory authority, but in some case by theministry. The trading licenses typically cover wholesale trade, retail supply of eligible

customers, cross-border trade and transit, but there are differences. The licensing proceduretypically has to be conducted in the national language and relevant documents are in mostcases not available on the internet.

There are differences in the maximum time allowed for completing the licensing procedureranging from 30 days in several countries up to 180 days. In the case of Bosnia andHerzegovina no limit is set. Furthermore there are variations in the licensing fees betweenthe countries, both in terms of structure and levels.

13 A survey on license requirements were made in 2008 and received answers from

Bosnia and Herzegovina, Croatia, Serbia, Greece, Slovenia, Austria, Hungary, FYR ofMacedonia and Cyprus. (Energy Community Regulatory Board, Licensing requirements2008). This section builds on that report unless otherwise stated.


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Table 3. Summary of licensing requirements in dif ferent countr ies

Country Trading licenserequired

The licensecovers

Requirement ofregisteredcompany in thecountry

Reporting

Albania YES Wholesaletrade, cross-border trade,transit

YES Annual report


YES Wholesaletrade, retailsupply toeligiblecustomers,cross-bordertrade, transit

YES Monthly reportson physicalquantities oftraded energy

Croatia YES Wholesaletrade, cross-border trade,transit

YES Financialreports

FYR ofMacedonia

YES Wholesaletrade, retailsupply to

eligiblecustomers,cross-bordertrade, transit

YES Monthly reportson tradedquantities of

electricity and ayearly generalreport withfinancial andtechnicalinformation

Montenegro Informationmissing

Informationmissing

Informationmissing

Informationmissing

Serbia YES Wholesaletrade, retail

supply toeligiblecustomers,cross-bordertrade, transit

YES Copy ofbusiness plan

for each year,annual balancesheet and profitand lossaccount forprevious year

Kosovo YES Supply, trade YES Quarterly andannual reporting

Source: Energy Community Regulatory Board (2008), Albanian Energy Regulatory Entity, ERO


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3.4 Market struc ture, market opening and market model

In most of the Parties there is one dominant, state-owned generator. There might be somefringe competitors, but each national market can typically be characterised as being veryclose to a monopoly (with the exception of Romania). As shown earlier, the national markets

are also small which limits the degree of competition that can be expected on each market inisolation. Distribution and supply are typically also dominated by one company, althoughthere might be some small distributors. However, given that the consumers in most caseseither are not eligible or not interested in exercising their eligibility this is currently of littleimportance. The limited interest in exercising eligibility seems to be explained by the fact thatmost consumers would face higher prices on the open market than under regulated tariffs.Given current regulated tariffs little switching can be expected unless customers are forced toswitch (or the regulated tariff is removed for eligible customers).


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Table 4. Degree of horizontal unbundling of state-owned company

Generation Distribut ion and supply

Albania KESH 99% market share. In addition to KESH Distribution

three private companies share thedistribution of electricity in parts notcontrolled by KESH.


Both electricity utilities in FBiH are heading to legal unbundling betweengeneration, distribution and supply.

Utility in RS has legally unbundled Generation from Distribution andSupply.

Electricity utility of Brcko District still fully bundled legal entity.

Bulgaria No ownership unbundling yet oftransmission.

National electric utility (NEK, 100% state owned) owns a largenumber of generation plants.

Process of privatisation.

NEK operates the transmissionsystem.

DSO function unbundled.

Croatia HEP Generation about 80%market share.

TPP Plomin (co-owned by HEPand RWE).

NPP Krsko 50% HEP owned.

Industrial power plants.

Small renewable.

HEP distribution legally unbundled.

FYR ofMacedonia

ELEM dominant generator.

TPP Negotina separate company.

Small HPP owned by othermarket players.

Distributor privatized (AustrianEVN).

Montenegro Functionally unbundled with four divisions (generation, transmission,distribution and supply).

The state owned power company (EPCG) holds 100% of the productioncapacity.

Romania Ownership unbundling oftransmission and generation.

Generation predominantly stateowned but split into severalindependent units.

Distribution unbundled and 5 out of8 regional distribution companieshave been privatised.

Serbia EPS 100% of generation. Legally independent subsidiaries.DSO function legally unbundled

from other operations.Kosovo Generation and distribution/supply integrated.


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Source: Team analysis

Vertically unbundling has progressed somewhat during the last years. Albania, Croatia, FYRof Macedonia, Serbia and Kosovo have legally unbundled TSO/MOs and Bosnia and

Herzegovina has ownership unbundled ISO and TRANSCO, while Montenegro has afunctionally unbundled TSO. However, in Croatia the HEP group is made up of multiplecompanies covering production, transmission and distribution, i.e., the transmissionoperations is part of the same group as the main generator. However, there is a separatemarket operator owned by the Republic of Croatia.

The unbundling between generation and distribution (including supply) has however notreached as far. In Albania KESH Distribution is unbundled and about to be privatized.However, KESH Generation is obliged to sell to the wholesale public supplier at regulatedprices. In FYR of Macedonia the distributor is now owned by Austrian EVN, but also here thedominant generator, ELEM, is required to sell at regulated prices. Among the remainingParties generation and distribution/supply are conducted within the same company or group

of companies that may be legally unbundled.


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Table 5. Degree of vertical unbundling

Transmission, system andmarket operator

Generation and distribution

Albania 100% state owned legallyunbundled TSO. KESH Distribution unbundled andabout to be privatized. Additionaldistributors selling in non-KESHareas.

KESH Generation obliged to sell tothe wholesale supplier.


Independent ISO and TRANSCO. Both electricity utilities in FBiH areheading to legal unbundlingbetween generation, distributionand supply.

Utility in RS has legally unbundledGeneration from Distribution andSupply.

Electricity utility of Brcko District stillfully bundled legal entity.

Bulgaria 100% state owned (by NEK)legally unbundled TSO.

NEK operates a large number ofgeneration plants but privatizationunderway.

Distribution unbundled andprovided by regional companies(E.ON AG, EVN AG and CEZ a.s.).

Croatia Legally unbundled transmissioncompany, but part of the HEPgroup.

Market operator 100% stateowned (legally unbundled).

HEP a group with multiple affiliatedcompanies in the energy valuechain.

FYR ofMacedonia

100% state owned legallyunbundled transmission systemand market operator.

Distributor privatized (AustrianEVN).

Main generator, ELEM, obliged tosell at regulated prices.

Montenegro Functionally unbundled TSO. Functionally unbundled with fourdivisions (generation, transmission,distribution and supply).

Romania 100 % state owned legallyunbundled TSO.

Partly unbundling of distribution

Serbia 100% state owned legallyunbundled TSO.

Generation and distribution/supplyintegrated. Legally independentsubsidiaries. DSO function legallyunbundled from other operations.

Kosovo 100% state owned legally

unbundled TSO.

Generation and distribution/supply

integrated.Source: Pyry Energy Consulting team analysis


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Very few end-customers are active on the open market. Typically the regulated tariffs arebelow the prices available on the open market and the incentives for exercising its eligibilityis thus often very limited.

Table 6 provides an overview of the current state of end-user market opening. Formally allthe seven contracting parties have opened their end-user markets. Albania, Bosnia andHerzegovina, Montenegro and Serbia have formally all opened their markets for all non-household customers. FYR of Macedonia and Kosovo have eligibility thresholds based onconnection levels, while Croatia has opened the market for all customers (in 2008).

In most cases, in spite of opening there has been no or limited market entry. In Croatiaeligibility is mandatory for high and medium sized customers, while in FYR of Macedoniaeligibility is mandatory for all customers above the stipulated threshold. Discussions to makeeligibility mandatory are ongoing also in other countries. In practice this implies that noregulated tariff is available for the eligible customers, but that they have to rely on the market.

An important barrier to market opening is that supply and distribution have, in general, notbeen unbundled. This can be expected to inhibit market entry, since new entrants may not

trust that they will be treated on an equal and fair basis with the distributors own supplybusiness.

Another important barrier the low regulated tariffs (see also section3.5). A key conclusionfrom IPA (2009)14

14 IPA Energy + Water Economics (2009), Study on Tariff Methodologies and Impact onPrices and Energy Consumption Patterns in the Energy Community, March 2009

was that there have been no new entrants and the incumbent hasretained 100% market share. This is because the regulated tariffs are below levels at whichnew entrants would be able to enter the market to compete effectively and have even beenstated as being below the wholesale energy price which a new supplier would have to buyenergy at. It is clear that as long as there are regulated tariffs available below the cost for anew entrant, effective market opening will be very difficult to achieve.


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Table 6. Degree of market opening

Eligibility threshold Customers exercising eligibility

Albania All non-household customers.

Customers can apply to becomeeligible. It has been proposedthat all customers on the 35 kVlevel or above shouldautomatically become eligible.

Currently only 1 customer.

Bosnia &Herzegovina

All non-household customers. They can stay under regulated tariffs andso far no one executes his eligibility.

Bulgaria All customers. Large and medium sized industry.

Croatia All customers. Mandatory for high and medium sizedcustomers.

FYR ofMacedonia

Connected on 110 kV. Mandatory for eligible customers.

As of 1 January 2008 there are 8 eligiblecustomers (those connected to 110 kV orabove), which implies a market openingof 34%.

Montenegro All non-household customers. Only one supplier. Traders access tofinal customers is currently subject toconsideration.

Romania All customers. Mostly large and medium sized industry.

Serbia All non-household customers(47% formal market opening). No one executes his eligibility.

Kosovo Connected at 10 kV or above. There are two declared eligiblecustomers

Source: Energy Community Treaty Implementation presentation at 14 thAthens Forum, DG TREN Report on progress increating the internal gas and electricity market, technical annex. Com(2009) 115, Pyry Energy Consulting and Nord PoolConsulting team analysis

Several countries have market models with a wholesale public supplier. The wholesale publicsupplier then often has priority access to the domestic generation which is ear-marked fordomestic consumption (tariff customers). This of course limits the amount of electricity that isavailable for trade.


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Table 7. Nature of trading model

Albania Market model based on bilateral contracts.

Wholesale and Retail supplier responsible for supply to tariff customers.

Bosnia &Herzegovina

12 traders (incl. 3 Generators). They cannot sell to final tariff customerswho are supplied by their (3) wholesale Supplier. These Suppliers haveall in contracts with their respective Generator.

Bulgaria Market model based on bilateral contracts.

Croatia HEP supplies all tariff customers. Eligible customers can by fromSuppliers/Traders who have access to export/import

FYR ofMacedonia

New market rules under development. MEPSOs previous role aswholesale supplier has been abolished.

Montenegro 56 Traders wait for access to final customers. Today only Trader/Trader

and cross border exchangeRomania Established power exchange (OPCOM) with good liquidity.

Serbia EPS-Trading serves tariff customers and potential eligible customers.EPS-Trading has full supply contract with EPS-Generation.

37 traders have access to eligible customers and export/import.

Kosovo Market model based on bilateral contracts.

KEK regulated wholesale supplier.Source: Team analysis

3.5 Prices and tarif fs

Low but varying retail tariffs

Figure 25 below shows that Albania has the highest retail tariffs for households and some ofthe highest retail tariffs for Industrial and Commercial (I&C) customers in the presentedmarkets in South East Europe (SEE).

Bosnia and Herzegovina has the second highest retail tariffs for commercial customers, whileits retail tariffs for industrial users and households are around the mean of the regionsvalues.

Croatia has some of the highest retail tariffs for households, while its retail tariffs for Industrialand Commercial (I&C) customers are around the median of the regions values.

FYR of Macedonia is offering some of the regions lowest retail tariffs to industrial customersand households, while its tariffs for commercial users are closer to the median level for thepresented countries in South East Europe. From 1 November 2008 all tariffs were increasedwith about 13%, which is valid until the end of 2008. A new tariff methodology is currentlyunder development.15

Montenegro has the highest retail tariffs for commercial users in the presented markets inSouth East Europe, while its retail tariffs for industrial customers are varying to some degree

15 Interview with ERC, December 2008


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closer to and above the mean of the regions values. Its retail tariffs for households are mid-ranked from the countries listed herein.

Serbia is having some of the lowest retail tariffs in the region, right across the threesegments of industrial, commercial and household customers. It is thought that some ofthese retail tariffs may not cover even the generation costs. This may be due to a number ofreasons, including the protection of so-called vulnerable costumers and some level ofsupport for energy intensive heavy industry.

A general feature across the region is that the commercial customers are typically payingmore than household customers. This can hardly be explained by differences in the coststructure motivating such differences in tariffs.

Figure 25. Retail tariffs 2007, /MWh

0

20

40

60

80

100

120

140

160

180

Households

Industrial

Commercial

Households

Industrial

Commercial

Households

Industrial

Commercial

Households

Industrial

Commercial

Households

Industrial

Commercial

Households

Industrial

Commercial

Households

Industrial

Commercial

Households

Industrial

Commercial

Households

Industrial

Commercial

Albania Bosnia and

Herzegovina

Bulgaria Croatia FYR of

Macedonia

Montenegro Romania Serbia Kosovo

/MWh

Source: ECRB 2008 Market Development Report and Eurostat, Kosovo comment on report

In March 2009 a Study on Tariff Methodologies and Impact on Prices and EnergyConsumption Patterns in the Energy Communitywas published. (IPA, 2009).16

Figure 25

The studyconcludes that the overall average retail tariff varies considerably between the parties, as isalso showed by .The study covered tariffs from 2005 to 2008 (2008 not availablefor all parties), and showed that the tariffs generally have increased over the period and inmany cases significantly so.

16 The study was commissioned by the Energy Community


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According to the report no country (with the partial exception of Albania) used tariff basedmethods to protect vulnerable customers. However, this seems hard to reconcile with the factthat commercial customers in most cases are paying more than household customers.Although, there might not be lower tariff targeted towards vulnerable customers, the tariffsseems to be kept low in general.

The study also included a review of the cost coverage. This showed differences in theallocation of costs between e.g. transmission and distribution, and also differences in howthe return on asset was calculated. The report specifically mentions that Serbia applies a 0%weighted average cost of capital on transmission, in Kosovo the distribution andtransmission system are deemed to be past their useful economic lives and have no valueand in Montenegro it was recognised that the applied cost of capital for both transmissionand distribution is below the true cost of capital.

Errors in the rate of return for monopoly operations such as transmission and distributionmay not distort the functioning of the wholesale market, as long as the transmission anddistribution companies are able to fund the necessary investments, However, the report also

states that for the regulated generation tariffs as with rate of return for transmission tariffs,the rate of return used may not reflect the full cost of capital of generation because of theassumption that Government as shareholder may prefer to keep prices down rather thatobtain a full return on its equity. From a market development point of view this is highlyproblematic since it will provide an important barrier for new entrants in generation in theregion.

One important conclusion from the above mentioned study is that Much of the variation inoverall tariff levels between the parties is driven by differences in generation costs and thatthis is largely related to the type of generation. A well-functioning regional market can beexpected to change this situation, as the wholesale power price can be expected to convergeacross the region. This would lead to a more efficient price formation, but is also expected tolead to increased profits for the generators having the low cost generation possibilities.


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4. CURRENT REGIONAL MARKET OPERATIONS ANDMECHANISMS

4.1 Current Balance Management in SEE

The level of real time automation and communication in many countries of SEE is still limited(ETSO, Current State of Balance Management in South East Europe, June 2006). Some ofthe obstacles are that changes to the output of individual generating units cannot beauctioned without substantial manual intervention. Remote metering on some HVtransmission network points are not installed and modern SCADA systems are yet to beimplemented in some countries.

Balancing mechanisms are still not in place in all countries. This is the case for Serbia,Montenegro and FYR of Macedonia. However, all three countries have market models (orare implementing market models) which include balancing mechanisms/balancing markets.

In Bosnia and Herzegovina a balancing mechanisms is in place and it is one of theresponsibilities of the ISO. In Croatia the market operator settles unbalancing energy forbalance responsible parties. In Albania the TSO is responsible for the organization andadministration of electricity payment settlements among the market participants and managethe imbalance settlements statement process. Also in Kosovo the TSO is responsible forprocuring system balance through the balancing mechanism.

South East Transmission System Operators (SETSO) are currently in the design stage of theRegional Balance Mechanism (BETSEE RBM or BETSEE). The aim is to achieve a systemthat facilitates: technical correctness, effectiveness, truthfulness, individual rationality, budgetbalance and social welfare.

This initiative has to be seen in view of the fact that electricity markets in the SEE region arestill in the early stages of development. Market operations and their degree of opennessvary greatly, traded volumes are low (especially in the short term) and exchanges strugglewith low levels of liquidity.

In consideration of the challenging environment the approach was chosen to develop aconcept of the RBM that assumes minimal prerequisites regarding the existing marketstructure.

In an Examination Paper (ETSO, Regional Balancing Mechanism BETSEE for South-EastEurope, April 2008) the SETSO Task Force simulated and analysed the potentialconsequences for SEE countries where the RBM Design (dated Nov 2006) implemented in

the Region today (April 2008).The examination paper concluded, under the premise that the RBM development in the SEERegion was still and ongoing process and therefore subject to uncertainties that:

Depending on the availability of balancing resources there will be parties having benefits andparties facing disadvantages in case of a country deciding to join the RBM.

The absence of a transparent balance energy price is a challenge for the RBM, short termmarkets are underdeveloped and cross-border transfer prices for balancing can not beaccurately accessed, this could cause irregularities in the function of RBM.

It is expected that the RBM will have low liquidity as a direct result for the fact that the RBM

is designed by an imperfect mechanism. TSOs and market participants will face risks thatthey are unable to fully manage due to lack of transparent information.


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Improvement to liquidity will not bee seen until the implementation or improvement of shortterm trading (Day-ahead, intraday) markets and improvement in transparency in the marketparticipant activities in the participating countries.

Monitoring processes conducted by Regulators will be required in order to preventmanipulations and to guarantee the necessary level of transparency in market participantsactivities.

4.2 Congestion management and cross-border capacity allocation

The principles for Cross Border Congestion Management are described in the Regulation(EC) 1228/2003. This regulation, through the Energy Community treaty, is also applicable inthe SEE countries.

One major task of the harmonization of SEE region is the establishment of a CoordinatedAuction Office (CAO). In the future, the office should provide mainly auctions on differentperiodical bases and should organize a secondary market for physical transmission rights(has still to be developed). The according action plan has been launched and the first stepsare already implemented. It is foreseen that the yearly Auction 2010 will be managed by theCAO.17

The CAO currently agreed to be established in Monteneg

south east europe wholesale market opening, poyry and nord pool

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