ELECTRICITY REFORM STATUS IN AND THE ASSESMENT OF THE DISTRIBUTION PRIVATIZATION REQUIERMENTS

Gh. Indre M. Indre I. Conecini Romania

Electricity industry is facing in the of a four years restructuring whole world radical changes regarding, the process core activities, generation, transmission, • Analyses of the objectives and the distribution and supply, deployment and general requirements for the organization. privatization of the electricity As an essential part of the electricity distribution sector. Define the industry value chain the electricity basic elements for an efficient distribution activity is organized as a natural privatization strategy. monopoly, its economics pertaining to the • Identify the issues to be considered economy of scale. This very important in the process of creating new feature determine that the investments in distribution companies, taking into distribution to be exposed to a very peculiar account the provision of the commercial risk generated by the fact that Romanian electricity legal and being a natural monopoly structure, it has to regulatory framework. admit a very well defined regulatory process • Presenting the basic elements of for its rates and tariffs. As a consequence the the process of valuation of the distribution investor is facing three major distribution company. They are risk categories: political risk, regulatory and indicated the necessary data and commercial risk. information which has to be used In spite of all this realities the for building a financial model for distribution companies and the distribution the valuation of the distribution business are very attractive for the investor company. They are mentioned a and the last years experience has proved that number of financial synthetic the privatization of the electricity sector in indicators used to asses the value many countries in the world like Brazil, of an electricity distribution Hungary, Argentina, s. o., began through company. privatizing the distribution. Key words: restructuring, economic Starting from these considerations and viability, regulation, privatization, market taking into account the fact that the value, regulatory risk, political risk, and Romanian electricity industry is facing a commercial risk. deep restructuring in order to attract foreign investors in this sector of the Romanian economy the paper performs analyses of the following important aspects: • Presents the actual status of the organization and operation of the Romanian power system as a result ELECTRICITY REFORM STATUS IN ROMANIA AND THE ASSESMENT OF THE DISTRIBUTION PRIVATIZATION REQUIREMENTS

Gh. Indre, SC ELECTRICA SA M. Indre, SC ELECTRICA – Subsidiary I. Conecini, Romania

1. INTRODUCTION perform the activity on a contractual basis, running as local natural monopoly. One of the main priority of the Romanian ♦ To establish new commercial companies Government policy in the last four years was the able to perform the electricity supply activities restructuring and the reform of the Romanian for the eligible customers. Power Sector ( RPS). In 1997 it was started the ♦ To create the necessary legal framework by process of transforming the former Romanian issuing an electricity had heat law and legal Electricity Authority RENEL into a commercial acts necessary for the creation of the company and planning the development of the electricity competitive market. process for creating a competitive electricity ♦ To create an independent regulatory body market in Romania. able to produce the secondary legislation and The main purpose of these efforts was the to issue the license and authorizations, to unbundling of the core activities of the RPS, assure the third party access to the generation, transmission, distribution and supply transmission and distribution networks, to of electricity and heat and to establish define and regulate the prices for the natural independent commercial company as legal monopoly activities, and to supervise the person designated to perform this activities on a operation of the electricity market. clear contractual basis. Following the principles ♦ To open to the retail electricity market by included in the EU directive 92/96 for the creation defining the eligible customers of the internal electricity market in Europe the This paper will present the present status of the RPS restructuring process was developed having restructuring and the reform of the RPS and some in mind the following objectives: aspects related to the privatization of the ♦ To reform RENEL which was organized by the distribution activities. time as a vertically integrated business covering the power sector activities and 2. PRESENT STATUS REGISTERED IN THE having a strong monopoly position all the ROMANIAN ELECTRICITY SECTOR electricity customer in the country, having to RESTRUCTURING PROCESS buy electricity from RENEL. As the main significant steps which has been ♦ To attract private investment in the RPS and followed in the process of the restructuring and decrease the state role in performing the the reform of the RPS we can mention: economic activities specific electricity and The promotion in July 1998 The government heat sector. decree 365 created The National Electricity ♦ To create competition in the electricity Company CONEL as a holding structure by generation sector by establishing a number of separation from the former autonomous regie electricity generation companies able to RENEL the nuclear sector, and the study and compete on this market. research activities. CONEL included the following ♦ To create an independent electricity independent commercial companies: transmission which has to remain as a natural Termoelectrica S.A. for the operation of the monopoly organized to provide the thermal power plant; transmission services for the whole sale Hidroelectrica S.A. the operation of the hydro electricity market, and to assure the power plant; dispatching and the operation of the RPS as a Electrica SA for the operation of the distribution system operator; networks formed by all the facilities with the ♦ To define a model and the basic rules for the voltage level 110 kV and less. Electrica had 42 wholesale Romanian electricity market and to subsidiaries, one for each county. Electrica had to create the institutional structure necessary to perform both the distribution activities and the operate this market by establishing an supply for all the electricity customers in the independent company with the role of the country. electricity market administrator. Conel had the mission to provide the operation of ♦ To separate the distribution activity and to the transmission network ( 220 kV, 400kV and 750 organize commercial companies meant to kV substations and lines). In October 1998 was promoted the Emergency On the liberalized market which represent 15% Ordinance 29 which has created the National the accredited eligible customers can buy Electricity Regulatory Authority ( NERA) which electricity on a negotiated base from the started to work in March 1999. producers which holds a supply license or from In December 1998 it was promoted by the other licensed suppliers. Government the Emergency Ordinance 63 for All the captive customers have to buy electricity electricity and heat which as the energy and heat from SC Electrica SA which holds a distribution law. On the base of the provision of this ordinance and a supply license. NERA started in march 2000 to elaborate the secondary legislation for the whole sale electricity 3.OBJECTIVES AND GENERAL market. REQUIERMENTS OF THE DISTRIBUTION During march 1999 and July 2000 NERA issued a PRIVATIZATION great number of electricity market regulations and licenses for generation, transmission, distribution The electricity distribution privatization is a and electricity and heat supply. complex process, which has to be developed on In February 2000 through the Government Decree the base of the Government political decision. 122 it was decided to open the electricity retail There are many parties interested and /or affected market up to the level of 10%. by the distribution privatization. We will try in o In June 2000 the Parliament issued the Law identify this actors and to define their main 99/2000 for the modifications and approval of the objectives. Emergency Ordinance 29/98 regarding the The commercial company SC Electrica SA has its creation of NERA. own priorities but we believe that as a possible In July 2000 through the Government Decree 627 vendor and as an distribution and supply company the National Electricity Company CONEL has the following objectives are likely to be important: been restructured and they have been created the ♦ Creating a successful privatization model for following independent commercial companies: the distribution and supply industry Termoelectrica SA created on the base of the ♦ Improving the quality of services and lowering former subsidiary of CONEL. the real cost for electricity supply industry Hidroelectrica SA created on the base of the ♦ Raising funds for the state budget former subsidiary of CONEL. ♦ Transferring the responsibility for the Electrica SA created on the base of the former investment to the private sector subsidiary of CONEL ♦ Securing public support for privatization and Transelectrica SA a new electricity transmission the economic reform process company which is licensed to perform the ♦ Encouraging foreign investment in the country transmission services and the operation of the ♦ Promoting domestic capital markets electricity market as system operator All this objectives and those of other stakeholders Opcom SA commercial company subsidiary of and interested parties involved in the process Transelectrica SA, established as independent may be conflicting and will need to be prioritized. legal person, which has the role of the The parties which we think should be considered wholesale electricity market administrator. for this process are: The Government of In October 2000 the Government decree 982 Romania, lenders, strategic investors, decided to open the electricity retail market upto management and employees, electricity the level of 15%. customers and the public and the regulator In the field of generation there are operating also NERA. Each of this parties is interested to will the commercial company Societatea Nationala have its own expectation from a successful created since 1998 from the privatization as follows: former nuclear sector of RENEL, commercial The Government of Romania : companies licensed as independent power ♦ To create a self financing and viable electricity producers, and a number of electricity self- sector producers. NERA licensed also commercial ♦ Cost effective and reliable power supply companies for electricity supply. ♦ NERA has elaborated the framework contracts for To attract high quality investors ♦ the operation of the wholesale electricity market To achieve a transparent and speedy and issued tariffs for the transmission and execution ♦ distribution services. For this interim phase of the To encourage foreign investment electricity market development the tariffs for the ♦ To win public support. electricity produced and sold by Termoelectrica The lenders : SA, Hidroelectrica SA and Nuclearelectrica SA are ♦ Enhanced credit worthiness determined and approved by NERA based on the ♦ A stable cash flows information and the requests formulated by the ♦ Minimal political interference in the process respective companies. ♦ Clear and stable regulatory environment Strategic investors: own specific aspects, which must be identified and ♦ Meaningful equity stake analyzed. ♦ Management participation or/and control The market issues comprise wholesale market ♦ Transparency and regulatory stability problems like bulk-supply contracts ,security of ♦ Improve efficiency supply and distribution companies direct access to ♦ Predictable cash flows the generators. In the present structure of the ♦ Achieve adequate investment returns market SC Electrica buys electricity from the ♦ Minimum political interference Termoelectrica and Hidroelectrica on the base of Management and employees: portfolio contracts and from the Nuclearelectrica and independent power producers using a kind of ♦ Terms and conditions of the future long term power purchase agreement. Electrica employment sells electricity on the retail market to the captive ♦ Protect benefits ♦ customers ( industrial , residential and tertiary). As Participation in management a distributor the company provides distribution ♦ Outsourcing opportunities services for the eligible customers, generators and ♦ New career opportunities independent suppliers. ♦ Share ownership and other employment Operational issues regards the following main incentives aspects: metering, billing, collection and The public and the customers: enforcement of electricity bills payments. It also ♦ System reliability and efficiency deals with load forecast, investment plant, ♦ Security of supply operational codes, operation and maintenance of ♦ Lower tariffs in real terms the distribution networks. It is important from the ♦ Wider share of ownership and liquidity operational point of view not to allow privatization The National Electricity Regulatory Authority: to affect the service, to collect data for investors ♦ To maintain control over sector and to launch pilot schemes in order to show ♦ Ensure a competitive environment potential for further improvements. It worth to ♦ Efficiency and security of supply mention that the company has already different ♦ Technological improvements pilot projects in order to decide on the best ♦ Attract quality investors to the power sector technology and business development solutions. ♦ Improve the payments The regulation area must cover the tariff structure, procedures, license provisions, service standards 4. PREPEARING OF THE PRIVATIZATION and competition. The tariff structure must provide PROCESS the cost recovery, a tariff reform, efficient use of electricity and economic incentives for the 4.1. Developing a Privatization Strategy business development. The service standards must define norms and performance indicators for The strategy of SC Electrica SA the distribution the service quality as well as investment company should be elaborated looking to the long obligations to improve the services. The term. In order to achieve the privatization the competition should be one of the main goals of the company must have the capability to promote the long term strategy. reform process. The management has to avoid uninformed decisions and to improve and 4.2. Configuration of new Distribution strengthen the corporate image. In the process Companies development is important to protect the staff but do not promise the undeliverable. The corporate The key factor for defining the new distribution and the Government interest has to be aligned companies is their economic viability. It must be and the diverging interests must be careful defined a set of criteria in order to asses the watched. It is important for the company to economic potential of a distribution company . In become a friend of the regulator and to organize this respect we may use as indicators: estimated its press relations. It is important to know the replacement value of the facilities, and the possible stakeholders in the distribution structure of the loads determined by the number privatization. The main categories of stakeholders of residential and nonresidential electricity to be considered are: investors, suppliers, customers to be served by a the new distribution management and employees, customers, company. The international privatization industries and the government. experience registered in different countries like, The strategy has to approach the following area: Argentina, Brazil, Hungary and others showed that the market structure issues, operational issues, the proper size of a new formed distribution regulation, financial structure, configuration of the company should have at least one million distribution companies which are to be privatized, customers. The geographical conditions are also the institutional strengthening and legal, tax and an important factor to be considered, taking into accounting. Each of this focus area contains its account the weather influence and the cost differentiation for the distribution networks ♦ In order to discount the cash flow it must be operation and maintenance induced by the used a percent value for WACC; geography of the region. In order to establish the ♦ It is important to note [ Charreaux, 1991] that new distribution companies the following key generally the WACC used by the seller is issues have also to be considered: different compare to the WACC used by the ♦ It would be difficult to maintain uniform buyer national tariffs with more than one distribution The main type of data, [WDI 1999], and company in Romania; information introduced as variables in the financial ♦ There will be differences among distribution model must cover the following important companies in transmission and distribution domains: macroeconomic, demand and revenue, charges for moving their power purchases to costs, expenses, income tax, reinvestment policy, their loads because the generation plants are other income and expenses, net operating profit not uniformly distributed over the country; after taxes and investors incentives. From the ♦ The ability of large industrial customers to macroeconomic point of view they have to be secure their supply from elsewhere can affect used the following variables: inflation, , the economic viability of the distribution devaluation, GDP growth and population growth. companies; As it concerns demand and revenue the following ♦ It is important for the new distribution parameters are important: elasticity of electricity company to have a well difined and a consumption to GDP growth, the structure of the operating electricity spot market in order to electricity revenue, electricity transfer to face the loss of the eligible customers: neighboring distributors, revenue from other ♦ The competitive market model choosen for services, evolution of the consumption due to Romania by the ministry and the NERA needs privatization, the price control and a special a clear separation between the wire business variable to reflect the eligibility effect, introduced in and the supply business. As a natural order as input in order to model, the effect of monopoly, the wire business receive granting eligibility to the main customers in the revenues based on costs. Ideally the supply region. business should neither benefit nor be The costs structure has to include: electricity disadvantaged by the wire business. costs, evolution of the acquisition prices, evolution For this transition period SC Electrica has restraint of the efficiency gain in generation, electricity the forty-two subsidiaries into nineteen. If the new losses and raw materials and materials. Government will decide to begin the privatization Expenses registered by a distribution company this structure might be reviewed according to the consist of: labor expenses, compensatory principles and the ideas expressed above. payments which may be formed by the payments paid to the employees laid off during the private- 4.3. Valuation of the distribution company ownership years due to efficiency gains, outsourcing expenses, depreciation and other The most important element to be used for the expenses. The last item is used as contingency valuation of the distribution company is the level and stands for small non-predictable discounted cash flow which must be determined expenses that may occur in time. using a financial model. The use of financial is Other income and expenses includes financial critical for testing sensitivities. For the privatization income rate, financial expense and extraordinary the market will decide and the minimum price can gains/losses like labor compensation. cause difficulties. The discounted cash flow In a financial model [ Bechtel, 1996] elaborate for valuation must be based on certain assumption the evaluation of the distribution, company among which we mention: operating o a competitive market it was assumed ♦ The valuation has to be done in US dollars , in that 30 percent of the average tariff used to sell order to represent a real term cash flow; power to the end user will be allocated for the ♦ All the revenues is assume to be collected in distribution and supply activities. In this scenario cash: the distribution reference company is somewhat ♦ It is necessary to chose a base period financially viable. This allocation covers network generally the last year. Some adjustments losses, personnel, and operation and may be necessary in the original budget maintenance costs. accounts; There are a number of financial synthetic ♦ It is necessary to assigne a certain indicators used to asses the value of an electricity reinvest/pay out policy: distribution company like enterprise value divided to the customers number and enterprise value ♦ The real GDP growth per annum is assumed, reported to annual sales. Determining this values over the period for which the valuation is we may use for the benchmarking taking into done:; account that this are figures used as measures for international transactions. Based on international experience and on the 5. CONCLUSIONS previous efforts made to identify the most appropriate ways to approach distribution The restructuring and reform process of the privatization in Romania the paper underline the Romanian power sector is developed in order to main objectives of this process and some improve quality of services, and on a long term to elements regarding its good preparation. reduce the electricity and heat tariffs for the final consumer. In order to obtain this goal it was 6.REFERENCES issued a legal framework which allowed to create a new electricity wholesale market presented in 1. Charreaux G, 1991 “Gestion Financiere” iitec, this paper. Libraire de la Cour de Cassation, Paris In order to achieve its goals the reform needs to 2.*** Bechtel International, Inc.1996, “Romania attract significant investment funds for improving Study of Options for the Long-term Structure of the infrastructure and the technology used now in the Power Sector” prepared by USAIDfor World the Romanian power system. One of the main Bank way to attract this funds is the distribution 3.*** The William Davidson Institute (WDI), 1999, privatization, a process which should be started as “CONEL Business Assistance And Survey soon as possible. Project” Distribution privatization requires a good 4.*** Bechtel International, Inc. 1998, “Analysis of understanding of the economic of the distribution RENEL’s Brasov Transmission and Distribution and supply business and an efficient and Subsidiary professional control from the Romanian experts.