Construction Contract for the “Kosova e Re” Power Plant

Eight Agreements, three major impacts!

April 2018

Contents

Introduction ...... 2 A financial fiasco ...... 3 Loan financing ...... 6 An Anti-European agreement ...... 11

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Introduction

On 19 January 2018, the Ministry of Economic Development published an already signed contract for the construction of the “Kosova e Re” Power Plant with the operator Contour Global. The documents were published a month after its signature in an event rather highly promoted by heads of state. Eight contracts rounding up a giant project were published only after Kosovo had signed upon all obligations imposed. Hence, we dealt with the transparency not as means of improving decision-making, but as means to justify action ex-post.

Kosovo Consortium of Civil Society Organizations for Sustainable Development (KOSID), and the Institute for Development Policies (INDEP) have analyzed these contracts, and we are convinced that this is the most harmful contract for Kosovo in all its modern history. The contract generates a twenty-year financial gap for the country, it isolates it from integration and electricity market liberalization, and extinguishes any hope for an energy system based on clean and environmentally friendly resources, and population health.

If this contract is implemented, Kosovo shall assume unbearable and undeserved costs. The state budget shall be burdened further, and many projects vital to Kosovo will not be implemented due to the focus on covering costs of a billion-dollar project. Contour Global cannot be named an investor in any economic logic. Quite the contrary, it is only a contractor to operate on a contract with not a single risk against its venture capital. It is a company that will not engage in construction, and will not even manage the project, since it can sub-contract that too! A company that has negotiated every single line of the contract to the detriment of Kosovo, and will have a safe profit, twenty four hours, seven days a week, for twenty years on row!

This contract damages the European future of Kosovo. Being a signatory party of the Energy Community Treaty, Kosovo is rendering itself a service to a private operator, and has largely violated all principles of market liberalization, European policy for market integration, domestic and European rules on free market competition, and EU legislation on state aid. The New power plant construction contract embodies an old policy of state subsidy to a certain company, thereby giving the operator an exclusive position in the market, and damaging the consumers’ interests for affordable energy.

The new coal-fired power plant is being built with no environmental impact assessment, or a social impact analysis. The Constitution of the Republic of Kosovo clearly requires that all projects with environmental implications must guarantee citizens’ engagement in decision- making, and that the environmental impact is taken into consideration in decision-making.

Article 52 Environmental liability

1. Nature and bio-diversity, environment and national heritage, are a responsibility for all.

2

2. Public institutions must engage in guaranteeing everyone a chance to influence decisions that are related to their living environment.

3. Implications on the living environment must be considered by public institutions in decision-making processes.1

The Government of Kosovo has negotiated a contract of billions, without considering environmental impacts and public health, and without engaging into proper public consultation processes. Ultimately, construction of a new coal-fired power plant has not taken into consideration Kosovo needs for market integration in regional and European markets. All planning, negotiations and finalization works in the contract were made under conditions of an isolated market, where the coal is “the only solution”, or the ideal solution to feed the system further.

The Kosova e Re Power Plant construction contract is harmful because it is financially damaging, environmentally and socially unpredictable, and in EU integration terms, it is isolating and short-sighted. From a bad idea of constructing a new coal-fired power plant to a horrid contract for its implementation! Hereafter, we shall list all financial, environmental and EU integration issues justifying why this contract and this project must be rejected and stopped!

A financial fiasco

Despite many arguments against a new coal-fired power plant for Kosovo, in current conditions after contract signature, we have to deal with its financial terms. With this agreement, Kosovo locks itself into an obligation of purchasing coal-fired electricity from a private operator for the next twenty years. Furthermore, a rather large portion of prior investments will be taken by the Government of Kosovo, thereby paving the way for the private operator to return on its investment and its profits.

Section 3.6 item a)2 of the Power Purchase Agreement obliges Kosovo to provide for water at a certain quality for the Power Plant. Specific requirements of water quality must be agreed with the GenCo (Contour Global). Under this section, Kosovo is technically bound to publish a tender for water supply with the quality required by GenCo. Such supply in all regards will require a water plant for the specific requirements of GenCo, and shall be a very expensive investment. This also does not comply with the introduction of a fully commercial operator in the market, since the operator is requiring conditions from the state, and does not seek for solutions in the open market for its own requirements.

Also, this article obliges the Government of Kosovo to require approval of specifications of the tender dossier before publication by GenCo.

1 Republic of Kosovo, (2008), Constitution of the Republic of Kosovo, Article 52, Responsibility for the Environment, Prishtina: Official Gazette of the Republic of Kosovo. 2 Power Purchase Agreement, 3.6 a). 3

Section 3.73 of the Power Purchase Agreement obliges the Government of Kosovo to conduct an Environmental and Social Impact Analysis. In Western countries, such a plan would be prepared by the vendor, and then accepted or rejected by the Government, as part of the licencing process. This study requires technical specifications of wind analysis, stack height, emissions, etc. Only then can GenCo perform its own analysis, and this contract does not bind GenCo to findings and conclusions of the Kosovo’s analysis.

Apart from massive investments in the coal mines (over 300 Million) and auxiliary infrastructure, studies required according to Section 3.8 of the Power Purchase Agreement, to be paid by Kosovo are:

a) Seismic Study b) Meteorogical Survey c) Topo-Geographic Survey d) Flood Risk Assessment e) Geological and Geo-technical study f) Bomb Assessment Survey g) Underground Obstacles Survey h) Raw Water Analysis i) Reserves and j) Other studies or surveys reasonably necessary for EPC contractors to accept the risk for differing ground conditions.

Section 3.9 of the Purchase Agreement provides that Contour Global shall conduct an international competitive tender for EPC (Engineering, the contract does not even Procurement and Construction) and LTM (Life Time bind Contour Global to Management). Or have two sub-contractors or a perform or manage combination thereof through consortia. This means that planning, construction and GenCo shall not have an executive operational role, but only project management, but that of planning and supervision.4 Such combinations enter into an agreement usually lead either to mismanagement of construction, with sub-contractors! because sub-contractors have incentives to non-lawfully reduce costs, or in the case we believe to be happening in Kosovo, in raising the price.

Tender conditions are set by GenCo, under the approval of the Government of Kosovo. However, Kosovo would have to respond within 20 days upon submission of tender specifications for EPC/LTM, otherwise GenCo may proceed without Government approval. This option, left in the contract with Contour Global, for GenCo to proceed with the tender for Owner’s Engineer, which is a standard financial procedure for such contracts. However, there should have been technically two owner’s engineers, since both are owners

3 Power Purchase Agreement, 3.7. 4 Ibid, Section 3.9. 4

(Kosovo and Contour Global). GenCo will conduct the tender itself, and it is not known whose interests will GenCo defend. And then, if GenCo does not have a role of the Owner’s Engineer, why would one need GenCo?

The Contract provides for at least five contractors:

 EPC – Engineering, Procurement and Construction  LTM – Life Time Management  O&M – Operations and Maintenance Contractor  GenCo Connection Assets – for the interconnection contract from the feeder, and connection to KOSTT network  Environmental Protection Contractor - (Optional)

According to Article 10.1.2 NKEC (or MED, which represents the Government, according to the first page of the Contract), is bound to pay for all net electricity from KRPP.

Also, item c of this Article

According to Article 16.25 the Government is required to reimburse GenCo for all lignite amounts which result from the “Take or pay” agreement with KEK Mining, unless Genco fails to fulfill the take- According to Article 27.12, the or-pay agreement, due to the inability of GenCo to Agreement is governed by New generate electricity. In a free power market, Kosovo York legislation. Government should not pay for lignite costs in cases when for example, there is a decline in market demand for power.

Apart from large preparatory costs until the project execution, such a project will cause an increase in electricity prices. This is due to the reason that final costs of construction are not known yet. Sub-contractors will be interested to enlarge costs, for their profits to be greater. Ultimately, the sole fact that we are required to purchase all power generated for the whole twenty-year period shall mean that we shall spend around 300 million Euros a year for purchasing electricity from the private operator.

While for the existing market operator, it will be paid for as much as it generates, under a guaranteed price, and preferential dispatching6. Priority market placement gives the private

5 Power Purchase Agreement, 16.2. 6 Priority network placement. Before this contract, a priority in dispatch was given only to power produced by renewable sources. 5 operator a favoured position against other operators. This immediately leads us to European standards of a free market, competition and state aid.

The power plant construction financing is planned with a financial structure in which 70% of the cost is to be covered by loan finance, and 30% from the investment of the private Contour Global company, as an investor designated for that obligation. By such a financing structure, 910 Million Euros shall be acquired through a loan, and 390 Million will be privately invested. A construction cost of 1.3 Billion Euros, or even 1 billion Euros, with such a great share of loan finance, already represents a set of concerns and risks of a political and regulatory nature, which need to be taken into consideration.

Loan financing

The loan finance which is expected to cover for 70% of the cost is expected to be acquired at a repayment rate of 7.5%. This return rate is taken as such, thereby considering that the remaining portion from the actual rate amount (which may reach up to 18%, and which shall be elaborated further in the sensitivity analysis below) may be subsidized. For this reason, the actual return rate, without the subsidization of the return rate, for the purposes of this analysis is taken to be 18 per cent. The maturity timeline is expected to be 20 years. Setting from these data, the loan interest cost for the whole specified period is expected to reach an amount of up to 1.36 Billion Euros. In fact, it is possible for the Kosovo Government to stipulate a loan agreement at a 7.5% interest rate, or even lower, and there would be no need for subsidies, however considering the economic reality in the country, it is difficult to assume that such a good rate would be possible to obtain at this moment. For this reason, the total Kosova e Re Power Plant construction cost includes also the interest cost subsidy (see Table 2).

How successful will the Kosovo Government be in acquiring this amount of a loan, it remains to be seen. However, considering the nature of this investment, construction of a fossile fuel power plant, coal-fired plant, known to not be ecological and environmentally friendly, there is no attractiveness, at least in principle, for lending from the development banks and other financial institutions, and even less possible at a rather low return rate of 7.5%. Furthermore, factors that measure financial market quality in the country, and the loan interest rates in commercial banks, which also reflects the risk of a possibility of failure in loan repayment, project for a much higher interest rate than 7.5%. Such a situation may be ascertained also from the preliminary requirment of a return rate of 21.5% from the private investor, which also reflects the high risk rate in this investment. In the last agreement, this rate was reduced, as a result of agreement between involved parties, however it would be rather rushing to believe that the interest rate was lowered due to a lower risk, in such a short period.

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An analysis of loan repayment rate sensitivity also represents various scenarios of loan finance increase or decrease, depending on the variations in the interest rate, which is still to be determined. The following table reflects such analysis.

Table 1. Analysis of loan sensitivity to return rate variation (amounts in Euro)

Loan amount Interest rate Amount repaid in amount paid in 20 years interests 2% 1,274,000,000 364,000,000 910,000,000 7.5% 2,275,000,000 1,365,000,000 9% 2,548,000,000 1,638,000,000 18% 4,186,000,000 3,276,000,000 From these projections, it can be proven, in the best possible scenario, that if the Government of Kosovo manages to obtain a loan at a 2% return rate, the total amount to be paid by the Government of Kosovo may reach 1.2 Billion Euros. In case a loan is obtained at a return rate of 7.5%, as stated recently, the total amount to be covered by the Kosovo Budget shall reach the amount of 2.2 Billion.7 Two additional return rate scenarios, 9 and 18 percent, are also incorporated into the analysis, for various reasons. The 9% is believed to be managed since in the published contract for the power plant, the private investment return rate was lowered from 21.5 per cent to 18.5 per cent, and this deduction may partially reflect into a lower interest rate for the portion financed by the loan (an increase from 7.5 to 9 per cent). In such a case, the total amount to be covered by the Kosovo Government reaches the value of 2.5 Billion. In recent analyses published by IEEFA, it has been clealy stated that the actual interest rate for this project may be 18 or more per cent, in due consideration of the current interest rates in commercial banks of Kosovo (in a range between 14% and 16.6%), and other factors determining the risk level in financial markets of the country.8 In such a case, the total amount to be covered is 4.1 Billion Euros, a cost that may be very difficult to cope with for our country.

Private investor financing

7 Institute for Energy Economics and Financial Analysis, The proposed New Kosovo Power plant: An unnecessary burden at an unreasonable Price, January 2016, page 26, http://ieefa.org/wp-content/uploads/2016/01/The- Proposed-New-Kosovo-Power-Plant_-Jan-2016.pdf 8 Institute for Energy Economics and Financial Analysis, The proposed New Kosovo Power plant: An unnecessary burden at an unreasonable Price, January 2016, page 15, http://ieefa.org/wp-content/uploads/2016/01/The- Proposed-New-Kosovo-Power-Plant_-Jan-2016.pdf 7

From the total cost of power plant construction, 30% are thought to be covered by the private investor, Contour Global. The 390 Million investment return rate is agreed to be 18.5 per cent, with a biannual interest application. Following analyses (table 2) take into account the total loan repayment duration for 3 to 5 years, as two possible scenarios, since it was not specified with the last published agreement. With detailed specifics in this manner, the cost paid only on interest over investment shall reach the amount of some 270 Million Euros for 3 years, and 550 Million Euros for a repayment period of 5 years.

Amount invested Total Loan Amount repaid amount paid in by Contour Interest rate Repayment (principal and interests Global Period interest) (# years) 390,000,000 18.5% 3 663,121,762.42 273,121,762.42 5 944,667,693.91 554,667,693.91 Table 2. Analysis of total return on capital investment by Contour Global in construction the Kosova e Re PP (amounts in Euro)

The following table includes construction costs, calculation also loan repayment rate costs, and also from the private investor. Calculations also include the subsidy cost, which may be covered only in case the agreement is conditioned with a very favourable interest for the lender. This means that if the loan is calculated at an interest rate of 18 percent, the amount paid in interests for a 20-year period shall be 3.2 billion Euros, compared to 1.3 Billion euros, if the interest rate is taken to be 7.5 percent. The difference to be subsidized reaches the amount of 1.9 Billion Euros.

Total Loan and Return Rate 2,275,000,000 Total private investment and Return Rate 663,121,762.42 Subsidy Cost 1,911,000,000 Total Cost of Kosova e Re Power Plant 4,849,121,762 Table 3. Analysis of Overall Cost of construction of Kosova e Re PP (amounts in Euro)

Based on these calculations, the construction cost for the new power plant reaches the amount of 4.8 Billion Euros, three times higher than the cost projections so far standing at 1.3 Billion Euros. one must take into account that the Table above incorporates the Contour Global investment return rate for a period of 3 years. Should the investment be repaid in a period of 5 years, the total construction cost may even reach over 5 Billion Euros.

Impact of Kosova e Re PP Construction on electricity prices

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Currently, operation costs at Kosovo A and B PPs, which implies the electricity price, are at the level of 28.93 Eur/MWh. In case the new power plant is not built, and the generation capacity remains as is today, but at a calculation of the inflation rate of 3 per cent, the electricity price should reach up to 33.53 EUR/MWh until 2021. The current agreement on Kosova e Re PP provides on an electricity price of 80 Eur/MWh. Furthermore, the agreement incorporates the obligatory repayment cost in case of energy generation over the planned rate9. This obligation requires an additional payment of 20 per cent over the agreed price for the time period of energy generation over the planned amount. In such a case, the electricity price may reach the amount of 90 EUR/MWh. The agreement also stipulates the measures to be taken in case the energy available for intake is under the amount planned. In this case, the penalty is to be determined on the basis of the difference between the amount generated and the amount forecasted. However, the penalty is not fixated at any specific additional percentage, as in the prior case.10

Considering the difference between the current power price, and the price in the New PP agreement, the price increase will reach up to 176.5 per cent. In cases of 20% bonuses applied, the increase in price will reach the amount of 231.8 per cent. Obviously, this increase will also affect the share of citizens revenues dedicated to electricity expense.

Impact of Kosova e Re PP Construction on electricity tariffs

(The following analyses will focus on how the Government of Kosovo would cover the costs of the electricity price differences)

The agreement price of 80 Eur/MWh that NKEC will have to purchase from

Contour Global GenCo.

NKEC and KEDS have no purchase agreement at the

NKEC price of 80 EUR/MWh, and it is expected that KEDS, as an independent entity, would purchase electricity from

other suppliers, at a price much lower, and not from NKEC. KEDS

9 Power Purchase Agreement, 2.3.1 Bonus for Availability Above the Expected Availability, faqe 171. 10 Power Purchase Agreement, 2.3.2 Penalty for Availability Below the Expected Availability, faqe 171. 9

Citizens may not face directly the electricity price hike in

KESCO their electricity bills, but they will be charged indirectly on their taxation by the Government of Kosovo, to cover the difference between the agreed price of 80 Eur/MWh, and the market price, which is supposedly lower, in case Citizens KEDS will find supply at a lower price.

It remains to be seen what should be the amount to be

covered by the budget, as a result of covering the difference in electricity prices.

Costs to be covered by the Government of Kosovo for Contour Global

Compensations that need to be covered by the Government of Kosovo for Contour Global, as stipulated in the agreement, include electricity compensation, availability charges and other monthly payments (Article 16).11 As for the electricity compensation, the agreement stipulates an hourly calculation of energy payments, which include the lignite price, price of water used per ccm, limestone expense, and hourly amoniac use, and other variable costs (Schedule 1, Article 4).12 Availability charges include periodic loan payments, and the interest rate costs, corporate taxes, fixed operation and management costs, and other costs included (Schedule 1, Article 3).13 Ultimately, other payments to be reimbursed to GenCo include payments for electricity network operation management.14 All these compensations must be taken into account in the project feasibility study, which in many terms is considered to be an expensive assignment, thereby largely burdening the country’s budget.

Possible variations in energy prices

The analyses and calculations above take into consideration the electricity price of around 80 EUR/MWh after the new power plant construction. The reason for quoting such a price is the fact that this planned price is stipulated in the agreement, and has been set as a threshold price, in statements by the Minister of Economic Development. However, the agreement shows some aspects which make us think that this price is only for guidance, and if other costs are

11 Power Purchase Agreement, Article 16: Compensation due to GenCo, faqe 120. 12 Power Purchase Agreement, Schedule 1, Article 4: The energy payment, page 183. 13 Power Purchase Agreement, Schedule 1, Article 3: Calculation of the Base Availability Credit Amount Used to Determine the Monthly Availability Payments in each ½ Year Period, page 172. 14 Power Purchase Agreement, Article 1: Definitions; Interpretation, page 9.

10 incorporated, it may be much higher. Firstly, the price quoted in the agreement specifies the 80 Eur/MWh as a planned (target) price, which renders clear that for GenCo, this figure is not the ceiling, but only a variable objective.

ËMIMI I IMPORTIT NË DHJETË VITET E FUNDIT

112.52

79.46 75.77 69.66 67.71 62.14 57.91 52.31 51.76 47.62

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Otherwise, in the last ten years, the average import price in Kosovo has only been 67 Euros, and in the last five years, only 56 Euros. Hence, even import prices are clearly more convenient than the prices of energy generated by the Kosova e Re PP.

Secondly, the agreement also includes details of calculating various costs, which may be variable, and can obviouly reflect in the prices as foreseen. Furthermore, changes in operating costs and interest rate costs for the loan financing are still unkown, but since these are additional costs, it can easily be expected to increase the prices even further. Hence, although the energy prices may initially be at the rate of 80 Eur/MWh, the odds of overtaking such figure are large. It is clear that the increase in power prices renders this project even less feasible in economic terms.

An Anti-European agreement

Upon adoption of new power legislation in 2016, Kosovo had fully transposed the Third Legislative Package of the Energy Community. Kosovo is a signatory party of the Treaty Establishing the Energy Community, a mechanism for approximating legislation and developing the regional energy market towards the EU. Thus, it is an obligatory treaty for Kosovo, for the pre-accession period of Kosovo.

The Energy Community is designed as an instrument for market liberalization and regional integration, but also to guide the Western Balkans countries towards a clean and sustainable

11 energy sector.15 Ideja e liberalizimit të tregut ka lindur nga rregullat e konkurrencës së lirë dhe garantimit të funksionimit të një tregu fer të energjisë duke ndaluar pozitën favorizuese apo dominuese të njërit operator ndaj tjetrit.

Also, the Objective 2 of the Energy Strategy 2016-2025, clearly specifies the Kosovo’s objective for market liberalization:

Create conditions for a liberal market within a regional energy market, which do not allow for discrimination of parties, regardless of the country of licence within the Energy Community, on the principle of reciprocity;16

Under this agreement, one of the generation operators in Kosovo, “Kosova e Re” shall have guaranteed its power purchase at a pre-determined price17. There cannot be a free and liberalized market if one of the operators has guaranteed supply of coal pursuant to the operator's own requirements, enormous water amounts, uninterrupted power purchase, price, and ultimately priority placement in the market!

In current contract conditions, no operator, not even renewable source generators, will have the advantages enjoyed by Contour Global. While the feed-in tariff scheme provides for 10-year, respectively 12-year contracts, at a price which only aims to make such investments competitive with conventional technology, Contour Global shall benefit from double the duration, with all prior conditions met.

The contract also violates internal competition legislation, and the European Union legislation. A special emphasis must be paid to the EU Legislation on internal market, and the Law no. 03/L-229 on Protection of Competition. This law defines the dominating position in the market as:

Position of one or more enterprises, which renders them capable of acting, in terms of supply or demand, independently from other market players, such as competitors, clients or consumers.

Kosova e Re PP and conditions in this contract precisely render the private operator in a fully independent position, entirely unaffected by the market. Therefore, “Kosova e Re” will enjoy a fully dominating position against other energy generators, who do not enjoy any of the guarantees that Contour Global enjoys with this agreement.

The contract also violates EU provisions on State Aid. The New Kosovo Power Purchase Company will take all energy produced by Kosova e Re PP at a certain price. Apart from this undermining the whole idea of a liberal market, because it assumes a regulated power price, it bears the risk that a large portion of energy is purchased directly by state budget subsidies. If the new company is not able to sell the energy purchased from Kosova e Re PP, the energy will

15 Energy Community, (2018), Knocking on the EU’s Door through the Energy Community: Integration of Western Balkans into the Pan-European Energy Market, faqe 1, Vienna. 16 Republic of Kosovo, (2018), Energy Strategy, Objective 2. Integration in the Regional Energy Market, page 33, Prishtina: MED 17 Although the price mentioned is 80 euro MW, such a price is expected to be even higher for the end users. 12 be sold at a much lower price, or be lost entirely. The difference will be paid directly by the budget, which again violates state aid legislation, undermines the implementation of the Stabilization-Association Agreement, and the European path of Kosovo.

1

Interconnection with other countries (export – import – exchange)

Transmission Operator (KOSTT)

New Kosovo Electric Company

(NKEC)

Generation Generation Distribution Operator (KEDS) a) Guaranteed Renewable Renewable purchase sources b) Guaranteed sources Dispatching advantages raw matter supply Generation c) Guaranteed profits Dispatching advantages!!! (KEK)

Supplier 1 Supplier 2 (JSC, Supplier 3 Generation (KESCO) HEP) (GSA sh.a.) Kosova e Re

Citizens Private Public 0