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Acceding to Succeed

How joining the EU may transform the Central and Eastern European electricity sectors
Fortnightly Magazine - July 2004

to quickly adopt EU auditing and legal standards will help to enhance investor confidence regarding some of these issues.

One last concern that is consistently observed across the region is the lack of fully independent regulators. The problem with regulators that are not fully independent is that government officials can lean on them to minimize rate shock to protect the officials in the next elections, or that asset sales can be encouraged or discouraged for political reasons. Ideally, regulators should be appointed to minimize political control for a fixed term with dismissal possible only within a narrow range of circumstances. Funding for regulators should come from industry, not from the government budget. Tariff-setting should be free from political influence. Thus, the regulator should be able to approve tariffs without interference from politicians, or the methodology for tariff setting should be officially published, reducing the regulator's role to that of an administrator.

Some challenges to investment are country-specific. The countries that chose fragmented single buyer models (Hungary, Poland, and Bulgaria) as their way to transition to a competitive electricity market are now facing the challenge of what to do with the long-term power purchase agreements (PPAs) that they set up at the onset of deregulation. The problem of the PPAs is multifaceted. On the one hand, they inhibit full competition within the generation sector as they are generally for fixed prices for the life of the contract. This decreases the total amount of competitive generation capacity available. In addition, the contracts were sometimes signed at high fixed prices, especially to entice Western developers, and are now considered "out of the money." Renegotiating these contracts can be expensive. There are, however, creative solutions to this issue. In Poland, the government is planning to renegotiate all of the outstanding PPAs (called KPN in Poland) and to finance the stranded costs via a bond issuance that would be collateralized by imposing a small levy on end consumers. Neither Hungary nor Bulgaria has started the restructuring process, and it may be that they are waiting to see if the Polish solution is workable.

In addition to its concerns about its single buyer model, Hungary also has struggled with the politicization of tariff setting, which has endangered the economic viability of the state-owned transmission company. Hungary's first tariff review in 1996 suggested the need for 35-percent tariff increase in end consumer tariffs. The government rejected this and increased tariffs by only 25 percent by postponing costs such as reserves for nuclear decommissioning, closing coal mines, and not recognizing some expenses such as insurance. During the second price review in 2000, increased generation prices were not reflected in end-consumer prices. This threatened the distributor's financial viability, causing them to actively protest to the regulator. Ultimately, the government forced the state-owned transmission company to cover the gap between the actual cost of power and the cost the government was willing to pass through to end consumers. The transco then sold the electricity to the distributors at the pre-established artificially low price.

While most of Central and Eastern Europe has addressed