## _wp1130

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---

### I. Introduction and summary
- Macedonia transitioning from centrally planned to a decentralized regulated free market in the energy sector.
- Demand-side challenge: improve efficiency of energy usage, hindered by below market pricing for all but the largest users.
- Supply-side challenges: lack of oil, gas, or high quality coal reserves; ageing generation facilities; shortage of domestic generation capacity; relatively inefficient and dirty facilities.
- Policy directions:
  - New investment in generation based on least-cost analyses, taking into account environmental standards.
  - Moderate demand growth by promoting energy efficiency measures, market liberalization, and concomitant price increases.
  - Establish an efficient energy market through further sector reform, including legislation and regulation.
- Commitments and reforms:
  - Macedonia has signed the Energy Community Treaty (ECT) to implement relevant parts of the EU acquis communautaire.
  - Government drafted a new Energy Law expected to bring compliance with Treaty obligations once fully implemented with necessary secondary legislation.
- Recent outcomes:
  - Implicit electricity pricing subsidies decreased from 3.8 percent of GDP in 2008 to 0.7 percent of GDP in 2010.
  - Privatization of distribution in 2006 led to substantial investment by the new owner, reducing distribution losses and collection shortfalls.
- Medium-term objectives:
  - Full electricity market liberalization by 2015 through implementation of the new Energy Law.
  - Market-based pricing, energy awareness (including insulation), and improved collection enforcement to contain demand.
  - Gasification to lower energy demand and increase supply via cogeneration combined heat and power (CHP) plants.

### II. Electricity sector — demand, supply, and emissions
- Demand and supply magnitudes and trends:
  - Energy consumption rose 34 percent between 2000 and 2008, from 6,433 GWh to 8,609 GWh.
  - 2009 consumption decreased to 7,597 GWh due to collapse of electricity-intensive exports from heavy industry.
  - Demand growth averaged 1.9 percent per year between 2000 and 2009; GDP growth averaged 2.7 percent over the same period.
  - Domestic supply decreased from 6,326 GWh in 2000 to 6,152 GWh in 2009.
  - Imports averaged 20 percent of demand (1,468 GWh) between 2000 and 2009, and peaked at 32 percent of demand (2,757 GWh) in 2008.
  - Imports cost an average of €95 million in 2003–09, and peaked at €235 million (or 3.6 percent of GDP) in 2008.
- Sector composition:
  - Ten largest industrial customers (mainly metals and mining) accounted for some 25 percent of total electricity consumption in 2005–08.
  - Households consumed around 50 percent of total; together with small industry and SMEs, regulated consumers reached around 72 percent of total (including over 15 percentage points in technical losses and theft).
  - In 2009, large industry used 17 percent of total electricity; regulated consumers consumed 80 percent.
- Generation capacity and structure:
  - Lignite-fired thermal power plants in Bitola and Oslomej together 800 MW; Bitola’s three generation blocks represent 675 MW.
  - Backup thermal plant in Negotino (210 MW capacity), not owned by ELEM.
  - Hydroelectric installed capacity: 528 MW, over 500 MW run by ELEM; hydro generates some 20 percent of total electricity.
  - Peak demand around 1,500 MWh; domestic generation capacity insufficient, requiring imports.
- Environmental and efficiency issues:
  - Thermal generation heavily relies on lignite and is “dirty by international comparison.”
  - Bitola emits much CO2, NOx (exceeding EU Large Combustion Plants Directive limits about 4 times), and SOx (exceeding LCP Directive limits about 7–8 times).
  - Total CO2 emission in Macedonia: 14.4 Megaton CO2-equivalent (about 7.2 tons per capita); thermal generation accounts for some 70 percent.
  - Emissions are 60 percent higher per unit of GDP than the OECD average.
  - Inefficient generation and inefficient usage are legacies of past policy choices and low subsidized electricity prices.

### III. Market structure and institutional framework
- End-user segmentation:
  - Households and small industry/SMEs: connected to low-voltage grids, pay a regulated price (tariff customers).
  - Ten largest electricity users: directly connected to high-voltage grid, operate on a liberalized market as of September 2008 (eligible customers).
- Post-2008 liberalization effects:
  - The 10 largest users must secure their own electricity supply via electricity traders and often import from the regional market.
  - Traders buy domestically produced electricity when domestic supply exceeds demand by regulated customers.
  - Large users pay a regulated transmission fee to MEPSO plus trader-agreed prices.
- Market participants and ownership:
  - ELEM: regulated generator and monopoly wholesale supplier for retail distributor EVN; state-owned.
  - MEPSO: sole operator of the electricity transmission network; state-owned.
  - EVN: retail distributor (supplier of tariff customers); privatized and sold to EVN Austria in April 2006.
  - The Energy Regulatory Commission (ERC) regulates prices of services these parties provide and end-user prices for tariff customers.
  - Market unbundling: generation, transmission, and distribution split between three regulated monopolies.

### IV. Planned investments, renewables, and major projects
- Renewable and hydro targets:
  - Strategy for Energy Development projects existing and new renewables could contribute up to 4,600 GWh by 2030, 90 percent from hydro.
  - Macedonia’s renewable energy target: 21 percent of total consumption by 2020.
  - EU renewable target: 20 percent of total consumption.
- Cost comparisons (Strategy calculations, 7 percent return on investment):
  - Hydro: 3.0–8.2 € cents per KWh.
  - Lignite: 4.0 cents per KWh.
  - Gas-fired CHP: 5.7 cents per KWh.
  - Note: only smallest hydro plant (Lukovo Pole and Crn Kamen, 8 MW) estimated below 4 cents; one medium plant (Boshkov Most, 68 MW) estimated below 5.7 cents.
- Investment and financing considerations:
  - A higher discount rate (reflecting country risk) would increase costs for all generation types and disproportionately increase hydro costs.
  - Carbon pricing (upon joining EU Emission Trading Scheme) would benefit hydroelectricity relative to lignite.
- Major projects and tenders:
  - Cebren and Galiste dams: total investment around €700 million; would add net generation capacity of 320–420 GWh.
  - Preparations under way for smaller hydro concessions:
    - Boskov Most (68 MW, €83 million)
    - Lukovo Pole and Crn Kamen (8 MW, €53 million)
    - Gradec (55 MW, €203 million)
  - Tendering history: several large European energy companies expressed preliminary interest; the fourth tender closed without bids in November 2010; authorities plan to re-launch the tender.
- Interconnection plans:
  - Additional high-voltage transmission interconnection capacity planned to reduce import cost and safeguard supply by relying on spare capacity elsewhere in a regionally connected network.
- Business climate caveat:
  - Attracting foreign investment on this scale requires general improvements in the business climate, including the judiciary.

### V. European integration, legal reform, and outstanding obligations
- Energy Community Treaty (ECT) commitments:
  - ECT objective: secure reliable and affordable energy supply in SEE while safeguarding the environment.
  - ECT requires implementation of relevant EU acquis communautaire and establishment of an integrated natural gas and electricity market.
  - Fixed time frame for adoption of the acquis: 2015.
  - Dispute settlement procedure supports enforcement of the ECT legal framework.
- Legislative and regulatory progress:
  - Energy Law adopted in 2006 and amended in 2008; comprehensively overhauled draft prepared; new draft (December 2010) in parliament expected to be adopted soon.
  - ERC established as a statutorily independent regulator reporting directly to parliament with authority to monitor market operations, set regulated prices, license, and participate in dispute resolution.
  - 2008 amendments created a liberalized market for the 10 largest industrial electricity users.
- Main outstanding Treaty issues and expected law effects:
  - Market structure: ELEM’s dominant position for tariff customers remains; ECT requires full liberalization of imports and generation.
  - Cost reflectivity: regulated prices do not fully incorporate technical and commercial losses and certain collection shortfalls; ECT requires prices to reflect these costs.
  - Liberalization deadlines: missed January 1, 2008 deadline for nonhousehold market liberalization; government committed to full liberalization by 2015 but so far only liberalized market for the 10 largest consumers.
  - Expected effects of proposed law and secondary legislation:
    - Abolish ELEM monopoly on imports for tariff customers; strengthen ERC monitoring and enforcement.
    - Amend rulebook to clarify technical and commercial losses and collection shortfalls; ERC to make rulebook amendments once new law is in place.
    - Clarify timeline for liberalization: non-household sector (2012) and household sector (2015).
- Social protection:
  - Lump-sum cash subsidy payment introduced targeted at the poorest households to partially protect from price increases (details referenced in Section IV).

### VI. EVN–ELEM dispute and investor perceptions
- EVN purchase and subsequent dispute:
  - EVN purchased distribution network ESM in 2006 for € 225 million; sale price later reduced by € 22.5 million due to negative deviations in IFRS-prepared balance sheet.
  - ELEM claimed EVN should pay € 90 million of outstanding receivables; with interest claim rose to € 160 million.
  - Skopje basic court found for ELEM; appeals court sent case back to first instance citing procedural shortcomings; EVN appealed.
  - EVN sued the Republic of Macedonia at ICSID and in London arbitration; reportedly claims damages of €1 billion from the Government.
  - Out-of-court settlement efforts continue; a negotiated solution likely would drop ELEM’s claim and EVN’s counterclaim and specify market conditions for EVN’s future operation, improving foreign investor perception.

### VII. Subsidies: levels, decomposition, trajectory, and social assistance
- Nature and effects of subsidies:
  - Electricity price for tariff customers regulated below regional market price -> implicit subsidization.
  - For domestically produced electricity, subsidy largely implicit (foregone opportunity to sell at regional market price); for imported electricity sold to tariff customers, subsidy is direct out-of-pocket expense.
  - Implicit subsidies are inefficient, distort incentives, stimulate overuse, benefit richer households disproportionately, and discourage investment.
  - ECT commitment to full liberalization by 2015 implies gradual phasing out of subsidies and rising end-user prices.
  - At current tariff and market prices, phasing out would require an almost 40 percent tariff increase over the next five years; rising prices should be accompanied by increases in targeted social assistance.
- Quantitative estimates (preserving source figures):
  - Total implicit subsidy estimate for 2009: about 2.3 percent of GDP in 2009, or €150 million.
    - Based on regional market price of €63 per MWh (ELEM’s average weighted import price in 2009) and domestic supply price equivalent to €30 per MWh.
    - Average transmission price of €4 per MWh accounted for when calculating opportunity costs.
  - Subsidized imports cost in 2009: 0.2 percent of GDP or €12 million.
  - IMF (2009) estimated total pricing subsidies at 3.8 percent of GDP in 2008.
  - Reasons for lower 2009 estimate:
    - As of September 2008, largest 10 customers obliged to secure their own supplies, eliminating subsidies to them.
    - Regional market price decreased from €82 per MWh in 2008 to €63 per MWh in 2009.
    - Tariff prices were raised 13 percent in late 2008 and another 10 percent at the start of 2010.
  - Estimated pricing subsidy for 2010: 0.7 percent of GDP.
    - Contributing factors: regional market price of €46 per MWh at start of 2010 when imports took place; 10 percent increase in regulated domestic electricity price on January 1, 2010 (domestic price €30/MWh in 2009 increased to €33/MWh in 2010); plentiful rainfall in 2009–2010 winter increased hydro generation (2010 estimate assumes no imports).
  - Unrecognized distribution losses and collection shortfalls now accrue to EVN, not the state:
    - Estimated at 0.8 and 0.6 percent of GDP in 2009 and 2010 respectively (assumptions: EVN distribution losses and collection rate improvements; assumed 20 percent total distribution loss and 85 percent collection rate for 2009 per industry discussions).
- Social assistance package (September 2010):
  - Estimated 58,000 families became eligible.
  - Benefit: € 10 per month per household (about 200 KWh).
  - Lump-sum can apply to total heating expenditures if total heating bill is above € 10 per month.
  - Total maximum estimated cost: €7 million (€10 * 12 month * 58,000 households), or 0.1 percent of GDP.
  - The subsidy is well-targeted and may need to be increased with future price increases.

### VIII. Scenarios and projections to 2015 and beyond
- Projections under unchanged policies (Baseline assumptions summarized):
  - Pricing subsidies remain roughly constant as a share of GDP in the near future.
  - Excess distribution losses and collection shortfalls decrease moderately.
  - Estimates for 2015 (assuming no imports, Baseline): quasi-fiscal subsidies decrease to some 0.5 percent of GDP; excess distribution losses and collection shortfalls decrease to 0.6 percent of GDP.
  - Assumptions for projections:
    - Domestic price increases of 10 percent per year.
    - Increases in transmission costs in line with inflation.
    - Regional market prices in line with the 2003–09 average (plus inflation).
    - Consumption increases equivalent to the real GDP growth rate.
  - Sensitivity: estimates are roughly linear in assumptions on future price increases and import prices.
    - Example (source text break): a 5 percent annual domestic price increase from 2011 to 2015 (instead of assumed 10 percent) would increase the estimated pricing subsidization...
- 2015 scenario outcomes (from source):
  - Pricing subsidy estimates for 2015:
    - 0.5 to 1.2 percent of GDP (2015 – Scenario 1).
    - A 10 percent lower average import price would reduce the estimate to almost 0 percent of GDP (2015 – Scenario 2).
  - Distribution loss and collection assumptions for scenarios:
    - Assumes 18 and 16 percent distribution loss for 2010 and 2015 respectively, and 11 percent distribution losses as the international standard (per Regulatory Commission formula).
    - Assuming EVN's collection rate remains at 90 percent after 2010.
- Longer-term outlook to 2030:
  - On current policies, electricity supply likely to decline over next two decades due to ageing generation and district heating facilities.
  - Total electricity consumption projected to increase by 3.1 percent a year on average, or over 100 percent over 2005 levels by 2030 (World Bank, 2010).
  - Regional market expected to experience a squeeze between declining supply and rising demand.

### IX. Policy recommendations — supply, demand, market, and investor environment
- Supply-side and investor environment:
  - Attract large private sector energy firms for generation capacity investment; consider privatization of existing capacity.
  - Reduce investor uncertainty by:
    - Setting a clear multi-year time frame for market liberalization and sticking to it.
    - Providing a stable and predictable legal and regulatory environment; a regulator independent both on paper and in practice.
    - Fully adopting the EU acquis on energy, as envisaged in the Energy Law.
    - Improving the environment for collection and lowering theft through cooperation between energy suppliers, the judiciary, and police.
    - Working with other countries in the region to strengthen regional security of supply, including sufficient interconnection capacity and non-discriminatory access.
- Demand-side and efficiency measures:
  - Promote energy efficiency consistent with Government’s Energy Strategy (MANU, 2010) and Renewable Energy Strategy (Ministry of Economy, 2010).
  - Short- and medium-term measures:
    - Promote better insulation of businesses and homes; higher electricity prices will incentivize insulation.
    - Transparent marking of energy efficiency of products, mandating energy efficiency standards, and promoting most energy-efficient products.
    - Gasification of the country and use of gas-fired cogeneration plants to reduce electricity as a source of heating.
    - Give consumers better control over district heat consumption (thermostatic valves instead of uniform on/off provision).
- Expected effects of policy implementation:
  - Full market liberalization (non-household customers to liberalized market in 2012; household customers by 2015) will reduce pricing subsidies and make remaining subsidies more visible and better targeted (likely accompanied by increased targeted subsidies for poorer households).
  - Investment in generation capacity and regional interconnection will reduce the import bill and the need for subsidization, benefit the environment through more efficient technologies and lower emissions per unit of output, and offer potential for renewables (in particular hydro) and knowledge transfer if sizeable FDI is attracted.
  - Establishing a carbon price in line with the European carbon trading scheme would promote environmentally friendly solutions.

*Source: _wp1130 — ELEM, MEPSO, Domestic Regulation, and Staff Estimates; MANU (2010); Ministry of Economy (2010); World Bank (2010).*

### References .............................................................................................................

### _wp1130 - References

### I. INTRODUCTION AND SUMMARY
- Macedonia transitioning from centrally planned to a decentralized regulated free market in the energy sector.
- Demand-side challenge: improve efficiency of energy usage, hindered by below market pricing for all but the largest users.
- Supply-side challenges: lack of oil, gas, or high quality coal reserves; ageing generation facilities; shortage of domestic generation capacity; relatively inefficient and dirty facilities.
- Policy directions:
  - New investment in generation based on least-cost analyses, taking into account environmental standards.
  - Moderate demand growth by promoting energy efficiency measures, market liberalization, and concomitant price increases.
  - Establish an efficient energy market through further sector reform, including legislation and regulation.
- Commitments and reforms:
  - Macedonia has signed the Energy Community Treaty (ECT) to implement relevant parts of the EU acquis communautaire.
  - Government drafted a new Energy Law expected to bring compliance with Treaty obligations once fully implemented with necessary secondary legislation.
- Recent outcomes:
  - Implicit electricity pricing subsidies decreased from 3.8 percent of GDP in 2008 to 0.7 percent of GDP in 2010.
  - Privatization of distribution in 2006 led to substantial investment by the new owner, reducing distribution losses and collection shortfalls.
- Medium-term objectives:
  - Full electricity market liberalization by 2015 through implementation of the new Energy Law.
  - Market-based pricing, energy awareness (including insulation), and improved collection enforcement to contain demand.
  - Gasification to lower energy demand and increase supply via cogeneration combined heat and power (CHP) plants.

### II. THE ELECTRICITY SECTOR

#### A. Demand and Supply
- Trends and magnitudes:
  - Energy consumption rose 34 percent between 2000 and 2008, from 6,433 GWh to 8,609 GWh.
  - In 2009, consumption decreased to 7,597 GWh due to collapse of electricity-intensive exports from heavy industry.
  - Demand growth averaged 1.9 percent per year between 2000 and 2009; GDP growth averaged 2.7 percent over the same period.
  - Domestic supply decreased from 6,326 GWh in 2000 to 6,152 GWh in 2009.
  - Imports averaged 20 percent of demand (1,468 GWh) between 2000 and 2009, and peaked at 32 percent of demand (2,757 GWh) in 2008.
  - Imports cost an average of €95 million in the years 2003–09, and peaked at €235 million (or 3.6 percent of GDP) in 2008.
- Sector composition:
  - Ten largest industrial customers (mainly metals and mining) accounted for some 25 percent of total electricity consumption in 2005–08.
  - Households consumed around 50 percent of total; together with small industry and SMEs, regulated consumers reached around 72 percent of total (including over 15 percentage points in technical losses and theft).
  - In 2009, large industry used only 17 percent of total electricity; regulated consumers consumed 80 percent.
- Generation capacity and structure:
  - Main domestic generation: lignite-fired thermal power plants in Bitola and Oslomej (together 800 MW); Bitola’s three generation blocks represent 675 MW.
  - Backup thermal plant in Negotino (210 MW capacity), not owned by ELEM.
  - Hydroelectric installed capacity: 528 MW, over 500 MW run by ELEM; hydro generates some 20 percent of total electricity.
  - Additional modest geothermal generation and plans for small wind farms.
  - Peak demand around 1,500 MWh; domestic generation capacity insufficient, requiring imports.
- Environmental and efficiency issues:
  - Thermal generation heavily relies on lignite and is “dirty by international comparison.”
  - Bitola emits much CO2, NOx (exceeding EU Large Combustion Plants Directive limits about 4 times), and SOx (exceeding LCP Directive limits about 7–8 times).
  - Total CO2 emission in Macedonia: 14.4 Megaton CO2-equivalent (about 7.2 tons per capita); thermal generation accounts for some 70 percent.
  - Emissions are 60 percent higher per unit of GDP than the OECD average.
  - Inefficient generation and inefficient usage are legacies of past policy choices and low subsidized electricity prices.

#### B. Market Structure
- Segmentation of end-users:
  - Households: connected to low-voltage grids, pay a regulated price (tariff customers).
  - Small industry and SMEs: on low-voltage grid, pay same regulated price as households (tariff customers).
  - Ten largest electricity users: directly connected to high-voltage grid, operate on a liberalized market as of September 2008 (eligible customers).
- Post-2008 liberalization effects:
  - The 10 largest users must secure their own electricity supply via electricity traders; they often import from regional market.
  - Traders buy domestically produced electricity when domestic supply exceeds demand by regulated customers.
  - Large users pay a regulated transmission fee to MEPSO in addition to trader-agreed prices.
- Market participants and ownership:
  - ELEM: regulated generator and monopoly wholesale supplier for retail distributor EVN; state-owned.
  - MEPSO: sole operator of the electricity transmission network; state-owned.
  - EVN: retail distributor (supplier of tariff customers); privatized and sold to EVN Austria in April 2006.
  - The Energy Regulatory Commission (ERC) regulates prices of services these market parties provide and end-user prices for tariff customers.
  - Market unbundling: generation, transmission, and distribution split between three regulated monopolies.

#### C. Plans for the Future
- Renewable and hydro targets:
  - Strategy for Energy Development projects existing and new renewables could contribute up to 4,600 GWh by 2030, 90 percent from hydro.
  - Macedonia’s renewable energy target: 21 percent of total consumption by 2020.
  - EU renewable target: 20 percent of total consumption.
- Cost comparisons (Strategy calculations, 7 percent return on investment):
  - Hydro: 3.0–8.2 € cents per KWh.
  - Lignite: 4.0 cents per KWh.
  - Gas-fired CHP: 5.7 cents per KWh.
  - Note: only smallest hydro plant (Lukovo Pole and Crn Kamen, 8 MW) estimated below 4 cents; one medium plant (Boshkov Most, 68 MW) estimated below 5.7 cents.
- Investment and financing considerations:
  - A higher discount rate (reflecting country risk) would increase costs for all generation types and disproportionately increase hydro costs.
  - Carbon pricing (upon joining EU Emission Trading Scheme) would benefit hydroelectricity relative to lignite.
- Major projects:
  - Cebren and Galiste dams: total investment around €700 million; would add net generation capacity of 320–420 GWh.
  - Tendering history: several large European energy companies expressed preliminary interest; the fourth tender closed without bids in November 2010; authorities plan to re-launch the tender.

*Source: _wp1130 - References*

### 2011. Apart from the pure economics of the project, attracting foreign investment on this

### _wp1130 - 2011. Apart from the pure economics of the project, attracting foreign investment on this

### Hydro projects, interconnections, and business climate
- Preparations under way for several smaller hydro concessions:
  - Boskov Most (68 MW, €83 million)
  - Lukovo Pole and Crn Kamen (8 MW, €53 million)
  - Gradec (55 MW, €203 million)
- Additional high-voltage transmission interconnection capacity planned to:
  - Reduce cost of importing power
  - Safeguard supply by relying on spare capacity elsewhere in a regionally connected network
- Attracting foreign investment on this scale requires general improvements in the business climate, including the judiciary

### European integration driving electricity reform
- Macedonia committed to gradual adoption of the EU energy policy via the Energy Community Treaty (ECT)
  - ECT objective: secure reliable and affordable energy supply in SEE while safeguarding the environment
  - ECT requires implementation of relevant EU acquis communautaire (the acquis) and establishment of an integrated natural gas and electricity market
  - Fixed time frame for adoption of the acquis: 2015
  - Dispute settlement procedure supports enforcement of ECT legal framework
- Institutional progress:
  - Energy Law adopted in 2006 and amended in 2008; currently being comprehensively overhauled
  - Energy Regulatory Commission (ERC) established as a statutorily independent regulator reporting directly to parliament with authority to monitor market operations, set regulated prices, license, and participate in dispute resolution
  - 2008 amendments created a liberalized market for the 10 largest industrial electricity users

### Outstanding treaty obligations and reform priorities
- Main outstanding issues:
  - Market structure: dominant market position of ELEM for tariff customers; ELEM remains monopoly wholesale generator and importer for tariff customers; ECT requires full liberalization of imports and generation
  - Cost reflectivity: regulated prices do not incorporate certain legitimate costs such as full technical and commercial losses (electricity theft) and certain collection shortfalls; treaty obligations require prices to reflect these costs
  - Liberalization deadlines: missed January 1, 2008 deadline for liberalization of nonhousehold market; government committed to full liberalization by 2015 but only liberalized market for the 10 largest electricity consumers so far
- Legislative progress:
  - New Energy Law prepared; approved by government and sent to parliament in October 2010, withdrawn in November 2010; new draft (December 2010) in parliament expected to be adopted soon
  - Expected effects of proposed law and secondary legislation:
    - Market structure: abolish ELEM monopoly on imports for tariff customers; strengthen ERC monitoring and enforcement
    - Cost reflectivity: amended rulebook to clarify technical and commercial losses and collection shortfalls; ERC to make rulebook amendments once new law is in place
    - Deadlines: clarify timeline for liberalization of non-household sector (2012) and household sector (2015)
- Social protection measures:
  - Authorities introduced a lump-sum cash subsidy payment targeted at the poorest households to partially protect poorer households from substantial price increases associated with market liberalization (details referenced in Section IV)

### EVN–ELEM legal proceedings and investor perceptions
- EVN purchased distribution network ESM in 2006 for € 225 million
  - Sale price later reduced by € 22.5 million due to negative deviations in IFRS-prepared balance sheet
- Dispute over pre-privatization receivables:
  - ELEM claimed EVN should pay € 90 million of outstanding receivables; with interest this led to a claim of € 160 million
  - Skopje basic court found for ELEM; appeals court sent case back to first instance citing procedural shortcomings; EVN has appealed
  - EVN sued the Republic of Macedonia at ICSID for breach of investment treaties and in London arbitration for breach of the share purchase agreement; reportedly claims damages of €1 billion from the Government
  - Out-of-court negotiated settlement efforts continue; a negotiated solution likely would drop ELEM’s claim and EVN’s counterclaim and specify market conditions for EVN’s future operation, improving foreign investor perception

### Subsidies: levels, decomposition, and trajectory
- Nature of subsidies:
  - Electricity price for tariff customers regulated below regional market price -> implicit subsidization
  - For domestically produced electricity, subsidy largely implicit (foregone opportunity to sell at regional market price)
  - For imported electricity sold to tariff customers, subsidy is a direct out-of-pocket expense
  - Long-term true cost may be understated because main Suvudol coal mine almost exhausted; replacement coal deposits projected to be more expensive; existing generation facilities valued below replacement cost
- Efficiency and policy stance:
  - Implicit subsidies are inefficient, distort incentives, stimulate overuse, benefit richer households disproportionately, and discourage domestic and foreign investment
  - Through ECT, government committed to full liberalization by 2015, implying gradual phasing out of subsidies and rising end-user prices
  - At current tariff and market prices, this would require an almost 40 percent tariff increase over the next five years
  - Rising prices should be accompanied by increases in targeted social assistance to protect poorer households

### Quantitative estimates of subsidies and losses (preserving source figures)
- Total implicit subsidy estimate for 2009:
  - About 2.3 percent of GDP in 2009, or €150 million
  - Based on regional market price of €63 per MWh (ELEM’s average weighted import price in 2009) and domestic supply price equivalent to €30 per MWh
  - Average transmission price of €4 per MWh accounted for when calculating opportunity costs
- Subsidized imports:
  - Cost for subsidized imports in 2009: 0.2 percent of GDP or €12 million
- Comparison to 2008 estimates:
  - IMF (2009) estimated total pricing subsidies at 3.8 percent of GDP in 2008 (not distinguishing direct vs indirect)
  - Reasons for lower 2009 estimate:
    - As of September 2008, largest 10 electricity customers obliged to secure their own supplies on regional market, eliminating subsidies to them
    - Regional market price decreased from an average of €82 per MWh in 2008 to €63 per MWh in 2009
    - Tariff prices were raised 13 percent in late 2008 and another 10 percent at the start of 2010
- 2010 developments and estimate:
  - Estimated pricing subsidy for 2010: 0.7 percent of GDP (Table 2)
  - Contributing factors:
    - Lower regional market price of €46 per MWh at start of 2010 when actual imports took place
    - 10 percent increase in regulated domestic electricity price on January 1, 2010 (regulated domestic price remained at €30/MWh in 2009 and increased to €33/MWh in 2010)
    - Plentiful rainfall during 2009–2010 winter increased hydro generation, reducing need for imports; 2010 estimate assumes no imports
  - Caveats:
    - If rainfall reverts to historic averages, imports (and subsidy outlays) could increase unless offset by price liberalization
    - Climate change studies suggest water-management and hydro generation will become more challenging in the future
    - Regional market price could increase again with demand recovery
  - Post-privatization losses:
    - Unrecognized distribution losses and collection shortfalls now accrue to EVN, not the state
    - These unrecognized distribution and collection losses estimated at 0.8 and 0.6 percent of GDP in 2009 and 2010 respectively (Table 2)
    - Assumptions underlying these estimates: EVN distribution losses and collection rate improvements (assumed 20 percent total distribution loss and 85 percent collection rate for 2009 per discussion with industry experts)
- Projections under unchanged policies:
  - Pricing subsidies remain roughly constant as a share of GDP in the near future
  - Excess distribution losses and collection shortfalls decrease moderately
  - Estimates for 2015 (assuming no imports, Baseline): quasi-fiscal subsidies decrease to some 0.5 percent of GDP; excess distribution losses and collection shortfalls decrease to 0.6 percent of GDP
  - Assumptions for projections:
    - Domestic price increases of 10 percent per year
    - Increases in transmission costs in line with inflation
    - Regional market prices in line with the 2003–09 average (plus inflation)
    - Consumption increases equivalent to the real GDP growth rate
- Sensitivity note (from source):
  - Estimates are roughly linear in assumptions on future price increases and import prices
  - Example: a 5 percent annual domestic price increase from 2011 to 2015 (instead of assumed 10 percent) would increase the estimated pricing subsidization (source text breaks off here)

* _wp1130 - 2011. Apart from the pure economics of the project, attracting foreign investment on this

### 0.5 to 1.2 percent of GDP (2015 – Scenario 1), while a 10 percent lower average import price

### _wp1130 - 0.5 to 1.2 percent of GDP (2015 – Scenario 1), while a 10 percent lower average import price

### Subsidies and Social Assistance
- A targeted social assistance package for poor households introduced from September 2010:
  - Estimated 58,000 families became eligible.
  - Benefit: € 10 per month per household, which would provide for about 200 KWh.
  - The subsidy is a lump-sum and can apply to total heating expenditures (electricity + district heating + fuel oil + firewood) if total heating bill is above € 10 per month.
  - Total maximum estimated cost: €7 million (€10 * 12 month * 58,000 households), or 0.1 percent of GDP.
  - Electricity prices have increased by 10 percent this year; further substantive increases are likely.
  - The subsidy is well-targeted and may need to be increased in line with future price increases.

### Scenarios and Quantitative Estimates for 2015
- Pricing subsidy estimates for 2015:
  - 0.5 to 1.2 percent of GDP (2015 – Scenario 1).
  - A 10 percent lower average import price would reduce the estimate to almost 0 percent of GDP (2015 – Scenario 2).
  - The import price for 2015 is based on the average import price 2003-09, increased by inflation.
- Distribution losses and collection assumptions:
  - Assumes an 18 and 16 percent distribution loss for 2010 and 2015 respectively, and 11 percent distribution losses as the international standard (as per Regulatory Commission formula).
  - Assuming EVN's collection rate remains at 90 percent after 2010.
- Table 3 (scenarios for 2015) source: ELEM, MEPSO, Domestic Regulation, and Staff Estimates.

### Longer-term Outlook: Demand and Supply Projections
- Regional risks and trends:
  - On current policies, electricity supply is likely to decline over the next two decades due to ageing generation and district heating facilities.
  - Total electricity consumption is projected to increase by 3.1 percent a year on average, or over 100 percent over 2005 levels by 2030 (World Bank, 2010).
  - The regional electricity market is expected to experience a squeeze between declining supply and rising demand.
- Market character:
  - Electricity markets are regional in nature (western Balkans); long-distance export is limited.
  - Investment in new generation is not currently making up for capacity losses from ageing plants.

### Supply-side Policy Options and Investor Environment
- Attract large private sector energy firms for generation capacity investment; consider privatization of existing capacity.
- Elements to reduce investor uncertainty and improve investment climate:
  - Setting out a clear multi-year time frame for market liberalization, as envisaged in the new Energy Law, and sticking to it.
  - Providing a stable and predictable legal and regulatory environment; a regulator independent both on paper and in practice.
  - Full adoption of the EU acquis on energy, as envisaged in the Energy Law.
  - Improving the environment for collection and lowering theft through cooperation between energy suppliers, the judiciary, and police where appropriate.
  - Working with other countries in the region to strengthen regional security of supply, including sufficient interconnection capacity and non-discriminatory access.

### Demand-side Policy Options and Energy Efficiency
- Promote energy efficiency as a policy priority, consistent with the Government’s Energy Strategy (MANU, 2010) and Renewable Energy Strategy (Ministry of Economy, 2010).
- Short- and medium-term measures:
  - Promoting better insulation of businesses and homes; higher electricity prices (in line with regional market price) will incentivize insulation.
  - Transparent marking of energy efficiency of products, mandating energy efficiency standards, and promoting most energy-efficient products.
  - Gasification of the country and use of gas-fired cogeneration plants to reduce electricity as a source of heating.
  - Give consumers better control over district heat consumption (thermostatic valves instead of a uniform on/off provision).

### Expected Effects of Policy Implementation
- Full market liberalization (non-household customers to liberalized market in 2012; household customers by 2015) will:
  - Reduce pricing subsidies and make any remaining subsidies more visible and better targeted (likely accompanied by increased targeted subsidies for poorer households).
  - Improve transparency and predictability of the regulatory environment.
- Investment in generation capacity and regional interconnection will:
  - Reduce the import bill and the need for subsidization.
  - Benefit the environment through more efficient technologies and lower emissions per unit of output.
  - Offer potential for renewables (in particular hydro) and knowledge transfer if sizeable FDI is attracted.
- Establishing a carbon price in line with the European carbon trading scheme would promote environmentally friendly solutions.

*Source: ELEM, MEPSO, Domestic Regulation, and Staff Estimates; MANU (2010); Ministry of Economy (2010); World Bank (2010).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp1130.pdf_