ARMENIAN GOVERNMENT GIVES ENERGY SECTOR A HALF-FIX

UNCLAS SECTION 01 OF 02 YEREVAN 002224

SIPDIS

SENSITIVE

STATE FOR EUR/CACEN FOR SIDEREAS, EUR/ACE FOR LONGI, EB/ESC,
PASS TO USAID EGAT FOR WALTER HALL

E.O. 12958: N/A
TAGS: ECON ENRG AM
SUBJECT: ARMENIAN GOVERNMENT GIVES ENERGY SECTOR A HALF-FIX

Ref: YEREVAN 1453


1. (U) This cable is sensitive but unclassified. Please
protect accordingly.

--------------
SUMMARY
--------------


2. (SBU) On October 1, Armenia' Public Service Regulatory
Commission (PRSC) ended ArmEnergo's reign as the state-owned
single buyer of midstream electricity, responding to demands
of the donor community (including the United States as part
of the most recent US-Armenia Task Force action plan). The
GOAM has fulfilled only part of its obligation: it has
failed, however, to implement the necessary market rules and
energy cost adjustment mechanisms to protect the energy
market from price instability and rent seeking. Without
such measures, the dissolution of ArmEnergo makes the
private energy distributor and generating companies part of
a market without rules and no secured payment mechanism. It
is unclear what will happen if energy input prices rise, but
the distributor has no right to pass costs onto consumers.
Sources from the Ministry of Energy point out that the
Ministry maintained significant control of Armenia's energy
sector through its ownership of the Vorotan Cascade,
Armenia's largest hydro-electric plant, Transmission Network
and Power System Operation. End Summary.

--------------
WHAT HAPPENS NOW?
--------------


3. (SBU) Until last week, ArmEnergo acted as a single-buyer
single-seller mediator of electricity, in effect making the
Government of Armenia the guarantor of the Armenian energy
sector. The Ministry of Energy used ArmEnergo to keep end-
use prices stable when generation costs fluctuated. Now the
privately owned electricity distributor, Electricity
Networks of Armenia (ElNetArm) must take over the financial
responsibility for the sector. This basically has shifted
the single-buyer responsibility from ArmEnergo to ElNetArm,
who currently must provide electricity at regulated tariffs
even if costs rise. The Public Service Regulatory
Commission (PSRC) has failed to establish an energy
adjustment fund or adopt an adjustment clause, which would
give the distributor the right to raise electricity prices
for end-users, upon PSRC's review, when the average
generation costs rise. The PSRC has prepared a draft Law to
provide the mechanism for funds flow and tariff adjustment;
we expect this will come before the National Assembly in
October.

--------------
MINISTRY TO KEEP CONTROL?
--------------


4. (SBU) Sources close to the Ministry of Energy say that
the Ministry intends to maintain its control of the market
through its ownership of the Vorotan Cascade, a hydro-plant
that supplies nearly 20 percent of the energy market.
Because hydroelectricity makes up the cheapest share of
Armenia's energy, the government has the flexibility to use
Vorotan's output to trade electricity and influence over-all
energy costs to the distributor. The government's control
of Vorotan also presents opportunities for profits: the
GOAM is currently exporting the plant's cheap electricity to
Iran, to pay the debt on constructing a new transmission
line and for a substation upgrade used for transactions with
Iran. (Note: Normally Armenia would "bank" this energy in
an energy swap where Armenia exports electricity in the
summer to Iran and imports electricity in the winter from
Iran. End Note.) The Ministry of Energy's project will
likely increase Armenia's need for higher-priced electricity
(generated in gas-fired plants),for which consumers will
ultimately pay significantly higher prices.

-------------- --------------
COMMENT: REMOVAL OF ARMENERGO NECESSARY BUT NOT SUFFICIENT
-------------- --------------


5. (SBU) International donors have long sought to separate
ArmEnergo and the Ministry's functions as a supplier of
electricity in order to reduce the capacity for corruption
in the energy sector. But the Ministry is reluctant to cede
complete control of the energy sector to private
enterprises. The removal of ArmEnergo is a necessary but
not sufficient step to withdrawing the Ministry from the
energy sector. Until the Public Service Regulatory
Commission establishes market rules governing private (as
well as public) actors as well as some safeguards to deal
with energy supply and financial settlements, there will not
be a viable private energy market. For now the Ministry's
involvement in the energy sector will continue to create
opportunities for rent seeking by those who control the
government's energy assets.
RICHTER