TURKEY'S LOOMING ELECTRICITY DEFICIT

UNCLAS SECTION 01 OF 03 ANKARA 004379

SIPDIS

USDOE FOR CHARLES WASHINGTON
USDOC FOR 4212/ITA/MAC/CPD/CRUSNAK
EXIM FOR PAMELA ROSS AND MARGARET KOSTIC
OPIC FOR R CORR AND C CHIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ENRG EINV EPET BEXP EXIM OPIC TU
SUBJECT: TURKEY'S LOOMING ELECTRICITY DEFICIT

REF: A: ANKARA 3716
B: ANKARA 2877

ANKARA 00004379 001.2 OF 003


Sensitive But Unclassified. Please handle accordingly.


1. (SBU) SUMMARY: With growing fears of an electricity supply
deficit in Turkey before the end of the decade (Ref B),the Turkish
government has announced plans to move forward more quickly on
privatization and establishment of an electricity market for pricing
and settlement. Meanwhile, long fixed consumer prices have squeezed
the one significant part of the electricity industry intended to
react to market signals: those which produce for their own needs and
sell the excess to the grid ("autoproducers"). The July 1 black out
has spurred the government to take measures to increase supply, to
facilitate privatization, and to reform the price system. End
Summary.

--------------
Electricity Cut Results from Fixed Prices
--------------


2. (SBU) The power cut that affected 13 provinces in Turkey on July
1 precipitated serious debate on Turkey's electricity needs and the
viability of the current pricing system. Recent developments pushed
the GOT to revise its supply-demand projections for the 2006-2015
period and to take measures to keep private generation companies in
the system. After keeping prices at the same level for three years,
the GOT is finally considering price increases in electricity and
some tax relief measures to support private producers.


3. (SBU) According to Turkish Electricity Transmission Inc.(TEIAS)
data, Turkey will produce 173.1 billion kWh electricity and consume
171.4 billion kWh in 2006. The same data indicates that the Turkish
state Electricity Generation Inc. (EUAS) plants will produce 38.1%,
private Build-Operate-Transfer (BOTs) 9.5%, private Build-Operate
(BOs) 23.8%, and "autoproducers" 11.1% of this total. Autoproducers
refer to plants that produce for their own needs - usually for an
associated factory - and have the right to sell to the grid, but at
controlled prices. BO's, BOT's, and autoproducers are mostly
gas-fired. (The clean coal-importing Iskenderun BO is the
exception.) The Energy Ministry is concerned about increasing
reliance on imported natural gas (and about two-thirds of this
coming from Russia).


4. (SBU) The GOT's reluctance to increase electricity prices in the
last three years, despite the 60% increase in natural gas prices
during the same period, has brought increasing pressure on
autoproducers. The gas-fired BOs and BOTs remained unaffected by
the natural gas price increases, since they have a pass-through
arrangement for their cost inputs. The autoproducers, however, were
directly affected by the gas price increase, and their profit
margins shrank to such levels that they were recording losses from
selling electricity at night time -- when the sales prices are
lower. For this reason, the autoproducers had recently been
shutting down their generation sales activities at night and had
formally expressed their concerns to the GOT.


5. (SBU) This problem finally hit Turkey badly on Jul 1, when the
GOT could not get the autoproducers to feed electricity to the grid
after one of the transformers in Bursa in north-western Turkey
broke. The state distribution company TEDAS was unable to provide
electricity to a total of 13 cities around Bursa for 11 hours that
night. The government criticized the companies that refused to
provide electricity that night, claiming these investments were made
for public service. Following these remarks, the Competition
Authority initiated an investigation into Ak Enerji, Zorlu, Koc,
Sabanci Energy and the Electricity Producers' Association (EUD),to
determine whether the companies acted jointly the night of Jul 1.
Alarko and Ak Enerji announced on Jul 13 that they would stop
generation in their autoproducer facilities as of the end of July,
since their cost of production exceeded the sales price. Newspapers
reported 7-8 other companies were planning to do the same.
Reportedly, the companies are looking for ways to import their own
gas to limit their costs (possible in principle, but difficult in
practice).


6. (SBU) The GOT is now looking for ways to overcome this growing
crisis. According to press reports, the Ministry of Energy is
getting ready to announce price increases in electricity as of
August. The Ministry is reportedly planning a 5-15% total increase,
which it will announce in the coming months. The GOT is also

ANKARA 00004379 002.2 OF 003


working on measures to provide tax relief to producers as a way to
lessen the shock and political cost of consumer price increases,
although the IMF program restricts their flexibility in this regard.
The Government held summits on July 27 and 31 to consult with
industry, and the Council of Ministers underscored the government's
intent to institute a combination of tax relief and electricity
price increases.

--------------
Supply Concerns
--------------


7. (SBU) The state electricity transmission company (TEIAS) revised
its electricity supply-demand projections for the 2006-2015 period,
moving the forecasted gap forward one year. According to the base
scenario, which is based on a 7% annual increase in electricity
consumption, Turkey will have a 3 billion kWh electricity shortfall
in early 2009. In response to the anticipated shortfall, The Energy
Minister Hilmi Guler has announced plans to add nuclear to the
energy mix (but these would not come on stream until after 2015 in
any event),to accelerate plans to privatize some power plants and
distribution regions - including hydroelectric facilities, and to
establish a balancing and settlement system to facilitate creation
of an electricity market.


8. (SBU) The long-delayed launching of privatization of regional
electricity distribution companies remains "imminent", but continues
to slip. The long awaited announcement of the tariff structure,
accompanied by some adjustment in the boundaries of regions, has
elicited complaints by a number of companies who have claims arising
from earlier failed privatization attempts. American company AES
and a number of European companies persevere in their interest.

--------------
Trouble at the BO's
--------------


9. (SBU) While the BOT's have faced threats and calls for
unilateral price reductions in the past from the GOT, because their
transactions were structured with higher prices and guarantees (and
higher returns based on a higher risk environment at the time of the
deals),they have been quietly producing electricity and have
recently stayed off the front pages of the press. It appears that
the GOT will continue to honor its contracts to purchase electricity
from these four plants (with some EXIM/OPIC exposure). Both BOT's
and BO's prices are adjusted for higher natural gas cost inputs, so
they are cushioned to some extent, but still rely on payment from
state entities.


10. (SBU) Recent rulings by the Danistay (Council of State) -
stemming from long-standing law suits - put the EXIM/OPIC financed
Izmir power plant at risk of closure. This 1400 MW gas-fired
Build-Operate (BO) was built by Enka and U.S. Intergen, but the
latter sold its interests to Enka. The Danistay annulled the
underlying Electricity Sales Agreement (between Enka and TETAS - the
state electricity trading company) claiming that this was a public
service concession on which it should have opined. The GOT
assiduously worked to overturn and delay implementation of this
decision, finally passing a new law requiring execution of a new
Electricity Sales Agreement (ESA) that would be ruled under private
law, outside of Danistay jurisdiction.


11. (SBU) In response to requests from EXIM and Enka, we gained a
verbal affirmation from Treasury officials that the existing
Treasury guarantee will still be operative and honored under a new
ESA with written affirmation to follow. (The law specifically says
this, but the lenders wanted additional comfort and assurance.)
Enka signed the new ESA on July 25, barely in advance of the
effective deadline created by the Danistay ruling.


12. (SBU) EXIM and OPIC financed a portfolio of BO power plants
with original exposure of almost $ 1 billion. Two other plants -
Adapazari (Thrace near Istanbul) and Baymina (Ankara) are also at
risk, but the law suit is less advanced, and the GOT appears willing
to make a comparable fix to avoid losing these significant sources
of power for the grid. Despite these woes, Enka announced in the
press on August 1 its intent to build another gas-fired power plant
in the northwest, but without providing details on the financing
structure.

--------------

ANKARA 00004379 003.2 OF 003


Comment
--------------


13. (SBU) Companies and Government Officials remain frustrated by
the still under-developed energy market in Turkey (electricity and
natural gas). The regulator EMRA is still waiting for a functioning
market based on price signals to oversee, which exacerbates turf
fighting between EMRA and the Energy Ministry. The relatively small
corporate autoproducer segment - which was the core of a potential
market-based component - has been squeezed between free cost and
wholesale prices but fixed retail prices (alarmingly reminiscent of
the crisis in California earlier in this decade). The supply
shortage is now foreseen to be coming sooner than the time required
for permitting, financing, and building power plants, so it looks
like Turkey may face more black-outs. Moreover, Turkey's neighbors
do not have excess capacity and it is not economic for Turkey to
transmit electricity from its east to its major markets in the west.
Turkey's small but important exports to Iraq (Ref A) may be put at
risk if domestic supply cannot meet demand. The perception of near
crisis and risk of more black-outs may force Turkey to finally take
measures needed to stimulate needed investment. On the other hand,
the under-developed nature of Turkey's electricity market and the
related political challenges are symbolized by the fact that it is
the Government cabinet which sets electricity prices.

McEldowney