GOVERNMENT OF KAZAKHSTAN EXPLORES OPTIONS FOR EXPANDING

UNCLAS SECTION 01 OF 03 ASTANA 001617

SIPDIS

E.O. 12958: N/A
TAGS: ENRG ECON EAID EINV PGOV KZ
SUBJECT: GOVERNMENT OF KAZAKHSTAN EXPLORES OPTIONS FOR EXPANDING
ELECTRICITY GENERATION

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SUMMARY
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1. In response to a request from Kazakhstan's Ministry of Energy and
Mineral Resources, on August 21, USAID completed and presented a
study on options for stimulating investment in new electricity
generation capacity through the use of capacity markets. The study
will be presented to stakeholders in a workshop as one of the
culminating activities of the first phase of the Regional Energy
Market Assistance Program (REMAP). REMAP has established a strong
rapport with Kazakhstani counterparts critical to the establishment
of a regional market capable of increasing market-based trading
within Central Asia, Afghanistan and Pakistan. End Summary.

BACKGROUND
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2. Kazakhstan has enviable economic growth and vast energy
resources and yet many parts of the country face frequent blackouts.
Even some urban areas in Kazakhstan are facing power shortages and
possible brown outs. Current electricity generation and
distribution assets need to be managed more effectively and
incentives need to be provided for adding generation and
distribution assets. In both areas, there is a potentially large
role for private sector investment and asset management techniques.


3. Private sector investment in new generation capacity has not
taken place or has been stymied due to restrictive government
policies to limit exports to meet domestic demand at a highly
unattractive domestic pricing cap. The pricing cap does not take
into account the cost of constructing new generation facilities.
Unless market mechanisms to address pricing issues are implemented
and transparent regulation to access the grid for unlimited export
of electricity to neighboring countries in Central Asia and
Afghanistan is allowed, it will be difficult to access
private-sector investment.


4. The Kazakhstani electricity market is evolving, but it is far
from complete. For example there are no market-based arrangements
to deal with transmission congestion, and various instruments to
allow market participants to manage risks, such as "contracts for
differences," and other options and futures contracts, are not
available yet. More importantly, due to price caps, the majority of
distribution companies in Kazakhstan cannot make the investments in
metering and communications needed for improving electricity
distribution. Companies continue to face high technical losses and
theft. There is a need to separate market operation from
transmission, and make both subject to economic regulation.


5. Despite weaknesses, the Kazakhstani government is showing some
leadership in electricity sector restructuring, promotes the idea of
creating a regional power exchange, and supports the operation of
the regional Coordination Dispatch Center in Tashkent.

REMAP: A CATALYST FOR REGIONAL COOPERATION
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6. The USAID REMAP activity, financed jointly by the Kazakhstani
government and the USG under the umbrella of USAID's Program for
Economic Development, focuses on fostering: a) increased electricity
exchange and trade; b) a transparent, competitive electricity
market; and c) a market-based regulatory framework for regional
cooperation. As REMAP winds down over the next few months, it will
focus on completing activities in the below areas.

TRANSMISSION
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7. Kazakhstan has a limited high voltage transmission network and
capacity within the country. This limitation impacts cross border
electricity trade. The Kazakhstan Grid Operating Company (KEGOC) has
a program to rehabilitate existing transmission lines and build
several new transmission lines to remove these constraints. There
are several high voltage lines under construction and there are
plans to construct additional lines in the near future.


8. In order to enhance operation of the regional transmission grid,
REMAP has established a regional Power System Planning Model based
on the country models of transmission companies in Kazakhstan,
Kyrgyzstan, Tajikistan, Uzbekistan and the Coordination Dispatch
Center in Tashkent. The model was established through the formation
of the CARTRANS Working Group (comprising transmission system
operators from the region with participation from Afghanistan),
which held a series of policy discussions. All five Central Asian
countries have installed USAID funded improved software.


9. The final meeting of the CARTRANS Steering Committee is scheduled
to be conducted on September 26 in Astana. During this meeting, the
CARTRANS Working Group will present to the Steering Committee for
its approval the final 2007 and 2012 national and regional models
and the analysis and findings of the CARTRANS final report.

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GENERATION
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10. Despite Kazakhstan's program of industry restructuring, the
introduction of competitive power markets, and establishment of
regulatory institutions, Kazakhstan has not attracted investment in
new generation facilities and remains a net importer of electricity
from Central Asian electricity suppliers. Old generation plants
with low operating costs supply most electricity at prices that are
far below the price needed to attract investors to build new plants.
Aware of this problem and the resulting shortages of electricity,
representatives of the Ministry of Energy, the Agency for Regulation
of Natural Monopolies, and the Agency for Competition Protection
have all stated that a high priority for Kazakhstan is the need to
provide incentives for investment in the generation sector.


11. In response to a request from the Ministry of Energy and Mineral
Resources, REMAP prepared a white paper on approaches to ensuring
resource adequacy and the international experience in stimulating
investment in new generation capacity through the use of capacity
markets. The paper reviewed various administrative and market based
approaches to resource adequacy, with a particular emphasis on the
structure, operations and results to date of capacity markets. In
so doing, the paper reviews the interplay between energy and
capacity markets and highlights the institutional roles of
regulators and market participants in the operation of such
markets.


12. The overall conclusion that can be drawn from the report is that
due to specifics of electricity markets, "one for all products"
pricing in many competitive power markets does not provide adequate
price incentives for investment in new generation, therefore
additional payment mechanisms need to be developed. The report
describes a variety of options employed in power markets around the
world and analyzes advantages and shortcomings of each of these
options. Since one of the most prevalent options is an installed
capacity market, the report also contains an overview of the
operations of the installed capacity market in the U.S. (PJM, New
York ISO, ISO-New England) and in the Russian Federation (which was
launched in early July).


13. Once counterparts have had a chance to comment on the paper, the
findings will be presented to stakeholders in a workshop scheduled
for September and entitled "Power Sector Resource Adequacy Plans
within a Market Environment and the use of Capacity Markets to
Stimulate Investment."

PRIVATE MARKETS
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14. REMAP support to on-going national market development and sector
reform processes will go a long way to help develop market-based
trading arrangements between all Central Asian countries and
increase exports available to Afghanistan and Pakistan. One of the
first activities that REMAP completed was a study tour for
Kazakhstani government specialists Ministry of Energy and Mineral
Resources (MEMR),the Competition Protection Committee (CPC),the
Kazakhstan Grid Operating Company(KEGOC),and Kazakhstan Market
Operator of Electricity and Capacity(KOREM) to the most progressive
electric power market in the United States, PJM.


15. The annual policy speech President Nazarbayev gave in February
2007 included support for regional energy cooperation and called for
the creation of a regional power exchange. In a related issue,
REMAP worked with KOREM to streamline its operations and strengthen
its capabilities to make it more accessible to cross-border trading.
Electricity trading on the KOREM market has steadily increased
since inception and now stands at 15 percent of the total energy
generated in Kazakhstan.


16. As a final activity in this area, on May 21-22, REMAP concluded
an analysis and organized a regional workshop on specific market
barriers in the area of the legal and customs frameworks in Central
Asia to see how these regimes can more effectively support
cross-border power trading.

REGIONAL COOPERATION HAS SIGNIFICANT BARRIERS
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17. Development of the electricity sector in Central Asia is closely
related to water/energy sharing issues and the irrigation regime.
As Kyrgyzstan and Tajikistan are planning to increase the
utilization of water resources for the production of electricity to
meet market demands,
the economic valuation of water as a commodity and the more
effective use of water for both electricity and agriculture are of
great importance. These issues have become even more critical due
to the current low water year.


18. Ancillary services, such as reserve capacity and regulation

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energy, are not procured using market-based mechanisms and
arrangements for market monitoring by a qualified regulatory agency
are weak. This results in distorted market pricing of electricity
which does not reflect true market costs of ancillary services.


19. The countries of Central Asia have to work together to develop
common policies and must be provided with the technical resources to
implement shared decisions. Consistent with best practices used in
other countries, there is an immediate need to harmonize legal and
regulatory issues facing the market and to support trade between
within and between Central Asia and Afghanistan and Pakistan.

USAID REMAP II
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20. USAID has designed and is in the process of procuring a
three-year $16 million follow-on to the REMAP activity. The bulk of
the funding for the activity in Kazakhstan will be financed under
the Program for Economic Development.


21. The following is an illustrative list of activities for
Kazakhstan that may be implemented by REMAP II:

- Advice/implementation of incentives for the development of new
generation capacity.

- Policy facilitation/training on market development/ modification;
legal and regulatory issues, market design, energy economics, and
economic regulation.

- Support for on-going national market development and sector reform
processes in ways that help to develop market-based electricity
trading arrangements between all Central Asian countries and
increase exports available to Afghanistan and Pakistan.

-Implementation of a regional transmission planning model for
transmission system analysis and planning work.

- Technical support for harmonization of national legislation and
regulations related to electricity trade.

- Development of a new regional methodology for pricing of ancillary
services.

- Development of a regional grid code and transmission pricing
arrangements.

- Development f ways for managing transmission congestion in the 500
kV regional grid to provide the necessary pricing signals for
additional transmission and generation.


22. While Kazakhstan's contribution to an efficient regional energy
market will not be achieved without continued reforms, it does have
the potential to play a significant leadership role. Kazakhstan has
undergone a first round of energy sector reforms and is potentially
a model for the development of the other Central Asian countries.
It is also a likely investor in generation and transmission in the
region. Over the long term, Kazakhstan could be a potential exporter
of energy to the region and further south. It is in the U.S.
interest to advance international energy security by ensuring
reliable access to global markets including regional energy
integration and the Central Asia South Asia Regional Energy Market
(CASAREM). Kazakhstan's active involvement in developing the
regional energy market is essential.

ORDWAY