KOSOVO: KEK PRIVATIZATION REQUIRES RELIABLE

C O N F I D E N T I A L SECTION 01 OF 04 PRISTINA 000561

SIPDIS

DEPT FOR EUR, EUR/SCE, DRL, INL, AND S/WCI, NSC FOR
HELGERSON, USUN FOR SGEE, USOSCE FOR AHYDE

E.O. 12958: DECL: 10/20/2018
TAGS: PREL ETRD ECON EAID EAIR ETTC PTER KTFN UNMIK
KV, YI
SUBJECT: KOSOVO: KEK PRIVATIZATION REQUIRES RELIABLE
COLLECTIONS SCHEME

Classified By: AMBASSADOR TINA S. KAIDANOW FOR REASONS 1.4 (B) AND (D)


1. (C) SUMMARY: The Government of Kosovo (GOK) has publicly
announced its commitment to move forward with privatization
of the distribution functions of the country's public
electric utility, the Kosovo Energy Corporation (KEK). While
the pledge to privatize is both significant and necessary,
the factors challenging a successful privatization process
are considerable. In its current state, KEK is largely
overstaffed and inefficient, with aging and sometimes faulty
equipment struggling to provide electricity to the country.
Collections are low and in some parts of Kosovo,
non-existent. Through a long history of non-payment, some
households have accumulated thousands of euros of debt.
Attempts to regularize customer payments throughout Kosovo
and collect arrears have highlighted political and ethnic
sensitivities, particularly in minority areas, where local
residents are being pressured not to engage with KEK and GOK
representatives.


2. (C) SUMMARY (cont,d): To make Kosovo's electricity
sector attractive to a prospective investor, it is essential
that KEK be able to collect payment at cost-recovery levels
for power delivered throughout Kosovo. To accomplish that,
the GOK and KEK must commit to normalizing collections
throughout the country in a manner that does not alienate
minorities, and offers a debt relief and repayment plan that
is applied equally to all households. Attempts to bring
Kosovo Serb enclaves into the regular KEK payment system may
push parallel Serbian government representatives to dig in
deep, and lead to a further strain on inter-ethnic relations.
However, not implementing a uniform and regular payment
system throughout Kosovo will perpetuate significant
financial losses for KEK, forcing the GOK to contribute more
money from the central budget to keep KEK running, while
running the very real risk of not attracting any investors
for privatization. This could leave Kosovo literally in the
dark and broke. A combined aggressive collection and debt
repayment scheme applied uniformly across Kosovo could
address these problems. However, these actions could also
result in increased inter-ethnic tensions, and possible
confrontation between representatives of Kosovo and Serbian
institutions. END SUMMARY.

KEK: DRAIN ON THE BUDGET


3. (SBU) On October 2, the GOK publicly announced plans to
move forward with the privatization of KEK's electricity
sector, starting with privatization of the company,s
distribution network by the end of 2009. We expect the GOK
to issue the tender for the multi-billion dollar "Kosovo C"
power plant (now known as "New Kosovo") before the end of

2008. Selection of a developer should follow by the end of
2009 or early 2010. With the exception of the high-voltage
transmission company KOSTT, the completion of these two
actions will completely privatize Kosovo's electricity sector
by the end of next year, and remove a large resource drain
from the government's books. Each year, KEK requires a
disproportionately large amount of budget assistance to cover
maintenance, equipment purchases and energy imports. Over
the past several years, the amount of GOK subsidies to the
sector has typically exceeded 100 million euro, due to
insufficient company revenues and mismanagement that has left
critical equipment purchases and repairs unfunded by the
company's own revenues. KEK budget requirements for 2009 are
well above the GOK budget projections, around 80.4 million
euro for time-sensitive capital investments in maintaining
continuous coal production, plus an estimated 70 million euro
to cover the cost of imported power. Without the attraction
of private capital through the timely completion of the
Kosovo C process and privatization of KEK,s distribution
functions, KEK,s drain on the GOK state budget will begin to
overwhelm all other budget lines.

NON-PAYMENT, COMPOUNDED BY KOSOVO SERB ISSUE


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4. (SBU) As the GOK privatizes KEK's distribution and seeks
to conclude a package for the development of Kosovo C,
establishing a normalized and uniform payment system
throughout Kosovo is critical. KEK provides service to all
areas of Kosovo but is unable to collect effectively from
consumers, particularly in the Kosovo Serb enclaves.
Throughout Kosovo, KEK estimates that only half of all
customers pay their electricity bill regularly. KEK is
unable to provide uninterrupted electricity service
throughout Kosovo at periods of peak demand due to real
network and generation capacity constraints, exacerbated by
over-consumption resulting from ineffective price-signals.
As a consequence, a power rationing scheme distributes power
based on the level of regular payments from a given community
or neighborhood. Called the "A-B-C" scheme, communities and
neighborhoods with the lowest level of electricity payments
are subject to the "C" category, receiving two hours of
electricity for every six hours. The most reliable customers
fall into the "A" category, and are subjected to minimal
load-shedding. Yet during periods of acute shortages,
rationing in the "C" category areas is most severe, with an
on/off ratio as limited as one hour "on" and five hours
"off". During these times, even "A" category customers,
service availability drops to four hours "on" and two hours
"off".


5. (SBU) Except for a handful of commercial businesses and
residences, customers in Kosovo Serb enclaves are not
registered as KEK customers. KEK has no ability to enter
enclave areas to establish service arrangements with
residents or to install meters, due to security and political
sensitivities. For similar reasons, service to enclaves has
not disconnected. In 2007, KEK completed the installation of
bulk-level meters at sub-stations serving enclaves.
According to KEK, service to the enclaves comprises about 10
percent of overall electricity consumption in Kosovo, a value
of 20 million euro per year. Of this 10 percent, the three
northern provinces of Zubin Potok, Leposavic and Zvecan, plus
Serb-majority north Mitrovica, are the largest consumers.
With the exception of the these areas, Serb enclaves in the
Albanian-majority south of the country automatically fall
into the "C" category of power rationing due to non-payment.
This would also happen in the north, but the A-B-C scheme
cannot be applied there due to lack of technical capacity.


6. (C) In the process of intensifying efforts to increase
payment compliance, KEK is discovering many households have
significant amounts outstanding to the utility, sometimes as
much as several thousand euro per household. Most Kosovo
residents are not in a position to pay this amount. Kosovo
Serbs who live in enclave areas are technically "debt-free"
because they are not registered as KEK customers and are not
receiving bills for consumption. Other Kosovo Serb
households, however, and particularly those in ethnically
mixed communities (for example in Viti/Vitina municipality)
are technically registered as KEK customers where KEK has
been able to install meters in that particular community, and
have accumulated debt, sometimes to a much larger degree than
their Albanian neighbors. In many of these cases, pressure
by Serbia's political leadership on Kosovo Serbs not to
participate in Kosovo institutions has led these Serb
households to avoid payment and thereby accumulate a
significant amount of debt. With the ethnic-Albanian Kosovo
media picking up on these cases, there have been attempts by
Kosovo officials, usually at lower levels, to disconnect
Kosovo Serb households in mixed areas. (Comment: Realizing
the potential for serious conflict, we have urged officials
at the highest levels here to leave the situation as is for
the time being. End Comment.) KEK's total outstanding debt
is close to 300 million euro, and KEK would undoubtedly
benefit from the collection of all its outstanding debt, but
it is even more crucial for the energy company to enhance its
potential for sale through achieving reliable and regular
payments from current electricity customers.

POSSIBLE SOLUTIONS CARRY RISK OF TENSION

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7. (SBU) Internal discussions with USAID advisors within KEK
have identified two obvious but flawed ways KEK could
approach this multi-pronged challenge: forgive all past debts
and focus solely on current payment discipline, or require
immediate repayment of all arrears. Universal debt
forgiveness may provoke a backlash from regularly paying
customers and inadvertently increase the expectation from
non-paying customers that debt forgiveness might be repeated
at some point in the future. On the other hand, aggressive
collection of all debts regardless of amount or age would
place many households in an untenable financial position, as
well as leave them facing service disconnection. Neither of
these options is feasible.


8. (SBU) A hybrid approach establishing a graduated debt
repayment program, uniformly applied to all customers
receiving electricity service, could be an acceptable and
practical solution. Large debts could be scheduled for
repayment over 12 months, as is current practice for arrears
up to 500 euro, and debts older than one year could be
forgiven. This would allow KEK to collect on a portion of
arrears and encourage customers to become regular payers,
with a minimal amount of debt forgiveness.


9. (C) To implement a uniform and reliable collections scheme
throughout Kosovo, KEK must be able to establish service
agreements with all customers, including with Kosovo Serbs.
But KEK's commercial relationship with the Serb community is
weak. Regardless of whether Kosovo Serb households are
willing to pay for electricity service, KEK is not able to
effectively engage this customer base, resulting in mixed and
minority areas bearing the brunt of load-shedding as a result
of non-payment. For their part, Kosovo Serbs are frustrated
at not receiving better service, but are pressured by
parallel structure representatives to engage with Serbia,s
public electric utility EPS, instead of formalizing
arrangements with KEK. Although EPS is not a registered
business in Kosovo and does not provide electricity, EPS is
active in Kosovo Serb areas, positioning itself as a direct
competitor to KEK. The company does have personnel on the
ground connecting Kosovo Serb households to the KEK grid and
providing equipment, as needed, to keep the lights on in
minority areas. Although the company does not currently do
so, EPS does have the capacity to supply electricity directly
to northern Kosovo.


10. (C) Recent efforts by KEK to intensify collections in
Kosovo Albanian areas have revealed that most Kosovo Serb
residents in mixed areas have accumulated arrears often
several times greater than the amounts owed by Kosovo
Albanians in the same community. Although it is important to
note that a significant number of Kosovo Albanian households
also have large unpaid debts to KEK, Kosovo Serbs tend to
feel singled out for non-payment due to poor communications
with KEK, and interference from parallel structure
representatives reinforces this perception. While KEK
insists on engaging directly with Kosovo Serb community
representatives, parallel Serbian government representatives
tend to insert themselves in the dialogue, preventing any
satisfactory agreement from emerging. With any payment
collection scheme that is put in place, maximizing the flow
of accurate information about changes in KEK's policies
toward Kosovo Serb households will be critical for success.


11. (C) COMMENT: A reliable and fully operational payment
collection scheme is vital to attract investors to Kosovo's
electricity sector. No company will accept the obligation to
provide service without assurances of being able to
reasonably recover costs. Likewise, to the extent that KEK
distribution will be the largest single buyer of power
generated within Kosovo by the Kosovo C power plant, the
project developer will require assurances that KEK
distribution will have sufficient revenues to pay for the
wholesale power delivered. In essence, the success of the
Kosovo C project and KEK distribution privatization rests on

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the ability of KEK to collect from its customers. It is
critical that payment discipline is achieved, and that KEK's
ability to enforce such discipline is credible. Continued
poor payment by consumers will have negative effects on
potential investors, perception of the Kosovo C project's
potential for revenue generation. Pilot projects to install
more meters and initiate an aggressive collection policy in
certain communities such as Ferizaj/Urosevac have yielded 60
percent increases in collection over the same periods in 2007
in the same areas. KEK believes that intensified collection
efforts over the coming six to nine months might allow KEK to
collect an additional 70 million euro of past debt owed by
households. Such a success might substantially reduce the
utility's 2009 request for GOK budget transfers from 150
million euro to 80 million euro.


12. (C) COMMENT (cont'd): Once a policy approach to
collection of past debts and regularization of service
conditions for Kosovo Serb enclaves is adopted, KEK and the
GOK's initiatives to implement uniform payment and collection
procedures throughout Kosovo will require direct engagement
from Kosovo Serbs with the Kosovo's national utility,
including in all the enclaves. This could lead to
confrontation between representatives of Kosovo and Serbian
institutions. USAID advisors within KEK have suggested that
while necessary for the sake of privatization, policies
writing-off any significant past-due amounts in order to
establish universal payment discipline for current and future
power consumption might best be postponed until mid-2009. In
the interim, KEK would continue to aggressively collect
past-due debts from households, but would avoid confrontation
with ethnic Serb households.
KAIDANOW