KAZAKHSTAN: REGIONAL ELECTRICITY MARKET MUST OVERCOME

UNCLAS SECTION 01 OF 04 ASTANA 000251

SENSITIVE
SIPDIS

STATE FOR SCA/CEN
STATE PLEASE PASS TO USTDA FOR DAN STEIN

E.O. 12958: N/A
TAGS: PGOV ECON EAID ENRG EINV KZ
SUBJECT: KAZAKHSTAN: REGIONAL ELECTRICITY MARKET MUST OVERCOME
POLITICAL, TECHNICAL CHALLENGES

REF: 08 ASTANA 2086

ASTANA 00000251 001.2 OF 004



1. (U) Sensitive but unclassified. Not for public Internet.


2. (SBU) SUMMARY: On February 5, Energy Officer accompanied USAID
Senior Energy Policy Specialist Michael Trainor to meetings with
major players in Kazakhstan's power sector to solicit feedback on
USAID's new Regional Energy Markets Assistance Program (REMAP-II),
expected to begin in March (see septel.) Kazakhstani industry
representatives thanked USAID for assistance provided under the
first REMAP project and expressed general support for the new
project, but expressed skepticism about the near-term prospects for
a regional electricity market encompassing all five Central Asia
Republics and linking Afghanistan's newly-constructed North-East
Power System with Central Asian high-voltage networks and
generators. Instead, it was suggested that early successes are more
likely with a sub-set of these countries, including Kazakhstan,
Kyrgyzstan, and Tajikistan in the first instance. Several
Kazakhstani commentators cited Uzbekistan's politics and past
behavior, its geography and the location of critical segments of the
region's high-voltage networks, and the nexus between
water-resources management and hydroelectric power as major
complicating factors. Discussions confirmed that reconciling the
different laws, authorities, institutions, infrastructure, and
tariffs of the six countries involved will be arduous work.


3. (SBU) SUMMARY CONTINUED: Kazakhstan's own wholesale power tariff
structure is expected to change in the near future, once a Prime
Ministerial decree is published to implement the new Law on
Electricity, which took effect January 1. The decree will establish
a seven-year price ceiling for power prices charged by generators,
with tariffs varying according to the type of power generation. The
chairman of the Agency for the Regulation of Natural Monopolies
(ARNM) said the purpose of the decree was to attract foreign
investment by guaranteeing a stable, long-term price for power
companies. This is in contrast to what Energy Officer learned
during a meeting on January 15 with AES, the largest Western
investor in Kazakhstan's power sector. AES said they anticipated
that the government's fixed prices would be below market rates and
would discourage future investment in infrastructure. END SUMMARY.

A BEAR MARKET


4. (SBU) Senior managers from the Kazakhstan Electricity Grid
Operating Company (KEGOC) were skeptical of USAID's proposal to
establish a regional electricity market encompassing Central Asia
and Afghanistan. KEGOC Vice President Vladimir Ossochenko said the
physical infrastructure of the countries in the region was at vastly
different levels of development and KEGOC would not invest its own
resources to modernize infrastructure in Kyrgyzstan or Tajikistan.
"If we did that," he said, "we would be left with nothing."
Ossochenko said that KEGOC will invest funds from a World Bank loan
to upgrade and modernize Kazakhstan's own power transmission network
and upgrade the power grid linking northern Kazakhstan and southern
Russia.


5. (SBU) Ossochenko also suggested that it would take a decade or
more to reconcile the different, often contradictory, laws of the
prospective participant countries to build the necessary legal
framework for a regional power market. He illustrated his point by
saying that -- thanks in part to the first REMAP project -- the
Kyrgyz National Electricity System was prepared to trade power via
Kazakhstan's electricity market operator, KOREM, but was unable to
do so because customs regulations in both countries do not
accommodate exchanges brokered on the KOREM trading platform.
(NOTE: Power is exchanged between Kazakhstan and Kyrgyzstan, but
under separate bi-lateral contracts negotiated outside of the KOREM
market framework. END NOTE)

LITTLE INTEREST IN AFGHANISTAN


6. (SBU) When asked about Afghanistan, Ossochenko simply said,

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"That's your initiative. That's in your interest, not ours." He
said that Afghanistan lacks basic power infrastructure and KEGOC
lacks the means to upgrade Afghanistan's grid. Ossochenko also
noted that the Central Asian republics have enough difficulty
generating and distributing sufficient power for domestic use and
would be hard-pressed to export electricity to Afghanistan. "If
Uzbekistan already cuts power to Tajikistan, which it is obliged to
deliver, how can they send electricity to Afghanistan?," he asked.
Ossochenko did, however, support the idea of regional training and
knowledge-sharing activities with counterparts from Afghanistan.

DEBATE OVER CENTRAL AUTHORITY


7. (SBU) Despite doubts about the development of a regional market,
KEGOC's Ossochenko supported USAID's proposal to upgrade the
capacity of the Coordination Dispatch Center (CDC),headquartered in
Tashkent and jointly-owned by the transmission system operators of
Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan. CDC would
provide centralized high-voltage network monitoring and management
services for the Central Asian electricity market. KEGOC claims it
needs a stronger CDC with modern equipment to ensure the rational
development of the marketplace. "Without it, we can do nothing on a
regional level," Ossochenko said. According to him, CDC's
communications equipment was made in the 1950s and is in dire need
of replacement. (NOTE: Under the three-year, $15 million REMAP-II
project, USAID would provide a grant of up to $1 million to CDC.
END NOTE).


8. (SBU) Unlike KEGOC, the operator of Kazakhstan's electricity
market, known by its Russian acronym KOREM, does not support the
modernization of the Coordination Dispatch Center. KOREM's Chairman
Suinshilik Tiyessov said it would be "incorrect" and "harmful" to
provide funding or assistance to the CDC. He correctly observed
that CDC has no formal legal basis for interacting with the five
Central Asian countries and no legal authority to issue compulsory
instructions to national system operators, or to apply sanctions for
non-compliance.

OVERCOMING MISTRUST OF UZBEKISTAN


9. (SBU) Tiyessov noted that the CDC is based in Tashkent and
called it a political instrument of Uzbekistan. "The CDC is good
for the Uzbeks," he said, "because they can use it to manipulate
other countries." Tiyessov then spent several minutes explaining
why Uzbekistan should not be trusted to host the CDC, arguing that
Uzbekistan would most likely manipulate data reporting and grid
management in favor of Uzbekenergo and at the expense of other
countries' system operators. The only way to partner with
Uzbekistan, he said, is to enforce contracts strictly, with
financial penalties for any and all violations. According to
Tiyessov, "If you try to be nice to them and negotiate, they simply
take it as a sign of weakness." (NOTE: Other senior officials,
including Nesipkul Bertysbayev, Director of the Electricity
Department at the Ministry of Energy and Mineral Resources, echoed
Tiyessov's comments about Uzbekistan. Bertysbayev, for example,
said the CDC is "firmly under the control of the Uzbeks." END
NOTE.)


10. (SBU) Like KEGOC's Ossochenko, KOREM Chairman Tiyessov had
doubts about the near-term prospects for a regional electricity
market involving all the Central Asian republics. Tiyessov
suggested USAID first establish a regional market connecting
Kazakhstan, Kyrgyzstan, Tajikistan, and Turkmenistan, which would
ultimately force Uzbekistan to "play by the rules." It was unclear,
however, whether that would be technically feasible immediately,
since the region's power grids do not neatly conform to its national
borders, and key segments of the Central Asian grid traverse
Uzbekistan's territory. (NOTE: Kyrgyzstan and Tajikistan have
embarked on the construction of 500kV lines connecting the two
countries to the Kazakhstan grid directly, bypassing Uzbekistan.
Completion, however, is still several years away. END NOTE.)


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GOVERNMENT PREPARED TO FIX ELECTRICITY PRICES


11. (SBU) As previously reported (reftel),Prime Minister Masimov
is prepared to introduce a new decree that will set wholesale
ceiling prices for electrical power for the next seven years. Power
industry representatives are strongly opposed to fixed prices set by
the government, although Nurlan Aldabergenov, Chairman of the Agency
for the Regulation of Natural Monopolies (ARNM),defended the
decree, saying it would increase investment. KOREM's Tiyessov noted
that since the decree was first drafted in October, the global
financial crisis has caused major power consumers to reduce demand
for electricity, which has moved the country from a power deficit to
a power surplus. Tiyessov therefore expects prices to fall on their
own accord and sees little value in a government decree setting a
price ceiling.


12. (SBU) Tiyessov said the government is now discussing tariffs
for various categories of power-generating companies, with
consideration of such factors as location, fuel type, plant
technology, and efficiency in determining into which category each
plant will fall. The ceiling price for each category will be
established at the level of the highest recorded output price of
power produced and sold by generators in that category in 2008.
According to Tiyessov, the Prime Ministerial decree setting the new
tariff schedule is expected to be published in May or June. (NOTE:
Tiyessov served on the parliamentary working group that drafted the
Law on Electricty and successfully lobbied to include a provision
allowing up to 10 percent of all electricity generated in
Kazakhstan, or approximately four billion kilowatt hours, to be sold
via KOREM's trading platform at a free market price, rather than the
government's fixed price. END NOTE.)

AES SAYS FIXED PRICES POSE A PROBLEM


13. (SBU) On January 15, Doug Herron, Head of the Representative
Office of AES Silk Road, Inc. in Almaty, told Energy Officer that
the government's proposal to fix electricity tariffs would have a
negative impact on the entire industry. He said the final rates
remain under discussion and added that it was unclear whether
companies could charge different rates for different customers
(i.e., industrial and residential). Herron also said that coal
prices comprise 65 percent of the price of electricity, so unless
the government also fixes the price of coal, power companies will be
squeezed by rising input costs and restricted retail prices. (NOTE:
A government working group is now considering whether to regulate
coal prices as well, despite the objections of the mining industry.
END NOTE.)

ANTI-MONOPOLY AGENCY UNAPOLOGETIC


14. (SBU) Anatoliy Shkarupa, Director of ARNM's Electricity
Department, justified the draft decree as a means to attract
much-needed investment into the power sector. He said that because
the government has not actively regulated the electricity market for
the last ten years, there have been no new investments in power
generation. When reminded about the millions of dollars AES has
invested in Kazakhstan's power sector, Shkarupa became defensive and
said that when AES first arrived in Kazakhstan, five of the eight
power blocks at Ekibastuz GRES-1 were in use. "Now, ten years
later, still only five of the eight blocks are producing
electricity," he said. Shkarupa claimed that AES used spare parts
from other blocks to keep a maximum of five functional. He said AES
has covered operational expenses, but did not make any major capital
investments at the power plant in Ekibastuz, or at AES's other
plants in Ust-Kamengorosk and Shulbinsk.


15. (SBU) Shkarupa's deputy, Khalila Kokozova, said the new Prime
Ministerial decree would be a "temporary measure" and that companies
planning to make capital investments could apply to the government
for an "individual tariff" that would be higher than that set by the
decree. Kokozova also said that power plants fueled by renewable
sources of energy would constitute a distinct group of enterprises

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and would likely be granted higher, "feed-in" tariffs.


16. (SBU) ARNM Chairman Aldabergenov was unapologetic about the
draft decree. He denied that ARNM was trying to regulate market
prices, saying his agency's role was to promote capital investment,
monitor investment commitments, and ensure stable, long-term market
development. He confirmed, however, that ARNM would review prices
annually to ensure compliance with the new decree and enable
companies to petition for changes to the tariff schedule.
Aldabergenov welcomed expert advice from USAID on the methodology
and mechanics of power tariff regulation, and in particular
requested assistance in developing options to provide tariff-based
assistance to low-income households and stimulate energy
conservation.


17. (SBU) Samruk-Kazyna National Welfare Fund representatives
engaged in management of state-owned assets in the power sector
exhibited strong interest in U.S. assistance to Kazakhstan's power
sector. They requested that REMAP-II provide support in assessing
policy options that might stimulate investment in new generation.
They also asked whether the U.S. Government, under REMAP-II or
otherwise, could provide direct assistance in enticing U.S.
investors to explore opportunities for new plant construction in
Kazakhstan. Energy Officer emphasized the importance of minimizing
investors' perceptions of risk, to which USAID Senior Energy Policy
Specialist offered that a sound policy and legal/regulatory
framework is prerequisite for such. USAID explained that REMAP-II
will contribute in this regard, and might also be in a position to
assist with the conceptualization, announcement, and management of
specific generation investment projects.


18. (SBU) COMMENT: Widespread, nearly universal criticism of
Uzbekistan by key players in Kazakhstan's power sector suggests that
a regional electricity market that includes Uzbekistan is unlikely
to emerge in the near term. U.S. programs and policies in support
of a regional market will be more effective if they focus initially
on Kazakhstan, Kyrgyzstan, and Tajikistan, which have demonstrated
greater willingness to cooperate on electricity issues.
Furthermore, based on conversations with our interlocutors, the
republics of Central Asia have yet to embrace Afghanistan as an
integral part of the region. Afghanistan is widely viewed as an
"American problem," not as a regional partner or potential market
player. Finally, the global financial and economic crisis has hit
the region hard, forcing countries to look inward and prioritize
domestic development over regional integration. In Kazakhstan, for
example, the government is focused on stemming rising unemployment,
maintaining the stability of the tenge, securing the solvency of the
banking sector, and meeting the basic needs of the population for
affordable food, housing, and energy. Kazakhstan is therefore
unlikely to invest much time, money, or political capital in the
near future to overcome the many obstacles to a fully integrated,
regional electricity market. END COMMENT.

HOAGLAND