ministry of energy and natural resources of georgia...

MINISTRY OF ENERGY AND NATURAL RESOURCES OF GEORGIA

Information Memorandum

19 May 2011

ii

Ministry of Energy and Natural Resources of Georgia

DISCLAIMER REGARDING THIS INFOMRATION MEMORANDUM This Information Memorandum has been prepared by the Georgian Energy Development Fund and is distributed for information purposes only. This Information Memorandum does not constitute an offer or invitation for the sale of any assets or shares, or recommendation to form a basis for investment. This Information Memorandum and the data contained herein shall not form the basis of or in any way constitute any contract or binding offer or agreement. While the information contained in this Information Memorandum has been prepared in good faith, it is not and does not purport to be comprehensive or to have been independently verified, and neither the Georgian Energy Development Fund or any of its officers, employees, advisers or consultants accept any liability or responsibility for the accuracy, reasonableness or completeness of or for any errors, omissions or misstatements, negligent or otherwise, relating to or makes any representation or warranty, express or implied, with respect to the information contained in the Information Memorandum or on which it is based or with respect to any written or oral information made, or to be made available to any of the recipients or their professional advisers and, so far as permitted by law and except in the case of fraudulent misrepresentation by the party concerned, any liability therefore is hereby expressly disclaimed. While considering the Information Memorandum, each recipient/interested party should make its own independent assessment and seek its own professional, financial, legal and tax advice.

iii


ACRONYMS

ADB Asian Development Bank

AERC Armenian Energy Regulatory Commission

BoG Bank of Georgia

BOO Build Own Operate

BOT Build Operate Transfer

BSRTPP Black Sea Regional Transmission Planning Project

BSTNP Black Sea Transmission Network Project

CCG Customs Code of Georgia

CCGT Combined Cycle Gas Turbine

CDM Clean Development Mechanism

CEE Central & Eastern Europe

CER Certified Emission Reductions

COFACE Compagnie Française d'Assurance pour le Commerce Extérieur (France)

CSF Critical Success Factor

DEG German Development Bank

EBRD European Bank for Reconstruction and Development

EEC European Energy Charter

EIA Environmental Impact Assessment

EIB European Investment Bank

EML Electricity Market Law 4628

EMRA Energy Market Regulatory Authority (Turkey)

EPC Engineering, Procurement and Construction

ESCO Electricity System Commercial Operator

EU European Union

FDI Foreign Direct Investment

iv


FIZ Free Industrial Zone

GDP Gross Domestic Product

GEDF Georgian Energy Development Fund

GEL Georgian Lari

GIEC Georgian International Energy Corporation

GIS Geographic Information System

GNEWRC Georgian National Energy and Water Supply Regulatory Commission

GoG Government of Georgia

GSE Georgian State Electrosystem

GW Gigawatts

GWEM Georgian Wholesale Electricity Market

GWH Gigawatthours

HIPP Hydropower Investment Promotion Project (USAID-funded)

Ha Hectare

HP Hydropower

HPP Hydropower Plant/Hydropower Project

HVDC High Voltage Direct Current

HVAC High Voltage Alternating Current

Hz Hertz

ICSID International Center for Settlement of Investment Disputes

ICT Investment Coordination Team

EIA Environmental Impact Assessment

IFC International Finance Corporation

IFI International Financial Institutions

IPS Investment Promotion Strategy

IRR Internal Rate of Return

v


JSC Joint Stock Company

KEPCO Korea Electric Power Corporation

KfW Kreditanstalt für Wiederaufbau/KfW Bankengruppe

kV Kilovolt

kW Kilowatt (a measure of power)

kWh Kilowatt-hour (a measure of energy)

m3/s Cubic meters per second

MDF Municipal Development Fund

M&E Monitoring & Evaluation

MENR Ministry of Energy and Natural Resources

MEP Ministry of Environment Protection

MoF Ministry of Finance

MVA Megavolt Ampere

MW Megawatts

MWH Megawatthours

MOU Memorandum of Understanding

NARUC National Association of Regulatory Utility Commissioners

NBG National Bank of Georgia

NGO Non-Governmental Organization

OHL Overhead (transmission) line

PBA Power Bridge Agreement

PE Permanent Establishment

PEA Programmatic Environmental Assessment

PfP NATO Partnership for Peace

PPA Power Purchase Agreement

PPP Public-Private Partnership

vi


PSP Pumped Storage Unit

RE Renewable Energy

ROE Return on Equity

SMHP Small and Medium Hydropower

SMP Short-term Marginal Price

SS Substation

TEDAŞ Turkish Electricity Distribution Company

TEIAS Turkish Transmission System Owner

TETAŞ Turkish Electricity Trading and Contracting Company

TPP Thermal Power Plant

TWh Terawatt Hours

TOE Ton of Oil Equivalent

TOR Transfer Own and Return

UNDP United Nations Development Programme

US ¢ United States Cent (also USc)

US$ United States Dollar (also USD)

USAID United States Agency for International Development

USEA United States Energy Association

VAT Value Added Tax

WB World Bank

vii


TABLE OF CONTENTS

EXECUTIVE SUMMARY.................................................................................................................................. 1

1.0 OFFERING PARTY ............................................................................................................................... 3

2.0 ECONOMIC TRENDS AND FINANCIAL SECTOR STATUS IN GEORGIA ..................... 5

2.1 GEORGIA, REAL GROSS DOMESTIC PRODUCT 2000 TO 2009 ......................................................................... 5 2.2 GEORGIA, ECONOMIC FORECASTS TO 2012 .......................................................................................................... 6 2.3 STATE BUDGET REVENUES ........................................................................................................................................... 6 2.4 FOREIGN DIRECT INVESTMENT ................................................................................................................................. 6 2.5 FUNDAMENTAL POLICIES AND REFORMS ............................................................................................................ 7

3.0 AVAILABILITY OF FINANCING ..................................................................................................... 9

3.1 THE GEORGIAN BANKING SECTOR .......................................................................................................................... 9 3.2 FINANCING OPPORTUNITIES ....................................................................................................................................... 9 3.3 RISK CONCENTRATIONS AND BANK LIMITATIONS TO SINGLE EXPOSURES .................................. 10 3.4 SECURED FINANCING .................................................................................................................................................... 10 3.5 BANK GUARANTEES ........................................................................................................................................................ 11 3.6 CURRENCY RESTRICTIONS ........................................................................................................................................... 11 3.7 INTERNATIONAL FINANCIAL INSTITUTIONS.................................................................................................... 11

3.7.1 IFI On-Lending Through Local Banks ....................................................................................................... 11 3.7.2 KFW 5.1 Million Euro Renewable Energy Fund ...................................................................................... 11 3.7.3 Future IFI Funding for Hydro Investment in Georgia ............................................................................ 12

4.0 GEORGIAN ENERGY MARKET ................................................................................................... 13

4.1 GENERATION AND CONSUMPTION IN GEORGIA ........................................................................................... 13 4.1.1 Consumption and Generation: Key Data Points ....................................................................................... 13 4.1.2 Preeminence of Hydropower Generation in Georgia ............................................................................... 14 4.1.3 Generation Tariffs .......................................................................................................................................... 14 4.1.4 Trading, Market Players, Market Formation .............................................................................................. 15

4.2 ELECTRICITY SYSTEM COMMERCIAL OPERATOR (ESCO) ............................................................................ 16 4.3 BRIEF OVERVIEWOF TRANSMISSION AND DISTRIBUTION ........................................................................ 16

4.3.1 Distribution and Retail Power Market ......................................................................................................... 16 4.3.2 Transmission and Dispatch ........................................................................................................................... 17

5.0 HYDROPOWER SECTOR IN GEORGIA ..................................................................................... 18

5.1 HISTORY ................................................................................................................................................................................. 18 5.2 GROWTH POTENTIAL ..................................................................................................................................................... 18 5.3 LONG-TERM ENERGY POLICY (ROLE OF RENEWABLE ENERGY) .......................................................... 19 5.4 MAJOR ACHIEVEMENTS ................................................................................................................................................. 22

6.0 REGIONAL ENERGY MARKETS .................................................................................................. 25

6.1 ARMENIA................................................................................................................................................................................ 26 6.1.1 Geography and Climate ................................................................................................................................. 26 6.1.2 Political Overview ........................................................................................................................................... 26 6.1.3 Economy .......................................................................................................................................................... 26 6.1.4 Energy Sector................................................................................................................................................... 27

6.1.4.2 Overview and Organization .................................................................................................................................... 27 6.1.4.3 Government Policy and Regulation ...................................................................................................................... 28 6.1.4.4 Interconnections and Trade .................................................................................................................................... 29

viii


6.1.4.5 Energy Trade With Georgia ................................................................................................................................... 29 6.1.4.6 Preliminary Conclusions on the Feasibility of Georgian Exports to Armenia .............................................. 30

6.2 AZERBAIJAN ......................................................................................................................................................................... 30 6.2.1 Geography and Climate ................................................................................................................................. 30 6.2.2 Political Overview ........................................................................................................................................... 30 6.2.3 Economy .......................................................................................................................................................... 31 6.2.4 Energy Sector................................................................................................................................................... 32

6.2.4.1 Overview and Organization .................................................................................................................................... 32 6.2.4.2 Government Policy and Regulation ...................................................................................................................... 33 6.2.4.3 Interconnections and Trade .................................................................................................................................... 34 6.2.4.4 Energy Trade with Georgia .................................................................................................................................... 34 6.2.4.5 Preliminary Conclusions on the Feasibility of Georgian Exports to Azerbaijan .......................................... 35

6.3 SOUTHERN RUSSIA ........................................................................................................................................................... 35 6.3.1 Overview and Organization .......................................................................................................................... 35 6.3.2 Government Policy and Regulation ............................................................................................................. 36 6.3.3 Interconnections and Trade .......................................................................................................................... 36 6.3.4 Preliminary Conclusions on the Feasibility of Imports from Georgia ................................................... 36

6.4 TURKEY .................................................................................................................................................................................. 37 6.4.1 Geography and Climate ................................................................................................................................. 37 6.4.2 Political Overview ........................................................................................................................................... 37 6.4.3 Economy .......................................................................................................................................................... 37 6.4.4 Energy Sector................................................................................................................................................... 38

6.4.4.1 Market Structure and Reform ................................................................................................................................. 38 6.4.4.2 Consumption and Production ................................................................................................................................ 40 6.4.4.3 Prices and Costs ........................................................................................................................................................ 40 6.4.4.4 Electricity Exports: Current and Future ............................................................................................................... 42 6.4.4.5 Countries Connected to Turkey ............................................................................................................................. 43

6.4.5 Preliminary Conclusions on the Feasibility of Imports from Georgia ................................................... 43

7.0 LEGAL ENVIRONMENT .................................................................................................................. 45

7.1 PERMITTING PROCESS FOR SMALL, MEDIUM AND LARGE HPPS ............................................................ 45 7.1.1 Construction Permit ....................................................................................................................................... 46 7.1.2 Environmental Protection ............................................................................................................................. 48 7.1.3 Environmental Impact Permit ...................................................................................................................... 49 7.1.4 Land Rights ...................................................................................................................................................... 50 7.1.5 Water Rights .................................................................................................................................................... 51

7.2 REGULATORY STRUCTURE OF THE SECTOR ...................................................................................................... 51 7.2.1 Energy Policy ................................................................................................................................................... 51 7.2.2 Electricity Law ................................................................................................................................................. 52 7.2.3 Organization of the Market ........................................................................................................................... 52 7.2.4 Ministry of Energy and Natural Resources ................................................................................................. 52 7.2.5 Georgia National Energy & Water Supply Regulatory Commission ...................................................... 52 7.2.6 Electricity System Commercial Operator .................................................................................................... 53 7.2.7 Hydropower Investment Promotion ........................................................................................................... 53 7.2.8 Generation License ......................................................................................................................................... 53 7.2.9 Licensing Procedures ...................................................................................................................................... 54 7.2.10 Deregulation .................................................................................................................................................... 54 7.2.11 Tariffs ................................................................................................................................................................ 54 7.2.12 Network Access .............................................................................................................................................. 54

ix


7.3 ELECTRICITY MARKET RULES .................................................................................................................................... 55 7.3.1 Market Rules and Wholesale Trading .......................................................................................................... 55 7.3.2 Taxation ............................................................................................................................................................ 56

7.3.2.1 Taxes and Tax Rates ................................................................................................................................................ 56 7.3.2.2 Withholding Taxation and Double Taxation Treaties ....................................................................................... 58 7.3.2.3 Customs Duties ......................................................................................................................................................... 58 7.3.2.4 Customs Tax (Tariff) ............................................................................................................................................... 58 7.3.2.5 Customs Fees ............................................................................................................................................................ 59

7.3.3 Tax Free Regimes in Georgia ........................................................................................................................ 59 7.3.3.1 Free Industrial Zones ............................................................................................................................................... 59 7.3.3.2 Free Warehouse Enterprise .................................................................................................................................... 59 7.3.3.3 International Finance Company............................................................................................................................. 60

8.0 DESCRIPTION OF GEORGIA’S TRANSMISSION SYSTEM ................................................. 61

8.1 TECHNICAL OVERVIEW OF THE TRANSMISSION SYSTEM .......................................................................... 61 8.2 TRANSMISSION LINE OWNERSHIP ........................................................................................................................... 61 8.3 INTERCONNECTIONS WITH NEIGHBORING COUNTRIES .......................................................................... 62

8.3.1 Interconnection with Russia .......................................................................................................................... 62 8.3.2 Interconnection with Armenia ...................................................................................................................... 63 8.3.3 Interconnection with Azerbaijan .................................................................................................................. 63 8.3.4 Interconnection with Turkey ........................................................................................................................ 63 8.3.5 Planned Interconnection Projects ................................................................................................................ 64

8.4 ACTIVE DONOR-SUPPORTED TRANSMISSION PROJECTS ............................................................................ 65 8.4.1 USAID Black Sea Transmission Planning Project .................................................................................... 65 8.4.2 USAID Power and Gas Infrastructure Project .......................................................................................... 65 8.4.3 Black Sea Transmission Network Project ................................................................................................... 65 8.4.4 ADB Regional Power Transmission Enhancement Project .................................................................... 66 8.4.5 World Bank Electricity Market Support Project ........................................................................................ 67

9.0 CONSIDERATIONS ............................................................................................................................ 68

1


EXECUTIVE SUMMARY

The Government of Georgia is inviting technically and financially qualified domestic and international developers to invest in its hydropower industry. Less than 25% of an estimated potential 40 billion kWh of economically feasible hydropower has been harnessed in the country. The government’s commitment to private sector led development of this remarkable natural resource, and the availability of outstanding sites combined with strong regional economic growth, means now is the time to invest in Georgian hydropower.

Georgia is blessed with enviable water resources that are well suited to hydropower generation. Prefeasibility studies carried out by leading engineering firms reveal sites that are at the forefront globally in their ability to produce energy. Viability is further enhanced by the availability of multiple sites well suited for cascades. When combined with a relatively simple procedure to gain the right to Build, Own and Operate a hydropower plant, it becomes clear that the Georgian hydropower market is a compelling investment proposition.

The Georgian power system cannot meet electricity demand from local sources during winter months. The country imports large volumes of energy to address this seasonal supply and demand imbalance. The government’s Energy Policy, adopted by Parliament in 2006, will reduce dependence on imports by encouraging further development of domestic hydropower resources. It is within this context that the government is inviting developers to enter or expand their presence in the hydropower industry.

The business case for investment into the Georgian energy sector is underpinned by an eye catching macro story. Real GDP grew by over 8% year on year in the second quarter of 2010. The economy is expected to continue expanding rapidly through 2011 and 2012. This will mark a return to a startling GDP growth trend that neared double digits in 2006 and reached 12% in 2007. Further evidence of macro level improvement is reflected in S&P’s recent raising of Georgia’s long-term sovereign credit rating to B-plus, based on the country’s relative economic strength and growth prospects.

According to the World Fact Book, in 2009 Georgia’s annual per capita electricity consumption was 1,800 kWh, as compared to 8,000 kWh in Germany, 8,500 kWh in Japan, 13,500 kWh in the US and 24,300 kWh in Norway. By making its leading hydropower sites available to qualified developers, the Government of Georgia is offering an unprecedented opportunity to secure a foothold in an economy and a power market that have a good track record in sustaining high growth.

Regional economies and energy markets are also expanding fast. Demand for power in neighboring Turkey specifically, could double between 2010 and 2020. An increasing and irreversible international appetite for electricity generated from renewable sources, and the highly productive nature of its rivers position Georgia to become a significant provider of export power in the midterm.

The government is improving its technical capacity to facilitate increased cross-border energy trade, harmonizing sector legislation and expanding interconnections in multiple directions.

2


The addition of a new, soon to be completed transmission line between Georgia and Turkey is a significant step towards realization of the country’s export potential. When other new transmission lines become operational, total capacity between Georgia and Turkey will reach about 1,400 MW, ten times more than currently available.

Reform within the Georgian power sector has already produced impressive results. Collection rates are up from 20% in 2000 to over 90% in 2009. End user tariffs have risen and companies along the industry value chain have been privatized and are profitable. Government policy is to continue to commercialize the sector. Against this backdrop of reform, increased private ownership of hydropower generation is a logical next step forward.

Multiple changes have already been made to stimulate increased commercial activity in the industry. Barriers to market entry have been removed. Tariffs and tariff policies intended to secure the sector’s economic sustainability and enable service providers to achieve cost recovery have been adopted. The use of direct contracts between power generators and wholesale purchasers has been expanded. Transmission and distribution networks are managed on an open access basis.

In order to attract investment into new hydropower plants with a capacity of up to 100 MW, Georgia passed a Renewable Energy Law in 2008. This Law makes clear the government’s support for private sector construction, operation and ownership of hydropower plants under the principle of Build, Own and Operate. Highlights include levy-free third party access to the national grid, freedom to enter sales contracts using deregulated tariffs, and the right to export for nine months of the year. Power produced during winter months may be sold to any buyer in Georgia or to the Electricity System Commercial Operator (ESCO) under a guaranteed PPA.

Georgia has taken other important measures to create an attractive environment for investment, prompting the World Bank to observe that “no other country has made so many deep reforms in so many different areas so consistently.” In fact, the World Bank reported in 2010 that it was now easier to do business in Georgia than in 22 of the 25 EU nations. Georgia also ranked 3rd in Eastern Europe & Central Asia for ‘protecting investors’. These results reflect clearly Georgia’s determination to harness private investment to meet its energy sector development goals.

3


1.0 OFFERING PARTY

1.1 GEORGIA Georgia is situated at the juncture of Eastern Europe and Western Asia between the Black Sea, Russia, Armenia, Azerbaijan, and Turkey. The country covers a territory of approximately 69,700 km2. Its population is more than 4.4 million.

The country is rapidly developing as a gateway from the Black Sea to the Caucasus and the larger Caspian region. Georgia’s natural resources include forests, manganese deposits, iron ore, copper, gold, minor coal and oil deposits, and abundant hydro resources. 1.2 GOVERNMENT Georgia's constitution reflects a representative democracy, organized as a unitary, semi-presidential republic. It is currently a member of the United Nations, the Council of Europe, the World Trade Organization, the Organization of the Black Sea Economic Cooperation, the Organization for Security and Cooperation in Europe, the Community of Democratic Choice, the GUAM Organization for Democracy and Economic Development, and the Asian Development Bank. The country aspires to join NATO and the European Union. 1.3 GEORGIAN ENERGY DEVELOPMENT FUND To facilitate investment in and development of the country’s renewable energy sector, the Government of Georgia on December 8, 2010, took a decision to establish the Georgian Energy Development Fund (“GEDF” or the “Fund”) by adopting Order No 1564. Registration of GEDF in the Public Registry took place on December 13, 2010. The Fund’s oversight is conducted by a three-member Board. The Chairman of the Board is the Prime Minister. Other Board members are the Ministers of Energy and Finance. The Fund’s General Director is former Deputy Minister of Energy, Archil Mamatelashvili. The legal status of GEDF will be a Joint Stock Company and its charter will be as follows:

Identification and analysis of potential “greenfield” hydropower plant development sites, including river-basin planning – and investigation of other renewable energy projects in Georgia;

Jointly – with a private investors – develop projects with an exit option for the Fund at various stages of development;

Support developing HPP projects; Finance initial costs related to the development of identified HPP projects; Facilitate project investment promotion;

4


Support potential financing arrangements with international financial institutions and/or private financial entities;

Provide risk mitigation support for investors regarding project development (PPA, financial planning, legal risks, etc.); and

Advise the Ministry of Energy and Natural Resources regarding amendments to energy sector regulation, if required.

The expected lifetime of the Fund will be 10 years. The government will support renewable energy project development in two ways: 1) through early project development investment, and 2) through an offering of the government’s shares in GEDF to potential investors. The aim of the government is to facilitate development and exit each project with consideration of private investor interests1. The Fund’s initial capitalization will be provided by the Government of Georgia. 1.3.1 Investment in Project Development GEDF will create special purpose vehicles (SPV) for each project. The preferred legal status of each SPV will be a joint stock company listed on the Georgian Stock Exchange. In case of interest from foreign portfolio investors, GEDF can issue GDRs during the IPO. GEDF shall make initial equity investment in the range of 5-10% of total project cost with the objective of selling each renewable energy project at the initial stage of construction. GEDF may be required to inject more funds in a particular SPV if a project could not be sold or if its IPO is postponed for any other reason. SPVs shall carry out all initial development work on a project, namely conceptual design, topographical and geological studies, hydrological calculations, environmental and social impact assessments, land acquisition for construction and impoundment areas for HPP projects, begin detailed project engineering and design, implement infrastructure development (access roads, grid connection, low voltage power supply lines, etc.), obtain all required licenses and permits, begin site construction, submit the Project Design Document (“PDD”) for validation, place orders for hydro-mechanical and electrical equipment, enter into Power Purchase Agreement (“PPA”) with local or foreign counterparty, and other project development activities. An SPV should be able to obtain loans from IFIs and private financial institutions to leverage a project. The preferred approach is project financing. Completion of debt financing will occur once sufficient equity investment is acquired. The debt to asset ratio can be in the range of 50-70%. Upon successful completion of the above, the government can announce an IPO of all or part of its shares in the SPV. 1 GEDF Share Offering Preliminary Prospectus

5


2.0 ECONOMIC TRENDS AND FINANCIAL SECTOR STATUS IN GEORGIA

Georgia is a small country with high skill potential. It has a good track record in sustaining high growth. The IMF in its most recent review under the Stand-By Arrangement it has with Georgia painted a positive scenario, revising GDP growth in 2010 upwards from 2 percent to 4.5 percent, making Georgia one of just a handful of countries that enjoyed this distinction in last year’s global environment. The Economic Intelligence Unit (EIU) raised its own full year forecast for Georgia at least twice and put its latest 2010 growth forecast higher than the IMF, at 5.3%. Remittances to Georgia have also picked up, and there are already indications of a revival of FDI inflows.

Georgia has undertaken major economy wide reforms since early 2000. These have yielded impressive results. Economic expansion averaged ten percent per annum from 2003-2007. The business environment improved drastically, lifting Georgia from #112 in the World Bank’s 2006 Doing Business Index to #11 in 2010. Corruption has also been reduced sharply, and important steps have been taken to reform the role of the state vis-à-vis the private sector.

The shocks from the August 2008 conflict with Russia and the global economic downturn somewhat derailed the government’s well sequenced reform program. Growth slowed to 2.3 percent in 2008, and sank into negative territory in 2009. Progress in trade and transport facilitation halted. Remittances and FDI were reduced. This resulted in the overall economy not measuring up to its potential in competitiveness.

2.1 GEORGIA, REAL GROSS DOMESTIC PRODUCT 2000 TO 2009

In spite of this, Georgia has come through the twin shocks of 2008. While this is partly due to official balance of payments (BOP) support from the IMF, the prognosis for a return to rapid economic expansion is good. This confidence is reflected in the country’s agreement to exit from official BOP support well before repayments peak in 2013-2014.

1.8%

4.8% 5.5%

11.1%

5.9%

9.6% 9.4%

12.3%

2.3%

-4.0%

5.5%

-6.0%-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%

10.0%12.0%14.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Y10III Q

GDP Growth

6


2.2 GEORGIA, ECONOMIC FORECASTS TO 2012

Forecast Summary

2009a 2010b 2011c 2012c

Real GDP growth (%) -3.9 5.3 4.1 5.2 Consumer price inflation (avg) 1.7 7.2 6.9 6.4 Lending rate (%) 25.5 24.3 20.8 20.3 Government balance (% of GDP) -9.2 -6.5 -5.0 -3.4 Exports of goods fob (US$ bn) 1.9 2.4 2.6 3.0 Imports of goods fob (US$ bn) -4.3 -4.9 -5.2 -5.5 Current-account balance (US$ bn) -1.3 -1.3 -1.3 -1.3 Current-account balance (% of GDP) -11.7 -10.9 -10.0 -8.6 Exchange rate GEL: US$ (avg) 1.67 1.78 1.74 1.69 Exchange rate GEL: € (avg) 2.33 2.36 2.18 2.03 Exchange rate GEL: Rb (avg) 0.05 0.06 0.06 0.06

a Actual b Economist Intelligence Unit estimates c Economist Intelligence Unit forecasts

The government is fully cognizant of the need to quickly reestablish the process of reform and all efforts are in this direction.

2.3 STATE BUDGET REVENUES

The government’s fiscal position was much improved over 2010, with state budget revenues rebounding strongly. The EIU reports that Ministry of Finance data shows collections during the first three quarters of 2010 growing by 13.8% year on year, to GEL 3.9 billon (US$2.2 billion). Total tax revenue expanded by a slightly less impressive 10% over the same period. This included a 5.8% gain in revenue from income tax, while the taxation of goods and services expanded by 11.6% year on year, due to higher consumer demand. Revenue from grants increased by 61% in January-September 2010, to GEL 284.2 million (US$160 million).

Expenditure totaled GEL 3.97 billion in the first three quarters of 2010, an expansion of 5.1% year on year. At 28.3% of total spending, social benefits were the largest component of budget expenditure. A small budget deficit, of GEL 59 million, was recorded in January-September 2010, down from a deficit of GEL 342 million in the first nine months of 2009. According to the EIU, this reflects not only the recovery in revenue inflows, but it also indicates a move towards greater fiscal discipline by the government in the second half of the year (i.e. 2010).

2.4 FOREIGN DIRECT INVESTMENT

Continued economic expansion in Georgia is partly predicated on a steady increase in private capital inflows, mainly FDI, which by 2011-2012 should enable the country to return to a path of privately financed high economic growth.

7


The need for resumption of FDI, and particularly of a green field nature, is partly responsible for the commitment to the promotion of private sector development of the country’s hydropower resources.

Georgia has attracted significant amounts of FDI in the past, evenly distributed between Industry, Transport, Construction and other services, while low productive Agriculture has been unable to attract much investor interest to date. There is clear potential for improvement here. Unsurprisingly, overall FDI fell significantly over the second half of 2008 and maintained levels of around US$160 million per quarter in 2009.

The recovery in FDI has been less impressive than other elements of the economy over the first half of 2010 as investors remained reluctant to return to Georgia after the global economic recession. According to preliminary data from the IMF, FDI inflows totaled US$271 million in the first six months of 2010, compared with US$293 million in the same period in 2009. FDI inflows remained substantially below the sum of US$1.14 billion recorded in January-June 2008.

The Netherlands was the most important investor in the first half of 2010, with FDI inflows into Georgia totaling US$85 million, equivalent to 31.3% of total. The next most important sources of FDI inflows were the US, which invested US$41 million, and Japan, which invested US$34 million. The decrease in FDI inflows in the first half of 2010 reduced net FDI’s coverage of the current account deficit to 49%, compared with 64% coverage in January-June 2008.

2.5 FUNDAMENTAL POLICIES AND REFORMS

Georgia has created and continues to strengthen fundamental policies that reflect a forward looking liberalized economic environment for the country.

Broad areas of focus have included a range of opportunities to support efficiency and encourage growth. Some of these include the following.

Rule of Law Property Rights Reduction of the State’s fiscal footprint

o Few, low and flat tax structures o Minimal social security burden for business

Inflation targeting (single digit inflation) Free trade; no customs tariffs or non-tariff barriers Flexible labor market with minimal State interference Limited government

o Aggressive deregulation o Dramatically reduced and simplified licensing o Transparent privatization

Means tested and focused social assistance Lean and efficient civil service sector

8


Georgia’s commitment to driving favorable market conditions in general, is admirable. The country has been recognized over the past several years for its aggressive approach to redefining its economic and financial structure – and its future outlook.

Recognition of Georgia’s reforms are reflected vis-à-vis the following indicators.

World Bank 4th in Ease of Doing Business, 2010

Heritage Foundation 4th in Economic Freedom Index, 2010

Bertelsmann Stiftung 4th in Bertelsmann Transformation Index, 2010

Transparency International 7th in the Global Corruption Barometer, 2009 (EU+Georgia)

Georgia’s continued growth and economic expansion will depend on its ongoing commitment to sound economic principles, and will of course be influenced by larger global economic trends and conditions.

9


3.0 AVAILABILITY OF FINANCING

3.1 THE GEORGIAN BANKING SECTOR

Georgia has a two-tiered banking system. The National Bank of Georgia (NBG) acts as a central bank, regulating banking activities, issuing licenses and supervising all commercial banks. The NBG is independent from legislative and executive authorities, within the limits of the rights granted under the Organic Law of Georgia on The National Bank of Georgia.

In past years the NBG has consolidated the banking sector and instituted reforms comprising increasingly stringent reporting and minimum capital requirements. The NBG’s basic priorities are price and exchange rate stability. The NBG’s strategy focuses on:

streamlining some of the more cumbersome regulations and harmonizing them with Basel principles;

consolidating NBG's functions and independence; refining the payments system; introducing measures to develop capital markets, including for government securities;

and facilitating entry into the Georgian market by foreign banks.

The strategy seeks to stimulate foreign direct and portfolio investments by liberalizing capital flow and the tax system. NBG also supports the implementation of modern risk management systems and corporate governance structures in local banks.

The Georgian banking system comprises 20 banking institutions, of which 18 are resident banks and two are the branches of non-resident banks. The foreign capital operating banking institutions comprise over 90% of the aggregate authorized capital of commercial banks. The share of foreign investments in the authorized capital of the banking system has increased in the recent years and includes investments by international financial and banking institutions such as EBRD, IFC, KfW, DEG, HSBC and Société Générale. The Herfindahl-Hirschman Index is at the top of its moderate concentration limit, and this implies that the sector is dominated by several large banks. The GoG has no stake in any bank.

3.2 FINANCING OPPORTUNITIES

The Georgian financial market is dominated by the banking sector. However, due to the stringent regulation, capital adequacy requirements and limitations on single exposures (see below), the availability of financial resources from local commercial banks for large capital-intensive projects, like HPPs, is limited. Some of the IFIs provide credit (on-lending) facilities for target areas like hydro power development (see below).

10


3.3 RISK CONCENTRATIONS AND BANK LIMITATIONS TO SINGLE EXPOSURES

Although NBG regulation is considered to be prudent and sound, some regulations inhibit financial sector expansion. These include a 200% risk weighting for all foreign currency loans and capital adequacy requirements which limit the availability of lending resources.

Current minimum regulatory requirements set by NBG for commercial banks reflect the limitations to the bank’s exposures.

CR1 (Tier I capital ratio)

≥ 8% of Risk Weighted Assets CR2 (Regulatory capital ratio)

≥ 12% of Risk Weighted Assets

LR1 (Ratio of one insider)

≤ 5% of Regulatory Capital LR2 (Ratio of all insiders)

≤ 25% of Regulatory Capital

LR3 (Ratio of one outsider)

≤ 15% of Regulatory Capital LR4 (Ratio of interrelated borrowers)


LR5 (Ratio of large loans)

≤ 200% of Regulatory Capital LR6 (Ratio of unsecured loans)

≤ 25% of Loan Portfolio

LiqR (Average liquidity ratio)

≥ 20% of Average Liabilities IR1 (Equity investment ratio)

≤ 50% of Share Capital

IR2 (Property investment ratio)

≤ 70% of Share Capital PL1 (Unsecured loan ratio)


PL2 (Total open currency position limit)


3.4 SECURED FINANCING

Any financing procured through the local banking system normally involves secured lending. Unsecured lending through Georgian banks is quite limited. Further, commercial banks normally require a high level of collateralization. More specifically, once the market price of an asset is established, banks take into account market price volatility and liquidity, when deducting value from the asset.

Loans are normally secured by immovable property, business assets, vehicles or shares/stocks in the business/enterprise. Charges on such assets can be registered. In order to secure a loan with assets that can be registered, an interested party enters into a hypothecation or pledge agreement with a lender. This agreement is the registered with the Public Registry38 (or, in the case of vehicles, with the Service Agency of the Ministry of Internal Affairs of Georgia) and such charge is reflected in the registry of the respective asset. Any third party transaction in relation to such asset will be restricted in accordance with Georgian law.

Several charges may be registered for a single asset with corresponding priorities and weights. An underlying collateral asset may be sold, subject to the charge following such sale. This will be the case unless the original obligation is fully covered.

A lender may not levy against collateral in the absence of a legal adjudication or arbitration process. For swiftness, commercial banks normally elect arbitration, which from the enforcement perspective, is more costly.

11


In the event of asset liquidation, by way of an enforcement proceeding (usually by way of a judgment by default or otherwise or by way of a bankruptcy proceeding) the lender conducts an auction which is intended to reflect the asset’s market price. Where the asset is not sold on the first auction, subsequent auctions usually result in a lower sales price. Once a claim is satisfied by the proceeds of the asset sale, the balance is returned to the asset owner.

3.5 BANK GUARANTEES

Obtaining a bank guarantee from a local commercial bank involves procedures identical to those involved in secured financing. Processes are lengthy, but entail less regulatory limitations, as bank guarantees are considered off-balance sheet transactions.

3.6 CURRENCY RESTRICTIONS

No currency restrictions apply to currency operations in Georgia. The Tbilisi Interbank Currency Exchange was abolished in 2009 and today, commercial banks are engaged in daily foreign exchange operations by way of real time trading through Bloomberg terminals. As a result, exchange rates experience intra-day fluctuations. No hedging instruments are currently available in Georgia to reduce foreign exchange risks.

3.7 INTERNATIONAL FINANCIAL INSTITUTIONS

3.7.1 IFI On-Lending Through Local Banks

The energy sector is of key strategic importance to Georgia. It is also high on the agenda of IFIs and donor organizations. From time to time, in collaboration with the local banking system, IFIs establish on-lending facilities for the energy projects, particularly with a focus on the development of the Georgian hydropower sector.

3.7.2 KFW 5.1 Million Euro Renewable Energy Fund

KfW Development Bank has committed a revolving fund of 5.1 million Euro to establish a revolving renewable energy fund in Georgia. The purpose of the fund is to promote investment into renewable energy infrastructure by enabling Georgian financial institutions (i.e. commercial banks) to extend loans to companies to invest in renewable energy projects, and particularly hydro.

12


3.7.3 Future IFI Funding for Hydro Investment in Georgia

The IFI community is active in Georgia – lending for large infrastructure, including roads, railways, power transmission lines, power generation, and water systems. For example, the 1400 MW Enguri power plant is undergoing major rehabilitation with IFI funding.

The IFI community in Georgia includes the following.

International Finance Corporation

European Bank for Reconstruction and Development

Asian Development Bank

German Development Bank

Kreditanstalt für Wiederaufbau

Most IFIs have local offices in Tbilisi, including investment bankers to directly support HPP developers. Representatives from the IFC, ADB, EBRD and KfW have all expressed their intent to support and invest directly into new hydropower projects in Georgia.

KfW Municipal Development Fund (MDF)

Program Banks

Private SHPPs

Supervisory Committee (MEP, MENR, MoF, KfW, UNDP)

UNDP

Advisory Service

Loan

Loan

Loan

13


4.0 GEORGIAN ENERGY MARKET

Over the last 20 years Georgia’s power market has evolved from a vertically integrated single buyer utility, to a competitive regional power market model. The Georgian wholesale power market operates on a bilateral contract basis, and balancing is done by the Electricity System Commercial Operator (ESCO). Georgia is a net exporter of power, with sales to Russia and Armenia, and swap arrangements with Turkey and Azerbaijan. Power export is conducted by and through different market entities. Any Georgian entity can export power from Georgia; no export license is required. The retail power market consists of three distribution companies – which capture both distribution and retail sales. All three are owned and operated by non-Georgian electricity sector investors. Some power generation is owned directly by the distribution companies, and one has a direct energy swap arrangement with a power utility in Turkey. The Dispatch Center of the main transmission company (GSE) schedules and dispatches the high voltage system and coordinates the network/contract flows across international boundaries.

4.1 GENERATION AND CONSUMPTION IN GEORGIA

4.1.1 Consumption and Generation: Key Data Points

Electricity consumption dramatically decreased (approximately 50%) in Georgia at the time of breakup of the former Soviet Union. But electricity consumption increased approximately 2 TWH between 1994 and 2004. Since 2004, electricity consumption has slowly but steadily grown. Electricity consumption in 2010 was slightly above 8 TWH.

Source: Energy Information Administration

0

2

4

6

8

10

12Net Consumption (GWh)

14


4.1.2 Preeminence of Hydropower Generation in Georgia

Hydropower generation dominates the Georgian power market.

Total Generation for 2010 (GWh)

Total Generation 10058 Thermal 683 Hydro total 9375 Hydro with seasonal regulation 6525 Hydro run of river 2533 Hydro <13 MW 317

Source: ESCO The electricity generating capacity in Georgia far exceeds the generating capacity requirement of the country. During several months of the year thermal power production is non-existent. As new hydropower plants are constructed or rehabilitated, the amount of thermal power as a percent of total production is decreasing. In 2010, thermal power production represented only 7% of total electricity production within Georgia. The Government of Georgia would like to eliminate all or nearly all thermal power production by 2020.

Source: ESCO

4.1.3 Generation Tariffs

While newly constructed hydropower plants will be deregulated and be able to sell at the market price, GNEWRC sets tariffs for regulated electricity producers in Georgia based on the following principles.

0.0

200.0

400.0

600.0

800.0

1000.0

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Generation and Net Consumption 2010 (GWh)

Thermal Hydro Net Consumption

15


Tariffs must provide a reasonable return on invested equity sufficient to attract financing

for the construction/reconstruction of assets and the further development of the sector. Energy and capacity losses during transmission/distribution must be reflected in tariffs. Tariffs for each customer group must reflect the actual cost of supplying that group.

Comparatively high cost electricity producers, including TPPs, have a two-tier tariff comprising a capacity payment based on the generator’s fixed costs, and an energy fee that covers costs for each kWh of electricity sold by the company. Lower cost electricity producers, including HPPs, have a single tariff that is calculated as the total annual cost plus return on invested capital, divided by the total generated electricity during the year. The average generation tariff in Georgia is approximately US$0.028/kWh – although it fluctuates widely between US$0.007 for older power HPP plants, and US$0.068 for newer power plants.

4.1.4 Trading, Market Players, Market Formation

The wholesale power market is a direct contract market with a wholesale market entity, ESCO, supporting wholesale trade. As new hydropower plants enter the market, they will have the opportunity to sell to ESCO, qualified consumers (industrial consumers), network operators (to cover energy losses), or to export power directly or sell to an exporter.

Direct Customers

Regulated Tariff Customers*

Retail Consumer

Export Markets***

Electricity Supply Agreements**

Energy Supply Agreements for HPPs greater than 13 MW*

Market Structure

Electricity Supply Agreements**

* HPPs < 13 MW can sell directly to consumers

ESCO

DISCO / Retail Supplier

HPP

** Regulated by GNEWRC *** With an off-take agreement, any market participant can export electricity

The eight largest retail consumers are qualified to purchase power competitively. The distribution companies and the transmission companies are also allowed to purchase power to cover their energy losses.

16


Hydropower plants less than 13 MW can contract to sell power in both the wholesale market as well as to any retail consumer. Hydropower plants greater than 13 MW built after August 1, 2008, have been fully deregulated and are entitled to trade electric power at deregulated tariffs to qualified consumers, ESCO and for export.

4.2 ELECTRICITY SYSTEM COMMERCIAL OPERATOR (ESCO)

The functions of ESCO are as follows.

Purchasing and selling balancing power (capacity) to cover differences between bi-lateral contracts and actual schedules.

Making sufficient medium and long-term contracts on power import and export to assure longer term balancing of supply.

Providing the power system with the reserve capacity under the law – and under the requirements established by the Ministry of Energy and Natural Resources in the Electricity Market Rules.

Providing licensees with information in order to plan their power requirements, and reserve capacity and consumption.

Maintaining a consolidated database for wholesale power trade including the creation of a consolidated accounting registry.

Specifying the quantity of electricity transacted hourly among sellers and buyers, and providing relevant settlement information required for appropriate payment.

According to the Electricity Market Rules, licensed suppliers of electricity and any eligible consumers (currently some of the larger wholesale customers) of electric power may make short- term or long-term direct contracts for the sale and purchase of electricity supply. Contracts must be registered with and scheduled by ESCO, the commercial operator, and the Dispatch Operator. Longer term balancing of electric power trade – when not covered by bilateral contracts – is carried out by ESCO. ESCO balances the difference between the actual consumption and the amount of electric power specified by direct contracts between suppliers or eligible customers, and producers. The Dispatch Operator, part of the GSE transmission system, is responsible for reliability of system operations.

4.3 BRIEF OVERVIEWOF TRANSMISSION AND DISTRIBUTION

4.3.1 Distribution and Retail Power Market

Three distribution companies provide most of the retail sales.

Telasi Distribution Company, JSC, covering the region in and near Tbilisi Kakheti Distribution Company, covering the eastern part of Georgia Energo-Pro Distribution Company, covering Central and Western Georgia, excluding

the regions of South Ossetia and Abkhazia

17


Georgian legislation allows that retail consumers above 7 GWh annual electricity purchases can negotiate power agreements with power producers and importers. There are eight qualified retail consumers and each purchases power from power producers.

Consumption (TWh)

2007 2008 2009 2010

Distribution Companies 5.80 6.01 5.93 6.36 Telasi 1.90 1.90 1.86 1.95 Abkhazia 1.26 1.27 1.36 1.38 Energo-Pro 1.50 2.62 2.48 2.80 Kakheti Energy Distribution 0.20 0.23 0.23 0.24 GSE 0.95 0.00 0.00 0.00 Direct Customers 2.01 2.06 1.71 2.08

Source: ESCO

4.3.2 Transmission and Dispatch

The transmission company is owned by two entities – the Georgian State Electrosystem which owns 500 kV substations, the 220 kV network and several facilities down to 35 kV, and SakRusEnergo which owns the existing 500 kV lines. The new 500 kV network under construction is owned by EnergoTrans, a subsidiary of GSE. Scheduling and dispatching of the network is performed by the Dispatch Center of GSE. The Dispatch Center also balances the system. Information on the scheduled and actual production from each power plant is recorded hourly and passed along by Dispatch Center to ESCO. In turn, ESCO calculates a monthly settlement for each market member that includes power purchases, and sales and balancing charges.

Transmission, Dispatching and Wheeling Tariffs (US¢)

Voltage 0.4 kV 6-10 kV 35-110 kV 220 kV 500 kV Eenergo-Pro 1.957 1.408 0.693 Telasi 1.957 1.408 0.693 Kakheti 1.957 1.408 0.693 GSE Transmission

0.603 0.272 0.272

GSE Dispatch 0.082 0.082 0.082 0.082 0.082 SakRusEnergo 0.098 0.098 0.098 0.098 0.098 EnergoTrans Tbd

Source: GNEWRC Section 8 of this Memorandum contains additional information on the transmission sector.

18


5.0 HYDROPOWER SECTOR IN GEORGIA

5.1 HISTORY

Generation of electricity in Georgia began in 1887 – when thermal generation was installed at the Georgian Drama theatre. The first hydropower plant (103 kW) was built in 1898 in the Borjomula gorge, near Borjomi.

By the end of 1913 there were seven small hydropower plants and a number of thermal power plants in Georgia, with combined capacity of 9 MW and annual production of almost 126,000 kWh. Over the next two decades three additional hydropower plants were built – Avchala HPP in 1927, Abasha HPP in 1928 and Rioni HPP in 1934.

By 1941, the total combined capacity of Georgia’s power generation (HPP and TPP) reached 180 MW. From 1945-1960 11 new hydropower plants were put into operation. In 1978 the Enguri HPP was brought online – with installed capacity of 1300 MW.

Electricity generation in Georgia is dominated by hydropower plants. Thermal power generation and electricity imports are steadily declining. TPPs are expected to continue to lose their competitiveness to more cost efficient HPPs. The long-term energy policy of the Georgian government envisages a near full substitution of TPPs with HPPs.

Total installed capacity of HPPs in 2010 stands around 2700 MW. TPPs account for approximately another 700 MW. The country’s peak load during the winter has approached 1750 MW. During summer it has dropped to 1200 MW.

HPPs in 2010 accounted for roughly 93% of the country’s electricity supply. TPPs generated around 7%2.

In 2010 Enguri HPP generated around 46% of the country’s total hydropower generation. The country’s other HPPs provided an additional 54% – some generated electricity throughout the year; others operated seasonally3.

5.2 GROWTH POTENTIAL

Water is a primary natural resource in Georgia. The country’s water resources – rivers, lakes, water reservoirs, ice, underground water, bogs – rank among the most abundant in the world.

By absolute indices of potential hydro resources, Georgia is fourth among CIS countries after Russia, Tajikistan, and Kazakhstan. By concentration of potential hydro resources, Georgia is one of the top territories in the world. With 60,000 km of rivers and a combined annual fresh water supply of 96.5 km3, the country ranks atop the world’s hydropower resources per-capita.

2 Electricity System Commercial Operator (ESCO) 3 ESCO

19


Georgia’s hydropower potential is largely undeveloped. Currently only 25% of total generation potential is realized. Hydroelectric generation will continue to play a major role in Georgia’s energy policy and planning for the foreseeable future.

Georgia’s hydro resources are concentrated in the western part of the country, where only the Enguri and Rioni Rivers have been aggressively exploited. Together, Georgia’s strategic location in the Caucasus region, vigorous energy sector reforms, and government policies create a range of new opportunities in the hydropower sector.

5.3 LONG-TERM ENERGY POLICY (ROLE OF RENEWABLE ENERGY)

In December 2005, the Georgian Parliament resolved that the Ministry of Energy and Natural Resources would draft a new energy policy to direct development of the sector. The policy was presented to Parliament and subsequently adopted on 7 June, 2006, as Resolution of the Parliament of Georgia on “Main Directions of State Policy in the Power Sector of Georgia.”

The government’s policy prioritizes full satisfaction of industrial and domestic demand, full utilization of energy resources existing in the country, and diversification of energy supply. An end goal of these objectives is achievement of economic independence and sustainability for the sector, and provision of energy security for the country. A primary objective within the country’s energy policy is increased generation through local hydropower.

Policy emphasis focuses on improvement of energy sector reliability and security, as follows4.

Refurbishing and rehabilitation of existing facilities

o Rehabilitation of existing hydropower plants

o Rehabilitation and upgrading of existing thermal power plants

o Rehabilitation of existing connections with neighboring countries

o Rehabilitation of the high voltage transmission network and dispatch control system

Construction of new facilities

o Deregulation of small HPPs (<13 MW)

o Phasing out thermal generation and imported power in base load, and replacing with hydro generation for base load demand – including new HPPs

o Use of alternative energy resources in a way that places traditional and alternative energy resources on an even playing field

4 Ministry of Energy and Natural Resources of Georgia

20


o Providing reserve high-voltage transmission capacity on lines connecting West and East Georgia to ensure energy system stability and security

o Construction of new high-voltage power transmission lines to neighboring countries

o Operation of the electricity grid in parallel mode with those of neighboring countries whenever technically feasible

o Expansion of the Trans Caucasian Energy Corridor

Provision of reserve capacity, by mandating that all wholesale buyers of electricity maintain (purchase) reserve capacity of at least:

o 10% during 2006-2009 - from domestic or imported sources

o 10% during 2010-2012 - including at least 50% from domestic sources

o 10% during 2013-2015 - entirely from domestic sources

o 15% during 2016-2019 - entirely from domestic sources

Improved metering by installing full metering at the level of communities, to be followed by complete individual metering by electricity distribution companies

Attraction of domestic and foreign investment

o Developing the appropriate legal and economic environment for attracting investment

§ Reduction of the number of required licenses and permits

§ Simplification of the procedures for issuing licenses

§ Deregulation of power plants commissioned after the January 1, 2007

o Implementing a transparent privatization process in the energy sector and ensuring reliable power supply to end consumers

o Defining and differentiating the rights and responsibilities of stakeholders (government and investor) involved in the privatization process

Achieving economic stability of the sector

o Liberalization and deregulation of the sector, and development of competition

o Restructuring commercial and economic relations

§ Introduction of direct contracts between power generators and wholesale electricity buyers

21


§ Implementing debt settlement measures to relieve the energy sector of debt accumulated in previous years

§ Enforcement of Electricity Market Rules

Developing and implementing sound tariff policies, including tariffs that protect consumers from monopolistic pricing, and at the same time ensuring long-term electricity system development in a financially and technically feasible manner.

o With this aim, tariff policy for various consumers might foresee the following.

§ Seasonal tariffs

§ Peak magnitude tariffs

§ Step tariff (based on consumed volumes)

§ Long-term preliminary fixed tariffs (including marginal)

§ Marginal tariffs

o Seasonal and peak load tariffs (24 hour) should be based on the principal of neutrality (application should not be mandatory and should be by mutual agreement between the seller and the consumer)

o The use of neutral step tariffs (based on consumption volumes), long-term pre-set tariffs, and marginal tariffs will be mandatory for electricity sellers and their consumers – except for customers connected to communal meters

o Electricity generation tariffs should be gradually deregulated

o Tariffs should reflect different service costs for different categories of customers

Promoting bilateral and regional cooperation

o Electricity exchange with power systems of neighboring countries

o Long-term cooperation with electric system operators of neighboring countries in order to support surplus electricity export, and imports as may be required

o Initiate harmonization and implementation of the relevant legal framework in order to create a regional power market

o Promote the geographic advantage of Georgia as an effective energy corridor

o Development of energy and energy transportation infrastructure between Europe and Asia, using East-West and North-South energy corridors

o Ensure diversification of natural gas and electricity sources

22


Third party access to the transmission and distribution network

According to the country’s energy policy, electricity consumers have the right to purchase electricity from any seller if a consumer’s annual demand is as follows5.

2006-2009 ≥ 30 GWh/Year 2010-2012 ≥ 7 GWh/Year 2013-2015 ≥ 3 GWh/Year 2016-2017 ≥ 1 GWh/Year 2017 1 kWh

The Government of Georgia developed the State Program for Renewable Energy of 2008 (the “RE Program”) for small- and medium-sized hydropower plants (<100 MW) and has initiated competitive tender procedures for large hydropower plants (>100 MW) in order to support investments in the sector. All new “greenfield” sites for HPPs are awarded to investors on a Build-Own-Operate basis.

Georgia has demonstrated its commitment to attracting foreign investment, especially in the energy sector. Reforms and other institutional developments demonstrate the government’s commitment to creating and supporting an enabling environment for energy sector investors.

The Georgian National Investment Agency at the Ministry of Economy and Sustainable Development, and the Investment Project Department at the Ministry of Energy and Natural Resources are available to facilitate investor interests and help establish mutually beneficial relationships.

5.4 MAJOR ACHIEVEMENTS

Consistent with the government’s energy policy, the Ministry of Energy and Natural Resources is actively promoting and supporting investment in Georgia’s hydropower sector. By the end of 2010 there were five hydropower projects under development.

To facilitate investment in the renewable energy sector, and in order to enhance the country’s value proposition for investors, the government, in 2010, established the Georgian Energy Development Fund.

The role of the fund is as follows.

Study potential “greenfield” hydropower plant development sites, including river-basin planning, and update the Ministry of Energy and Natural Resources’s development site list

Jointly (with private investors) develop strategically important projects with an exit option for the fund at various stages of development


23


Finance initial costs for the development of a project

Facilitate capital and loans from international financial institutions and/or private financial entities for the development of a project

Support investors in risk mitigation associated with the development of a project

Advise the Ministry of Energy and Natural Resources regarding amendments to regulations as required

In 2010, Georgia’s net electricity exports reached record high volumes of approximately 1300 GWh6. The country has gradually established itself as a net electricity exporter in the region – a major achievement given that little more than five years ago it was heavily dependent on electricity imports.

Source: ESCO

In addition to a steadily increasing trend in electricity exports, Georgia has made substantial progress in increasing hydropower generation and eliminating thermal power generation across the country. In 2010, hydropower generation represented around 93% of the country’s total generation. Georgia’s goal is to become a 100% renewable energy producer and exporter in the near future.


-400

0

400

800

1200

1600

2006 2007 2008 2009 2010

Net Exports (GWh)

24


Source: ESCO

The Government of Georgia launched the Black Sea Transmission Network Project (BSTNP) in 2010, which is the largest infrastructure project currently under construction in Georgia.

The project will add 300 km of high-voltage transmission line across southern Georgia – connecting the Georgian transmission grid to the Turkish grid.

The Government of Georgia, The European Bank for Reconstruction and Development, the European Investment Bank, the European Union Neighboring Investment Facility, and the German Kreditanstalt für Wiederaufbau financed the project. Construction began in 2010.

The USAID-funded Hydropower Investment Promotion Project was launched in 2010 to support market-based initiatives to stimulate and secure international investment in Georgia’s small- and medium-sized hydroelectric power market. Key activities include the following.

Developing Quality Engineering and Technical Information

Providing Targeted and Effective Investor Outreach and Promotion

Supporting Institutional Strengthening and Capacity Building

Partnering Programs and Opportunities to Stimulate Investment

Kreditanstalt für Wiederaufbau signed the first project loan out of KfW’s Renewable Energy Fund of Georgia in June, 2010. The fund is designed to provide long-term loans to allow investments in hydropower plants with an installed capacity of up to 10 MW. The fund’s goals are to increase hydropower generation in Georgia and keep expensive, non-renewable generation to the minimum, further promote the private sector in Georgia, to develop the banking sector, to ensure Georgia's continued economic growth, and to protect the environment and the climate.

80%

84%

88%

92%

96%

2008 2009 2010

Share of Hydropower in Generation

25


6.0 REGIONAL ENERGY MARKETS

This section is framed on four brief overviews of electricity markets in Armenia, Azerbaijan, Russia and Turkey. Each of the section’s four subparts ends with preliminary conclusions on the viability of exporting Georgia’s hydropower to these countries. The overarching goal of this section is to contextualize the Georgian hydropower market and to present a factual and compelling case for investment therein. Over the past several years, Georgia has been a net exporter of electricity, and economic growth within the greater Caucasian region will most likely accelerate this trend. Rapidly expanding markets throughout Turkey will, for example, require its own domestic energy sector to double production by 2020. Other contiguous countries may continue to look to Georgia for power as consumption outstrips their available domestic supply.

Source: ESCO

As seen above, Georgia has, in increasingly larger amounts, supplemented the power appetites of each of its four immediate neighbors – Russia, Azerbaijan, Armenia, and Turkey. Such consistent outward flows are underpinned by Georgia’s extensive high-voltage networks, which extend into each of these countries and are connected synchronously to Russia and Azerbaijan. In light of its robust growth and resilience in the face of recent macroeconomic headwinds, Turkey stands out as the most attractive export market for Georgian hydropower. As such, the GoG continues to invest significant resources in existing and new high-voltage transmission lines into Turkey. Moreover, in September 2010, Turkey joined the European Network of Transmission System Operators for Electricity (former UCTE), which will eventually enable Georgia to access electricity markets in mainland Europe.

0

50

100

150

200

250

300

Georgia's Electricity Exports 2006 - 2010 (TWh)

Russia Azerbaijan Armenia Turkey

26


6.1 ARMENIA

6.1.1 Geography and Climate

Armenia is a landlocked country situated roughly between the Black and Caspian Seas and along Georgia’s southeast border. It borders Azerbaijan to the east, Iran to the south and Turkey to the west. Armenia’s climate is primarily continental, and thus has relatively traditional seasons: hot summers and cold winters. Its area of 29,743 square kilometers of mountainous land is written over by an extensive network of rivers and patches of thick forests. Armenia’s lands rise to 4,430 meters above sea-level at the historic Mount Aragats, and no point falls lower than 390 meters.7 28 rivers and streams feed Lake Sevan, one of the highest altitude lakes in the world and a critical component to Armenia’s energy economy.

6.1.2 Political Overview

Armenia maintains friendly relations with both Western powers and Iran and Russia, and in so doing embraces a foreign affairs doctrine of complementarism. However, relations between Armenia and its immediate neighbors Turkey and Azerbaijan remain strained due to conflicting views of the Armenian Genocide of 1915, as well as by the separation by ethnic Armenians from Azebaijan in the territory of Nagorno Karabagh. Nonetheless, Armenia is a member of more than 40 international organizations, including the United Nations, the Council of Europe, the Asian Development Bank, the Commonwealth of Independent States, the World Trade Organization, World Customs Organization, and the Organization of the Black Sea Economic Cooperation. It is a member of the CSTO military alliance, and also participates in NATO's Partnership for Peace (PfP) program.8 Armenia is also an observing member of the Eurasian Economic Community and the Non-Aligned Movement. The country is also viewed as a strong emerging democracy, and is currently in negotiations with the European Union, of which it may become an Associate Member in the near future. Like many Eurasian states, the Government of Armenia holds European integration as a key priority in its foreign policy.9

6.1.3 Economy

Armenia has experienced relatively strong economic growth since the mid 1990s, building consistently on the turnaround that began in 1993. Moreover, inflation has been negligible for the past several years. New trade sectors such as precious stone processing and jewelry making, information and communication technology, and even tourism are beginning to supplement more traditional facets of the economy, such as agriculture, which, in the late 1990s, accounted for approximately 30% of GDP.

7 "Geographic Characteristic of The Republic of Armenia". Marzes of the Republic of Armenia in Figures, 2002–2006. National Statistical Service of the Republic of Armenia. 2007; accessed online on 15 February 2011 8 http://www.panarmenian.net/eng/politics/news/24261/; accessed 15 February 2011 9 http://www.armradio.am/news/?part=pol&id=18723; accessed 15 February 2011

http://www.panarmenian.net/eng/politics/news/24261/

http://www.armradio.am/news/?part=pol&id=18723

27


As the graph below shows, Armenia’s GDP has grown consistently over the past several years and, by most estimates, recovered admirably after being buffeted by a global economic downturn in 2008 and 2009.

Source: International Monetary Fund, World Economic Outlook Calendar, 2010

Such steady economic progress has earned Armenia increasing support from international institutions. As evidence of faith in Armenia’s underlying fundamentals, The International Monetary Fund, World Bank, European Bank for Reconstruction and Development, and other IFIs continue to extend Armenia considerable grants and loans. In fact, loans to Armenia since 1993 exceed USUS$1.1 billion. These loans are targeted at reducing the budget deficit; stabilizing the currency; developing private businesses; developing energy, agriculture, food processing, transportation, and health and education sectors; and ongoing rehabilitation in the earthquake zone.

6.1.4 Energy Sector10

6.1.4.2 Overview and Organization

In 1995, Armenia unbundled the monopolistic energy company Armenergo into several separate companies. In addition to unbundling reforms, Armenia has also created:

Separate power generators, most of which are privately owned; A single, privatized distribution company, Energy Networks of Armenia; A high-voltage transmission company, “High Voltage Grids CJSC”; A power system operator, “Power System Operator CJSC”; and The creation of a center for settlement of accounts.

10 Portions of the section describing the energy sector in Armenia draw on information presented in the 2007 GoG-commissioned Econ-Poyry report entitled, “Potential export markets for Georgian electricity”.

-20.00%-15.00%-10.00%-5.00%0.00%5.00%

10.00%15.00%20.00%

GDP as Real Growth Rate in Armenia 2002 - 2011

28


The distribution company remains, for all intents and purposes, the single buyer of electricity in the country and contracts directly with the generation companies, the grid and the system operator. The distribution company was privatized in 2001, after being sold to a UK-registered trading firm, Midland Resources Holding. Midland subsequently sold its shares in September 2006 to Interenergo BV, a subsidiary of Russia’s United Energy Systems (RAO UES), although UES had been de facto owner since June 2004 under a management contract with Midland. Russian companies also currently control about 80% of generating capacity. UES owns Sevan-Hrazdan Cascacde, a series of hydropower stations (550 MW), providing management services for Armenia’s nuclear power plant (408 MW). Over the past several years, Armenia has experienced modest increases in electricity consumption. Natural gas-fired heating has reduced residential consumers’ dependence on electric heating, while, at the same time, demand for electric air conditioning has increased during summer months. Based on data from the U.S. Energy Information Administration, the following two charts depict energy generation, consumption, and total generation production in Armenia from 2002 to 2008.

Source: U.S. Energy Information Administration

6.1.4.3 Government Policy and Regulation

Today, Armenia’s Ministry of Energy and Natural Resources maintains overall policy responsibility for the electricity sector. In conjunction with the power-sector reforms begun in 1995, the government created an independent regulator, the Armenian Energy Regulatory Commission. Renamed as the Public Service Regulatory Commission, the energy regulator now has more than a decade of experience and has won the confidence of several major donors, including the World Bank and USAID. Many cite the energy regulator’s creation and it alleged degree of independence as models for other emerging energy markets.11

11 Sargsyan, Gevorg, Ani Blabanyan and Denzel Hankinson. From Crisis to Stability in the Armenian Power Sector. The World Bank Group, 2006; accessed online, 14 February 2011

01234567

Electricity in Armenia 2002 - 2008

Consumption (GWh) Generation (GWh)

29


In the early 1990s both Turkey and Azerbaijan imposed a trade blockade on Armenia due to conflicts related to Nagorno-Karabakh – the landlocked, de facto independent state populated by ethnic Armenians that exists within Azerbaijan’s borders. Consequently, Armenia lost its main source of natural gas from Azerbaijan, and became inextricably reliant on existing hydropower capacity, which drew down, at a rapid pace, the water levels on Lake Sevan. The gas cut also led to Armenia’s decision to refurbish and restart one unit of its nuclear power plant, which had been shuttered since 1989 following the Spitak Earthquake a year before. At a higher level, the blockade also led the Armenian government to shift part of its economic development strategy to a renewed focus on energy independence. However, even without large imports of electricity, Armenia continues to rely on imported natural gas and nuclear fuel to generate power.

6.1.4.4 Interconnections and Trade

Armenia has interconnections with all of its neighbors, although only those with Georgia and Iran are currently in operation.12

Azerbaijan o 330 kV out of commission o 220 kV out of commission o 2 x 110 kV out of commission

Georgia o 220 kV o 2 x 110 kV

Turkey o 220 kV out of commission

Iran o 2 x 220 kV o 400 kV under construction

6.1.4.5 Energy Trade with Georgia

Unofficially, Georgia is reported to import about 50 MW from Iran via Armenia during winter months. This is expected to increase to 350 MW following the completion of new high-voltage lines. The table on the following page reflects available data from the Georgian ESCO on Georgia’s electricity exports to Armenia during the period spanning September 2006 – December 2010.

12 http://www.inogate.org/index.php?option=com_inogate&view=countrysector&id=8&Itemid=63&lang=en; accessed 17 February 2011

http://www.inogate.org/index.php?option=com_inogate&view=countrysector&id=8&Itemid=63&lang=en

30


Source: Government of Georgia ESCO

6.1.4.6 Preliminary Conclusions on the Feasibility of Georgian Exports to Armenia

Given a general surplus of hydroelectricity and a staunch policy emphasis on self-sufficiency, major export opportunities to Armenia do not appear promising, especially if hydro power plant development in Armenia continue and/or replacement nuclear is built.

6.2 AZERBAIJAN


Its eastern maritime border with the Caspian Sea, a range of Caucasus mountains to the north, and flatlands among its central provinces create in Azerbaijan another strikingly diverse set of geographies and climates. Indeed, Azerbaijan is home to nine of the world’s existing 11 climate zones with temperatures ranging from −33°C to 114.8 °F. A vast network of more than 8,000 rivers dominates Azerbaijan’s geography, yet, curiously, Azerbaijan is below world averages for annual rainfall. Azerbaijan shares contiguous borders with Armenia, Iran, Russia, Turkey, and Georgia, which makes the country another critically important part of the Eurasian energy corridor.


Many scholars cite Azerbaijan as the first successful attempt to establish a democratic and secular republic in the Muslim world.13 Today Azerbaijan exists as a unitary republic the majority of whose population are Turkic and Shi‘ite Muslims. Azerbaijan is one of the six independent Turkic states and has diplomatic relations with 158 countries as well as membership in 38 international organizations. 13 Reinhard Schulze. A Modern History of the Islamic World. I.B.Tauris, 2000.

0

5

10

15

20

25

30

Georgia's Energy Exports to Armenia (GWh)

31


Azerbaijan is one of the founding members of GUAM and the Organization for the Prohibition of Chemical Weapons; in September 1993 Azerbaijan joined the Commonwealth of Independent States. On 9 May 2006 Azerbaijan was elected to membership in the newly established Human Rights Council by the United Nations General Assembly. Azerbaijan is also a member of the United Nations, the OSCE, the Council of Europe, and the NATO Partnership for Peace program.14

6.2.3 Economy

After gaining independence in 1991, Azerbaijan became a member of the International Monetary Fund, the World Bank, the European Bank for Reconstruction and Development, the Islamic Development Bank and the Asian Development Bank. The banking system of Azerbaijan consists of the Central Bank of Azerbaijan, commercial banks and non-banking credit organizations. The National (now Central) Bank was created in 1992 based on the Azerbaijan State Savings Bank, an affiliate of the former State Savings Bank of the USSR. Azerbaijan’s Central Bank is empowered to issue the national currency, the Azerbaijani manat, and to supervise all commercial banks. Two major commercial banks are the state-owned International Bank of Azerbaijan and the UniBank. Early in the 21st Century chronically high inflation was brought under control, which led to the issuance of a new Azerbaijani manat. Made official on January 1, 2006, the move was said to cement the acquisition of economic reforms and erase the vestiges of a wildly volatile economy. In 2008, Azerbaijan was cited as one of the top 10 reformers by the World Bank's Doing Business Report.15 Azerbaijan led the world as the top reformer in 2007 – 2008, with improvements in seven out of 10 indicators of regulatory reform. In January 2008, Azerbaijan began operating a one-stop shop aimed at halving the time, cost and number of procedures required to start a business. Within its first six months of operation, business registrations increased by 40%. Azerbaijan also eliminated the minimum loan cutoff of US$1,100, more than doubling the number of borrowers covered by the credit registry. Further, taxpayers can now file forms and pay taxes online. Azerbaijan’s extensive reforms launched the country from 97 to 33 in the World Bank’s rankings for ease of doing business. Azerbaijan is also ranked 57th in the Global Competitiveness Report for 2010–2011, which exceeds that of CIS peers.16 Despite the recent economic slowdown, Azerbaijan’s economy continued to grow by approximately 5% in 2010 with nominal GDP increasing by an impressive 53.3% on an annualized basis. Azerbaijan’s economy is again expected to see positive growth again in 2011.17

14 http://en.wikipedia.org/wiki/Azerbaijan; accessed 14 February 2011 15 World Bank Group. "Top 10 reformers from Doing Business 2009"; accessed 13 February 2011. 16 "World Economic Forum - The Global Competitiveness Report 2010-2011" (PDF); accessed 14 February 2011 17 http://www.freshplaza.com/news_detail.asp?id=70309; accessed 14 February 2011

http://en.wikipedia.org/wiki/Azerbaijan

http://www.freshplaza.com/news_detail.asp?id=70309

32


Source: International Monetary Fund, World Economic Outlook Calendar, 2010

6.2.4 Energy Sector18

6.2.4.1 Overview and Organization

Electricity imports into Azerbaijan are contracted through the integrated publicly owned electricity utility, Azerenergi. However, the government foresees allowing private investment into the generation sector, and expects that a significant percentage of generation may be in private hands by 2015. This could be via sale of existing assets, concessions or new IPPs. Today, the peak power demand in Azerbaijan is far more than the combined peak loads of Armenia and Georgia. Moreover, retail sales have grown significantly due to a state policy of keeping retail power tariffs low. In 2007, the distribution network was subdivided into five regional grids. (The grid for connecting the Nakhchivan Autonomous Region, which is not contiguous with the rest of Azerbaijan, is isolated from the main grid.) The other four grids were placed under 25-year concession agreements in 2002 and 2003, though two of these were terminated at the end of 2006. The Baku High Voltage Electrical Equipment Company was awarded concessions to the Ali-Bayramli and Gandja networks. Barmek Holding, a Turkish firm, was awarded the Baku and Sumgayit distribution networks. According to the 2007 ECON-Poyry report, Azerbaijan’s public prosecutor opened an investigation into Barmek in early 2006 over alleged exaggerated reporting of infrastructure investments, among other claims; Barmek was subsequently stripped of its concessions. The Government of Azerbaijan continues to invest aggressively in order to increase power capacity (hydropower and gas-fired) and to improve the reliability of the distribution networks.

18 Portions of the section describing the energy sector in Azerbaijan draw on information presented in the 2007 GoG-commissioned Econ-Poyry report entitled, “Potential export markets for Georgian electricity”.

0%5%

10%15%20%25%30%35%40%

GDP as Real Growth Rate in Azerbaijan

33


In particular, Azerbaijan has planned significant upgrades to transmission interconnections with Georgia. Additionally, Azerbaijan, Georgia and Turkey recently signed the so-called AGT Memorandum of Understanding, which established the framework that will govern how energy from Azerbaijan will be sold to Turkey via the new Black Sea Transmission Network Project during winter months when power production in Georgia is consumed domestically.

Source: U.S. Energy Information Administration

6.2.4.2 Government Policy and Regulation

In 2007, the main policy-making bodies in Azerbaijan’s power sector were the Ministry of Economic Development (MED) and the Ministry of Industry and Energy (MIE). The MED was vested with broad policy-making responsibilities, including licensing, pricing, and management of fixed assets. The MIE, which also controlled policy in the oil and gas sector, appeared to be chiefly concerned with generation and transmission. At the time, the Tariff Council oversaw monopoly services for electricity, gas and water. In 2007, the MED and MIE were represented on the Tariff Council, which, at the time, was chaired by the Minister of Economic Development and received technical and administrative support from MED. At a high level, the Tariff Council recommended tariffs, which were reviewed by the Council of Ministers prior to final approval by the Office of the President. Some of the legislative successes in the sector resulting from such assistance include the:

Law on Power Engineering (1998), Law on Energy (1999), Law on the Use of Energy Resources (1996), and Law on the Protection of Foreign Investments (1992)19.

19 http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2005/06/20/000160016_20050620104718/Rendered/PDF/323710AZ.pdf; accessed 14 February 2011

0

5

10

15

20

25

Consumption and Generation in Azerbaijan 2002 - 2008

Consumption (GWh) Generation (GWh)

http://www-

34


6.2.4.3 Interconnections and Trade

While under Soviet rule, Azerbaijan was connected to the power systems of its neighboring Soviet republics and to Iran. Today, its grid is connected to the following.

Georgia o 500 kV out of commission o 330 kV o 35 kV o 10 kV

Turkey o 154 kV o 34.5 kV

Iran o 230 kV o 132 kV o 10.5 kV

6.2.4.4 Energy Trade with Georgia

During the 2006-2007 period, Georgia and Azerbaijan exchanged power on a seasonal and sometimes a daily basis. For example, during part of 2006/2007’s peak winter hours, the two countries arranged a swap whereby Georgia imported some 1.9 GWh daily at 150 MW, under the assumption that Georgia would send an equivalent amount to Azerbaijan during the summer. There have also been recent deals by which Georgia transfers electricity to Azerbaijan at night and Azerbaijan returns the same amount during the day.

Source: ESCO

05

10152025303540

Electricity Exports to Azerbaijan (GWh)

35


6.2.4.5 Preliminary Conclusions on the Feasibility of Georgian Exports to Azerbaijan

The most recent data available suggest that electricity production in Azerbaijan today far outpaces national consumption. Azerbaijan’s plans to continue to increase domestic generation capacity, reported uncertainties on the elimination of electricity subsidies, and the prospect of a glut of cheap domestic gas (both to fuel electricity production and provide a substitute for electricity) further dampen the prospects of electricity export into the Azeri market.

6.3 SOUTHERN RUSSIA20

6.3.1 Overview and Organization

As of late 2007, the Russian electricity sector had been enmeshed in substantial restructuring efforts, led by the government-owned former electricity monopoly, RAO United Energy Systems (UES). Guided by a strategy articulated in government resolution No. 526 of 11 July 2001, and in principles laid out in a set of Federal laws in 2003, UES aimed to create a competitive and largely privatized electricity sector. However, while nominal reform began in 2002, structures did not begin to change shape until 2006. At the time, the basic task laid out before the Russian electricity sector was to take the 70+ regional, vertically-integrated monopolies (“energos”), which were under the management and ownership of UES, divide them into generation, transmission, distribution and dispatch functions, and re-form the components into several larger, single function entities. Large generation and transmission assets owned directly by UES were also included in the restructuring process, and most of the new companies were bound for the Russian stock exchange, using IPOs fund raising mechanisms. Division and re-formation of company components into new company groups was complicated by the fact that many regional “energos” already possessed a degree of private (or at least non-UES) ownership, thus making protection of minority shareholder rights a contentious issue. Political instability in the Russian Caucasus, which continues to this day, led to delays in restructuring efforts. However, despite roadblocks, ECON-Pyory’s comprehensive 2007 report notes that the following types of companies had been or were in the process of being created within the Russian Caucasus:

Six wholesale generation companies – OGKs. The sixth OGK, HydroOGK, was intended to amalgamate all major regional hydropower assets, while being kept under government control. OGKs with assets in the Russian Caucasus region are HydroOGK, OGK-2, and OGK-7.

Fourteen territorial generating companies – TGKs. These entities were to be based on the generating units of regional energos. TGK-8 will operate in the Russian Caucasus.

20 Portions of the section describing the energy sector in Southern Russia draw on information presented in the 2007 GoG-commissioned Econ-Poyry report entitled, “Potential export markets for Georgian electricity”.

36


Seven inter-regional transmission grid companies, which will operate under the Federal Grid Company, FGC. OES Yuga covers the territory adjacent to Russia’s neighbors in the Caucasus and corresponds roughly to the territory of TGK-8.

Eleven to twelve inter-regional distribution companies – or MRSKs. These entities were scheduled to be formed in 2008 from the distribution assets of the energos. They were originally planned as four MRSKs, but in early 2007 it was decided to expand to 11 or 12, apparently to satisfy a number of key minority shareholders in the energos.21

In 2007, the inter-regional distribution company closest to Russia’s southern border in the Caucasus was MRSK North Caucasus, which was, essentially, the successor to “Southern Grid Company”. MRSK North Caucasus is significant in that it was seen by some as a major potential buyer of Georgian hydropower exports.

6.3.2 Government Policy and Regulation

In 2007, Russia’s Federal Energy Agency, a subdivision of the Ministry of Industry and Energy, had overall policy-making responsibility for the energy sector, including electricity. At the time, the Ministry’s Federal Agency for Technical Regulation and Metrology dealt with technical regulation in the power sector. Strategic and tactical aspects of the reform process were handled by the Reform Committee under the Board of Directors of RAO UES. The regulator for transmission tariffs and regulated generation tariffs was the multi-sector Federal Tariff Service, while retail tariffs were regulated by Regional Energy Commissions. Today, the goal of the government remains to steadily increase the amount of (unregulated) electricity traded on the wholesale market and decrease the role of regulated bilateral contracts.

6.3.3 Interconnections and Trade

Current information shows that Russia’s OES Yuga (“South”) grid has the following major interconnections to its sovereign Caucasian neighbors.

Georgia o 220 kV o 500 kV o 2 x 110 kV one is out of commission

Azerbaijan o 330 kV o 330 kV under construction

6.3.4 Preliminary Conclusions on the Feasibility of Imports from Georgia

The Southern Region of Russia is generally understood to occupy the territory above Georgia between the Black Sea, the Caspian Sea, and Turkmenistan. Up to 500 MW of electricity flows each hour from the Enguri Hydropower plant in Georgia to the southern region of Russia.

21 http://www.rzbfiles.at/russiannetworks.pdf; accessed 14 February 2011

http://www.rzbfiles.at/russiannetworks.pdf

37


The Southern Russian power market initiated competition between generators and large consumers several years ago as part of the so-called Russian “5-15% capacity market”. Today, the competitive power market across Russia has increased in volume and is expected to continue to trend positively for the next several years. Further, the Southern Region of Russia has experienced a recent wholesale price increase making it the highest priced market in Russia. The Caucasus region of Russia is currently in deficit and imports power from other regions, as well as from Ukraine, Azerbaijan and Georgia. Further, expected increases in demand growth appear to be outpacing plans for capacity expansion. Thus, Russia remains a promising export market for Georgian hydropower. Good links to Ukraine and to the rest of Russia will, however, provide healthy competition in this potential export region.

6.4 TURKEY


Turkey shares national borders with Bulgaria, Greece, Syria, Iraq, Iran, Armenia and Georgia. Seen by many as a geographic and cultural gateway from mainland Europe into Eurasia and the Middle East, Turkey has also become a very geopolitically significant country. Its maritime borders enjoy some of the world’s most pristine Oceanic and Mediterranean climates while its great eastern plateau is known for baked summers and bitterly cold winters. As a general rule, Turkey’s terrain becomes progressively jagged as it pushes further into Eurasia and the Middle East. Notably, Turkey is the source of several key rivers such as the Euphrates and Tigris, which, along with Lake Vaz, are three of the nation’s key sources of domestic electricity production.


Since its founding in 1923, modern Turkey has evolved into a parliamentary representative democracy and embraces a strong tradition of secularism. Turkey is a founding member of the United Nations (UN), the Organization for Economic Cooperation and Development (OECD), the Organization of the Islamic Conference (OIC), and the Economic Cooperation Organization (ECO). In Turkey, these organizational ties play against a backdrop of strong Western political orientation. Political stability and a pro-business government have helped Turkish GDP grow rapidly since the AK Party was elected in 2002.

6.4.3 Economy

Turkey’s expansive physical area – nearly one million square kilometers – supports a voracious and productive economy, likely ensuring long-term influence.

38


From 2002 – 2007, Turkey’s GDP grew by an average rate of more than 7%.22 From 2007 to the present day, Turkey has with poise weathered world economic storms and has positioned itself for continued macro success. As of October 2010, Turkey was ranked 16th in terms of purchase power parity GDP, and is expected at least to maintain its position well into the coming decade.23

6.4.4 Energy Sector

Turkey represents the fastest growing regional power market, both in terms of percentage and total energy demand. By most expert estimates the Turkish power market will be short of energy by 2014. New generation is being outstripped by rapidly growing demand which is coming mostly in the western and far northern parts of the country. While the Turkish government has pushed for competition in the wholesale and retail markets, large energy consumers are signing long term purchase power agreements with reliable long-term energy producers. Investors are relying on an increase in wholesale market prices as they construct new plants. And with demand outstripping generation, there will likely be upward pressure on the wholesale market price. Indeed, electricity consumption, spurred by industrialization and an urbanizing population, has historically outpaced economic expansion in Turkey. The Turkish Government expects demand for power to continue surpassing GDP growth for the foreseeable future. According to the Turkish Electricity Transmission Corporation, over the last three decades Turkish demand for electricity has grown at an average rate of 7.6% per annum. Turkey is facing future significant power shortages as demand surpasses supply. By 2013 Turkey is expected to be a net importer of electricity. The large tariff differential between privately generated electricity in Turkey and Georgia results in an excellent export opportunity for Georgian producers. In spite of showing significantly more resilience than some of the EU's most developed countries, the global recession caused the Turkish economy to contract by 4.7% in 2009. Turkey has quickly returned to its high growth trend, with GDP expanding by 10.3% year on year in 2010 Q2. The E.I.U. expects full year 2010 GDP to grow by 6.1%, followed by a further 3.1% in 2011. With GDP per capita less than one third that of its western neighbor Greece, the prognosis for sustainable long term economic growth is excellent.

6.4.4.1 Market Structure and Reform

Turkey is implementing a clearly defined strategy to create a financially sound and transparent electricity market operating in a competitive environment; electricity prices are increasingly correlated to demand and supply dynamics.

22 http://bennettlawfirm.typepad.com/abraham_dialogue_society/2008/06/turkey-360-did.html; accessed 22 February 2011 23 http://www.imf.org/external/index.htm; accessed 22 February 2011

http://bennettlawfirm.typepad.com/abraham_dialogue_society/2008/06/turkey-360-did.html

http://www.imf.org/external/index.htm

39


In pursuit of this strategy, in 2001 Turkey enacted Electricity Market Law 4628 (EML) in order to create a financially sound and transparent electricity market operating in a competitive environment. The implementation of EML – and a variety of subsequent market enabling laws and regulations generally compatible with the EU Internal Energy Market – has necessitated a decade of comprehensive reform and restructuring. The current industry composition is presented below.

Source: Turkish Electricity Market Overview, as produced by DRT Kurumsal Finans Danışmanlık Hizmetleri A.Ş., a Deloitte Member Firm

The majority of power is traded through bilateral contracts using three different pricing mechanisms. Approximately 15% of electricity volumes are bought and sold using a fourth mechanism, the balancing and settlement market (i.e. the system marginal price market). This mechanism currently uses one day-ahead scheduling, which means that buyers use consumption estimates to request the volume of electricity they will need 24 hours in advance. The system operates under an eligible consumer concept whereby any permissible market participant that requires more electricity supplied to it by the grid is free to choose its supplier on a market with hourly tariffs. When short term demand is undersupplied, this allows producers and wholesalers to sell at higher prices than under the other three pricing mechanisms. The balancing and settlement market pricing mechanism is scheduled to change from day-ahead planning to a day-ahead market by the end of 2010. When fully implemented, this wholesale electricity market will consist of an organized day-ahead market operated by the Market Operator, a real-time balancing mechanism (balancing power market) operated by TEİAŞ as the Transmission System Operator, and a bilateral contracts market. In addition, there will be one or more organized markets for the procurement of ancillary services.

40


Source: Turkish Electricity Market Overview, as produced by DRT Kurumsal Finans Danışmanlık Hizmetleri A.Ş., a

Deloitte Member Firm

6.4.4.2 Consumption and Production

Turkish electricity consumption doubled between 1995 and 2008, rising from 85.5 TWh to 198.0 TWh, representing average annual growth of 6.7%. Government forecasts for the next ten years (2009 to 2018) envisage average growth of a similar rate, at between 6.3% (low growth scenario) and 7.0% (high growth scenario) per annum. These forecasts, when combined with Government estimates for firm generating capacity, show domestic output will be insufficient to meet demand from 2015 onward. Per capita consumption of approximately 3,000 kWh/year, is less than a quarter of some EU countries. Strong demand growth is expected to continue over the longer term.

6.4.4.3 Prices and Costs

In the framework of market reforms, electricity prices are becoming more transparent and correlated to demand and supply dynamics. Power generators in Turkey are allowed to sell electricity:

at contracted terms to TETAŞ (Turkish Electricity Trading and Contracting Company, the state-owned wholesaler) if they have BOO, BOT or TOR (Transfer Own Return) contracts,

at a discount to a regulated TEDAŞ (Turkish Electricity Distribution Company) price to eligible customers under bilateral contracts,

at spot prices on the SMP market, at guaranteed prices if they are eligible under Turkey’s renewable energy law, and at negotiated prices under bilateral contracts.

The following four systems determine the prices paid to private generators.

SMP prices set by supply-demand dynamics. Electricity is sold at ‘imbalanced’ prices in advance when supply fails to meet demand. The SMP market is closest to a liberal market where the private sector sells to state companies and eligible consumers at higher than regulated prices.

41


TEDAŞ prices regulated by CBP mechanism. With an automatic pricing system in place as of July 2008, end-user electricity tariffs are now set by TEDAŞ and approved by EMRA. Tariffs are adjusted in line with changes in the cost of fuel, foreign exchange rates, inflation and the cost of acquisition of electricity from TETAŞ and the SMP market.

BOO-BOT prices. There are specified terms of individual contracts. TETAŞ prices regulated by CBP mechanism. TETAŞ determines the wholesale prices of

electricity to be applied for the regional distribution companies with the retail distribution licenses applying for the CBP mechanism.

In 2006, the State initiated a 5-year transition process which would yield a liberalized electricity market with a cost-based tariff system. An EMRA (Turkish Regulator) announcement in 2008 declared an extension of two years to the transition period. Hence, power distributors and retailers will determine their cost-based retail tariffs, subject to EMRA’s approval, for sale to all customers after 2012. Turkish tariff levels are expected to meet the tariffs of European peers following liberalization. Until 2012, EMRA will set end-user tariffs based on fixed components such as allowance for loss/theft ratios, direct pass-through of changes in wholesale prices, and projected expenses. EMRA aims to incentivize distributors to lower loss/theft ratios and make optimization investments. Between 2003 and 2007, the State kept industrial and residential user tariffs at a flat level on a Turkish Lira basis in order to maintain growth. In the meantime, increasing energy production costs hindered private and public generation companies’ profitability, creating an unfavorable environment for generators and historically providing a disincentive to investment. Consequently, the SMP system was introduced to enable merchant private generators to sell their production at prices substantially higher than regulated prices. In 2008, a CBP mechanism was launched to allow State-owned energy companies to pass through rises in input costs to prices to some extent. Average SMP prices have historically been above TETAŞ prices. Due to the economic contraction in 2009, and the ensuing reduction in demand for electricity, average SMP prices were closer to TETAŞ prices than had been the case previously.

42


Source: TEİAŞ

Based on State data from TEİAŞ, the following chart shows, in stark terms, that within its current regime of production and consumption, Turkey will be short of power by 2015.

Source: TEİAŞ

6.4.4.4 Electricity Imports: Current and Future

The Turkish Government is actively supporting cross border power trade and is on the lookout for alternative sources of power supply to reduce its dependency on imported oil and gas; hydropower produced in Georgia is therefore an attractive proposition. Turkey produces less than 5% of the oil and gas it consumes.

0

20

40

60

80

100

120

140

Evolution of Wholesale Electricity Prices in Turkey (TL per MWh)

TETAS TEK-TEAS TORETOSAF SMP

0

50

100

150

200

250

300

350

400

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Supply and Demand Balance and Forecast in Turkey (TWh)

Production High Demand Low Demand

43


In 2009 it imported over USUS$16 billion worth of hydrocarbons – much of which was gas for power generation, accounting for almost 50% of total output. Government policy is to seek alternative sources of supply to improve energy security. Turkey has demonstrated its support for an increase in electricity imports from Georgia in several ways.

By signing several Memoranda of Understanding with the Government of Georgia and negotiating a detailed bilateral agreement

By investing in new transmission facilities for power imports from Georgia By promoting power trade with neighboring countries within its Electricity Energy Market

and Supply Security Strategy Paper With numerous references to reliance on Georgian power imports in Ministry of Energy

and Natural Resources’ reports

6.4.4.5 Countries Connected to Turkey

Turkey has many international interconnections. High voltage transmission lines connect Turkey’s power market with power markets in Iraq, Syria, Greece and Bulgaria. In fact, most Turkey’s neighboring countries are in a deficit mode or have very expensive clearing prices on the wholesale market. The legislation for wheeling power (transit) across Turkey is still under development. While the power markets in those neighboring markets look attractive, until the legislation relating to the transit of power is in place, the ability and the value of selling into those power markets cannot be accurately determined.

6.4.5 Preliminary Conclusions on the Feasibility of Imports from Georgia

Turkey has already begun importing electricity from Georgia to meet domestic demand and will likely continue to do so in the medium-term. Given the rising demand for air-conditioning, summer peak demand has overtaken winter peak demand, increasing the prospects for summer imports from Georgia. In February 2011, Turkish and Georgian energy ministers, as well as the head of Ağaoğlu Energy signed a protocol for the construction of three hydroelectric power plants in Georgia. The power plants will be built along the River Paravani and will have an annual production capacity of 277 million kWh. The construction work is expected to take 4 years. Further export opportunities for new Georgian hydropower projects will depend primarily on their generation costs with respect to market prices in Turkey. As has been the case for several years, market prices in Turkey will be increasingly deregulated, although they will depend, to a large extent, on Turkish generation costs and the price of other competing imports. Based on present Turkish generation costs and import prices, there is little to suggest Georgian power

44


imports could not be competitive, even with a decline in Turkish wholesale prices as the market continues to liberalize.

45


7.0 LEGAL ENVIRONMENT

Georgia’s legal system is civil law-based. The Civil Code is the foundation for all of the country’s civil legislation. It also forms the basis for corporate structures as well as the right to ownership. The Civil Code guarantees freedom of contract and provides guarantees against arbitrary interference in private matters and freedom of entrepreneurial activity. Under the Civil Code, foreign investors hold the same rights and obligations, as do Georgian citizens and legal entities.

Company law of Georgia (the Law on Entrepreneurs, adopted in 1995) regulates formation and organization of entrepreneurial (commercial) legal entities, provides requirements for setting up an enterprise and carrying out entrepreneurial activities. Entrepreneurial activities may be undertaken only under one of the legal forms prescribed by the Law on Entrepreneurs. That law provides legal and organizational forms suitable for numerous combinations of entrepreneurial competencies and responsibilities. The two most common legal structures for capital businesses, the JSC & LLC, allow for limited liability. Procedures for establishing a commercial legal entity have been significantly simplified and it is possible to incorporate an entity within one business day.

Georgian legislation allows foreign investors to have their contractual obligations governed by the law of the country of their choice. The choices of law provisions are legal, valid and binding under the laws of Georgia and will be recognized and followed by Georgian courts. Respectively, disputes between foreign and Georgian counterparts may be addressed to the foreign/international tribunals. Investment disputes in which Government of Georgia may be a party can be resolved through an International Center of Settlement of Investment Disputes (ICSID). ICSID decisions are enforceable under 1958 New York Convention on Recognition and Enforcement of Foreign Arbitral Awards to which Georgia joined on June 2, 1994.

Disputes may also be referred to the Georgian courts. Since 1998 the Georgian judicial system has undergone major reforms. Changes have affected among others, judicial qualifications, judicial independence, social guarantees, court jurisdiction, court administration and case flow management. The court system’s physical infrastructures have also been significantly improved, both in Tbilisi and in the regions. International donor organizations are continuously seeking to improve the judicial system, targeting elements such as efficiency and transparency of court administration and case management. All of these efforts have led to increased confidence in the Georgian judiciary and improved comfort as to the quality of adjudication, impartiality and facilitation.

7.1 PERMITTING PROCESS FOR SMALL, MEDIUM AND LARGE HPPS

To implement a hydropower investment project, investor needs to obtain a construction permit. Environmental Impact Permit in such case forms part of the process for issuing construction permit as discussed below.

46


7.1.1 Construction Permit

Construction is regulated by three legislative acts: Law of Georgia on Construction Activities (2000), Law of Georgia on Control of Technical Hazards (2010), Resolution #57 of the Government of Georgia on Rules of Issuance of the Construction Permits and Terms of Licenses (2009).

Resolution #57 is the main legislative act governing procedures pertaining to obtaining construction permit. It divides constructions into five categories for the purpose of issuing construction permit. Hydro Power Plants with the installed capacity exceeding 50MW fall under category V, which is also subject to independent review (see below). Construction permits for the objects under category V are issued by the Technical and Construction Inspection under the Ministry of Economic and Sustainable Development. Process of issuing construction permit for HPPs also involves the Ministry of Energy and Natural Resources of Georgia.

Generally the process of obtaining a construction permit covers three stages, each of which is followed by a respective administrative act issued by relevant administrative authority.

Stage I Defining terms for urban development. Upon completion of this stage, terms of usage of land plot for construction is approved under an administrative act within 30 days from submission of the appropriate application appended with the required documentation. Such documentation mainly includes application, IDs, topographical map of the land plot, cadastre map, and a situation plan.

Stage II Approval of the architectural-construction design. Upon completion of this stage, architectural design, construction and/or technological scheme is approved within 20 days from submission of the architectural-construction design of the object. Second stage documentation includes construction/technological scheme, administrative act approving the terms of usage of land plots for construction (obtained under Stage I), report on the environmental impact assessment, volume and types of expected emissions (technical report on stationary sources of contamination and inventory of their splashed harmful substances; and allowable limits for splashing harmful substances), situation plan of implementation of the planned activity (with indicated distances), a short annotation on the activity (in the form of non-technical resume).

When construction permit is processed under one-stop-shop principle incorporating environmental impact permitting process, application submitted for the construction permit should also comply with the requirements of the Law on Environmental Impact Permit. In particular, it should meet requirements related to public hearing (review) of Environmental Impact Assessment Report and formalization of the protocol of the hearing. Conclusion of the ecological expertise is issued on the II stage of the construction permitting process (see Environmental Impact Permit below) and constitutes a part of the construction permit.

For the applicant of the construction permit therefore observance of the terms of the conclusion of an ecological expertise is mandatory since they constitute conditions of the construction permit at the same time.

47


Stage III Issuance of a construction permit. In order to obtain construction permit for HPP, applicant should submit to the Technical and Construction Inspection following documents.

Document verifying the ownership or right of use of the plot of land

Administrative act approving the terms of usage of land plots for construction

Administrative act on approval of the architectural design, construction and/or technological scheme

The receipt certifying the payment of construction permit fee

Description of functional purpose of the facility and aim of its use

Data of the designer of the facility: name/legal title, contact information, code of entrepreneurial registration or number of ID card and the date of birth

If there is a necessity of carrying out the study of the land plot (construction ground), the researcher data: name/title, contact information, code of entrepreneurial registration or number of ID card and the date of birth

Construction documents (see below)

Report of independent review (see below)

Design of construction documents of buildings and structures to be submitted under Stage III include the following.

Title page – name and address of the site

Terms of construction (issued during the first stage)

Engineering-geological study/conclusion of the plot of land

Explanatory note

Technical characteristics of buildings and structures

Situational plan with appropriate details

Topographic plan of the plot of land showing existing engineering-communal networks

Land plot marked on topographic plan of the land plot (e.g. showing cadastral borders of the land plot, existing engineering-communal networks, placement of buildings and structures on the land plot, marking accessible roads, parking, fences, green area, etc.); Scale 1:500 or 1: 1000

48


Plans of all types of floors of facilities

Plan of the roof of buildings and structures

Characteristic profiles of buildings and structures

Drawings of all building frontages with defining finishing materials, architectural details and colors of frontages

Where necessary, drawings of frontages (calculating surfaces), showing schematic drawings of frontages of buildings and structures located on adjacent land plots

Where necessary, schematic drawings of roadside frontages (calculating surfaces) showing intersection of buildings and structures and soil surfaces

Where necessary, plan of land plot soil changing

In case of necessity, technological scheme of the industrial processes

Design of construction organization

Report of an independent review of the project covers review of engineering-geological research, review construction basis.

Construction permits should be issued within 10 days of submission of relevant documentation.

For the buildings of category V that are considered to have special state and social importance and that are financed through the funds of IFIs or other investment agencies/companies, the construction permit may be issued without submitting the construction documents and/or documents evidencing property rights over the land plots. In this case, the Ministry issues conditional construction permit, which comes into full force subject to presentation of the above listed documentation.

7.1.2 Environmental Protection

Environmental issues are governed by the Constitution of Georgia and environmental protection legislation. The Law of Georgia on Environment Protection regulates the legal aspects of relations between State organizations and individuals or legal entities in environment protection and natural resource utilization matters across the whole territory of Georgia. The law covers different aspects of protecting natural eco-systems, protected areas, global and regional management issues, bio-diversity and international cooperation matters. Further, specific pieces of legislation regulate the issues/fields such as: environmental permits, ecological examination, water protection, forests, tourism and recreation, wildlife, sanitary protection, resort areas, etc.

In general, environmental protection is implemented and enforced by the Ministry of Environment Protection (“MEP”) through its central and regional offices.

49


The Ministry is authorized to Prevent, limit or terminate any activity that has or may have a negative impact on the environment or exercise the same rights when natural resources are used irrationally, issue licenses and permits (including Environmental Impact permit), control the mitigation activities implemented by construction companies, obtain complete information from a construction company regarding the utilization of natural resources, monitoring systems, waste management and other issues, receive explanations from government representatives involved in the project.

7.1.3 Environmental Impact Permit

Law on Environmental Impact Permit defines activities, which are subject to ecological examination, and legal basis for issuing environmental impact permit, conduct of ecological examination, involvement (and informing) of the public in the process of environmental impact assessment and permit issuance. Environmental impact permit issues are also regulated by the Law of Georgia on Environmental Protection and the Law of Georgia on Ecological Examination.

Construction of hydropower plant requires ecological examination and issuance of environmental impact permit (“EI Permit”).

When environmental impact permit is related to the project requiring construction permit, the Law on Environmental Impact Permit requires the MEP to make the process of issuing environmental impact permit a part and one of the basis for issuing construction permit by the Technical and Construction Inspection. Therefore, conclusion of ecological review is delivered to the Inspection in the form of an administrative legal act of MEP and forms a part of construction permit. Observance of any other requirement of the Law on Environmental Impact Permit, including those related to public hearing (review) of an Environmental Impact Assessment Report, formal issuance of the results of the hearing and observance of terms of the Environmental Impact report, is also a condition to filing application for construction permit.

Documents to be submitted for obtaining EI Permit include the following.

Application (submitted, reviewed and ruled in compliance with the Law on Licenses & Permits)

Information required under the Law on Licenses & Permits

EI Report compiled in compliance with the Georgian legislation (see below)

Situational plan of the planned activities (with distances/scale)

Estimated types and volumes of emissions

Short description of the activities (non-technical resume)

Statement on any confidential part of the submitted application

50


Prior to submission of EIA Report to MEP for issuance of EI Permit (or in case of consolidated permitting procedure, prior to the II stage of the construction permit procedures with the Ministry of Economic Development of Georgia), applicant is required to conduct its public hearing (review). With the aim to conduct a public hearing of the EIA Report, applicant should publish information on the planned activities in the central and regional periodic print media. Information should include aims of the activities, location and name of the relevant place, contact info for access to information including EIA Report, date and place of public hearing of the EIA Report. EIA Report is submitted to the permitting body (MEP or Ministry of Economic Development respectively) within a week from publishing information. Within 45 days from publishing information applicant is required to receive and review comments.

Public hearing of EIA Report should be held anywhere between (no earlier than) 50th and (no later than) 60th days of publishing information. Representatives of state bodies (local self-governance bodies, MEP, Ministry of Economic Development and other interested administrative bodies) should be invited in writing. Any interested party may attend public hearing of EIA Report.

EI Permit is issued under simplified administrative procedure envisaged by General Administrative Code of Georgia within 20 days from the registration of the submitted application in accordance with the Law on Licenses & Permits. Prior to issuance of the EI Permit, MEP conducts ecological examination of the project based on the respective documentation. Review is implemented by an ad hoc commission established by the MEP. Commission may also include independent experts. If conclusion of ecological review is negative, EI Permit is not issued. Refusal can be appealed under administrative order or in the court. Form of the Permit is endorsed by the MEP.

EI Permit is transferable subject to joint written application of the EI permit holder and assignee to the MEP. Permitted activities may be undertaken only after the review of the application and issuance of the new permit with relevant amendments by MEP. New EI permit holder shall be obliged to observe all permit conditions. Control of the EI Permit conditions is implemented by MEP. Control and enforcement (liability for breach) is implemented under the Law on Licenses and Permits.

MEP functions related to environmental permitting shall soon be transferred to the Ministry of Energy and Natural Resources of Georgia.

7.1.4 Land Rights

Land is an important asset for the HPP project. It is critical that such land be transferred to investor/project entity with clear title as both construction permit as well as generation license require evidences of rights to the assets used for construction and operation of the HPP. Under Georgian law, any improvement on the land belongs to the owner of the land.

Various types of rights to the land are envisaged by the Georgian law.

51


Any investor shall seek to obtain ownership rights to the land plots involved in construction to have clear title to any improvements made on such land. Under the MoU, GoG commits to assist investor with obtaining such rights if the land plots are owned by the State.

However, under the latest amendments to the Law of Georgia on State Property Law, land plots adjacent to the rivers which are tendered for construction of HPPs under Renewable Program are not subject to privatization. Exceptions are allowed in relation to agricultural land under solicitation of the Ministry of Economy to the GoG for important projects.

For other cases investor shall need to enter into long term lease agreements unless amendments are introduced into the State Property Law.

If the land plot required for construction of an HPP is privately owned, investor shall need to enter into negotiations with a private party. Georgian law also envisages eminent domain procedures for the projects of significant importance.

Certain land plots may have other status restrictions (cultural, recreational, sanitary) which need to be cleared prior to acquiring rights to such land plots. Under the MoU GoG is expected to support investors with similar issues.

7.1.5 Water Rights

Georgia’s water resources are not subject to alienation. Investor may obtain rights to use water resources through environmental impact permitting process. No licensing or permitting is required for water abstraction or discharge in connection with process of obtaining regulatory clearances

Fees are paid to the State Budget on monthly basis, on or before the 15th day of the month following the usage. Collections are administered by the Georgian Tax Authorities (except for the fees paid prior to acquiring a license or permit for which MEP is responsible).

7.2 REGULATORY STRUCTURE OF THE SECTOR

7.2.1 Energy Policy

The energy policy of Georgia was adopted by the Parliament of Georgia in 2006. One of the key objectives under the policy is to fully satisfy its demand for electricity through Georgia’s domestic hydro resources. As the natural gas prices keep growing, GoG’s long-term energy policy envisages a near-full substitution of thermal and imported power by hydro generation. To achieve strategic objectives of the energy policy, its principal elements include, among others, attraction of investment to the sector, the reduction of bureaucratic burdens on local and foreign sector participants, deregulation of new hydro power plants, harmonization of sector legislation, expansion of interconnections (Europe-Asia, East-West and North-South).

52


7.2.2 Electricity Law

Georgian power sector is governed by the Law of Georgia on Electricity & Natural Gas passed in 1997 (“Electricity Law”). Electricity law governs all activities related to electricity system operation, the trade in wholesale electricity (capacity), electricity generation, transmission and dispatch, distribution, import and export and consumption.

The Electricity Law reflects state policy in energy sector and is intended to promote foreign and domestic investments for the purpose of rehabilitating Georgia’s electricity and natural gas sectors, to encourage the priority use of indigenous hydro, renewable, alternative sources of energy and natural gas, to establish an independent regulatory framework for the electricity sector, to promote the long-term financial stability and development of the electricity sector.

7.2.3 Organization of the Market

In line with the defined energy policy, GoG has implemented significant restructuring of Georgian power sector. In the last few years the Georgian electricity sector has undergone major changes.

The state has unbundled electricity assets into generation, transmission and distribution companies, transferred regulatory duties to the independent Georgian National Energy and Water Regulatory Commission (“GNEWRC”) and limited the role of the Ministry of Energy and Natural Resources (“MENR”) to the general policy setting and approval of the annual energy balances.

7.2.4 Ministry of Energy and Natural Resources

The Ministry of Energy and Natural Resources is the policy-making institution for the electricity sector. Its obligations include promotion of medium and long-term investment in the sector, identification of credit resources, rehabilitation and development of the energy sector, participating in the development of an appropriate legal and regulatory framework, promoting environmental protection, supporting development of transit and import/export relationships in the electricity sector and implementing state programs to increase energy efficiency. MENR is has no ownership of assets or operational or regulatory functions in the electricity sector.

MENR approves annual electricity (capacity) balances, Market Rules & the Rules of Operation, Arrangement and Use of Energy Facilities and other Technical Equipment in the Electricity sector.

7.2.5 Georgia National Energy & Water Supply Regulatory Commission

GNEWRC is an independent regulator with five commissioners. The President of Georgia appoints its Chairman. GNEWRC issues licenses and regulates and supervises activities of the licensees in the power and natural gas sectors as well as in water sector in Georgia. GNEWRC is responsible for tariff setting, dispute settlement, enforcement and certification.

53


GNEWRC is authorized to issue subsidiary legislation in the form of rules or orders of general or specific applicability.

Decisions adopted by GNEWRC are subject to judicial appeal in accordance with applicable law. Pursuant to the Electricity Law GNEWRC establishes rules and procedures for the granting of licenses, sets and regulates tariffs for generation, transmission, dispatch, distribution, import, export and consumption of electricity, monitors and enforces license terms and applicable law; and oversees the certification of electrical technicians.

7.2.6 Electricity System Commercial Operator

ESCO was established in 2006 to succeed Georgian Wholesale Electricity Market (GWEM), which operated as a sole market maker in the power sector throughout the 1990s and early 2000s.

ESCO is responsible for ensuring grid stability and balancing the market and its functions include buying and selling electricity, including through medium- and long-term import/export contracts; providing the system with reserve capacity; informational support of the market players on wholesale consumption volumes; wholesale data maintenance and facilitation of settlement.

ESCO’s share in the total electricity trading in Georgia is more than 25%. Although ESCO is involved in export/import of electricity, it does not have monopoly rights on cross-border operations – any market participant has the right to conduct such operations directly, bypassing ESCO, without any permit or license with some seasonal exceptions.

7.2.7 Hydropower Investment Promotion

To further promote hydropower development, in April 2008 GoG adopted Resolution (“Renewable Program”) specifically dealing with the hydropower investments. Under this resolution and related normative acts GoG invites all interest parties to express interest to construct, operate and own HPPs on potential sites. The ultimate objective of the Renewable Program is to facilitate utilization of hydro potential of Georgia and eliminate consumption of thermal power (using imported gas) and electricity imports. Renewable Program rules and procedures are applicable to the HPPs with the installed capacity below 100MW. Large HPP Projects may involve similar procedures but are individually entitled to further benefits granted at GoG’s discretion.

7.2.8 Generation License

The Electricity Law establishes the terms and conditions pursuant to which the GNEWRC issues all electricity licenses. The rules governing the monitoring and control of licensed activities are addressed in detail in GNEWRC’s Licensing Regulation. Generation license is one of the types of licenses issued by GNEWRC. The import and export of electricity is carried out pursuant to direct contracts and is not subject to licensing.

54


7.2.9 Licensing Procedures

In order to obtain a generation license, an applicant must submit a standard application form to GNEWRC, together with the following information.

A report certifying possession (usage of generation assets) A report on compliance of the technical condition of the generation assets with

standards A list of fixed assets and audit report on the enterprise An environmental impact assessment report (this is part of the construction permit) A technical conditions for connection to the electricity network A scheme of the electricity network, relevant to the license application

7.2.10 Deregulation

The Electricity Law establishes a legal framework for the full or partial deregulation of certain electricity sector participants, including generation licensees. All hydropower plants constructed after 2008 are fully deregulated. Respectively, in its commercial transactions with the qualified enterprises (including ESCO) and exports new HPPs are fully deregulated.

7.2.11 Tariffs

The Government’s tariff policy is that electricity generation prices should be gradually deregulated and until deregulation occurs, tariffs set by GNEWRC should reflect the separate costs associated with separate categories of customers. Electricity to be generated by new HPPs shall not be subject to tariffs set by GNEWRC. Under Renewable Program however, for 10 years from launching generation new HPPs are obligated to sell electricity generated in three winter months only within Georgia either through a direct contract or to ESCO. Price of electricity for PPA with ESCO for those three months is negotiated with the GoG.

7.2.12 Network Access

Access to transmission and distribution networks are governed by the Electricity Law and the Regulation on Fees for Access to the Distribution Network. In exchange for the tariff established by GNEWRC, transmission and/or distribution licensee is obliged to wheel through its network electricity of those parties, who under the Electricity Law have a right to sell electricity to the consumers directly. Tariffs are individually prescribed for the relevant licensees under the common regulation on tariffs adopted by GNEWRC. Third parties who are wheeling electricity through the assets of other licensees or small capacity power plant should enter into direct agreement with such licensees or plants. Wheeling of electricity cannot be refused by the owner of the corresponding transmission or distribution network, unless restrictions are caused by the capacity of the network or are justified by the failure of the third party to pay the tariff for wheeling.

55


In 2006, in line with the country’s long term energy sector liberalization plan, the country’s largest electricity consumers were allowed to bypass ESCO and distribution companies, and to deal with electricity suppliers directly. The electricity consumption threshold, above which consumers are allowed to choose their own supplier and must be provided with third-party access to the transmission grid, is currently set at annual 7 GWh. As described above, the cap will be gradually lowered, however, in a measured pace, until it is almost fully withdrawn in 2017.

7.3 ELECTRICITY MARKET RULES

7.3.1 Market Rules and Wholesale Trading

MENR established a framework for operation of the electricity market in Georgia in 2006 when it adopted the Electricity (Capacity) Market rules (“the Market Rules”).

Market rules govern the operation of the electricity market and ESCO; commercial, financial and technical relations ensued from direct contracts and/or electricity purchase and sale, transmission, dispatch, operation of electricity system in parallel regime and consumption of generated electricity by Generation licensee for its own needs through ESCO; the establishment of electricity (capacity) balances and their implementation rules; terms of execution, enactment, validity and termination of the direct contracts; terms for conclusion of direct agreements and their enforcement; definition of the categories of electricity sellers for the establishment of terms of sale; the registration of qualified enterprises; and the General Principles of Technical Standards for Wholesale Trading.

Trading in electricity and capacity generated by generation plants connected to the Georgian power grid and imported to Georgia is carried out by way either of a direct contract between the parties or by ESCO. The Market Rules require parties of direct contracts to register their contracts with the dispatch licensee.

ESCO is licensed by GNEWRC. ESCO sells and buys balance electricity and capacity, provides the electricity system with the reserve capacity, supplies the Dispatch Licensee with the information it requires to carry out supply and consumption planning. ESCO fulfills its legal obligation on the basis of information received from qualified enterprises and parties to transit arrangements.

A qualified enterprise is an entity authorized under the Market rules to participate in the wholesale trade of electricity and includes generation and distribution licensees, direct customers, importers, exporters, small hydro power plants and ESCO. Direct customers are consumers of electricity whose annual consumption of electricity exceeds 7 GWh. Gradually, this threshold will mdecrease and will be eliminated by 2017 as prescribed by the energy policy of the country.

Electricity export is carried out on the basis of a direct contract and, for a newly built HPPs, is subject neither to licensure nor tariff regulation. An exporter must register its contracts with the dispatch licensee, which may, for system security, hold in reserve a certain amount of the transmission line capacity. The dispatch licensee allocates capacity on the basis of Market Rules.

56


All market participants are required by contract to provide system capacity of reserve, which is used by the dispatch licensee to balance electricity supply and consumption. In order to ensure reliable operation of the power grid and to balance supply and consumption, ESCO tops up reserves that have not been covered by qualified enterprises. Those costs associated with the top-up are covered by such qualified enterprises.

7.3.2 Taxation

To enhance Georgia’s Investment & Business Climate, the GoG has dramatically overhauled its tax system since 2004. By implementing a liberal reform agenda, Georgia has simplified its processes and has reduced the number of taxes. The Tax Code, which took effect on 1 January 2005, reduced the number of taxes from 21 to seven (excluding tariffs), introduced a flat personal income tax rate, abolished social tax, reduced the VAT rate from 20% to 18% and reduced the profit tax (corporate tax) rate from 20% to 15%, although it increased excise tax rates on some products and broadened the tax base for VAT and profit taxes.

From 2011 another set of reforms to the taxation system became effective. A new tax code entered into force on January 1, 2011, with further emphasis on principles of simplicity and the low rates. The new code introduced simplified administration procedures and additional protections for taxpayers such as (a) electronic declarations, (b) written legally binding agreements on interpretations, (c) personal tax agents (d) tax ombudsman, and more.

7.3.2.1 Taxes and Tax Rates

There are six taxes currently in force in Georgia.

Income Tax

The personal income tax rate is 20% and it is scheduled for further reductions to 18% through 1 January 2013 and to 15% by January 2014.

Corporate (Profit) Tax

Legal entities carrying out activities in Georgia are subject to corporate profit tax which is 15%. Georgian entities, meaning entities incorporated or managed in Georgia, pay corporate profit taxes on their worldwide income.

In contrast, foreign entities pay corporate profit taxes only on Georgian-sourced income. Taxable profit of Georgian entities, as well as that of foreign entities operating in Georgia through their permanent establishment, is equal to the difference between taxable income and tax-deductible expenses.

Foreign entities earning Georgian-sourced income (including dividends, royalties and interest income) without a permanent establishment in Georgia are subject to withholding tax on this income at the source of payment (i.e. by the company paying income) at the rate of 10% or 15%. Certain relief on non-resident income withholding tax may be available through applicable double taxation treaties, if any.

57


Georgia has no separate tax on capital gains. Capital gains of resident natural persons, as well as Georgian-source capital gains of non-resident natural persons arising from the sale of any asset (including securities), are taxable at the flat personal income tax rate of 20%. The sale of tangible assets (including securities) held by an individual for more than 2 years is exempted from personal income tax.

Capital gains of Georgian entities, as well as Georgian-source capital gains of foreign entities, are taxable similarly to other taxable profit at the flat profit tax rate of 15%.

Withholding Tax on Dividend

A 5% withholding tax is imposed on dividends paid to natural persons and foreign entities, subject to certain relief which may be available through applicable double taxation treaties. Dividends paid to Georgian entities or Georgian permanent establishments of foreign entities are not subject to withholding tax and are not included in taxable profit.

Withholding Tax on Interest

A 5% withholding tax is imposed on interest payments made by Georgian entities or Georgian Permanent Establishments of foreign entities, provided that the source of interest income is in Georgia. Interest received from licensed financial institutions is no longer taxed at the source and is not included in the gross income of the recipient unless it is also a licensed financial institution. If the recipient is a licensed financial institution, the interest is not taxed; it is however included in its gross income.

Relief on withholding tax on interest income may be available through applicable double taxation treaties.

Property Tax

Georgia applies property tax at a flat rate of up to 1% on the annual average net balance sheet value of tangible and intangible non-current assets of Georgian entities and Georgian permanent establishments of foreign entities. The property tax is a local tax. As such, its exact rate is determined by Units of Local Self Governance. Notably, land and certain movable property (cars, yachts, etc.) are taxed based on specific rules set out by domestic tax law.

Value Added Tax

The Tax Code of Georgia sets the value added tax at the rate of 18%. Taxable operations include supply (and import) of goods and services in Georgia. Certain business activities, such as, for instance, financial services, are exempt from VAT. The Tax Code of Georgia establishes a mechanism to, on a monthly basis, offset input VAT (VAT on purchase and import) against output VAT (VAT on sale). Surplus VAT payments can be reclaimed or offset against future VAT payments or current tax liabilities pursuant to the special provisions of the Tax Code of Georgia.

58


With respect to the electricity sector, VAT exemption applies to the import of goods and/or construction-installation, renovation, rehabilitation, testing and/or geological exploration services financed by the favorable credits issued by the foreign states and/or international organizations under international agreements ratified by the Parliament of Georgia for the purposes of rehabilitation of the Georgian electricity sector. Supply of electricity to the consumers (except to the retail consumers) is exempt from VAT until January 1, 2012.

7.3.2.2 Withholding Taxation and Double Taxation Treaties

Income earned by foreign companies and individuals from Georgian sources not having a Permanent Establishment (PE) in Georgia is subject to withholding tax at the source of payment. Double taxation treaties may reduce the tax rates. In general, double taxation treaties provide relief from the payment of non-resident income withholding tax (such as on interest payments, for instance), as well as withholding tax on dividends and capital gains in Georgia when the non-resident has invested in the Georgian company in excess of a certain investment threshold, while taxing dividends and capital gains in other cases at lower tax rates compared to the statutory rates.

Currently Georgia has double taxation treaties with: Armenia, Azerbaijan, Belgium, Bulgaria, China, France, Germany, Greece, Iran, Italy, Kazakhstan, Latvia, Lithuania, the Netherlands, Romania, Turkmenistan, Ukraine, The United Kingdom, Uzbekistan, Poland, Austria, and Czech Republic. Because double tax treaties vary from country to country, they must be analyzed in the light of the investor’s specific circumstances.

7.3.2.3 Customs Duties

The Customs Code of Georgia (“CCG”) regulates Georgia’s customs procedures. The CCG defines various customs regimes under which goods are brought in or taken out of the customs territory of Georgia. Taxpayers of customs duties are persons who cross the customs border of Georgia holding the goods. Where imported goods are subject to customs duties, the importer or the importer’s authorized representative is responsible for the payment of any customs duties due at the time the goods are released by customs for free circulation within the territory of Georgia. Customs duties include taxes and fees payable upon bringing goods in or taking them out of the customs territory of Georgia, and for some special goods a license fee is payable. Taxes payable upon import include customs (import) tariff, VAT (payable on imported goods by both VAT registered and non-VAT registered persons) and excise tax (if applicable).

7.3.2.4 Customs Tax (Tariff)

Customs tax is based on either customs value or per physical unit of goods.

59


The rate applicable to the customs value of the goods is fixed at 0%, 5% or 12%, depending on the classification of the goods. Most goods fall into the 0% rate. Most food products and construction materials fall under the 5% or 12% tax rates.

7.3.2.5 Customs Fees

Customs fees are payable at the time of declaration of the goods to customs and are due on import, export, or transit of goods into, out of, or through Georgian customs territory, as well as upon the registration of temporarily imported transportation means.

7.3.3 Tax Free Regimes in Georgia

Specialized tax rates and procedures have been adopted for 3 types of Tax-Free Regimes in Georgia. These include: 1. Free-Industrial Zones (FIZs); 2. Free Warehouse Enterprise; and Entities designated as International Finance Companies. These innovations are intended to establish new international financial institutions within the country, to attract inward investments and to encourage economic growth and sustainable development. The introduction of free warehouses and international enterprises into the tax and legal systems is intended to encourage the trade-transit function within Georgia.

7.3.3.1 Free Industrial Zones

Free Industrial Zone legislation was introduced in Georgia in 2007 for the purpose of encouraging foreign investments, stimulating exports and developing Georgia’s international trade-transit activities. A favorable tax and customs framework for FIZ is intended to provide incentives for international firms to develop their production bases within such zones. As of date, 2010 there are 3 FIZs in Georgia, which entitle FIZ-incorporated International Companies to operate in a tax-free environment.

In Free Industrial Zones firms can process, produce and export goods with minimal tax burden; export goods free of trade barriers to global markets; and export more than 7,200 types of goods under GSP+ terms to the EU.

7.3.3.2 Free Warehouse Enterprise

Due to its geographic location, of Georgia’s goals is to facilitate shortest and fastest transit route between Europe and Central Asia. This goal is supported by the legislation which enables incorporation of Free Warehouse Enterprises. Such an entity are intended to be an integral part of an international transit company and to benefit from exemptions from profit tax applied to income received from re-exporting goods from an independent warehouse via Free Warehouse Enterprise. The VAT rate on the supply of goods by a Free Warehouse Enterprise to a VAT taxpayer is 0%.

60


7.3.3.3 International Finance Company

Georgian tax legislation offers incorporation of an International Finance Company. An International Finance Company is defined as an entity whose revenues received from financial operations implemented or financial services provided in Georgia do not exceed 10% of its gross revenues. An IFC is not required to obtain a license from the National Bank of Georgia. Activities of IFCs are exempt from taxes (i.e., it operates under a Tax-free Regime).

Comparative Table of Tax Exemptions

Tax FIZ Int’l Company

Free Warehouse

Int’l Finance Co

Corporate Income Tax 0% 0% 0%

Value Added Tax 0% 0% 0%

Customs Tariff 0% up to 1% up to 1%

Property Tax 0% 0% 0.5 or 12%

Personal Income Tax 20% 20% 20%

61


8.0 DESCRIPTION OF GEORGIA’S TRANSMISSION SYSTEM

8.1 TECHNICAL OVERVIEW OF THE TRANSMISSION SYSTEM

Power generation potential in the Republic of Georgia comes from both renewable sources of energy such as hydro and wind power and from thermal generating capacity. The country’s hydropower potential is estimated at up to 80 billion kWh per year, of which up to 40 billion kWh may be economically attractive. The current system consists of about 60 hydropower stations with a maximum output capability of 6.8 billion kWh annually (that is, about 17 percent of the economically feasible potential) plus about 650 MW of thermal capacity at Gardabani, southeast of Tbilisi. In addition, the construction of two units (150-160 MW) of Combined Cycle Gas Turbine power plants and 300 MW of mine-mouth coal-fired power generation is envisaged. Thermal generation is mostly used in winter to balance low water availability, but it would also be available for export in off-peak demand season (spring-summer).

The electric power transmission and distribution systems within Georgia are generally well-developed, but had slipped into disrepair during the years leading up to, and after, the breakup of the Soviet Union. However, partial privatization and heavy investments in rehabilitation and upgrades during the past decade have brought the system back to reasonable reliability standards. The investments in the transmission system are continuing, with funding coming from international financial institutions and from operating revenues.

The transmission assets in Georgia are owned by six companies: a jointly owned Georgian-Russian company, two Georgian state-owned transmission companies, and three privately owned distribution utilities. Their transmission assets are listed in the following table.

8.2 TRANSMISSION LINE OWNERSHIP

(kilometers owned)

Line Owner 500 kV 400 kV 220 kV 110 kV 35 kV Total

SakRusEnergo (Georgian-Russian) 600† 600

Energo-Trans (100% GSE-owned) 260* 35* 295

Georgian State Electrosystem (GSE) 1,609 863 537 3,009

Energo-Pro (distribution utility) 2,642 2,537 5,179

Telasi (distribution utility) 284 102 386

Kakheti Energy Distribution (distribution utility) Operates at 10 kV and below only

0 0

Total 860 35 1,609 3,789 3,176 9,469

†Not including 308 km of 500 kV transmission line within Russia *Under construction

62


The arrangement of the Georgian transmission system is shown on the GSE System Map at the end of this section of the Memorandum. Georgia has one 500 kV transmission line that runs east to west, connecting Gardabani in the east to Ksani (northwest of Tbilisi) to Zestaponi in the west. In the 1980s, another line was designed and partly constructed under the Soviet system, this one connecting Gardabani and Zestaponi by way of Akhaltsikhe, which is far south of the existing line. Over half of the foundations and towers for the new line were constructed between 1989 and 1991, when the project was abandoned.

There is a significant generation-load imbalance in the Georgian power system: two-thirds of Georgia’s energy resource is located in the northwest of the country, while two thirds of domestic demand is located in eastern Georgia, and most of the potential export market is located in countries south of Georgia (for example, Turkey, Iran, and Iraq, all of which are experiencing rapid economic development and growth in electricity demand). Power delivery to any of these markets requires a reliable high voltage transmission network. At present, only one strong line connects West and East Georgia, the 500 kV transmission line constructed as part of the Enguri hydro development. Any fault on this line, especially during autumn and winter, overloads the underlying 220 kV lines and causes a large power deficit in the East. This has resulted in frequent total system blackouts. Apart from reducing domestic grid reliability, this also limits existing and future power swap or export potential. In addition to being an exporter of electricity, Georgia also wishes to seize an opportunity to act as a transit country, notably for electricity exports from Azerbaijan to Turkey.

To address the concern with the existing system and to accommodate future growth, Georgia has authorized the Black Sea Transmission Network Project, which is now under construction. This development uses much of the partly completed 500 kV Soviet line mentioned above, and is described in more detail below.

8.3 INTERCONNECTIONS WITH NEIGHBORING COUNTRIES

Georgia has interconnections with all of its neighbors and is planning additional interconnections in the future. These facilities are described below.

8.3.1 Interconnection with Russia

Georgia currently has four interconnections with Russia.

A 500 kV interconnection from the Enguri HPP to Russia to accommodate Russia’s partial ownership of the Enguri plant

A 220 kV line interconnects from the Tkvarcheli TPP and Vardnili HPP in occupied Abkhazia to Russia

Two 110 kV lines: one from Russian-occupied South Ossetia into North Ossetia; and one along the Tergi River and Georgian Military Highway in the northern Kazbegi area, which is currently disconnected

63


8.3.2 Interconnection with Armenia

Georgia has three current and one planned interconnection with Armenia.

A 220 kV interconnection from the Gardabani SS

Two 110 kV lines from isolated areas in southern Georgia

A planned 400 kV interconnection from Ksani SS

At the present time, the interconnections with Armenia are not in service or are operated to isolated areas in Armenia. Experience has shown that Georgia is not able to operate synchronously with Armenia because of Armenia’s interconnection with Iran. The Iranian grid frequency control has a greater allowable range which has caused instability on the Georgian system in the past.

8.3.3 Interconnection with Azerbaijan

Georgia has two interconnections with Azerbaijan.

A 330 kV interconnection from Gardabani

A 500 kV interconnection from Gardabani which is currently not functioning.

Plans are underway to rehabilitate the 500 kV line so that both interconnections can be used when needed. Azerbaijan’s electric grid is synchronized with Georgia and Russia.

8.3.4 Interconnection with Turkey

Georgia has one current interconnection and two planned interconnections with Turkey.

A 220 kV interconnection from the Batumi SS to a Turkish SS at Khopa, feeding an isolated area in Turkey (operating at the 154 kV Turkish voltage). Energo-Pro has plans to install a 350 MW HVDC back to back converter at this interconnection in the future to allow the line to connect to the Turkish grid.

A planned 220 kV interconnection by Energo-Pro from Batumi to a Turkish SS at Muratli (operating at the 154 kV Turkish voltage).

A planned 400 kV interconnection through a HVDC back to back converter located at the new Akhaltsikhe SS. This connection is now under construction, as part of the Black Sea Regional Transmission Project.

Turkey’s power grid is synchronized with Europe, which requires use of the converters mentioned above to isolate the Georgian and Turkish grids.

64


8.3.5 Planned Interconnection Projects

In recent years, the Ministry of Energy and Natural Resources has examined the need to integrate the national grid into the regional system, both for economic and national security reasons.

The German consultant Fichtner completed a study in 2007 that evaluated the concept of developing an extremely high-voltage interconnected system in Caucasus nations. The intent would be to allow easy and efficient cross-border exchanges and make better use of regional energy resources. The study considered Georgia, Armenia, Azerbaijan, Iran, and Turkey. The study recommended going forward with the two projects studied in detail, which were to develop lines to connect Armenia and Georgia, and to connect Turkey and Georgia. The study concluded that Georgia (and Armenia) would profit from and share in development momentum in Turkey, Iran, Azerbaijan, and Russia.

The Ministry of Energy and Natural Resources also commissioned a study (Econ Pöyry for Ministry of Energy and Natural Resources of Georgia, undated but completed in 2008) to determine whether there is adequate demand in Turkey for electricity exported from Georgia and Azerbaijan and whether there are sufficient existing and feasible electricity generation projects in Azerbaijan and Georgia to supply the Turkish markets using a newly constructed transmission line. The study determined that this was feasible, given a competitive price and additional investment in hydropower generation facilities in Georgia. The study also noted that the hydropower investment would likely depend on a firm commitment to complete the transmission line, whereas financing for the transmission line would depend on commitments to generation projects.

Finally, the Ministry of Energy and Natural Resources sponsored a feasibility study funded by the United States Trade and Development Agency to determine the least-cost technical options to make power transmission more reliable in Georgia (Kuljian, 2008). Specifically, the study examined the construction of a new 500 kV line that would further integrate the west and east parts of the Georgian power system and operate in parallel with the existing Zestaponi – Ksani – Gardabani 500 kV transmission line. The study also examined the feasibility of having this new line include a new high voltage interconnection to Turkey by way of a new substation at Akhaltsikhe.

Subsequently, the Ministry of Energy and Natural Resources decided to go forward with completion of the line and approached lenders for financing. The Project Execution Agency for the project is the Georgia State Electrosystem (GSE), which was responsible for designing and constructing the line together with the Technical Consultant hired through international tender specifically for the Black Sea Transmission Project. As the project progressed, GSE passed on responsibility for execution to EnergoTrans, its daughter company (100 percent ownership), which is the legal entity established to own the entire line. More detail on the project is provided below.

65


8.4 ACTIVE DONOR-SUPPORTED TRANSMISSION PROJECTS

8.4.1 USAID Black Sea Transmission Planning Project

This ongoing planning and institution-building project is being implemented for USAID by the US Energy Association. Information on the project can be found on the USEA web site at: http://www.usea.org/Programs/Blacksea/BSTPPMeetings.htm

This project does not include any money for construction—it is supporting regional planning for transmission improvements through modeling software purchase, training, and sponsoring frequent meetings among the transmission system owner/operators in the Black Sea countries.

8.4.2 USAID Power and Gas Infrastructure Project

The electric power component of this project, that started in 2010, includes reconstruction of the 220 kV Senaki double-circuit power lines dismantled in 1992 during Georgia's Civil War. It also includes construction of new power substations and modification of existing facilities to support the Senaki line, and installing operational controls designed to improve efficiencies and reduce risks in transmission management. The project is being implemented by TetraTech and their subcontractor Power Engineers.

8.4.3 Black Sea Transmission Network Project

The Black Sea Transmission Network Project (BSTNP) is the largest infrastructure project currently under construction in Georgia. Total investment is about € 290 million. It is funded by the following.

KfW Entwicklungsbank

European Bank for Reconstruction and Development

European Investment Bank

European Union Neighbourhood Investment Fund

Government of Georgia

The project will add about 300 km of high-voltage transmission line across southern Georgia and connect the Georgian transmission grid to the Turkish grid.

BSTNP will extend Georgia’s existing 500 kV transmission system – running east from Enguri to Zestaponi, Ksani and Gardabani – by adding two new 500 kV links from the Gardabani and Zestaponi substations to a new substation at Akhaltsikhe. The Akhaltsikhe substation will include a back-to-back High Voltage Direct Current (HVDC) link feeding a 400 kV overhead transmission line that connects to the Turkish 400 kV grid at the border, then through a Turkish-built line to the Borchka substation.

http://www.usea.org/Programs/Blacksea/BSTPPMeetings.htm

66


For more information, please see:

http://www.kfw-entwicklungsbank.de/EN_Home/Countries%2c_Programmes_and_Projects/Europe/Georgia/Project_-_Black_Sea_Transmission_Network/index.jsp

or

http://www.ebrd.com/english/pages/project/psd/2009/39579.shtml

This new transmission capacity will be operational by segment in 2012 and 2013 – dramatically improving the reliability of the Georgian transmission network and facilitating the export of Georgian-generated electricity to the large and fast-growing Turkish market. Preferential access to the Turkish connection will be given to newly constructed hydropower plants.

An Interconnection Agreement has been signed by the Governments of Georgia and Turkey. The two Governments are working closely to develop additional new transmission capacity – available in the near future.

8.4.4 ADB Regional Power Transmission Enhancement Project

This new project is currently in preparation. The current status can be reviewed on the ADB web site at: http://www.adb.org/Projects/project.asp?id=44183

It is expected to include investments in transmission facilities as well as institution building.

http://www.kfw-

http://www.ebrd.com/english/pages/project/psd/2009/39579.shtml

http://www.adb.org/Projects/project.asp?id=44183

67


8.4.5 World Bank Electricity Market Support Project

The aim of this ongoing project is to support efficient functioning of electricity market through priority investments in metering, dispatch and transmission of electricity. The project is facilitating the development of the power industry, leading to improved reliability and efficiency of supply and use of electricity in the country.

68


9.0 CONSIDERATIONS

While considering the Information Memorandum, each recipient/interested party should make its own independent assessment and seek its own professional, financial, legal and tax advice. Each recipient/interested party is encouraged to take into consideration a wide range of factors, among other things the Georgian transmission tariff methodology, the Georgian distribution wheeling tariff methodology, transmission transfer capability with Turkey in non-winter months, transmission capacity allocation, Georgian transmission capacity congestion management, harmonization of legislation and regulations relating to cross border power trading, Georgian market rules, Turkish transmission capacity allocation, Turkish transmission congestion management, and other considerations not referenced herein.