Report No. 14036-K(G

Kyrgyz RepublicEnergy Sector Review

May 15, 1995

Ilhtr-.s(i, Wlre, Lwtegry . [IvkiO w('!it I)ivie,ior

I iroI v I Jn f l! .1t Ar r iI

Document of the World Bank

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CURRENCY EQUIVALENTSCurrency unit = Som

US$1 = 10.65 som (as of December, 1994)WEIGHTS AND MEASURES

atm atmosphere mt million metric tonsbcm billion cubic meters MW Megawatt (106W)Gcal Gigacalorie (109 cal) MVAR Megavolt Ampere ReactiveGJ Gigajoule (091J) psi pound per square inchGW Gigawatt (1 09 W) Pi Petajoule (105J)kg kilogram t metric tonkin2 square kilometer tce ton of coal equivalentkoe kilogram of oil ecluivalent tcm thousand cubic meterskV kilovolt toe ton of oil equivalentkWh kilowatt hour Tcal Teracalorie (1012 cal)MCM million cubic melers TWh Terawatthour (1012 Wh)

CALORIFIC VALUESI Unit of Fuel Gcal

Coal (ton) 3.9Wood (solid m3) 1.8Natural gas (000m3) 8.1Mazut (ton) 9.7Diesel (ton) 10.2Gasoline (ton) 10.5Kerosene (ton) 10.3Liquefied petroleum gas (ton) 10.8Crude oil (ton) 10.()

CONVERSION FACTORSI Gcal = 4.187 GJ = 3.968 million Btu = 1,163 kWh; I tce = 7 Gcal; I toe 10 Gcal

CHEMICAL COMPOUNDS

NO, Nitrogen Oxides SO2 Sulfur Dioxide

ABBREVIATIONS

KR Kyrgyz RepublicCIS Community of Independent StatesEBRD European Bank for Reconstruction and DevelopmentEU TACIS European UnionTechnical Assistance for the CISGDP Gross Domestic ProductERRA Enterprise Reform and Resolution AgencyKNEHC Kyrgyz National Energy Holding CompanyCHP Combined Heat and PowerHOB Heat-only BoilerLPG Liquefied Petroleum GasNMP Net Material ProductSCADA Supervisory Control and Data AcquisitionSPF State Property FundUSAID U.S. Agency for International DevelopmentVAT Value--Added Tax

FISCAL YEARJanuary I - December 31

Preface

The review is based on findings of an energy mission which visited the KyrgyzRepublic in October 1994. The mission consisted of Messrs./Mmes. S. Ouahes (missionleader, power and district heat), W. Floor (household energy, renewables and energyconservation), C. Green (consultant, natural gas and petroleum products), Y. Guven(energy data analysis and energy balance) M. Heitner (financial aspects and sectorrestructuring), H. Hendriks (coal), and S. Mathrani (consultant, energy pricing and trade).Mr. Green's participation was financed by the UK Know-How fund. Drafting of theExecutive Summary and editing of the document was done by J. Koch with valuablecontribution by D. Craig. H. Garcia and R. Hamilton were the peer reviewers. The reportwas processed by J. Ramos and D. Drake. The work was carried out under the generalsupervision of Jonathan Brown, Division Chief, and Yukon Huang, Director.

The mission's work is based on the report "Energy Program of Kyrgyzstan"approved by the Government of Kyrgyzstan in 1992 and on extensive discussions with theentities involved in the energy sector as well as the EU-TACIS-financed Energy AdvisoryGroup. The World Bank wishes to thank the authorities of the Kyrgyz Republic for theirsupport and cooperation.

TABLE OF CONTENTS

ExEcurnvE SUMMARY ......................................................... i

Main Report

CHAPTER 1 - ENERGY AND THE ECONOMY ......................................................... 1A. Macroeconomic Context ........................................................ 1B. Energy in the Economy ......................................................... 3C. Energy Resources ......................................................... 4

CHAPTER 2 - ENERGY CONSUMPTION AND DEMAND .......................................................... 7A. Energy Consumption and Use ......................................................... 7B. Household Energy Consumption Patterns ......................................................... 10C. Energy Efficiency Improvements ......................................................... 11D. Energy Demand Forecasts ......................................................... 13

CHAPTER 3 - ENERGY PRICING ......................................................... 21A. Primary Energy Production and Supply ..................................... 21B. International Trade in Energy ......................................................... 28

CHAPTER 4 - ENERGY PRICING .......................................................... 35A. Overview .35B. Current Approach to Price Setting .36C. Coal .37D. Natural Gas .38E. Petroleum Products .39F. Electricity .41G. District Heating. 45H. Energy Price Reform and Collections .461. Targeted Program of Energy Subsidies for Low-Income Consumrs .48

CHAPTER 5 - ORGANIZATION OF THE ENERGY SECTOR ........................................................ 55A. Government Institutions ........................................................ 55B. Privatization and Financial Management ...................... .................................. 61C. Options for Restructuring the Subsectors ........................................................ 62

CHAPTER 6 - ENERGY AND THE ENVIRONMENT ........................................................ 71A. Introduction .71B. Environmental Issues in the Energy Sector .71C. Environmental Policies for the Energy Sector .73

ATTACHMENTS:

1 - Energy Sector Issues and Recommended Actions2 - Priority Investments3- Priority Technical Assistance Actions

ANNEXES -- WORKING PAPERS (AVAILABLE ON REQUEST)

Annex I - PETROLEUM EXPLORATION AND PRODUCTION

Annex II - PETROLEUM PRODUCTS DISTRIBUTIONAnnex III - NATURAL GASAnnex IV - COAL

Annex V - POWER AND DISTRICT HEATINGAnnex VI - HOUSEHOLD ENERGY CoNsuMPTIoN

EXECUTIVE SUMMARY

The Executive Summary begins with a brief overview of the present situation and main issues

facing the Kyrgyz energy sector, followed by core recommendations for the near and medium-

longer term for the sector's restructuring and commercialization.

Present Situation and Main Issues

Energy Resources and Supply

* Kyrgyz Republic has abundant low-cost hydropower resources which have been partiallydeveloped, small (and declining) oil and gas production, and a collapsing coal industry (despitesignificant coal resources).

* Imports of coal, petroleum products and natural gas account for about 60% of primary energy use,with net energy inports contributing about US$ 100 million to the country's annual tradeimbalance (estimated at US$ 73 million in 1994).

* Energy consumption, with the exception of household use of electricity and natural gas, hasdeclined sharply since independence (1991), and is unlikely to return to pre-independence levelswithin the coming decade.

Energy Policy and Sector Organization

* Increased reliance on indigenous energy supplies (particularly electricity/hydropower) and effortsto attract the private sector to assist in developing domestic resources constitute the main focus ofthe Govemment's post-independence energy policy. Public sector enterprises remain responsiblefor the bulk of activities in the sector.

i Central coordination of the energy sector is diffuse, with some enterprises coming under theMinistry of Industry, Trade and Material Resources and others reporting to a Deputy PrimeMinister. The State Committee for the Economy and State Property Fund are also involved.

* Existing data on the sector are scarce, and transfer to consumers of information on efficiencymeasures is lacking. Projections of energy consumption, production and trade are necessarilyuncertain.

Energy Pricing and Arrears

* Inport prices for coal, petroleum products and natural gas for industrial use are largely passedthrough to consumers. However, prices of electricity, district heating and household gas have beenkept artificially low. The Government's unwillingness to raise these prices is weakening the energysupply industry, and distorting consumption pattems and investment requirements.

* The power and gas utilities are effectively bankrupt due to the low prices, accumulation of massiveconsumer arrears, and tight credit situation prevailing in the country. Imnplicit subsidies, borne bythe power utility on behalf of its customers, for power and heat just to cover cash operating costsamounted to about US$ 20 million in 1994, and year-end accounts receivable were equivalent toten months, or about US$ 128 million.

* Household use of electricity has nearly tripled since 1990, and the transmission and distributionsystems are dangerously overloaded. The Govemment's policy of switching households andcommercial consumers to electricity for heating is costly to the economy; electrical heating costsabout three times that of heating with coal or natural gas. Moreover, domestic (i.e., within thecountry) consumption displaces exports, necessitating costly investment in new generating capacityif electricity exports are to be maintained and increased over the medium term.

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Energy Enterprise Performance

* Governance and financial management of the state-owned energy enterprises are very weak, andthere is considerable risk that energy supply will deteriorate to unsustainable levels unless theentities begin to operate on a commercial and responsible basis.

* Most of the enterprises (except petroleum exploration/production entities) have been cut off fromthe national budget, and Government has little or no control over their operations whilemanagement has considerable powers. At the same time, due in part to the lack of a legislativeframework enabling them to behave otherwise, the enterprises remain akin to governmentdepartments in terms of adopting social policies (e.g., agreeing to keep prices low, not enforcingpayments and allowing overstaffing).

* Financial reporting is not in line with international accounting practices, and the basic informationsystems needed by management for decision-making do not exist.

Private Sector Involvement in Energy

* The domestic private sector has been quick to indicate its willingness to participate in the Kyrgyzenergy sector and has already ventured into trading and distributing petroleum products and coal,mining coal and bottling liquefied petroleum gas (LPG).

* A small US-based company is also working with the state oil company to enhance oil productionfrom its existing fields and build a small refinery for processing its oil production. International oilcompanies may also be interested in petroleum exploration in the Kyrgyz Republic.

Regional Energy Trade

* Kyrgyz Republic is a small, land-locked country for which regional trade is critically important.The trade-offs between competing electricity and irrigation needs for water as well as the trade ofnatural gas, petroleum products and coal, pose important challenges to regional economiccooperation.

* International energy trade arrangements, as presently negotiated, are rather disadvantageous to thecountry. Electricity is exported at a price close to its cost of supply, while natural gas is importedat a price close to the cost of alternative fuels. The differentials between the cost of supply ornetback from alternative markets and cost of alternative energy sources are sizable (about USS 100million for electricity and US$ 30 million for gas in J994) and may be more equitably sharedbetween the concerned countries.

Donor Assistance and Future Strategy

* Considerable donor assistance has been provided to the Kyrgyz Republic as it makes the transitionfrom centralized systems to a market economy. A number of agencies (ADB, EBRD, EuropeanUnionlTACIS, Islamic Development Bank and World Bank) and bilateral donors (Austria,Germany, Japan, Norway, Switzerland and U.S.) have been involved in the energy sector inparticular.

* For the future, the Kyrgyz energy sector should be increasingly self-financing rather than a drainon the national budget and balance of payments. The present underutilization of the sector's supplycapacity provides an important opportunity for the Government to restructure and rehabilitate thesector without being under intense pressure to add new capacity.

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Core Recommendations: Near Term(12-18 months)

Improving Energy Policy, Sector Organization and Coordination

* Establish small energy cell/unit as the single focal point for energy in the Government, withresponsibility for formulation of general energy policies, central repository for energy data anddissemination of energy conservation information

* Evaluate and modify Government policy of switching households and commercial consumers toelectrical heating.

* Prepare strategy for restructuring and privatizing the electricity and district heating sector

* Use opportunity of May 1995 Consultative Group Meeting in Paris to coordinate donor assistancearound the program below for restructuring and commercializing the Kyrgyz energy sector

Enhancing Private Involvement

Privatize/auction off the depots, retail outlets and other assets of Kyrgyzmunaizat (petroleumproducts trade and distribution); establish depots as common carriers providing transport andstorage services but no involvement in retail sales 4

* Privatize/auction off the depots and other assets of Kyrgyztopsnab (coal trade and distribution)

* Separate LPG from Kyrgyzgas' natural gas operations td privatize/auction off the LPG activities

Restructuring and Commercializing State-owned Enterprises

* Close Kyrgyzkumyr's uneconomic coal mines

* Restructure Kyrgyzneft (oil production) as a commercially operated state oil company

* Separate electricity from district heating wvithin KNEHC

* Restructure KNEHC's (electricity and district heating) and Kyrgyzgas' (natural gas) balance sheetsand enforce sound financial targets

* Introduce international accounting practices and management information systems into KNEHC andKyrgyzgas

* Prepare program of priority investments for KNEHC and Kyrgyzgas, and identify potentialfinancing sources

Adjusting Energy Prices and Improving Collections

* For petroleum products, establish system of posted prices for depot services and monitor retail pricesto guard against monopolistic behavior by suppliers

* For electricity, district heating and natural gas, raise prices to cover fuel, maintenance and otheroperating costs by end-1995 and to additionally cover depreciation by end-1996; raise householdtariffs to at least equal industrial tariffs by end-1995 and to full cost recovery by end-1996, exceptfor the first 100 kWh of electricity consumed per month by households which will be priced at a

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subsidized lifeline rate; in the case of electricity, this means a 35% increase in 1995 and 1996 forindustry and a three-fold increase in 1995 and two-fold increase in 1996 for households

Prepare and implement program to reduce KNEHC's and Kyrgyzgas' payment arrears to morenormal levels (e.g., two months) and to preclude further accumulation of arrears; actions include (i)stop supplying consumers who are effectively bankrupt, paying other suppliers in preference toenergy, or otherwise diverting their funds; (ii) negotiate mutual settlements among creditors; and (iii)increase and enforce penalties for non-payment, and/or offer incentives for timely payment

Develop and implement meter reading and billing system for all electricity consumers; prepareprogram for metering and billing of all natural gas consumers, and consider options for variablecontrol and metering of district heating

Review taxes on energy (particularly petroleum products), move them toward rates typicallyobserved in market economies, and enforce collections

Establishing Targeted Social Safety Nets

* Develop and implement severance programs for employees made redundant by restructuring andprivatization of energy enterprises

* Set up and implement social safety net for low-income consumers to mitigate impact of higherenergy prices, perhaps in the form of a voucher system for coal in rural areas and districtheating/natural gas in urban areas; system proposed in the report is estimated to cost about USS 10million a year and could be funded out of increased taxes on petroleum products (e.g., gasoline)

Preparing Appropriate Legislation and Regulatory Framework

* Complete drafting and enact petroleum law/fiscal framework

* Review law on subsurface resources and make necessary changes, if any, to enable unrestrictedprivate sector participation in coal mining and otherwise facilitate its entry to the industry

* For coal and petroleum products, draft and enact necessary regulations pertaining, for example, toproduct standards, safety and environment

* For electricity, district heating and natural gas, consider options for the type of regulation (e.g., lightto heavy-handed) and range of responsibilities for the regulatory agency (e.g., electricity only, allenergy, all network utilities)

* Consider options of single energy law with laws/regulations for individual subsectors (e.g.,electricity, district heating and natural gas) and of separate energy law for each subsector, anddecide how other necessary regulations (e.g., safety and environment) should be handled

Improving Regional Trade Arrangements

* Prepare background papers on estimates of alternative benefit-sharing arrangements for intra-regional energy trade and examples of inter-country contractual agreements used elsewhere in theworld; this could be done with the assistance of the World Bank and other donors, and the papersprovided to all countries in the region

Consider various options for regional discussion of these issues, including exploring with otherGovernments in the region the possibility of convening a regional conference to discuss energy tradeand water sharing arrangements

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Core Recommendations: Medium-Longer Term(beyond 18 months)

Sector Organization, Private Involvement and Institutional Aspects

* Privatize/auction off Kyrgyzkumyr's coal mines which are viable and other assets

* Restructure Goskomgeologia (exploration and geology) as a geological survey for the country andsell its operations assets

* If warranted, carry out promotion of Kyrgyz Republic's prospective basins and enhanced oilrecovery prospects to the international oil industry

* Assess long-term potential for natural gas use in the country

* Reconstitute KNEHC's and Kyrgyzgas' boards to operate as true corporate boards

* Implement strategy for restructuring/corporatizinglprivatizing electricity and district heating, whichis likely to include several power entities (e.g., separate generation, transmission and distributioncompanies, some of which may be privatized or have private involvement), district heatingenterprises, and independent power producers for new thermal/hydro generation

Pricing, Collections and Social Safety Nets

e For electricity, district heating and natural gas, prices should be structured to encourage efficient useand cover full financial costs (including profits) for all consumer categories, with the possibleexception of continuing a lifeline tariff for household electricity consumption

i Implement metering and billing program for natural gas and, if warranted, variable control andmetering for district heating

* Regularly review and adjust as needed social safety nets for low-income consumers and severanceprograms for redundant employees

Legislation and Regulatory Aspects

* Draft and enact necessary laws/regulations concerning the energy sector

* Establish energy regulatory agency and transfer regulatory oversight responsibilities to it

Trade and Other

* Negotiate longer termi contracts for regional energy trade aimed at obtaining equitable sharing ofbenefits among concerned countries

* Implement KNEHC's and Kyrgyzgas' priority investments, which are likely to be mainlyrehabilitation and upgrading of existing facilities and measures to improve efficiency in the near-medium term

Consider future development of hydropower resources for export, only on basis of long-term powersales agreements

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The rest of the Executive Summary gives background information and further details supporting the

summary issues and core recommendations outlined above. This is organized around the following topics,

with two pages on each:

Page

Recent Trends-Energy Consumption, Production and Trade ............................ ............ viii

Household Energy--Household Use of Energy and Electricity Consumption ........... .......... x

Energy Trade--Electricity and Other Energy Trade ................................................... xii

Pricing and Competition Policy--Price Control versus Decontrol andCompetition Policy and Privatization ................................................... xiv

Energy Utilities--Utility Tariffs and Utility Financial Restructuring ............................... xvi

Investment and Environment ................................................... xviii

viii

Recent Trends in Energy Consumption

1. Final energy consumption in Kyrgyz Republic during 1991-94 and projection for 1997 in physicalunits are:

1991 1994 1997ACrUAL ESTIMATE PRoJECrION

COAL (1000 TONS) 3400 1052 1100

PETROLEUM PRODUCrS (1000 TONS) 2289 550 800

NATURAL GAS (MiLLIoN cuBic METRs) 1166 815 900

ELECTRICITY (SAzs) (GWH) 8129 7825 8200

DiSTRICT HEATING (TERACALORES) 5423 2715 3500

FIREWOOD(1000 CUBICMETERS) 1000 1600 1600

DUNG CAKES (1000 TONS) 70 100 100

ToTAL FINAL CONSUMPTION (MILLION TOE) 5.6 2.7 3.0Note: Projedions are mission estimata based on Bank's nuacro projections.

2. Final energy consumption has more than halved during 1991-94. Growth in the economy's realoutput (GDP) has similarly declined, the biggest drop being in industrial production.

3. Consumption of coal, petroleum products and natural gas have declined sharply. Three factorshave contributed to this: (a) the overall decline in the economy and in household incomes; (b) high pricesKyrgyz Republic pays to import these fuels from neighboring republics (at or above international prices);and (c) distortions in relative energy prices within the country. The collapse of industrial production hasaffected demand for all three fuels, while declines in agriculture and transport have affected petroleumproducts use. Electricity has been substituted, where possible, for household consumption of these fuels.

4. Consumption of electricity has declined slightly, while that of district heating has halved.Household consumption of electricity has more than doubled during 1991-94, industrial and agriculturalconsumption have reduced by one-quarter to one-half, and others have remained unchanged. This reflectsthe low relative price for electricity and increased use of electricity for cooking and heating. The sharpdrop in district heating consumption is mainly due to rationing by KNEHC to conserve fuel.

5. Consumption of firewood and dung have increased, particularly in rural areas. Firewood, which istraditionally purchased on a barter basis in Kyrgyz Republic, and dung have substituted for household useof high-priced coal and petroleum products. This may also reflect a more accurate accounting of firewoodusage, and raises concerns about the potential impact on the country's forest reserves.

6. Energy consumption can be expected to begin to grow slowly as the economy stabilizes and beginsa gradual recovery. The mnix of consumption can also be expected to change, due both to the changingstructure of the economy (agriculture and services are expected to lead the recovery, with a lesser role forindustry relative to pre-independence) and to the Government's efforts, with the help of the private sector,to enhance development of its indigenous energy resources. Increased efficiency and conservation measuresare also expected to lead to reduced intensity of energy use in the economy.

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Recent Trends in Energy Production and Trade

7. Production and trade of primary energy in the Kyrgyz Republic during 1991-94 and projectionfor 1997 in physical units are:

1991 1994 1997ACTuAL ESTIMATE PROJECTION

COAL (1000 TONS)PRODUCTION 3483 670 500NETIMPORTS 917 1196 1300

CRUDE OIL (1000 TONS)PRODUCTION 143 90 90NET EXPORTS 143 90 90

PETROLEUM PRODUCrS (1000 TONS)NETIMPORTS 2589 700 950

NATURAL GAS (MILIoN CUBIC MbTpm)

PRODUCTION 70 39 40NET IMPORTS 2136 1000 1200

ELECTRICITY (GWH)PRODUCTION (HYDRO) 10058 10710 10000NETEXPORTS 4293 2505 2000

N&: Projedcts are mission etima based oi Bank's macro projections.

8. Primary production of electricity (from hydropower) has remained stable during 1991-94, while netexports of electricity have nearly halved due to the drop in demand from neighboring republics. In parallel,thermal power production, which is dependent on imported coal and gas, has been reduced by two-thirds(and with it, district heating produced by the combined heat and power plants).

9. Imports of petroleum products and natural gas have declined sharply. This follows the drop infinal consumption of petroleum products, while for natural gas the main reduction is in the use of gas togenerate electricity and heat. Local production of oil and gas have continued at low (and declining) levels.

10. Net imports of coal have increased, while production of domestic coal has collapsed and theclosing of at least some mines is unavoidable. Demand for Kyrgyz coal has fallen sharply because of: (a)the drop in coal demand from neighboring republics and in household use of coal; (b) logistics of coalproduction and use (coal mines in south and main domestic markets in north); (c) high transit fees ofneighboring republics; and (d) poor productive capacity of the mines due to their deteriorated condition andinefficient operation. Hence, the present cost of producing and transporting domestic coal makes ituncompetitive with alternative energy sources in the Kyrgyz Republic including imported coal and naturalgas.

11. Projections of future energy production and trade are necessarily uncertain. Key factors include:(a) the rate of economic recovery in the Kyrgyz Republic and neighboring republics; (b) tradingarrangements negotiated with neighboring countries; and (c) Kyrgyz Republic's ability to attract privatesector participation and financing to enhance production of domestic coal, oil, natural gas and hydropowerresources.

x

Household Use of Energy

12. Household use of energy in the Kyrgyz Republic, based on a mid-1994 survey of urban and ruralhouseholds, is (in % of households):

NATIONAL URBAN RURAL

ELECrRICrrY 100 100 99

DIgTRICr HEATING 23 52 1

NATURAL GAs 24 56 0

LPG 24 18 29

KEROSENE 4 0 7

COAL 52 32 67

FIREWOOD 66 28 95

DUNG CAKES 49 5 81

13. Household consumption of energy has declined by 36% during 1991-94, while consumption byindustry, agriculture and transport have fallen to 33% - 45% of their pre-independence levels. Householdand industrial shares of total energy consumption have switched positions, with households now accountingfor 39% and industry 32%4, compared with 1991 when the shares were 27% and 41%, respectively.

14. Reliance on energy resources differs significantly between urban and rural households, althoughelectrification of households is 100% nationwide. Of the 4.5 million people living in the Kyrgyz Republic,about 38% live in urban areas and 62% in rural areas. The penetration rate of subsidized natural gas anddistrict heating for cooking and heating in urban areas is high; coal and firewood also play a significant rolealthough considerably less than in rural areas. In rural areas, the population depends on firewood, dung,coal and LPG for cooking and heating. With the recent increases in coal and LPG prices to internationallevels, household use of these fuels has declined significantly, partly at the expense of increased use offirewood. If firewood use is not controlled, Kyrgyz's fragile forest cover will be at risk. Electricity is alsobeing increasingly used for cooking and heating, particularly in rural areas, because of its availability andlow price relative to alternative energy resources.

15. There is an imbalance in the access of urban and rural households to energy resources, with urbanconsumers having access to significantly lower cost resources (namely, natural gas and district heating).Moreover, while electricity is available to all households, consumers without access to district heating (i.e.,those outside urban areas) are subsidizing those with access; the underlying reasons for this are: (a)KNEHC's thermal plants generate both heat and power without clear separation of the costs of each; (b)heating tariffs do not reflect full cost recovery; and (c) losses are high due to the lack of regulatory devicesand pricing incentives to conserve energy. Industrial and other consumers are also subsidizing householdconsumption of natural gas, electricity and district heating.

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Electricity Consumption by Households

16. Electricity consumption in urban and rural households in the Kyrgyz Republic during 1990-94 is(in GWh):

1990 1991 1992 1993 1994

NATIONAL 1110 1454 1950 2454 3154URBAN 537 573 819 1087 1520RuRAL 573 881 1131 1367 1634

17. Household consumption of electricity increased 117% during 1991-94 (184% during 1990-94).This is contrasted with a 36% drop in overall energy consumption by households over the same period.

18. Increased use of electricity for cooking and heating is the main factor contributing to thespectacular rise in household consumption. This has resulted in overloading of the transmission anddistribution systems and need for rehabilitation and upgrading of the same to improve system efficiency andreliability of supply. Moreover, while existing generating capacity is judged sufficient for domesticconsumption for the next 8-10 years, it would be at the expense of the country's electricity exports. Tomaintain and increase existing export agreements, costly investment in new capacity will be required.

19. Since independence, the Government has promoted the use of domestic energy resources, e.g.,hydropower, in place of high-cost imported fuels. 100% electrification enabled households to switchquickly to electricity. However, distortions in relative energy prices and lack of know-how and incentivesto conserve have led to inefficiences in the use of electricity. Electrical heating, for example, is not costeffective, particularly with the poorly insulated houses and inefficient appliances which are prevalent in theKyrgyz Republic; the Government's policy of promoting electrical heating needs to be re-assessed and mostlikely reversed. Moreover, adjustment of electricity prices to get the incentives right and cover someminimum of costs (e.g., operating and maintenance costs and the additional transmission and distributionworks investment), implementation of sanctions against defaulting consumers, introduction of properbilling/collection systems for households, and promotion of energy conservation and consumer educationare critical to the power utility's future viability.

xli

Electricity Trade

20. Value received and paid by Kyrgyz Republic for electricity trade and related services withneighboring republics in 1994 compared to estimated avoided cost are (in US$ million):

PHYSICAL VALUE AVOIDED

QUANTITY RECEIVED/PAID COST

EXPORTS:

ELECTRICrrY SALES (GWH) 4252 110 170-191

RESERVE CAPACITY & FREQUENCY 5300 5 17REGULATION (MW)

IMPORTS:

ELECrRICITY PURCHASES (GWH) 1747 45 26

TOTAL NET TRADE na 70 161-182Note: Kyrgyz Republic exports electricity to Kazakhstan during the day (i.e., during the system peak), and Kazakhstan pays for about40% of this by exporting electricity to Kyrgyz Republic during the night (i.e., off-peak). There is no actual payment aude byKyrgyz Republic for the imporls, rather payment is made in electricity exports during Kazakhsta's peak denaunL

21. Kyrgyz Republic sells electricity to its neighboring republics, mainly Kazakhstan, within theCentral Asian Integrated System (CAIS). It also provides reserve capacity and frequency regulation for theregional system. The bulk (80%) of KNEHC's generating capacity is hydropower, developed for the dualpurposes of electricity and irrigation water supply; however, KNEHC's use of the capacity in winter, whenits electricity demand peaks, is limited due to the need to store the water for downstream (mainlyKazakhstan and Uzbekistan) summer irrigation requirements.

22. Contracts for electricity trade with neighboring republics are negotiated on an annual basis, andprices agreed have been rather low (although substantially above Kyrgyz domestic prices). Negotiatedprices, as in the case at hand, are a combination of the buyer's willingness to pay and seller's willingness tosell, with the relative strength of each country's negotiating position being affected by, inter alia, theavailability of alternative sources of supply and alternative markets and the cost of supply. In the case ofelectricity trade for Kyrgyz Republic in 1994, for example, it is estimated that the US$ 70 million whichthe country received for net electricity exports more than covered KNEHC's actual cost of supply (notincluding a profit margin). On the other hand, if Kazakhstan and the other republics in the CAIS had hadto build additional capacity, it is estimated that it would have cost them about US$ 170 million to substitutedomestic generation for these imports (i.e., the avoided cost). The difference between these two amounts,US$ 100 million equivalent, reflects the additional benefits which might be shared more equitably betweenKyrgyz Republic and its neighbors. It may also be noted that these figures do not take into account theadditional 1700 GWh of electricity which Kyrgyz Republic could generate during the winter if it did notneed to store the water for summer use by its neighbors. Sharing of water rights in the Aral Sea Basin wasagreed by the five republics concerned in February 1992, shortly after their independence. Negotiation oflonger term contracts for electricity supply with more equitable sharing of benefits is a priority area forGovernment action. KNEHC has also accrued sizable arrears from the Kazakh power utility which need tobe addressed.

23. Kyrgyz Republic has abundant hydropower resources which could potentially be developed forexport to neighboring countries. Provided long-term sales agreements can be arranged under secure andprofitable conditions, these resources should be developed.

xiii

Other Energy Trade

24. Imports of energy resources--coal, natural gas and petroleum products--totaled US$ 160 million in1994, or about 39% of all imports, while energy exports (mainly electricity) totaled US$ 73 million, orabout 21% of all exports. Kyrgyz Republic's overall trade imbalance in 1994 was US$ 73 million. Thiscompares with an energy trade imbalance of US$ 140 million, out of an overall trade imbalance of US$159 million in 1993. Imports, including energy but to a lesser extent, were reduced in 1994 due to theacceleration of output decline partly induced by the tight credit situation, while electricity exports wereincreased.

25. Kyrgyzgas, the state enterprise responsible for importing the country's natural gas supplies,imports gas from Uzbekistan (also Turkmenistan in the past). The 1994 negotiated price was US$ 65/1000cubic meters which is about equivalent to fuel oil or coal (not taking environmental benefits into account)which Kyrgyz Republic might use in its place. Gas is abundant in the region, and the main alternativeexport opportunity is Western Europe; based on estimnated netbacks to Uzbekistan of US$ 20/1000 cubicmeters, the cost to Kyrgyz Republic would be US$ 35/1000 cubic meters (including transport). As in thecase of electricity, the difference between these amounts, or about US$ 30 million equivalent in 1994,reflects the additional benefits which might be shared more equitably. At the same time, KNEHC whichuses gas for power generation has accumulated sigrificant arrears to Kyrgyzgas which, in turn, hasaccumulated significant arrears to the Uzbek supplier. Such an arrears situation is not conducive toUzbekistan's being willing to negotiate a better gas price. Moreover, while there is good potential for alarger natural gas market within Kyrgyz Republic, the high import price is likely to preclude its earlydevelopment.

26. Trade in petroleum products and coal are no longer state monopolies, and import prices are onlyslightly high relative to international prices. With the break-up of the Soviet Union, petroleum productimport prices immediately rose to international levels. The main impediment to the private traders has beenarranging trade credits because of the dysfunctional banking system; this has tended to push up importprices. While petroleum product consumption will certainly rise with economic recovery in KyrgyzRepublic, the domestic market is too small and available refining capacity in the region too high to justifyconstruction of a refinery to process imported crude oil.

27. Together with the sharp drop in coal exports, rise in domestic coal prices and collapse of theKyrgyz coal industry, demand for imported coal has also declined. The main consumers are householdsand the power utility; the power utility imports coal in exchange for electricity under a barter arrangementwith Kazakhstan. With the main domestic coal production in the south and high cost of its transport tonorthern markets, it makes sense for consumers in the north to continue importing from Kazakhstan.Hence, the domestic coal industry, if it is to survive, will need to compete in nearby markets to the south,including Uzbekistan, Tajikistan and southern Kazakhstan.

28. Regional energy trade will continue to be critically important for the Kyrgyz Republic.Negotiating long-term contracts with equitable terms of trade and working out appropriate paymentsystems are a high priority for the Government. The cost of not doing this, as illustrated above for powerand gas, is high. The proposed Regional Conference on Energy Trade provides a potential approach toaddressing this issue. Also, there is a need for harmonization of energy policy among the Central AsianRepublics given the informal trade and transactions taking place across the borders. Background papersoutlining benefit-sharing and contraeting alternatives in an impartial manner and drawing on experience inother country-to-country trade situations, could be prepared and provided to the concerned countries in theregion. If requested, the World Bank and other donors could assist in the preparations for such aconference.

xiv

Price Control versus Decontrol

29. The state-owned energy enterprises, particularly the power utility, face severe financial difficulties.These have arisen in the first instance because of delays in adjusting output prices in response to rapidly risinginput prices, and have been exacerbated by a large build-up of consumer arrears (many of which aregovernment and inter-enterprise arrears) and the broader problem of a tight credit situation in the country.Hence, the enterprises are facing considerable problems in purchasing needed inputs and providing thenecessary resources to properly operate and maintain their assets, let alone finance rehabilitation or newinvestments.

30. The commercial practices of the energy enterprises leave much to be desired. A clear strategy toreduce payment arrears, particularly the accumulation of further arrears, needs to be developed andimplemented. An important first step is identifying the defaulting consumers and extent of arrears. Suppliesto consumers who have no potential for being able to pay should be cut off (e.g., non-operating industries).Proper metering and billing systems should be put in place for consumers who are not presently covered bysuch systems (e.g., household consumers of electricity and gas), and incentive and penalty systems instituted.In some cases, barter arrangements may continue to be appropriate for a limited time provided equitable pricesare used in valuing the goods (e.g., as in the case of the power utility with its fuel suppliers), or offsets fromthe government budget may be necessary (e.g., government departments and essential services). Arrears ofgovernment agencies are very high, in excess of one year of sales for electricity; these must be resolved, andgovernment agencies begin to set an example for others to follow.

31. Domestic prices of petroleum products and coal are now at or above international prices and are fullyliberalized. Kyrgyztopsnab and Kyrgyzmunaizat maintain, respectively, coal and petroleum products depotsthroughout the country, although private traders (as well as Kyrgyzkumyr, state entity producing domesticcoal) are now also active in trading and distributing both fuels. As there remains some concem whether thereis sufficient competition to ensure fair pricing of petroleum products, a system of posting storage fees at thedepots should be introduced and the Anti-Monopoly Commission should continue to monitor retail prices buton an ex-post basis. The Government should also review the tax element attached to petroleum product pricesin light of the higher rates levied in many Western countries and actively enforce collection of these taxes; aspart of its 1994-97 stabilization program with the Fund, the Government has raised excise duties on petroleumproducts from 15% in 1994 to 25% in 1995, with a further increase to 35% agreed for 1996.

32. Despite substantial increases in domestic prices of natural gas, electricity and district heating in thelast two years, current prices (except industrial gas use) are far below financial and economic prices, and thestructure of prices is heavily biased in favor of household consumers. Prices are set by the Anti-MonopolyCommission based on submissions from Kyrgyzgas for gas and KNEHC for electricity and district heating;prices have been kept low because of concern about inflation and people's ability to pay. Improvedgovernance and financially responsible management of the energy utilities are critically needed. Gas,electricity and district heating networks are natural monopolies; hence, some form of regulatory interventionby the Government will be needed to guard against monopolistic behavior. This may range from heavy-handedregulation as at present whereby the regulator effectively prescribes prices, to more light-handed regulationwhereby the regulator requires participating entities to publish basic cost data with the threat of controls ifunfair practices emerge. The Government should consider the various options and type of energy regulatoryagency it wants (e.g., it might handle other sectors as well such as water supply). In the interim,responsibility for regulatory oversight of the utilities should remain with the Anti-Monopoly Commissionunder ground rules which allow for full pass-through of all financial costs (as defined in a market economy).The most immediate priority for the utilities is to raise prices and commercialize their operations.

33. Faced with rising energy prices, the Government (from the national budget) will need to protect low-income consumers, perhaps through provision of cash subsidies, fuel coupons or lifeline tariffs. Revenuesfrom excise taxes levied on energy use could be used for this purpose. In addition to providing a subsidizedlifeline tariff for the first 100 kWh of electricity per month, a voucher system for coal in rural areas anddistrict heating/natural gas in urban areas is proposed, at an estimated annual cost of about US$ 10 millionwhich could be funded out of increased taxes on gasoline.

xv

Competition Policy and Privatization

34. The private sector is actively involved in trading and distributing petroleum products and coal and, inthe case of petroleum products, is estimated to have 60% of the market. The Govenmient should allow theprivate sector to take over these activities fully and privatize/auction off the depots, retail outlets and otherassets of the financially distressed Kyrgyzrnunaizat and Kyrgyztopsnab. The petroleum product depots andretail outlets should be sold separately, and the depots operated as common carriers providingtransportlstorage services; depot operators would neither own the products nor be involved in retail sales.

35. Kyrgyzkumyr is a holding company for eight enterprises which own and operate 14 coal mines, ofwhich only a few (perhaps 2-4) are likely to be economically viaWe. A number of private or semi-private coalmining enterprises have also been formed, although their production to date has been small. Five ofKyrgyzkumyr's enterprises have already been placed under the control of the Enterprise Reform andResolution Agency (ERRA), pending the results of a diagnostic study and decision on their liquidation orrestructuring; a decision is expected during 1995. Similar action will be needed for the three remainingenterprises. Those mines which are considered viable and Kyrgyzkumyr's other assets should then beprivatized/auctioned off to the private sector. A social safety net will be needed for those employees who leavethe industry during this process.

36. Due to KNEHC's heavy dependence on multi-purpose hydropower plants for electricity generation,relatively small size of the gas market, and integration of electricity and gas supply with regional trade, it maybe appropriate that KNEHC and Kyrgyzgas remain in the public sector for some time. Nevertheless, thereare aspects of each utility which could be separated, commercialized and ultimately privatized. In the case ofpower, a long-term strategy for restructuring the electricity and district heating sector and opening it to privatesector participation is needed. KNEHC is a joint stock holding company for a number of enterprises handlinggeneration, transmission and distribution of electricity and district heating, which operates, for all practicalpurposes, like the headquarters of a single vertically integrated utility. As a first step, district heating shouldbe separated from electricity, with each treated as an autonomous, commercial operation within the utility.Consideration should also be given to unbundling the generation, transmission and distribution functions,commercializing them and, over the longer term, privatizing some of the generation and distributionenterprises. In the case of Kyrgyzgas, which handles liquefied petroleum gas as well as natural gas, its LPGoperations should be handed over to the private sector, which is already involved in importing, bottling anddistributing LPG.

37. Two state entities are active in petroleum exploration and production, Kyrgyzneft in the onlyproducing basin (Fergana Valley) and Goskomgeologia in the rest of Kyrgyz Republic; Goskomgeologia alsocarries out exploration for minerals and is responsible for general geological matters for the Government.Given the country's limited budgetary resources and petroleum potential, the Government should leaveexploration and its concomitant risks to the private sector. Kyrgyzneft should be converted to a commerciallyoperated state-owned oil company, independent of the national budget, which could operate as a local jointventure partner with international oil companies working in Kyrgyz Republic. Goskomgeologia should berestructured as a geological survey for the country, and its assets associated with operations sold. A petroleumlaw and fiscal framework enabling private participation is under preparation; available geological data is alsobeing assembled and reviewed, with a view to carrying out a promotion of prospective areas.

38. A focal point for formulation and oversight of general energy policies on the Government's behalfshould be established; this could be handled by a reasonably small energy cell or unit within the Government.An energy law, mainly concerning the power sector, is now under preparation; the law on subsoil resources isalso undergoing some revisions. Regulations concerning, inter alia, product standards and quality, safety andhealth, and environmental aspects are needed for the various fuels. Consideration may be given to extendingthe energy law to cover all formns of energy, or handling each on its own. Oversight for the regulatoryactivities could be provided by the energy cell or energy regulatory agency depending upon how it isconstituted.

xvI

Energy Utility Tariffs

39. Comparison of domestic energy utility tariffs in the Kyrgyz Republic at end-1994 with tariffs leviedby market-oriented utilities in the West and assessment of the impact on total sales revenues of the Kyrgyzutilities are:

--KYRGYZ REPUBLIC PRICES-- -WESTERN MARKET PRICES-

AVG.UNIT PRICE TOTAL REVENUES AVG.UNIT PRICE TOTAL REVENUES(USS/UNIT) (USS MILLION) (USS/UNrT) (USS MILLION)

NATURAL GAS (1000 cM)HOUSEHOLD 93.61 29 180 56INDUSTRIAL & OTHERS 93.61 47 100 50

ELECTRICITY (KWH)HOUSEHOLD 0.57* 18 7.5 - 12.5* 237 - 395INDUSTRIAL 1.04* 49 4.5 - 7.5* 210 - 350

DISTRICT HEATING (GcAL)HOUSEHOLD 2.83 4 25-45 38 - 68INDUSTRIAL& OTHERS 11.70 14 25-45 30 - 54

* USOIKWH

40. As illustrated above, increasing energy utility tariffs in Kyrgyz Republic to the lower end of tariffscharged by commercial utilities in the West would have resulted in a nearly four-fold increase, from USS 161million to US$ 621 million, in the combined sales revenues of Kyrgyzgas and KNEHC in 1994. WhileWestern market prices are very high in the present Kyrgyz context, they highlight the very low level of currentutility tariffs (except for gas for industry) and the need for significant increases over the longer term if theenergy utilities are to operate on a commercial basis without direct support from the national budget. TheGovernment has agreed, as part of its 1994-97 stabilization program with the Fund, to raise natural gas,electricity and district heating tariffs to households to achieve cost recovery by the end of 1995.

41. As a minimum in the near term, utility tariffs should be high enough to enable the energy utilities topay their suppliers (thus addressing the inter-enterprise arrears problem) and to properly operate and maintaintheir assets. Over the medium-longer term, they should move toward covering needed investments inrehabilitation of existing assets and expansion, as well as providing a reasonable return on the utility's assets(revalued). In the case of electricity and district heating, for example, it is expected that household tariffswould need to be increased three-fold and seven-fold, respectively, and industrial tariffs by 35% and 75%,respectively, to reach the near term target; this would increase KNEHC's annual revenues by about US$ 80million.

42. As noted previously, the structure of tariffs is distorted in favor of household consumers which aremore costly to supply than bulk consumers. Further, gas and heat consumption by households are notmetered, rather a flat monthly rate is charged; there are no controls by which the consumer can regulate hisheat consumption; household use of electricity is metered but no bill is issued, rather the consumer reads hismeter and makes his payment on his own initiative; and various special discounts apply for gas and electricityuse, with the result that most consumers qualify for a 50% discount. These factors, together with the relaxedattitude of the utilities toward bill payment and lack of consumer knowledge about conservation measures,undermine energy conservation and cause unnecessarily high demand for new capacity, hence investment. Arelevant example is the present overloading of the transmission and distribution system for electricity due toincreased household consumption. Aside from raising the level of tariffs, appropriate structuring of tariffsthrough introducing, inter alia, time-of-day, seasonal and progressive tariffs, can also help guide consumerbehavior.

xvii

Energy Utility Financial Restructuring

43. KNEHC's performance compares with that of BC Hydro, a power utility in Canada which has asimilar mix of hydro and thermal capacity (but no district heating) and is considered representative of utilitiesin the West, as follows (in US$ million unless indicated otherwise):

KNEHC BC HYDRO

INSTALLED CAPACITY (MW) 3,433 10,838

GWH GENERATED/IMPORTED 12,926 48,978

% OF WHICH LOSSES 20 9

NUMBER OF EMPLOYEES 11,638* 6,539SALES/EMPLOYEE (MWH) 885 6,830CONNECTIONS/EMPLOYEE (NUMBER) 74 214

REVENUES 161 1,659

EXPENSES - OF WHICH: 127 870FUEL & PURCHASES 100 165OPERATION & MAINTENANCE 26 316DEPRECIATION 1 224

FIXED ASSETS IN OPERATION 50 8,849

LONG TERM DEBT 2 5,550DEBT: DEBT & EQUITY RATIO (°/O) 2.5 87.1

ACCOUNTS RECEIVABLE (DAYS) 290 56a Excluding 2,419 staff from three "non-power enterprises".

44. It may be noted that: (a) BC Hydro sells four times as much power as KNEHC but has half thenumber of employees; (b) operation and maintenance and depreciation account for more than 60% of BCHydro's expenses but only 20% of KNEHC's; (c) BC Hydro has 3.5 times as much generating capacity asKNEHC but its assets are valued nearly 180 times as much; (d) KNEHC has negligible debt while BC Hydrohas a debt:debt and equity ratio of over 85%; and (e) BC Hydro's accounts receivable are less than two monthsequivalent compared with ten months for KNEHC.

45. Recognizing the severity of the financial problems facing the energy utilities and their criticalimportance to the economy, the Government has included KNEHC and Kyrgyzgas in a special group ofenterprises to receive policy advice and technical assistance from ERRA. True commercialization andfinancial restructuring of the energy utilities are essential steps in their transition from a centralized system toa market economy if the utilities are to begin to operate on their own, responsibly and efficiently, independentof the national budget and in response to market signals. Moreover, the corporate structure of the utilitiesshould be reviewed, and consideration given to reconstituting them as true corporate entities, with boardsresponsible for policy and oversight and management for operations; government representatives should beactive participants on the boards as should individuals from outside the sector.

46. As is evident from the comparison of KNEHC and BC Hydro, some key considerations in financialrestructuring of the Kyrgyz utilities include: (a) revaluation of existing assets to reflect their true worth andensure future depreciation provisions are made accordingly; (b) adding debt to the balance sheets (long-termloans from Government in place of equity) and requiring utilities to service the debt, to bring them into linewith typical utilities elsewhere in the world; (c) setting dividend targets to ensure a return on governmentequity; (d) using financial targets to drive tariff increases; and (e) separating the various operations of theutilities, e.g., district heating and power supply, and requiring each to meet its own financial targets (i.e.,eliminate any cross-subsidies). Critical to this will be introduction of proper financial management andaccounting practices, management information systems, and budgeting and cost control systems.

xviii

Investment

47. With energy demand unlikely to reach pre-independence levels within the coming decade, theprimary investment requirements in the near-medium term will be for rehabilitation and upgrading ofexisting facilities and measures to improve energy efficiency both in supply and use. With plans to tummany activities in the sector over to the private sector, the Government's main investment concems will bewith the energy utilities since the private sector will make its own investment decisions. Even the utilities'investments should be financed with a mix of long-term debt and their retained earnings.

48. Some of KNEHC's priority investments include: (a) rehabilitation, upgrading and extension of thepower transmission and distribution system; (b) rehabilitation and upgrading of the district heating systemsin Bishkek and Osh; (c) retrofitting of the combined heat and power thermal plant in Bishkek; (d) overhauland retrofitting of the hydropower plants; and (e) upgrading of the telecommunication and network controlsystems. Feasibility studies for several of these activities are already underway. Technical assistance willbe needed both for carrying out the feasibility studies and for implementation of the investments,particularly where Western technology is being introduced; at the same time, Kyrgyz engineers and otherprofessionals should be directly involved in this work to ensure technology transfer.

49. Large scale investments for export, such as the Kambarata hydropower project, could go aheadas enclave projects secured by long-term power sales agreements, and should be handled separately fromthe power utility's investment plans to meet domestic demand. Similarly, the 220 kV line to China could becompleted once a satisfactory long-term sales contract is in place. The private sector may be interested ininvesting in small (mini/micro) hydropower projects.

50. Kyrgyzgas' priority investments include: (a) installation of metering at the border, SCADAsystems and consumer metering; and (b) completion of the natural gas pipeline under construction withKazalchstan (needed because of problems with the existing pipeline and, over the longer term, for additionalimports) and rehabilitation of the existing pipeline. Technical audits of the existing gas transport anddistribution network are also needed to assess its present condition and determine the need for a minimuminvestment program to safeguard the system.

51. Investment in technical assistance and training will also be required on a number of fronts. Thisincludes assistance in: (a) preparing the various energy entities or parts thereof for privatization; (b)restructuring and commercializing those entities which are to remain in the public sector; (c) introducinginternational accounting practices and management information systems; (d) preparing various energylegislation/regulations; and (e) defining the roles/responsibilities of government agencies (e.g., the energycell and regulatory agency) interacting with the energy sector. Assistance and training will also likely beneeded in the implementation phase of these activities, and in carrying out energy audits and educating end-users in energy efficiency measures. Assistance may also be needed in preparing for the proposed RegionalConference on Energy Trade and negotiation of long-term energy supply contracts.

xix

Environment

52. A national environmental action plan for the Kyrgyz Republic has been prepared with assistancefrom the World Bank. The main recommendations of the plan for the energy sector in the near-mediumterm include:

l legislation/regulations pertaining to environmental standards, monitoring and enforcement,environmental impact assessments, and roles and responsibilities of concerned entities, as these relateto the energy sector, need to be prepared; so as not to discourage private sector investment, it shouldalso be clearly (legally) established that liabilities for past pollution damages are the responsibility ofthe entity which caused the damages or the Government;

* proper maintenance and operation of dust collection equipment and handling of ash disposal in existingcoal-burning power, heat and industrial boilers, and rehabilitation/upgrading of the same, particularlyin urban areas, are of high priority;

* with the pending closure of uneconomic coal mines (both open pit and underground operations), specialattention must be given to ensuring their closure is carried out in environmentally acceptable waysincluding water supply and surface restoration; increased attention is also needed on environmentaland worker health and safety aspects of those mines continuing operations;

* independent evaluation of the safety of existing dams, particularly those in seismically active zones andnear major faults, should be undertaken;

* low-cost means of providing energy for low-income rural communities for space/water heating andcooking to take pressure off limited renewable energy resources should be investigated; reforestationand fuelwood planting projects should be promoted; and

* options for increased reuse of ash from coal burning facilities should be evaluated.

53. A master plan of the country's hydropower resources was completed in 1993 which identifiespromising projects for future development. Priority should be given to exploiting those resources whereimpacts on the population and environment can be minimized, and to integrating a multi-sectoral andcountry-wide review process into planning and evaluating projects. Environmental and social impactassessment must be fully integrated into the technical and economic evaluation of these resources. Suchanalyses may show that certain areas should not be exploited for these purposes, rather they should be setaside for conservation or alternative uses such as tourism.

I. ENERGYAAND THE ECONOMY

A. MACROECONOMIC CONTEXT'

1.1 Background. The Kyrgyz Republic (KR) is a small, land-locked country with a populationof 4.5 million. It is one of the poorest of the newly independent states with a per capita incomeestimated at US$ 830 in 1993. After significant declines in 1992 and 1993, real GDP is estimatedto have declined by a further 26% in 1994. Under the Former Soviet Union (FSU), the KRevolved from an agricultural and pastorally based-autonomous Republic into an economy with asignificant industrial base that accounted for about 40 % of GDP just prior to Independence. Theeconomy was highly integrated with the rest of the FSU, and until 1991, annual fiscal transfersfrom Moscow accounted for about 11 % of GDP.

1.2 The breakdown of inter-Republic trade and payments mechanisms and general economicdecline in the FSU have caused severe disruptions to the Kyrgyz economy. The industrial sectorhas experienced the sharpest loss in output, with a 60% fall in production since 1990, andagriculture is not far behind with a 45% decline. During the same period, export volumes haveshrunk by 60%, while the sharp rise in import prices, particularly for energy, has led to a largedeterioration in the terms of trade.

Table 1.1: Main Macroeconomic Indicators (1991-1994)

1991 1992 1993 (1) 1994(l)GDP (2) 15.6 161.9 5720 10740Real GDP, % change - 3.6 -19.0 -16.0 -26.5GDP Deflator, % change 107 1,487 782 156

Production, % changeIndustry 0 -26 -25 -25Agriculture -10 -7 -8 -17

Real wage indices, 1990 = 100Average wage 81 50 35 24Minimum wage 56 24 16 9

Trade Balance, %of GDP -1.5 -11.0 -15.8 -9 7Exports 42.4 32.6 33.3 34.3Inports 42.9 43.6 49.1 43.9

Budget Deficit, % of GDP 4.5 16.6 13.5 8.4(1) Preliminary estimates.(2) Billions of rubles 1991 - 1992; millions of soms 1993 - 1994.

The main source for the macroeconomic statistics is the Economic Report (No. 12942-KG) of May 1994 andupdates provided by the Bank's March 1995 economic mission.

Kyrgyz Republic Energy Sector Review

2

1.3 Economic Reforms since Independence. The KR was among the first states of the FSU tolaunch a systemic reform program in late 1991. Faced with the inability to pursue an independentfinancial stabilization program as part of the ruble zone, it created its own national currency inearly 1993 with support from the IF. Most prices were freed, trade restrictions lifted and legalbarriers to private sector activity eliminated. Privatization of state-owned assets proceededrapidly and by end-1993, a third of such assets had been privatized. However, progress inrestructuring the remaining State-Owned Enterprises (SOEs) has been slow, and a lax creditpolicy until mid-1993 allowed many non-viable enterprises to survive by accumulating arrears tosuppliers and defaulting on their bank loans. Thus, the financial problems of ailing enterprisesspilled over to other enterprises, banks and the NBK, leading to a temporary relaxation ofmonetary control. By end-1993 NBK had regained monetary control, and in May 1994 the IMFapproved a three-year ESAF in support of the Government's stabilization program. Recentdevelopments suggest that financial stabilization is taking hold with inflation down to 1-2% permonth and the Som stabilized at 10-11 Soms to the dollar. This monetary tightening, togetherwith the lack of functioning financial intermediaries, has resulted in a massive credit crunch.Barter has become a principal mode of transaction, and wages, energy bills and pensioncontributions are being paid in kind.

1.4 Short to Medium Term Reforms. The priority for the coming years is to complete theongoing systemic reform program, particularly in the areas of privatization, restructuring of theremaining SOEs, and banking. Agriculture is expected to lead economic recovery throughrestoration of yields to pre- 1994 levels, with land reform and farm restructuring, improved inputand marketing channels, and availability of rural credit instrumental in improving farmproductivity. As the recently introduced liberalization measures in pricing, trade and marketingare diffused throughout the economy, newly emerging private firms are expected to expand andfill the vacuum created by the collapse of the state dominated marketing systems. The enterpriserestructuring effort is also expected to eventually lead to some recovery of industrial output,particularly in agroprocessing industries. As non-viable enterprises are phased out of the system,more resources would be freed for enterpreneurs to start new private enterprises, as well as forrestructured and privatized enterprises. The focus of macroeconomic policies is to try to narrowthe current account deficit through improved export performance, and to expand the tax base soas to bring down the budget deficit.

1.5 Longer Term Prospects. The KR appears to have good potential for expansion in theagricultural and services sectors and, to a lesser extent, the minerals sector. Energy resourcesare also significant and may offer development prospects, both for import-substitution and export.However, the country is handicapped by its small size, remoteness from export markets and stiffcompetition among Asian developing countries for private capital. Future growth will have tocome from a combination of increased domestic consumption and expansion in external trade bothwithin and outside the FSU.

Kyrgyz Republic Energy Sector Review Chapter I

3

B. ENERGY IN THE ECONOMY

1.6 The energy sector in the KR is relatively large, although its share in GDP is not known.Total direct employment in the sector of about 30,000 only represents about 2% of the totalnational employment of 1.8 million. The details of employment in each of the energy entities aregiven in Chapter 5. However, this understates the importance of the sector in the economy, dueto its heavy capital intensity. For example, the power utility has an asset base with a replacementcost well in excess of US$ 5 billion. While the KR is a net importer of oil, gas and coal, itproduces and exports to its neighbors hydroelectric power generated from the water of the NarynRiver2. The dams on the Naryn also play a key role in regulating the flow of water to majorirrigation schemes in neighboring countries downstream. The trade-offs between competingelectricity and irrigation needs for water pose a delicate issue in the sharing of benefits whichneeds to be addressed at the regional level.

1.7 Trade in energy has a significant negative impact on the balance of payments as importsheavily outweigh exports. Thus, in 1993, energy imports were US$171 million, or about 35% oftotal imports, while exports (essentially electricity) amounted to only US$31 million, just under10% of total exports. The energy trade balance is estimated to have improved somewhat in1994, with exports of about US$73 million as compared to imports of about US$160 mnillion,due to increased power exports and reduced energy imports because of the continued decline ineconomic activity partly induced by the tightened credit situation.

FIGURE 1.1: PERCENTAGE SHARE OF ENERGY GooDs IN TOTAL IMPORTS

40%

35%

30%

25%

20%

15%

10%/

5%-

0% -1991 1992 1993 1994

| Peiroleum * NaturalGas S CoalProduct

2 The Naryn eventually flows into the Syr Daria and the Aral Sea.

Chapter I Kyrgyz Republic Energy Sector Review

4

FIGURE 1.2: PERCENTAGE SHARE OF ELECTRICITY IN TOTAL EXPORTS

40%

4 0 %-_

35% _

3 0 % -

2 5 %_

2 0 %_15%-_

15%10%

1 991 1 992 1 993 1 994

1.8 This imbalance is likely to persist and may increase somewhat as the consumption ofimported energy is likely to rise once economic growth resumes. On the other hand, prospects forincreasing electricity exports (in both volume and value terms) are rather limited in the short tomedium term because of contracting economies and drop in electricity demand in the region.Measures to promote the efficient use of energy and to increase domestic oil and gas productionare therefore vital to any reduction in the weight of the energy sector in the overall balance ofpayments of the KR. The collapse of the coal industry will further deteriorate the trade deficit inenergy.

C. ENERGY RESOURCES

1.9 Hydroelectricity. The KR is fortunate in possessing abundant, low-cost hydroelectricresources which have been well investigated and partially developed. However, despite majorinvestments in the past, 90% of the KR's hydro potential of 26,000 MW has yet to be developed.The Naryn basin which today provides the bulk of the KR's generating capacity offers theprospect of an additional 2,200 MW of capacity at a relatively low unit cost, although largeabsolute investment. Numerous other hydro generation sites also exist, including some suitablefor mini and microhydro schemes.

1.10 Oil and Natural Gas. During the Soviet era, there was little exploration for oil in KR.Hence, the true extent of its petroleum resources is not known. Due to the low priority given tothe sub-sector, comprehensive geological and geophysical work was carried out only in a fewareas and only one, the Fergana basin, is in production. Out of 24 million tons of recoverablereserves in this basin, over 14 million tons remain in place as enhanced oil recovery techniques arerequired to extract them. Several potentially promising oil provinces such as the Chui and AksaiValleys have yet to be explored. The Alai structure in the extreme south of the KR, a highlymountainous area bordering Tajikistan, is the only area where significant seismic work has beencarried out.

Kyrgyz Republic Energy Sector Review Chapter I

5

1.11 Coal. The KR has large coal deposits of about 2 billion tons in four distinct basins.Proven reserves are about 1,200 million tons and over 650 million tons have been prepared formining. About 190 million tons of commercial reserves are located in active fields, the vastmajority of which are in the Kara Keche deposit in the center of the Republic. The commercialexploitation of these reserves is severely handicapped by the mountainous terrain and difficultaccess to the deposits.

1.12 Renewable Energy. The KR has potential of renewable and non traditional energyresources. Solar radiation ranges between 15 to 25 Megajoule per square meter per day. Thepotential of hydro-electricity in small rivers has been estimated at 7 billion kWh, of which only 3%has been exploited. In many valleys the wind regime is 4 to 5 meter per second offering a greatenergy potential. Annually, 80,000 to 110,000 tons of dry dung is being produced, of which 15%could be processed in biogas plants representing a potential production of 200 million cubicmeters (MCM) of methane or one million Gigacalories. The Government is promoting thedevelopment of renewable energy through the business project KUN ("sun" in Kyrgyz), but theeconomic context is not favorable as the relative pricing is distorted in favor of electricity anddistrict heating.

1.13 Forests. Forests do not represent a major energy resource in the KR. Only 4.2% of thecountry is covered with forest representing a standing stock of 23.5 million cubic meters,consisting of 843,000 hectares (ha) of closed forests and some 2 million ha of dispersed forests.The annual reforestation effort is barely 3,000 ha. The main purpose of the forests is soilprotection. Annual legal wood production is 40,000 cubic meters, but there is a rise in illegalcutting of trees, which in 1993-94 amounted to an estimated 500,000 cubic meters. However,this figure, based on a household energy survey, may actually be twice as high. The forests areunder threat not only from illegal cutting, but also from overgrazing and land clearing as a resultof the break up of collective farms.

Chapter I Kyrgyz Republic Energy Sector Review

6

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Kyrgyz Republic Energy Sector Review Chapter I

11. ENERGY CONSUMPTION AND DEMAND

A. ENERGY CONSUMPTION AND USE

2.1 Total commercial primary energy consumption was 6.8 million tons of oil equivalent (toe)in 1991, the first year of independence for the Kyrgyz Republic. This was equivalent to 1,510 koeper capita, rather low by standards of the FSU' but relatively high compared to middle-incomecountries in Asia and Latin America. In 1992 per capita energy consumption dropped to 1,148koe. Table 2.1 below shows that the KR had a higher per capita energy consumption than morethan half of the countries analyzed in 1992. This was due to the much higher energy intensity ofproduction in the FSU and the colder climate in the KR. However, the picture has changedfundamentally over the past three years as energy consumption in the KR has fallen dramaticallyto 59833 koe per capita in 1994.

TABLE 2.1: ENERGY INTENSITIES VS. GDP, 1992

Country GDP/capita Energy Country GDP/capita EnergyCons./capita Cons./capita

($US) (Kg. oil eq.) ($US) (Kg. oil eq.)Kyrgyz Republic 814 1,148 Ukraine 1,820 3,885Albania 282 811 Poland 2,183 2,407Pakistan 35 1 223 Chile 3,030 837China 435 600 Malaysia 3,095 1,445Bolivia 703 255 Hungary 3,419 2,392Peru 987 330 Mexico 3,871 1,525Romania 1,077 1,958 Korea Rep. 6,777 2,569Colombia 1,455 670 Argentina 6,912 1,351Turkey 1,704 948 Ireland 12,370 2,881

2.2 Commercial energy consumption in the KR has more than halved and real GDP shrunk byabout the same amount over period 1991-94. Total primary energy demand in 1994 is estimatedto have fallen to about 3.30 million toe. During the same period, the pattern of energyconsumption has also shifted dramatically, as shown in the energy balances (Tables 2.6, 2.7, 2.8,

1 The equivalent figure for Turkmenistan was 3800 koe (1992), Belarus 4370 koe (1990), and Kazakhstan 4,400koe (1993).

Kyrgyz Republic Energy Sector Review

8

2.9) for the years 1991 and 1994. The drop in consumption has been most pronounced forpetroleum products (down by 73 %) while electricity consumption was more or less constant2 .

FIGURE 2.1: ENERGY INTENSITIES VS. GDP, 1992

4000 -

Ukraine

3 500 ._ . . ... ....

3 0 0 0 . . . .. .... ..... .. ......... ... .. ..... .... ................. ...... ... ....... ...... . .. ....

ed j ; . . , ~~~~~~~~~~~~~~~~~~~~~~~~~~~Ireland

2 5 0 0 .. . . . . .. . .. . . . . .. . . . .. . . .. .. .. . . ... . . . . . . . . . . . .. . . . .. ........ .... . ..... .. .. . .. . . -- - - -- -- - -- -----------,,,,,, ,,,, ,,, ,, ,,, ,,, , ,,,,,

Poland Hungary

°2 0 0 0 .. ... . ... .. .... ..... .. .. .. . . .... ... ................ ..... ................ ........ ................. . ............ ... .................

Romanai

1500 t 15 0 0 . M a l a . - - - - + - ----- ------- ----- - --- ................. ..... .........~~~~~~~~~~~~~~~~............ .................... . ... ....

Mexico

1000 - Argentina,1 0 0 0 .. . ....... ,...... ... . .. . .. . .... ...... .. . .. ... ...... .. ..... .. ............. ... .. .... ......... ................. ....... .. . . .. .... ..... ...... ... . ......

~~ ~Turkey Alban a Chile

500 c.a Colombia 5 0 0 - Chi n a C o lombia > ........................ : + ............ +~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. .......... ..... . .. . .. .. .. ..

* * PeruPakistan Bolivia I '

0 2000 4000 6000 8000 10000 12000

GDP per capita(US$)

2 The structure of electricity consumption changed dramatically over the 1991-94 period. Industrial demanddropped by 43 % and demand from households increased by nearly 120% both in urban areas and in rural areas.

Kyrgyz Republic Energy Sector Review Chapter II

9

FIGURE 2.2: SECTORAL DISTRIBUTION OF FINAL ENERGY CONSUMPTION

1991 1994

0 xetd *Fbnt12% 10% *Fsty

6% a 29% * F 6%13% wAgIma 11% V 45% r Aqjt

40% lTrar _ 28t TtW 28

Total Fhd Bngv 0:- 51 th toe Tal Ri &gv Cam 263t. tht

FIGuRE 2.3: CHANGE IN FINAL ENERGY CONSUMPTION BY SECTOR(thousand tons of oil equivalent)

~bmdi _ __ _ m

(25%cae) (67%dc (60og F6% dx

12003 ZO1D 60D 4QO1,50040D 8 200

vaCD - -1,00 0 \ 4QO - 200

i,x 50 200 2 Q [ 1j

_ _ _ _- - 0 - .

FIGURE 2.4: BREAKDOWN OF TOTAL PRIMARY ENERGY SUPPLY

7,000 .... __ _ _ __ _ _ __ _ _

6,000 _ Firewood and Dung Cakes

5,000 D]coai

4 3,CO Natural Gas

'S3,000

2000 Petroleun Produl s

1,000 _ Elcctricity

0

1991 1994

Chapter II Kyrgyz Republic Energy Sector Review

10

B. HOUSEHOLD ENERGY CONSUMPTION PATTERNS

2.3 A household energy survey carried out in mid-1994 among 686 households, arepresentative sample of both urban and rural households in the KR, revealed that energyconsumption by households as compared with industrialized countries is rather low. What is morestriking, however, is the increase in electricity use by households and the high share of traditionalfuels (dung cake, firewood) in the national energy mix. Some 49% of households use dung cakesand 66% use firewood for cooking and heating. These fuels are mainly consumed in rural areas(dung: 81%; firewood: 95%). The penetration rate of gas and district heating in the urban areas ishigh, as 56% and 52% respectively, of urban households are connected.

TABLE 2.2: USE OF ENERGY BY HOUSEHOLDS (IN %)

Ener/lLocation Kyrgyz Repubhlic Urban Ruml

Electricity 100 100 99District Heating/Steam 23 52 1Natural Gas 24 56 0LPG 24 18 29Kerosene 4 0 7coal 52 32 67Firewood 66 28 95Dmg Cakes 49 5 81

Source: Household Energy Survey

2.4 Consumption of traditional fUels is mainly in rural areas which do not have access todistrict heating nor natural gas. The bulk of traditional fuels are not traded; only 17% ofhouseholds surveyed reported purchases of firewood. Consumption of traditional fuels hasincreased over the past few years, in response to the sharp increase in the price of coal and LPG.Household consumption of coal has shrunk from about 2.5 million tons in 1991 to an estimated800 thousand tons in 1994. LPG consumption has shown a similar trend, dropping from 125,000tons in 1991 to only 10-15,000 tons in 1994. The increase in the use of firewood if notcontrolled, may threaten the fragile forest cover.

2.5 The different patterns of energy use between the urban and rural areas cannot be explainedby difference in income. In fact, energy consumption across the income groups does not differmuch for electricity. Electricity is almost universally available and rural households use more of itthan urban ones. This can be explained by a higher incidence of electric heating and cooking inrural areas, as district heating and natural gas are not available to rural households. Kerosene,dung cakes and firewood are mainly rural fuels. Although used by twice the number of ruralhouseholds, coal and LPG are also used by urban households.

Kyrgyz Republic Energy Sector Review Chapter 11

I1

2.6 Another characteristic of household energy use is the rise in the consumption of electricity,which has nearly tripled for rural and more than doubled for urban households during 1990-94.However, the installed electric capacity per urban household is estimated to be only 4.8 kW,where rural households have a somewhat higher capacity (5.1 kW), most of which is for cooking(60%). In addition to light bulbs, households own cooking appliances (58%), refrigerators (73%)and washing machines (62%), electric water heaters (9%), and electric space heaters (11%). Theownership of energy-intensive electric appliances (freezer, dish-washer, air-conditioner), may leadto future increases in demand when incomes are sufficiently high. The increasing use of electricheating systems in poorly insulated houses with existing energy inefficient appliances will furtherstrain the electrical network. However, the lack of disposable income and inappropriate wiring inhouses may slow down the rapid increase in electricity consumption. Nevertheless, electricityconsumption by households is expected to increase for the time being, because of cost andavailability of alternative heating fuels.

2.7 The 100% electrification rate in the KR has enabled the household sector to rapidly switchto electricity for heating and cooking in response to the much bigger real increase in the price ofLPG, natural gas and coal compared to electricity.

TABLE 2.3: ELECTRICITY CONSUMPTION BY HOUSEHOLDS(million kWh)

1990 1991 1992 1993 1994

National 1110 1454 1950 2454 3159urban 537 573 819 1087 1520.5rural 573 881 1131 1367 1638.5

Table 2.3 shows that between 1990-94 electricity consumption increased by more than 180% inrural and urban households mainly due to increased electrical heating and cooking. The householdenergy survey shows that the penetration of electricity-intensive household appliances is stillrelatively low. Moreover, it is unlikely that income growth in the next five years will be sufficientto have much impact on the ownership of such appliances.

C. ENERGY EFFICIENCY IROVEMENTS

2.8 Although the Kyrgyz Republic's energy intensity is among the lowest in the FSU, there arestill inefficiencies and energy waste inherited from the FSU both on the supply and end-use sides.This is due mainly to obsolete industrial processes, inadequate building codes and distorted energypricing.

Chapter 1I Kyrgyz Republic Energy Sector Review

12

2.9 On the supply side, there is a potential of loss reduction in electricity distribution anddistrict heating. Rehabilitation of the distribution system to reduce overloading of lines andtransformers and the increase of the medium voltage (to 20-kV for instance) could reduce lossesby about 5 percentage points. Upgrading of the district heating system and introduction ofvariable flow and metering could reduce losses by as much as one third based on estimates madefor similar systems in the FSU.

2.10 On the end use side, the main concerns are economic pricing, proper metering andenforced payment collection. In addition, there is a need for non-price measures includingpromoting energy conservation and educating consumers. In industry the shift to electrificationshould, as experienced in the West, introduce more efficient processes and increase energyefficiency.

2.11 Households The households survey found a high level of ignorance about energy savingopportunities. For example, the use of fluorescent lamps is hardly practiced (3% of households),while there is a variety of appliances with differing efficiencies, some very low, but unknown tothe uninformed consumers. Consumers do not know where to get information on energyconservation measures. Because of the unfamiliarity with energy conservation methods consumersare unsure how to react, and even with partial Government assistance, it is uncertain whether theywould be willing to invest their own money in insulation and other energy saving measures.These attitudes prevail among all income groups. Also, it is unclear whether the relevantappropriate insulation materials, energy-efficiency improving devices and competent craftsmen areavailable in the KR.

2.12 Industrial Energy Conservation While there is considerable scope for energy savings inthe industrial sector, the practice of non-payment for delivered energy reduces incentives forenergy savings. Increasing energy prices to economic costs and enforcing strict payment policiesare necessary conditions to promote energy conservation. A number of walk-through audits ofselected industries were performed by consultants financed under the EU-TACIS program whichrecommendations on: (a) good house-keeping measures; (b) investment with existing technology;and (c) investment with new technology. Although simple maintenance activities that have nocost/low cost or require small capital investment can produce meaningful energy saving benefits,significant improvements can be realized by reorganizing and restructuring the energy consumingenterprises provided that they are financially viable. By preparing estimates of potential energysavings and the cost of energy efficiency investments, the energy audits could provide informationregarding the future viability of industrial enterprises.

2.13 Space Heating Energy Conservation Existing building stock suffers from energy lossesdue to poor insulation, construction and maintenance. Issuance of a proper building code isimportant to ensure that new construction complies with suitable requirements of insulationstandards and other energy conserving features. Also, consumers should be encouraged topurchase energy efficient appliances through proper education campaigns, labeling and promotion.

Kyrgyz Republic Energy Sector Review Chapter II

13

Box 2.1: Cost of Electric Heating

* Electric heating is a comfortable form of heating but could turn out to be highly expensive to the economy.Electricity is a high quality form of energy, which, per effective heating Gcal, is much more costly than otherfuels as indicated below. The table shows that from an economic point of view electricity is the most expensiveheating option, the least-cost option being coal, closely followed by natural gas. However, from a financialpoint of view, the prices of coal, natural gas and kerosene are very high compared with electricity. Hence,households and public institutions have started to use electricity for heating purposes on a large scale, resultingin very high growth rates of electricity consumption

Table 2.4: Comparison of space heating systems for different energy forms

Economic EconomicType of Fuel Gcal/ton Current tariff Economic price per price per

(or Gcal/MWh) $/ton price $/ton Gcal Efficiency eff. Gcal(or $/MWh) (or $/MWh)

Electricity(per MWh) 0.86 5.7 29.2* 33.5 98% 34.6Natural gas 10.7 45.0 85.0 7.9 75% 10.6Coal 4.0 32.0 27.0 6.7 65% 10.4Kerosene 10.3 200.0 180.0 17.5 80% 21.8

* Although electricity should be priced at its opportunity cost which is equivalent to the export tariff in winter,US$29.2AMWh has been used as calculated in Box 4.2.Source: mission estimate

* The consumers have not only reacted to distorted financial relative prices, but also to an explicit Governmentpolicy that aims to substitute domestically produced electricity for imported oil, coal, and natural gas. Thispolicy may be misguided. In substituting electrical heating for fossil fuels the KR would spend more ineconomic terms for its energy needs given the marked difference in relative economic prices. An additionalproblem is that the power distribution network is not designed to accommodate the additional load for electricheating, about 10-12 kW per household, all of which in winter.

D. ENERGY DEMAND FORECASTS

2.14 Total energy consumption in the KR is unlikely to fall further, although the trends in inter-fuel substitution are likely to continue in the short-term as coal loses more ground to electricity.Once economic growth recovers, total energy consumption will inevitably rise, but at a slowerrate than GDP as energy efficiency measures begin to have some impact; an important exceptionto this in the near term is growth in petroleum products consumption which has fallen to very lowlevels in 1994. There is considerable uncertainty as to the future composition of energyconsumption as this depends on the future role of gas.

2.15 The Kyrgyz economy is under an energy shock and is still in transition. It is difficult atthis stage to predict how energy demand will evolve as major uncertainties remain particularly onthe future of the industrial sector. A best estimate of energy demand forecast up to 2000 is givenbelow taking into consideration -economic projections on the economy's recovery:

Chapter II Kyrgyz Republic Energy Sector Review

14

TABLE 2. 4: FINAL ENERGY DEMAND FORECAST 1995-2000

1993 1994 1995 1996 1997 2000actual estimate projection projection projection projection

GDP Growth (%) -16 -26 +2 +3 +4 +7Pet. Products (th.tons) 900 550 600 700 800 +5%Gas (MCM) 1,300 815 900 0 900 +5%Coal (th.tons) 2,000 1,052 1,100 1,100 1,100 +3%Elec. Consumption (GWh) 7,985 7,830 7,900 8,000 8,200 +7%(excl.exports)District Heating (Tcal) 2,715 3,000 3,300 3,500 +3%

2.16 Petroleum Products: Consumption is unlikely to fall below the 1994 level, which isestimated to be about 700,000 tons (including 150,000 tons for power generation), but this figuremay be largely understated. Future demand will closely follow the trend in GDP growth, and therecovery in the agricultural sector in particular, which accounts for over half the consumption ofdiesel and gasoline. Fuel oil use for power generation is at a minimum level of about 150,000tons needed in the CHP plants and is likely to remain roughly constant. Incremental powerdemand will be met from hydro generation.

2.17 Coal: Following the collapse in demand for coal by both the household and industrialsectors, which in 1994 together consumed only about 1.1 million tons, total demand is nowdominated by the Bishkek CHP plant, which consumes about 0.8 million tons annually. Unless gasprices are reduced, it is unlikely that less coal will be burned for power generation in the next fewyears. Economic recovery in the second half of the 1 990s is unlikely to raise the share of coal inthe household sector to a significant degree, even if the present price distortion in favor ofelectricity is corrected. Consumers value the convenience of electricity and have already investedin electrical appliances for heating. In overall terms, consumption of coal is therefore likely to lagbehind the rate of GDP growth.

2.18 Gas: The present low level of gas consumption is the result of the high price KR has topay to buy gas from Uzbekistan. Gas used in 1991 for power generation alone exceeded the totalconsumption of gas in 1994. Installation of meters for household use will further reduce demandover the next 2-3 years. While there may be some increase in gas use by industrial users, oncethere is a return to economic growth, the key determinant of future gas demand is an agreementon a long-term supply contract with Uzbekistan at a lower price. This would open up the optionof high-efficiency combined cycle plants for power generation to replace the aging Bishkek CBPplant as well as the option of gas-fired boilers as an altemative to district heating.

Kyrgyz Republic Energy Sector Review Chapter 11

15

2.19 Electricity and District Heating: Total recorded sales (excluding exports and losses) haveremained roughly constant since 1991, despite the collapse in economic activity. At the sametime, residential demand has doubled to 40% of total sales, while industrial use has fallen byalmost a half District heat has been reduced mainly through the drop in demand from industriesand rationing of households because of fuel problems. The low price of electricity for householdsrelative to other fuels explains the massive switch to electricity in the residential market. Thepoor commercial practices of KNEHC have also contributed to the trend as there are no sanctionsfor non-payment of electricity consumption. Both of these policies are likely to be rectified in thecoming years, with the result that electricity consumption by households will probably stagnate oreven decline if consumers using electricity for heating start to introduce energy conservationmeasures to reduce heat losses. Demand by industrial users will increase in line with economicgrowth, but as they now account for under 26% of total sales, it is unlikely that the overall rate ofincrease in electricity consumption will match the increase in GDP. There is also considerablescope to meet the incremental demand through a reduction in losses which in 1994 were anunacceptably high 16% against a more normal 10 to 12%.

Chapter II Kyrgyz Republic Energy Sector Review

Table 2.5 KYRGYZ REPUBLICEnergy Balance, 199

Coal Crude Oil Petroleum Natural Gas Electricity District Firewood DungProducts Heating Cakes

gk tons tkions thtons MCM GWh Tcal L Cm thtons

Production 3,483.00 143.00 - 70.00 10.058.00 - 1,000.00 70.00

Imports 2,657.00 - 2,589.00 2,136.00 1,054.00

Exports -1,740.00 -143.00 - - -5,346.00

Stock Change -

TPES 4,400.00 - 2,589.00 2,206.00 5,766.00 0.00 1,000.00 70.00

Conversion to Electricity and Heat -1,000.00 - -300.00 -1,040.00 3,914.00 5,806.00 -

Losses - - - - -1550.89 -383.20 -

Statistical Differences - - - - 0 -

FINALCONSUMPTION 3,400.00 - 2,289.00 1,166.00 8.129.00 5,422.80 1,000.00 70.00

Households 2,542.00 - 118.00 139.00 1,455.00 3036.7 1,000.00 70.00

Industry 700.00 - 1,042.20 731.00 3,509.00 1,247.24

Agriculture - - 534.60 - 1,986.00 108.46

Transport 329.20

Other 158.00 - 265.00 296.00 1,179.00 1,030.33

I. Proportioms of sedondl disuibttion for coal and natl gas consunption (in parcentage of the total) are taken from the Enrzrw Prorarn

of Kyrgytan, Bisltkek. 1992

2. LPG i included in peroletn products

3. Due to lwi of reliabc dat on eccoral distibution of ptroleum products consumption, the following is assined:

the remainng buee of 600 tltons of nmzt (aftr using 300 th ton for powe nd heat geration) is consumed by the iutrial setor

624 tbhtons of moline s cumned u follows: 30Yftqnuot 30%/. induy, 40%riculture

570 thtonr of diesel is coasned m follows: 30^ indamy, 50%a spiattue, 20%. trusport

125 thtonm of LPG is cmaned a folows: 93 thtoan by households, 28 thtor by tmspon, 4 tb.tons by indtry

105 tita ofkemsenc is consuoed a: 80 Ltoiw by industy, i.e.s jet fueL and 25 th-torn by boueholds for cooking

4. Elericity loon ame _maed to be 11.1% oftoaal poduction.

5. District heating loomes vs med to be 6.6% oftotal gperMioL

6. 56% of diltrid hetg iS ped to hoWbldr, 23% to iuiry, 2% to ac,e (geuabcm)

7. The msre entent of dua a as mr*ed to be 12%.

S. TPES: Total Prinwy Emaey Syplpbd

Source: E- AdviA-y 0s. Cocett Pqar, En- Prap of KyW , IRG Rapot ayr etities of KR, mnons eimmatest

Tok 2.6KYRGYZ REPUBLICEnergy Balance, 1994

Coal Crude Oil Petroleum Natural Gas Electricity District Firewood DungProducts Heating Cakes

th.tons ih.tons th.tons MCM GWh Tcal d.cm th.tons

Production 670.00 90.00 - 39.00 10,710.00 * 1,600.00 100.00

lmpofts 1,358.00 - 700.00 1,000.00 1,747.00 -

Exports -162.00 -90.00 - - -4,252.00

Stock ChangeTPES 1,866.00 0.00 700.00 1,039.00 8,205.00 - 1,600.00 100.00

Conversion to Electricity and Heat -800.00 - -150.00 -224.00 1,140.00 3,335.00 -

Losses - - - - -1,520.00 -620.00 -

Statistical Differences -14.00

FINAL CONSUMIPTION 1,052.00 - 550.00 S15.00 7,825.00 2,715.00 1,600.00 100.00

Households s00.00 - 20.00 312.00 3,154.00 1,502.00 1,600.00 100.00

Industry 152.00 - 129.00 468.00 2,001.00 493.00 -

griulture - 152.00 - 1,526.00 96.00

Transport - 149.00 -

Other 100.00 - 100.00 35.00 1,144.00 619.00

1. LPG * inchdd in petrcoum products

2. Due to lack of reiable data on sctoral distribution of petroleum products comutupion, the fodowwg is asumed:

a0 150 tLtonh of maaut has been used for heat and power generation

200 thLtonr of gsol is conaumed as foow: 40%transport, 30% inusty, 30%rgiculture

230 thton of deid is conair ed r follows: 30% industry, 40% agncultue, 30% traupoat

3. Due to lack of relia natu s consurption data spat frm gS conmmed for beat and power genatin (22% of tofal) the folbowin is aansed:

45% of total i conumed by the indurl or and 30% by the hmhold ector.

4. Ekcti loses m arc ned to be 20% of tol producio

5. Distict bhet_ lose am aaed to be 7.3% of total geserkmn

6. 56% of didrct bcatingi suplied to hoeholb, 23% to industry, 2% to ricuLe (greenhousex)

7. l'e mno_ coat of dmng cakcc is anumd to be 12%.

3. C yssnplo of "g cs and frewood by households hae incremed reda to 1991 die to the increas in coal priesa wich Ied to the subst_on

of col with dog eam ad fiewood.

9. TPES: Total Prmy Eamr Supplid

Sources: E*C Adley Om, Cone P per, En. Propm of K1TV , IRO Repot, eny crm of KB, nujias esa a-e

00

KYRGYZ REPUBLCEne'g Bajaine, 19"1

(tlotuad tons of oil equivalent)

Coal Crudc Oil Petrolewn Natumnl Gas Electricity District Firewood Dtng TOrAL

Products Heating CakcsProduction 1,393.20 143.00 - 56.70 865.13 - 1I0.00 23.S7 2,661.90

Imporls 1,062.S0 - 2,389.00 1,730.16 90.66 - - - 5,472.62

Exports -6.00 -143.00 - - -459.92 - -298.92

Stock Change - - - - - - -e ooTPES 1,760.00 - 2,589.00 1,786.86 495.87 - 180.00 23.87 6,S35.60

Convcaion to Electricity and Heat 400.00 - -300.00 -842.40 336.66 58.06 - - -1,147.69

Loases - - - -133.32 -3.83 - - -137.15Statistical Differences - - - - 0.00FINAL CONSUMPTION 1,360.00 - 2,289.00 944.46 699.21 54.23 180.00 23.87 5,550.77

Houscholds 1,016.80 - 118.00 112.59 125.15 30.37 180.00 23.37 1,606.78

lnusty 280.00 - 1,042.20 592.11 301.82 12.47 - - 2,228.61

Agriculture - 534.60 - 170.82 1.08 - - 706.51

Transport - - 329.20 - - 329.20

Other 63.20 - 265.00 239.76 101.41 10.30 - - 679.67

I. Proportions of sedoral distnbution for coal nd natul gas cosunpion (im percentage of the total) are taken from the Enery Progrm

of Kyrgymftan,tsbWke 1992

2. LPG is mehided in petroleum pucts

3. Due to lack of reiabe date on sectoral distnbubon of petrokum produt conLumption, the foUowsg is assumed:

the remainig balnee of 600 thtons of mazut (after using 300 tLtorn for heat and power generation) is consumed by the industrial sector

624 tltors of gasoine is consumed as folows: 30'%tranpoit, 30% industry, 40%agniculture

570 thtom of diesel is consr ned us folows: 30%/ ixhdsty, 50Y agciteuhte, 20%/ tranport

125 tktons of LPG is consumned as foDows: 93 thtons by househods, 28 th.tons by transport. 4 th.tons by industry

105 thtton of kerosene is ronsumed as: S0 thtons by industry e.as jet fuel, and 25 thtons by households for cookmig.

4. Elbctcity losses are assuned to be 11. 1% of total production.

5. Dittiet heeng loe a assumed to be 6.6% of total generation.

6. 56% of distrit heating is supplied to households 23%. to mdustry, r2 to agiculure (grenhouse)

7. The dung cakes e swnued to have 1 5% moisture and 20%' asb content

S. TPES: Total Primay Energy Suppld

Sources: Energy Advsoy Goup. Ccept Paper. Energy Progrm of Kyrgyzatan, IRG Repott energy entit of RR. mi esons estimates.

Coal Crude Oil Petroleum Natural Gas Electricity Heat Firewood DungProducts Cakes

Conversion Factors 0.4 1 1 0.8 0.09 0.01 0.1I 0.34

Initial units th.tons tA tom h.lons MCM GRW Teo] th.cm tAR tons

Tabb 2.8KYRGYZ REPUBLCFmeU Br e 1 "4

(thousad tons of oil equivalent)

Cool Cmde Oil Petrolaem Naurl Gas Elecricity Disrict Firewood Dung TOTL

Produds Hetting CakesProduction 268.00 90.00 - 31.59 921.21 - 238.00 34.10 1.632.90

Inyts 543.20 - 700.00 310.00 150.27 - - 2203.47

Expots -64.80 -90.00 - -365.73 - - -520.53

Stock Ch ,.

TPES 746.40 0.00 700.00 341.59 705.75 - 238.00 34.10 3,315.34

ConveniontoElecricityandHeat -320.00 - -150.00 -181.44 98.06 33.35 - - -520.03

Lw - - - - -130.74 -6.20 - - -136.94

Statidil Dffernca -5.60 - - - - - - - -5.60

PINAL CONSUMPnON 420.30 - 550.00 660.15 673.06 27.15 288.00 34.10 2.653.26

Housebolds 320.00 - 20.00 252.72 271.29 15.02 288.00 34.10 1201.13

Industry 60.30 129.00 379.08 172.11 4.93 - - 745.97

Agkculbze - - 152.00 - 131.26 0.96 - 284.22

Trapot - - 149.00 - - - - - 149.00

Other 40.00 - 100.00 28.35 98.40 6.19 - - 272.94

1. LPG la italed in pdrolm po

2. Due to lack ofrdbl don on aectgl d6ution ofpetomn produc:t commuopto the folowing s muned

.150 ULtm of nm n u od for best and poawr gwon.m Dn

200 4toM of " iscowmnedasfolm: 40%upt , 30% dmhmy, 30% _iculm

230 t6Ltcm of dbms 3 comned a folo: 30% indmty, 40% e ,culnse. 30% eumpon

3. Due to lck of roble nusl pi comuapton dehf apart from go comned for hbet and power gemutm (22% of total) tme follwing is mumed:

45% of toBl a co_m d by the in l or ma d 30% by tbe homehold sector.

4. Eecbirkty lees_ we mmxned to be 20' of total pndcto

5. Dfict b_ig m mamed to be 7.3% of totsl g o

6. 56% of imdkigu dowopphedto _omeo,23%to dty, 2% top - (p-enb--)

7. Th &u calm me mm_nd to hme 15% mon i mad 20% sh coahIat

S. Ceumpion of g we mand fewood y hmeb ho eiosed.i to 1991 due to die meee a coal pcrwiwh ledto dfie subtitution

of eod whb &" ds and frewood.

9. TPES: Totl Ptiuy EswrV S&pied

Sa: EU Adb y Ggotp. Comwe Pqe E-w P -mi of Kya. IRG Report, ent of KR, noms s

Coal Crude Oil Petroleum Natural Gas Elect ncity Heat Firewood DungProductr Cakes

Conversion Factors 0.4 1 1 0.31 0.09 0.01 0.IS 0.34

Ininal units ALeu A "o, O, aw rTe sc

'I

20

Kyrgyz Republic Energy Sector Review Chapter II

III. ENERGY SUPPLYAND TRADE

A. PRiMARY ENERGY PRODUCTION AND SUPPLY

3.1 As described in Chapter 1, there are significant unexploited energy resources in the KR.Given the present high degree of import dependency for oil and gas supply, it is likely that thereare good prospects of increasing domestic supply in this subsector. The large hydroelectricresources are a major asset for the development of long-term electricity export markets if they canbe arranged on secure and profitable conditions. On the other hand, although recoverable coalreserves are significant (1 to 1.2 billion tons), the coal industry is in crisis, and if it is to survive,drastic measures will have to be taken to restructure and privatize the industry.

1. Oil and Gas Production

3.2 A detailed description of the exploration and production activity is provided in Annex-1.The Kyrgyz Republic has several sedimentary basins, of which only one, the Fergana basin, is aproducer. The Fergana basin, where oil production started in the late 1930's is considered amature petroleum province; out of 24.2 million tons of recoverable oil reserves, 14.6 million tonsremain to be produced. In 1993, production was about 100,000 tons and 60 MCM of gas from 10fields (at its peak, in 1958, oil production was close to 500,000 tons). There are some 433production wells so that productivity is very low (5 barrels/day per well). The application ofenhanced recovery techniques and introduction of modem exploration tools might well lead to anincrease in production and an upward revision of the reserves, but the downward trend of theFergana Valley's present reserves is clear over the long term.

3.3 Little or no exploration has taken place in the other basins although there is a potential fordiscoveries, particularly if modem exploration techniques are introduced.

3.4 The only realistic approach to arrest the decline in production, and accelerate exploration,is to create joint ventures with foreign oil companies with adequate resources, expertise, andtechnology. To that effect, it is essential that: (i) appropriate legal and fiscal frameworks beintroduced; and (ii) a promotional effort be undertaken to the international petroleum industry. Arecent promotional effort has not proven effective and a new one is presently being undertakenwith the support of the Japanese and Norwegian governments.

3.5 Meanwhile, Kyrgyzneft, the state oil and gas production company and operator in theFergana basin, has set up a joint venture with a small US oil company, Aztec, for oil fieldrehabilitation to increase production from existing wells. Further details on oil and gas productionare in Annex-i.

Kyrgyz Republic Energy Sector Review

22

2. Refining and Petroleum Products Supply

3.6 The present production is processed in the Fergana refinery in Uzbekistan which charges,as a processing fee, the very high rate of 33% of the throughput. Furthermore, the products slateis heavily biased towards fuel oil (which is of lower value). Moreover, from time to time, therefinery is reported not to be available for processing Kyrgyz crude, forcing the shut down ofwells once the tanks are full. Aztec (para. 3.5), which has obtained the exclusive right to processdomestic crude, is presently installing a small 5,000 barrel/day refinery in Jalalabad (to becommissioned by end-1995).

3.7 The bulk of the KR's needs (about 700,000 tons in 1994) are met through imports by railand road tankers from Russia and Kazakhstan. As a result of the dramatic fall in consumptionfrom 2.6 millions tons in 1991, there is considerable overcapacity in storage and distributionfacilities.

3.8 A proposal to build a 300,000 tons per annum refinery in the north, near Karabalta, usingcrude imported by rail has been considered. This project needs to be scrutinized thoroughly giventhat: (i) in view of its size, the refinery would not be competitive with other refineries in theregion; (ii) to supply the northern market of the KR, a processing contract with the Chimkentrefinery (in Kazakhstan) which receives crude from Siberia by pipeline could be more attractive;and (iii) the construction of a products pipeline from the Chimkent refinery to Almaty is underconsideration, with only a 50 km spur would be needed to connect Bishkek. Assuming that nearbyrefineries price their products fairly, there would not be much justification for a refinery in thenorthern part of the KR. Distribution of petroleum products is described at Annex 2.

3. Natural Gas

3.9 The KR has received natural gas since 1968, through a gas pipeline network originating inTurkmenistan and Uzbekistan and terminating in Kazakhstan. Until 1993, gas was mostly suppliedby Turkmenistan (and transiting in Uzbekistan); since then, Uzbekistan has taken over the supplies(and, reportedly, the interconnection to Turkmenistan has been removed).

3.10 There are two distinct markets for gas with separate supply lines. The northern sector issupplied by the main Gazli-Bukhara-Tashkent-Bishkek-Almaty trunkline, while the southernsector is only linked to the Uzbek system in the Fergana Valley. There are about 3,000 km ofdistribution pipelines supplying 200 industrial consumers and over 300,000 households. With thecollapse of the gas market to about 815 MCM as a result of high prices, the future role of naturalgas in the Kyrgyz economy is uncertain'. Details on the gas sector are at Annex 3.

lThe domestic production of 60 MCM is consumed by Kyrgyznefl in its own installations.

Kyrgyz Republic Energy Sector Review Chapter III

23

4. Coal

3.11 Two types of coal are mined in the KR: hard coal (bituminous) of jurassic age and browncoal (sub-bituminous) of younger geologic age. While the heating value of both types is similar(3,500-5,200 kcal/kg for hard coal and 3,300-4,800 kcal/kg for brown coal), the two types arenot interchangeable in industrial markets because brown coal has a higher volatile content andlower ash fusion temperature and thus it cannot be used in boilers designed for hard coal.

3.12 There are 8 large coal mining enterprises, consisting of 7 surface mines and 7 undergroundmines, employing about 8,800 workers2. Most of the mines are located in the southern part of thecountry, and by rail it takes 1,200 km and the crossing of three borders to reach the bulk of themarket in the north. Only one enterprise has a coal cleaning plant, and this can only clean 10-15%of the coal; further, the cleaning effect is poor - the cleaned coal fraction still contains 18% ash.All other mines simply screen the raw coal into coarse (over 13 mm) and fine (under 13 mm)products, or have no treatment at all. The marketed coarse product for household and communaluse is accordingly of poor quality as the industrial fine coal. Only three mining enterprises have adirect railway connection; two are relatively close to a railway station (26 km and 40 kin,respectively); and the remaining three have no access to the railway and depend entirely onexpensive road transport.

3.13 Two products are being marketed by the Kyrgyz coal industry: coarse coal forhousehold/communal consumption; and fine coal for industrial consumption. Almost all coarsecoal is marketed in the KR, while a large portion of the fine coal was exported until the collapseof markets in neighboring countries. This creates a serious problem for coal producers sincecoarse coal accounts for 29% of the market but only 20% of the output. Appropriate marketingof fine coal excesses is critical to the profitability of the mines3.

3.14 Coal production has collapsed from 3.5 million tons in 1991 to an estimated 0.7 milliontons in 1994. This is essentially due to the falling demand for Kyrgyz coal on account of: (i) itspoor location in relation to the markets - the mines being largely in the south and the market in thenorth; (ii) the competitive advantages of Karaganda coal from Kazakhstan in terms of quality andprice; and (iii) the high price of coal relative to other energy sources. In addition, the productivecapacity has deteriorated sharply as the mines are in poor condition: (a) in underground mines,galleries suffer from rock pressure, walking paths are untidy and too long, and water inflowshamper work at the coal face; (b) in surface mines, overburden has not been removed fast enough,and the pit walls have become dangerously steep; and (c) service facilities, such as workshops,often are in disrepair and unable to provide necessary services.

2 This excludes the small, private "artisanal" coal extraction businesses that have sprung up over the last 1-2years. In 1994, these accounted for 55,000 tons sold mainly in local markets.

3 Briquetting of surplus industrial coal for household use could be an option but would require significant capitalinvestments and its economic attractiveness is not well established.

Chapter In Kyrgyz Republic Energy Sector Review

24

3.15 The outlook for most coal enterprises is gloomy - in essence the cost of producing coaland transporting it to markets is too high in relation to competing sources of energy, includingimported coal. Most coal enterprises are for all practical purposes, bankrupt. In September 1994,five coal mining enterprises (together representing about 60% of present output and employment)were put under the control of the Enterprise Reform and Resolution Agency (ERRA). Inaccordance with an agreement with the Bank within the framework of the Privatization andEnterprise Sector Adjustment Credit,4 these enterprises are put under a care and maintenanceprogram until a decision on their liquidation or restructuring is taken, based on diagnostic studiesfor each enterprise which will be completed with the assistance of a management consultant. Theexpectation is that the enterprises will be liquidated.

3.16 In the medium term, the remaining market for industrial and household coal may justifythe operation of only a few mines, perhaps two - four. In this respect, the private sector hasalready demonstrated an interest in this activity and is already operating several coal mines, withapparent success. Consequently, to allow increased participation of the private sector, suitableregulation for the exploitation of coal deposits should be issued. Details on the coal subsector areprovided in Annex-4.

5. Electricity

3.17 The Kyrgyz National Energy Holding Company (INEHC) operates 20 power plants witha total installed capacity of about 3,433 MW including 18 hydropower plants (2,774 MW) andtwo combined-heat-and-power plants in the cities of Bishkek (609 MW) and Osh (50 MW). In1994, KNEHC generated 12.7 TWh (of which 2.2 TWh were from thermal plants and 10.5 TWhfrom hydro) and net electricity exports were 2.5 TWh. The peak load in 1994 was 2,170 MW.While the peak load has increased rapidly over the past few years, currently the system is notconstrained by generating capacity but by limitation in the transmission and distribution networkcapacity. Additional generating capacity could be obtained through the development of mini andmicro hydroelectric plants, some of which were developed in the 1920's and 1930's and laterabandoned.

3.18 The first phase of a massive program to develop the Lower Naryn River began in the1960s with the construction of the Toktogul reservoir, with a 16 billion m3 storage capacity (oneand a half times the annual inflow) and four downstream projects. This phase is now completedand the installed hydroelectric capacity is 2,770 MW with an average annual energy generation of10,000 GWh. However, the operation of these hydro power stations is driven by irrigationreleases in summer, mainly for Kazakhstan and Uzbekistan, with the result that summer energyproduction exceeds KR's internal demand. Conversely, generation is restricted in winter whenelectricity demand is at its highest, because of the requirement to store water for summerirrigation.

3.19 A second phase development, planned before the break-up of the FSU, was to develophydro sites upstream of the Toktogul dam which could be operated without the irrigation

4Privatization and Enterprise Sector Adjustment Credit (Credit of June 9, 1994)

Kyrgyz Republic Energy Sector Review Chapter III

25

Kambarata 2 - 360 MW) offer a potential 2,260 MW of additional capacity at a relatively low unitcost (800 to 900 US$/kW) (fig. 1). However, the investment would amnount to US$2 billionwhich is out of proportion to the size of the Kyrgyz economy. The Kambarata-2 project wasstarted in 1989, but because of lack of funds construction work has stopped; about US$250million would be required to complete a downsized alternative of the project (250 MW) but, inthe absence of Kambarata-l, Kambarata-2 would operate in a run-of-river mode and itsguaranteed capacity would be only 50 MW in winter.

Figure 3.1: Existing and Proposed Hydro Projects on the Naryn River

planned f

1.200- [1 V t,l90 Kamborst 1. Vo X ~3 41i,,' 1,W00 btW

1...0o-- .\existing

; OtO ,\ S K mbwsta 2

e < ao btW~~~~~~~~~~~~g Toktgul

9 StO- 1. V *.' t200 MWI~~~~~~~~~~~~~~~~~~~~~~~~UA 724 ~~~~~~~~~~~~~~~~~~~~~~Kurpeal

700-- _o

, \ V 62 ~~~~~~~~~astik.mir450M

00- _ .''W\ V Shamadll. 240 SW

Ut.hurga

266 1t92 17? 96 52 33 12 0

Dietance (kilometr,)

Source: Harza Engineering Company

3.20 Based on the forecast indicated in para 2.15 and findings from USAID-financedconsultants studies, a simple analysis, restricted to evaluating the difference between installedcapacity and demand, shows that there will be an excess capacity during the next few years whichcould continue to be exported (Figure 3.2). The reserve margin available in the early years isadequate for a mixed system such as the one in the KR. However, in dry years it is likely that themargin will be seriously reduced. Therefore, it will be necessary to rehabilitate the Bishkek CHP

Chapter III Kyrgyz Republic Energy Sector Review

26

or, if an agreement could be reached on gas supply, to retrofit gas-fired combined cycle powerplants.

3.21 The Kambarata-1 and Kambarata-2 projects could be economically attractive and theiroperation would not be subject to irrigation constraints since the water drawn down would still beretained downstream in Toktogul. However, in view of the capital cost involved, these projectscould be justified for export markets and could be developed as 'rnclave projects" Thegovernment should secure long term purchase contracts for the energy to be generated beforeproceeding with the construction.

Figure 3.2: Supply - Demand Energy Balance

16,000

14,000 X

12,000 - | ll-lI l _I Existing Thermal CHP

10,000 -1- [111111] Existing Hydro3 8,000 Generation

6,000 -U--Gross DomesticConsumption

4,000

2,000 * Average hydro generation asstmned"* The difference between generation and

0 - gross consumption would be exported

3.22 The transmission system consists of 500-kV lines (541 km), 220-kV lines (1,009 km) and1 10-kV lines (4301 km). The distribution network consists of 35-kV lines (4,172 km) and morethan 60,000 km of 10, 6 and 0.4-kV lines. There are a total of 481 step-down transformersubstations (500, 220, 110 and 35-kV), with a total capacity of 7,790 MVA.

3.23 The Kyrgyz transmission system is part of the Central Asian Integrated System (CAIS)integrated at 500 kV and 220 kV (see map) The northern part of the KR is connected to thesouth, where the bulk of hydro generation is located, through a 500-kV transmission line crossingthe mountain ranges at 3,500 meters altitude and through a second 500-kV line at lower altitudevia Uzbekistan and Kazakhstan. The construction of a second 500-kV direct link to the north hasbeen planned together with the future development of the Kambarata site.

Kyrgyz Republic Energy Sector Review Chapter m

27

3.24 The distribution system is of the 3-phase type as commonly used in Europe. The recentrapid increase of electricity use by households is subjecting the network to major overload whichmay severely damage the equipment. According to the EU-TACIS-financed Energy AdvisoryGroup, out of the 17,000 substations of KNEHC, 2,261 were found to be overloaded in winter1993-94. The situation in winter 1994-95 was worse and lead to voltage drop and widespreadinterruption of supply. Moreover, natural disasters - the 1992 earthquake and the avalanches andlandslides in 1993-1994 - have caused severe damage to the transmission and distribution lines inthe districts of Dzalal Abad, Osh and Naryn.

3.25 To address the situation and achieve an adequate quality of supply, 25% of the 10-kV and40% of the 0.4-kV lines would have to be reconstructed on the distribution alone and similarinvestments would be required on the transmission side. This would imply for the distributionalone reconstructing about 2,000 km per year over 7 years, instead of the current 70 km annualprogram. Further, the existing medium voltage levels (6-kV and 10-kV) have a low capacity andhigh losses. Higher voltages (20-kV or 35-kV) should be introduced in the future. Concurrently,the transmission system will have to be upgraded to avoid bottlenecks. A further description ofthe subsector and list of investment requirements is given in Annex 5.

6. District Heating

3.26 The two major thermal power stations in Bishkek (609 MW) and Osh (50 MW) aredesigned to supply heat and steam to the district heating network in a combined-heat-and-powerscheme. Supply of heat load in Karakol, Karakul and Kizil Kiya, as well as peak heat load inBishkek and Osh, are supplied with heat from heat-only-boilers (HOBs), some of which areelectrical boilers. The Bishkek CBP plant consists of 10 steam turbines and 24 boilers with acombined capacity of 4,250 tons per hour. The CHP plant of Osh consists of two 25 MW steamturbines and three boilers with a combined capacity of 375 tons per hour. Box 3-1 gives somedetails on the Bishkek district heating system and on the '5nergy efficiency" of heat generatedwith CLP.

3.27 The Bishkek CHP is the only major power generating station in the northern part of theRepublic and plays, therefore, an important role in the operation of the system. It requires,however, major rehabilitation and upgrading as some of the boilers and steam turbines units dateback to the 1950's. The plant used to undergo major reconstruction work annually but, because offinancial constraints, the maintenance programs have been drastically reduced. Furthermore, plantmaintenance problems are becoming critical as more and more low grade high ash coal is beingused because of its availability through barter deals. Lastly, the lack of adequate instrumentationand control equipment contributes to the low efficiency of the units and to the high emissions overBishkek.

3.28 While Kyrgyz coal is readily available in the south, the Osh CHP plant boilers are notdesigned to burn coal but use only fuel oil and natural gas. The plant is affected by the samedeficiencies in terms of instrumentation and control but maintenance problems as somewhat lessacute than at Bishkek.

Chapter III Kyrgyz Republic Energy Sector Review

28

3.29 The overall district heating networks consists of about 460 km of hot water pipelines, thebulk of which is in Bishkek (about 350 km of hot water pipelines and 33 km of steam lines). As inother cities of the FSU, the district heating system is designed without control of temperature atthe user end. The systems are operated on a constant flow regime with variation of the hot watertemperature at the heat source (CHP or HOB). Because of poor water treatment, pipes in the hotwater distribution network tend to corrod quickly resulting in substantially reduced life time of thenetwork and large water and heat losses. There are no meters for residential consumers and onlyabout 10 % of industrial users have meters in working condition. As a result the bulk of billing isbased on estimates and overall energy losses are high.

B. INTERNATIONAL TRADE IN ENERGY

3.30 Following the sharp decline in economic activity provoked by the break up of the FSU, thevolume of trade in energy between the KR and its neighbors has also declined. This trend has beenreinforced by the tendency of each of the newly-independent states to try to be as self-sufficient aspossible and also by the difficulties in conducting international trade without appropriate bankingand international payment systems. The system of interstate barter (clearing) for certain primarycommodities, including energy, was devised as a means to overcome some of these barriers totrade, but is far from satisfactory.

3.31 Even where physical trade on a large scale continues, such as between the KR andKazakhstan, major payment problems persist, with a consequent large build-up of arrears. Thepresent trade in energy products with Kazakhstan is characterized by an overly complex set ofinterlocking swaps arising from the acute illiquidity of the main energy enterprises in the twocountries. Kazenergo, the Kazakh power utility, has large debts to KNEHC for electricityimports which it partly offsets by providing Karaganda coal, equipment and spare parts. KNEHChas debts to the state oil trading company for fuel oil imported from Kazakhstan. Electricityexports are used to offset part of this debt for fuel oil by using Kazenergo as an intermediary.

3.32 Regional trade will continue to be critically important for the KR. Negotiating long-termcontracts with equitable terms of trade and working out appropriate payment systems are a highpriority for the Government. As outlined in Box - 3.2 a regional conference could be organised todiscuss trade issues. Background papers outlining benefit-sharing and contracting alternatives inan impartial manner and drawing on experience in other country-to-country trade situations, couldbe prepared and provided to the concerned countries in the region.

1. Electricity

3.33 KNEHC's power system is interconnected at 500-kV to the Central Asian IntegratedSystem which encompasses Kazakhstan, Tajikistan, Turkmenistan, Uzbekistan and KR. Thesystem is controlled by a regional dispatch center located in Tashkent. In recent years, energy (ona net basis) has been exported to Kazakhstan; capacity as well as load regulation services havealso been provided by KNEHC to CAIS. In 1993, small scale (5 GWh) exports to China were

Kyrgyz Republic Energy Sector Review Chapter m

29

initiated at 10 kV. A 220-kV line is under construction to increase exports to China to 50-80GWh. Annex 5 contains a detailed description of the trading arrangements for electricity.

3.34 In essence, the trade relationship centering on the water usage of the Naryn River can besummarized as an exchange of summer water against winter power. The Toktogul reservoir onthe lower Naryn River in the KR has a storage capacity of about 1.5 times average annual inflow.It was conceived as a multipurpose development to provide irrigation water to downstreamUzbekistan and Kazakhstan, and to supply hydroelectric power to the KR. Irrigation water isrequired mainly in July and August, whereas electricity demand in the KR is at its lowest at thistime of year and highest in December/January. This disparity is increasing as electricity issubstituting for the more expensive fossil fuels (coal and gas) for domestic heating purposes.Load demand curves for three typical days in 1993 and 1994 are given below.

Figure 3.3: Load Demand Curves for Three Days in 1993 and 1994

Electricity Generation and DemandWeekday in 16 December 1993

2300220021002000

1900

18001700

16001300

14001300

We-kday

* Generation a Demand

Electricity Generation and DemandWeekday In 16 February 1994

260025002400

2300

2200

210020001900

17001600.l

Weekday

l- Generation U Demand

Chapter IHI Kyrgyz Republic Energy Sector Review

30

Ele ctricity G ene ration and D em andWeekday in 16 June 1994

I 00

1600

1400

1 1200

1000

60 0

W eekday

[ --- v Gcneration - Demand

3.35 With current load forecasts it is expected that assuming average hydraulicity, the KRwould have excess energy until year 20055. However, the bulk of this energy would be availablein summer and the KR would need to import significant quantities of energy in winter. Theincreasing use of electrical heating will aggravate the unbalance between demand and availabilityof hydroelectric energy if irrigation requirements are to be met.

3.36 With a generating capacity deficit of nearly 40%, southern Kazakhstan is by far the mainexport market for the KNEHC energy surpluses. However, unlike most power export contractswhich are of a long tern nature, the agreement with Kazakhstan is renewed on an annual basis,and revised on a monthly basis. Exports declined from about 4,000 GWh in 1990 to 1,000 GWhin 1993, but rose sharply to about 2500 GWh in 1994 due to generation bottlenecks inKazakhstan. The outlook for power exports to Kazakhstan is uncertain, as the Kazakhs are keento build their own generating plant in order to become self sufficient. KNEHC is actively seekingalternative export markets for electricity in the region, including as far away as Pakistan.

3.37 The present situation is not favorable to the KR as: (i) KNEHC is unable to incorporatethe export market in its long term development since it does not have long term export contracts;(ii) it is unclear whether the KR is adequately compensated for water releases in the summeragainst which it is required to import power in the winter; and (iii) it is unclear whether the KR isgetting a fair compensation for spinning reserve and frequency regulation services it provides tothe interconnected system (para 4.27) Only by securing long term contracts on economic termswill the KR be able to mobilize investment resources for the construction of new generatingplants.

5 For a 90% exceedence level and taking into account the irrigation constraints only 7,933 GWh could be generatedwith the existing hydro facilities (instead of the average 9,902 GWh).

Kyrgyz Republic Energy Sector Review Chapter m

31

2. Petroleum Products

3.38 The import of petroleum products ceased to be a state monopoly in 1992 so that theprivate sector has moved in rapidly to take about a 60% share of the present sharply reducedmarket. It would appear that private importers are able to obtain products at lower prices thanthose of Government agencies, but due to the poorly functioning banking sector, they are unableto arrange trade credits. Reliance on private brokers for credit in Russia erodes much of the costsavings and drives up the import price to the KR.

3.39 There is also reported smuggling of products into the KR by road tanker from Kazakhstanto evade the payment of excise duties. The widespread practice of direct sale to motorists fromtankers parked at the roadside in the KR makes it hard to distinguish those selling smuggled fuelfrom those who are legitimate importers. This practice also has undesirable safety andenvironmental risks and needs to be stopped. Furthermore, it is unclear whether Kyrgyzstan hasaccess to security stocks, and if so how they are managed.

3.40 Given the critical importance of oil products to a modern economy, it is essential thatappropriate policies for the sector be adopted regarding: (i) product specifications; (ii) safety andenvironmental requirements; (iii) security storage; and (iv) taxation policies and their enforcement.As long as a set of measures are not adopted, the country will continue to take needless risks, atthe expense of its finances and security, given the potential revenue potential of the petroleumdistribution activity.

3. Coal

3.41 While Kyrgyz coal used to be sold in Uzbekistan and South Kazakhstan, virtually no coalis being exported at present because of payment problems, each republic desiring to achieve selfsufficiency. The main source of coal in northern part of the KR is the Karaganda mine inKazakhstan. The sharp rise in rail freight rates in early 1994 rendered the transport of Kyrgyzcoal to Bishkek through Uzbekistan and Kazakhstan uneconomic. The Bishkek CHP plant, whichwas the main consumer of Kyrgyz coal, has stopped burning local coal and has increased its use ofKaraganda coal which is largely obtained through a barter transaction for electricity exports. Thisplant will remain the largest user of imported coal in the KR over the medium to long term.

4. Natural Gas

3.42 There is a significant long-term market for imported gas both for power generation as wellas household use in the KR. Present supply from Uzbekistan is constrained by: (i) the high priceof natural gas in relation to other fuels (fuel oil and electric power, in particular); and (ii) a seriousarrears problem with the supplier. Nevertheless, expansion of gas usage in the KR could beeconomically as well as environmentally attractive, particularly if the KR were able to secure along term gas supply contract at an attractive price.6

6 At present, the price of gas is close to that of fuel oil. Given that the alternative for Uzbekistan is to export todistant markets for which it gets a lower netback, Uzbekistan should find it attractive to share the transportdifferential with Kyrgyzstan to the mutual benefit of both parties.

Chapter III Kyrgyz Republic Energy Sector Review

32

Box 3.1

District Heating in Bishkek

The Bishkek district heating systems account for about 80% of the centralized heat supplied throughout the KyrgyzRepublic. It is operated by the Bishkek Heat Supply Enterprise (BHSE) ,a KNEHC affiliate, and provides heat to atotal residential area of 8.5 million square meters (about 12.5 m2 per person) and to a number of industrialconsumers (process steam as well as hot water). In residential areas single-level buildings account for 30% of aUbuildings, those with 2 to 3 floors 70/o, and those with 4 floors or more 63%. BHSE operates the Bishkekcombined-heat-and-power (CBP) plant, TES-1, which in 1991generated 3.6 billion kWh and 3.4 million Gcal ofwhich 1.4 million Gcal in the form of steam.

Most of the heat supplied in Bishkek is from the CHP plant, TES-1, which is equipped with 24 boilers and 10twbines. The plant, located in the eastern outskirts of the city, started operation in the late 1950s. TES-1 has beengradually expanded since then to its current capacity of 609 MW and 1,600 Gcal per hour. The plant is connectedto the gas pipeline and railway network for heavy fuel oil and coal delivery, and can burn all three fuels. In 1993, abrand new gas-fired heat-only-boiler plant, TES-2, was commissioned at the other end of the city, but because ofthe large increase in the gas price, the plant has been mothballed. In addition to TES-1 and TES-2, the city ofBishkek uses more than 150 individual boiler rooms equipped with 660 boilers to generate about 900 Gcal per hourof heat.

The Bishkek district heating distribution system consists of:

- 350 km of steel hot water pipelines of various diameters, of which approximately 15% are located aboveground and the remaining 85% underground;

- a 33-km steam network, comprised of pipelines ranging from 33 mm to 900 mnm in diameter;- 10 heat exchanger stations which convert steam to hot water;- 17 booster pump stations (100 pumps, each 100m head, constant speed and 360 kW rating) to

keep water circulating within the system and to overcome the 200-meter elevation differential withinthe Bishkek district.

The rate of heat delivery varies from 65 Gcal/h to 1,100 Gcal/h, with an average of 550 Gcal/h and an average flowrate of 16,000 m3/h. The quantity of heat supplied is centrally controlled at the power plant by adjusting thetemperature of the hot water (up to 150 °C in principle) in relation to the outside temperature. Since the flow ofwater circulating in the network is mnaintained at a constant rate, customers have no means of adjusting thequantity of heat taken from the network to meet their individual needs. Water make-up for the system is about4,000 rn31h, representing both consumption and leaks in the network. Total make-up water in 1992 was about 32million in3. Because of the lack of proper water treatment and inadequate insulation, pipes corrode quicklyresulting in an average life of 5 to 10 years, against a normal life of 30 years. In the past, 10 to 15 km of pipelinewere laid yearly to replace corroded pipes, but since 1991 less than 2 km have been replaced annually because ofthe lack of funding.

The use of CUP plant in a district heating system increase significantly the efficiency of heat use and thereforereduce the environmental emissions. The advantages of CHP production can be illustrated by the following:

- in a condensing plant with a thermal efficiency of 400/f, out of 100 units of fuel:- 8 units are lost in the flue gas and other losses- 52 units are released to the environment (river, sea or air) in the process of cooling the

condenser to about 40 °C;- 40 units are available in the form of electricity;

Kyrgyz Republic Energy Sector Review Chapter Ill

33

Box 3.1 CON'T

- in a combined-heat-and-power plant, with no condensing, instead of releasing heat to theenvironment, the heat is sent to the district heating system; therefore, out ofI00 units of fuel:

- 8 units are lost in the flue gas and other losses;-30 units are available in the form of electricity (less power is produced because of the

need to extract water at a temperature of 90 0C-150 °C, instead of 40 °C);and- 62 units are released in the district heating network as useful heat.

The reduced production of electricity by 10 units in the CHP has achieved a production of 62 units of heat. Thechange from a condensing plant to a CBP plant with the same fuel input (100 units) means that 10 units ofelectricity not being produced in the CHP have to be produced elsewhere, e.g. at another condensing plant with40"/o efficiency. This will require 10/0.4 = 25 units of fuel. Therefore the "energy efficiency' achieved forproducing heat in the CBP plant is 62/25 = 2.48 or 248Y. This assumes a full-back pressure operation with anoverall efficiency of 90%. Typically CHPs have an efficiency of 70-75% and the "energy efficiency" achieved inheat production is about 200%. The usual nrle of thumb is that CBP saves about 30% fuel as compared withseparate production of heat and electricity.

In the case of Bishkeck, the bulk of the heat is produced from the CBP TES-1. However, there are seriousinefficiencies in the FSU-designed district heating system itself, including lack of control of heat by consumers,significant losses of heat and water, and a shortened life of the distribution network because of severe corrosion. Anumber of these issues can be addressed by proper investments in heat exchangers, variable flow, metering andinstallation of pre-insulated pipes. Concurrently, improving insulation and upgrading construction standards fornew homes are also important. Pricing of heat at proper financial/economic levels is essential to sound operation,maintenance and upgrading of the district heating system in Bishkek and to encouraging efficient use of heatwhich is produced.

Chapter m Kyrgyz Republic Energy Sector Review

34

Box- 3.2

ENERGY TRADEbetween the KR and its neighbors

Key issues:

* Electric power. The KR's electric power system is part of theintegrated Central Asian regional power and irrigation system.The KR receives lower compensation for itscontribution to the power and irrigation benefits supplied toneighboring countries, than would have prevailed under competitivemarket conditions.

* Natural gas. Uzbekistan (and Turkmenistan) export gas to theKR at prices that are:

- much higher than the profits (netbacks) available frompossible gas exports to other countries;

- too high to allow full development of a natural gas marketwithin the KR.

* Refinedproducts. The market for refined products in the KR is toosmall to justify a separate refinery in the KR. Spare capacity isavailable in refineries in Uzbekistan and Kazakhstan. The KR shouldrely mainly on its own private traders to import refined products fromthese refineries.

* Coal. It is economic for the northem part of the KR to continue toimport coal fromKazakhstan. If trading arrangements are improved,coal produced in the southem KR should be competitive in Uzbekistan(the Fergana valley), southern Kazakhstan and northem Tadjikistan.

Recommendation

* Background papers should be prepared on estimates of benefit sharingarrangements and on inter-country contractual agreeements usedelsewhere in the world; the World Bank would be willing to seek grantfinancing for consultants to prepare these background materials;

* the KR should consider various options for regional discussions of theseissues, including exploring with other Governments in the region theconvening a regional conference to discuss energy trade and watersharing issues.

Kyrgyz Republic Energy Sector Review Chapter IE

IV ENERGYPRICING

A. OVERVIEW

4.1 A description of energy pricing in the KR is complicated because of the very differentconditions prevailing in each sub-sector. As it is largely dependent on imported energy, the KR hashad little choice but to align its domestic energy prices to those imposed by its suppliers. In generalterms:

* the level of petroleum product prices is about right;* coal is at the upper limit of prices and should probably be lower in real terms;* natural gas prices are about right for industry and low for households;* electricity and district heating are priced far too cheaply.

The distortion in relative prices of competing fuels has created major distortions in consumptionpatterns, such as the collapse of coal usage for household heating. These distortions are nowfeeding through into investment decisions and, therefore, need to be redressed before this pushesthe economy into costly and sub-optimal choices. Further, the present policy of artificially keepingdown electricity tariffs is also seriously weakening the Kyrgyz electricity supply industry at a timewhen the Government wishes to promote the use of electricity as a means of reducing theconsumption of expensive imported fuels.

4.2 Energy enterprises are subject to regulated energy prices and face severe financialdifficulties as their ability to adjust their prices in the face of rapidly escalating input costs isconstrained. Equally critically, the broader problem of illiquidity in the monetary system and thehigh-level of inter-enterprise arrears mean that it is becoming increasingly difficult to acquire newsupplies, so much so that payment terms become more material than the actual price paid. Further,enterprises do not have the means to properly operate and maintain their assets while investmentshave essentially halted. Under these conditions, there is a serious risk that energy supply(particularly electricity) could deteriorate sharply in the near term. Equally importantly, mobilizingforeign funding for priority investments depends on the capacity to generate resources from withinthe sector.

4.3 The Government needs to develop an overall strategy for energy pricing and taxation.Firstly, the primary objective should be replacement of governmental controls by a competitivemarket situation to the extent possible. In this context, the Government should move towarddecontrolling as many energy prices as possible, i.e., as soon as there is sufficient competition toensure fair practices. Secondly, for those energy prices that are to remain under some form ofregulation, the Government should consider alternative, more light-handed approaches as well asthe traditional price control approach which has been followed to date. Finally, the Governmentshould review taxes on energy--particularly on petroleum products--and move them toward therates typically observed in market economies.

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B. CURRENT APPROACH TO PRICE SETTING

4.4 At present, coal and petroleum products prices are fully liberalized. Tariffs of energyutilities are set by the Anti-Monopoly Commission of the State Committee on the Economy. ThisCommission is principally concerned with containing inflation rather than ensuring the financialviability of the energy sector. Another major difficulty arises from the cost-plus-fixed markupapproach to price determination, which is not functioning appropriately in the new economicenvironment. Price increases are authorized if there is evidence of increased input costs.Enterprises are then allowed a markup of 15-40% on top of "costs", depending upon the fuel typeand final user. In an inflationary context, where many parameters necessary for a more rationalapproach to pricing are impossible to estimate, a cost plus approach could offer a pragmaticsolution, provided all costs were known and included in the calculations. However, as costingcontinue to be based on the old Soviet accounting conventions, many direct and indirect costs areseverely underestimated. Hyperinflation has eroded the book value of assets in the sector with theresult that the provisions for depreciation are totally inadequate. Internal cash generationrequirements for investment are also excluded. Consequently, authorized price increases provebarely sufficient to cover operating expenses. Despite high inflation in the recent past, there is noautomatically (e.g., a fixed percentage increase each month/quarter) or indexation process, whichwould enable enterprises to improve their cash flow. Pricing distortions have been accentuated bygranting much higher increases for non-residential energy consumers, in an effort to mitigate thesocial impact of the price rises. For instance, the electricity tariff for industry is almost double thatfor residential usage, despite the fact that the cost structure is the reverse. Table 4.1 shows theevolution of energy prices in KR during 1993-94.

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TABLE 4.1: ENERGY PRICES - KYRGYz REPUBLIC

n& somorp4mns tESWor c

Kyiyzas %ofMT*,93 Aug93 Ocd-93 Fb-94 Jul-94 Aow9 WoridRi KyiyzPic World

PslrsllfPrt,da (uc brY )

Gadlie 531.25 863.00 3,990.00 3,990.00 3,990.00 3,990.00 S157(1) S64(2) 168Vh

1Dmd 425.00 688.00 3,200.00 3,200.00 3.20D000 3.200.00 S150(1) S213(2) 142Y

Pud Oil 21250 337.00 840.00 840.00 840.00 840.00 W51) S80(2) 81%

tG*" Gs (mm o l 000 cn)

Inby 100.30 254.88 305.75 760.32 99225 99Z25 S100.00 S4 94%

Statg riam 100.30 155.93 213.80 710.32 710.32 99225 S100.00 S94 94%

Rld.gia(3) 65.36 128.11 146.36 208.24 208.24 99Z25 $180.00 S4 52Y

COMM (rSuimn) 34.00 73.00 139.00 290.00 340.00 340.00 S30-S40 S32 107l/.80

3.du4di (tyirncr caws&-h)

In&My 4.18 5.45 11.00 11.00 11.00 11.00 4.5-7.5 1.04 23%.14%

SLbepztaeiE 1.90 3.78 11.00 11.00 11.00 11.00 45-7.5 1.04 230/.14%

UL:bu 0.75 3.00 3.00 3.00 6.00 6(5) 7.5-12.5 0.57 M5%

Rlural 0.60 3.00 3.00 3.0D 6.0D 6(5) 7.5-12.5 0.57 81/*5%

DSr1d1c h (or Gc S'GrI)

Rduda1 200.00 5.00 5.00 5.00 15.00 30.00 S25-45 283 11%.6%

kd,iy 9,550.00 48.00 48.00 12400 124.00 124.00 S25-45 11.70 47%/26%

(I)Roferwcif:

(2)Kyrzcif

(3) Nld" Ga: mit rm fcr ibty ard thmd wre e a ]Ade l e, almthddks are rit nmetd ard are dcaigd a flat rate per pmm.az1h a the arn fthe apytrgrts and the Wme dfqwptusim ed dc

Tne axe$ VlOOOcnpriehs b ndfwHe a 4 pfr a lODm2 h100nh £auudadratiosof6.9 m3lpam ^rr fcr

e . pipm S.4 rmm%u m1h for hot wat purpo, and 4 m/rn2%th for qace hatg pupom Av.ugeftal ormuniptm

andttal tuffftor Mmfhouiudds usgass fcr the above pIpJ istaka into cairdetatcrL I is bVkd her, that the adual Va

aons rxub hmid ud uraundtmAed mad rmy be 2 -4 tin hoier.

(4)AvuWeprnefswi- -rnjau.

(5d lds d ouame ovea 300 kIwh are dwcd 1I tymwhi

C. COAL

4.5 Coal prices have officially been liberalized. As a result, the main coal producer,Kyrgyzkumyr, a state enterprise, has increased its prices sharply (they tripled in nominal terms overthe twelve month period to October 1994). The demand for domestic coal has collapsed takinginto account that:

* freight rates have increased considerably between the south of the KR (where mostof the mines are located) and the north (where the biggest market is);

* the same prices are charged for coarse and fine coal (which are joint products) butthere is a surplus of fine coal for which there is no market;

Chapter IV Kyrgyz Republic Energy Sector Review

38

* imported coal, of better quality, can be acquired through barter transactions; and

* the price of electricity for domestic use has been kept deliberately low.

4.6 In September 1994, the price of domestically produced coal delivered to Bishkek variedfrom about 280 to 400 somi/ton (including VAT), depending upon the location of the producingmine (minemouth prices were about 110 to 220 som/ton). On the other hand, imported Kazakh coalfrom Karaganda with a higher calorific value was sold for 434 som/ton (including VAT). At anaverage calorific value of 4000 kcal/kg, this translates into a price of US$2.47/GJ at the depot.There is little justification for further increases in coal prices in real terms as the value ofinternationally traded coal in Western European markets is about US$2/GJ. Further, in terms ofunit cost per GJ, coal is as expensive as imported gas, even though the latter would be expected tocommand a premium.

4.7 The decision to liberalize (decontrol) coal prices was both wise and courageous. The coalindustry has no "natural monopoly" characteristics that would justify price control. Unfortunately,the new market-based prices of coal reveal that the full costs of producing and--equally importantly--transporting coal to final consumers are very high. Coal transport costs now reflect the real costsof transport fuels and are unlikely to fall in future. Coal production costs, on the other hand, areartificially inflated by the high staffing levels inherited from the socialist period. The best way toreduce coal production costs is to offer all state-owned mines to the private sector and to offer anadequate severance package to the miners whom the new private mine owners do not wish to re-employ. Under these conditions, a small number of mines should be able to compete profitably withgas and fuel oil in the Fergana valley and to serve local needs in areas close to the mines.

D. NATURAL GAS

4.8 Sharp increases in the price of gas imported from Uzbekistan began in mid-1992. They hadrisen ten-fold by mid-1992 to about US$24/MCM and about $65/MCM in 1994. Reportedly theprice of US$65/MCM has been agreed for 1995 following bilateral negotiations. Since July 1994Kyrgyzgas has been charging 992 som/MCM (including 20% VAT) to all its customers for meteredgas supplies (a six-fold increase over the price a year before). One should note that for powergeneration, gas can barely compete with fuel oil or coal.

4.9 Residential consumers are not metered and are charged flat rates which have also risen bysimilar percentages, but they are still below full-cost recovery. The flat rate charges are based onthe size of premises and the number of occupants using standards of gas consumption which areunderestimated by a ratio of 1.3 to 4.7. Further, many categories of residential consumers veterans,retired etc.) are entitled to a 50% discount - it is alleged that most households qualify for thediscount one way or another.'

' A program is under consideration to install some 300,000 meters which would allow more accurate billing, andprobably reduce the consumption of households, but obviously would not address the fundamental issue of socialdiscounts being given by a utility which is expected to operate on a commercial basis.

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4.10 Thus, Kyrgyzgas continues to sell gas at a loss. Taking into account the lack of liquidity (thepower utility, KNEHC, for all practical purposes does not pay its bills), Kyrgyzgas has built upconsiderable arrears to its Uzbek supplier, at the expense of its credibility, including the willingnessof its Uzbek supplier to sell gas at more attractive rates.

4.11 The Government should consider the following measures in relation to natural gas pricing:

* Gas should be priced in accordance with the true cost of supply for the differentcategories of consumers. Should the Government decide to support low-incomegroups, it should do so through the general budget with the provision of direct cashsubsidies or fuel coupons for the beneficiaries;

* The utility should embark on a conservation effort, a first step being to meter allhouseholds and bill them according to actual consumption;

* While the price of imported gas is outside the control of the Kyrgyz authorities,there is no economic rationale for a further increase in real terms. At $65/1000cubic meters, the import price is about equivalent to that of fuel oil or coal (nottaking environmental benefits into account). Moreover, there are plentiful low-costgas reserves2 in the neighboring Central Asian countries. For the foreseeable future,these states also have limited prospects to export their gas outside the FSU.

Compared to exports to Western Europe, gas sales to the KR already yield much higher returns toUzbekistan due to the much lower transport costs; based on estimated netbacks from WesternEurope, the cost to Kyrgyz Republic would be only about $35/1000 cubic meters. As a result, theKR could become an attractive long-term market provided that the transport windfall is shared andnot taken solely by the supplier. High level discussions between all four countries are recommendedto examine ways of providing a stable and reliable gas supply to the KR on terms which encouragedevelopment of gas consumption; gas exporters should be made aware that for gas-fired powergeneration, or heat production, fuel oil and coal from Kazakhstan present stiff competition to gas.As an input to such talks, Kyrgyzgas needs to be able to demonstrate to gas exporters the gasmarket potential at various price levels.

E. PETROLEUM PRODUCTS

4.12 The biggest adjustment to international price levels for petroleum products took place in1992 and by mid-1993 prices had stopped increasing in real terms. The formal prices are establishedon the basis of submissions of Kyrgyzmunaizat, the State petroleum importer/distributor, to theAnti-Monopoly Commission. As of October 1994, the price structure for the main products wasassessed as follows:

2 Under $20/1000 cubic meters at the well-head, including a depletion premium, source: Turkmenistan EnergySector Review, World Bank, November 1993.

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TABLE 4.2: STRUCTURE OF PETROLEUM PRICES

(US$/ton)

Retailcif Price Margin Duty Total

LPG 280 68 43 390Gasoline 264 53 40 357Diesel Oil 213 43 32 288Fuel Oil 80 16 12 108

Source: Mission estimates, Kyrgyzmunaizat, Kyrgyzgas. Data on kerosenepnces were not available

The above table calls for the following comments:

• The cif prices of gasoline and diesel oil are considerably above international prices. Thereasons are unclear but could be a result of the pricing policy of the Chimkent(Kazakhstan) refinery towards Kyrgyzmunaizat, a State company with considerableliquidity problems. Since Kyrgyzmunaizat has only a 40% market share, by establishinghigh benchmarks, other importers have an opportunity to make windfall profits;3

* The retail margin of 20% should not be uniform, as the costs of handling LPG, gasoline,diesel oil and fuel oil are essentially different - it should be lowest for fuel oil, andhighest for LPG (given the cost of handling, bottling, and distributing the product);

* The duties are low by international standards as they were reduced from 20% to 15% inearly 1994. The Government has raised petroleum products excise duty to 25% (onaverage) in 1995 and agreed to a further increase to 35% in 1996 as part of its IMF-approved program of fiscal measures to reduce the budget deficit;

* The duty of 15% applies uniformly to all products. This policy should be reviewedtaking into consideration the end use of each product. Thus, gasoline, which isessentially used for private transport, could be taxed at a much higher rate than diesel oil(used for public transport and agriculture) which, in turn, could be taxed at a higher ratethan fuel oil (used by industry and for power generation). Box 4.1 shows retail pricesand the tax component for gasoline in KR and a range of OECD countries;

* Considerable quantities of oil products are believed to be smuggled into the KR both byroad and rail, thus escaping payment of duties. This is due to the lack of adequatecontrols at the customs department (which also does not appear to have statistics on theconsumption of petroleum products);

3 An informal quotation of cif price of gasoline in Bishkek was US$220/ton, i.e. nearly 20% less than the officialquotation.

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* In view of the difficulty in ascertaining ex-refinery prices (the Chimkent refinery doesnot post prices, rather they are established on a deal by deal basis), the duty should beset at a fixed, flat rate per ton as opposed to an ad valorem basis; and

* Finally, given the landlocked nature of the country and the limited supply options itfaces, consideration could be given to including a special levy in the price structure tofinance the build-up of a strategic stock of petroleum products (30-60 days consumptionequivalent seems adequate). It appears that such stocks existed in the past, but haverecently been depleted.

4.13 Private traders are estimated to have about 60% of the market in petroleum products andare apparently able to operate at a profit, despite Kyrgyzmunaizat's effective monopoly overpetroleum product storage capacity within the KR. This is likely due to some combination of theprivate traders: (a) operating more efficiently than Kyrgyzmunaizat; (b) operating at lower safetyand environmental standards, e.g., by storing products in trucks; and (c) not paying petroleumproduct import duty. The Government should get out of the petroleum products trading business,selling its depots, retail outlets and other assets of Kyrgyzmunaizat. Over the near term, however,there is concem about whether there is sufficient competition among the private traders to ensurefair practices. A system of posting of storage fees at the depots, should be introduced and the Anti-Monopoly Commission should continue to monitor retail prices, but on an ex-post basis. TheGovernment also needs to direct its attention toward developing and enforcing safety andenvironmental standards for petroleum products transport, storage and distribution and moreeffective collection of import duties. Once sufficient competition has developed among the privatetraders, petroleum product prices should be completely decontrolled. See Chapter V.

F. ELECTRICITY

1. Domestic Tariffs

4.14 Despite the doubling of tariffs in July 1994, the price of electricity cheaper in real termsdecreased as the tariff increase was offset by inflation during the same period. As the prices of otherforms of energy (except district heating and gas for households) were brought rapidly into line withintemational levels in 1993, the consumption of electricity by households has risen sharply,particularly as the lax commercial practices of KNEHC make it easy to consume without payment.The lack of a meter reading and billing system for residential users is a severe handicap to KNEHCand undermines any efforts to raise tariffs.

4.15 In October 1994, residential consumers were charged 6 tyins/kWh (0.57 US cents) for thefirst 300 kWh of their monthly consumption. The industrial tariff was set at 11 tyins/kWh (1.04 UScent). These tariff levels are far from any international equivalent. In a highly efficient, low-costpredominantly hydroelectric system in an OECD country, low-voltage tariffs would be at least 7.5cents/kWh, over ten times the present tariff in KR; high-voltage customers would expect to pay atleast 4.5 cents/kWh.

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4.16 At present, 80% of electricity consumers in Bishkek use less than 150 kWh/month. Thismeans that their monthly electricity bill is under 9 soms. Even in relation to the prices of othergoods in the KR, electricity is a very low value product. At such a price, there is no incentive forconsumers to be careful in their consumption habits, nor to invest in energy saving measures such asbetter insulation.

4.17 The present level of household tariffs also has another undesirable feature: it encourageseven more consumers to switch to electricity from gas or coal for heating as the prices of thesealternative fuels has increased much more in real terms. The effects of this trend on domesticelectricity demand have already been observed over the past two winters. The cost in terms ofreplacement of damaged distribution equipment is high and will rise further in the future; the presentlow level of tariffs is insufficient to cover the cost of rehabilitation of the distribution system.

4.18 The present structure of electricity tariffs could be improved in a number of respects inorder to link the cost of supply to the price paid by different consumer categories. In the recentpast, tariff increases for residential users were less than for medium and high voltage supply to largeconsumers, with the result that the latter now pay much more than the former. Normally, bulksupply is priced lower than low voltage supply to residential consumers. In addition, seasonalvariations in tariffs would reflect KNEHC's differing supply costs. Such a policy would encourageconsumption in summer when supply is plentiful and would restrain excessive consumption inwinter when supply costs are higher and energy is scarce.

4.19 To encourage residential consumers to conserve energy, a progressive tariff was introducedin mid-1994 whereby monthly consumption beyond 300 kWh is priced at nearly double the basetariff. One should note that about 76% of the consumers consume less than that quantity. Further,as is the case for natural gas (para. 4.9), special categories of consumers (veterans, retired etc.) areentitled to 50% discounts - it is alleged that most households qualify one way or another. The sizeof the subsidized lifetime block for households should be reduced to, at most, 100 kWh/month, andall other discounts on electricity eliminated.

4.20 The KR inherited a well-developed, low-cost electric power supply industry atindependence. Further, the industry has no debt associated with its large asset base. However,maintaining and expanding the existing system in the future will necessitate the mobilization ofsubstantial resources, through a mix of direct consumer contributions and long-term borrowings.Tariffs will need to be increased to incorporate these capital costs.

4.21 A power tariff study is recommended which will take into account inter alia the costs ofsupplying electricity to various customer categories, the financial constraints of KNEHC, and theinvestment program of the utility. The study will also have to address the issue of district heatingprices, since KNEHC owns and operates the district heating system as well, including twocombined heat and power plants.

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2. Export Tariffs

a Exports to Kazakhstan

4.22 The Kyrgyz-Kazakh power exchange is based on annual agreements. In 1993, the averageprice received by KNEHC for exports to Kazakhstan was US02.5/kWh. Export prices in 1994 wererevised on a monthly basis (in the US1.9-3.8/kWh range), as incremental quantities over the initialcontract were supplied at a lower price than the contracted amount. Prices in summer 1994 werereduced drastically to avoid spillage as the Toktogul reservoir was full.

4.23 Typically, KNEHC imports power from Kazakhstan during the night and exports to itduring the day, the two energy quantities being offset against each other (with a balance of netexports from the KR). This means that night energy (low load) is treated at the same value as dayenergy (high load), which does not correspond with its economic value. In effect the KR is payingtoo much for its night imports and getting too little for its day exports. Seen from the perspective ofan all-thermal generation system (such as South Kazakhstan), the cost avoided by peak powerimports might be up to three times as high as the additional cost caused by off-peak power exports.This relationship could be reflected by different rates for day-time exports and night-time importsof power by the KR to and from Kazakhstan. The power imports during peak hours (daytime) saveSouth Kazakhstan the installation and operation costs of peaking capacity, such as gas turbines,with generation costs for peak energy of about 4 to 4.5 USp/kWh.4 On the other hand, the powerexports during off-peak hours (night time) from the idle capacity in coal-fired steam turbine plantscauses South Kazakhstan additional costs of about 1.5 USp/kWh.5

4.24 The fact that the hydroelectric plants were transferred free of debt from the FSU to the KRtends to give the impression that hydropower is very cheap at any time of day (at the supplier'scost). However, the same applies to Uzbekistan and Kazakhstan which inherited the thermalstations, coal mines, and oil and gas industry. Nevertheless, they sell oil and coal to the KR at worldmarket prices. The same criteria could apply to the hydroelectric system as well, except thatelectricity is a less easily traded commodity as a transmission system is needed for its export, andthe market for Kyrgyz hydropower is presently limited due to the economic situation in the region.The issue of electricity exchanges between the KR and Kazakhstan is a bilateral matter. However,it is clearly in KR's interest to try to negotiate more equitable sharing of the benefits of its relativelycheap power supply.. Moreover, KR could seek alternative export opportunities for its hydropowerwhich may be more favorable.

b. Spinning Reserve and Frequency Regulation

4.25 The dispatch center in Tashkent handles the regional trade between the KR and itsneighbors within the Central Asian Interconnected System (CAIS). It inter alia fixes a price for

4 Gas turbine fixed costs assumed at SUS40AkW/year; for an annual utilization of 2,000 hours, this will translate intoabout USp2/kWh for fixed costs; in addition fuel cost would be US02-2.5/kWh.5 Using a coal price of about US$30/ton, plant heat rate of 3,500 kcalkWh or 0.5 kg coal/kWh

Chapter IV Kyrgyz Republic Energy Sector Review

44

making available peaking and reserve capacity to the system. This extra capacity seems to bedetermined as the monthly average of differences between the daily maximum and daily minimumcapacities contributed by the Kyrgyz system to the CAIS. The present rate is US$0.9/kW/month.Based on a rough estimate of the cost of gas turbine capacity,6 the present rate appears to be onlyabout one fourth of the economic value of such capacity. The countries supplying this capacity, inparticular the KR, are required to bear the cost of this under valuation. By way of illustration, theextra capacity supplied by the KR during 1994 was estimated at 5,300 MW cumulative for the year;at economic pricing (US$3.3/kW per month), the KR would have received about US$ 17million,instead of US$ 5 million.

4.26 The issue of a more equitable sharing of benefits from and contributions to the CAIS shouldbe treated at the multilateral level of the CAIS Council. The different service components, such asbase load and peak load generation, frequency regulation, other capacity reserves, etc., should becosted out separately using a commonly agreed methodology. This could then form the basis fornegotiating agreements among the contributing partners.

c. Supply of Regulated Waterfor Irrigation

4.27 The relationship centering around water utilization of the Naryn River can be summarizedas an exchange of summer water against winter power. Irrigation water is required in summer,particularly in July and August, whereas electricity demand in the KR is the lowest in July/Augustand the highest in December/January. Under the FSU, the surplus power was exported along withirrigation water, while the Kyrgyz power shortage in winter was covered by imports fromneighboring thermal generating systems. The prices attached to these imports and exports (ofpower and water) were centrally determined in the planned economy of the FSU; they probably didnot reflect the economic costs, but it may be assumed that the exchange of summer water and itscorresponding summer against an equal amount of winter power was about balanced in economicterms. Shortly after independence, in February 1992, the five republics in the Aral Sea Basin metand agreed on water sharing arrangements for the Basin.

4.28 A simulation carried out by USAID-financed consultants (Harza) in 1993 shows that, if theexisting hydroplants were operated without irrigation constraints (power scenario), the averageenergy which could be generated annually would be 11,625 GWh, compared with 9,902 GWh in theirrigation scenario. The value of the "foregone energy" priced at US03/kWh is US$52 million. Inthe power scenario case, little water would be spilled from the Toktogul reservoir, and little powergenerated, in summer. The water saved in summer would allow a greater amount of power to begenerated in winter, when demand is highest. It may be argued, therefore, that if Toktogul reservoiris required by international obligations to spill irrigation water with the corresponding generation insummer, KR should in tum receive back an equivalent amount of energy when it is needed, i.e. inwinter, from the downstream countries which are benefiting from summer water releases and powergeneration. Once the principle of the exchange is agreed, a more detailed calculation may show thatit would be lower cost/more efficient to generate the winter power in the KR using imported gas,rather than generating power in neighboring countries and transmitting it to the KR.

6 Installation cost of US$300/kW, life expectancy 15 years, real rate of return 100, resulting in annual financialcost of US$40/kW, or $3.301kW per month, and more when operating and maintenance costs are included.

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45

d Exports to China

4.29 In October 1992, KNEHC entered into an agreement to supply electric power via a 10-kVtransmission line across the border to an isolated area in the neighboring Lindzen-Uigur province ofChina. Although the agreement has a stipulated validity of 25 years, the amount of energy to betaken by the buyer was fixed at 2-8 GWh for the first year only. The energy received is paid for on abarter basis, according to separate contracts between the foreign trade agencies of the twocountries. The value of the electricity received is set at Yuan 0.14 /kWh during the first five years,corresponding to about US 1.7/kWh at the current exchange rate.

4.30 In parallel, a second contract is being negotiated between KNEHC and China for supply ofelectricity to the Kuzul-Sui and Kashkar regions of Western China, via a new 220-kV transmissionline to be constructed by the two parties. The validity of the agreement would be 20 years from itsdate of signature. Energy sales would be expected to start in early 1996. According to the draftcontract, the amount of energy to be provided by the KR during the first year shall be no less than50 to 80 GWh at a price of Yuan 0.14 per kWh for the first 50 GWh. The price for additionalquantities is to be determined by separate agreements "within the limits of the Yuan 0.14 /kWhprice".

4.31 In both contracts, the quantities of energy to be bought by China need to be determined on alonger term basis. This is of particular importance with respect to the contract for the 220-kVsupply, as it would not be feasible to justify economically and financially the construction of thecorresponding transmission line in the KR without a longer term commitment by China to receiveand/or pay for stipulated annual quantities of energy. The price of energy should also bedetermined for the same longer period, but with protection against inflation by means of anadequate indexing mechanism.'

4.32 These two contracts need to be revised with respect to energy quantities and prices at theearliest opportunity. The strengthening of intemational negotiating and contracting capacities inKNEHC is one of the areas recommended for technical assistance.

G. DIsTRICT HEATING

4.33 The domestic tariff was tripled from 5 to 15 som/Gcal in July 1994 and doubled to 30som/Gcal in November, thus keeping up with inflation. However, it still remains far below the costof supply. The industrial tariff of 124 som (US$11 .70)/Gcal, is close to the full cost of fuel' but islow by international standards9 as it contains no element for the rehabilitation and renewal of thesector's assets.

7 Between December 1993 and December 1994, the depreciation of the Yuan against the US$ has resulted in theprice falling by 30% from US02.4 to 1.7/kWh.8 With gas priced at 992 soms/1000 cubic meters, the equivalent price of the heat content is about US$13/Gcal.9 In the US, district heating charges vary from US$25 to US$45/Gcal.

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46

4.34 In homes served by district heating, a flat monthly charge of 0.45 son/square meter islevied. No devices for temperature control exist on radiators, and as there is a flat fee, consumershave neither the means nor the incentive to conserve energy. This is an intractable problem towhich there is no short-term solution at the level of the individual consumer.

4.35 As district heating is not separated financially from electricity supply, losses in home heatingare covered by electricity consumers, particularly those outside the six main cities who do notbenefit from district heating. These consumers are heavily penalized: (i) they tend to use more than300 kWh/month so that they pay a higher price for electricity which is used to subsidize thoseenjoying district heating;"' and (ii) for their own heating needs, they might be using coal or naturalgas, for which prices are at international levels. Thus, the subsidized price of district heating forhouseholds is inappropriate from a social standpoint, as it effectively provides a subsidy to the high-income group in urban areas. In the longer term, distribution of district heat should be separatedfrom the power company; this would reveal the full financial costs of heat distribution and simplifythe task of eliminating the cross subsidies from electricity consumers.

4.36 Obviously, the pricing of district heating is an issue that should be addressed as a matter ofpriority together with that related to electricity tariffs (para. 4.22). As was recommended above inthe case of electricity and natural gas, district heating rates should reflect full costs. With respect tolow-income households, a cash subsidy or a fuel coupon system should be instituted. The possibilityof introducing variable control and metering should also be considered, as this would enableindividual consumers to control their consumption.

H. Energy Price Reform and Collections

4.37 As discussed in the sections above, prices for electricity, district heating and household use ofnatural gas are significantly below cost recovery levels and prices to industry/others are higher than thoseto households while the cost structure is the opposite. In the context of understandings reached with theIMF and the World Bank the Government has committed itself to raising the utility tariffs to householdsto cost recovery levels by end-1995. As the gaps are quite large in some cases, a phased approach toraising electricity, district heating and household gas prices is recommended: (i) the first step being toraise prices, by end-1995, to cover all cash operating and maintenance costs with sufficient allowance formaintenance to enable proper maintenance to be carried out; (ii) the second step being to raise prices, byend-1996, to additionally cover depreciation with the allowance for depreciation taking intoconsideration replacement cost of assets which are likely to need rehabilitating/replacing in the mediumterm; and (iii) the third step being to raise prices to cover full financial costs including allowance forreturn on assets and a reasonable self financing share (30%) of the investments. Mission estimates ofthese tariff adjustments are given below; these should be treated as indicative figures only as presentlyavailable information is rather incomplete. An assessment of unit supply cost for electricity and heat isgiven in Box 4.2

10The cross subsidy is in the range of 200 million Som per annum.

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47

Table 4.3: Utility Tariff Pricing Levels

ALL FULL ALL

CURRENT CASH COST FINANCIAL

TARIFF COSTS RECOVERY COSTS

ELECTRICITY(US¢/KWH)HOUSEHOLD 0.57 1.5 3.0 4.5 - 6.0INDUSTRY/OTHER 1.04 1.5 2.0 3.0 - 4.0

DISTRICT HEATING(US$IGCAL)HOUSEHOLD 2.83 20 24 26-30INDUSTRY/OTHER 11.70 20 24 26 - 30

NATURAL GAS(US$/1000 CM)HOUSEHOLD 94 100- 120 120- 150 140- 180

Source: Mission estimates.

4.38 Even with the phased introduction of tariff adjustments, a system of financial assistance to low-income households will be needed to cover part of the cost of their higher energy bils. Most of thisshould be provided in the form of targeted assistance as discussed in Section I below. In addition, asubsidized lifeline tariff for the first 100 kWh of electricity consumed by households per month may beconsidered, with the tariff set initially at 10 tyin/kWh. Al special discounts, as are presently applied,should be eliminated. Appropriate structuring of tariffs through introducing, inter alia, time-of-day,seasonal and progressive tariffs, wiDl also be important in guiding consumer behavior.

4.39 The commercial practices of the energy suppliers is of equal, if not greater, importance than thelevel of prices. As stated above, the sector enterprises, particularly KNEHC, are suffering from an acuteliquidity crisis. Pricing reform will do nothing to rectify this; rather higher prices will simply raise thelevel of accounts receivable even further. A clear strategy to reduce payment arrears to more normallevels (e.g., two months) and to preclude further accumulation of arrears needs to be developed andimplemented. Key actions include: (i) identify defaulting consumers, the extent and age of their arrearsand cause of non-payment; (ii) stop supplying consumers who are effectively bankrupt, paying othersuppliers in preference to energy or otherwise diverting their funds; (iii) negotiate mutual settlementsamong creditors; (iv) continue barter arrangements for limited time where necessary and appropriate; (v)introduce modern metering, biling and consumer management systems for consumers not presentlycovered by such systems; (vi) increase and enforce penalties for non-payment and introduce incentivesfor timely payment; and (vii) promote investments in energy-saving measures by consumers to helpreduce their bills. Arrears of government agencies are very high, in excess of one year of sales forelectricity; these must be resolved, and government agencies should begin to set an example for others tofoDlow; offsets from the government budget may be necessary in some cases. Arrears on exports, as forelectricity, may need special attention from the Government.

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48

L TARGETED PROGRAM OF ENERGY SUBSIDIES FOR LOW-INCOME CONSUMERS

4.40 The household energy survey, undertaken in July 1994, gave the following results:

Table 4.4: Energy Expenditures by Income Group and by Fuel (Soms)

KYRGYZ No CASH LOW M1DDLE HIGHREPUBLIC INCOME INCOME INCOME INCOME

TOTAL ENERGYEXPENDITURES 119 87 114 121 151

Electricity 14 12 15 14 14District heating 5 1 4 5 8Natural gas 23 1 16 29 41LPG 12 4 20 8 15Kerosene 2 1 0 2 6Coal 50 47 47 52 53Firewood 12 21 11 8 11

Source: Kyrgyz Household Energy Survey (July 1994).Note: Income groups (SonmmonthWhousehold): Low<150 Som, Middle 151-300 Som, High>301 Som. Energyexpenditures represent total energy use as reported by households, whether "paid for" in cash, by barter or throughaccumulation of arrears.

4.41 The table shows average monthly energy expenditures ranging from Som 87 for thosereporting no cash income (mainly in rural areas), to Som 151 for the highest income group, with amean expenditure of Som 119. For the poorest group, the bulk of energy expenditures are on coal(54%), firewood (24%) and electricity (14%). In urban areas, the situation for low-income groupswill worsen as the prices of district heating and gas are increased (by about 7-fold for districtheating just to achieve recovery of operating and maintenance costs).

4.42 Since in the Kyrgyz Republic winter is usually cold, particularly at high altitudes, providingsome form of heating to households is a basic need. The targeted subsidy should, therefore, beprovided as a priority for the heating fuels, namely coal in rural areas and district heating/natural gasin urban areas, as the current tariffs will have to be increased. Electrical heating bears a higheconomic cost which needs to be reflected in the electricity rates. The electricity tariff for residentialconsumers should normally be higher than for industries.

4.43 How many households would be affected by the subsidy. Of the 4.5 million population inthe Kyrgyz Republic, about 38% live in urban areas and 62% in rural areas. The average size ofhouseholds is 5.0 persons in rural areas and 3.4 in urban areas. From the findings of the WorldBank's Poverty Assessment and Strategy report (yellow cover, March 19, 1995), 48% of thepopulation in rural areas and 28% in urban areas are considered below the poverty line. However,

Kyrgyz Republic Energy Sector Review Chapter IV

49

it seems reasonable to give the assistance in meeting energy expenditures to those who are alreadyreceiving the monthly income support from the Ministry of Labour and Social Protection. Thisrepresents 265,000 households, of which an estimated 175,000 households are in rural areas and90,000 in urban areas. These figures are likely to change over time and would have to bemonitored regularly through local surveys. The criteria to be applied for the entitlement may berevised after some experience.

4.44 How to provide the subsidy and how much it would cost. There are three general optionsfor offsetting the negative social effects of utility price increases: (i) cash payments can be made tothose in need; (ii) vouchers can be used; and (iii) utility rates can be differentiated. A combinationof such measures is also possible. There is no single system which is clearly advantageous. Intheory, there are "consumer sovereignty" advantages in having social protection support paid incash rather than in kind (through vouchers) or tied to utilization of energy. In practice, however, itshould be recognized that such financial support could be used for "inappropriate" purchases, so theGovernment may want to tie the assistance in order to ensure that increased energy charges areindeed defrayed directly. It is, therefore, recommended that the Government consider thefollowing:

in rural areas, providing a voucher to targeted households which could be used against thepurchase of coal; the subsidy could cover the full cost of an amount of coal considered tobe the minimal consumption for an average household for the year. This is estimated as oneton per year, fully subsidized at a cost of 400 soms per ton; the subsidy would amount to400 soms per household per year or 70 million soms;

in urban areas, the same amount of subsidy (400 soms per household per year) in the formof a voucher could be provided to use against payment of district heating or gas bills; thiswould amount to 36 mnillion soms;

lifeline rate for electricity would remain at the subsidized level of about 10 tyins/kWhcountrywide, but the first block would be reduced from 300 kWh to 100 kWh per month;the rate beyond the lifeline would be increased progressively to recovery of all financialcosts.

4.45 Subsidizing coal in rural areas would result in: (i) reduced pressure on fuelwood use; (ii)less use of electrical heating (which is not economic); and (iii) increased market for coal suppliedlocally by small private mines. Further, the tariff increases would improve the financial situation ofthe power and gas entities, KNEHC and Kyrgyzgas, and therefore lessen the burden of theseentities on the financial system.

4.46 How to finance the subsidy. The total direct subsidy would amount to 106 million somsannually (about US$ 10 million, or 1% of GDP) and would target approximately 26% of thepopulation. Financing of this subsidy could be from an additional tax on gasoline. Considering aconsumption of gasoline for 1994 of 300,000 tons (375 million liters), the additional tax would be0.28 soms per liter, compared to the current retail price of 3.2 soms per liter, or a 9% increase inthe retail price. The additional tax would be on the order of 0.15 soms per liter if applied to bothgasoline and diesel sales.

Chapter IV Kyrgyz Republic Energy Sector Review

50

4.47 Eligibility criteria. A program of monthly income support to low-income householdsalready exists and is being administered by the Ministry of Labour and Social Protection. Thetargeted subsidy for fuel expenditures could be an add-on to this program to be administered in thesame way. The program would be included in the national budget, and advances disbursed monthlyby the Ministry of Labour and Social Protection to the local budget accounts of districts ormunicipalities. The low-income households entitled to the benefits would be families raisingchildren, pensioners and other low-income families unable to maintain a minimum basic incomelevel. The entitlement to the program will have to be reviewed periodically.

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51

Box 4.1Gasoline Prices and Taxes in KR and OECD Countries

(Third Quarter 1994, US$/liter)

67.8% Nomway25 485% Japan

-7 .49 h rdy s-

22 7:.^ ay7 .9 % wedon

6.5% FrAsa1 3 9 7.5% Bnmim

72.2% Faondl_ ' 670.6% 5wkay

1 6 _ 72.2% Portugml

77.5% eand61.6% AMMae

1 3 - - - _ 67.5% DCumwd

_I 372.3% Uted KSkaom1 . . -a-73.7 Gr A

0 50% Sp1n_, ~~~~~ ~~~ ~~"' 6a.09E -: Luwnobourg

:: : 9 ~~~~67.61X Turkey

7 --- o47.4% Now Z mbnd

_ ~~~~~~~~~~~~55.6% Au*_

4 -~~~~~~~~~~~ ~~47.7% Come

32.5% Urtd Sittat

15 % Kyrgyz Ilopubkl

0 50 100 150

| Tax Component

M Net Price

* The chart shows final retail prices for gasoline in the KR and a range of OECD countries. The pricesinclude ex-refinery (or product import) costs, wholesale and distribution costs, and all taxes (includingvalue-added taxes, where they are applied). The pre-tax cost component is shown in the dark shading, thetax component in light shading.

* The final retail price of gasoline in the KR is approaching the price in the US, which is well below all othergasoline prices in the OECD.

* The pre-tax cost of getting gasoline to the final consumer in the KR is higher than the US, but is similar tothe cost in many other OECD countries. As a land-locked net importer of refined products, the KR canexpect its supply cost to be moderately high. Wholesale and distribution costs are also high, although theremay be some scope to reduce them through more intense competition.The tax component of the retail price of gasoline varies widely within the OECD -from just over 30% in theUS (the lowest in the OECD) to more than 60% in many of the European OECD countries. Al about I5%,the tax component for gasoline in the KR is less than half the lowest gasoline tax component in the OECD(except Mexico).

Source: SEA Statistics(1993) and, mission estimates

Chapter IV Kyrgyz Republic Energy Sector Review

Page 1 of 2

Box 4.2

Assessment of Unit Electricity Supply Cost

Generation TypeHydro Thermal

1. Fuel Costs

Kg coal/kWh generated 0.490Average Cost of Coal (per kg) $0.03Fuel cost (USc/kWh) 1 .47

2. Operations and Maintenance Costs

Total Capital Cost (US$/kW) 2050 1450Generation ($/kW) 1,500 900Transmission and Distribution ($/kW) 550 550Capacity Factor (100% = 8760 hours) 45% 55%Electricity Generated in kWh/year/kW of Capacity 3,942 4,818Annual non-fuel O&M Cost (% of Capital Generation Costs) 1.5% 3.0%Annual non-fuel O&M Cost (% of Capital T&D Costs) 3.0% 3.0%Annual Non Fuel O&M Cost, US$/kW $39.00 $43.50Non Fuel O&M Cost (USc/kWh) 0.99 0.90Total Direct Costs 0.99 2.37

3. Unaccounted for Electricity @ 20% 0.20 0.47

4. Depreciation

Generation: Estimated Lives (years) 40 25T&D: Estimated Lives (years) 25 25Annual Depreciation Expense (US$/kW) 59.5 58Annual Depreciation (USc/kWh) 1.51 1.20

5. Total Cost (USc/kWh) 2.70 4.05

6. Weighted Costs

Hydro 83.55% 2.25Thermal 16.45% 0.67

Total Weighted Cost 2.92

m:\so\kyr\elecost.xis

Page 2 of 2

Box 4.2Assessment of Unit Heat Supply Cost

CHP HOB(coal) (gas)

1. Fuel Costs

Kg coal/Gcal generated 308Average Cost of Coal (per kg) $0.03Fuel cost (US$/Gcal) 9.24

Gcal/MCM 9Average cost of gas (US$/MCM) 90Plant Efficiency 75%Fuel Cost (US$/Gcal) 13.33

2. Water Costs

CM/Gcal 10 10Cost (US$/CM) 0.10 0.10Cost (US$/Gcal) 1.00 1.00

3. Operation and Maintenance Costs

Total Capital Cost (US$/Gcal/hour) 90,000 190,000Generation ($/Gcal) 0 100000Transmission & Distribution (US$/Gcal/hour) 90,000 90,000

Capacity Factor (100% = 8760 hours) 30% 20%Heat Generated in Gcal/year/Gcal/hour of Capacity 2628 1752Annual non-fuel O&M Cost (% of capital cost) 3.0% 3%Annual Non Fuel O&M Cost, US$/Gcal/hour 2,700.00 5,700.00Non-Fuel O&M Cost (US$/Gcal) 1.03 3.25

4. Unaccounted for Hea 10% 1.13 1.76

5. Depreciation

Estimated Lives (years) 30 20Annual St. Line Depreciation 3.33% 5.00%Annual Depreciation Expense (US$/Gcal/hour) 3,000 9,500Annual Depreciation (US$/Gcal) 1.14 5.42

6. Total Cost (US$/GCal) 13.54 24.77

m:\so\kyr\heatcost. xis

54

Kyrgyz Republic Energy Sector Review Chapter IV

V ORGANIZATION OF THE ENERGY SECTOR

A. GOVERNMENT INSTITUTIONS

1. Background

5. 1 The introduction of an appropriate institutional set up for KR's energy sector represents achallenging task, particularly given that: (i) until independence (1991), most decisions were takenby the central authorities of the Former Soviet Union; (ii) limited expertise in policy and planningexists locally; and (iii) a painful adjustment process to the new economic environment has beentaking place, with the result that immediate problems have taken precedence over the introductionof appropriate policy making bodies.

5.2 Nevertheless, aware of the need to formulate national energy policies, a Ministry ofEnergy was established in 1992. However, its existence was brief, and its functions are nowhandled by:

a Deputy Prime Minister who directly oversees the electric utility Kyrgyz National EnergyHolding Company (KNEHC) and a state committee involved in exploration (minerals aswell as petroleum) and geology across the country (Goskomgeologia);

under the Minister of Industry and Trade, one Deputy Minister is entrusted with domesticenergy production of coal, natural gas and oil including oversight of the state-ownedentities involved (Kyrgyzkumyr and Kyrgyztopsnab for coal; Kyrgyzneft for domesticpetroleum production); another is entrusted with trade with Turkmenistan and Uzbekistanand, as a result, oversight of natural gas imports (including the natural gas utilityKyrgyzgas); and a third one with trade with Russia and, as a result, oversight over theimports of petroleum products (including the state entity Kyrgyzmunaizat).

In addition:

the State Committee for the Economy through its Price Commission controls the prices ofcontrolled commodities including electricity, gas and heat; its Anti-Monopoly Commissioncontrols the prices of petroleum products;

the State Property Fund is the Government Agency entrusted with the management of theGovernment's holdings in State enterprises and as such has been particularly concernedwith the formulation of privatization plans.

The present set-up for the sector has not been conducive to the articulation of appropriateenergy policies, realistic tariffs or effective institutional restructuring plans. These

Kyrgyz Republic Energy Sector Review

56shortcomings have been recognized by the State Committee for the Economy whichrecently launched the preparation of an Energy Concept Paper.! Nevertheless, anappropriate institutional framework for the energy sector remains to be defined, andintroduced - this chapter outlines the key areas which need to be addressed both from thestandpoint of the Govemment, and that of the main enterprises in the sector.

Figure 5.1: Kyrgyz Republic - Energy Enterprises

Deputy Prime

Minister Minister

Goskomygeologia n K rNgEyHuC

(Mineral Re sources * u (Power Utility)Exploration) o

Mnister of Industry, T rade and Materialp

Resou rces J

Depu y Deut D eputyMinister JMinister Minister ,

Kyrolzgas Kyr yzmunait t Kyrgyzkumyr(Gas Distribution) l.ti . acts i (Coal Mining)

Distribution)I

Kyrgyztopsnab (Coal Distribution)

Kyrgyzneft E(Petroleum Explor.

and Development)|

2. Policy Making, Regulation and Ownership

5.3 In studying the roles of Governrnents in the energy sector, a distinction should be madebetween the forrnulation of policies, regulation of activities in which market forces alone cannot

l The Concept Paper was still in draft form during the mission's visit (October-November 1994).

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57

address comprehensively all issues, and exercise of ownership over state enterprises. In view oftheir different characteristics (and potential conflicts of interests), separate agencies/departmentsare generally required to fulfill these functions.

a. Formulation of Energy Policies

5.4 The formulation of energy policies normally rests with the Government. In view of therange of issues to be addressed and the spectrum of expertise required,2 it is important to makeone Government agency the focal point of this activity. Often this objective is fulfilled by aMinistry set up specifically for this purpose. However, in the case of KR, which is a small countryand is endeavoring to reduce Government involvement to only key areas, this activity could behandled by a relatively small cell or department, within the Government3 . The staff of this unitcould be kept reasonably small by calling on consultants to tackle specific subjects.

b. Regulation

5.5 The need to regulate the energy sector is recognized as essential whenever market forcesalone cannot address satisfactorily issues of public concern. This is the case of power supply, heatand natural gas which are in many respects natural monopolies; 4 this is also the case of petroleumproducts with respect to safety of installations, specifications, and emergency storagerequirements; lastly, this is also the case of the exploitation of exhaustible mineral resources.

5.6 In order to address and balance the interests of Governments (whose decisions can beinfluenced by short term political priorities), those of shareholders in the enterprises in reference(who normally give priority to financial performance),5 and those of consumers (attentive to theprices of goods and services provided by monopolies, as well as safety), international experiencehas shown that some form of regulation by a regulating agency has proven to be effective.

5.7 Such regulating agency must be free from the executive arm of the Government. This isparticularly required from the standpoint of private investors, who could otherwise faceunacceptable risks. The regulator must also be independent from the enterprises being regulated,otherwise its decisions could be detrimental to the state or to consumers.6 In order to achievesuch independence, it is essential that the regulating agency be granted political and financialindependence. The autonomy can be secured through the legal framework under which the agencyis established, and through the terms and conditions of employment of its senior officials. The

2 Skills in this context refer not only to the energy subsectors (coal, electricity, natural gas, oil, renewable energy)but also to professional affiliations (economists, engineers, financial analysts).3 Many governments have recognized in recent years that interventionist policies in the energy sector failed toachieve the anticipated results. Hence, they increasingly rely on market forces to achieve sectoral objectives. Thisdecreases the emphasis on energy sector management, and hence on the status of departments entrusted with theformulation of energy policies.4 A natural monopoly, as referred to by economists, is an activity with increasing return to scale, or positiveeconomies of scale.5 Such enterprises can be State owned, publicly owned or private.6 This is the case of Kyrgyzneft which reportedly awards exploration and production rights in the Fergana Valley.

Chapter V Kyrgyz Republic Energy Sector Review

58financial autonomy can be best obtained by a levy on energy sales (electricity, heat, natural gas orpetroleum).

5.8 Regulating agencies are not only responsible for the proper application of pricing policiesbut also for the enforcement of the rights and obligations of the different parties (includingparticularly quality of service and the protection of consumers' rights). The scope of theiractivities, and their powers are anchored in legislation and regulations. This ensures thatregulatory agencies operate in a transparent fashion and that their rulings are based on objectiveconsiderations (i.e. law and available data). The rulings should be published, and objectionsshould be submitted to the courts system.

5.9 It is important to clearly define the operating philosophy of the regulatory agency. At oneextreme, the agency could have the right to approve all regulated energy prices in advance. Thiswould be similar to the current practices of the Anti-Monopoly Commission. At the otherextreme, the agency could simply monitor prices and respond to specific consumer complaintsthat a particular energy supplier has behaved uncompetitively, i.e., taken advantage of a monopolyposition. In recent years some countries (i.e. New Zealand).have adopted a more "light-handed"approach to regulation of monopolies.

5.10 In KR, considering the relatively small size of the energy sector, one could think ofregulatory arrangements along the following lines:

(i) Power Sector; Heat; Natural Gas Imports; these activities are largelynatural monopolies. Some form of regulatory intervention by theGovernment will be needed to guard against monopolistic behavior. TheGovernment should consider the various options and type of regulatoryagency it wants. This agency could also handle in due course naturalmonopolies occurring outside the energy sector (such as water supply andtelecommunications). In the interim, responsibility for the oversight of theutilities should be transferred to the Anti-Monopoly Commission undernew ground rules which allow pass-through of all financial costs.

(ii) Petroleum Products Distribution and Storage: Except for the storagedepots which need regulatory oversight (para 5.29), this activity isnormally carried out on a competitive basis. The main concerns heretherefore lie with safety, the environment and consumer protection(through standardized specifications for petroleum products).8 These taskscould be handled through the energy cell/department, there being nosignificant conflict between the articulation of policies in these areas, andtheir enforcement. Further, as long as the authorities are not satisfied thatthe distribution of petroleum products operates on a competitive basis, itwill be essential to maintain price caps on retail prices. This activity could

7 Given the financial requirements of the regulating agency, and the volume of energy products sold, theimplications on price levels would normally be minimal.8 In many countries, taxation on oil products represents an important source of fiscal revenues. The mission couldnot assess the fiscal framework in place, and the effectiveness with which the Government was collecting fiscalrevenues commensurate with the size of the petroleum markets. This matter should be studied separately.

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be subject to oversight by the Anti-Monopoly Commission, as is the case atpresent.

(iii) Petroleum Exploration and Production: The prime concern here is theorderly access to the natural resources of the state, the protection ofinvestors who are to invest substantial amounts, over long periods, prior tomaking profits, if any, as well as protection of State's rights to share ofrevenues from its resources. This is best handled by a Petroleum Lawspecifying the conditions under which one can explore and developpetroleum deposits in KR. The agency in charge of its application couldalso be entrusted with the management of the national exploration database, monitoring of companies under contracts,9 and reporting to thegovernment cell/department in charge of energy policy.

5.11 Through the EU-TACIS program, technical assistance is being provided for the drafting ofan energy law, mainly concerning the power sector; USAID has also indicated interest inproviding complementary assistance in preparing/implementing a regulatory framework for thepower sector. Integral to this will be the Government's consideration of the longer term structurethat it envisages for the power sector, which may include separation of district heating and power,and formation of several power entities, e.g., for generation, transmission and distribution, andseveral district heating enterprises. This should also open the way to private sector participationin the sector, including independent power producers and enclave type projects for developmentof future hydropower for export. Consideration may also be given to preparing a single energylaw for the country, with laws/regulations for the individual subsectors (e.g., power, districtheating and natural gas).

5.12 With respect to petroleum and coal, Norway and Japan are providing technical assistancein drafting a petroleum law/fiscal framework and reviewing the country's existing data andexploration/enhanced oil recovery prospects with a view to the Government's possibly carryingout a promotion to the international oil industry. The law on subsurface resources is alsoundergoing some revisions with assistance from the World Bank (under the Rehabilitation Credit);the need for further revisions to enable unrestricted private sector participation in coal mining'0

and otherwise facilitate its entry to the industry also needs to be assessed.

c. Ownership

5.13 At present, the State does not have legal mechanisms to control the enterprises, whetherstate owned or so called joint stock companies. As a result, the managers of such enterprisesenjoy extraordinary powers. For instance: (i) they do not have to submit budgets or annual work

9 Goskomgeologia, which is presently engaged in petroleum policy, as well as exploration in Kyrgyzstan (outsidethe Fergana Valley) could be convened to such a policy arm, provided that it restructures its activities andparticularly ceases to perform the duties of an operator.10 It is the mission's understanding that private coal mines are restricted in their annual production to 10,000 tons;this restriction should be eliminated.

Chapter V Kyrgyz Republic Energy Sector Review

60programs to their Boards; and (ii) when Boards exist, they are staffed by the senior personnel ofthe enterprises so that they lack independent power and objective view.

5.14 The absence of a legal framework for state enterprises also constitutes an impediment atthe policy level. Thus corporate policies can be adopted which are of a social rather than of abusiness nature". By adopting such policies, enterprises become akin to government agencies/department and lose their initial purpose. Moreover, the enterprises are effectively enjoying freeuse of major assets provided by the State.

5.15 As a result, the Government should accelerate corporatization and commercialization ofthe state-owned entities and define: (i) the commercial basis for the operations of Stateenterprises; (ii) the duties and prerogatives of the enterprises' management; (iii) the selection andappointment process for senior personnel of the enterprises; and (iv) the role of the Boardsincluding the selection procedures for Board members. It is further recommended that as aninterim measure, the State Property Fund (SPF) appoints to each Board of State enterprises atleast two Directors with suitable backgrounds in commerce and finance.

5.16 Financial restructuring of the entities is also an essential part of their commercialization.Key considerations include: (i) revaluation of existing assets to reflect their true worth andensuring future depreciation provisions are made accordingly; (ii) adding debt to the balancesheets (long terms loans from the Government in place of equity) and requiring them to servicethe debt; (iii) setting dividend targets to ensure a return on government equity; and (iv) usingfinancial targets to drive tariff increases. As an illustration of the differences in the financialsituation of energy utilities in centrally planned countries in transition and market economies, Box5.1 compares KNEHC's financial statements with those of BC Hydro (a power utility in Canadawhich has a similar mix of hydro and thermal capacity (except no district heating) and isconsidered representative of utilities in the West).

" Social goals of governments can be acconunodated through other methods, for instance by providing support tolow income groups to pay energy bills. By so doing, the business integrity of the State enterprise is preserved.

Kyrgyz Republic Energy Sector Review Chapter V

61

Table 5.1: Main Features of Energy Enterprises (1994)

Main Focus Number of Sales in MMSoms Corporate Status RemarksStaff Connections

Network

KNEHC Power & District Heating Utility 14,057 863,000 305 Joint Stock 19 enterprises of which 16 are

involved in power activities

Kyrgyzgas Gas Distribution 1,600 300,000 207 State Owned

Petroleum

Goskomgeologia* Exploration 150 n.a. nma. State Committee Outside Fergana Valley

Kyrgyzmunaizat Petroleum Products Distribution 2,300 n.a. n.a. State Owned Until recently, had monopoly on oil

production

Kyrgyznefl Petroleum Exploration and 3,000 n.a. n.a. State Owned Fergana Valley

Development

Coal

Kyrgyzkymur Coal Mining 8,800 n.a. n.a. State Owned 8 mining enterprises operating

14 mines

Kyrgyztopsnab Coal Distribution 600 n.a. 26 State Owned Until recently, had monopoly on

coal distribution

: The total staff of Goskomgeologia is 3,100, of 150 are involved in oil and gas activities.

B. PRIVATIZATION AND FINANCIAL MANAGEMENT

5.17 The Government of KR has embarked on an ambitious privatization program which alsoencompasses the energy enterprises. Various plans have been drawn for most energy enterprises,but no energy entity has yet been privatized. This is not surprising, given the importance of energyfirms to the economy, and the ramification of such privatizations. Moreover, the energyenterprises do not have appropriate financial information systems and are weak in the financialmanagement of their affairs. In order to privatize properly these enterprises, efforts should beundertaken in these areas prior to privatizing.

1. Financial Systems

5.18 Books of energy enterprises are kept in accordance with the accounting systems in effectprior to independence. This system has major drawbacks from a financial standpoint including: (i)inter-enterprise balances are not always eliminated in the consolidation process; (ii) income issometimes recognized only when payment is received; and (iii) assets are not revalued so

Chapter V Kyrgyz Republic Energy Sector Review

62depreciation provisions are inadequate. Further, books are not audited by an independent auditor,so prospective investors would have great difficulty in ascertaining the value of privatizationcandidates.

5.19 As a result, it is recommended that a new accounting code be introduced in KR based oninternational accounting standards. In the meantime, technical assistance should be sought to: (i)train counterpart staff in international accounting standards; (ii) restate the financial results since1993 (the year the national currency (the som) was introduced); and (iii) revalue the assets(including stocks and inventories) in accordance with appropriate guidelines.

2. Financial Management

5.20 Notwithstanding the conversion of a number of energy enterprises to Joint StockCompanies, modern financial management practices are yet to be adopted. These include inparticular: (i) preparation of annual budgets and their monitoring during the year; (ii) costaccounting systems enabling the enterprises to cost the goods and services with reasonableaccuracy; (iii) enforcement of financial discipline in the enterprises, including the management ofliquid resources; and (iv) financial (and corporate) planning including the application of financialmodeling for tariff setting. This calls for technical assistance at the enterprise level.

5.21 An area where enterprises have been particularly weak has been the collection of revenues(this especially applies to KNEHC and Kyrgyzgas). While the international practice is to invoicecustomers monthly, these companies rely on their consumers to read their meters"2 and to pay (ona voluntary basis). As a result, the amount of unaccounted for gas and electricity has beenvariously estimated as being as high as 60% (for a good gas utility this should not amount tomore than 2-3%; for an electric utility, it should not exceed 10%). Thus there is a need forassistance, including hardware and software to: (i) introduce modern computerized billing,recording, and consumer records systems; (ii) install meters at all gas connections; (iii) train staffand introduce appropriate systems of meter reading, invoicing and collection; and (iv) disconnecton a timely basis delinquent customers. With the support of both EU-TACIS and USAID,assistance to KNEHC has been initiated in this area but there is scope for increasing it.

C. OPTIONS FOR RESTRUCTURING THE SUBSECTORS

1. Introduction

5.22 KR's energy sector and enterprises are in a transition from the centralized systems to amarket economy. In some instances, it would appear that the private sector caught the publicsector unaware, and was able to capture profitable niches of the energy market.

5.23 While this development is welcome, there is a clear danger that under certaincircumstances, the private sector could acquire undesirable levels of market power (for instanceby being able to determine prices without being subject to adequate competition), or couldprosper at the expense of consumer's safety or community well being.

12 This applies to electricity only as gas connections are not metered. Gas consumers are charged a flat rate.

Kyrgyz Republic Energy Sector Review Chapter V

63

5.24 An essential objective of the Government in the energy sector should be to disengage itselffrom the energy entities, and rely on competition to rule the market. Yet there are situations inwhich competitive forces alone will not suffice to protect the consumers. This section makesspecific recommendations at the subsector level based on international experience and KR'sunique challenges, taking into account: (i) the potential for competition in each activity; and (ii)the priority being assigned to privatizing in KR.

2. Petroleum Exploration and Production

5.25 At present, two Government entities are active in petroleum exploration and production:(i) Goskomgeologia which is in charge of exploration in the whole of KR, except for the FerganaValley (the only producing basin); and (ii) Kyrgyzneft which is in charge of exploration andproduction in the Fergana valley.'3 This system, which results from the state of affairs atindependence, is anomalous given that: (i) both entities depend on scarce public resources; (ii) thescope of activities does not justify two companies; and (iii) given the state of the economy and thegeological conditions, there is little justification for the drilling of wells with public funds(exploration wells are normally financed by risk capital).

5.26 Given the financial constraints, the Government has correctly concluded that the bestcourse of action to follow is to attract foreign oil companies which have the capital and knowhow. To attract foreign capital successfully, in addition to presenting a worthy case from ageological standpoint, it is essential to adopt an appropriate legal framework (para. 5.10), anddefine the roles of the national oil companies in relation to foreign investors.

5.27 The following measures should be considered under these circumstances: Kyrgyzneft,which has access to production, should become a state oil company, operating on a commercialbasis (and thus be weaned from the national budget). Kyrgyzneft's drilling department shouldbecome a separate entity operating as an independent contractor (the combination of an operatorand a drilling department within one enterprise is not conducive to efficient operations).Goskomgeologia, once restructured, should become a policy arm of the Government in chargeof: (i) formulation of exploration and development strategies including the promotional programto the international petroleum industry; (ii) enforcement of the Petroleum Law (under drafting -see para.S. 10 ); (iii) management of the national petroleum data base; and (iv) monitoring of oilcompanies under contract.

3. Petroleum Storage and Distribution

5.28 This activity used to be dominated by one State enterprise, Kyrgyzmunaizat, which ownsstorage depots and retail outlets for petroleum products. In recent years, its position has becomeeroded as private firms have started importing products directly from foreign refineries and selling

13 Kyrgyzneft has entered into a Joint Venture with a US company, Aztec, to enhance production in specific areasof the Fergana Valley.

Chapter V Kyrgyz Republic Energy Sector Review

64them directly to consumers. The private operators sometimes make use of Kyrgyzmunaizat'sstorage depots.

5.29 The market share of the private sector is now estimated at 60% - it is understood thatKyrgyzmunaizat is left with the high risk segment of the petroleum market, particularly thosecustomers who cannot pay on a timely basis, or make a down payment. Taking into account thegrowing share of the private sector, and the lack of rationale for the involvement of a Governmentcompany in oil trading, consideration should be given to: (i) privatizing or dismantlingKyrgyzmunaizat's trading arm; and (ii) privatizing Kyrgyzmunaizat's storage depots subject totheir regulation as common carriers. Under the common carrier concept, the operators of depotswould provide storage and handling services, on a non-discriminatory basis, under a fee structureto be posted and subject to oversight by the Anti-Monopoly Commission. Depot operators wouldnot be allowed to trade in petroleum products as they would thus acquire excessive market powerat the expense of consumers.

4. Coal Production and Distribution

5.30 Kyrgyzkumyr is a State entity involved in coal mining. Through its eight enterprises, itowns and operates 14 mines, for the most part located in the southern part of the Republic.Kyrgyzkumyr has been gradually losing its markets, its production declining from 3.5 million tonsin 1991 to an estimated 0.9 million tons in 1994. This is the result of (i) relatively high coalprices relative to other fuels and electricity; (ii) high rail transport costs from the south (where themines are located) to north of the Republic (the main markets) which makes domestic coaluncompetitive with coal imported from Kazakhstan; and (iii) the poor quality of Kyrgyz coal.Kyrgyzkumyr's financial problems have been exacerbated by the inability of some large customersto pay for their coal consumption.

5.31 Four of Kyrgyzkumyr's enterprises have placed under the control of the Enterprise Reformand Resolution Agency (ERRA) supported by a IDA credit,'4 pending the results of a diagnosticstudy and decision on their liquidation or restructuring. Similar actions will be needed for the fourremaining enterprises. Those mines which are considered viable and Kyrgyzkumyr's other assetsshould then be privatized/auctioned off to the private sector. A social safety net will be neededfor those employees who leave the industry during the process. Box 5.2 gives an overview of theneeded restructuring and likely employment impacts and options for reduction.

5.32 Kyrgyztopsnab is the Government enterprise in charge of the import and distribution ofcoal throughout the Republic. To that end, it operates 12 storage depots. Its monopoly on themarket has been eroded as the following demonstrates: (i) private companies are now involvedwith the trading of coal; (ii) KNEHC now imports coal directly from Kazakhstan; (iii)Kyrgyzkumyr markets coal directly from its mines (thus bypassing Kyrgyztopsnab's depots); and(iv) two storage depots have declared themselves private and operate independently. Under thesecircumstances, there is no longer a rationale for a Government presence in the coal distributionactivity, so that the storage depots should be privatized. At the same time the trading arm ofKyrgyztopsnab should be privatized or dismantled.

14 Privatization and Enterprise Sector Adjustment Credit (No. P-643 1-KG, June 9, 1994).

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5. Electric Power and District Heating

5.33 In January 1994, the Government approved the new statutes of the national power utility,changing its name to the Kyrgyz National Energy Holding Joint Stock Company (KNEHC).Under KNEHC, 16 different enterprises are entrusted with the production, transmission anddistribution of electricity in various parts of KR; a further 3 enterprises are involved in engineeringand construction.

5.34 The Government attaches priority to privatizing energy enterprises, and various plans toprivatize KNEHC have been elaborated. In the understanding of the mission, the 16 enterprisesinvolved in electricity operations are to be consolidated into a joint stock company which wouldbe gradually privatized. Shares would be distributed to the workers and sold to the investingpublic. This approach has several drawbacks: (i) it does not recognize the potentially-competitivenature of the generation activity, as opposed to transmission and distribution which are bothnatural monopolies; (ii) no regulatory regime for the power sector has been set up, so thatinvestors face great uncertainty (para. 5.7); and (iii) the power sector has had a dismal financialrecord in recent years so that investors might well be disappointed when investing in such shares.

5.35 Prior to taking any measure (which will necessary reduce its subsequent options), theGovernment should analyze the alternatives available to privatize the power sector. As a first step,district heating could be separated from electricity, with each treated as an autonomous,commercial operation. In addition, the alternative of creating separate power entities (not in aholding company) in charge of generation, transmission and distribution should be considered.The prices under which the generating plants sell power to the transmission company, the bulktariff to the distributors, and the distributor's retail tariffs would all be subject to the regulatoryframework described above (para 5.10).

5.36 The first priority for privatization should be the distribution enterprises. That is because:(i) the generating plants are mostly hydroelectric, and fulfill multi-purpose functions; (ii) thetransmission company will play a critical role in the network, it being also in charge of criticalpower exports; and (iii) the distribution companies are critical to the financial rehabilitation of thepower systems. The district heating enterprises could also be privatized.

5.37 The privatization of distribution companies could take different forms including: (i)outright sale of assets; (ii) the grant of a 20-30 years concession to a private firm, following whichthe company is returned to its initial owners; and (iii) management contracts, under which acompany (preferably a foreign utility) is given a 5-10 year contract, with performance-relatedincentives, to manage the distribution company (but not to invest in network strengthening orextensions). No matter which approach is selected, the introduction of a regulatory frameworkconstitutes a pre-condition for privatization, and it is highly recommended that specializedtechnical assistance be sought in order to design and implement the privatization program.

6. Natural Gas

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66

5.38 Kyrgyzgas is the transporter and distributor of natural gas. Because of its configuration,the network extends only to two distribution markets in KR, and the number of consumers isrelatively small (only 300,000). As a network monopoly, Kyrgyzgas should be subject to theregulatory framework described above (para 5. 10).

Kyrgyz Republic Energy Sector Review Chapter V

67Box 5. 1

KNEHC a/ & BC HYDRO (CANADA)-How do They Compare-

KNEHC BChydro Balance Sheets

(USS million)Number of Customers 862,975 1,397,154 Assets

KNEHC BC-hydroInstalled Capacity (MW) Current AssetsHydroelectric 2,774 9,706 Casb (12) 76Thefnal 659 1,132 Accounts Receivable 128 252

Other 5 134GWh Geerated & Purchased 12,926 48,978 _ _GWh Sold 10,296 44,663 Subtotal 121 463

Number of Employees* 11,638 6,539 Fixed Assets in Operation 50 8.8495XN2iC HC.. hd2.4DS Mf5.fr.. '-"o ".Pi Less Depreciation: I0 2,.61

40 6,288Income Statements

(US S million)Work in Progress 16 270

Revenues(USSrnillion) 161 1,659Revenues (USc/kWh) 1 29 3.77 Other Assets 14 533

Expenses Total Assets 1 7.554Water Rights 0 165Fuel andE EneagPurchases 100 165Operation and Mainteanc 26 316 Liabilities and EquityDepreciation 1 224 Current Liabilities

Accounts Payable 129 202127 870 Other Current Liabilities _ 313

Operating Income 34 789 Subtotal 131 515

Less: Interest 1 515 Long Term Debt 2 5,550Taxes 10 129

Other Liabilities 0 663Net Income 23 144

Retained Earnings 59 825

Operating Ratio 400/. 52%/e Total Liabilities and Equity 192 7.554Retum on Equity 40e% 17Rate of Reurn on Asss S5% 13% Accounts Receivable (days) 290 56Times lnterest Eamed 62.6 1.5 Debt:Debt & Equity 2.5% 87.1%

Productivity RatiosSales/Employee (MWh) 885 6,830Connection/Emnployee 74 214

The above table calls for the following comments:

* Although BC Hydro sells four times more power. it has less than half the naumber of eaployees.• BC Hydra's sales per employee are 9 times those of KNEHC.• BC Hydr's aveage revenue per kWh sold is three times highe than that of KNEHC.• BC Hydro has three times as much generating capacity, but its assets are valued at I 80 times as much

If KNEHCs usest were revalued (perhaps by as much as 60 times), this would add sigaificantly tothe value of the govemrents equity in the company.

• KNEHC has negligible debt on its balance sheet If KNEHCs assets were revalued, the governmentcould add long-term loans to KNEHCs balance sheet and require KNEHC to raise its tariffs toservice this debt And it future, KNEHCs investment should be financed by a mix of long tern debtand rtained earnings. In the long run. KNEHC's debt to debt-plus-uty ratio should be in the rnageof 80-90% rather than 2.5% as at present

5KNEHCs accounts receivable, at nearly 10 months equvalent, we fwve times higherthan those of BC Hydro (two months).

* Unlike KNEHC, BC Hydro pays a significant royalty to the Government in the form ofwater rights (USS 165 million).

a/ Includes Heat Operations

Sowm: JO-WC, BC HydroAnnual Repor 1994

68

Box 5.2: COAL INDUSTRY RESTRUCTURING

Scope of the Industry's Down-Sizing

historic futureproduction metric tons 3.5 0.5-0.8number of mines number 14 2-4employment number 14,000 (estimated) 2,000productivity tons/staff- 250 300

yearfor comparison: WEurope today 500

* at present, there are 14 mines in operation* 7 mines should be closed immediately-to avoid uneconomic investments* 3-5 mines have depleted their economic reserves-and should be closed within 1-2 years* 2-4 mines could be economically viable-and should be transferred to the private sector* in addition, the private sector should be encouraged to open small mining operations to serve

local energy needs* the government 's role is to provide:

* adequate regulatory supervision of safety and environment aspects ofprivate sector miningoperations-and of mine closures

* a social safety net for coal industry employees who agree to leave the industry during theclosure and/or privatization of state-owned mines

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Box 5.2 (con't)

Employment Impacts/Reduction

Mining Enterprise June 93 Employment June 94 Employment FutureEmployment

Sulyukta 2560 1950Kyzil Kiya 2850 2130Tash Kumyr 2170 1890Kok Yangak 1660 1110Almalyk 600 550Djergalan 540 470Tsentralnaya 560 430Agulak 370 320

Total 11310 8850 2000 approx.

* the coal industry has already achieved a rapid reduction in employment,by 22 percent in the 12 months from June 1993 to June 1994

* however, the government needs to find a way to reduce employmentfurther, perhaps by as much as another 6000-7000, as part of theprivatization of the coal industry

* some of the options for accelerated employment reduction in the coalindustry are listed below

Options for Accelerated Coal Industry Employment Reduction

Retirement * normal* early

Voluntary Departs * for specified agegroups

on basis ofincentve payments a for all workers

Temporary Employment * at enterprise levelPrograms * at regional levelfor labor-intense tasks, e.g.: * at national levelclean-up, maintenance & repair ofinfrastructure

Counseling and Job Placement * at industry levelServices * at regional level

Special Programs * retrainingat industry and regional level * assistance for small

businesses

Chapter V Kyrgyz Republic Energy Sector Review

70

Kyrgyz Republic Energy Sector Review Chapter V

[7. ENERGYAND THE ENVRONMENT

A. INTRODUCTION

6.1 Environmental aspects are controlled by the State Committee for the Protection of Nature,Goskomprioda. Safety and occupational hazards aspects of workers protection are regulated bythe Technological Committee.

6.2 Both production and consumption of energy have impacts on the environment, especiallywhen using coal. The halving of energy consumption between 1991 and 1994 and the greater useof electricity in households have reduced pollution and other environmental impacts at leasttemporarily. A possible exception concerns the use of fuelwood. The increase in illegal cutting oftrees in rural areas has probably increased the risk of soil erosion.

6.3 This chapter covers two topics:

(I) discussion of environmental issues in the energy sector; and

(ii) discussion of appropriate environmental policies relevant to the energy sector,based on recommendations of the Kyrgyz Republic - National EnvironmentalAction Plan.

B. ENVIRONMENTAL ISSUES IN THE ENERGY SECTOR

6.4 Coal Production. Most surface mines are exploited without due regard to theenvironment. As a norm there is no back-filling of pits. Waste dumps are scattered, and minesurfaces are not being reclaimed (except for the Sulyukta surface mines). Access roads cutthrough the mining areas irregularly, and condition of the roads is poor. The side walls of openpits are too steep, and accidents of sliding walls have occurred. Water discharge is not controlled.Underground mines are environmentally less harmful. The mines are not gassy and do not poseserious explosion risks. There is, however, a moderate risk of fire due to a tendency of the coalto self-ignite. The accident record of Kyrgyz underground coal mines appears to be normal.

6.5 Combined Heat and Power Plants in Bishkek and Osh. The use of high ash low gradecoal at the Bishkek CHP is a major source of pollutant emissions and the associated large volumesof ash, to be handled and disposed of, cause further environmental concerns in the Bishkek area.The Kyrgyz standards concerning the emissions are :-(a) 100 mg per cubic meter for fly ash; (b)400 mg/m3 for SO2; and (c) 240 mg/m3 for NO,. These standards are generally exceeded. Thefines which are imposed are ineffective as they are quite low. The Osh CHP burns heavy fuel oiland gas. Emissions of SO2 and NOx are also exceeded.

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72

6.6 In Bishkek the main concem is dust emission. The design of the boilers is such that about90% of the ash is leaving the furnace in the form of fly ash. As the coal being burned has a highash content (30 to 35%), the flue gas is carrying a high proportion of ash. Gas scrubbers have anefficiency of only 96%; hence the flue gas emitted contains too much fly ash.

6.7 The emission of SO2 is above the limits but is not considered as a major problem as thecoal is low in sulfur (0.8 to 0.9%). NO, emissions could be reduced by using low-NO. burnersand staged combustion. However, in view of the high cost of the equipment needed to reduceernissions, it would be preferable to allocate more natural gas for power generation, and, in thefuture, to retrofit the existing plant with more efficient combined cycle units.

6.8 Fly ash is deposited in a special dumping site close to the power plant. The dumping siteis normally a pond-like structure with water-tight soil deposited at the bottom to prevent leakageinto the water table. The ash is pumped to the dumping site in the form of a slurry. Contrary towhat is done elsewhere, the ash is not used by the cement industry.

6.9 A significant amount of water is consumed in the CHP plants because of the supply of hotwater and substantial losses in the district heating network. It is anticipated that rehabilitation ofthe district heating network will reduce both water and heat losses. In Bishkek there is normallyno waste water from power plant operation as the contaminated water from boiler blow down,cooling tower blow down or demineralization plant filter backwash is mixed with the ash waterand pumped to the ash dumping site together with the ash slurry. However, the water from theslurry is not recycled and is discharged into a nearby canal.

6.10 Hydro Projects. Construction of new hydro projects may create environmental problemssuch as: (a) loss of farm land in the reservoir area and resettlement of populations; (b) depositionof silt in the reservoirs may result in some loss of nutrients and thus decrease the productivity offarmland downstream, (c) impact on the fauna and flora and microclimatic changes in case of bigreservoirs. There are other hazards related to natural disasters (earthquakes, land slides) whichmay affect the populations downstream of the reservoirs. The existing Toktogul dam and theplanned Kambarata project are located near a major fault in an active seismic area.

6.11 A master plan of the country's hydropower resources was completed in 1993 whichidentified attractive projects for future development. Priority should be given to: (a) exploitingthose resources where impacts on the population and environment can be minimized and (b)integrating a multi-sectoral and country-wide review process into planning and evaluatingprojects. Environmental and social impact assessment must be fully integrated into the technicaland economic evaluation of these resources. Such analyses may show that certain areas shouldnot be developed for the proposed projects, rather they should be set aside for conservation oralternative uses such as tourism.

6.12 Petroleum Exploration and Production. In spite of old equipment and lack of spareparts and resources for repair and maintenance, the oil and gas industry does not present a majorconcern to the environment. However, areas of improvement exist and consist of: (a) description

Kyrgyz Republic Energy Sector Review Chapter VI

73

of the government control activities and the respective roles of Goskomgeologia, theTechnological Committee and Goskomprioda as a guide to foreign investors; (b) the currentsystem of Environmental Passport should be reviewed and simplified; (c) the past and presentpractices with open mud pits should be evaluated; (d) the hazard associated with the use ofchemicals should be evaluated and a catalog of the chemicals cleared should be catalogued.Further, it should be stated that an investor cannot be held be liable for pollution damagesoccurred before his involvement in an area.

6.13 Petroleum Products and Gas Distribution. The main issue relate to the safety of thepopulation in view of the current practice of distributing gasoline and other petroleum productsin urban areas directly from road tankers. Also maintenance of the gas distribution network iscritical to avoid gas leaks and risks of explosions.

6.14 Risks associated with fuels used by households. Burning of fossil fuels by householdsmay lead to emission of particulates and other pollutants in the atmosphere. The seriousness ofthe problem depends on the density of the population and the background pollution especiallyduring cold winters in cities. In the KR, however, background pollution in most cities is lowerthan other cities in the FSU because of less industrial development.

6.15 Use of energy by households poses some risks to the users. Poor chimney drafts canresult in smoke inside the dwelling unit. If not properly connected to the chimney, keroseneheaters can emit sufficient pollutants hazardous to the health of the people with heart andrespiratory problems. Electric heaters also pose problems, the most serious being the risk of firecaused by the use of inadequate wiring within the dwelling unit.

6.16 Soil Erosion Caused by Deforestation. The limited forest cover in the KR is underthreat from illegal cutting of trees, overgrazing and land clearing as a result of the break up ofcollective farms. As the price of coal and other household fuels have increased significantly, morefuelwood is being used for heating and cooking. This has resulted in illegal cutting of trees in ruralareas and along the roads. Among the adverse effects of soil erosion is increased siltation ofreservoirs, thereby reducing the life of the dams.

C. ENVIRONMENTAL ACTIONS FOR THE ENERGY SECTOR

6.17 The National Environmental Action Plan recommends policy actions which wouldaddress, inter alia, issues in the energy sector. The main recommendations include:

(a) enact legislation ensuring that environmental liability for past pollution damages isborne by the Government (or entity concerned), so as not to discourage privatesector investments;

Chapter VI Kyrgyz Republic Energy Sector Review

74

(b) prepare clear guidelines for drafting legislation concerning the institutional role andresponsibilities, monitoring and enforcement, requirement for environmentalassessment, and environmental financing;

(c) improve the operation and maintenance of dust collection equipment and ashdisposal site in the power plant in Bishkek to reduce emissions;

(d) with the pending closure of uneconomic coal mines (both open pit andunderground operations), special attention must be given to ensuring their closureis carried out in environmentally acceptable ways, including water supply andsurface restoration; for those mines continuing operation increased attention isneeded on environmental and worker health and safety aspects;

(e) carry out an independent evaluation of the safety of existing dams, particularlythose in seismically active zones and near major faults; and

(c) implement a strategy for reducing deforestation in most severely affected areas andimprove transport and distribution of fuelwood and other energy supplies.

Kyrgyz Republic Energy Sector Review Chapter VI

ENERGY SECTOR ISSUES AND RECOMMENDED ACTIONS

W MUA s -'................ . .n.w. ... N........r , ,. , , v. ... .....

A. Energy Sector 1. Energy trade arrange- (a) Explore with neighboring (a) By mid-1997.Management ments are disadvantageous republics possibility of

for KR. convening a RegionalConference on EnergyTrade, and if agreed,arrange such conferencc.

D_ _ =:. .. .X2. Strengthen sector policy (a) Entrust single agency/ (a) By mid-1996.

capacity and management. energy cell with form-ulation of cnergypDolicies.

3. Regulatory framework (a) Assess options for level (a) By mid-1996.for energy sector is of regulatory control.weak.

(b) Establish energy regula- (b) By end-1997......... ~ ~ ~ or . a .... 'enCv

4. Financial management (a) Introduce international (a) By end-1996.and accounting practices accounting, budgetingdo not follow inter- and cost control, andnational standards. management information

systems, with appropriatetraining in their use.

__.~INAE, i_, I q1 ~k-~~=5. Data on energy sector is (a) Prepare basic data base (a) By end-1997.

scarce and incomplete. for sector within energycell.

B. Power and District 1. Power generation Coordination through (a) Regional initiative on a (a) By end-1997 agreeHeating is constrained by need to CAIS council but agree- common approach to long-term trading

store water for irrigation. ments reached are short- valuing the opportunity contracts.Pricing of power trade term. cost of regulated water foris disadvantageous to KR. irrigation and of hydro-

power, and optimizationof the long-term develop-ment of the regionalpower system.

B. Power and District 2. Tariffs for electricity Tariffs were increased (a) Tariffs raised to cover (a) By end-1995.Heating (con 't) and district heating are in 1994 but still too low. cash operating and

artificially low. maintenance costs willhouseholds tariffs at least.equal to those for.industry.

(b) Tariffs raised to full cost (b) By end-1996.recovery (includingallowance for replacementof assets) for allconsumers.

(c) Tariffs raised in accor- (c) By end 1997.dance with KNEHC'sfinancial targets.

3. Sector is vertically inter- (a) Consider options for (a) By end-1996.grated and district heating longer term structure ofand electricity treated sector including forma-jointly; scope exists for tion of several powerincreased private role in entities (e.g., unbundlingsector. generation, transmission,

distribution) and districtheating enterprises, andinvolvement of privatesector in generation anddistribution.

4. Corporate and regulatory Draft electricity law is (a) Complete draft electricity (a) By mid-1996.framework for sector being prepared (EU/ law.unclear. TACIS).

(b) Assess options for regula- (b) By mid-1996.tory controls.

(c) Enact electricity law. (c) By end-1996.

(d) Prepare/enact sector (d) By end-1997.______________________ ______________________ ______________________ regulations. ________________rg l in .

SUE.....A I..../C.......WS ....D .. ~NX tP .. IPCWT3NB. Power and District 5. Governance and financial KNEHC has been cut off (a) Prepare program for (a) By end-1996.Heating (con 't) management of KNEHC from national budget and corporate and financial

are very weak. organized as a joint stock restructuring of KNEHCcompany. including separation of

electricity and districtheating operations.

(b) Initiate program (b) By mid-1997implementation.

~~~~~~~~~~..:.-.... ... ..~:..... ... x.... :k: . ::..~....2::..::....:6. Distribution and trans- (a) Rehabilitation of T & D (a) By end-i999.

mission network is over- network is priorityloaded due to increased investment.residential demand.

7. District heating systems in (a) Rehabilitation of district (a) By end- 1999.Bishkek/Osh and CHP heating systems and CHPplant in Bishkek are in plant are priority invest-poor condition and ments.inefficient.

8. Construction of Kamba- Feasibility study of complet- (a) A long-term purchase (a) By end-1996.rata-2 hydro project ing project was carried out contract should be con-was started in 1991 and (EBRD). cluded for the energy ofis 30% complete but Kambarata-2 beforeconstruction stopped proceeding with projectbecause of lack of funds. completion.

9. Securing export market Agreement in principle has (a) Assess feasibility of such (a) By end-1996.for Kyrgyz hydropower. been reached with Pakistan a scheme (USAID).

to export power throughChina.

C. Natural Gas 1. Secure long-term supply Regional initiative (a) Assess long-term poten- (a) By end-I997 agreeof natural gas. on common approach to tial for gas use in KR long-term supply

gas transport pricing and review options for contracts.and contracts. gas pricing and

contracts.

:~~~~~~~~~~~~~~~~............. : :: . ....... ..........

C. Natural Gas (con 't) 2 Tariffs for household use Tariffs were increased in (a) Tariffs raised to cover (a) By end-1995.of gas are artificially low. 1994 but still too low. cash operation and

maintenance costs for allconsumers.

(b) Tariffs raised to full cost (b) By end-1996.recovery (includingallowance for replace-ment of assets) for allconsumers.

(c) Tariffs raised in accord- (c) Beginning in 1997.ance with Kyrgyzgas'financial targets.

3. Install gas meters for Discussions entered (a) Review meter tech- (a) By end-1995.all customers. into with German nology options.

manufacturers forlicensing of technology (b) Prepare installation plan (b) By nid-1996.and domestic manufac- and obtain financing.ture of meters.

(c) Complcte installation. (c) By end-1998.

4. Governance and financial Kyrgyzgas has been cut (a) Prepare program for cor- (a) By end-1995.management of Kyrgyzgas off from national budget. porate and financialis very weak. restructuring of

Kyrgyzgas.

(b) Initiate program (b) By mid-1996.implementation.

5. Government should not be (a) Prepare program for (a) By end-1995.involved in LPG market- privatizing LPG opera-ing. tions.

(b) Implement program. (b) By mid-1996.

:T ::-:-:J:::: :: l :: #::: -: : : : :SSUE$iAC N:-s - TEM - AX: N N::T :-: [ TC. Natural Gas (con 't) 6. Improve safety and (a) Assess condition of (a) By mid-1996.

efficiency of gas trans- gas network and safety/mission and distribution. efficiency of system

operation and main-tenence, and evaluateoptions for improvement

D. Petroleum Downstream 1. Address regulatory (a) Prepare regulations (a) By mid-1 996.issues of petroleum on safety, environment,products. product specifications,

registration on entry,customs, etc.

(b) Enact regulations. (b) By end-1996.

2. Government should not Trade of petroleum (a) Prepare program to pri- (a) By end-1995.be involved in petroleum products liberalized. vatize Kyrgyzmunaizat.products trading.

(b) Implement program. (b) By mid-1996.

3. Supply of petroleum (a) Study options for im- (a) By end-1995.products to KR. proving supplies through

Cimkent refinery.

E. Coal 1. Coal industry is in Out of 8 enterprises, (a) Close uneconomic mines (a) By end-1995.deep financial crisis and 4 are designated for care (estimated at 7 mines).needs to be downsized, and maintenance underrestructured and ERRA and are likely (b) Prepare plan for closing/ (b) By mid-1996.privatized. to be liquidated. restructuring remaining

mines.

(c) Close mines with (c) By end-1996.depleted economicreserves(estimated at 3-5mines).

Sul3sEoWAenISSUE/ACTIOS STES ALRDY TAKN ........ ...... u.................NE. Coal (con 't.) (d) Restructure and priva- (d) By mid-1997.

tize remaining mines(estimated at 2-4 mines)

2. Closure of mines will Industry has reduced (a) Prepare strategy to miti- (a) By end-1995.reduce employment, staff from 11,000 to gate impact of expected

8,800. employment reductions(5,000-6,000).

(b) Social safety net in (b) By end-1995........ ....... W.place/available .

...... '.........

3. Safety and environmental (a) Prepare specific regula- (a) By end-1995.standards are inadequate. tions for the coal indus-

try; this could be done asfollow-up on work ongeneral mining law.

......... ................................. (b) Enacti regulations. 2(b)nymid-1996.

.............. ,

4. Government should Coal trade and pricing (a) Prepare program to (a) By end-1995.not be involved in coal liberalized. privatize Kyrgyztopsnab.trading.

(b) Implement program. (b) By mid-1996.

E. Ups tream Petroleum 1. As Government should Draft petroleum law, (a) Approval by Parliament (a) By end-1995.not be involved in high model contract and of petroleum lawrisk petroleum explora- fiscal regime are being and model contract.lion, create appropriate prepared (Norwegianlegal and fiscal frame- Trust Fund).work to attract privatesector.

: .: s - .... .... .. :: :: :::: :: :Es -:~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~. .. . .. .SuBScmTWAnAi ..ISuSAClN .S..LEAWn .. mctflMF. Upstream Petroleum (b) Review of petroleum (b) By end-1995.(con 't) taxation regime and

codification of taxrules (NorwegianTrust Fund).

. -......... .....-- *-...... ..... *... . ** . * * - -. ~ ** ..

2. Formulate and promote Some acreage tendered (a) Assess existing data and (a) By end-1995.exploration strategy for exploration but no undertake review of

concrete results to date. exploration andenhanced oil recoveryprospects (JapaneseTrust Fund).

(b) Prepare exploration (b) By end-1996.promotion strategyand data packages.

(c) Award selected (c) Beginning in 1997.acreage for explorationto international oil

.~::::::::::~:~:: companies. .

.... '...'...... . ...................... . .................. . ... '...~ ~ ~~~~~~~~~~......................................... .... . ~~~~~~......... ............. ...

3. Clarify the institutional (a) Set-up Kyrgyzneft as (a) By mid-1996.framework and restruc- state oil companyture Kyrgyzneft and and separate/privatizeGoskomgeologia. its drilling unit.

(b) Prepare program to re- (b) By end-1996.structure Goskomgeo-logia as geologicalsurvey.

n:\ec3iv\so\iatrxgm.cvr

4/13/95 10:ooAM (c) Implement Goskomgeo- (c) By mid-1997..____________________ _____________ __ logia restructuring.

Attachment 2Page 1 of 1

PRIORITY INVESTMENTS

POWER ANm) DIsTIcT HEATING

1. rehabilitation, upgrading and extension of the power transmission and distribution systems;feasibility study/master plan under execution and expected output by end May 1995;

2. rehabilitation and upgrading of the district heating networks in Bishkek and Osh; feasibilitystudy under execution and expected output by end May 1995;

3. retrofitting of the Bishkek thermal power station; feasibility study underway and out putexpected, by end May 1995;

4. completing the construction of Tashkurnir (450 MW) and Shamaldisai (240 MW) hydroplants;

5. overhaul and retrofitting of the hydropower stations of Utchurgan (180 MW) and AtBashi (40 MW);

6. upgrading the telecommunications and control systems;

7. completing the construction of Kambarata-2 (250 MW), subject to a long-term agreementfor power exports;

8. completing the 220-kV transmission line to China, subject to a long-term power salesagreement;

UPSTREAM OIL AND GAS

restoration of idle wells to production and enhanced recovery measures in existing wellsby Kyrgyzneft and foreign oil companies on production sharing contracts.

NATURAL GAS

1. installation of metering at the border, SCADA systems and consumer metering;

2. completing the natural gas pipeline under construction with Kazakhstan, andrehabilitation of the existing pipeline.

l

Attachment 3Page 1 of 3

PRIORITY TECHNICAL ASSISTANCE ACTIONS

POWER AND DISTRICT HEATING

1. further to completion of preparation of the Energy/Electricity Law (currentlyunderway with support from EU-TACIS), setting up of a regulatory agency forthe power and heat sector (and gas sector), including initial operational support,training of staff, and drafting essential regulations;

2. organization and management systems for KNEHC, including commercialization,corporatization, and restructuring of the utility and preparation for itsprivatization;

3. determination of tariff structures and levels for electricity and heat reflecting thecost of supply to various customer categories, and financial constraints ofKNEHC;

4. introduction of costing, budgeting and control systems; introduction of billing,collections and customer management systems;

5. introduction of modem system planning tools in KNEHC for generation,transmission and distribution; review of current practices, standards and designcriteria; training and transfer of skills to staff, and

6. assistance in pricing and negotiation of long-term power export agreements.

NATURAL GAS

1. drawing up a legal framework for the gas sector and setting up jointly with thepower sector a regulatory agency; and

2. determination of an appropriate tariff structure for natural gas, taking intoaccount the cost of supply to various customer categories and financialconstraints of Kyrgyzgas;

3. introduction of costing, budgeting and control systems for Kyrgyzgas;introduction of metering, billing, collections, and customer management systems;

4. restructuring and commercialization of Kyrgyzgas, including separation andprivatization of LPG operations;

Attachment 3Page 2 of 3

5. technical audits of the existing gas transport and distribution network to assess itspresent condition and determine the need for a minimum investment program tosafeguard the system; and

6. definition of a long-term supply strategy (including market surveys andassessment of demand for natural gas at different price levels), and assistance innegotiation of long-term supply agreements.

UPSTREAM PETROLEUM

1. preparation of data packages and carrying out promotion of prospective basinsand enhanced oil recovery prospects; and

2. restructuring of Goskomgeologia as a geological survey for the country;reorganization of Kyrgyzneft as a state oil company, including eventual separationand privatization of its drilling unit.

PETROLEUM PRODUCTS DISTRIBUTION

1. plan for privatization of the depots and facilities of Kyrgyzmunaizat, with a viewto ensuring a competitive market for petroleum products and LPG (currentlybeing handled by Kyrgygas) throughout the republics; and

2. regulations for distribution of petroleum products, concerning productspecifications, safety and environmental aspects, and mode of operation ofcompanies in the sector, including common carriers.

COAL

1. market study to define quantitatively the potential market for Kyrgyz coal through2010, both in the domestic market (especially new markets for specification coalsand briquetted coals), and export markets.

2. detailed plans for the safe closure of non viable mines including the environmentalreclamation of the mining sites; detailed plans for the privatization of the viablemines; setting up of a social safety net for the coal industry workers and theirfamilies.

3 drafting the necessary requirements for safety and environmental protection rulesfor the coal industry, including the reclamation of the mining sites.

Attachment 3Page 3 of 3

ENERGY SECTOR MANAGEMENT

I. preparation of background papers on estimates of benefit-sharing arrangementsfor intra-regional energy trade and examples of inter-country contractualagreements used elsewhere in the world in view of the preparation of a regionalconference to discuss trade and water sharing issues.

2. assistance in setting up an energy cell with formulation of energy policies,assessing options for regulatory control and establishing a regulatory agency.

MAP SECTION

i

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5lff s f to -~ J* : L ANNE S E XISIIN G HY DRO G R EA T ER TH A N 100 0 m OIL D E POS I T S

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|- NTTENATIONAI EOUNDA..E5

LARCH 7SS

IMAGING

Report Ncl: 14036 KGType: SP