Report No: ACS13855 . Republic of Moldova District Heating and Electricity Tariff and Affordability Analysis October 26, 2015 1 District Heating and Electricity Tariff and Affordability Analysis FINAL World Bank October 2015 Foreword This study was financed by Energy Sector Management Assistance Program (ESMAP) and conducted by a team lead by the World Bank Energy and Extractives Global Practice, with team members drawn from Poverty Global Practice and Social Protection and Labor Global Practice. The objective of the study is to: 1. Assess the adequacy of the existing heat and electricity tariff levels for achieving financial viability of the energy sector operators 2. Analyze the distributional implications of energy tariff increases 3. Assess the effectiveness of the existing social assistance programs and how to adjust them to mitigate the impact of energy tariff increase on the poor This report presents the key findings and recommendations for the government of Moldova as well as other energy sector stakeholders. The report starts with a synopsis that summarizes the key findings and recommendations. The main report section starts with an introduction to country context, presents the design of tariff setting methodologies and assesses the adequacy of tariffs based on constructed scenarios. Thereafter analysis of the distributional impact of projected range of tariff increases and the need to adjust the social assistance programs to mitigate the impact on the poor are presented. The report concludes with recommendations for the government on actions to be implemented on tariff setting methodologies and social assistance as well as areas for further research. Appendices include further background information of the analysis. 3 Synopsis Moldova is dependent on energy imports and is vulnerable to supply and price shocks. The current regulatory system is well structured, but implementation is lagging. Nominal energy tariffs have not been adjusted since 2012 due to delay in regulatory actions by the regulator, ANRE. On July 18, 2015, ANRE decided on new electricity and gas tariffs, but the implementation of tariff adjustment has been suspended for 60 days. During this time, companies are required to conduct an audit to inspect the justification to raise consumer tariffs. Since the 2012 adjustment, costs have risen continuously and energy tariffs have fallen short of cost recovery, which has had a negative impact on the financial status of the sector. The currently suspended tariff changes are based on current electricity import tariff and the MDL exchange rate. ANRE decided on increasing the end-user electricity tariff by 37% for RED Union Fenosa, 30% for RED Nord and 35% for RED Nord-Vest. No decisions on adjusting district heating as well as heat and power generation tariffs have been made. The suspended tariff adjustments do not aim to cover past deviation caused by lagging tariff increases. ANRE will evaluate the deviations and may change tariffs accordingly in the future. Net profit margin of energy sector operators* *The profit reported by Union Fenosa is based on an 20% assumed revenue calculated 10% based on tariffs according to regulation, but not approved 0% by ANRE. Deducting the -10% 2010 2011 2012 2013 2014 annually accumulated -20% receivables results in a net profit margin shown as “Union -30% Fenosa, approved tariffâ€? -40% 2014 data not available for Union Fenosa Union Fenosa, approved tariff Moldelectrica CHP-2 CHP-1 Termocom Termocom and Union Fenosa 4 Synopsis Scenario analysis conducted in this study estimates the future range of electricity and heat tariffs by constructing a low and a high scenario based on parameters influencing the end- user tariffs. The analysis takes into account among other factors the electricity and gas tariffs decided upon by ANRE in July 18, 2015. A new heat tariff has not been decided upon. Based on the analysis, the cumulative electricity tariff increase is estimated to range between 42-61 % from 2014 to 2016 and 73-113% from 2014 to 2020. The range of cumulative heat tariff increase is estimated to be 21-80% by 2016 and 30-78% by 2020. The consumer gas tariff increase is assumed to be 25% by 2016 based on the tariff decided upon by ANRE in July 18, 2015 and the analysis assumes a cumulative increase of 50% by 2020. Electricity supply tariff, RED Union Fenosa Heat supply tariff 350 323 1900 1773 300 245 1700 1759 250 263 1500 bani/kWh MDL/Gcal 200 1300 216 1286 150 1100 1211 100 152 152 987 900 50 700 0 500 2013 2014 2015 2016 2017 2018 2019 2020 2012 2013 2014 2015 2016 2017 2018 2019 2020 Tariff approved Low scenario High scenario Tariff Approved Low scenario High scenario 5 Synopsis The Household Survey Data (2013) indicates that 80% of Moldova’s population may be considered to be in “Energy Povertyâ€?, meaning they spend more than 10% of their budgets on energy bills. On average, energy expenditure is 17% of the total, which is high compared to other countries in the region. The estimated range of energy tariff increases would increase the average share of energy costs in total expenditures to 18–20% in 2016 and with projected economic growth, the share would decrease to 17-18% in 2020. The impact on poverty is highest among the groups that already have a high poverty rate: women living alone and rural population, because of their high vulnerability to electricity tariffs. However, overall impact on poverty will be moderate.* Within the estimated range of energy tariff increases, the poverty rate is expected to increase moderately. In 2016, poverty rate would increase by 1.1-1.9 percentage points compared to a baseline and in 2020 by 1-1.5 percentage points. Simulated poverty share (%) 25.0% Proportion of the population 20.0% 15.0% 10.0% 5.0% 0.0% Total Chisinau Other urban Rural Central Heating Gas central Nat. Gas stove Wood or coal area system stove Baseline 2016 Low 2016 High 2016 *These simulations incorporate the World Bank projections for economic growth: 6 Annual average private consumption growth 0.6% by 2016 and 2.3% by 2020. Synopsis The projected poverty impacts of higher tariffs would increase the need for social assistance. The national level social assistance programs, Ajutor Social and Heating Allowance, are generally well targeted, but the programs could be improved to increase uptake and provide more support to poorest population. To ensure adequacy of social assistance, the threshold and benefit size of the programs should be adjusted in line with the increasing energy costs, which will have fiscal implications. Adjusting social assistance in line with the estimated energy cost increases, would increase social program share of government budget from 0.5% of GDP to 1.9-2.2% in 2016 and 1.3-1.7% in 2020 assuming that all eligible people apply for assistance. In case the take-up remains at the same level, social program share of GDP would increase to 0.7-0.8% in 2016 and decrease to 0.5-0.6% in 2020. Fiscal impact of social assistance 2.5% 2.0% % of GDP 1.5% 1.0% 0.5% 0.0% 2016 2020 AS+HA budget, current take-up, low scenario AS+HA budget, perfect take-up, low scenario AS+HA budget, current take-up, high scenario AS+HA budget, perfect take-up, high scenario 7 Synopsis Conclusions: Under the current situation, the security of energy supply and the sustainable development of the sector are jeopardized due to the risk of service disruptions and the lack of capital for needed investments in the infrastructure. The delay in regulatory actions has led to loss of confidence and credibility in the institution and process of the tariff setting regime. Restoring confidence in the system is urgently needed to provide for an investment climate that would attract the badly needed capital to Moldova. The Government needs to urgently take action to ensure the financial viability of the energy sector, such as pass through mechanism for fuel costs and forex volatility. The impact of the needed tariff increase on poverty rate is expected to be moderate. However, the Government should plan and budget to mitigate the impact of tariff increase on the most vulnerable population by adjusting the targeted social assistance programs, Ajutor Social and Heating Allowance, and by increasing the take-up among poorest population. To accommodate increased fiscal cost of targeted social assistance, the Government is recommended to consolidate other categorical benefits. Recommendations: • Consider introduction of automatic pass through mechanism for fuel and electricity costs and other measures to ensure timely tariff adjustment. • For the recovery of past deviation, consider an approach to adjust tariffs over multiple year period in agreement with regulated companies to limit impact of tariff increase on the vulnerable. • Improve targeted coverage of the social assistance for the poor, adjust threshold and benefit size to be in line with increasing energy costs, and improve targeting to control the fiscal impact of increased need. • Design a plan to communicate about the planned tariff adjustments, their reasons and available social assistance. • Develop detailed approach to how the above may be implemented. 8 Outline • Introduction • Design of heat and electricity tariff setting methodologies • Tariff adequacy and forecast of tariffs • Distributional impacts of tariff adjustments • Social protection • Conclusions • Recommendations for government • Appendices • Appendix 1 – Detailed analysis of tariff setting methodologies • Appendix 2 – Detailed scenario analysis and sensitivity analysis of heat and electricity tariffs • Appendix 3 – Recommendations on tariff methodology and implementation • Appendix 4 – Detailed analysis of relations of heating type and poverty • Appendix 5 – Detailed analysis and conclusions on social protection • Appendix 6 – Summary of scenario analysis 9 INTRODUCTION 10 Moldova is highly dependent on imported electricity and fuel Electricity generation and import in Moldova 5000 4500 4000 3500 3000 MWh 2500 2000 1500 1000 500 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Domestic electricity generation Electricity generation in Transnistria Electricity import In 2013: • 82 % of electricity was imported • 93 % of domestic electricity generation was based on imported fuel • 100 % of centralized heat production was based on imported fuel 11 The exchange rate is the main driver of recent electricity tariff increase and drives the need for heat tariff adjustment Natural gas price, Europe 600 500 - 26 % USD/ 1000 m3 400 300 Electricity supply tariff set for Union Fenosa 200 Heat supply tariff set 100 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 MDL/USD exchange rate Fuel and imported Request for natural 25 power are gas tariff update purchased in USD from MoldovaGaz 20 15 +33 % 10 Electricity supply tariff set for Union Fenosa 5 Need to raise electricity and heat Heat supply tariff set supply tariffs 0 1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014 1/1/2015 12 Fuel cost and the cost of imported electricity heavily influence the heat and electricity tariffs Heat Tariff Structure (Termocom), 2012 Electricity Tariff Structure (RED Nord), 2012 1% 0% 5% -2% 14% 7% 5% 8% 57% 13% 23% 69% Heat other sources Own heat Electricity costs Capital costs Operating costs Cost of capital Operating costs Profit Deviation Other costs Transmission Deviations 13 From 2007 to 2012, nominal electricity and heat tariffs have increased significantly due to periodic adjustments Heat Tariff 1200 No new heat 987 987 987 987 987 1000 821 898 tariffs have 800 719 719 719 719 been set after 719 716 580 600 512 456 529 2011 390 588 323 588 588 588 400 500 588 423 410 376 200 241 289 0 16.02.2007 19.01.2008 01.08.2008 19.01.2010 18.05.2010 01.02.2011 28.10.2011 2012 2013 2014 2015 CHP-2 CHP-1 Termocom Electricity tariff 250 223 200 168 168 154 216 143 150 120 152 108 133 144 152 Electricity tariff 100 78 78 78 78 101 110 65 68 72 80 98 increase 50 96 50 70 70 70 70 70 decided upon 57 65 63 24 25.5 42 50 in July 2015 0 No new electricity tariffs has been have been set after 2012* suspended for 60 days RED Union Fenosa RedNord, Nord Vest 14 The Energy Poverty rate is high in Moldova 100% 90% 80% Percentage of the population 70% 60% 50% 40% 30% 20% 10% 0% Poverty Energy Poverty By residence area By region By Type of heating Data source: HBS 2013 “Energy Povertyâ€? is defined as: More than 10% of total household expenditures devoted to energy (heat, electricity, gas, wood, coal) 15 Well-targeted social protection measures can play an important role also in improving energy affordability • Targeting of social protection improved in Moldova in 2009 • However, most social assistance benefits are provided to certain groups of beneficiaries regardless of their welfare. • Since 2009, the country has launched two cash transfers targeting the poor and has eliminated a few inefficient categorical benefits. • This resulted in declined spending from 2.6% of GDP to 1.6% and more pro-poor benefits distribution. • However, after 2012, some policies were reversed • Targeted benefits were reduced and categorical transfers were boosted • There is need to improve the existing social protection schemes • The targeted transfers need to be expanded to offer a safety net to the poorest households and cushion income shocks, including those stemming form higher energy costs. 16 DESIGN OF HEAT AND ELECTRICITY TARIFF SETTING METHODOLOGIES 17 Moldova has established regulatory structures and aims to implement the core EU energy legislation National regulatory structures • Ministry of Economy is responsible for energy sector policies and legislation • The National Agency for Energy Regulation (ANRE) is an independent organization responsible for setting energy tariffs Most important sector laws • Law on Electricity, December 23, 2009 • Energy Sector Law No. 1525-XIII of February 19, 1998 (amended February 27, 2003) • Law on heat and promotion of cogeneration, No. 92 of May 29, 2014 Moldova is a member of the Energy Community and is therefore committed to implementing the core EU legislation in electricity, gas, environment, competition, renewable energy, energy efficiency, oil and statistics 18 Energy sector has been unbundled and tariffs are set for each company by ANRE Tariff for heat Electricity and Tariff for heat sold Heat generation Heat supply to users heat generation consumers CHP-1 Termocom CHP-2 Termogaz-Balti CHP-Nord CHP-Nord Hidrocentrala Costesti Tariff for electricity generation Electricity import Tariff not regulated Tariff for electricity Electricity Tariff for electricity sold to users, Electricity transmission Electricity supply distribution grid transmission* consumers Moldelectrica Tariff for electricity RED Nord sold to users, RED Nord-Vest transmission grid entry RED Union Fenosa Electricity Tariff for electricity distribution distribution** RED Nord Tariff for electricity *Separate tariffs for transmission to domestic users and cross-border transfer RED Nord-Vest sold to users, RED Union transmission grid exit **Separate tariffs for high (35-110 kV), medium (6-10 kV) and low voltage Fenosa (≤0.4 kV) grids 19 Tariffs are set based on specific regulations Tariff for heat Electricity and Tariff for heat sold Heat generation Heat supply to users heat generation consumers CHP-1 Termocom CHP-2 Methodology for Generation Termogaz-Balti Methodology for Tariffs of Electricity and Heat and CHP-Nord CHP-Nord on Heat Sold to Users on Feed Water Hidrocentrala (No. 147 of Aug 25, 2004) (No. 482 of Sep 6, 2012) Costesti Tariff for electricity generation Electricity import Methodology for Tariffs on Electricity Transmission Tariff not Services (No. 411 of April regulated 27, 2011) Tariff for electricity Electricity Tariff for electricity sold to users, Electricity transmission Electricity supply distribution grid transmission* consumers Moldelectrica Tariff for electricity RED Nord sold to users, RED Nord-Vest transmission grid entry RED Union Fenosa Electricity Tariff for electricity distribution Methodology for distribution** Electricity Distribution Service RED Nord Tariff for electricity Tariffs and Regulated Electricity *Separate tariffs for transmission to domestic users and cross-border transfer RED Nord-Vest sold to users, Supply Tariffs RED Union transmission grid exit (No. 497 of December 20, 2012) **Separate tariffs for high (35-110 kV), medium (6-10 kV) and low voltage Fenosa (≤0.4 kV) grids 20 Tariffs follow a rate-of-return methodology • General principle of tariff the setting methodology is defined below. More details of the tariff setting is given in appendix 1. Deviation is the difference between the result of the Ü´Ý?݃‫ Ý?݉݋ܿ݊݅ Ý€Ý?Ý?݈ܽݑ‬േ Ý€Ý?‫ݎܽÝ?Ý• Ý?Ý‘Ý‹Ý…Ý’Ý?ÝŽÝŒ ݉݋ݎ݂ ÝŠÝ‹Ý…Ý?ܽ݅ݒ‬ operator determined based on estimated parameters in ܶܽ‫ ݂݂݅ݎ‬ൌ tariff approval and the result based on actual values ܸ‫Ý?Ü¿Ý…Ý’ÝŽÝ?Ý? Ý‚Ý‹ Ý?݉ݑ݈݋‬ during a year. If preliminarily estimated parameters change and the tariff is not adjusted during the year, this results in a deviation. The positive or negative deviation is included in the following year’s tariff. Ü´Ý?݃‫ Ý?݉݋ܿ݊݅ Ý€Ý?Ý?݈ܽݑ‬ൌ ܶ‫ Ý?Ý?Ý?Ý‹Ü¿ Ý€Ý?Ý?݈ܽݑ݃Ý?ÝŽ ݈ܽÝ?݋‬൅ Ü´Ý?݃‫Ý?Ý…Ý‚Ý‹ÝŽÝŒ Ý€Ý?Ý?݈ܽݑ‬ Total regulated costs include operating costs, working capital costs and depreciation. Other operators Electricity supply Ü´Ý?݃‫ Ý?Ý…Ý‚Ý‹ÝŽÝŒ Ý€Ý?Ý?݈ܽݑ‬ൌ Ü°Ý?‫݊ݎݑÝ?Ý?ÝŽ Ý‚Ý‹ Ý?Ý?ܴܽ Ý” Ý?Ý?Ý?Ý?Ý?ܽ Ý‚Ý‹ Ý?ݑ݈ܽݒ Ý?‬ Ü´Ý?݃‫ܧܴܰܣ ݕܾ ݕ݈݈ܽݑ݊݊ܽ Ý€Ý?ÝŠÝ…Ý‚Ý?Ý€ Ý?Ý…Ý‚Ý‹ÝŽÝŒ Ý€Ý?Ý?݈ܽݑ‬ 21 Main finding: Tariff regulation is based on global good practices, but further capital attraction is needed • Heat and power tariff setting has been mainly well defined and they are based on a global good practice, rate of return methodology • Electricity and heat generation tariff setting methodology is not as well defined and lacks a definition for a rate of return • Both heat and power sector have high investment needs in the future and therefore attraction of capital with a fair return is necessary • District heating and natural gas tariff revision should go in parallel, otherwise increasing the heat tariff may lead to disconnections from district heating system 22 TARIFF ADEQUACY AND FORECAST OF TARIFFS 23 While tariffs have remained unchanged in 2012–2014, the utilities’ costs have increased* Moldelectrica RED Nord RED Union Fenosa 18 200 16 Approved 180 200 Approved 2012 160 2012 14 140 12 150 bani/kWh bani/kWh Approved 120 10 2012 100 8 100 bani/kWh 80 6 60 4 50 40 2 20 0 0 0 2012 appr. 2012 2013 2014 2012 2012 act. 2013 act. 2014 act. 2013 appr. 2013 act. 2014 act. appr. Electricity costs Transmission costs Capital costs Operating costs Return Deviation Electricity costs Capital costs Operating costs Distribution costs Operating costs Other costs Transmission Deviations Deviations Heat Tariff (CET-2) Termocom 700 Approved 1600 2012 600 1400 1200 Approved 500 2012 1000 MDL/Gcal MDL/Gcal 400 800 300 600 200 400 100 200 0 0 2012 appr. 2012 act. 2013 act. 2014 act. 2012 appr. 2012 act. 2013 act. 2014 act. *Based on the costs Fuel Operating costs Return on assets Deviation Heat other sources Own heat Cost of capital provided by the companies Operating costs Rate of return Deviation 24 The financial status of the sector has been deteriorating CHP-2 Moldelectrica 20% 20% 10% 10% 0% 0% 2010 2011 2012 2013 2014 2010 2011 2012 2013 2014 -10% -10% -20% -20% -30% -30% -40% -40% CHP-1 Union Fenosa 0.2 20% 0.1 10% 0 0% 2010 2011 2012 2013 2014 2010 2011 2012 2013 2014* -0.1 -10% -0.2 -20% -0.3 -30% -0.4 -40% *Forecast Termocom* Operating profit margin 20% Net profit margin 10% Return on total equity Operating profit margin based on approved tariff 0% 2010 2011 2012 2013 2014 -10% -20% -30% -40% *Termocom – negative equity 25 All operators have accumulated either short or long term debt – debt levels vary substantially CHP-2 Moldelectrica 1,600,000,000 50% 250,000,000 12% 1,400,000,000 10% 40% 200,000,000 1,200,000,000 1,000,000,000 8% 30% 150,000,000 MDL MDL 800,000,000 6% 600,000,000 20% 100,000,000 4% 400,000,000 10% 50,000,000 2% 200,000,000 0 0% 0 0% 2010 2011 2012 2013 2014* 2010 2011 2012 2013 2014* CHP-1 Union Fenosa 500,000,000 50% 500,000,000 16% 14% 400,000,000 40% 400,000,000 12% 300,000,000 30% 300,000,000 10% MDL MDL 8% 200,000,000 20% 200,000,000 6% 100,000,000 10% 4% 100,000,000 2% 0 0% 2010 2011 2012 2013 2014* 0 0% 2010 2011 2012 2013 2014* Termocom Short term debt end of year Long term debt end of year 2,500,000,000 140% 120% Short term debt/ total equity and debt 2,000,000,000 100% Long term debt/ total equity and debt 1,500,000,000 80% MDL 1,000,000,000 60% 40% 500,000,000 20% 0 0% 26 2010 2011 2012 2013 2014* The estimation of future tariffs is based on scenario analysis • Scenario analysis aims to present potential future development of the tariffs • The scenarios are not presented to indicate what the tariff level should be in the future, but projections based on the implementation of current tariff setting methodologies used in Moldova. • The baseline assumption used for the analysis is that current tariff methodology is fully complied with (see information on next slide) • Scenarios constructed and the projected consumer tariffs are presented in the following slides • Macroeconomic and sector specific common assumptions of the scenario analysis and detailed projections of tariffs are presented in Appendix 2 27 The baseline of the scenario analysis are the previously approved methodologies • Although the new methodologies for tariff setting have been approved in 2012, no tariffs have been set based on them for: • Heat supply • Tariffs used as a starting point are: • Heat generation– Oct 2011 • Heat supply – Oct 2011 (old methodology) • Electricity generation in CHP – Oct 2011 • Electricity distribution and supply – July 2015 (implementation suspended) – RED Union Fenosa: increased from 158 to 216 bani/kWh – RED Nord: increased from 171 to 223 bani/kWh – RED Nord Vest: increased from 173 to 233 bani/kWh • Electricity transmission – July 2015 – Moldelectrica: increased from 8.02 bani/kWh to 14.5 bani/kWh • CHP gas tariff – July 2015 (implementation suspended) – Moldovagaz: increased from 5237 to 6028 MDL/tcm • Some companies are requesting revaluation of assets for regulatory purposes, which would lead to increased depreciation and assets remuneration. The analysis includes no impact of revaluation in the low scenario and includes the impact in full in the high scenario. 28 The constructed scenarios project a range of potential tariff levels • Low scenario • Based on July tariff adjustment • Tariffs as decided by ANRE on July 18, 2015 and assumed inflation thereafter • Heat tariff based on gas tariff as decided on July 18, 2015 • High scenario • Based on estimated maximum tariff • Estimated high value of commodity prices, exchange rate, other operating costs and investments • Past deviation divided to 2015-2019 tariffs • Revaluation impact included in full Commodity prices, Other operating Deviation from past Revaluation of Scenario Investments exchange rate costs years assets Electricity: Tariff as of July 18, 2015 Low scenario Heat: Gas tariff as Heat: As approved Heat: BAU Heat: 0 Heat: 0% of July 18, 2015 in 2011 (annual average) Transmission line: Split to 2015-2019, Actuals of 2014 2019-2020, High scenario Passed through revaluation part 100% +indices DH rehabilitation: included 2017-2022 29 Based on High Scenario, nominal end user electricity tariff could be twice as high in 2020 compared to 2014 RED Union Fenosa nominal end user electricity tariff 350 323 End user electricity tariff includes generation, 300 transmission, distribution and supply of electricity 245 250 263 200 216 bani/kWh 150 High scenario – all deviation 152 included in 2015-2019 152 100 Total deviation from 50 2012-2014 is MDL 890 million 0 2013 2014 2015 2016 2017 2018 2019 2020 Tariff approved Low scenario High scenario 30 Based on High Scenario, nominal end user heat tariff could be 80 % higher in 2020 compared to 2014 Termoelectrica* nominal end user heat tariff 1900 1773 1759 1700 1500 1300 1286 MDL/Gcal 1211 1100 987 900 End user heat tariff includes generation and distribution of heat. 700 500 2012 2013 2014 2015 2016 2017 2018 2019 2020 Tariff Approved Low scenario High scenario * established by the merger by absorption of the CHP-1 into CHP-2 31 and purchase of operational assets of Termocom by CHP-2 Movement in the exchange rate is the main driver of the estimated electricity tariff adjustments RED Union Fenosa – Estimated electricity tariff development based on High Scenario 350 300 2015 tariff 250 suggested by ANRE bani/kWh 200 Electricity import 150 cost increase due to currency devaluation 100 50 0 2013 appr. 2014 act. 2015 2016 2017 2018 2019 2020 -50 Electricity costs Transmission costs Distribution costs Operating costs Deviations 32 Gas price and movements in the exchange rate are the main drivers of the estimated heat tariff adjustments Termoelectrica – Estimated heat tariff development based on High Scenario 2000 1800 1600 1400 1200 Fuel cost increase due to currency MDL/Gcal 1000 devaluation and requested natural 800 gas tariff increase from MoldovaGaz 600 400 200 0 2012 appr. 2014 act. 2015 2016 2017 2018 2019 2020 Termocom heat, fuel costs Heat other sources, fuel costs Termocom heat, other costs Heat other sources, other costs Cost of capital Operating costs Profit Deviation 33 Main finding: The energy sector has not been financially sustainable – further tariff increases are projected • Financial status of companies has been deteriorating: • All companies analyzed, except for Union Fenosa, made a loss in 2013-2014. • Union Fenosa has accumulated a significant amount of receivables, based on an assumed revenue calculated based on tariffs according to regulation, but not approved by ANRE. The reported profit of the company is misleading and the situation is leading to cash flow issues for the company. • Unsustainable status of the sector creates significant risks • In short to mid term, there is a risk for disruption of service due to inability to pay for bulk energy imports and for requiring a financial bail out • In long term, the sector operators cannot attract investments to expand and refurbish the infrastructure • Tariff adjustment for electricity transmission and supply proposed by ANRE in July 2015 will improve the situation, but does not lead to financially sustainable situation. • Heat end user tariff needs to be adjusted to reflect current cost levels. • Significant accumulated losses in 2012-2015 for the companies may require additional tariff increases. • The study estimates the minimum and maximum increases in the energy tariffs to range between a low and a high scenario (see table below). • The impact of the scenarios on population and on social assistance is analyzed in the following sections. Estimated range of nominal tariff increase* Low scenario High scenario 2014 2016 2020 2016 2020 Heat tariff projection (MDL/Gcal) 987 1,211 1,286 1,773 1,759 Heat tariff projection (USD/Gcal) 71 65 63 96 86 Electricity tariff projection (bani/kWh) 152 216 263 245 323 Electricity tariff projection (cents/kWh) 11 12 13 13 16 *Further scenarios presenting the impact of specific parameters are presented in appendix 1. 34 Recommendations to be considered on improving the tariff adjustment process • Delay in ANRE’s actions has led to significant financial impact and accumulation of regulatory deviation/losses. The following revisions to the tariff setting methodology may be considered: • An automatic pass through of costs for fuel and imported electricity to avoid repetition of a similar situation. Good examples of implementation include Kenya (electricity), India (fuels), and Indonesia (fuels). • To avoid a big one time increase, it is recommended to negotiate with the sector operators on dividing the inclusion of past deviation to the tariffs over a longer time period. Sector operators could be compensated for the delay. • Prior to beginning of the next regulatory periods in 2016-17, the tariffs including the base costs will be set again. A firm deadline for completing the review and setting the tariffs prior to the beginning of the new regulatory period should be set. To allow time for the regulatory review, the operators may be required to send their tariff applications e.g. one year in advance. • Credibility of the regulatory framework and the regulator need to be restored rapidly. The current perception of lack of credibility and transparency that is voiced in the market increases the risk of service disruptions in the short and medium term, while discouraging capital investment in the energy infrastructure. • Regulatory methodology for determining the regulated assets base value, depreciation and rate of return for investments need to be reviewed for clarity and consistency. Clear and credible rules can not only attract investments, but lower WACC, which leads to increased efficiency and cost reduction which can lower energy costs for the end consumers. • Transfer to valuation of asset base and rate of return in real terms may contribute to moderate the sudden increase in tariffs caused by investments. • Promote increase in operational efficiency of the operators without compromising service quality by providing incentives for operating cost reduction. Having a communication strategy on efficiency gains and service quality improvement by operators may help increase the willingness to pay. 35 DISTRIBUTIONAL IMPACTS OF TARIFF ADJUSTMENTS 36 On average, energy already represents 17% of total expenditures for Moldovan households • The poorest households in Moldova spend on average 21% of total expenditures on energy • The spending pattern for energy or “energy mixâ€? is very heterogeneous, with urban households spending 15% on utilities (central heating, gas and electricity) while rural households spend more on solid fuel (wood and coal) • Energy consumption is highly seasonal with central heating and gas expenditures twice the annual average during the first quarter. • The share of household resources spent on electricity remains rather constant across the year as few households rely on electricity for heating. • Wood is often purchased ahead of the heating season, during the 3rd quarter. Average Energy Expenditures by Residence and by Current Energy Expenditures by Quintile of Total Expenditures, Moldova 2013 Quarter, Moldova 2013 25% Share of total expenditure 25% Share of total expenditure 20% 20% 15% 15% 10% 10% 5% 5% 0% 0% All Chisinau Other rural Quintile Quintile Quintile Quintile Quintile Quarter 1 Quarter 2 Quarter 3 Quarter 4 urban 1 2 3 4 5 areas Residence area Quintile of total HH expenditures Central share Electricity share Gas share Central share Electricity share Gas share LPG share Wood share Coal share LPG share Wood share Coal share The regionally comparable share of energy expenditure in Moldova was 15% in 2013. This is high compared to some other countries in the region: Armenia 12%, Kyrgyz 37 Republic 10%, Kazakhstan 8%, Kosovo 7%. Heating sources vary by residence area and income group Central Heating is only available in urban areas, and is the main heating source among most households in the capital city (72% in Chisinau and 57% in Balti), except the poorest category. Gas use for heating increases with wealth, especially in urban areas outside Chisinau; there is also a slight income gradient in rural areas. Wood is the main heating source in rural areas but also for urban poor, outside Chisinau*. Using electricity for heating is rare. Heating type, by quintile of ae expenditures and residence area, Moldova 2013 100% Percentage of households 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Quintile Quintile Quintile Quintile Quintile Quintile Quintile Quintile Quintile Quintile Quintile Quintile Quintile Quintile Quintile 1 2 3 4 5 1 2 3 4 5 1 2 3 4 5 Chisinau Other Urban Rural Central Heating Gas central system Nat. Gas stove Wood or coal stove Electric heaters No Heating * Poorest category is too small to be significant in Chisinau 38 Energy affordability is an issue for most households Most households in Moldova spend on average more than 10 % of their total expenditures on energy and 80% of the population is deemed energy poor according to this usual affordability threshold. Rural households and wood stove users represent the most vulnerable categories, as 19% and 18% of the population respectively in these category are poor (compared to 12.7% nationally) Poverty and Energy Poverty rates, Moldova 2013 100% Percentage of the population 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% All Chisinau other urban rural Central Gas central Nat gas Wood or Electric areaa Heating system stove coal stove heaters By residence area By Type of heating Poverty Energy poverty Data source: HBS 2013 39 Energy affordability is an issue particularly for vulnerable female headed households Women living alone spend on average 22% of their total expenditures on energy. They are mainly widows (63 years old in average). In addition, even though women living alone with kids (either divorced or widows) spend the same share of their budget on energy as the rest of the population, they are poorer (15.7% of them live under the poverty line) and thus more vulnerable to tariff increase. These vulnerable groups of households with women living alone and women living alone with kids represent respectively 21 % and 6% of the households. Average Energy expenditure shares, by type of Poverty and Energy Poverty rates, by type of household, Moldova 2013 household, Moldova 2013 Share of total expenditure 100% Percentage of the population 25.0% 90% 20.0% 80% 70% 15.0% 60% 50% 10.0% 40% 30% 5.0% 20% 10% 0.0% 0% woman alone woman alone with married female male headed HH woman alone woman alone with married female male headed HH kids headed kids headed Type of households Type of household Central share Electricity share Gas share LPG share Wood share Coal share Poverty Energy poverty 40 Scenario analysis of the distributional impact of energy tariff increases Based on the scenario analysis of heat and electricity tariffs, the poverty impact of low and high scenarios was simulated. In addition, the analysis takes into account the gas tariff set by ANRE in July 2015 and its forecast increase. Assumed tariff increases Low scenario High scenario 2014 2016 2020 2016 2020 Heat tariff (MDL/Gcal) and increase 987 21% 30% 80% 78% compared to 2014 (%) Electricity tariff (bani/kWh) and increase 152 42% 73% 61% 113% compared to 2014 (%) Average consumer gas tariff (MDL/tcm) and 6096 25% 47% 25% 47% increase compared to 2014 (%) Inflation compared to 2014 (%) - 16% 47% 16% 47% Methodology for the assessment of the impact of the energy tariff increase : The increase in energy shares and poverty are calculated compared to baseline scenarios in a two-step approach: 1. 2016 and 2020 baselines are constructed using HBS 2013 households expenditures, and assuming a uniform economic growth according to World Bank estimates. The baseline scenarios assume that gas, heat and electricity tariffs remain at 2014 levels. 2. Low and high scenarios are based on the estimated range of energy tariff increase and the difference in expenditures is measured for each year compared to the baseline*. *World Bank estimate for average annual private consumption growth is 0.6% in 2014-16 41 and 2.6% in 2014-20, see detailed methodology and assumptions in appendix 4 Energy tariff increase would increase poverty moderately Energy tariff reform is 80 Share of population below national poverty line (absolute poverty ratio) conducted in a context of 70 declining poverty in Moldova. 60 50 40 % 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: National Bureau of Statistics of the Republic of Moldova In 2016, the poverty impact would reach by 1.1 and 1.9 percentage points respectively for the low and the high tariff scenarios, compared to the baseline with no tariff increase. This means a total of 38 000 to 64 000 additional poor in 2016, with a higher increase in rural areas (up to 2.3 percentage points). In the long term, the poverty impacts remain contained because of the economic growth (1 to 1.6 % percentage point increase in 2020). If household incomes remain constant (without economic growth), the poverty impacts would be higher in 2020 (1.7 to 3 percentage point, which means up to 100,000 additional poor). Low scenario High scenario 2016 2020 2016 2020 Increase of the poverty rate +1.1% +1.0% +1.9% +1.6% compared to baseline (%-points) 42 Energy tariff increase would increase poverty especially among rural population, whose main fuel is wood Wood users are vulnerable to the electricity tariff increase, as a significant proportion of this category lives close to the poverty line. Poverty increase reaches 1.5 and 2.3 percentage points in 2016 for the low and high scenario respectively. As a consequence, the increase in poverty is higher in rural areas even if wood is the main heating source. Users of natural gas stoves are the most vulnerable to the gas tariff increase. For this group the increase in poverty reaches 2 and 3 percentage points for low and high scenario respectively (but note that this is a very limited category)*. Simulated poverty share (%) 25% Proportion of the population 20% 15% 10% 5% 0% Total Chisinau Other urban Rural Central Heating Gas central Nat. Gas stove Wood or coal area system stove Baseline 2016 Low 2016 High 2016 Baseline 2020 Low 2020 High 2020 Note that the poverty rates for 2016 and 2020 are simulations intended to capture only the impacts of tariff increases, by comparing the yearly baselines with the high and low scenarios. They do not represent World Bank poverty forecasts which would depend on a plurality of other factors not taken into consideration here. * Natural gas stove category too small for statistically significant 43 results, as they represent only 2% of the households nationally Energy tariff increase would increase the share of energy costs in total expenditures moderately Energy share would reach on average 18 to 20 percent of total expenditures in 2016 depending on the tariff increase scenario, thus would increase by 2.3 to 3.8 percentage point compared to the baseline scenario for the same year. Average energy expenditure share would reach 24% in 2016 for the poorest households for the high scenario. By 2020, the share would decrease to 17 and 18 percent respectively for the low and high tariff scenarios assuming World Bank projection for economic growth. This means respectively a 3 and 4.6 percentage point increase compared to the baseline. Low scenario High scenario 2016 2020 2016 2020 Energy share (%) 18.2% 16.7% 19.7% 18.3% Energy share increase compared to baseline (percentage point) 2.3% 3.0% 3.8% 4.6% Energy expenditure share of total expenditures 25% share of total expenditures 20% 15% 10% 5% 0% All Chisinau other rural Central Gas Nat. Gas Wood or Electric quintile 1 quintile 2 quintile 3 quintile 4 quintile 5 urban Heating central stove coal heaters areas system stove Residence Heating type Quintile of total expenditures Baselines Low scenario 2016 High scenario 2016 44 Vulnerable female headed households would be more impacted by the tariff increase The share of resources spent on energy would increase more for women living alone than for other types of households, and would reach 25% in 2016 for the high scenario, thus a 4 percentage point increase compared to the baseline. More women alone with kids would become poor because of the tariff increase (4 percentage point increase in 2020 for the high scenario), because this category of household lives closer to the poverty line and is vulnerable to price shocks. Simulated energy share, by household type Simulated poverty share, by household type Share of total expenditures (%) Proportion of the population 30.0% 20.0% 18.0% 25.0% 16.0% 20.0% 14.0% 12.0% 15.0% 10.0% 10.0% 8.0% 6.0% 5.0% 4.0% 2.0% 0.0% 0.0% woman alone woman alone married female male headed HH woman alone woman alone married female male headed HH with kids headed HH with kids headed HH Baselines Low scenario High scenario Baselines Low scenario High scenario Baselines Low scenario High scenario Baselines Low scenario High scenario 45 Main finding: Energy tariff increase would increase poverty and the share of energy costs moderately • Energy tariff increases would increase the share of energy costs in total expenditures on average to 18-20% in 2016 which is 2.3-3.8 percentage point above the baseline. • By 2020, assuming equal distribution of World Bank projection for economic growth, the energy share of total expenditures would decrease to 17-18%, which is 3-4.6 percentage points above the baseline. • The increase in the energy share caused by the raise in tariffs is highest for households that use gas for heating under the low scenario, while it is highest for district heating users under the high scenario. • In 2016, the poverty rate would increase by 1.1 percentage points in the low scenario and 1.9 percentage points in the high scenario compared to the baseline, due to increasing heat, electricity and gas tariffs. • In 2020, the increase in poverty rate ranges between 1-1.5 percentage points. Without economic growth, the increase would reach 3 percentage points. • The increase in poverty is highest among the population that already has a high poverty rate: rural population, women living alone and people who use wood or electricity for heating. 46 SOCIAL PROTECTION 47 Moldova has targeted social assistance programs that can help protect the poor from income and price shocks • Two targeted social assistance programs, Ajutor Social and Heating Allowance, channel effectively social assistance to poor households. • Since 2009, the government of Moldova has launched two targeted cash transfers, Ajutor Social (AS) and Heating Allowance (HA). The programs target the poor well: about 80% of the AS and over 50% of HA benefits go to poorest 20% of population. • The effective coverage of the programs remains modest: in 2014 AS covered 3% of total population and HA about 7%. With the current income thresholds the coverage of HA can potentially be increased to 30 %. • Effective coverage of the poorest quintile by AS benefits declined between 2012-14 from 19% to 12%. • Most social assistance benefits remain categorical, i.e. they are provided to certain groups of population (disabled, elderly, children) regardless of their welfare. • Categorical benefits accounted for 1% of GDP whereas AS and HA accounted for 0.6% of GDP in 2014. • The beneficiaries of AS and HA mostly reside in rural areas, which is consistent with the national poverty profile. • The municipal heating benefits in Chisinau and Balti are important to complement the national programs. 48 Key characteristics of social assistance programs • Ajutor Social (AS) – Uses the income and proxy-means test to identify the poor. – Benefit is provided during a year to fill out the gap between the household`s income and a Guaranteed Minimum Income (GMI) threshold set annually by the law. – There are about 51,000 beneficiary households but with a perfect take-up (all eligible households apply and receive benefits) there would be 128,000 beneficiary households. • Heating Allowance (HA) – Complements the AS to compensate the poor for increased cost of living during 5 months of heating season. – A flat monthly benefit of 250 MDL offered to all recipients of AS and to those households whose income is below 1.6 times the Guaranteed Minimum Income. – During 2014-15 heating season, there were 136,000 beneficiary households, but with a perfect take-up could cover 446,000 households. • Municipal heating benefits in Chisinau and Balti – Have higher income eligibility threshold than the HA program. – Average monthly benefit paid during five months in Chisinau for gas, wood and coal users is 450 MDL and for central heating users 285 MDL. Average monthly benefit in Balti during five months is 200 MDL. – Despite high potential coverage benefits take-up is low: in Chisinau of 189,000 HHs that could qualify for benefits only 33,000 HHs receive them. – Application is cumbersome: high transaction and opportunity cost may discourage the poor to apply. 49 How could social assistance respond to increasing energy tariffs? Effective coverage of targeted cash transfers must be expanded to offer a safety net to poor households and cushion price shocks, including those stemming from higher energy tariffs. The most efficient means to offset the increase of energy expenses for the poor households are the existing targeted social assistance programs: • Increasing electricity costs can be compensated through AS program • AS program benefits and most electricity expenses do not vary significantly throughout the year • Increasing district heating and gas costs can be compensated through HA program • HA program benefits are delivered during heating season when households are mainly impacted by increasing costs of district heating and gas • Improving the design, implementation and coordination of municipal heating benefits can further compensate increasing heating costs • This impact is not included in the analysis 50 Compensating increased energy costs – current impact • Increase in energy costs do not automatically result in higher benefit and increased coverage of social assistance, because the level of benefits and the number of eligible households is determined by the defined Guaranteed Minimum Income, GMI. • With increasing household income due to economic growth, the number of households receiving social assistance would decrease Social Assistance Benefits with constant GMI 2015 2016 2020 Income threshold for AS (MDL/month) 765 765 765 Number of HHs benefiting from AS 50,832 37,831 22,761 Number of HHs eligible for AS 127,826 95,131 57,237 Coverage by AS with current take-up (% of population) 4.3 3.2 2.1 Coverage by AS with perfect take-up (% of population) 10.8 8.2 5.4 Income threshold for HA (MDL/month) 1,224 1,224 1,224 Number of HHs benefiting from HA 136,466 101,474 47,640 Number of HHs eligible for HA 445,821 331,504 155,635 Coverage of HA with current take-up (% of population) 9.1 7.0 3.8 Coverage of HA with perfect take-up (% of population) 30.0 23.0 12.4 Source: Staff calculations based on HBS 51 Recommended adjustments to compensate energy cost increase The following adjustments are recommended to social assistance programs to compensate for higher energy costs: • Increase in eligibility threshold • The threshold for receiving AS (GMI) must be regularly revised to reflect increasing cost of living (including electricity cost). Likewise, the threshold for HA should be adjusted accordingly at 1.6xGMI. • The change in GMI should reflect increasing energy costs as part of overall increase in cost of living (inflation). • Increase in social assistance benefits per household • The AS benefit size adjusts automatically with GMI growth as it fills the gap between the actual household income and GMI. • The HA benefit size should be revised in line with average increase in monthly heating cost per household during heating season. 52 The fiscal impact of recommended adjustments to social assistance The fiscal impact of increasing social assistance has been estimated based on the following assumptions: • Income thresholds and benefit size of AS and HA programs are adjusted in line with energy cost increases in low and high scenarios • Current take-up is based on current ratio of actual beneficiaries to eligible households and is adjusted based on historical correlation of take-up and income threshold increase (100 MDL of benefit increase the take-up ratio by 1 percentage point) • Perfect take-up assumes that all eligible households apply and receive benefits Low scenario High scenario 2015 2016 2020 2016 2020 Income threshold for AS (MDL/month) 765 903 1,186 941 1,274 Average monthly AS benefit, MDL 697 823 1,117 835 1,169 Income threshold for HA (MDL/month) 1,224 1,444 1,897 1,506 2,039 Monthly HA benefit, MDL 250 548 811 683 1,119 53 The fiscal impact of compensating energy tariff increases through national social assistance programs • With the adjusted GMI, the number of eligible households rises in 2016 and then declines as real income growth, based on WB forecast, starts to offset part of tariff increase. • The total fiscal impact of AS and HA programs ranges from low to high scenario in 2016 between 0.7-2.2% of GDP and in 2020 between 0.5-1.7%. Low scenario High scenario 2015 2016 2020 2016 2020 Number of HHs benefiting from AS 50,832 51,181 41,202 55,626 47,534 Number of HHs eligible for AS 126,796 127,666 102,775 138,753 118,569 Number of HHs benefiting from HA 136,466 154,536 126,545 164,115 145,788 Number of HHs eligible for HA 397,066 449,644 368,199 477,515 424,190 AS budget, current take-up, mln MDL 425 506 552 558 667 AS budget, perfect take-up, mln MDL 1,061 1,261 1,378 1,391 1,663 AS budget, current take-up, % of GDP 0.36 0.39 0.29 0.43 0.35 AS budget, perfect take-up, % of GDP 0.89 0.98 0.72 1.07 0.87 HA budget, current take-up, mln MDL 171 390 392 509 519 HA budget, perfect take-up, mln MDL 496 1,136 1,139 1,480 1,511 HA budget, current take-up, % of GDP 0.14 0.30 0.21 0.39 0.27 HA budget, perfect take-up, % of GDP 0.42 0.88 0.60 1.15 0.79 AS+HA budget, current take-up, % of GDP 0.50 0.69 0.50 0.82 0.62 AS+HA budget, perfect take-up, % of GDP 1.31 1.86 1.32 2.23 1.66 54 Main findings of social assistance analysis • Moldova’s two targeted social assistance programs, Ajutor Social and Heating Allowance, can help protect the poor from income shocks, including energy tariff increase, in a cost-effective manner. • Municipal heating compensations have important complementarities to the national programs especially those for the urban poor. • Growing tariffs will increase the need for social assistance. To protect the poor, adjustment of the income threshold, GMI, as well as HA benefit size are needed. • Higher benefits may encourage enrollment, but effective outreach is required because the take-up of both national and municipal benefits is currently low. With improved coverage, the national programs could cover over 30% of the population. • As a result of the social assistance, energy affordability for the poorest HHs receiving AS and HA would improve. • Significant increases in benefits would drive up the budget of targeted programs. In the high case scenario assuming perfect take-up, the total fiscal cost of HA and AS would be more than 2 % of GDP in the period of most intensive tariff growth, 2016. • To limit the fiscal cost of social assistance, it may be necessary to adjust categorical benefits, which currently present 1 % of GDP. In addition, tightening the proxy test of social assistance may help contain the cost and decrease benefits “leakageâ€? to better-off households. • Municipal benefits should be better linked with the national social assistance system to streamline administration, improve targeting accuracy and better contain fiscal cost of both national and municipal programs. 55 SUMMARY OF KEY FINDINGS 56 Energy tariffs need to ensure cost recovery to ensure security of supply and sustainable development of the sector • Fundamental regulatory structures and billing performance are at a fairly good level: • Moldova has in place a fundamentally well structured regulatory system that is considered to be in principle adequate also by private sector operators • The electricity distribution service quality has improved significantly and there is good billing performance in both heat and electricity sectors • Significant short to mid term risks are related to consumer tariffs for heat and electricity not covering all service production costs: • Risk of major financial bail out being required with significant fiscal implications • Risk of disruption of service due to inability to pay for bulk energy imports • New electricity tariffs decided upon by ANRE in July cover fairly well current operating costs, but further actions are needed to ensure the long term development of the sector: • A long term plan on recovery of past accumulated debt needs to be reached • Without a credible long term plan, the sector operators cannot attract investments to expand and refurbish the infrastructure • Efficiency of the sector may deteriorate as the focus of the management is on short term financing and not on developing operations 57 Increasing energy tariffs will increase the demand for social assistance programs • Tariff setting had ceased to work adequately – ANRE had not fulfilled its role in setting the tariffs in 2012-2014 and losses Based on scenario analysis, the electricity have accumulated. tariff increase by 2020 is estimated to be – There is potential to improve the tariff setting methodology to ensure further 73-113% and heat tariff 30-78%. Analysis development and efficiency improvement in the energy sector also assumes 50% increase in gas tariff by • Energy sector financial status is poor 2020. – All companies made losses in 2013-2014 due to significant cost increase after latest tariff approval – Union Fenosa does not report losses, but instead has increased its receivables • The electricity tariff adjustment decided in July would be a first step in required direction Due to tariff increases, the poverty rate is – Electricity tariff increase by 30-37% depending on operator would cover expected to be 1-1.5 %-points higher in fairly well current operating costs 2020, a moderate increase compared to a – Based on decided gas tariff, heat tariff would need to be increased by 21% scenario without tariff increases. • Increasing tariffs will have an impact on the population and the economy – The poverty rate would be 1-1.5 percentage points higher in 2020 due to increasing heat, electricity and gas tariffs – The impact of increasing electricity costs is particularly high on the most vulnerable part of the population – District heating is predominantly used by the wealthiest part of the Moldovan Increasing need for social assistance may population (the urban one). lead to social program share of – Further analysis is needed to understand the broader impacts of tariff government budget to increase from increases, and the way such reforms might be best communicated 0.5% of GDP to 1.9-2.2% in 2016 • Social assistance programs may help protect the poor and 1.3-1.7% in 2020. – Moldova`s two targeted social assistance programs may help protect the poor from income shocks in a cost-effective manner – Municipal heating compensations have important complementarities to the However, this would require a significant national programs increase in take-up of programs. – The fiscal impact of the social protection programs may increase from 0.5% of GDP to over 2% in 2016 and 1.7% in 2020. 58 RECOMMENDATIONS FOR GOVERNMENT 59 Recommendations for immediate actions by government on tariff setting methodologies • The credibility of the regulatory regime needs to be restored and the financial status of the utilities improved. Tariff adjustments are required for electricity supply, heat supply as well as heat and electricity generation. • There should be automatic pass through of costs for fuel and imported electricity to ensure timely adjustment of tariffs to avoid further accumulation of losses/debt. • Timely setting of tariffs and calculation of base costs at the beginning of a regulatory period should be ensured by starting the consultation process well in advance and determining a firm deadline for approval of tariffs. • To avoid imposing a large impact on the population through big one-time increase, it is recommended that ANRE and Government negotiate for medium term adjustment of tariff to resolve the accumulated losses in a structured manner. • Design a plan to communicate about the planned tariff adjustments, their reasons and available social assistance. 60 Recommendations on social assistance policies • Improve the take-up of Ajutor Social and Heating Allowance programs as well as municipal benefits through better outreach to increase the coverage of the poorest population • Increase the threshold for social assistance and maintain the adequacy of benefits in line with the increasing energy costs • Increase the Guaranteed Minimum Income in line with the increasing cost of living (including electricity costs) • Increase the Heating Allowance benefit size in line with increasing heating costs • Prepare for the fiscal impact of increasing social assistance in the macroeconomic and fiscal management • Consolidate categorical benefits to create fiscal space for expanding the targeted transfers and discuss the implications with IMF 61 Recommendations for further analysis • To improve the regulatory framework, the following areas should be analyzed • Regulatory rules for determining the regulated asset base value, depreciation and rate of return • Switching to valuation of asset base in real terms and real rate of return • Better incentivizing the operators to continuously increase efficiency without compromising the service quality • The World Bank is planning to complement the analysis with qualitative work aiming at an initial exploration of: • The perceived quality of heat and electricity services, the acceptability of tariff increases; the expected impact and coping strategies adopted by households • The potential impact of heat and electricity tariff increases on small businesses, and their likely coping strategies • The expected impact of tariff increases on businesses, including developers, and their perceptions/decisions on connecting new developments to District heating if possible • Such findings are expected to complement the existing quantitative assessment, even if by design they will be conducted on a much smaller scale • Analyze how to further improve the effectiveness of the social assistance • Consider consolidation of categorical benefits and tightening proxy means-test to prevent “leakageâ€? of benefits to better off households • Increase cooperation of municipal and national authorities on social assistance to analyze how to link municipal benefits to national social protection system and work towards further integration • Analyze how to promote supply and demand-side energy efficiency to decrease the energy expenditures in the long-term 62 APPENDICES Appendix 1 – Detailed analysis of tariff setting methodologies Appendix 2 – Detailed scenario analysis and sensitivity analysis of heat and electricity tariffs Appendix 3 – Recommendations on tariff methodology and implementation Appendix 4 – Detailed analysis of relations of heating type and poverty Appendix 5 – Detailed analysis and conclusions on social protection Appendix 6 – Summary of scenario analysis 63 APPENDIX 1 – DETAILED ANALYSIS OF TARIFF SETTING METHODOLOGIES 64 Main principles of tariff methodologies provide a good basis for tariff design All tariff setting methodologies are based on common principles: • Reliable supply • Efficient operation • Financial sustainability of the operators In addition, the following principles are stated: Heat supply • Operator should be able to invest in the Electricity and heat generation development and upgrading of the assets Electricity transmission Electricity distribution • Phasing out cross-subsidies Electricity supply tariffs are equal for all consumers connected to the same voltage level 65 Tariffs follow a rate-of-return methodology Deviation is the difference between the result of the operator determined based on estimated parameters during tariff approval and the result based on actual values during a year. If preliminarily estimated parameters change and the tariff Ü´Ý?݃‫ Ý?݉݋ܿ݊݅ Ý€Ý?Ý?݈ܽݑ‬േ Ý€Ý?‫ݎܽÝ?Ý• Ý?Ý‘Ý‹Ý…Ý’Ý?ÝŽÝŒ ݉݋ݎ݂ ÝŠÝ‹Ý…Ý?ܽ݅ݒ‬ ܶܽ‫ ݂݂݅ݎ‬ൌ is not adjusted during the year, this results in a deviation. ܸ‫Ý?Ü¿Ý…Ý’ÝŽÝ?Ý? Ý‚Ý‹ Ý?݉ݑ݈݋‬ The positive or negative deviation is included in the following year’s tariff. Volume of service refers to amount of electricity or heat generated, transmitted, distributed or supplied by the operator. Ü´Ý?݃‫ Ý?݉݋ܿ݊݅ Ý€Ý?Ý?݈ܽݑ‬ൌ ܶ‫ Ý?Ý?Ý?Ý‹Ü¿ Ý€Ý?Ý?݈ܽݑ݃Ý?ÝŽ ݈ܽÝ?݋‬൅ Ü´Ý?݃‫Ý?Ý…Ý‚Ý‹ÝŽÝŒ Ý€Ý?Ý?݈ܽݑ‬ Total regulated costs include operating costs, working capital costs and depreciation. See following slides for more information. Other operators Electricity supply Ü´Ý?݃‫ Ý?Ý…Ý‚Ý‹ÝŽÝŒ Ý€Ý?Ý?݈ܽݑ‬ൌ Ü°Ý?‫݊ݎݑÝ?Ý?ÝŽ Ý‚Ý‹ Ý?Ý?ܴܽ Ý” Ý?Ý?Ý?Ý?Ý?ܽ Ý‚Ý‹ Ý?ݑ݈ܽݒ Ý?‬ Ü´Ý?݃‫ܧܴܰܣ ݕܾ ݕ݈݈ܽݑ݊݊ܽ Ý€Ý?ÝŠÝ…Ý‚Ý?Ý€ Ý?Ý…Ý‚Ý‹ÝŽÝŒ Ý€Ý?Ý?݈ܽݑ‬ Net value of assets includes assets used for the Rate of return varies for the operators. Currently the regulated profit is provision of regulated activities. See following See following slides for more information. set as 2.5% of annual sales. slides for more information. 66 Most significant external costs are passed through and other operating costs are based on indexed growth • The tariff setting methodologies have been approved for a specified time period – Electricity transmission, distribution and supply – 5 years – Electricity and heat generation – 7 years • Operating costs are divided to three groups Pass through of external costs Index-based increase Based on actual Cost category Fuel costs for electricity and heat generation General and other costs, Material costs, O&M, labor costs Cost of electricity purchased by depreciation electricity supplier Base cost approved by ANRE at the beginning of 5-7 year period Basis Approved annually by the Approved annually by the regulator based on actual costs Annual update based on regulator based on actual costs predefined parameters including efficiency factor Approximately 80 % of heat and electricity end-user tariff results from external costs 67 Working capital costs are included in the tariff based on predetermined parameters Cost basis Number of days Interest rate Short term loans in Electricity and Sales 30 National Bank of heat generation Moldova Electricity Not included in tariff transmission Electricity Costs, not including 10 WACC as for assets distribution depreciation Average interest of Costs, not including Electricity supply depreciation 25 loans in National Bank of Moldova Based on heat and Sales, deducted with Short term loans in gas payment Heat supply depreciation and patterns, number of National Bank of regulated profit Moldova days not defined 68 Tariff setting methodology includes incentives to reduce losses, operating costs and cost of imported power All operators • The regulatory framework includes an incentive for the operators to reduce operating costs. • Baseline of operating costs are set at the beginning of the regulatory period. • If the costs of the operator are higher, its profits are reduced. • If the costs of the operator are lower, its profits are increased. Electricity distribution • The regulatory framework includes an incentive for electricity distributors to reduce technical and commercial losses • The commercial losses taken into account at the beginning of the period is 2 % and this reduces gradually to 1 % at the end of the period. • The technical losses taken into account are based on a fixed value that is defined separately for each company. Technical losses of Union Fenosa are 10.5%. • If the actual losses are below the set level, the operator is still allowed to include the set value of losses in the tariff and can therefore earn more profit • The regulatory framework includes a potential penalty for electricity distributors on insufficient quality level (see next slide) Heat supply • The regulatory framework includes a potential penalty for heat suppliers on insufficient quality level (see next slide) • Losses in heat network are determined annually and the cost is directly passed to end-consumers no incentive for the heat supplier to reduce losses • Heat loss of Termocom is 22% Electricity supply • The regulatory framework includes an incentive for the power suppliers to reduce the cost of electricity purchased from non-regulated suppliers • The operator can get additional return when the power purchase price is lower than the price on previous year. 69 Electricity distributors can be penalized for inadequate quality of service Electricity distribution • The following indicators are followed for all electricity Development of SAIDI distribution companies and the quality of service has (System Average Interruption Duration Index) improved significantly 1500 • CAIDI (Customer Average Interruption Duration Index) 1000 • SAIDI (System Average Interruption Duration Index) • SAIFI (System Average Interruption Frequency Index) 500 • Insufficient quality level can lead to reductions in 0 company sales 2007 2008 2009 2010 2011 2012 2013 • Maximum reduction is 5 % of income RED Union Fenosa RED Nord • ANRE determines case by case the penalty on an operator RED Nord-Vest Regulatory requirement Heat supply • The district heating company tariffs may also be reduced in case of inadequate service quality • Quality indicator • Temperature of the apartments must be above 18°C. • If the criteria is not met, consumers are eligible to have a reduction in their bill. • In practice, reductions in profits are applied rarely. Other operators • No quality parameters included in tariff setting 70 Regulated asset base is mainly based on book value of assets Existing assets New assets Value taken into account in tariff setting Value taken into account in tariff setting • Electricity distribution – agreed asset value • Union Fenosa – depreciation of old assets by • Actual investment expenditure deducted with annual end of 2014 depreciations • Other operators – based on book values or agreement Rate of return Rate of return • Heat and electricity generation – no return • Heat and electricity generation – varies depending on • Electricity transmission and heat supply – Fixed rate; whether equity or debt financing used return must be used for investment • Other operators – WACC • Electricity distribution - WACC Approval of investments • Companies submit their investment plan to ANRE at the end of each year. • ANRE should approve the investment within a month, but the negotiation often continues even until next summer. • At the beginning of the following year, the operators report on the actual investments done based on the approved investment plan. • The actual investments done by the end of year are 71 taken into account in the tariff of the following year. Rate of return is set separately for existing and new assets Interest rate – existing assets Interest rate – new assets Electricity and heat No return – cost of debt included Fixed to market rates generation based on actual interest paid Transmission Fixed rate, 5% WACC WACC Electricity distribution WACC same as for new assets Regulated return specified by ANRE separately, not based on asset Electricity supply value. Currently the regulated profit is set as 2.5% of annual sales. Heat supply Fixed rate, 5% WACC 72 Rate of return parameters vary between the operators Definition of parameters for return on new assets Rate of return for new assets* Electricity - Investment based on equity: 1 year treasury 20% and heat bond of Moldova Rate of return - Investment based on debt: average interest in 18% generation based on previous national Bank for more than 5 year loans (max. 5 methodologies points more) 16% Transmission - Risk free rate: US government securities with 10 14% year maturity - Country risk: <6.75% 12% - Debt/equity = 50%/50% - Cost of debt 8% 10% Electricity - Risk free: US gov securities with 10 year distribution maturity 8% - Country risk: <9% - Market risk premium: fixed value based on US 6% market statistics - Industry-based systemic risk 4% - Debt/equity = 35%/65% - Cost of debt: average rate of loans in foreign 2% currency by national bank of Moldova Heat supply - Risk free: US gov securities with 10 year 0% 2009 2010 2011 2012 2013 2014 2015 maturity - Country risk: <6.75% CHPs Heat supply - Debt/equity = 65%/35% Electricity transmission Electricity distribution - Cost of debt 9.13% *Source: ANRE 73 Tariffs can be amended throughout the year Including deviation from year T-1 Automatic pass-through of external costs 74 Ten globally accepted principles of public utility rates 1. Effectiveness of yielding total revenue including a fair return with a socially desirable level of service and safety 2. Stability and predictability of revenue for utility companies 3. Stability and predictability of consumer rates 4. Discouraging wasteful use of services 5. Reflection of all private and social costs occurred for the provision of service (including externalities) 6. Fairness of rates in the apportionment of total costs of service among different consumers 7. Avoidance of discrimination in rates 8. Promotion of innovation and cost-effectiveness in the face of changing demand and supply patterns 9. Simplicity, understandability, public acceptability, and feasibility 10. Freedom from controversies as to proper interpretation 75J., Source: Principles of Public Utility Rates, Bonbright, Danielsen, A., and Kamerschen A., 1988 Tariff regulation is mainly well-defined and based on global good practices Tariff design principle* Compatibility with the principle in Moldova Effectiveness of yielding total revenue including a + Total revenue is determined effectively with a rate of return based on WACC fair return with a socially desirable level of service included − No rate of return is set in the methodology for electricity supply and no and safety detailed definition given for heat and electricity generation − WACC and asset valuation can be determined based on a more clear and consistent method ± Desirable level of service is determined for distribution of electricity and heat, no definition for other operators Stability and predictability of revenue for utility + Methodologies are determined for 5 – 7 years companies Stability and predictability of consumer rates ± Changes in operating costs may lead to sudden changes in consumer tariffs, but capital costs are included gradually Discouraging wasteful use of services + Electricity and heat are billed based on consumption and in principle total cost of production is covered − Customers cannot easily regulate their heat consumption Reflection of all private and social costs occurred ± The tariffs cover in principle all costs of the operator, but unclear whether for the provision of service (including externalities) price indices reflect well the development of costs. Fairness of rates in the apportionment of total + Distribution tariffs aim to take into account the difference in cost of service at costs of service among different consumers different voltage levels − Cost allocation for heat and power is not based on global best practice Avoidance of discrimination in rates + No cross-subsidization, same tariff for consumers with similar connection Promotion of innovation and cost-effectiveness in − Tariff design does not include any specific features to promote cost- the face of changing demand and supply patterns effectiveness or innovativeness Simplicity, understandability, public acceptability, + The structure of the tariff design is fairly simple and feasibility Freedom from controversies as to proper + There are no major controversies in the methodologies interpretation − Timeline of tariff setting has not been defined clearly in the methodology and 76 some methodologies lack detailed clarifications of some terms *Source: Principles of Public Utility Rates, Bonbright, J., Danielsen, A., and Kamerschen A., 1988 APPENDIX 2 – GENERAL ASSUMPTIONS AND DETAILED SCENARIO ANALYSIS AND SENSITIVITY ANALYSIS OF HEAT AND ELECTRICITY TARIFFS 77 General assumptions in the energy tariff scenarios • Annual operating costs included by ANRE in electricity and natural gas tariffs decided upon on July 18, 2015, are not yet available and therefore the future cost increase is estimated based on the total costs implied based on the tariffs • The following factors were added to the baseline in different combinations to show their sensitivity for each scenario: • Commodity prices and exchange rate • Other operating costs • Deviation from past years (2012-2014) – Assumed deviation of Union Fenosa MDL 890 million – Assumed deviation of CET-2 MDL 26 million – Assumed deviation of RED Nord MDL 119 million – Assumed deviation of MoldElectrica MDL 165 million (Scenario 2) and 192 million (Scenario 4) – Assumed deviation of Termocom MDL 265 million (Scenario 2) and 745 million (Scenario 4) • Investments • Revaluation of assets • Costs not included in the analysis • Debt accumulated to Termocom prior to 2012 • Decommissioning and debt of CHP-1 78 Key assumptions used in the scenario analysis Index 2015 2016 2017 2018 2019 2020 Natural gas price, MDL/tcm 7154 7352 7551 7725 8078 8442 MGRES price, bani/kWh 142.2 149.1 156.2 163.5 171.1 178.8 Romanian power price, bani/kWh 100.9 105.9 CPI 6.5% 5.5% 5.3% 5.3% 5.3% 5.3% USD/MDL rate 18 18.5 19 19.5 20 20.5 GDP change, % -2% 2% 4% 4% 4% 4% New investments, 225 225 MoldElectrica, mln USD New investments, 7.5 7.5 7.5 7.5 Termocom, (IBRD Loan), mln USD Business as usual investments, 210 210 210 210 210 210 MoldElectrica, mln MDL Business as usual investments, 100 100 100 100 100 100 RED Nord, mln MDL Business as usual investments, 18.7 18.7 18.7 18.7 18.7 18.7 RED Union Fenosa, mln USD Business as usual investments, 47.8 47.8 47.8 47.8 47.8 47.8 CHP-2, mln MDL Business as usual investments, 65.1 65.1 65.1 65.1 65.1 65.1 Termocom, mln MDL 79 Sources of the data used in the scenario analysis Data Source Natural gas price Moldovagaz estimate and WB Commodity markets outlook Romanian power price WB estimate based on European power prices CPI WB forecast USD/MDL rate WB forecast GDP change % WB forecast MGRES price company data BAU investments company data New investments WB 80 The constructed scenarios project a range of potential tariff levels • Tariffs as set by ANRE to be applied on July 1, 2015 and assumed July tariff adjustment inflation thereafter • Heat tariff based on gas tariff as of July 1, 2015 Minimum tariff • Adjustment of tariffs based on the projected natural gas and electricity import price as well as changes of currency exchange rate increase Recover past • Adjustment of tariffs based on the projected natural gas and electricity import price as well as changes of currency exchange rate deviation • Past deviation divided to 2015-2019 tariffs By the book including • Implementation of the current methodology, including past deviation in 2015 and planned investments investments Estimated maximum • Estimated high value of all parameters tariff • Past deviation divided to 2015-2019 tariffs 81 The following parameters were set for each scenario Commodity prices, Other operating Deviation from past Revaluation of Scenario # Investments exchange rate costs years assets Electricity: Tariff as of July 18, 2015 scenario Scenario 0 Low ‘July tariff Heat: Gas tariff as Heat: As approved Heat: BAU adjustment‘ Heat: 0 Heat: 0% of July 18, 2015 in 2011 (annual average) Scenario 1 As approved in BAU ‘Minimum tariff Passed through 0 0% 2011 (annual average) increase’ Scenario 2 As approved in BAU ‘Recover past Passed through Split to 2015-2019 0% 2011 +indices (annual average) deviation‘ Scenario 3 Transmission line: 'By the book Actuals of 2011 2019-2020, Passed through All in 2015 0% including +indices DH rehabilitation: investments' 2017-2021 Transmission line: scenario Scenario 4 Split to 2015-2019, High Actuals of 2014 2019-2020, ‘Estimated Passed through revaluation part 100% +indices DH rehabilitation: maximum tariff‘ included 2017-2022 82 Based on Scenario 4, RED Union Fenosa nominal end user electricity tariff could be twice as high in 2020 compared to 2014 End user electricity tariff includes generation, 350 transmission, distribution and supply of electricity 323 321 300 272 288 275 245 250 241 268 227 200 222 152 152 bani/kWh 150 Scenario 3 – Scenarios 2 and 4 – all deviation included all deviation included 100 in 2015 in 2015-2019 Total deviation from 50 2012-2014 is MDL 890 million 0 2013 2014 2015 2016 2017 2018 2019 2020 Tariff approved Scenario 0 ‘July tariff adjustment‘ Scenario 1 'Minimum Tariff Increase' Scenario 2 'Recover Past Deviation' Scenario 3 'By the Book Including Investments' Scenario 4 'Estimated Maximum Tariff' 83 Based on Scenario 4, nominal end user heat tariff could be 80 % higher in 2020 1900 1773 1759 1700 1662 1565 1528 1500 1450 1473 1300 1286 1375 MDL/Gcal 1211 1100 987 900 End user heat tariff includes generation 700 and distribution of heat. 500 2012 2013 2014 2015 2016 2017 2018 2019 2020 Tariff Approved Scenario 0 ‘July tariff adjustment‘ Scenario 1 'Minimum Tariff Increase' Scenario 2 'Recover Past Deviation' Scenario 3 'By the Book Including Investments' Scenario 4 'Estimated Maximum Tariff' 84 Based on Scenario 4, RED NORD end user electricity tariff could be twice as high in 2020 350 330 300 235 263 214 250 261 bani/kWh 200 213 Scenario 3-4 takes into account respective scenarios of 167 Moldelectrica tariff, which causes 150 more rapid tariff increase compared 167 to business as usual, Scenarios 1-2 100 2012 2013 2014 2015 2016 2017 2018 2019 2020 Tariff approved Scenario 0 'July tariff adjustment' Scenario 1 'Minimum Tariff Increase' Scenario 2 'Recover Past Deviation' Scenario 3 'By the Book Including Investments' Scenario 4 'Estimated Maximum Tariff' 85 Based on Scenario 4, electricity transmission tariff could be almost seven fold in 2020 due to large investments 60 Big investments considered 56 53 in Scenarios 3-4 is the main 50 reason of significant tariff increase 40 [VALUE] bani/kWh 30 20 15 20 20 19 10 14 8 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 Tariff approved Scenario 0 'July tariff adjustment' Scenario 1 'Minimum Tariff Increase' Scenario 2 'Recover Past Deviation' Scenario 3 'By the Book Including Investments' Scenario 4 'Estimated Maximum Tariff' 86 Scenarios 2-4 show an increase of more than 60 % in the heat generation tariff of CHP-2 1100 992 1000 868 900 956 838 815 800 MDL/Gcal 828 700 702 600 Scenario 0 is based on gas tariff suggested by ANRE, 588 no adjustment of heat tariff has been suggested 500 400 2012 2013 2014 2015 2016 2017 2018 2019 2020 Tariff approved Scenario 0 'July tariff adjustment' Scenario 1 'Minimum Tariff Increase' Scenario 2 'Recover Past Deviation' Scenario 3 'By the Book Including Investments' Scenario 4 'Estimated Maximum Tariff' 87 Scenarios 2-4 show an increase of more than 50 % in the electricity generation tariff of CHP-2 300 250 246 206 238 200 202 204 bani/kWh 174 150 159 159 Scenario 0 is based on gas tariff suggested by ANRE, no adjustment of heat tariff has been suggested 100 50 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 Tariff approved Scenario 0 'July Tariff Adjustment' Scenario 1 'Minimum Tariff Increase' Scenario 2 'Recover Past Deviation' Scenario 3 'By the Book Including Investments' Scenario 4 'Estimated Maximum Tariff' 88 Sensitivity analysis for the main cost drivers were conducted • Sensitivity analysis on heat end user tariff • Gas import price +/- 30 % • Sensitivity analysis on electricity end user tariff • CHP-2 electricity generation tariff based on gas import price +/- 30 % • MGRES electricity import price +/- 30 % based on same change in gas tariff • Import all electricity from Romania in 2019 and 2020 based on 2017 price in Romanian power market and increase in line with 2017-2020 power price in European power markets and Romanian transmission cost 89 Gas price variation has a high impact on heat generation and end user tariffs 2500 1400 Termoelectrica CHP-2 1261 1097 1200 2000 1919 1720 1000 991 868 1405 1565 1500 800 640 721 1089 1211 MDL/Gcal MDL/Gcal 600 588 1000 987 400 500 200 0 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2012 2013 2014 2015 2016 2017 2018 2019 2020 Tariff approved Tariff Approved Scenario 3 'By the Book Including Investments' Scenario 3 'By the Book Including Investments', NG-30% Scenario 3 'By the Book Including Investments', NG-30% Scenario 3 'By the Book Including Investments', NG+30% Scenario 3 'By the Book Including Investments', NG+30% Scenario 3 'By the Book Including Investments' 90 Gas price and electricity import price variations have a high impact on electricity generation and end user tariffs 350 400 CHP-2 RED Nord 313 300 350 261 287 342 300 250 246 284 204 250 241 200 226 147 179 194 bani/kWh 200 bani/kWh 159 150 167 150 100 167 100 50 50 0 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2012 2013 2014 2015 2016 2017 2018 2019 2020 Tariff approved Tariff approved Scenario 3 'By the Book Including Investments' Scenario 3" 'By the Book Without Investment', MGRES +30% Scenario 3 'By the Book Including Investments', NG-30% Scenario 3" 'By the Book Without Investment', MGRES -30% Scenario 3 'By the Book Including Investments', NG+30% Scenario 3" 'By the Book Without Investment' 91 Importing electricity from Romania would reduce the end user tariff by 16% 400 Scenario 3â€?: transmission system remains the same and power is 350 imported from MGRES 342 300 287 284 241 239 250 bani/kWh 194 226 200 167 150 Scenario 3: interconnection constructed and all power imported from Romania 100 In addition to constructing transmission line, there are many obstacles to importing power from Romania. In 50 addition, the price of import is uncertain. This should be considered as a potential future scenario. 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 Tariff approved Scenario 3" 'By the Book Without Investment' Scenario 3 'By the Book Including Investment' + ROM Power Scenario 3" 'By the Book Without Investment', MGRES -30% Scenario 3" 'By the Book Without Investment', MGRES +30% 92 APPENDIX 3 – RECOMMENDATIONS ON TARIFF METHODOLOGY AND IMPLEMENTATION 93 Key areas for improvement in tariff setting General good practice in Good practice in tariff Need to develop tariff Need to develop tariff tariff setting setting in Moldova methodology in Moldova methodology implementation in Moldova Set rate of return for heat and electricity generation; Attraction of capital Fair return determined More regular updating of Set asset value based on with a fair return and at acceptable level tariffs required economic value (not accounting) Should not limit Socially desirable level Quality criteria set for Set quality criteria for all investments that improve of service and safety electricity distribution operators service quality Reflection of all private All reasonable costs Analyze how well price Updated tariff levels should be reflected in and social costs close to cost recovery indices used reflect the tariffs with update on a occurred actual cost drivers regular basis Incentivize reduction of Should not limit cost- operating costs and Promotion of cost- Based on principle of effective investments, improving quality; Long- effectiveness minimal costs should not limit paying for term approval of more qualified staff investments 94 Recommendations for improved tariff setting (1/2) • General – Approval process of cost changes that are based on external factors should be simple and fast; preferably automatic Predictability, – Fuel price capital attraction – Purchased electricity price – Currency exchange rate – Regular updating of tariffs would lead to smaller one-time changes for Financial sustainability consumers and improve financial sustainability of operators. This would also improve the efficiency of the economy as there would be an incentive to reduce energy consumption when gas prices are high. – District heating and natural gas tariff revision should go in parallel, otherwise Cost recovery and cost increasing the heat tariff may lead to disconnections from district heating effectiveness system • Operating costs – All reasonable costs should be included in tariffs, e.g. there should be no limit to paying reasonably higher salaries to more qualified staff Cost recovery – Alternative 1 – current method with base year alternative costs approved by ANRE – There seems to be need to change criteria for approving operating costs and follow changes in the market more carefully. Cost effectiveness – Analyze how well price indices reflect the cost development. – Alternative 2 – stronger incentives for operators – Strengthen incentives to improve efficiency with reductions in operating costs as a benefit for the operator during a set period and after the set Quality improvement period given to the consumers through tariff reductions. – At the same time, strengthen incentives and penalties related to quality. Efficiency of regulation – By strengthening the incentives, the close fit of price indices or scrutiny by the regulator would not be as relevant. 95 Recommendations for improved tariff setting (2/2) • Service quality – Set quality criteria for all operators – Especially if stronger incentives are set for quality improvement and Quality improvement operating cost reduction, the regulator needs to be able to follow the quality indicators set rigorously • Rate of return Private capital – Analyze how best to implement rate of return for electricity and heat attraction generation • Asset value Economical use of – Analyze, how to set regulated asset value based on economic value, assets i.e. real life time (not accounting), especially for new major investments • Investments – Investment plans could be done for a longer time perspective, e.g. for 5 Cost-effective planning years and in compliance with the country energy strategies, if available Investor credibility – – Criteria for approving investments should be clarified capital attraction – Should not limit reasonable investments that improve service quality – In the long-term, there should be a way to incentivize efficiency of Quality improvement investments Cost effectiveness • Cost allocation – Costs should be allocated between heat and power based on a global best practice. Recommended method could be alternative generation Optimal cost allocation method as it is close to current practice. 96 APPENDIX 4 – DETAILED ANALYSIS OF RELATIONS OF HEATING TYPE AND POVERTY 97 Gas users spend more on energy as a share of total expenditures According to heating source: The highest share of energy expenditures is observed among gas users for whom the average share reaches about 20% of total expenditures. Gas share alone represents about 13 % of total expenditure for gas users. For the households heating with electric heaters, the electricity share alone reaches 10%, compared to the national average of 5%. Average Energy Expenditures by Heating type, Moldova 2013 Share of total expenditure 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% All Central Heating Gas central Nat gas stove Wood or coal Electric heaters system stove Heating type Central share Electricity share Gas share LPG share Wood share Coal share 98 Share of district heating has remained stable in Chisinau and use of wood has increased in all areas In Chisinau, the heating pattern remains fairly stable across the years, where central heating is the main heating source for about 70% of the households. In other urban areas, a significant increase in wood stove use is observed (from 35% in 2007 to 47% in 2013) as a switch from gas use. Even in rural areas, wood stove use is expanding (from 90 to 94%). Main Heating Source in Moldova, 2007-2013 100 90 80 % of households 70 60 50 40 30 20 10 0 2007 2008 2009 2010 2011 2012 2013 2007 2008 2009 2010 2011 2012 2013 2007 2008 2009 2010 2011 2012 2013 Chisinau other urban areas rural Central Heating Gas central system Nat gas stove Wood or coal stove Electric heaters No Heating 99 Methodology and assumptions for the impact analysis I- Baselines for the simulations : Baselines for years 2016 and 2020 assume a constant nominal tariff for gas, electricity and central heating since 2014. All other expenditures are extrapolated using households expenditures from 2013 Household Budget survey, assuming inflation and uniform private consumption growth as per World Bank projection (average annual private consumption growth 0.6% by 2016 and 2.6% by 2020). Also, electricity consumption is assumed to increase by 2% per year. Poverty rate of baseline scenarios is calculated using the national poverty line, increased by the inflation. II- Assumptions for impact of tariff increase, a low and a high scenario, for central heating, gas and electricity as in table below. Both low and high tariff scenarios also use World Bank projection for economic growth, as well as inflation for all other expenditures than central heating, gas and electricity. Poverty is calculated using the national poverty line, increased by the inflation. Low scenario High scenario 2014 2016 2020 2016 2020 Heat tariff (MDL/Gcal) and increase compared to 987 21% 30% 80% 78% 2014 (%) Electricity tariff (bani/kWh) and increase 152 42% 73% 61% 113% compared to 2014 (%) Average consumer gas tariff (MDL/tcm) and 6096 25% 47% 25% 47% increase compared to 2014 (%) Inflation compared to 2014 (%) - 16% 47% 16% 47% We do not apply price elasticity for conservative estimates. In the long term, it is possible that demand side energy efficiency investments reduce consumption. III- Increase in poverty is calculated in adjusting the welfare aggregate for each individual (total expenditures per adult equivalent) for the loss of purchasing power due to the energy tariff increase 100 APPENDIX 5 – ADDITIONAL DETAILES TO SOCIAL PROTECTION ANALYSIS 101 Heating Benefits Overview Heating Benefit Programs, heating season 2013-2014 National Heating Chisinau Munic`l Balti Munic`l Key characteristics/data Allowance Compensation Compensation Benefit type Cash In-kind/cash Cash Income and proxy- Targeting method means test Income test Income test* Income eligibility threshold, MDL 1,088 2,000 1,500 Average monthly number of beneficiary households, including by type of service 100,289 30,378 5,473 district heating -- 23,288 -- hot water -- 3,874 -- natural gas, electricity, wood, coal used for heating -- 3,216 -- Average monthly size of benefit, MDL, including by type of service** 250*** -- 200 district heating -- 285 -- hot water -- 517 -- natural gas, electricity, wood, coal used for heating -- 450 -- Budget spending FY2014, million MDL 107 60 6**** Source: Staff estimates based on administrative data * The benefit is granted to pensioners and the disabled, considering the level of their social benefits. No other/household`s income is checked. Some of these categories (i.e. disabled) are eligible for benefit regardless of their income. ** In Chisinau compensation for district heating and hot water is 40% of the household`s bill, the actual amounts are estimates based on admin data ***Ajutor Social beneficiaries receive the HA as a top-up hence the overall size of their cash transfer is larger ****allocations in Nov 2013 102 Design features of municipal heating benefits Key features “+â€? “--â€? Higher income potentially better coverage of the benefits targeting accuracy may suffer threshold than in urban poor to complement the as only formal income is included (not national HA program national HA benefit; even overall household income in Balti`s case). Discount on certain benefit directly linked to particular in-kind benefits are not fungible which energy expenses energy consumption; constrains the poor households` benefit size adjusts to changes in flexibility in meeting various stringent energy cost and consumption; needs. no need to collect cash; Direct settlement may decrease scope of arrears of may affect transparency of the with providers residential consumers; scheme. Administration cumbersome application and less outside of the effective outreach; national social prevents monitoring and more efficient protection system use of overall country SP resources. 103 Challenges of the municipal heating benefits Although it is not possible to analyze the poverty performance of municipal benefits because they are not reported in HBS, analysis of available data and design suggests that: • Despite high potential coverage benefits take-up is low: in Chisinau of 189,000 HHs that could qualify for benefits only 33,000 HHs receive them; • More than half of all Chisinau HHs using district heating or gas and about 80 percent of those heating with wood/coal would qualify for the benefit; • Benefits may be poorly targeted as only formal income is included which may not reflect the total HHs income. • Application is cumbersome: high transaction and opportunity cost may discourage the poor to apply; • Lack of coordination with national benefits prevents more efficient use of public resources and benefit administration; • Eligible households are larger than non-eligible ones and they have higher average monthly expenditures for district heating and gas per household (not per capita though); moreover, the distribution of benefits may have larger coverage gaps among the poorest households using solid fuels. Average monthly expenditures by households in Quintile 1 and 2 and heating benefits, MDL Central heating 500 450 Gas (gas central system or 400 natural gas stove) 350 Wood or coal stove 300 HA benefit (annualized) 250 200 Chisinau benefit, central heating 150 (annualized) 100 Chisinau benefit, gas, wood and 50 coal (annualized) 0 Balti benefit (annualized) Q1 Q2 104 Adjusting Heating Allowance to compensate increased district heating and gas costs • Higher benefit may encourage more HHs to enroll for HA; yet, the gap between effective and potential coverage of HA is even higher than that of AS and must be reduced via effective rural outreach and better coordination with municipal benefits; Increase in energy costs and adjusted HA benefit size Low scenario High scenario 2016 2020 2016 2020 Increase in energy cost (without electricity) per winter month, MDL 298 561 433 869 Adjustment in monthly HA benefit, MDL 548 811 683 1119 Parameters of Targeted Social Assistance Benefits with adjusted GMI and HA benefit size Low scenario High scenario 2015 2016 2020 2016 2020 Income threshold for HA, MDL 1,224 1,444 1,897 1,506 2,039 Number of HHs benefiting from HA 136,466 154,536 126,545 164,115 145,788 Number of HHs eligible for HA 397,066 449,644 368,199 477,515 424,190 Coverage by HA (current), % of population 9.2 10.4 8.6 11.1 9.8 Coverage by HA (perfect), % of population 26.8 30.4 25.2 32.2 28.6 HA budget, current take-up, mln MDL 171 390 392 509 519 HA budget, perfect take-up, mln MDL 496 1,136 1,139 1,480 1,511 HA budget, current take-up, % of GDP 0.14 0.30 0.21 0.39 0.27 HA budget, perfect take-up, % of GDP 0.42 0.88 0.60 1.15 0.79 Source: Staff calculations based on HBS 105 Adjusting Ajutor Social to compensate increased electricity cost • With adjusted GMI, the number of eligible households rises in 2016 and then declines as real income growth starts to offset part of tariff increase; • Nonetheless, the take-up of eligible households must improve which requires concerted implementation efforts to enroll more eligible population; • Average benefit increase is higher than the average increase in monthly cost of electricity, but at the same time other costs of living increase as well. As the GMI increases in line with increasing cost of living, the affordability would not change. • Higher take-up requires additional budget that may exceed 1% of GDP; tightening the proxy test may help contain the cost and decrease benefits “leakageâ€? to better- off households Parameters of Targeted Social Assistance Benefits with adjusted GMI Low scenario High scenario 2015 2016 2020 2016 2020 Income threshold for AS, MDL 765 903 1,186 941 1,274 Number of HHs benefiting from AS 50,832 51,181 41,202 55,626 47,534 Number of HHs eligible for AS 126,796 127,666 102,775 138,753 118,569 Coverage by AS (current), % of population 4.3 4.4 3.6 4.6 4.1 Coverage by AS (perfect), % of population 10.7 10.8 8.9 11.5 10.2 Average monthly AS benefit, MDL 697 823 1,117 835 1,169 AS budget, current take-up, mln MDL 425 506 552 558 667 AS budget, perfect take-up, mln MDL 1,061 1,261 1,378 1,391 1,663 AS budget, current take-up, % of GDP 0.36 0.39 0.29 0.43 0.35 AS budget, perfect take-up, % of GDP 0.89 0.98 0.72 1.07 0.87 Source: Staff calculations based on HBS 106 Detailed recommendations on social assistance policies • Improve the take-up of AS and HA programs to increase the coverage of the poor by national benefits through design and implementation measures • Introduce mandatory annual revision of the income threshold (GMI) by CPI growth to maintain its real value and make further adjustments over the budget year, as necessary to address acute income shocks such as significant energy tariff increases • Streamline eligibility for rural self-employed and households without workable members • Better outreach by local social assistants • Better coordination with municipal benefits • Increase the coverage of the poor and targeting accuracy of municipal benefits • The national and municipal programs should be coordinated better to improve their performance and to manage fiscal pressure on local budget • Incremental cost of covering the urban poor with national benefits is high, hence municipal benefits are important complementarity • The potential coverage of municipal benefits is high but the targeting accuracy and take-up can be significantly improved • Streamline administration by linking municipal benefits to national social protection system to reduce paper work (MIS, cross-checks with registries), to prevent overlap and enhance take-up through referrals, to reduce abuse (expand mandate of the Social Inspection), and to better manage municipal budgets` fiscal risks • Maintain adequacy of benefits: • HA will have to raise while AS benefit will adjust through higher income threshold • Municipal programs may offer higher benefits for lower income and larger households through offering higher compensation at lower income threshold and an increment for the third and above household member • Contain fiscal cost: • Proxy means-test may need to tighten to prevent high “leakageâ€? of benefits to better off households • The increased benefits could cost the budget over 2% of GDP in 2016. Therefore categorical benefits` consolidation is needed to reallocate budget resources to targeted transfers • Linking of the municipal and national programs is needed to avoid overlap and to ensure complementarity of benefits (e.g. for the households eligible for both national HA and municipal benefits the local budget can pay the difference between the two). This would require a lot of changes in benefits delivery. 107 MIS = national management information systems APPENDIX 6 – SUMMARY OF SCENARIO ANALYSIS 108 Summary of tariff scenarios, their impact on poverty and mitigation through social protection Low scenario High scenario 2014 2016 2020 2016 2020 Heat tariff (MDL/Gcal) and increase 987 21% 30% 80% 78% compared to 2014 (%) Electricity tariff (bani/kWh) and 152 42% 73% 61% 113% increase compared to 2014 (%) Average consumer gas tariff (MDL/tcm) and increase compared to 6096 25% 47% 25% 47% 2014 (%) Change in poverty rate compared to baseline for that year 1.1% 1.0% 1.9% 1.6% (pct-points) Change in energy share compared to baseline for that year (pct-points) 2.3% 3.0% 3.8% 4.6% assuming no change in social protection Program budget with current take-up 596 896 944 1067 1186 Heating Allowance (million MDL) Ajutor Social + Program budget with current take-up 0.5% 0.7% 0.5% 0.8% 0.6% (% of GDP) Program budget with perfect take-up 1557 2397 2517 2871 3174 (million MDL) Program budget with perfect take-up 1.3% 1.9% 1.3% 2.2% 1.7% (% GDP) 109 Social protection – program specific impact Low scenario High scenario 2015 2016 2020 2016 2020 Impact with current income threshold Number of households with current 50,832 37,831 22,761 37,831 22,761 take-up Ajutor Social Number of eligible households 127,826 95,131 57,237 95,131 57,237 Impact with recommended adjustment to social assistance program Number of households with current 50,832 51,181 41,202 55,626 47,534 take-up Number of eligible households 126,796 127,666 102,775 138,753 118,569 Average benefit with modified income 697 823 1,117 835 1,169 threshold (MDL/month) Impact with current income threshold Number of households with current 136,466 101,474 47,640 101,474 47,640 take-up Heating Allowance Number of eligible households 445,821 331,504 155,635 331,504 155,635 Impact with recommended adjustment to social assistance program Number of households with current 136,466 154,536 126,545 164,115 145,788 take-up Number of eligible households 397,066 449,644 368,199 477,515 424,190 Average monthly benefit (for 5 250 548 811 683 1,119 months) 110 Assumptions related to social protection estimates Low scenario High scenario 2014 2016 2020 2016 2020 No change in social assistance programs Income threshold for Ajutor Social 765 765 765 765 765 Income threshold for Heat Allowance 1,224 1,224 1,224 1,224 1,224 Adjustments in social assistance programs based on energy tariff increases Income threshold for Ajutor Social 765 903 1,186 941 1,274 Income threshold for Heat Allowance 1,224 1,444 1,897 1,506 2,039 111