Report No. 38360-IR Islamic Republic of Iran Power Sector Note January 9, 2007 Sustainable Development Department Middle East and North Africa Region FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. SABA so IranEnergy Efficiency Organization System Operator SPP Small Power Producers SUNA IranRenewableEnergy Organization T&D Transmission and Distribution TREC Tehran Regional Electricity Company TWh use Terrawatt hour US cents Vice President: Daniela Gressani Country Director: Joseph P. Saba Sector Manager: Jonathan D. Walters Task Team Leader: Anna Bjerde Table of Contents PREFACE ....................................................................................................................................................................... 1 EXECUTIVE ~S R ................................................................................................................................................. Y 2 CHAPTER1: OVERVIEWOFDEMANDFORELECTRICITY AND ITS CHARACTERISTICS ............................................ 12 CHAPTER 2: OVERVIEW OF ELECTRICITY SUPPLY AND THE IMPACT OF SUBSIDIZED NATURAL GAS .................... 19 CHAPTER 3: RENEWABLE ENERGY POTENTIALAND ENERGYEFFICIENCY OPPOR'IZTNITIES .................................. 28 CHAPTER 4: FINANCIALPERFORMANCE OFTHE SECTOR ....................................................................................... 36 CHAPTER5: THE INTRODUCTION OF A MARKET AND COMPETITION ...................................................................... 40 CHAPTER6: THE ROLE OF THE PRIVATE SECTOR .................................................................................................... 48 CHAPTER7: LEGAL REGULATORY FRAMEWORK AND ............................................................................................. 59 ANNEXES ANNEX 1A: HISTORIC CONSUMPTIONOFELECTRICITY (1995-2003) ..................................................................... 64 ANNEX 1B: ELECTRICITYEXPORTSAND IMPORTS. GWH(1992-2003) .................................................................. 65 ANNEX 2: FORECASTELECTRICITY DEMAND OF ...................................................................................................... 66 ANNEX 3: NETWORK MAP ........................................................................................................................................ 67 ANNEX 4: DEMAND SCENARIOS AND SAVINGS POTENTIAL ..................................................................................... 68 ANNEX 5: DETAILEDTECHNOLOGY-SPECIFIC ASSUMPTIONS FORLEVELIZED GENERATING COST CALCULATIONS .................................................................................................................................................................. 70 ANNEX 6: GERMANY'S EXPERIENCE WITH FEED-IN TARIFFS ................................................................................. 72 ANNEX 7: TEXAS RENEWABLES PORTFOLIOSTANDARDS ........................................................................................ 74 ANNEX 8: DETAILEDDESCRIPTIONOFENERGY EFFICIENCYMEASURESINTHE POWER SECTORUNDER IMPLEMENTATION .................................................................................................................................... 75 ANNEX 9: RECOMMENDATIONS FOR ENERGY EFFICIENCYAND INTERNATIONALEXPERIENCE .......................... 81 ANNEX 10: ELECTRICITY PRICES FOR VARIOUS CONSUMER CATEGORIES INIRAN .............................................. 88 ANNEX 11: DETAILEDCALCULATIONSFOR SUBSIDIES, CONTINGENT LIABILITIES ............................................... 89 ANNEX 12: ORGANIZATION OF THE ELECTRICITY SECTOR ..................................................................................... 92 ANNEX 13: COMPARING SCHEDULING REGIMESAND POOLPRICING INSPAINAND SCANDINAVIA ...................... 93 Contributors: This note was written by ateam comprising Anna Bjerde. Armarquaye Amar. Pierre Audinet. Scott Sinclair. Mark Moseley. Sophie Jablonsh. Rome Chavapricha and Franz Gerner. The authors are grateful for the guidance provided by Hossein Razavi and for the helpful comments from Habib Fetini. Vladislav Vucetic and Eric Groom. peer reviewers. The work was made possible through assistance from the Energy Sector Management Assistance Program (ESMAP) . Preface The FourthFive Year Development Plan' sets the stage for important reforms of the power sector inIran, some of which are now being implemented. In establishing the reform path, the Government of Iran (GoI) has reviewed alternative models from around the world and has incorporated lessons learned. The reforms are aimed at increasing the efficiency of the sector, both from a technical and commercial point of view. To facilitate the reforms, the industry has been unbundled and key institutions important for a liberalized market to function have been established, including a regulatory body and a markethystem operator. In June 2005, the World Bank was invited by the Government of Iran to engage in a dialogue on reform of the power sector, as well as to identify areas of cooperation. It was agreed that a Power Sector Note would be prepared which would review some of the key challenges in the sector, identify the strategic implications of the challenges, document international experience and provide a viewpoint on next steps2. In January, 2006, a workshop was held in Tehran to discuss private sector participation in the power sector and the development of a power exchange. During this workshop, the World Bank presented international lessons learned and was further informed of the Government's plans for reform. Through this dialogue, a number of areas of cooperation are emerging. These include Bank support to reinforce the transmission and distribution networks (given their important role as the backbone of the power system); technical assistance for price reforms, development of the power pool and private sector participation in generation; and assistance to step up energy efficiency. This cooperation will be presented inthe Country Assistance Strategy (CAS) for Iran currently under preparation. 'Managementand PlanningOrganization(2005) "Law of the fourth economic, social and culturaldevelopmentplan of the IslamicRepublicof Iran,2005-2009 (1384-1388)" enacted on September 1,2004. The Note is structured around 7 Chapters. In Chapter 1, demand for electricity is presented, including a description of the drivers of demand and the economic impact of reduced demand. Chapter 2 presents current supply strategies, with a focus on thermal power production and the impact of the subsidized natural gas that is availableto the sector. The options considered are only those currently operationaland therefore excludes nuclear, geothermal, etc. Chapter 3 presents Iran's potential for renewable energy and for stepping up energy efficiency measures. In Chapter 4, the financial performance of the sector - through the holding company Tavanir - is presented, including some estimates of the subsidies to the sector caused by below-costrecovery electricity tariffs. Chapters 5 and 6 review the Government's plans for the introductionof competitive electricity market and private sector participation;compares the plans to internationalexperience; and identifiesimportantnext steps to realizethe plans. Finally, in Chapter 7, the legal and regulatory framework that underpinsthe market development and private sector participationplans is presentedand analyzed. -1- Islamic Republic of Iran Power Sector Note Executive Summary Over the past decade, the Iranian electricity sector's ability to supply reliable service has come under increasing pressure. This i s evidenced by more frequent gas supply constraints to generation plants, high levels of debt and increasing losses in the network. The key roots of the problems in the sector are the under-pricing of natural gas which fuels the majority of the power generation, and the low retail electricity tariffs which lead to high per capita consumption of electricity and thus large investment requirements innew generation capacity to keep up with the demand. The Government of Iran i s aware of the challenges and i s pursuinga number of reforms to improve the performance of the sector, including private sector participation in the generation of electricity and implementation of a power pool with a view of developing a competitive market. While these reforms will eventually contribute towards a more sustainable sector, their implementation and success will require tackling the under-pricing of natural gas and electricity. Without tackling these issues, the impact of reformefforts will remain limited and to some extent academic, and run the risk of increasing the Government's fiscal exposure as under-writer of the policies and transactions in the sector. This Note reviews some key challenges in the sector and highlightstheir strategic implications. The Note also provides some suggestednext steps - in the form of a 'road-map' - to address the issues. Demand for electricity Consumption of electricity is high in Iran, as evidenced by per capita consumption of nearly 2,000 kWh per person (see figure 1) below. Demand has been growing at a steady rate of about 8% per year in the last few decades and the residential and industrial segments account for about a third each of the consumption. Demand i s projected to continue at this rate in the foreseeable future. Figure I: Per capita power consumption in Iran vs other MNA countries The high levels of consumption and the high annual consumption growth require substantial investment in new generation capacity and in the transmission and distribution networks to support service delivery. Indeed, over the period covered by the Fourth Five Year Development Plan (FYDP), a total of US$30billion i s required by the sector (see Table 1below). -2- IslamicRepublic of Iran Power Sector Note Table I: Investment requirements (billion rials) 2005 2006 2007 2008 2009 Total Generation 17,325 24,169 28,611 29,176 26,367 125,648 Transmission 9,773 13,427 18,345 24,73 1 32,893 99,169 Distribution 7,108 8,464 10,102 12,052 14,413 52,139 Total 34,206 46,060 57,058 65,959 73,673 276,956 The majority of the consumption is concentrated along the main cities of Tehran, Esfahan and Ahwaz. The networks servicing these consumption centers have losses ranging from the average for Iran as a whole to quite severe, as is the case inAhwaz (see table 2 below). Table 2: T&D losses in Iran and three major provinces (%), 2004 Tehran Esfahan 2.4 14.3 Khuzestan (incl. Ahwaz) 6.0 34.2 Source: Tavanir; TREC As a result of the high demand growth and the relatively high losses (average in the MENA region i s about 15% and in the OECD countries it is about 6%), there are significant investment needs in the sector, averaging about US$6 billion per year, close to 4% of GDP3. This level of investments into the sector i s very high by international standards and is primarily driven by the under-pricing of electricity which, in turn, results in excessive consumption by households and possibly keeps otherwise non-competitive industries operational. This implies that Iran could be over-investing in power system assets. This Note estimates that a reduction in demand from the projected 8.6% to 7% or 5.5% on average per year would generate savings inthe order of 1.5% - 2.8% of GDP in avoided investments and avoided gas consumption, ranging from 0.12% of GDP at the current subsidized cost of natural gas to 3.4% of GDP at the assumed economic cost of natural gas4. Such a reduction in demand growth would require action on several fronts, including a reduction in the network losses and an aggressive demand-side management program targeting each consumer category. Electricity supPlv and the impact of subsidized natural gas Installed capacity has essentially doubled in the past ten years, reaching 34 GW in 2003, while the reserve margin has deteriorated to about 19% (with significant seasonal variations reaching a low point below 10% in the summer). Deeper regional integration could be incorporated to manage geographical and seasonal electricity requirement and to enhance Iran's overall energy trading program. GDPin2004/05 was US$158.6 billion(IMFStaff Report for the 2005 Article V Consultation). 4Economic cost assumed as 420 rialdm3 by Tavanir, or US$I.Ymmbtu. -3- Islamic Republic of Iran Power Sector Note The highly subsidized price for natural gas to the power sector (28 rials/m3,US$ 8/mmbtu) has resulted ina large share of steam-cycle and single-cycle gas turbines inthe generation technology mix, with a slower incorporation of combined-cycle gas turbines and hydro-power technologies. Figure 2: Technology Mix in Power Generation (1980-2002) Steam i l Gas Tubine 0 C.C. Diesel Hydro BUWind Energy 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% ~ 980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 Source: Tavanir (2003-2004) To assess the impact of natural gas prices on new generation capacity, this Note has estimated the marginal cost of electricity production based on variations inthe natural gas price. Tables 3 and 4 illustrate that at - and beyond - US$1.3/mmbtu, CCGT and large hydro become the most economical technology options. The technologies would also have significant impact on emissions, in that CCGT has a much greater fuel efficiency than steam-cycle power plants and hydro-power would replace gas-fired power plants altogether. The low price charged for natural gas i s widely debated in Iran and, as long as it remains as low as it is, it appears to slow down decisions regarding improvements to natural gas infrastructure and storage which, in turn, i s requiredto eliminate the increasingly common natural gas supply shortages to the sector. The debate is also based on several views on the availability of gas in Iran (i.e., the reserves) and on a policy for its allocation. Table 3: Levelizedelectricity generation costs US$/MWh) Small Gas Mediudarge Combined Cycle Gas Hydro Wind Turbine Gas Turbine Turbine (indicative) Capacity cost 5.30 7.62 7.42 11.22 14.68 52.53 Energy cost 2.45 2.77 2.30 3.32 2.70 9.27 Total cost 7.75 10.39 9.72 14.54 17.38 61.80 -4- Islamic Republic of Iran Power Sector Note Table 4: Sensitivity of levelized electricity generation costs tofuel prices (US$/MWh) MediumLarge Combined Steam Large Wind Turbine Gas Gas Turbine "`le Gas Turbine Plant hydro Natural gas price = $0.77 per mmbtu 14.29 16.92 14.20 20.36 17.38 61.8 Natural gas price = $1.3 per mmbtu 18.86 21.50 17.34 24.44 17.38 61.8 Renewables and energy efficiency Inreviewing Iran's power supply options, it is important to consider its renewable resources. Indeed, Iran has substantial potential for the development of renewable energy, including wind, solar and hydropower. Significant research, development and pilot projects have also been implemented to demonstrate the technical feasibility of the resources. The key barrier to fulfilling the potential rests with the subsidies on conventional power production, notably the price for natural gas. These subsidies, in addition to the overall shorter lead-times for construction of thermal power plants, have hampered development of renewable projects. Today, many renewable projects remain stranded with incomplete financing plans after several years of preparation, feasibility testing and - in some cases - partial construction. Likewise, in energy efficiency, Iran has introduced several measures to promote energy efficient consumption, including fuel switching, energy audits, development of standards, distribution of energy efficient light bulbs (CFLs) and introduction of mandatory energy performance labels for electrical appliances. Nevertheless, demand remains very high. This, as in the case with the relatively modest achievements on renewables, is largely due to the lack of economic cost recovery inpricingof electricity. Other common barriers to wider scale development of renewables and energy efficiency include a somewhat fragmented institutional set-up, with several organizations involved in promoting renewables and energy efficiency, but lack of clarity on roles and responsibilities. This was however addressed in 2004 when the Ministry of Energy was appointed - legally - to handle renewable energy development. Under this arrangement, the Renewable Energy Department within the Ministry of Energy is responsible for renewable policy and planning while the Iran Renewable Energy Organization (SUNA) i s responsible for the implementation of renewable projects. Furthermore, beyond the support for both renewables and energy efficiency in the Fourth FYDP in which feed-in tariffs to guarantee the purchase of renewable energy are supported, the existing legal and regulatory framework need to go further to adopt more specific measures and incentives to promote these two important elements of a more sustainable power sector. Therefore, Iran is encouraged to set targets for renewable energy, but it also needs to ensure that that the legal, commercial and regulatory frameworks be put in place to achieve the targets. This i s particularly imperative in the case of hydro-power, where Iran possesses a strong capability for construction and management of hydro-power plants and where capital costs are close to those of thermal power plants when using economic natural gas price. Strategically, the modest achievements to date in both of these areas represent missed opportunities for Iran to save on costly thermal power generation. -5- IslamicRepublic of Iran Power Sector Note Financial performance and cost of subsidies The financial revenues and costs are consolidated at the level of Tavanir, the electricity holding company. Tavanir also plays a role in managing the sector's cash flow. Due to lack of cost recovery, Tavanir borrows funds from local banks to meet the cash flow requirements of the sector. These loans are guaranteedby the Government and are reported to eventually convert to grants. In 2003, the average price for electricity in the sector was 132 rialskWh, while the average cost to supply electricity to end-users was estimated at 331rials/kWh (see table 5 below). Table 5: Electricity tarifs and subsidies in 2003 (rialsikWh) Consumer Cost to Price at which electricity Subsidy as a % category supply was sold at of set price Residential 407 97 310 76% Public 318 152 166 52% Agriculture 323 14 309 96% Industrial 289 163 126 44% Commercial 396 412 Average 3315 132 200 60% Source: Tavanir (2003-2004) The tariff policy established under the Fourth FYDP states that electricity prices should remain constant during the first year (2004) and that any changes would require approval by the Parliament. Recently, tariff increases are reported to have been proposed for parliamentary approval. This Note attempts to calculate the level of deficits inthe sector by estimating the revenue deficit due to below-cost recovery tariffs. The analysis i s not detailed but is intended to provide a sense of the magnitude of the subsidies, so as to facilitate the debate on this issue and on the overall need for price reforminthe sector. Based on the forecast of electricity consumption at 8.6% demand growth, the revenue deficit based on the pricingpolicy inthe Fourth FYDPwould amount to close to US$4.7 billion per year (see figure 3 below). Figure 3: Electricity Subsidies Source:Tavanir Rials US& 2,129,538 GWh verage tariff in 2003 132 1.7 Over 10years verage cost of service supply in 2003 331 4.1 = US$4.7 billion/year A sensitivity analysis has been undertaken, to assess the impact on the deficit from variations in the natural gas price and the average cost of transmission and distribution in the sector. As figures 4 and 5 illustrate below, the revenue deficit would range from US$1.25 billion to US$4.1 billion (at 3.8 USGkWh). -6- Islamic Republic of Iran Power Sector Note Figures 4 & 5: Sensitivity Analysis Distribution(int. benchmark)* 1.5 -2.0 US$411 billion/year Q 3.8 US@/kWh Transmission (int. benchmark) 0.5 US3.1 billion/year Q 3.3 US@/kWh Generation (marginal cost for medium-sized GT) 1.3 1.3 US$l.25 billion/year Q 2.3 US@/kWh Distribution (int.benchmark)* 1.5 2.0 - 2,129,538 GWh Over 10 years = Transmission (Int. benchmark) 0.5 US$2.75 billion/year Q 3.1 USdkWh Generation (marginal cost for medium-sized GT) 2.1 2.1 International Benchmark based on mature T&D system US$4.1 billion represents close to 3% in 2004/05 GDP figures. It i s important to note that this figure is based on the subsidized price of natural gas. Hence, it does not include the opportunity cost of the gas. This Note has estimated the opportunity cost of the gas (required to generate electricity to meet the demand projections at 8.6% annual demand growth) as being an additional US$4 billiodyear. Development of national electricity trading The Government of Iran has established, as a policy objective, the creation of a competitive market for the supply of electricity. The purpose of this is to enhance efficiency and the reliability of supply. To implement this goal, important institutions have been established, including the Iran Grid Management Company (IGMC), which serves as both system operator and market manager, and the Electricity Market Regulatory Board (EMRB), which reviews and proposes prices in the sector and assesses options for further market and regulatory evolution. The market rules of 2005 allow for a fully-fledged competitive market to develop. A truly competitive market will take some time to develop, given that certain pre-requisites for such a market are not yet in place. These include a reliable transmission network to serve as the backbone of the power system, i.e., the 400kV. Furthermore, international experience shows that markets do not work well when the competition i s between subsidiaries of the same holding company, particularly when such companies have limited financial autonomy. The Government recognizes this, and i s currently focused on putting in place a power pool, whereby dispatch of electricity is centralized - allowing for a merit order to be followed - and forcing the uniform set pool price towards the marginal cost of electricity supply. However, several important challenges will not be addressedby the power pool. For instance, given the low price for natural gas, there i s no incentive for public or private market participants to construct CCGTs, given their relatively higher capital cost. Furthermore, the lack of fuel diversification and indeed fuel price competition limits the competition among generating units to O&M costs, which are likely to differ very little, given that the majority of generation assets comprise steam cycle and gas turbines. -7- Islamic Republic of Iran Power Sector Note Going forward, and with the immediate goal of making the power pool function, it will be important for the Government to focus on key steps, such as transferring high voltage assets to the IGMC to enable it to fully function as a marketkystem operator; improving information systems for dispatching and updating; and clarifying the role of the national grid. Improvement of the pricing methodology may also be necessary by, for example, the introduction of capacity payments so as to diversify the generation technologies used. Finally, and despite the role of Tavanir in the settlement process to ensure pool participants can recover cost, the introduction of the power pool is bringingbenefits in that it forces transparency in the cost of electricity supply which, in turn, will facilitate the debate on price reform in the sector. Involvingthe private sector The Government is paving the way for private participation in the sector, initially in the generation segment. The objective is to increase efficiency and reliability of supply by involving the private sector. This will be achieved by reducing the debt burden of financing new power plants in the public sector and relying on the expertise and efficiency of the private sector in the construction, completion and operation of new and existing power plants. So far, the interest by the private sector has been driven by domestic investors, with some agreements (e.g., O&M) with foreign suppliers. The involvement of the private sector i s a good initiative, and starting with generation sub-sector makes sense, given the significant investment needs in this sub-sector and the ability to attract investors to it. Nonetheless, the Government of Iran needs to be aware of the risks. Firstly, while the financing of the power plants will be shifted off of the balance sheet of the public sector, the Government will be assuming significant contingent liabilities by guaranteeing the Energy Conversion Agreements (ECAs) being put in place. Indeed, this Note has estimated the annual obligation will amount to about US$1billion, once several of the BOO and BOT projects are operational. Moreover, most of the new plants are based on single-cycle gas turbine technology and do not include any provisions or incentives for conversion to CCGT down the road. Having said that, the single-cycle gas turbines will allow for a retirement of the steam-cycles and, as such, they are a step in the right direction, as long as they can eventually be converted to CCGT. Also, the overall rate of returnrequirements of the private sector, which reportedly averages 20%- 25%, reflects investors' perception of risk and will need to be compensated in the tariff agreed to under the ECAs. This risk, in addition to the fuel supply risk, i s assumedby the Government and, needless to say, should there be fuel shortages and the private generation plants are inoperational for some period of time, the tariff will still need to be paid. Therefore, the strategic implication of involving the private sector points to the need for the Government to monitor carefully its guarantees in the sector. Furthermore, this Note recommends that the Government review its overall generation strategy, in light of the plans to have greater private sector participation and move towards a more competitive market. Given the high demand growth, it is likely that there will always be elements of base-load demand which would warrant long-term contracts. The Government may, therefore, wish to consider liberalizing the market at the margin, starting, for example, with highvoltage customers. Legal and regulatory framework The plans for reforming the power sector are comprehensive and include several elements of reform. However, the main legislation that governs the sector dates back to 1967 and i s basedon -8- Islamic Republic of Iran PowerSector Note a vertically integrated power sector with a monopoly on generation, transmission and distribution. This law has been at the center of debate and has been requested to be updated and proposed in the form of a new law to the Parliament. Nevertheless, the new law remains in draft form and has not been submitted for approval, likely due to further need to reach consensus on the future structure, ownership and regulation of the sector. In contrast, significant progress has been made on passing a new investment law, the Foreign Investment Promotion and Protection Act (FIPPA). This act i s of international best practice standard and covers all the key features an investment promotion act is expected to cover. However, notwithstanding the FIPPA legislation - and the openness of the Government to foreign investment -there i s still a lack of significant foreign investment inthe power sector. This Note includes a review of the major legal frameworks that affect the power sector but concludes that the most important next step will be for the 1967 law to be revised and updated. This will force the Government to articulate its intentions with regard to ownership and industry structure, both of which are critical elements to a successful program of private power and achieving the envisaged efficiency gains of the power pool, and ultimately a competitive market. Looking forward - Elements of a RoadMap The power sector in Iran has, inmany ways, gone as far as it can interms of implementation of its intended reforms. On the one hand, there are many advanced sector reforms being contemplated and initiated, including competition in the market and involvement by the private sector. On the other hand, several non-commercial practices remain (e.g., tariffs and subsidies) which are problematic in themselves and which will ultimately stand in the way for a more full-fledged implementation of the reforms. The scope of this Note i s not to provide definitive recommendations to the Government of Iran on what to do next, nor how to do it. Rather, the scope of the Note i s to highlight the strategic implications of some key aspects of the sector and to capture possible next steps in the form of a Road Map below. The Road Map i s intended to guide the debate and to facilitate identifying the trade-offs in proceeding with the reforms of the sector, given that all worthwhile efforts come with a series of compromises and trade-offs. The main challenges in the sector essentially come down to three: subsidy and tariff reform; planning for adequategeneration; and ensuring reliable and efficient transmission and distribution of electricity supply. Depending on the desired scope and pace of reform, there are a number of steps in each of these areas that need to be taken. Some of these steps are summarized below. Subsidy and Tariff Reform: The subsidy on natural gas causes significant distortions in the sector, as well as sub-optimal decision-making on technology. Therefore, to arrive at a more balanced energy resource development strategy in Iran where more efficient generation technology i s implemented, the natural gas subsidy to the sector needsto be phased out. Eliminating the natural gas subsidy to the power sector will contribute to establishing the real cost of electricity supply. Cost recovery can then be introduced step by step, starting with the generation segment. This would improve the creditworthiness of the generating companies, allow for the power pool to function better without the interference of the holding company, and create a more level playing field for public and private power. -9- Islamic Republic of Iran Power Sector Note Subsidy support can then be provided in the transmission and distribution sub-sectors, with the subsidy being gradually phasedout, beginning inthe transmission sub-sector. Work can then commence on achieving a more flexible retail tariff regime (e.g., removing the equalized retail tariffs), and targeted social support mechanisms for eligible consumers can be designed and implemented. This will help establish a more sustainable financial foundation for the sector and provide the necessary signals for more efficient energy usage. Generation Planning: The objective is to achieve a more efficient generation mix, funded and implemented increasingly by the private sector, with fuel supply constraint bottlenecks removed. The phasing-out of natural gas subsidies would improve the generation mix, leading to the construction of more combined cycle gas turbine plants and competitive hydro-power plants. However, since the full elimination of gas subsidy will take some to achieve, the government policy should support construction of CCGT and economically feasible hydro projects. The increase in combined cycle facilities would enhance local manufacturing capacity of the technology, which would, over time, bringdown the costs. Given the size of the market and the growth in demand, there i s room for both public and private power, including long-term contracts as required by the private sector, but the Government should consider reducing its take or pay obligations on the margin, forcing private investors to also compete for market-share. The contracts with the private sector should build in flexibility and incentives to construct CCGT or enable conversion of single-cycle to CCGT. The key incentive inthis regard i s gas- pricing, which would be more effective than promoting CCGT through for example capital subsidies. Besides gas pricing, prospective investors could be given flexibility on when and how to apply the CCGT option through (a) investment decision (system expansion) where for CCGT results from "market-derived'' (economic merit order dispatch) benefits that would accrue from low heat rate or; (b) investment decision (loss reduction) where for CCGT i s selected as a means to accelerate the phase-out of existing low-efficiency "Steam Turbine Power Plants". Given the potential for less competitive renewable sources, such as wind, the Government could consider mandated market shares to promote their development which, in turn, will pave the way for price reductions on capital costs over time as well as develop technical know-how. Efficient transmission and distribution of electricity supply: To achieve improved reliability, the power pool must dispatch electricity in the most economic way; the transmission and distribution networks must support the required levels of service provision and there must be no constraints preventing capacity-rich provinces from supplying capacity-poor provinces. For this to happen, the power pool needs to be further operationalized. This will require the transfer of the transmission assets to the IGMC; the design and implementation of new IT systems; and revisions to the technical and commercial market rules. The highvoltage transmission network will need to be expanded and modernizedto allow for unconstrained transfer of electricity, including loss reduction. The distribution network needs to be reinforced and rehabilitated for loss reduction, so that service provision to consumers i s satisfactory and payment discipline can be maintained and further improved among government consumers. -10- Islamic Republic of Iran Power Sector Note Once better cost recovery is achieved in the sector, the power pool can start evolving away from the single buyer model to a market with an increasing share of bilateral contracts. This can happen inphases, starting with high voltage consumers. -11- Islamic Republic of Iran Power Sector Note Chapter 1: Overview of demand for electricity and its characteristics 1.1 Demandfor electricity in Iran has been growing at a steady rate of 8%per year for the past few decades and is reported to be closer to 10% at present. Demand is driven by increased consumption among households as well as steady economic growth. Although increased demand for electricity ofren signijies a growing economy, it can also signify lack of energy efSicient production and consumption patterns. In the case of Iran, the heavily subsidized retail electricity tariffs ranks Iran as one of the countries with the highest per capita power consumption in the Middle East and North Africa Region and is putting signijicant pressure on the system to supply electricity without interruption and forcing huge investments in new generation capacity every year. Indeed, this Note estimates that a reduction of afew percentages in demand provides savings potential in capital investments equivalent to 1.5%-2.8% of Gross Domestic Product (GDP) as well asfie1 savings rangingfrom 1.85%-3.4%of GDP. Introduction: 1.2 Per capita electricity consumption i s relatively high in Iran compared to the rest of the Middle East and North Africa (MNA) region, but relatively low compared to other industrial countries (see Figures 1and 2). Figure 1: Per rapita power consumption in Iran vs other Figure 2: Per capita power consumption in Iran vs other MNA countries industrial countnes 1.3 Energy intensity on the other hand (as defined in relation to GDP), i s higher in Iran than in most industrialized countries and also higher than more densely populated developing countries such as India or China6 (see Figure 3). The Iranian energy consumption pattern resembles the structure of energy demand in industrialized countries in that it has relatively low non-commercial energy demand, a high share of building sector energy end-use (heating and appliances) and a high share of electricity consumption. World Energy Council (2001) PricingEnergy in DevelopingCountries. World Energy Council, London, UK. -12- Islamic Republic of Iran Power Sector Note Figure 3: Comparisonof energy intensities between countries (2004) toe / 000' 95 US$ of GDP i 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 1 iource: World Bank (2004) 1.4 Access to electricity i s close to 100% in Iran and demand for electricity has been growing at an average rate close to 8% per year over the past few decades. Total electricity connections reached 18 million in 2003 and domestic consumption reached 114 TWh. In addition, there i s demand for Iranian electricity in neighboring countries, through power interconnections with Azerbaijan, Turkey, Armenia, Turkmenistan, Pakistan and Afghanistan. Although quite small, Iran exported 919 GWh in 2003. Furthermore, imports were greater than exports in 2003 (see Annex 1 for a presentation of past consumption of electricity as well as the import and exports for the period covering 1992-2003). Characteristics of demand for electricity: 1.5 Of the total final electricity consumption in 2003, residential and industrial consumers represented the largest shares (around one third each). Their share of the consumption has remained steady since 1995 (see Table 1.1). Agricultural and public electricity consumption amounted to around 12% each. Consumption data for the period 1995-2003 (Annex 1) shows that residential consumption grew at an average annual rate of 6.3%, industrial consumption at 7.1%, public consumption at 10.4% and agricultural consumption at 12.5%, while commercial consumption declined by 0.3%. Table 1.1: Electricity consumption per consumer 1995and 2003 1995 2003 GWh % GWh % Residential 23,374 35.5 37,967 33.1 Public 6,203 9.4 13,714 12.0 Agricultural 5,402 8.2 13,859 12.1 Industrial 21,390 32.5 36,951 32.2 Commercial 7,655 11.6 7,461 6.5 Others 1,830 2.8 4,672 4.1 1.6 At the same time, the load factor (i.e., the ratio of average demand to peak demand) has grown from 60% in 1995 to over 65% in 2003, indicating an increase in base and mid-load demand and thus -13- IslamicRepublicof Iran Power Sector Note increased efficiency of the system. In terms of peak-load, the highest demand in Iran occurs in the summer months (May-August) and peak demand reached 27 GW in 2003. 1.7 Demand growth i s driven by population growth and increase in income which has resulted in a larger use of electricity in consumer appliances. Iran's estimated GDP for 2004/05 was US$158.6 billion and real GDP growth has averaged around 6% for the past few years'. 1.8 Energy intensive industry also accounts for a significant share of electricity consumption (see Table 1.2 for a list of the largest industrial consumers inthe Tehran area as an example). Table 1.2: Largest electricity sectors in Tehranprovince Sector MW Automotive industries 138 Cement 57 Other manufacturing 31 Underground transport services 26 Oil pumping station 26 Services (radio and television broadcasting station) 10 1.9 There are significant regional disparities in electricity consumption in Iran with the largest shares of consumption concentrated along the main cities of Tehran, Esfahan and Ahwaz. The single largest share of the consumption takes place in the Tehran province (21% of the total electricity consumption in 2004). Future forecast of electricity demand: 1.10 According to forecasts prepared by Tavanir, the national power sector holding company, peak load i s projectedto grow at about 8.6%per annum over the 10year period, 2005-2015 to reach 70 GW by 2015, or 400 TWh (see Figure 4 and Annex 2 for detailed forecast). This forecast takes into account continued efforts to reduce electricity price subsidies (see chapter 4) and continued improvements in income and GDP growth. Although the forecast considers a gradual reduction of price subsidies, this i s expected to have little impact on demand given the prevailing very low tariffs. 'InternationalMonetary Fund(IMF): Staff Report for the 2005 Article V Consultation. -14- Islamic Republic of Iran Power Sector Note Figure 4: Iran's peak 1oad.forecast2005-2015 80000 --7 70000 60000 50000 v U -g 40000 Y a 30000 20000 I 10000 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Tavanir (2003-2004) 1.11 The continued growth in electricity demand challenges the Iranian power system's ability to meet demand. As a result, load-shedding (Le., cutting off the electric current on certain lines when the demand becomes greater than the supply) still occurs in certain parts of the country (it was on average 1.7 minutes per day in 2003, compared to 3.9 in 1998)'. Furthermore, in 2002 and 2003 Iran was a net importer of electricity. Although imported electricity is small and some of it may make sense due to the interconnections with exporting countries near the load centers in Iran, it may reflect the difficulty of the sector to keep up with demand. 1.12 The quality of the transmission and distribution networks i s also contributing to the reliability of supply problem. The system losses in 2003 (excluding auxiliary uses) comprised transmission losses (5.1%) and distribution losses (12.5%). Average losses in the Middle East and North Africa Region in transmission and distribution are about 15% and in OCED countries it i s about 6%'. Yet, there are considerable variations between the 16 different electric power regions of Iran. Table 1.3 presents the losses in Iran on average and the three largest consumption centers, individually. Effort to reduce the losses i s a key priority inthe sector, but financial constraints pose a major challenge. Table 1.3: T&D losses in Iran and three major provinces (%), 2004 Tehran Esfahan 2.4 14.3 Khuzestan (incl. Ahwaz) 6.0 34.2 Source: Tavanir; TREC 1.13 In 2003, the 400 kV lines totaled 11,361 kmcircuit, 230 kV lines were 22,419 kmcircuit , 132 kV lines 14,972 km and the 66 kV lines 32,776 km. In 2003, the 400 kV network represented 33.6% of the 400-230 kV network length, against 23.8% in 1978. Nevertheless, the length of high voltage network ~ ~~ Tavanir, January 2006 World BankEnergy Mission. Basedon Proceedingsfrom RegionalRoundtableon Water and Power inthe Middle East, May 2004, Marrakech, Morocco, organizedby the World Bank. -15- IslamicRepublicof Iran Power Sector Note i s still insufficient given the size of the country. Interconnection of networks i s particularly important given the plan to develop a domestic electricity market (see chapter 4). A map of the transmission infrastructure is attached inAnnex 3. 1.14 Investment in new generation to keep up with demand, in addition to the need for rehabilitation and extension of the transmission and distribution networks i s substantial. Most of the investments have been undertaken by the public sector to date, but increasingly the private sector i s starting to contribute to investment needs, particularly in generation of electricity. The investment plans include reinforcing the 400 kV network along the north south corridor between the cities of Ahwaz-Arak-Tehran and connecting the cities of Busher, Esfahan and Fasa along the southern coast to meet the growth of large industrial consumers and to reinforce the interconnection between the Khorassan province and the rest of the country (with Tehran in the north and with the central southern provinces of Yadz and Kerman). Table 1.4 presents the investment needs in the sector under the Fourth FYDP. As i s shown in Table 1.4, a total of 276,956 billionrials ( U S 3 1 billion) i s required duringthe period 2005-09. Table 1.4: Investment requirements (billion rials) 2005 2006 2007 2008 2009 Total Generation 17,325 24,169 28,6 11 29,176 26,367 125,648 Transmission 9,773 13,427 18,345 24,73 1 32,893 99,169 Distribution 7,108 8,464 10,102 12,052 14,413 52,139 Total 34,206 46,060 57,058 65,959 73,673 276,956 Impact on demand growth from increased elasticity of demand: 1.15 According to forecasts by Tavanir, Iran will need to add about 45 GW of generation capacity by 2015. As stated earlier, there has been little attention given to the elasticity of demand in Iran given the low retail prices and thus the limited incentive to reduce consumption as a result of price increases. However, given the impact of growing demand on investment requirements, there are potential savings in terms of avoided investments should demand be reduced. The calculations are based on analyzing alternative scenarios of electricity demand growth at annual rates that could possibly result from electricity price increase and slower economic growth than the base case calculated by Tavanir (i.e. average annual growth rate of 8.6%). Scenario 1 has an annual growth rate of 7.0%, still high by international standards, but lower than the growth rate observed inthe decade 1995-2005. Scenario 2 has an annual growth rate of 5.5% which may result from a combination of higher electricity prices, more aggressive end-use efficiency measures as well as a slower economic growth. By 2015, total electricity consumption would be reduced by 14% in scenario 1and 25% in scenario 2 compared to the base case. Over the period 2005-2015, a saving of 246 TWh would be achieved in scenario 1 and 457 TWh in scenario 2 (see Figure 5 below). Figure 5: Electricity demand scenarios, 2005-2015. -16- Islarmc Republic of Iran Power Sector Note 400,000 350,000 300,000 250,000 200,000 150,000 m a b c o m o - N o 6 m 0 0 0 0 0 - - - - - - 0 0 0 0 0 0 0 0 0 0 0 N N N N N N N N N N N Source: Tavanrr: WorldBank 1.16 Lower electricity demand would in turn require reduced investments in new generation capacity. By 2015, capacity saved compared to the base case amount to 7.6 GW in scenario Iand 13.9 GW in scenario 2. In addition, avoided new generation capacity would translate into fuel savings. Assuming all saved capacity i s using natural gas, lower electricity demand translates into annual savings amounting to cumulative figures of 63 billion cubic meters (bcm) in scenario 1 and 117 bcm in scenario 2 over the period 2005-2015 (see Table 1.5 below and Annex 4 for details). Table 1.5: Avoided generation capacity andfuel savings compared to base case. Assumptions: - All capacity saved i s inthe form of large gas turbines (159 MW boiler plate) operating at a plant factor of 83%. - Natural gas savings calculated using an average (de-rated) heat rate of 9150 Btuper kWh. Source: World Bank. -17- Islamic Republic of Iran Power Sector Note 1.17 Using capital cost figures of US$296 per kW" installed of additional electricity generation, the lower electricity demand scenarios translate in total capital investments savings equivalent to 1.5% of GDPinscenario 1and 2.8% of GDPinscenario 2 (see Table 1.6 below). Additional savings are achieved through lower natural gas consumption for electricity production. At the current price of gas of 28 rials/m3, the lower electricity consumption translates into a direct financial fuel saving over 2005-2015 amounting to 0.12% of GDP in scenario 1 and 0.23% of GDP in scenario 2. At 420 rials/m3,the fuel savings reach 1.85% of GDP in scenario 1and 3.43% of GDP in scenario 2. - Scenario 1 Scenario 2 Electricity demand (expressed as generation growth) 7.0% 5.5% 2015 avoided generation 1I %% -14% -25% *assuming all capacity savedis in the form of new gas turbines to be installed(figuresinyear 2004US$) **GDP figures used inthe calculationare inyear 2004 US$ Capital cost of $296 per kW installed Gas savings are calculatedin2004$, usinga 10%discount rate Source: World Bank. 10Average cost for medium size single cycle gas turbines inEgypt. -18- Islamic Republicof Iran Power Sector Note Chapter 2: Overview of electricity supply and the impact of subsidized naturalgas 2.1 Most of Iran's electricity is generated by thermal power plants using natural gas as the mainfuel. Theprice for natural gas to the power sector is remarkably low at 8 US$/mmbtu - as a comparison, gas to Europe on pipelines or as Liquefied Natural gas (LNG) on long term contracts sellsfor $4-5/mmbtu1'. The natural gas subsidy impacts generation planning and decision-making and is a key reason for the wide use of single-cycle gas turbines, the deferred retirement of steam-cycle plants and the under- development of renewables, notably hydro-power. Furthermore, the subsidies are slowing down government decision-making on the allocation of natural gas to different sectors, including the power sector, resulting in gas shortages at times and the need to usefuel oil which could otherwise be exported. Introduction: 2.2 Iran's installed capacity was 34 GW in 2003 and production reached 149 TWh12. As shown in Figure 6, nominal electricity production capacity doubled between 1992 and 2003 and during the same period the average annual reserve margin deteriorated to about 19% in 2003. Demand for electricity varies greatly during the year in Iran and so does the reserve margin, reaching - in 2003 - a maximum of 30.5% inJanuary-February and a minimuminJune-July of 8.8%. Figure 6: Electricity generation capacity (1988-2003) 35000 ------ _II 60% 30000 t 4 50% 25000 40% 20000 30% 15000 10000 20% 5000 10% 0 0Yo 92 ,90%,9 @ 90 9%,9 9%99%,9 g! 9% 96 ,9 ,9 ,9 ,9 ,9 ,9 90 9 00 0, 0%$04 ,99 rp rp rp 0Peakbad(MW) -Reserve margin(O/. of peak load) Source: Compiledfrom various report and documentsfrom Tavanir. Iran's gas: I 1Inaddition,the average 2006price for naturalgas at the HenryHub Spot Market was US$8/mmbtu. 12 Tavanir Report: "Electric Power in Iran", 2003-2004. -19- Islamic Republic of Iran Power Sector Note 2.3 With 971 Tcf of proven reserved3, Iran has the world's second largest gas reserves (see Table 2.1 below). About 10percent of Iran's gas reserves are inthe South Pars gas field, the largest gas field in the world. Other major gas fields in Iran include North Pars, Kangan, Nar and Khangiran. The current reserves to production (W)ratio i s over 100 years and the share of Iran's proven gas reserves is 15 percent of total proven world gas re~erves'~. Table2.1: Proven Gas Reserves, 2004 Source: BP Statistical Review of World Energy. June 2005 2.4 Iran currently produces 85 Bcmof natural gas annually or 3.2 percent of total world production (see Table 2.2 below). Considering its large reserves, there i s enormous potential to increase production in the near future. But Iran faces challenges to capitalize on its reserves. Lack of investment in pipeline infrastructure and storage has forced the power sector to rely on fuel oil for power production during the winter months in recent years when residential demand for gas i s high. For example, in 2003, the steam power plants consumed about 6 Mtoe of fuel oil, representing an economic cost of close to US$1billi~n'~ and Iran imports natural gas from Turkmenistan to supply fuel to power plants in the north-eastem part of the country. As in the case of electricity imports, importing gas i s logistically useful given that Iran's gas reserves are concentrated in the south and the imported gas i s coming in from the north. Nevertheless, given the deteriorating capacity reserves margin in Iran, additional pressure on security of supply due to possible gas import (or electricity) interruptions would have significant negative impact on supply availability inIran. Table 2.2: Gas Production, 2004 Source: BP Statistical Review of World Energy, June 2005 l3 StatisticalReviewofWorldEnergy,June2005. BP 14BP Statistical Review of World Energy, June 2005 Assuming a calorific value o f 42 GJ/t and a price of US$154.5/ton based on average 2003 Mideast Gulf price of high sulfur oil (3.5% sulfur (source: Energy Intelligence). -20- Islamic Republic of Iran PowerSector Note 2.5 The under-investment in the gas infrastructure may also be closely linked to US sanctions16, which keeps US companies out of Iran and also serve as a disincentive to other countries' firms and multinationals because of the threat of secondary sanctions. US policy also discourages the import of Iranian gas and as such the opportunity cost of using gas domestically i s reduced. Nevertheless, the continuedheavily subsidized natural gas prices to the sector hinders investment and slows down decision- making as to allocation of natural gas given the opportunity costs involved in supply to the power sector. At the same time, the domestic demand for oil products has increased and oil exports have gradually declined. Today, Iran, despite having a major share of the world's oil reserves, has become a net importer of petroleumproducts. For the financial year that ended inMarch 2006, Iran is reported to have imported petroleum products worth US$4.5 billion (close to 3% of GDP using the 2004/05 figure of US$158.6 billion). There could be reasons of economic geography behind the import of petroleum products, but import requirements are also reported to be closely linked to lack of investment in refining capacity and the rapidly growing demand due to low retail prices. 2.6 Today, most of Iran's gas i s consumed domestically. However, an operational gas pipeline exists with Turkey for exports (see Table 2.3 below) and with Turkmenistan for imports. Iran imported 5.2 Bcm of natural gas from Turkmenistan in 2004 and an accord recently signed between Iran and Turkmenistan will see Turkmenistan increase its natural gas exports to Iran to 14 Bcmlyear by 2007. Iran pays a competitive price for the gas which i s reported to be about $65/Mcm (or US$2.3/mmbtu)". As a comparison, the economic cost of domestic gas is estimated at US$1.3/mmbtu (see more below in paragraphs 2.13-2.17) and gas to Europe on pipelines or as LNG on long term contracts sells for $4- 5/mmbtu. Table 2.3: Exports to Turkey in million cubic meters To Turke 2003 3520 2004 3550 4322 Source: Boras website, 2006 2.7 Besides Turkey, potential piped gas markets for Iranian gas include Europe, South Asia (India, Pakistan) and the south Caucasus (Armenia, Azerbaijan, Georgia). LNGexport markets include Taiwan, South Korea, Japan and China. British Gas and the National Iranian Oil Company are developing a $2.2 billion LNG plant at Bandar Tombak on the Persian Gulf coast. The plant i s to comprise two LNGtrains, with capacity of at least 4 milliontons per year each. This plant i s planned for completion in 2008. Natural gas inthe Dower sector: 2.8 To increase oil exports, the Government has been implementing a fuel switching strategy to increase the use of natural gas in the power sector - a cleaner fuel with a lower economic value than oil - and to pursue non-fossil fuel technologies such as hydro and renewables. Today, most of the electricity generation is based on natural gas and the share of oil (heavy fuel oil and to a lesser extent, diesel) has l6 1995 Executive Orders (extended by President Bush in March 2004) prohibiting US companies and their foreign subsidies from conducting business in Iran and the US Iran-Libya-Sanctions Act (ILSA) of 1996 (renewed for 5 more years in 2001) imposes mandatory and discretionary sanctions on non-US companies investing more than US$20 million in the Iranian oil and natural gas sectors. Sanctions on Libya were recently lifted. l7"Gas Matters", April 2006 -21- Islamic Republicof Iran Power Sector Note fallen to 18% (see Table 2.4 below on the fuel mix in Iran and a few other countries with significant hydrocarbon resources). As i s illustrated in the table, additional scope remains to reduce further the use of oil products in Iran. Oil products Natural gas Hydro Iran 18% 76% 6% Algeria 2.2% 97.6% 0.2% Egypt 7.5% 76.0% 16.5% 2.9 Further to the information in Table 8, inEgypt, the increase of natural gas usage continues in line with the large capacity of combined cycle plants being added. By 2003, the natural gas share had increasedto 79% and about 1% wind had also been added. Generation technology mix to supply electricity: 2.10 Power i s mainly produced from thermal and some hydro plants in Iran. More specifically, steam boiler plants have been used for a long time in Iran and still have a dominant position when it comes to share of power plant technology used. Inaddition single-cycle gas turbines also play a significant role. However, their share i s reducing in favor of combined-cycle gas turbines with higher fuel efficiency (see Figure 7 below). Indeed, the Bank financed such a conversion in the mid-1990s when 6 128 MW gas turbines at the Ghom Power Plant were converted to combined cycle, adding 200 MW of capacity18. As can be seen, hydro plays a role, but wider deployment i s hampered by the low cost of natural gas to the power sector and hydro projects' relatively longer constructionlead times (see more in Chapter 3). Figure 7: Technology Mix in Power Generation (1980-2002) I 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 l8Power Sector Efficiency Improvement Project, approved on March 30, 1993. -22- Islamic Republicof Iran Power Sector Note Source: Tavanir (2003-2004) 2.11 In 2003 single-cycle gas turbines accounted for 21% of installed capacity and produced 12% of total electricity. These plants have the advantages of low initial capital costs and short construction periods but they also have low generating efficiency and thus high running costs (fuel efficiency of single-cycle gas turbines was 28%, compared to 44% for combined cycle gas turbines and 38% for steam cycle plants in 2003). The use of this technology choice has been largely driven by the need to construct power plants quickly and the low cost of natural gas to the sector. However, the inefficient use of natural gas by these plants has further aggravated the problem of gas shortages during the winter months. In OECD countries, single-cycle gas turbines are typically used to meet peak load demand and as such account for much smaller shares of capacity and electricity generation, whereas in Iran they have been usedto meet both base and peak demand at times. 2.12 The Government recognizes the inefficiency of using single-cycle gas turbines as much as it does and for other purposes than to meet peak-load. The plan i s therefore to convert these plants to combined cycle to reach higher efficiency. Yet, the low price of natural gas charged to the electricity sector clearly affects the speed at which these conversions take place and the ability of the Government to make optimal investment decisions regarding generation projects, taking into account an economic value of the natural gas resources. As a result, the share of combined cycle gas turbines power plants had only reached 20% of total nominal capacity by 2003 (see Table 2.5 below). Furthermore, Iran's potential for renewable energy from sources such as hydro, wind and solar remains under-developed (see Chapter 3). Table 2.5: Gas turbines and combined cyclepower plants (% of total nominal capacity), 1991-2003 Gas Turbine CombinedCycle 1991 27% 2000 2003 22% 20% Source: Tavanir,2003-2004 2.13 To assess the impact on technology choice from changes in natural gas prices an analysis was carried out to calculate the levelized cost of electricity production in Iran. Usinga 10% discount rate and a gas price of 28 rials/m3 (8 US$/mmbtu) the levelized cost of electricity production from gas production inIranrangesfrom around $7.75 to $14.54 per MWh(see Table 2.6 below). Table 2.6: Levelized electricity generation costs US$/MWh) Small Gas MediudLarge Combined Cycle Gas Hydro Turbine Gas Turbine Turbine 'Iant (indicative) Wind Capacity cost 5.30 7.62 7.42 11.22 14.68 52.53 Energy cost 2.45 2.77 2.30 3.32 2.70 9.27 Total cost 7.75 10.39 9.72 14.54 17.38 61.80 Assumptions: -- discount rate i s 10%. naturalgas price is $0.08per mmbtu (See annex 4 for details) Source: World Bank analysis, 2006 -23- Islamic Republic of Iran Power Sector Note 2.14 Looking forward, towards the ambitions to develop a market, the low price of gas reduces the energy component of electricity prices but ends up playing against technologies with relatively higher levels of payment requiredto cover the capacity component of electricity prices due to their higher capital costs. Fuel price distortions therefore have a significant impact on investment decisions. Similarly, low gas prices reduce the incentive to retire older and less efficient steam plants and undermine the opportunities to develop the hydroelectricity potential of the country more extensively. 2.15 Changes in the fuel price would alter the relative electricity costs of different types of plants. Indeed, at a gas price of US$ 77/mmbtu (compared to the actual price of US$ 8/mbtu), CCGT claims the first position in the merit order based on capacity + energycosts. Beyond US$1.3/mmbtu for natural gas (or 420 rials/m3), hydro technology costs becomes lower than CCGT.19 See Table 2.7 and Figure 8, as well as Annex 5 for details. Also see Chapter 3 for more analysis on hydro-power in Iran. Table 2.7: Sensitivity of levelized electricity generation costs tofie1 prices (US$/MWh) Small Mediumnarge Combined CycleGas Large Wind Turbine Gas Gas Turbine Turbine Plant hydro Natural gas price = $0.77 per mmbtu 14.29 16.92 14.20 20.36 17.38 61.8 Natural gas price = $1.3 per mmbtu 18.86 21.50 17.34 24.44 17.38 61.8 Assumptions: discount rate is 10%. Source: World Bank. Figure 8: Sensitive of Electricity Generating Costs to Natural Gas Price 3.0 3 h r 2.5 + v) 95 -Large gas turbine 0 2.0. v --Smllgas turbine CCGT +- 8 -_.-_ SteamTurbine -a,>a,1.5 --m- - Largehydro .Y -I 1.0 0.5 f I I I I 0 0.5 1 1.5 2 Gas price (US$/Wtu) Source: World Bank analysis, 2006 19US$l.Ummbtu (420 rials/m3)is the value usedby Tavanir as areferencefor electricity planning purposes. -24- Islamic Republic of Iran Power Sector Note 2.16 Reducing the subsidy on natural gas prices would also allow existing CCGT to be operated for longer periods of time. Assuming a system using only single cycle gas turbines and CCGTs, the number of hours during which single cycle gas turbines would be used for peak purposes at differentprices of gas can be calculated. 2.17 Comparing the current subsidized gas price to the power sector (US$O.O86/mmbtu) with the economic price usedby Tavanir (US$1.3/mmbtu), shows - inTable 2.8 - that, when an economic value i s used, it i s economic to runcombined cycle gas turbines longer than single cycle turbines and there would be a reduction inthe time when single cycle gas turbines are dispatched for peak purposes from 312 hours (4% of the time) to 41 hours (0.5%of the time). Largegas turbines CCGT Share of time Total fixed cost $/kW/year 45 62 Total variable cost $/kWh 0.15 0.10 Peak operating time Hours 312 3.6% Off-peak time hours 8448 96.4% Large gasturbines CCGT Share of time Total fixed cost $/kW/year 45 62 Total variable cost $/kWh 1.26 0.86 Peak operating time hours 41 0.5% Off-peak time hours 8719 99.5% Substantial engineering and dome mbly capacities ha contributing to the relatively low case of capital costs for medium US$296to 497 per kW, consider -25- Islamic Republic of Iran Power Sector Note Regional Integration: 2.18 Iran also meets its power supply needs by trading with neighboring countries and there is potential for expanding interconnections (see Figure 9 and Table 2.9). Although Iran has huge primary energy resources, they are mostly located inthe south and south eastern part of the country whereas some of the large load centers are located in the northern half of the country, in the northwestern province of Azerbaijan bordering the Republic of Azerbaijan, Armenia and Turkey, and in the eastern province of Khorassan. Trade with adjoining electricity systems would therefore be developed to even out energy shortages on both sides of the borders. It i s important to note that the interconnection between Iran and Turkmnistan i s based on a tri-lateral agreement for energy transit from Turkmenistan to Turkey via Iran's network. The potential for electricity trade development needs careful review to exploit potential economic opportunities. Figure 9: Electricity imports and exports (Gwh) 148! 91E i i ~ 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 --cln-port-4-Export Source: Tavanir (2003-2004) ;r Table 12: Exchange of electric energy between Iran and the neighboring countries, 2003 Exports 1 1 Country Importto Capacity Capacity IranGwh VoltagekV MW frofian Volt;;; kV Pakistan Afghanistan 17 20 2.7 Turkmenistan 584 1 230 12 Azerbaijan 582 210 569 132,2x20 97 Armenia 323 230 159 230 208 Turkey 126 132 89 Iraq 230 80 -26- Islamic Republicof Iran Power Sector Note Source: Tavanir (2003-2004) 2.19 Recent discussions between Iran and its neighboring countries, indicate that exports to Pakistan are likely to increase. At about US$ 6/kWh, Pakistan views imports from Iran as attractive compared to self-generation. Iraq is also keen on increased imports as i s Afghanistan. In the case of Afganistan, Iran provides aid through electricity supply and sells electricity at a subsidized rate of about US$ 2/kWh. -27- Islamic Republicof Iran Power Sector Note Chapter 3: Renewable energy potential and energy efficiency opportunities 3.1 Iran has devoted signifcant time and effort into the research and development of renewable energy technologies and enhancement of eflciency in the energy consuming sectors. Nevertheless, exploitation of both to enhance energy supply remainsfar from optimal largely due to the needfor short construction periods of new power plants to meet demand and the relatively higher cost of renewables given the subsidies on natural gas, as the previous Chapter illustrated. Experience from around the world points to important policy instruments to encourage development of renewables even when there is a cost disadvantage. Likewise, energy eficiency, particularly related to demand side management measures, face challenges when prices are too low to establish incentive. Under such circumstances, measures aimed at reducing the demand at peak periods and thus relieving the pressure of maintaining investment to meet peak demand is critical. This Chapter documents experiencesfrom within and outside Iran and provides suggestionsfor further action. Introduction: 3.2 When reviewing supply options for power generation in Iran it i s important to consider Iran's potential for renewable energy. At present, development of renewable energy remains limited however, as it does in many countries with an abundance of fossil fuel resources. Nevertheless, the Government realizes that renewable energy sources could take up a significant share of the energy supply options if they were properly developed and has therefore made it a priority in order to diversify the power generation mix. 3.3 Several institutions are involved in the promotion of renewable energy in Iran. The most significant of them i s the Iran Renewable Energy Organization (SUNA) which in 2004 assumed the staff and facilities of the Center for Renewable Energy Research and Applications (CRERA) when the latter ceased in existence. 3.4 SUNA was created in 1995 under the Ministry of Energy, in order to assume the responsibility of developing renewable energy inIran, through the implementation of research projects, studies, awareness raising and pilot plants. In 2000, SUNA was changed into a state-owned organization and has independently of the Ministry of Energy assumedthe responsibility of several renewable energy projects since 2003. 3.5 CRERA was created in 1992 with the objective of conducting research and studies in the field of renewable energy technologies. Since its creation, CRERA has been active inthe solar, wind, biogas and geothermal energy domains. In the field of solar and wind energy in particular, CRERA has been responsible for the purchase and installation of more than 11 MW of wind and solar power plants.". CRERA staff and facilities were transferred to SUNA in 2004. The capacity of Manjil and Roodbar wind sites were recently increased to 34 MW. 2o Data basedon the following: (1) CREDwebpage on the Atomic Organizationof Iran's website at httu://www.aeoi.org.ir/NewWeb/Research/Cred/CRED.htm (March 7,2006). (2) Hazemi Karegar, H.et al. (2002)Windand Solar Energy Developmentsin Iran.Paper presented at the 2002 Australian Universities Power Engineering Conference, Melbourne, 29 September -2 October, 2002. -28- Islamic Republic of Iran Power Sector Note 3.6 Development of the renewable energy sources has focused on hydro, wind and solar, however, Iran also has potential in developing geothermal and biomass. The section below presents the potential for hydro, wind and solar along with current activities being pursued in Iran. Barriers to development of renewable energy are also discussed along with ideas for removing barriers and enhancing renewables' potential. 3.7 Hydropower: Most of Iran's hydroelectric plants are located in the Western and Southwestern provinces along the Karoon and Dez rivers. The development of future hydropower plants i s planned for the Northern and Northwestern parts of Iran.21 Today's hydropower plants are mainly large reservoir hydroelectric plants. The lower share of output relative to the share of installed hydroelectric capacity reflects a relatively low plant factor of hydroelectricity due to the multi-purpose use of the dams, including large use by the agricultural sector. 3.8 Iran has large potential for hydroelectric power production. The total potential for hydropower has been estimated at about 50 billion kWh/year.22 In 2003 installed hydro capacity contributed to 11 GWh of power production (7.5% of the total power produced). 243 hydropower plants are under study, construction and operation in Iran. In fact, the Government targets an expansion of hydropower to 19% of the electricity producedby 2010 (about 6,800 MW additional capacity).23. 3.9 However, increasing the share of hydro power in Iran faces several challenges including their longer construction time, need for significant upfront investment and, under current natural gas and electricity pricing policies, being relatively more expensive. This situation has left the hydro capacity expansion plans somewhat stranded and some hydro construction projects unfinished. 3.10 Wind: The potential for wind energy in Iran has been estimated based on data from 26 meteorological sites throughout the country, and analyzed by CRERA and the Ministry of Energy. The potential amounts to about 6,500 MW. Iran's first experience with installation and operation of modem wind turbines dates back to 1994, when two sets of 500 kW wind turbines were installed in Manjil and Roodbar. After this successful experience, contracts for 27 wind turbines (totaling 10.5 MW of installed capacity) were signed in 1996 and installed by 1999 in Manjil, Roodbar and Harzevil (also located near Manji1).24 As of 2004, the Manjil-Roodbar windfarm had been equipped with 39 wind turbines and an overall capacity of 15.7 MW, while in the Harzevil location there were three units and a total capacity of 900 kW. In aggregate, the wind farms produced about 30GWh in 2004, representing a share of 0.02% of the total power produced that year.25 In addition, future projects amounting to 130 MW of wind power plants are underway. These include wind power projects in Binalud and Dizbad (Khorasan province) for a total capacity of 28.9 MW). 3.11 Solar: Solar radiation in Iran varies between 2.8 kWh/m2 in the South East and 5.4 kWh/m2in the central region, with an average of more than 2,800 hours of useful solar radiation per year. Several small-scale solar projects were started between 1993 and 1998 in order to test the exploitation of Iran's solar potential, and have resulted in the installation of about 112 kW of solar capacity (photovoltaics and 21Data extractedfrom the "Introduction to Rudbar LorestanDamand HPPProject", document providedby the Iran Water and Power Resourcesdevelopment Company during the World Bank power sector missioninJanuary 2006. 22Data extractedfrom the "Introduction to Rudbar LorestanDamand HPPProject", document providedby the Iran Water and Power Resourcesdevelopment Company during the World Bankpower sector missioninJanuary 2006. 23Tavanir (2004) Electric Power IndustryinIran 24Hazemi Karegar, H.et al. (2002) Wind and Solar Energy Developments in Iran. Paper presentedat the 2002 AustralianUniversities Power EngineeringConference, Melbourne,29 September -2 October, 2002. 25Tavanir (2004)Electric Power Industryin Iran. Tavanir specialized holdingcompany, Tehran. -29- Islamic Republicof Iran Power Sector Note solar pumps).26Iran i s also developing capacity for solar-thermal plants with a 250 kW plant inShiraz for which parts of the civil works, including landscaping, buildings and relevant accessories, as well as purchasing the mechanical equipment, have been completed. As of 2004, the collector farm was at a testing and commissioning stage and installation of the mechanical equipment and steam-generation section are expected to start shortly. 3.12 It is worth mentioning that a survey has been carried out that estimates Iran's biomass potential to be about 806 MJ. Barriers to renewable energy development: 3.13 While renewable energy has significant potential in Iran, this potential i s not being fully realized due to various barriers which prevent larger scale investment and development to take place. These barriers put renewable energy at a disadvantage relative to conventional forms of energy supply. The barriers include the subsidies on fossil fuels, the high initial capital costs requiring additional financing, the lack of an operational plan to implement the policy support in the Fourth FYDPfor the promotion of renewable energy and the limited manufacturing sector for renewable energy technologies. Several of the barriers are being addressed and feed in tariffs set at US$7/KWh have been introduced but there deployment and impact are unknown. In addition, the difficulty of quantifying economic externalities (e.g. fuel price risk for fossil fuels, environmental damage, etc.) further prevents renewable energy resource development from taking place. International experience on mechanisms to promote renewables: 3.14 Given the difficulty the power sector already faces in financing generation capacity under the prevailing low electricity rates, the incentive to allocate resources to development of renewable energy whether by the public or the private sector remain weak. Under such circumstances, it may be necessary to accelerate renewable energy market development through incentive mechanisms. These mechanisms (policies) would aim to accelerate cost reductions of the renewable technologies through learning and economies of increased production resulting in speeding up the date by when the technologies are economically competitive without the promotional policies. Secondly, such policies have been known to grow strong industries to provide renewable energy systems and equipment that can quickly capture export markets as their technologies become more competitive inother markets. 3.15 In terms of policy instruments, the most effective mechanisms used to date in the world for the development of renewable energy markets, have been feed-in tariffs and renewable portfolio standards. With feed-in tariffs, electric utilities are obligated to allow renewable energy plants to connect to the electric grid, and they must purchase any electricity generated with renewable resources at a fixed, minimumprice. These prices are generally set higher than the regular market price, and payments are usually guaranteed over a specified period of time. Tariffs may have a direct relationship with cost or price, or may be chosen instead to spur investment in renewable energy. The example of Germany shows how the use of feed-in tariffs can stimulate - significantly - the growth of renewable energy market, as well as the emergence of a domestic renewable energy technology industry (see Annex 6 for the case study). Laws similar to the Germany Pricing Law have been enacted in Spain, and several other European countries, including France, Austria, Portugal, and Greece, in addition to South Korea. Recently, both Brazil and China have enacted legislation that combines pricing laws and mandated capacity targets. 26 Hazemi Karegar, H.et al. (2002) Wind and Solar Energy DevelopmentsinIran.Paperpresentedat the 2002 Australian Universities Power EngineeringConference, Melbourne,29 September -2 October, 2002. -30- Islamic Republic of Iran Power Sector Note 3.16 Renewable Portfolio Standards (RPS) policy measures legally establish a target for the minimum amount of capacity or generation that must come from renewable energy sources according to a specific schedule leading to a target amount at some future date. The types of renewable resources or technologies that can be usedto meet the target are specified and defined as qualifying resources. In addition, fees are usually established for non-compliance. An example of an RPS scheme in the United States is presented inAnnex 7. 3.17 Both feed-in tariffs and renewable portfolio standards could be used inthe case of Iran to promote renewable energy. A summary of their relative advantages and disadvantages are presented in table 3.2 below. Table3.1: Key pros and cons of feed-in tar@ and renewableportfolio standards2' Feed-intariffs I Can be designedto account for differences Promote the least cost projects intechnologies andinthe marketplace Provide certamty regarding future market Encourage steady growth of small and share for renewable energy mediumscale producers Perceived as being more compatible with open markets 0 Involve low transactioncosts Are more likely to fully integrate renewable energy into electncity supply infrastructure 0 Facilitate the establishmentof renewable energy credits trading system High nsks and low rewards for equipment suppliers andproject developers, which slows down innovation Tariff difficult to set, particularly at the Instability and ``gammg" in the quest for beginning when the true costs of renewable contractslikely to happen due to pnce energy systems are unknown fluctuations in "thin" markets Overpayments likely to occur and to result Small investors disadvantaged compared to ineconomc inefficiency andunnecessanly large, centralized merchant plants high pnce padby customers for renewable Concentration of projects in areas with the best resources, leadingto inequities inthe Requirementfor domestic production which repartition of renewables benefits can involve restrants on renewableenergy 0 No incentive to install more thanthe mandated level Complexity to design, administer and enforce High transaction costs, not very flexible Source World Bank analysis, 2006 3.18 It is important to note that price-settingpolicies (e.g., feed-in laws) have to date been responsible for most of the additions in renewable electricity capacity, while the track record from quantity-setting policies remains uneven. In addition, international experience has suggested that feed-in tariffs are more effective instruments for renewable energy market initiation, while quota systems are more effective at a later market development stage.** 3.19 Irrespective of whether a price-setting or a quantity-setting policy i s adopted, the critical issue i s that cost be spread out over the full customer or population base. In most countries, the additional cost of 27 Table based on "Comparison of market mandates", paragraph of the World Bank Renewable Energy Toolkit website available at http:///www.worldbank.or&etoolkit (March 8,2006). 28 UNDP(2005) "Removing Barriers to Large Scale Commercial Wind Energy Development." GEFProject Document for Work Program. PIMS #747. Available on the GEF on-line project database at http://www.Pefonline.org/home.cfm (March 3,2006). -31- Islamic Republicof Iran Power Sector Note higher payments to renewable energy producers is allowed to pass through to the consumers. In some countries, the incremental costs are paid through an additional per kilowatt-hour (kWh) charge to consumers, such as the system benefit charges inthe US. Ina few cases, taxpayers share in the cost, such as in Denmark through a combination of feed-in rates and reimbursement of a carbon tax. In Mexico, a Green Fund supported by government budget and Global Environment Facility (GEF) resources is set up to pay for the incremental costs.29 3.20 InIran, possibilities for financing policy support to renewable energy could include: 30 A compensation from the Ministry of Petroleum for avoided fossil fuel use available for the support of renewables31;and A fiscalllevy mechanism (on carbon for instance) usedto create a fundto support renewables. Energy Efficiency and DemandSide Management: 3.21 Iran was one of the ftrst oil producing and exporting countries in the world to start programs to improve efficiency inthe different energy consuming sectors.32 3.22 Several institutions are involved in the field of energy efficiency in Iran. The Ministry of Energy (MoE) and the Ministry of Oil (MOO) cover the bulk of the activities, with the latter covering mostly energy efficiency for oil and gas products, and not directly the power sector. The Iran Energy Efficiency Organization (SABA) works as the "operational arm" of the MoE's Energy Efficiency Office, and deals with energy audits, technical consultancy services on energy efficiency, and training.33 The MoE's Energy Efficiency Office deals with planning and policy making for energy efficiency in the industrial, residential and commercial sectors. It also implements pilot and research projects in the field of energy efficiency. In addition and specific to the power sector, Tavanir has implemented various activities in 34 the field of energy efficiency and demand side management, in collaboration with the E C s , notably the field of T&D losses reductions, and efficient lighting. 3.23 In 1994, an end-use energy efficiency strategy35 was prepared by the World Bank which suggested that the potential economic energy savings for the period 1994-2005 were about 8,040 GWh (or 2,015 MW) based on the implementation of a set of, measures in the residential, commercial, public services and industrial sectors. Table 3.3 below presents the implementation measures which were identified by the strategy to have the most potential for energy efficiency in terms of energy savings and reduction of power demand for the period covered by the strategy. 29 Informationextracted from the World Bank RenewableEnergy Toolkit website available at http:///www. worldbank.ore/retoolkit (March 8, 2006). 30 UNDP(2005) "Removing Barriers to Large Scale Commercial WindEnergy Development." GEFProject Document for Work Program. PIMS #747. Available on the GEF on-line project database at http://www.gefonline.c)rg/home.cfm (March 3,2006). 31 Such a compensation, called a Green Fund, has been established inEgypt where up to 4 piasters/kWh (US$75 cents/KWh) is being compensated for avoided fossil fuel use. 32 World Energy Council (2001) Pricing Energy in Developing Countries. World Energy Council, London, UK. 33 Information available on the website of the Iranian Ministry of Energy at http://www.iranenerev.org.ir (March 17, 2006). 34 Abdollahshirazi, A. (2004) Energy Management Promotion in Iran. Paper prepared for the International Summer School 2004, "Renewable Energy in Schleswig-Holstein. Regional Experience for International Development." 07- 13 June 2004, University of Flensburg, Germany. 35World Bank (1994) An End-Use Energy Eficiency Strategy for Iran. Technical Report. Industry and Energy Division. The World Bank, Washington, D.C. -32- Proposedsectoral actions (extract) Recoverable potentialover 1994-2005 Power GWh I o/b I MW 1 o/o a. h. c. 4. e. f. e. h. 1. Islamic Republicof Iran Power Sector Note j. Information, education and awarenesscampaigns on energy efficient behaviors and technologies (including training programs). 3.25 A detailed descriptionof each of these efforts and their status i s presented inAnnex 8. Barriers to energy efficiency: 3.26 As can be seen in Annex 8, while technological and policy options are being applied in Iran to promote energy efficiency, several barriers exist which hamper real achievement. These barriers include lack of adequate information, technical knowledge and training, uncertainties about the performance of investments in new and energy-efficient technologies, lack of adequate capital or financing possibilities, highinitial perceived costs of more efficient technologies and lack of incentives for careful maintenance. However, the single most important barrier i s the overall low electricity tariff which reduces the incentives to consume less electricity and to invest in energy efficient appliances; leaving large untapped potential for energy efficiency inthe power sector, both on the supply side and on the and demand side. Policy options to step up energy efficiency: 3.27 Inan environment where electricity tariffs will increase only gradually, there are limitedactivities that can be taken and that can also have impact. Inthe case of Iran, the objectives of energy efficiency in the power sector should be to manage the load (Le., the demand for power) so that investment needs in new generation capacity can be controlled and the associated financial position of the sector improved. Load management can have a variety of impacts on the load shape, depending on the type of program used(see figure 10below). Figure 10: Load Management Strategies t t Load z:: shifting Efficiency (LM) . 1 4 Flexible Load shape Source: CRA International. 2006 -34- Islamic Republic of Iran Power Sector Note 3.28 Based on the initiatives already taken in Iran and international experience from countries with similar characteristics, the activities to continue the focus on should be: (i) loss reduction intransmission and distribution; (ii) load management and smart meters; (iii) audits in energy intensive industries energy and development of an ESCO industry; (iv) distribution of subsidized CFLs and other energy efficient light bulbs; (v) development of mandatory energy performance labels for electrical appliances; and (vi) information, education and awarenesscampaigns and trainings. A description of what i s recommended in each of these areas along with case studies from other countries i s presented inAnnex 9. -35- Islamic Republic of Iran Power Sector Note Chapter 4: FinancialPerformance of the Sector 4.1 Thefinancial position of the electricity sector in Iran rejects the impact of below cost-recovery pricing policies and associated high consumption of electricity. Indeed, the sector accumulates significant debt year after year to cover capital investments and cash short-falls. Thesedebts represent a direct contingent liability to the Government. Ifthe tariffpolicy of the Fourth FYDP continues, the sector could accumulate debt amounting to US$.50 billion over the coming decade to cover costs. While some publically finded generation will be of-set by investment by the private sector, these transactions will result in significant contingent liability for the Government. Finally, the opportunity cost of the gas used in the power sector to meet the demand for power over the coming decade adds up to close to US$40 billion. Introduction: 4.2 Financial revenues and costs in the power sector are consolidated at the level of Tavanir, the electricity holding company responsible for generation, transmission and distribution of electricity. In 2003, the sector generated revenues from sales of electricity and services to end-users amounting to 19,261 billion rials (US$2.4 billion). The net operating income reached 4,475 billion rials (US$0.6 billion), equal to an operating margin of 23%. Loans are provided to the sector to cover cash shortfalls and are primarily provided by state owned banks such as Tejarat, Melli, Mellat and the Central Bank of Iran. The banks provide funds for about 5 years at a charge of 13%-19%. These loans are reported to convert to grants after some years. Overall the collection performance inthe sector i s good at 90%-95%, excluding the collections of bills from government entities, where military is particularly problematic. Including billings to these consumers would reduce the collection performance to about 70%. Electricity tariff policy and rates: 4.3 Electricity tariffs are set by the Parliament (the Majlis) and are presented in the FYDPs. The average tariff i s determined based on an estimate of the electricity available for sale and the revenue requirements to meet planned investment and operating cost. Based on the average price requirements, the tariff to different consumer categories (residential, public, agriculture, industrial and other/commercial) is determined. The tariff comprises a demand charge, measured in kW for the rate at which the energy is used and an energy charge, measured in kWh, for the variable energy consumed. The tariff in2003 to the different customer segments i s shown inTable 4.1 below. Table4.1: Retail Tariffs in 2003 Customersegment RialskWh US$/kWh Residential 97 1.2 Public 152 1.9 Agriculture 14 0.2 Industrial 163 2.0 Other/Commercial 412 5.2 Average 131 1.7 -36- Islamic Republic of Iran Power Sector Note 4.4 The Government allows the electricity prices charged to end-users to cover O&M costs. The actual revenue required to fully cover costs beyond what the tariff brings in i s filled by loans from local banks (as described above), bonds, loans from the government and postponement of investments and delayed payments to suppliers. The difference between the revenue required and the tariff charged is presented in Table 4.2 below. The difference is referred to as a subsidy and it is financed by loans and to some extent by deferring expenditures (e.g., investments, maintenance). The loans are reported to convert to grants after some time. Table 4.2: Electricity tariffs and subsidies in 2003 (rials/kWh) Consumer Cost of Price at which electricity Subsidy as a % category supply was sold at of set price Residential 407 97 310 76% Public 318 152 166 52% Agriculture 323 14 309 96% Industrial 289 163 126 44% Commercial 396 412 Average 331 132 200 60% 4.5 Electricity prices were increased by 20% under the Second FYDP (1994-1998), which was marginally greater than the rate of inflation which has been around 15% per annum. Under the Third FYDP (1999-2004), the price increase was capped at 10%. The Fourth FYDP (2005-2010) states that electricity prices should remain at the 2004 level for the first year and that any change in the price for the remainingyears of the Fourth plan would need to be approved by the Parliament. It was recently reported that a retail tariff proposal would be presented for approval. A detailed presentation of historical electricity tariffs can be found inAnnex 10. "Cost" of the sector to the Government: 4.6 The lack of cost recovery is having severe implications for the financial well-being of the sector. Consequently, it makes moving from plan to implementation of the envisaged electricity market as well as development of sustainable transactions with the private sector difficult. Moreover, it represents a substantial cost to the Government both in terms of contingent liability and opportunity cost. Details are presented inAnnex 11. 4.7 Sector debt: By 2003, the consolidated debt of Tavanir reached 20,000 billion rials (US$2.5 billion). Most of the debt is raised to finance investment needs but also to cover cash short falls. The bonds issued as part of the debt raised to finance investments are guaranteed by the Management and Planning Organization and thus represent a contingent liability of the Government. In the present year37, bonds worth 1,500 billion rials (US$200 million) have been issued. 4.8 Based on the forecast of electricity consumption presented in chapter 1 and in Annex 2, the difference between the tariff charged and the tariff required to cover full costs would average about 42,590 billion rials/year or US$4.7 billion. Over the ten year period, the amount would be close to US$50 billion in constant terms, which would mostly be covered through local bank loans guaranteed by the Government. The analysis and findings inaddition to sensitivity analysis i s presented below. 37The financial year ends March 31 -37- IslamicRepublic of Iran Power Sector Note Source: Tavanir Rials US$ 2,129,538 GWh Average tariff in 2003 132 1.7 Over 10years Average cost of service supply in 2003 331 4.1 = US$4.7 billion/year A sensitivity analysis to assess the impact on the deficit from variations in the natural gas price and depending on the average cost of transmission and distribution in the sector, based on proxies has been undertaken. As illustratedbelow, the revenue deficit would range from US$1.25 billion to US$4.1billion (at 3.8 US$/kWh). 2,129,538 GWh Over 10 years = Distribution (int. benchmark)* 1.5 -2.0 US$4.1 billion/year Q 3.8 US&/kWh Transmission (Int.benchmark) 0.5 US$3.1 billion/year Q 3.3 USOIkWh Generation (marginalcost for medium-sizedGT) 1.3 1.3 US$1.25 billion/year Q 2.3 USdkWh Distribution (Int. benchmark)* 1.5-2.0 2,129,538 GWh Over 10years = Transmission (int. benchmark) 0.5 US$2.75 billion/year Q 3.1 USdkWh Generation (marginalcost for medium-sizedGT) 2.1 2.1 ' US$4.I billion represents about 3% in 2004/05 GDP figures. It i s important to note that this figure i s based on the subsidized price of natural gas. Hence, it does not include the opportunity cost of the gas. 4.9 Natural Gas Subsidies: The sector receives a very favorable gas price. Natural gas contracts are entered into between the National Iranian Gas Company (NIGC) and each regional company and the natural gas price to the power sector i s 28 rials/m3(US$ 8/mmbtu) compared to an estimated opportunity cost of 420 rials/m3 (US$1.3/mmbtu). The price increase restrictions that apply to the power sector as described above also apply to the natural gas sector. 4.10 Based on the future electricity supply requirements to meet demand presented in chapter 2, the sector would consume about 820 bcm of natural gas over the ten year period. At the prevailing estimated difference between the price charged for natural gas to the sector and the assumed opportunity cost, the subsidy would amount to approximately 728,974 billion rials or US$40 billion. 4.11 Transactionswith theprivate sector: The favorable gas price also applies to private sector projects. However, this i s not an issue per se since all deals with the private sector to date are based on so called energy conversion agreements, whereby the gas i s provided free-of- charge by the buyer of the electricity. 4.12 The private sector projects are able to access debt financing through the Oil Stabilization Fund. A rate of return requirement of (ROR) of 23%-25% is the norm, arriving at a selling price, excluding the cost of fuel since it is provided by the buyer, of 1.5-1.7 US$/kWh. The power i s purchased by Tavanir. This model represents a contingent fiscal riskto the Government should the sector not be able to pay for the "private power". -38- Islamic Republic of Iran Power Sector Note 4.13 Looking at the next ten planned BOO projects and the BOT projects, the contingent liability of the Government arising for the take or pay agreements amount to about US$690 million and US$438 million per year, respectively. -39- Islamic Republicof Iran Power Sector Note Chapter 5: The introduction of a market and competition 5.1 Iran is laying the foundations for a market to trade electricity. The aim is to introduce a commercial power exchange market whereby bidding and purchasing are driven by competitive pricing and service-quality. To date, thefoundations in place have resulted in greater eficiency in the dispatch of electricity by centralizing the function to the system operatodmarket manager (IGMC). This is the beginning of market reform and, in parallel, will require significant work to, inter alia, enlarge the market, upgrade the quality and capacity of the transmission (and distribution} network and its function, and define system operation rules, implement IT investments to operate the market and build capacity among staff in IGMC. Furthermore, in light of the centralized supply of fuel and lack of fuel diversification, the pricing method applied may need to be revisited to also include a capacity payment mechanism so that bidding generation units can differentiate, and thus compete, beyond O&M costs and heat rates. Introduction: 5.2 Iran's power sector has been unbundled and comprises 16 regional electricity companies (RECs) operating within specific provinciallregional boundaries. Each company i s responsible for electricity generation, transmission and distribution in its jurisdiction. Tavanir, under the control of the Ministry of Energy (MoE), serves a holding company for the sector and thus has overall responsibility for the sector except for hydroelectricity which falls under the control of the Deputy Minister for Water Affairs. The structure of Iran's power sector i s presented inAnnex 12. 5.3 Tavanir i s the main shareholder of the 16 RECs, which in turn control 27 generating companies and 42 distribution companies. Tavanir also controls other companies dealing with power plant development and construction, project maintenance and management, new energy sources and energy efficiency. Other important institutions in the sector include the Iran Grid Management Company (IGMC) and the Electricity Market Regulatory Board (EMRB). 5.4 In August 2005, the MoE issued a set of "Market Rules" that are intended to transform the emerging electricity market reforms inIran into a hybrid "electricity pool". The objectives of introducing the market are to achieve more efficiency and quality in the supply of power and to introduce more commercial practices (i.e. prices more reflective of cost) for power purchases and transactions. 5.5 The "Market Rules" introduce a two-tier structure for electricity sale and purchase transactions, comprising: (i) one tier based on a "centrally scheduled and dispatched" operational regime for Tavanir-owned and/or controlled power generation plants; and (ii) (ii) tierfora"semi-centrally scheduledanddispatched" operationalregimeapplicableto another autonomous power generation plants (owned and/or controlled by MoE licensees). 5.6 This chapter describes how the current "electricity market" functions, includingthe main market participants (Box 5.l), describes pricing of electricity in the market, outlines the Government's plans for -40- Islamic Republic of Iran PowerSector Note ~ ~~ future electricity market development and reviews key transitional issues and medium-term market design options that need to be addressedto achieve the vision embodied inthe "Market Rules". Box 5.1: MainParticip an's "Electricity Mar The "Market Rules" ide llowingparticipants int 's Electricity seven (7) member b Energy to oversee th other week to review p electricity market, Iran Grid M a t Manager,to intermediatethe wh of electricity among a assure safe, reliable and secure grid operations. Although the transmission assets, it also functions as the transmission services pro "use and control" of the n under which electricity electricity. Power Station Owners -the majority of power generation plants on the national grid are owned by the FECs and operated by the Tavanir subsidiaries that are referred to as "Generation Management Companies" or GMCs. There are other autonomous public sector entities, such as the Khozestan Electricity and Water Organization. The privately-owned power stations include industrial auto-generation and/or co-generation plants and also the BOOBOT entities that are being established under "Energy Conversion Agreements" with the IranPower Development Company (IPDC). Suppliers -these are public or private sector licensees of the Minis and control" rights over power generation units for the sole purpos wholesale supply through th national grid to consumers unde licensees also may participate the import and/or export of electricity. Buyers - these are predominantly the Cs who arrange bulk electri electricity market (thr ket Manager) for distribut captive subscribers. 0 t licensees of the also arrange bulk ele he IGMC Marke consumers, such as au Consumers - these are entities or persons that receive all or part of their el through the national grid basedoncontracts with one or more Suppliers :Ministerof Energy-Ele (issuedon 25 August 200 Current market structure: 5.7 The "Market Rules" project a basic market structure that is similar in design concept to the original "electricity pool" of England and Wales. Specifically, the "Market Rules" define, in some detail, -41- Islamic Republicof Iran PowerSector Note the pool intermediation arrangements between the IGMC Market Manager3*and "Power Station Owners". They also define procedures to be followed by "Buyers" to purchase electricity from the "Market Manager"39. Schematically, Iran's emerging pool-based "Electricity Market" i s depicted in Figure 11 below. Figure 11:Electricity Market Structure IRAN ELECTRICITYMARKET STRUCTURE "CENTRALIZED SCHEDULING & DISPATCH 'Pool Suppty Price" RECl t3EC2, ,KEG3 Customers Captive Subscribers 5.8 The market structure that has been put in place has achieved efficiency gains in that the most efficient plants' electricity production is`dispatched first. As such, the role of the IGMC for the time being i s mostly as a central dispatchingcenter for the power production. Pricing inthe market: 5.9 Under the "Market Rules", all "Buyers" - including the RECs - purchase electricity directly from the "generation pool" at a uniform "pool supply price" that i s seuregulated by the Electricity Market Regulatory Board (EMRB), based on informatiodcomputations provided by the IGMC. The "pool supply price" i s computed by the IGMC using a "day-ahead bidding" process that also informs the scheduling and dispatch of available power generation units by the IGMC (see Box 5.2 below on the dual role of the IGMC). Furthermore, the IGMC intermediates the procurement of ancillary services based on prices (capacity availability and energy charges) that are regulated by the EMRB and the Minister of Energy.@ 38Refer to Article 6 of the "Market Rules" 39Refer to Article 7 of the "Market Rules" 40The IGMC base rate for "available capacity" is derived based on the annuity o f investment cost plus O&M cost for reserve generation capacity to sustain security o f supply on the national grid. IGMC also pays a base rate for "energy supplied" which reflects the average variable cost of grid-tied thermal power generation units. -42- Islamic Republic of Iran Power Sector Note Box 5.2: luI.l. On a day-ahead basis "Power Station Owner" and/or "Su the supply of electricity (ene submits bids for generation un stacking all of the su On the day of actua Station Owner" and/or " transmission constraints System Operator a1 ngements with "Power Owner" to impleme All other Tavanir-controlled market partic ely on the results of the IGMC as Market Manager's pooling and settlement process to Tavanir's internal corporate "clearinghouse" to sort out payment obligations between RECs, ndBOOBOT entities. 5.10 The uniform "pool supply price" that i s set should, in principle, allow all generators to recover costs. More specifically, the price setting procedure for the "generation pool" appears to be as follows: (i> The IGMC computes a "minimum rate for energy supply" which covers the average variable costs of energy production by the "generation pool" of grid-connected power plants in the Iranian common carrier 230kV & 400 kV transmission networks. This excludes the "embedded power plants" that are connected in the distribution networks of the RECs. (ii) The IGMC requests day-ahead bids from "Buyers" to purchase energy at different times of the daily pool production cycle. Based on these `Lpayas bid" prices for energy, the IGMC as Market Manager records the "maximum rate for energy purchases" from the "generation pool". (iii) For each pricing interval for "day-ahead transactions", the IGMC as Market Manager sets a "market clearing rate for energy supply" that i s at least equal to the "minimum rate for energy supply". 4' Tavanir functions as an aggregatorkentral trader of electricity produced based on Energy Conversion Agreements with any particular BOO/BOT entity. -43- Islamic Republic of Iran Power Sector Note 5.11 Since there i s a uniform price for each type of fuel used for any particular category of power generation plants (Le., steam power plants, single cycle gas turbines, combined cycle gas turbines, etc.), the only other variable to differentiate between performance of power generation plants is O&M costs and heat rate. But this procedure allows the IGMC to recover costs for the supply-side (Le., generation pool). Tavanir i s then able to administer payments to cover actual contractual costs of BOO/BOT plants from the total pool revenues and also the payment obligations for each of the REC owned power plants. To that extent, the present set up appearsto be that of a "cost-based generation pool". 5.12 Under this pricingprocedure, it is likely that some licensed "buyers" may, from time to time, bid to pay prices for energy supply that are higher than the average variable costs of energy production by the "generation pool". It nevertheless i s unlikely that the RECs (power plant owners) have any incentive to "bid", since they (i) already are guaranteed supply at the "minimum rate for energy supply", and (ii)may not be able to recover the cost of such power purchasesfrom end-use tariffs. 5.13 That said, the above "cost-based generation pool" already applies, de facto, a form of "weighted average price" of energy for all supplies to the RECs. This procedure needs to be revised to fully compatible with the current strategy of promoting BOOs/BOTs based on Energy Conversion Contracts ("tolling capacity contracts") to alleviate capacity constraints. Should the present national uniform fuel pricing policy remain the same for power generation regardless of fuel (gas, fuel oil, diesel) the only avenue left open for the creation of a "power exchange" would be that of a "Capacity Payment Mechanisms" (see Box 5.3 below). -44- Islamic Republic of Iran Power Sector Note lso for having generation Payments for available nevertheless, the System Operator in NordPool i s allowe r a premium above market sanctions on non-compliant LSEs. A capacity market mechanism similar to that being applie SO may improve the overall design of Iran's pool-based electricity market and th approach i s a capacity contracting obligation. The IGMC could leverage such to reward owners of generation plants that make capacity availability for dispatc e of actual production levels. Key features of the mechanism would be that: o a standardmeasure of capacity would need to be de of forced outages - the units of trade ("capacity tic with a highprobability of being available; o IGMC SO, as the accreditation agency, would awa owner of a generation plant a number of standardized "capacity tickets", account of availability records. As is presently the case, IGMC SO would ed with ensuring that the owner declared capacity i s actually operable ca also for monitoring availability; o RECs (or other Buyers) would have to procure "capacity tickets" to cover their peak MW demand of the year plu determined reserve margin (of, say, an additional 30%). REC contractingbilaterally with owners of generatio o to facilitate the capacity market function, IG an auction of "capacity tickets" once or twice a s would inform the setting by EMRBof amarket clearingprice -45- Islamic Republic of Iran Power SectorNote Future electricity market development: 5.14 According to the EMRB,there are plans to introduce revisionsh-efinements to the "Market Rules" so as to allow for hourly differentiation of pool supply prices inthe day-ahead biddingprocess. Measures beingcontemplated include introduction o f (i) hourly-based differentiation of capacity charges (to be set by IGMC and approved by the EMRB); (ii) a ten-step bidding process to accommodate price-quantity bids for the supply of electricity (energy); and (iii)seasonal adjustment of IGMC payment levels for the supply of ancillary services, such as reactive power, spinning reserves, frequency control, etc. That said, such revisions are not expected to introduce any significant structural changes to the emerging electricity market. 5.15 The market design options being contemplated by the EMRB are common in several other countries. Starting from similar "pool-based" platforms, several European countries made design choices based on country-specific considerations that have significantly influenced the subsequent evolution path of their respective electricity markets. For example, electricity market designs, which are now very advanced in both Spain (OMEL) and Scandinavia (Nordpool), evolved from generically "pooled-based'' trading platforms similar to that being put in place in Iran. They nevertheless have evolved into differentkontrasting market designs. Spain has retained a centrally scheduled market design for which participation in the day-ahead market i s compulsory for all generators over 50MW. By contrast, NordPool has evolved into a competitive market combining bilateral contracts with a self-scheduling market design for which the role of the market operator i s to intermediate day-ahead market transactions between five transmission zones. Both market designs are acceptedmodels of competitive power markets that stakeholders in Iranneed to consider more carefully. Annex 13 presents a comparison and contrast of key characteristics of the wholesale electricity markets in Spain (OMEL) and Scandinavia (Nordpool), with particular regard to the (i) the scheduling regime; and (ii) use of single or multiple "pool prices". the Transitional issues and medium-termmarket design options: 5.16 Overall, the emerging "pool-based'' electricity market structure in Iran i s conceptually appropriate and operationally feasible, taking into account the relatively large size of the generation segment of the power sector: there are some 400 plus power generation units, the mix of power generation technology i s sufficiently broad and main power generation centers are not remotely located relative to the main load centers Teheran, Esfahan, Ahwaz). 5.17 That said, there are several important challenges that will impact successful implementation as well as gaps in the current reform strategy design which need to be addressed. These include: There are substantial improvements needed to reinforce the transmission network, not only its capacity (see chapters 1and 2), but also to improve the information systems (through investments in optic fiber networks, modernized dispatch facilities, etc.) which support transmission of electricity over the network. The lack of competition inthe supply of fuel and the lack of fuel diversification, limits competition to develop between generating units and limits the competition to O&M and heat rates. Under the current set up, key responsibilitiesfor the national grid, including ownership, operation and maintenance, are fragmented and not well articulated4'. At present, the IGMC as System Operator 42 For example, the "Articles of Agreement" indicate that the IGMC also has oversight responsibility for implementation of all relevant regulations, standards and procedures required to support the several core mandates also assigned to the IGMC under its "Articles of Association", which are: (i)Grid System Operator -to develop, equip and administer the national grid control and monitoring center (the national dispatching center) as well as to -46- Islamic Republicof Iran PowerSector Note currently relies on and applies regulations, standards and procedures for system operation that were originally put in place for the vertically integrated REiCs. These need to be comprehensively re- formulated to ensure alignment with the "Market Rules". The IGMC System Operator, in its current configuration, lacks the tools and trained personnel to perform the necessary indicative transmission system planning in support of the other mandate concerning the development/expansion of the grid. A fundamental decision has to be made about the efficacy of retaining the current fragmented ownership arrangement involving 16 different RECs. At the very least, continuation of the current fragmented ownership structure for the national grid under the new regime requires imposition of more complex pooling and settlement procedures between IGMC and the REiCs. In other words, the more fragmented the ownership of the national grid, the more complicated the commercial agreements that will have to be negotiated and enforced to ensure that the IGMC i s able to guarantee the delivery of non-discriminatory "open access" transmission services to all market participants. Therefore, a consolidation of key segments of the national grid, especially the 400 kV segments,43may be called for, not only to secure economies of scale but also to ensure that transaction costs due to the pooling and settlement of electricity flows at the interfaces between REC are minimized. A further benefit of consolidation of the 400 kV networks under a single owner is that supervision and delivery of the numerous ongoing and planned 400 kV transmission projects would be rationalized and streamlined. 5.18 To address the challenges outlined above, the following is needed: A review of the investment needs intransmission (and distribution) to support the development of the market, starting with the large load centers but ultimately covering the entire country; Build capacity within EMRB and the IGMC in system operationu, including: J Preparation of new "rules of practice" for system operations, which would be fully compatible with the "Market Rules"; J Acquisition and deployment of IT and communications systems (hardware and software) that are adapted to the to the "Market Rules"; and J Acquisition and deployment of computer-aided tools and software programs and simulators to be applied for short, medium and long term system planning and market development. coordinate and supervise the existing network o f regional grid control centers. Such regional grid control centers are owned and operated by the RECs; (ii)Grid System Development - to determine and notify plans for the adjustmenVexpansion o f relevant grid systems which are deemed necessary to ensure reliability and security of electricity supply inIran. Furthermore, to monitor compliance with such adjustmenVexpansion plans by owners and operators o f facilities that constitute the national grid; and (iii)Grid System Access - to manage access to, and transit of electricity through, the national grid, especially to assure private sector owners of power plants and/or suppliers (licensees o f the Ministry o f Energy) of "open access" to the national grid and to facilitate the import and export of electricity in a manner that would promote competition in the electricity market. 43 The consolidation o f the 230 kV transmission networks may not necessarily bejustified, since such networks play a dual role in terms of providing the RECs with access to the national grid and also for transmission within individual REC territory. 44 These actions would strengthen the IGMC's capability to ensure that transitional and medium term arrangement are made to work more effectively and thereby establish a robust operational platform to support the future development of Iran's electricity market beyond the "pooling and settlements" phase into an envisioned "power exchange". -47- Islamic Republic of Iran Power Sector Note Chapter 6: The role of the private sector 6.1 Several transactions with the private sector to build power plants are underway in Iran. Competitionfor new generation capacity has met with significant interest by domestic investors and is resulting in efSiciency in the cost of building power plants through the introduction of competition at the bidding stage. Private sector led generation projects also sh$ thefinancing burden off of Tavanir, but does not eliminate the Government's exposure given that the transactions are currently based on take or pay agreements backed by Government guarantees. Furthermore, the predominance of the Government in terms of ownership in the domestic investmentfirms active to date in the sector may hamper ambitions for apower exchange in that it may create perception of collaboration within the Government. Introduction: 6.2 The Fourth FYDP indicates, in Article 25 (B), that the Government wishes to encourage "other domestic entities" (i.e., independent power producers (IPPs), distinct from Tavanir) to become involved in the production of electricity. While the plan specifically refers to "domestic" entities, the Government i s clearly interested to also attract foreign investors to the sector, as discussed below45. The objectives of this plan are to (i) the efficiencies of private sector involvement in power plant construction and realize operation; (ii) shift the burden of supplying capital for power plant constructionoff of the balance sheet of Tavanir; and (iii) achieve more transparency in the cost of power development (thereby accelerating the debate and the decisions on the need for tariff increases). Modes of private sector participation: 6.3 To facilitate private sector participation (PSP), the Government has issued a Decree46prescribing four basic options for the sale of power from IPPplants, covering bothnew power plants and plants that a private investor may have acquired from Tavanir: a. An IPP can sell power directly to end-users, paying the transmission charges prescribed by the IGMC; b. An IPPcan participate inthe wholesale market (described inChapter 4, above); C. An IPPcan sell power to Tavanir under a long-termEnergy Conversion Agreement (ECA);and d. An IPPcan sell power to see IGMC under a "guaranteed fee arrangement". 6.4 To date, only the third option i s being actively pursued by private investors, reflecting the lack of transparency in setting of tariffs for "third party access" to the grid (by IPPs) and also for "wheeling" power (from an IPP) to end-users (under option l), compounded by the cumbersome way that IGMC is required to deal with transmission congestion issues while scheduling for real-time dispatch of generation and transmission facilities, according to the "market rules". 6.5 The immaturity and lack of clarity of the "market rules" in the wholesale market, including the lack of transparency in setting/adjusting market clearing prices for energy which underpin amounts 45 The reference to "domestic" companies (as opposed to foreign companies) arises from the requirement that all foreign investment be made either through shareholdings in a new or existing Iranian company, or through contractual arrangements with an Iraniancompany (see the section in Chapter 6 on the Foreign Investment Promotion and Protection Act) 46 Cabinet Decree Implementing Article 25 B o f the Fourth Economic, Social and Cultural Development Plan 2005- 2009, Articles 2,4 and 5 -48- Islamic Republic of Iran Power Sector Note offered by the IGMC under the "guaranteed fee arrangement", all act as further barriers to implementation of the options allowed. As discussed below, all of the agreements concluded to date, under the third option, have been ECAsrather than PPAs. 6.6 The PSP effort has been managed by two implementing groups organized under Tavanir, one for transactions involving BOO agreements and one for BOT agreements. In Iran, BOO schemes have typically involved and targeted domestic investors, while BOTShave typically been targeted at foreign investors. Box 6.1 describes the three most common models for PSP in the power sector. Because there are no ownership restrictions in Iran, it has not used the BuildTransfer Operate model. nershipModelsfor rate - This common technique calls for an investor to take indefinite basis, for construction, ownersh operations of the project. It i s n known as the perpetual franchi ing, financing and operating project developer retains title this model, al1 financial borrowings i s provided by the private entity. The safety, quality of service and, possibly, user charges or profits. The perpetual ccommodate financing in the public securities market. However, in view of the economic risks, the public securities markets, both fter a project has operated successfully for a few rate-Transfer - This scheme i s similar to BOO but has a future ee, typically the government. The future transfer can be very ect has unique characteristics that preclude permanent private ownership, such stations. The private entity receive a franchise to finance, build and operate the r which ownership reverts to the host government (or some local hority administered by the host government). Ownership reversion i s planned to payment of, and a satisfactory return on, the the ownership reversion, the host government might ns; the project co 6.7 InIran, there aretwo principal assumptions driving the differentiation inschemes to domestic and foreign investors: (i) that foreign investors cannot own land; and (ii) that foreign investors wish to avoid -49- Islamic Republic of Iran Power Sector Note residual ownership. With regard to the first assumption, it appears that the requirement for local ownership of land can easily be met by the incorporation of a local entity or establishment of a branch in Iran. Concerning (ii), international experience in IPPs indicates that investors generally view positively the net residual value of power stations at the end of their initial contract periods (e.g., after 20 years), although it i s too early to say what investors have actually done with their residual projects because most IPP contracts are still running. It is, however, true that most investors, when evaluating a project, assume a minimal value for residual assets, as any remaining value i s perceived to be offset by demobilization costs. 6.8 Although there is no right or wrong approach, most developing power markets prefer the BOO scheme for most power projects, although BOT schemes are still actively used where there i s a unique site (e&, a hydroelectric dam) or other local considerations. But for projects where siting i s less important (as is usually the case with thermal projects), the current trend i s to favor BOO structures. Additionally, many national utilities expect to lack the operational skills in 20 years when these power stations are reaching the end of their initial contract periods, and changing this would require a presumptive change in government policy that moved power generation into the private sector inthe first instance. Inthe case of Iran, the sector i s going through significant reform and, possibly, restructuring, which may make it difficult to identify who would take a power plant back inthe case of BOT schemes. 6.9 To date, Tavanir has been arranging for the private ownership of land in the BOO projects, and land leases or usufructs in the BOT projects. International experience supports the use of land leases or usufructs in BOT projects, where there is high certainty that the assets will transfer after the initial contract period. However, international experience i s not consistent on BOO projects, where many investors appear content to enter into long-termextendable land leases that forgo any residual value in the land. 6.10 For both BOO and BOT projects, ECAs rather than PPAs have been used. The substantive difference between these two (as these terms are commonly used in the IPP industry) i s that a PPA has a fuel component and an ECA does not. However, it i s important to stress that PPAs do not necessarily transfer the fuel risk to investors, as the fuel component i s often a pass-through in the rates charged. However, even where it i s a pass-though, there is risk that the pass-through will not be respected simply because higher tariffs bringhigher political risk. In addition, it i s not necessary to have a fuel component (as in a PPA) to hold investors responsible for the plant heat rate. In international experience, PPAs are much more common than ECAs, but, for the reasons stated, this distinction i s not particularly meaningful. The reason ECAs are being used in Iran i s that fuel supply i s under a monopoly, and the risk of gas supply i s considered to be better managed by the public entities. Box 6.2: IPPsand CompetitivePower Markets Given the intention of the Government to cre competitive wholesale power market, care should be taken in designing the Iranian IPP a manner that does not interfere with the development of that market and that i s flexible rmarketreform. ly, i s that long-termEC nts can distort pow more difficult to obtain. Ps with long-term ,itreducesthe liqui er supplies available ition, the ECAsPPAs may hinder the abi rdance with the new market structure. -50- Islamic Republic of Iran Power Sector Note A good discussion of this problem, and the solutions initially attempted in various jurisdictions, c found in the World Bank Policy Research Working Paper No. 2703, Integrating Independent Power Producers into Emerging WholesalePower Markets, available at Iittp://rru.worldbanh.o~~/PapcrsLinks/Opcn.a~px`?i~=575, Much of this paper deals with the integration of pre-existing IPPs (with long-term PPAs) into newly established competitive markets. However, the paper also touches upon designing new PPAs that contemplate the development of such markets, which contain: (i) provisionsdesignedtoencourageIPPstoparticipateinthemarketforthepurposeofsupplying ancillary services and relievingcongestion; (ii) provisions designed to mandate the gradual entry of the IPP into the market, through progressive assumptions of market risk; and (iii) provisionsdesignedtoachievegreaterbalanceor"symmetry" inthebuyoutandtermination clauses, so that there are appropriate incentives and penalties for both the IPP and the off-taker when the transition i s made to full market participation. It would also be worthwhile for the Go1to examine the steps currently being taken by RAO UES in Russia, a state-owned utility that i s attempting to create a competitive market while simultaneously attracting private investment in new generation. In particular, it would be worthwhile for Iran to monitor the development of new types of flexible PPAs that are currently being drafted for this purpose inRussia, that aredesignedto accommodate the transitionto a competitive market while stillprotecting the financial interests of the IPP investors. It i s proposed that these new flexible PPAs will have the following features: (i) the IPPwill be amarket participantwhen full productionbegins, butona special basis, whereby the prices that are bidby the IPP into the market cannot be higher than the prices agreed upon by the IPPandthe off-taker; (ii) theIPPwillreceivepaymentsfortheancillaryservicesthatitsuppliestothesystemoperator; and (iii) therewillbeflexibleterminationprovisions,wherebyboththeIPPandtheoff-takerwillhave options to terminate the PPA on a financially symmetrical basis. Box 6.3: The Extent of Competitive Power Markets In the case of developing countries, few countries at present have advanced competitive wholesale power markets. A number of countries have initiated the move towards wholesale competition, but only to fine-tune such initiatives along the way. Two countries with comparable economy size, number of population, and electricity demand with Iranare Egypt and Thailand. The following summary is for comparison purposes and provides an insight into these countries' experience with competition in the power sector. With a $79 billion economy and a 72 million population, Egypt's installed generating capacity totaled 18 GW in 2005. Egypt commenced a period of unbundling electricity distribution, with the aim of a full corporatization, as far back as 1964 and only to re-bundle distribution and generation again in 1998. -51- Islamic Republic of Iran Power Sector Note e first round of a highly competitive IPP scheme was awarded in 1998/1999 wit1 ational (approximately 11% of installed capacity), albeit lanfor additiona ncelled due to the fall out of the deep devaluation of th sed the fust IPPs' tariffs inlocal currency. as subsidy and the absence of fuel supply competition are becoming les: opportunity cost of exporting natural gas rises in tandem with higher globa gas export activities. i s at ajunction of a few broad options: generation capacity to be developed by the national electricity utility wit1 ding sources (Egyptian Electricity Holding Company); P scheme that contemplates a higher component of local currency tariff anc and a component of embedded bilateral off-take with industrialkomrnercia (iii) preparation and subsequent actions for the establishment of a competitive wholesalc ower market, including the setting up of systems operator and commercialization Oj ution entities; and (W based electricity tariff adjustment towards covering economic costs . Egypt's experience with competition in the power sector i s therefore limited to IPP projeci development. The next challenge for Egypt would be to integrate and converge state-ownec and IPPpower plantstowards the chosen whoIesale power market structure. Thailand With a $161 billion economy and a 63 million population, Thailand's installed generating capacity totaled 25 GW in 2005. Thailand's first significant step towards liberalizing the sector started in 1992 with a sale 01 selected state-owned power plants to newly established and subsequently publicly-listed genco followed by a similar transaction in 2000. Both gencos remain publicly-listed with some foreign shareholdings, but are under significant control of the state-owned utility at present Both gencos have self-financed the purchase of the original power plants and been active witk the acquisitions of later IPPs and SPPs. The generation sector was opened for private competition in the e d 1990's with the approval of 7 IPPs and an on-going approvals of small power producers (SPP; inclusive ol renewable energies and biomass fuels) scheme. As of 2005, IPPs, SPPs and the aforementioned gencos represent 39% of the country's installed capacity and 52% of GWh produced. Transmission and distribution activities have remained government-owned until today. he 1997 economic crisis, many state-owned enterprises were slated foI This was also the time when a blueprint for competitive power market was drafted and contemplated. With economic recovery inthe early 2000s and a series of change in government and of the energy sector, the plan for competitive power market ed following what was h ther major developing Asian countries donesia, Malaysia and t ptions for Thailand include. ond-round of competitive P Pscheme that contemplates a higher component of currency tariff and a di tion from naturalgas; nuation of SPP scheme hasis on renewable energies; and rfast, low-cost an project development with the ability to sell electricity on a standardized and transparent PPAs. Thailand's experience with competition inthe power sector i s also limitedto IPPproject -52- Islamc Republicof Iran PowerSector Note Current projects with the private sector: 6.11 The private sector participation projects in Iran currently focus on gas-turbine power stations. The following arethe proposed BOOprojects and their status: Table 6.1: Proposed BOO Projects (first 10) ~ ~~~ ~~~ Project Name Sponsor Size (ISO) Status 1.Rood'e shoor Arian Mahtab Gostar 2112 Under construction 2. Mashhad(Toos Mapna 954 Under construction Development) 3. Zanjan 4 Bank Melli Investment Co. 544 ECA signed 4. Gheshm Island Hirbodan 160 ECA signed 5. Hormozgan Azar Ab Energy Co. 500 ECA signed 6. Assalluyeh Bonyad Mostazafanva Janbazan 500 No ECA yet 7. Zanjan 3 SanatEnergy Tamin 500 No ECA yet 8. Assalluyeh 2 Mapna 942 No ECA yet 9. Semnan SarmayehGozari Tamin Ejtemaii 500 NoECA yet 10. Ali Abad Mama 950 No ECA yet Box 6.4: Case study: efficiency gains from the Rood'e shoor project: Rood'e shoor i s the first large scale private power plant in Iran. The pla construction, i s a 2,112 MW single cycle plant consisting of eight gas turbine u manufactured by Siemens each with a capacity of 264 MW at I S 0 condit implementedinthree phases, with the first phaseunder construction. The project i s expected to deliver efficient electricity to the power sector inthe J price for electricity more reflective of real cost as it includes market cos J expected to be completed on time, due to a fmfinancing plan up-fron J expected to operate according to plan, due to an O&M contract with Si d by the Arian Mah-Taab Gostar Gompa Investment Co. s (224.5 million Source: site visit to Rood'e shoor in January, 2006. -53- Islamic Republic of Iran Power Sector Note 6.12 Many of the BOO projects listed above include quasi-governmental entities. Indeed, the term private sector" in Iran includes companies that may not officially be part of the state but which nevertheless have significant connections with the Government. As a result, those domestic investors who have participated in the IPP programs to date are, in many instances, wholly or partially owned or controlled by government or quasi-government entities. Interms of the success of the IPPprogram, these projects will bring greater efficiency only if the quasi-governmental investors demonstrate corporate governance and financial discipline comparable to the fully private sector. Furthermore, the ownership and/or controlling stake by the government could have serious implications for the future development of the power trading market, due to the perception that some market participants may engage in collaborative and non-competitivebehaviors. 6.13 The following are the BOT projects: Table 6.2: Proposed BOT Projects Project Name Sponsor Size MW status at site condition South Isfahan MapnaInternational, IranForeign 734 Operational Investment Company HoldingAG ( W G ) Pareh Sar Gruppo Falck, Mapna International, 900 Project company DSDDillinger Stahlbau GmbH shareholders changing Tabriz Xenel 1000 Prepared for ECA signature Fars Mapna International, Quest Energy 735 ECA signed Middle East Ltd. Ali Abad Saudi Oger Ltd, International Power 863 ECA under negotiation plc, Sojitz Corporation Genaveh TBD 500 To be bid 6.14 As can be seen from Table 6.2, there has been a relative lack of interest in IranianIPPprojects by `truly foreign' investors. Instead, most of the investors are actually Iranian entities using offshore investment vehicles. This absence of conventional foreign investment has continued to exist notwithstanding the above-noted range of options available for the sale of power from IPPs, and notwithstanding the provisions set out in the Foreign Investment Promotion and Protection Act (FIPPA) and the associatedlegislation described below in Chapter 7. 6.15 Clearly, one of the impediments for foreign investment i s the perception of `country risk. In all likelihood, this perception i s not primarily attributable to the Iranian legal or regulatory framework (indeed, the FIPPA legislation seems to be in general conformity with international practices) but, rather, it is, more probably, a function of geo-political tensions. Accordingly, until such tensions are abated, substantial foreign investment in the sector i s unlikely. Having said that, some investors from certain countries may actually see an advantage in the geopolitical inhibitions of Western investors (e.g. Chinese, Indian). ost governments . Investors often trvrisks. Ones -54- Islamic Republicof Iran Power Sector Note Government Stability J Government J Unemployment J Consumer Confidence J Poverty Investment Profile J Contract Viability J Profits Repatriation J Payments Delays Internal Conflict J Civil War J Terrorism J Civil Disorder ExternalConflict J war J Cross-border Conflict J Foreign Pressures Future prospects of the Private Sector Participation(PSP) program: 6.16 The PSP program that Iran has embarked upon in the power sector should be able to achieve, at least partially, some of the objectives of introducing private sector efficiencies in power plant construction and operation, in addition to shiftingthe burden of such construction and operation off of the balance sheet of Tavanir. However, the current design of the program (particularly in regard to the procurement issues discussed below), and the overall risk profile that Iran currently has in the eyes of prospective investors - particularly foreign - suggest that the benefits of private sector efficiencies may be limited to the benefits that domestic investors can bring. Further, as has been the case in many countries that have embarked on similar programs, there will likely be `trade-offs' in terms of accommodating the financial and security needs of IPP developers, and the medium and long-term implications of IPPcontractual arrangements for the future development of the Iranian power market, as discussed above in Boxes 6.2 ands 6.3 on PPs and competitive power markets. :BenefitsofDomesticIn 47Publishedby The PRS Group, Inc. (see www.prsgroup.com). -55- IslamicRepublicof Iran Power Sector Note e interest rate to their risk-adjusted tions, investors are als ed to fix interest rat have an advantage over foreign s through their abilit struments such as short-term ,abilitytoabsorbc may accept local currency tariff. denominated in local currency the non-fuel costs cy denominated project cost and during the shorter underpinnings and documentation to allocate every c c investors, being a e local community, of the complexity, resultinginfaster 4. Domestic investors often have greater access to lower-cost and capable local specialists, or regional specialists with direct experience in the country/sector offering discounted professional fees, thus keeping operations costs u 01 by relying less on expensive Inthe case of Iran, there is evidence that vestors are bringing commercial, private-sector, perspectives to the development of lants. Accordingly, there would appear to be reasonably good being realized through the IPP rogram, notwithstanding the ab a1foreign investors. Source: World Bank 6.17 It i s beyond the scope of this Note to review in detail the procurement procedures being used by Tavanir to solicit the private sector. However, from the types of issues being raised in regards to soliciting and contracting of IPPs, some comments are appropriate. The most significant point i s that virtually all of the issues that have been drawn to the attention of the World Bank team have been encountered in other countries before. Accordingly, the Go1 should be able to obtain structuring and procurement advice from international consultants that specialize in this subject and that can offer workable solutions to the problems. 6.18 Tavanir would be well served if it were to engage international financial and legal advisors to guide them through, and advocate on their behalf, a pilot IPPproject. Highly experienced consultants are not inexpensive but, for the first major initiative, would be worth the expense. Fixed or capped fee arrangements with such consultants are now commonplace. The financial structuring and legal components could be engaged as a package or separately. The structuring consultants are most often from an investment bank, consulting company, or engineering consulting company. Despite their high -56- Islamic Republic of Iran Power Sector Note billingrates, the top tier legal firms will have the most experience and depth of knowledge. Not involving the appropriate advice up-front can have long-term detrimental impacts (see box 6.7 below). e study: Nigeria EmergencyPower - advisors comes fr had no experience to comment on th act with IPP contracts Enron had covered every conceivable risk, leaving Nigeria highly exposed to contingent 6.19 The recommendation i s to engage international consultants to put together a model IPP transaction on a pilot basis, which would constitute a useful precedent even if the IPP investment in question i s ultimately made by a domestic entity. The consultants can create a bidding form of ECA (or PPA), Government Support Agreement, LandLease (or Usufruct), and other forms of contract (e.g., water supply, backup fuel) to form the Security Package for the IPP. These forms of agreements will be based on Iran's needs in the context of a rich experience of IPP investing around the world. The consultants will also develop a detailed set of Instructions to Biddersto attract qualified bidders. The consultants can solicit Expressions of Interest, recommend a short-list, manage the bidding process, including a transparent clarification process, evaluate technical and financial bids, and make recommendations as to the final award. While Tavanir i s perfectly capable of doing these things by itself, having an internationally recognized firm visible in this process will enhance the perceptions of bidders, each of whom will be weighing the expenditure of significant time and monies to prepare a bid. 6.20 N o less important i s to engage legal counsel experienced inIPPtransactions in other jurisdictions. Contrary to expectations, experienced IPP investors consistently prefer to sit opposite experienced advisors because they will then have confidence that reasonable solutions will be negotiated, based on precedents in other countries, when issues arise. It i s important to note that despite best efforts in preparing the forms of contract that are included in the Request for Proposals, a complex long-term business relationship cannot be fully anticipated by just one party in advance, and some negotiation on non-tariff contractual undertakings i s always necessary. 6.21 Furthermore, in the vast majority of IPP investments, limited recourse lending i s included in bid structuring. Lenders, with their relatively modest margins, and typically no upside potential, will look -57- Islamic Republic of Iran Power Sector Note most carefully at contractual structuring to avoid taking on risks. Again, experienced advisors can be invaluablein guiding Tavanir through a pilot project. 6.22 The international legal advisers will, of course, need to work closely with lawyers who are familiar with Iranian law. Further, the legal team will have to be familiar with the proposals that the Go1 i s developing for the future establishment of a more competitive power market in Iran. This latter consideration is significant, since, as mentioned above, the PPAs (or ECAs) entered into between Tavanir and the IPPs should be designed so as to avoid, or at least mitigate, the problems that other jurisdictions have faced inattempting to integrate older forms of PPAs into a new competitive market environment. 6.23 In summary, experienced advisors should be able to assist in Iran in minimizing the `trade-offs' noted above, both interms of meeting of the financial and security needs of the investors, and in terms of the impact of IPP plants on the development of the Iranian power market over the medium and long terms. -58- Islarmc Republicof Iran PowerSector Note Chapter 7: Legal and regulatory framework 7.1 Major conceptual frameworks have been put in place and agreed to for the development of the power sector and several institutions are up and running to implement advanced and sophisticated market models and transactions with investors. Nevertheless, the key legislation dates back to 1967 and despite Tavanir being charged in 2002 to draft new legislation for the sector reflecting the new policy directions, the law from 1967 remains in place and has yet to be replaced by an up to date legal framework. Introduction 7.2 The preceding chapters of this note, particularly Chapters 5 and 6, have already referred to some of the key elements of the legislative and regulatory framework of the Iran power sector. Against this background, this Chapter presents a summary consolidation of the key legislation and regulations that impact the sector. Law of Electricity Organizationof Iran; July 10, 1967 7.3 This legislation, which is almost 40 years old (predating the establishment of the Islamic Republic of Iran in 1979), remains in force as a fundamental pillar of the legal framework of the power sector. The law gives wide powers to the former Ministry of Water and Power (whose responsibilities have now been assumed by the Ministry of Energy -- see below) to organize and control the power sector throughout the country. These wide powers include the ability to establish the various regional electricity companies49and to control, through the issuance of licenses, the operations of those companies plus other government-owned, privately-owned and municipally-owned entities engaged in the generation, transmission, distribution or sale of ele~tricity.~'The Ministry also has the ability to set tariffs.51 Further, this Law gives the Ministry a general power to issue regulations governing the activities of companies in the sector52-- which is still used as the basis for some of the market establishment regulations recently promulgated, as discussed below. 7.4 In 2002, the Ministry of Energy53assigned Tavanir the task of preparing anew law for the sector, dealing with, inter alia, the protection of consumer rights; arrangements for the import and export of electricity; and licensing provisions designed to promote private participation in the sector. However, as of yet a new legislation has not been approved by the Parliament (Majlis). Given the significant changes that have taken place the Government's plans and commitments to a competitive power market, independent regulation and private participation in the sector, a modem Electricity Act should be prepared and enacted as soon as possible. Law Establishing the Ministry of Energy; June 1, 1978 7.5 This Law, originally passedin 1974, designates the Ministry of Energy (MoE) as the successorto the Ministry of Water and Power. It gives the MoE policy-setting responsibilities in the energy sector, 49Law of the Electricity Organization of Iran, Articles 2 and 3 50Ibid, Articles 5 and 6 51Ibid, Articles 9 and 10 52Ibid, Article 12 53Tavanir Power News, Issue 43, November 2002, available at http://news. tavanir.org.ir/nashriat/PwNews/SubNews.asp?NashriehNO=43&Ne wsID=48 -59- Islamic Republicof Iran Power Sector Note including the power sector, as well as specific coordination responsibilities for the production, operation, transit and distribution of energy, again including electricity. 7.6 In 1978, the Law was amended to give the MoE explicit responsibilities for the construction and operation of nuclear power plants.54 Law of the FourthEconomic, Social and Cultural Development Plan 2005-2009; SeDtember 1,2004 7.7 The Legislation adopting Iran's five-year plan for 2005-2009 (the Fourth FYDP) i s a foundation enactment by the Parliament. The key provision in regard to the electricity sector i s Article 25 B, as follows: "While preserving its responsibility in the provision of electricity, government is bound to determine by the end of the first year of the fourth plan, the conditions for production and guaranteed purchase price of electricity in order to encourage other domestic entities to get into production of electricity as much as possible through the power plants out of managerial and supervisionjurisdiction of the Ministry of Energy.'' 7.8 As indicated in Chapter 6 of this note, this Article documents the desire of the Parliament to encourage "other domestic entities" (Le. independent power producers, distinct from Tavanir) to become involved in the production of electricity. As i s also noted in Chapter 6, the reference to "domestic" companies (as opposed to foreign companies) arises from the requirement that all foreign investment be made either through shareholdings in a new or existing Iranian company, or through contractual arrangements with an Iranian company (see the section below on the Foreign Investment Promotion and Protection Act). Cabinet Decree ImplementingArticle 25 B of the Fourth Economic, Social and Cultural Development Plan 2005-2009; June 29,2005 7.9 This Cabinet Decree is the instrument that identifies the options for private investment described in the section on "Modes of private sector participation" in Chapter 6 of this note.55 This Decree also deals generally with the Tavanir PPAECA agreements, including the prices to be paid for the power purchased under such agreement^.^^ Further, there are provisions dealing with the purchase of power at guaranteed prices by the IGMC, including provisions dealing with natural gas fuel price adjustments and special incentive provisions for renewable energy and co-generation plants.57 Finally, the Decree provides that it does not apply to electricity export^.^' Given that the arrangements set out in this Decree are critical to potential private investors in the sector, it would be preferable if those arrangements were embodied inprimary legislation, such as the above-mentioned new electricity law. Cabinet Decree Establishingthe IGMC; September 20,2004 7.10 This Cabinet Decree establishes the Iran Grid Management Company (IGMC), and sets out its duties and responsibilities. 54 Law Establishing the Ministry of Energy, Article 1(Q)and (R) 55 Cabinet Decree Implementing Article 25 B of the FourthEconomic, Social and Cultural Development Plan 2005- 2009, Articles 2,4 and 5 56 Ibid,Articles 6 and 7 '* 57 Ibid, Articles 8,9 and 10 Ibid, Article 12 -60- Islamic Republicof Iran PowerSector Note 7.11 Although the IGMC does not own the transmission network in Iran, it does have responsibility for the operation of the grid59,including all dispatch functions6'. In addition, the Decree gives the IGMC responsibilities for key aspects of the development of the competitive power market in Iran, including: the establishment of the competitive terms for purchase and sale of electricity and the establishment and administration of the market itself6l; the development of strategiesto expand private investor participation inthe sector6'; the implementation of non-discriminatory grid access arrangements, on the basis of competitively procured capacity rights63;and the preparation of reports, for Tavanir and the MoE, on the status of competition in the power sectoru. 7.12 The IGMC i s not a fully independent entity, in that its shares all are indirectly owned by Tavanir, and there i s provision in the Cabinet Decree for Tavanir to be represented on the IGMC Board of director^^^. The IGMC i s also bound by policy directives given by the MoE~~. IGMC operates on a The not-for-profit basis67. Given the centrality of the IGMC in the new, competitive, market arrangements, and the desire to encourage private investor participation in the sector, it would be preferable if the IGMC were completely independent of Tavanir, reporting solely to the MoE. Ministerial Order Establishingthe Electricity Market; August 16, 2005 7.13 The initial version of this Ministerial Order was issued on August 25, 2003, and the August 2005 version is the first revision. As indicated in Chapter 5 of this note, this important Ministerial Order establishes a number of the key features of the Iranianpower market, including the regulatory agency, the EMRB, which oversees the operation of the Market Rules.68 The Ministerial Order also identifies the mechanisms by which the IGMC controls market transactions6' and the rules for relinquishing power station^.^' 7.14 As has beennoted above inregard to other items of subordinate legislation, it would bepreferable if the important provisions of this Ministerial Order were embodied in a law adopted by the Parliament. Indeed, as a Ministerial Order, this particular instrument would seem to have even less permanency than the Cabinet Decrees discussed above. Of particular concern i s the fact that it is this Ministerial Order which establishes the EMRB as the key regulatory agency. Given the composition of the EMRB, it i s clear that the government wishes it to have a degree of independence, especially from Tavanir. To support this desirable quality of independence, the EMRB enabling provisions should be found inprimary legislation. 59 Cabinet Decree Establishing the IGMC, Article 2( 1) Ibid, Article 7(1) 61 Ibid, Article 2(3) 62 Ibid, Article 2(4) 63 Ibid, Article 7(8) 64 Ibid, Article 7(10) 65 Ibid, Article 16 66 Ibid, Article 29 67 Ibid, Article 33 68Ministerial Order Establishing the Electricity Market - Revised Version, Article 5 69 Ibid, Articles 6 and 7 70 Ibid, Article 8 -61- Islamic Republic of Iran Power Sector Note The Foreign Investment Promotion and Protection Act (FIPPA); March 2002 and the FIPPA ImplementingRegulations; July 2002 7.15 The FIPPA legislation passedin March 2002 and the accompanying Implementation Regulations introduced in July 2002 are modem enactments designed to encourage and protect foreign investment in Iran, including investments inthe power sector. 7.16 Two basic types of foreign investment are contemplated inthe legi~lation:~' Foreign Direct Investment, in those sectors where private investment are permitted, through the mechanism of foreign ownership of shares inan existing or new Iranian company; and Foreign Indirect Investment, in all sectors of the economy, through the mechanism of contractual arrangements suchas Joint Venture arrangements, Buy-Back arrangements and BOT arrangements. 7.17 It is noteworthy that, on the website of the Organization for Investment, Economic and Technical Assistance of Iran (OIETAI), the government organization responsible for administering FIPPA, the reference inthe legislation to "BOT arrangements" i s defined as including"BOOT, BOO, BLT, ROT etc. schemes."72 7.18 Certain provisions in the FIPPA legislation and Implementing Regulations apply to both direct and indirect foreign investments. These include the following significant provisions in regard to investor rights: there is a guaranteeof foreign capital against nati~nalization;~~and investors may convert profit and capital gains to a foreign currency, or into goods, and repatriate same.74 7.19 Inregard to foreign direct investments, it is noteworthy that there are no restrictions on the level of foreign shareholding in a particular enterpri~e.~~ 7.20 In regard to foreign indirect investments, the following provisions are particularly relevant to power sector investments through the mechanism of a BOT-type scheme: the inclusion of "generation, transfer and distribution of electricity" as permitted areas of foreign investment76(but it should be noted that the legislation explicitly prohibits the granting of concessions to foreign investors if this would lead to such investors being "in a monopolistic po~ition"~');and provisions for compensatory payments inthe event of a change in law, and for the guarantee of any payments to be made by government purchasers of goods and services (such as electricity) resulting from a foreign investment project.78 71 FIPPA, Article 3 72 OIETA website, at http://www.investiniran.ir/pages(english)/rules.htm 73 FIPPALegislation, Article 9; and the FIPPA ImplementingRegulations,Article 4 (a) 4 74 FIPPALegislation, Articles 14to 18; and the FIPPA ImplementingRegulations, Article 4 (a) 5 75 FIPPA ImplementingRegulations, Article 4 (b) 1.2 76 Ibid, Scheduleon "Sectorsand Sub-sectorsreferredto inPara(d) of Article (2) of FIPPA" 17FIPPA Legislation, Article 2 78FIPPA ImplementingRegulations, Article 4 (b) 2.1 and2.2 -62- IslamicRepublicof Iran Power Sector Note Additional GuaranteeProvisions found inthe Annual Budget Laws 7.21 As a result of concerns expressed by prospective Independent Power Producers as to the adequacy of the above-noted guarantee provisions in the FIPPA Implementing-Regulations, the Parliament has begun to include, ineach year's Budget Law, special provisions permitting the Ministry of Finance to offer prospective IPPs a separate guarantee to secure Tavanir' s contractual obligations to purchase power generated in the plants owned by the IPP. 7.22 An example of these special guarantee provisions can be found in the 2004 Budget Law, which provides that: "In implementing the Foreim Investment Promotion and Protection Act, approved on March 10, 2002, the Cabinet is hereby authorized to take action in order to attractforeign investment in electricity generation plansfrom water, steam, gas, combined cycle, storage pumps, new energy and energy transfer up to a capacity of 12,000megawatts. In order tofilfill this Paragraph, the Government is hereby authorized, in addition to the guarantees that can be offered within theframework of the Foreinn Investment Promotion and Protection Act, approved on March 10,2002: 1- To take action towards guaranteeing the payment of the contractual commitments of Iran's governmental corporations that areparties to contracts (whose goods and services must ultimately be purchased by the government). 2 - on the basis of government decision or prevailing law, the selling price of products (goods or 8 services) produced by theseplants to customers is less than its guaranteed purchase price by the government or governmental corporationsfrom the investor, the difference would beforecast in the annual budget by the National Organization of Management and Planning, and its payment would be guaranteed by the government (the Ministry of Economic Afsairs and Finance} ". 7.23 Ifthe Go1intends to offer these additional guarantees on a continuing basis (notwithstanding the current difficulties in attracting foreign investment discussed above in Chapter 6), it would be sensible to amend the FIPPA legislation and/or the implementing regulations to consolidate all of the relevant guaranteeprovisions in one location. -63- I -r I Islamic Republicof Iran Power Sector Note Annex 2: Forecast of electricity demand (8.6%demand growth) I11IIII LoadMW ConsumptionGWh 2005 31,494 175,528 2006 34,074 190,623 2007 37,053 207,017 2008 40,189 224,820 2009 43,762 244,155 2010 47,501 265,152 II 2011 51,484 287,955 2012 55,797 312,720 2013 III1IIIII 60,500 I1IIII111 339,614 II111IIII 64,843 368,820 69,473 400,539 Source: World Bank analysis 2006 -66- Islamic Republic of Iran Power Sector Note Annex 3: Network Map -67- 8 Ins co 2: N O I I t I I I I I I 3 t Islamic Republic of Iran Power Sector Note Annex 6: Germany's Experience with Feed-in Tariffs In the early 1990s, Germany had virtually no renewable energy industry and, in the view of most Germans, the country was unlikely ever to be at the forefront of alternative energy sources. Yet, by the end of the decade, Germany had transformed into a renewable energy leader, with a new, multibillion- dollar industry and tens of thousands of new jobs. Driven by growing public concerns about security of energy supply, and environmental impacts including global climate change, the German government passeda new energy law in 1990 that required utilities to purchase the electricity generated from all renewable technologies in their supply area, and to pay a minimum price for it. The "Electricity Feed-in Law" was inspired in part by similar policies that had proved effective in neighboring Denmark. The law has beenadjusted numerous times since it entered into force in 1991.Most significantly, in2000, the German Bundestag required that renewable electricity be distributed among all suppliers based on their total electricity sales, ensuring that no one region would be overly burdened. Additional technologies, such as geothermal power, were included under the new law. Also, with help from scientific input and the various renewable industries, the Bundestag established specific per kilowatt-hour payments for each renewable technology based on the real costs of generation. Electric utilities also qualify for these tariffs; a change that the government correctly expected would reduce utility opposition while further stimulatingthe renewable energy market. The German Renewable Energy Act of 2000 sets specific feed-in tariffs for various renewable energy technologies for a period of 20 years, based on their generation cost and generation capacity. The aim i s to secure pioneering markets for renewables, and to support technological learning through large-scale market introduction. The law covers electricity from wind (on- and offshore), biomass plants of up to 20MW, photovoltaic, hydro and geothermal. Generally, the tariffs decrease for newly installed plants. The electricity from renewable energies i s distributed proportionately amongst grid operators, according to the amount of electricity supplied to customers (flexible shares at the transmission system level). All electricity suppliers are obliged to purchase from their regional grid operator an equal share of electricity from renewable energy (flexible shares at the electricity supplier level). Pricing i s based on fixed norms unique to each technology, which in turn were based upon estimates of power production costs and expectations of declines in those costs over time. For example, wind power prices remained at the previous level of DM0.17/kWh for plants commissioned in 2001, but only for the first five years of operation, after which prices paid declined. Solar PV prices were set initially at DM 0.99/kWh. All prices had built-in declines over time (i.e., 1.5% annual decrease in starting tariffs paid for wind power plants commissioned in subsequent years). This provision addressed one of the historical criticisms of feed-in approaches, which was that they did not encourage technology cost reductions or innovation. The new law's provisions for regular adjustments to prices addressed technological and market developments. The law also distributed the costs of the policy (i.e., the additional costs of wind power over conventional power) among all utility customers in the country. This issue of burden sharing had become a significant political issue in Germany by 2000 because the old law placed a disproportionate burden on utility customers in specific regions where wind power development was heaviest. -72- Islamic Republic of Iran Power Sector Note So far, the Feed-in Tariffs have been a success in massively increasing wind energy generation, and accelerating biomass and solar technologies. In 2004, the Law was revised again to also cover larger- scale hydro, and differentiating tariffs between biomass types, and size of plants. EU countries like Austria, Belgium, Denmark, France and Spain have adopted similar legislation, and Brazil (among other developing countries) i s inthe process of establishing a comparable scheme. Germany also addressed the challenge of high initial capital costs of renewable energy through low- interest loans offered by major banks and refinanced by the federal government. The "100,000 Roofs" program, which expired in 2003 (and has since been replaced with higher PV tariffs), provided 10-year low-interest loans for PV installation. Income tax credits granted only to projects and equipment that meet specified standards have enabled people to take tax deductions against their investments in renewable energy projects. In addition, the federal and state governments have funded renewable resource studies on- and off-shore, have established institutes to collect and publish data, and have advanced awareness about renewable technologies through publications of subsidies and through architectural, engineering and other relevant vocational training programs. Source: World Bank Renewable Eneregy Toolkit website at httu://www.worldbank.ordretoolkit(March 8, 2006) -73- Islamic Republic of Iran Power Sector Note Annex 7: Texas Renewables Portfolio Standards79 Under the Renewables Portfolio Standard (RPS) in Texas, retail electricity suppliers are required to include a specified percentage of renewables in their generation portfolio. Annual renewable energy generation targets back the policy. Texas state authorities have set targets to increase the amount of energy generated by renewables to 2,880 MW by 2009, including 2,000 MW from "new renewables" (Le., modern biofuels, wind, solar, small-scale hydropower, marine, and geothermal energy). Wind energy currently dominates the installed capacity of renewables, with supply costs of around 4.7 cents/kWh (of which 1.7 centkwhi s covered by a federal production tax credit). Reports show that the first-year target of 400 MW of new capacity installed by 2003 was exceeded significantly. Several factors are contributing to the policy's success: clear renewable energy targets, clear eligibility of what qualifies as a renewable resource project, stringent non-compliance penalties, a Tradable Renewable Energy Certificate system that encourages flexibility and minimizes costs, and a dedicated regulatory commission that fully involved numerous stakeholders during the detailed design of the policy. A major lesson from Texas is that, although new and relatively untested as a policy tool, the RPS, in combination with tax credits, has the potential to cost-effectively support the establishment of a robust renewable energy market. Source: G8 Task Force on Renewable Energy, Final Report, June 2001. 19 Informationobtained in: UNDP,UNDESA andWorld Energy Council (2004) WorldEnergy Assessment: Overview 2004 Update.UnitedNationsdevelopmentProgram, New York. -74- Islamic Republic of Iran Power Sector Note Annex 8: Detaileddescription of energy efficiency measures inthe power sector under implementation 1. Energy recovery, fuel switching and cogeneration for the power sector Since the early 1990s, supply side activities have been implementedinthe power sector with the objective of improving energy efficiency". The key activities include: The conversion of existing gas power plants to combined cycle; The implementation of energy recovery projects such as installation of turbo-expanders" and co- generation (CHP) in power plants. Energy recovery projects in the gas turbines in Kish Island (Persian Gulf) and from the Tabriz power plant are successful examples of CHP projects designed and implementedin collaboration with the Ministry of Energy; and Various co-generation projects have been implementedin several cities. The development of supply-side energy efficiency activities has been successful overall, but the low electricity tariff has made it difficult to justify the projects from an economic point of view. For most of the supply-side energy efficiency activities, the financing of the needed equipment remains too costly for such measuresto be widely implementedinthe present tariff contextg2. 2. T&D lossesreduction activities Due to the relatively high rate of T&D losses, it is a priority for the Iranian power sector to implement measures for loss reduction. Efforts have focused on the distribution side given the larger share of the losses in this part of the network. To assess what can be achieved; pilot projects have been implemented in each Regional Electricity Company for one or two zones of their distribution network in recent years, under the supervision of T a ~ a n i r .In~ ~ practice, project component actions have covered, inter alia, the replacement of low voltage by medium voltage cable, installation and/or rehabilitation of transformers, and overall improved maintenance of the installations. The pilots have shown that with investments of about US$90 per customer, it has been possible to achieve a 4% reduction in distribution losses. At the current level of tariff, such investments do not make economic senseg4,but they could be viable if focused on zones where customers are the most energy intensive (e.g., industrial zones). However, due to the level of investment required, and budget shortages experienced by Tavanir, the pilot measures have not been extended as far as envisaged. Thus the effects of this particular effort remain somewhat limited. Informationavailable on the website of the Iranian Ministry of Energy at http://www.iranenerm.org.ir (March 17, 2006). Devices that recover power from flue gas or process gas streams. Based on discussion with Tavanir in January, 2006. 83 Based on discussions with Tavanir in January, 2006. 84 Based on using an average power tariff o f about 132Rials/kWh (2003 data), the savings realized on the total power consumption correspond to about US$75 million only. -75- Islamic Republicof Iran Power Sector Note 3. Load management/shedding/TOU activities inthe industrial sector Because of rapid growth in demand for power, Iran i s now turning towards load management activities, especially in the industrial sector, where most of its energy intensive consumers are. The efforts to date have been somewhat modest, mainly focused on stimulating voluntary or mandatory load shifting through the introduction of: Mandatory holidays (5-7 days) for big industrials during the summer peak: if such engagement i s not respected, industrial consumers are penalized by being the first disconnected in case of load sheddings5;and Monthly changes to basic tariff rates (per kWh or per kW depending on the tariff structure chosen), inorder to stimulate load shiftingtowards cheaper periods of the year.s6 The design of more elaborate mechanisms for load shifting should be possible once better data is available on consumption patterns. The activities undertaken in the field of smart meters are contributing to reachingthat stage (see paragraph below). 4. Installation of smart meters As agreed under the Fourth FYDP, Iran has started to install smart meters at selected customers' connections in order to make better use of load management activities. The related by-law under the FYDPgives Tavanir the responsibility to buy and the RECs to install smart meters as followss7: By 2009, all of new and existing connections in the industrial and commercial sectors should be equipped with smart meters; By 2009, about 30% and 20% of -respectively - all new and existing connections for urban residential consumersssshould be equipped with smart meters. Intotal, more than 5 million smart meters should be installedinthe next five years for industrial, commercial and residentialconsumers.89 5. Energy audits for industrial facilities Energy audits have probably been the most common initiative in Iran in the field of industrial energy efficiency. Audits have been conducted by various agencies, SABA, FCO, but also Tavanir) and most of them have not focused on the power sector only. In order to stimulate the implementation of the measures recommended in the audit, the Iranian government also developed a financial facility for energy efficiency projects with the following characteristic^:^^ s5 Basedon discussions with Tavanir, January, 2006. s6 Basedon discussion with Tavanir, January, 2006. s7 Basedon discussion with Tavanir, January, 2006. Priority will be given to the consumerswith big power consumptionand/or demand within the urbanresidential sector. (basedon discussions with Tavanir, January, 2006.) s9 Based on discussion with Tavanir, January, 2006. -76- IslamicRepublicof Iran Power Sector Note 100%of the costs of new and demonstration projects can be financed; Up to 50% of the costs of energy audits and measures implemented can be financed for projects with high energy saving potential; and Payment of the bank loan's interest in the case of high cost measures with high energy savings potential. As of 2004, energy audits had been conducted in more than 70 factories. These audits have led to the implementation of various measures,resulting in about 85,000 tons of crude oil savings per year." 6. Development of a domestic ESCO industry International experience suggests that the most important factor in the creation of an energy efficiency market i s the emergence of Energy Services Companies (ESCOs). At present, about 40 ESCOs exist in Iran, working on energy auditing and on the installation of smaller-scale energy efficient equipment and fuel combustion settings.92 However, the impact of the existing ESCOs - in terms of energy savings - i s difficult to assess. In addition, the lack of technical expertise in the field of large industrial energy efficiency i s affecting the development of a more effective ESCO industry, despite some recent initiatives to tackle this issue (e.g., in 2005, an MOU was signed between Iran and Japanese ESCOs to provide Iranian ESCOs with training on how to implement industrial energy efficiency audits and measures).93 7. Efficiency standards for energy intensive industries Due to the large share of energy consumption coming from the industrial sector, the Go1has set up some mandatory energy efficiency targets for the following industrial sub-sectors: cement, brick and ceramics, tires, glass, agriculture, pulp and paper, textiles, aluminum, food oils, sugar, and chalk and lime.94These do not focus on the power sector per se, but should have an impact on electricity savings/load reduction. Under the Fourth Development Plan, new targets have been set for the period 2005-2009. In case of consumption above the targets, the industries are fined by having to pay an extra 20% for the energy Abdollahshirazi, A. (2004) Energy Management Promotion in Iran. Paper prepared for the International Summer School 2004, "Renewable Energy in Schleswig-Holstein. Regional Experience for International Development." 07- 13 June 2004, University of Flensburg, Germany. 9' UNEconomic and Social Commission for Asia and the Pacific (2004) End-Use Energy EfJiciency and Promotion ofa Sustainable Future. Energy Resources Development Series No. 39. United Nations, New York, USA. 92 Some of the ESCOs mentioned are: Yekta benideh Tavan, Bareen energy, Sepahan, Pishran Energy Persia, Ehdas Control, Tabeh Rayan Energy, N o Andishan Energy Novin, Shianak, the center for environmental and energy research and studies, and Samen Niro. See: article on the Second Gathering o f Managers of ESCOs in Iran, Scientific-technical monthly magazine of electrical power industry, No. 106, March 2005. Also available on the Tavanir website at http://news.tavanir.ore.ir/nashriat/mahbars/Subnews.asp?NashriehNO=106&MahbarsBG= 15 (March 21,2006). 93.See: article on the Second Gathering of Managers o f ESCOs in Iran, Scientific-technical monthly magazine of electrical power industry, No. 106, March 2005. Also available on the Tavanir website at htt~://news.tavanir.or~.ir/nashriat/mahbar~/Subnews.asp?NashriehNO=lO6&MahbarsB~l5 (March 21, 2006). 94UNDP/ GEFProposalfor PDFBlock B Grant for the Iran's IndustrialEnergy Efficiency Program (IEEP), available on the GEF website at http://www.nefonline.orq (March 17,2006). -77- IslamicRepublic of Iran Power Sector Note consumed.95 In order to help the industries reach their target, supporting legislation was passed that an energy managementdepartment be created in all large-scale ind~stries.~~ 8. Energy efficient light bulbsand Compact Fluorescent Lamps Activities intendingto make use of the economic benefits97of Compact Fluorescent Lamps (and other energy efficient bulbs) were started in 1995, with the objective of stimulating the creation of a domestic market, supported by a domestic manufacturing industry. Most of the lampshulbs are sold to consumers at subsidized prices, under a scheme whereby manufacturers receive a subsidy from the state on the production costs for the CFLs, which are then channeled through specific retail shops proposing energy efficient lamps for sale. Other lamps are also bought by Tavanir and distributed directly by RECs to customers, who can repay for the CFLs through their electricity bills.98The subsidy on energy efficient bulbs depends on whether the customer's residence is in a rural area (70% subsidy) or in a city (40% subsidy)99. In parallel, information campaigns have been implemented (by RECs, Tavanir and by the Ministry of Energy) to raise awareness among electricity consumers, including the public sector. Up to now, about 15 million subsidized energy efficient lamps have been disseminated through this mechanism, at a present rate of 5 to 6 million bulbs per year. Such diffusion has also stimulated the overall efficient bulbs market which now i s estimated at about 25 million units sold in 10years (see figure 6.A below).'00 However, the potential for development of the efficient bulbs market i s still much higher, and could reach at least 30 million units per year if properly stimulated."' The Fourth FYDP aims at a distribution of more than 25 million CFLs by 2009. 95 Information based on discussion with Mr.Hasanzadeh, Director of Electrical D S M Department at Tavanir, on January 16,2006. 96 UNEconomic andSocial Commission for Asia and the Pacific (2004) End-Use Energy Eficiency and Promotion ofa Sustainable Future. Energy Resources Development Series No. 39. United Nations, New York, USA. 97 An economic analysis on CFLs dissemination's economic benefits in Iran was prepared in2003 by a consultant for Tavanir, and concluded that CFLs could bring economic benefits to Iran o f about US$20 / bulb sold at subsidized price. Inthis estimation, the economic benefits are about 8 times as high as the costs to buy and procure a CFL. (Calculation based on data extracted from the Powerpoint presentation of Noorgestar Co. Ltd entitled "Economic analysis o f CFL diffusion inIran", prepared for Tavanir. The printed document was provided to the World Bank by Mr.Lavaee, Distribution Manager at Tavanir, on January 18,2006.) 98 Based on discussion with Mr.Lavaee, DistributionManager at Tavanir, on January 18,2006, the latter CFL distribution scheme has not been such a success in Iran, partly due to resistance from Regional Electricity Company to take on the responsibility of selling the lamps and consider it as part as their core business. 99 Mainly for income distribution reasons, the Iranian government assumesthat rural consumers should be more subsidized than urban consumers. 100 Data based on discussions with Mr.Lavaee, DistributionManager at Tavanir, on January 18,2006. 101 This calculation is based on the assumption that there are 20 million potential customers inthe country, that each could install on average 5 CFLs, for which the average lifetime is 3 years. (Data based on discussions with Mr. Lavaee, Distribution Manager at Tavanir, on January 18,2006.) -78- Islamic Republic of Iran Power Sector Note Figure 8.A CFLmarket development (modeled) 1994-2005102 Nunber of units sold (in thousands) 61000.00 7 4,000.00 2.000.00 i 95 96 97 98 99 00 01 02 03 04 Due to rapid demand growth in Iran, it is reported that it has not been possible to properly monitor the effects of CFLs diffusion on energy consumption and peak demand.'03 Some studies based on pilot testing suggest that for each million units sold, the equivalent reduction in peak load i s 30-50MW.'04 At the current rate of CFL sales, the impact on the peak demand i s a reduction of about 400-600 MW. With a more developed market, the potential i s estimated at about 2700-4500 MW inpeak load reduction. 9. Energy performance labels and standards for electrical appliances Energy performance labels and standards are common means to address end-use inefficiencies. They started being developed in Iran in 1994, with the design and approval of standards for refrigerators. In 1995, a specific Standardization and Labeling Department was created under the Energy Efficiency Office in the Ministry of Energy, and in 1996, a legal text was ratified which called for more systematic preparation and implementation of standards for energy intensive appliances. Following that legislative support, additional measures were implemented in the field of labeling and standardization. Studies were conducted on the most energy intensive household appliances, as well as the related energy consumptionpatterns. National laboratories were established for the testing of labeled appliances. As of 2004, several standards andor labels had been established for appliances such as freezers, refrigerators, washing machines, water coolers, single-phase electro motors, irons, electrical water boilers, electrical heaters, pumps, compressors, lamps, fans and chiller^).'^^ According to annual monitoring and Modelling by the World Bank (March 2006) basedon data gathered through discussion with Mr.Lavaee, DistributionManager at Tavanir, and with Mr.Hasanzadeh, Director of Electrical DSM Department at Tavanir, in January 2006. lo3Informationbased on discussion with Mr.Hasanzadeh, Director of Electrical DSM Department at Tavanir, on January 16,2006. lo4Informationbasedon discussion with Mr.Hasanzadeh, Director of Electrical DSM Department at Tavanir, on January 16,2006. `05Abdollahshirazi, A. (2004) Energy Management Promotion in Iran. Paper prepared for the International Summer School 2004, "Renewable Energy in Schleswig-Holstein. Regional Experience for International Development." 07- 13 June 2004, University o f Flensburg, Germany. -79- Islamic Republic of Iran Power Sector Note testing of the standardized appliances, it i s possible to estimate the average savings per appliance per year, However, it i s more difficult to monitor the total energy savings achieved since the start of the program. A recent study reports that standardization and labeling activities for freezers and refrigeratorshave been particularly successful, and contributed to savings of about 450 million kWhin2002-2003.'06 However, challenges still remain to motivate consumers to buy (often) more expensive but energy efficient appliances, as well as to increase the collaboration with manufacturers and sales points.'07 10. Information, education, training and awarenessraising.activities Inparallel to specific energy efficiency projects, all stakeholders (Ministry of Energy, Energy Efficiency Organization (SABA), Iranian Fuel Conservation Organization(IFCO), Tavanir) have developed information programs and forms of awareness raising activities, in order to reinforce the benefits of energy efficiency activities. Some training courses have also been organized to create and/or improve technical expertise of people in the field of energy efficiency. The Ministry of Energy notably contributed to the training of more than 1,500 experts on energy audits and energy efficient technologies through four different courses. Informative leaflets, TV and radio ads, education programs for children, and various workshops inthe industrial sector are some of most important activities implemented. 106UNEconomic and Social Commission for Asia and the Pacific (2004) End-Use Energy EfJiciency and Promotion ofa Sustainable Future. Energy ResourcesDevelopment Series No. 39. United Nations, New York, USA. 107Informationbased on discussion with Mr.Hasanzadeh, Director of Electrical D S MDepartment at Tavanir, on January 16,2006. 'OsInformation available on the website of the Iranian Ministry of Energy at http://www.iranenergy.org.ir (March 17,2006). -80- Islarmc Republic of Iran Power Sector Note Annex 9: Recommendations for Energy Efficiency and InternationalExperience Loss reduction activities for transmission and distribution lines Loss reduction activities should be considered as priority options for energy efficiency, and the pilot measures should be extended. Inorder to limit the budgetary implications, the program would first prioritize the areas where such measures are the most economically viable (for example where loss rates are very high, or where particularly energy intensive consumers are concentratedj. Load management activities and smart meters inthe industry Based on the smart-meters (to be) installed the introduction of pricing signals for electricity should be investigated, such as Time of Use tariff or other innovative price mechanisms for energy efficiency. This process should be started inthe short term by targeting large (mostly industrial) customers through simple mechanisms (such as loadbuy-back / "interruptability" schemes'09)to be able to gain from this knowledge and expand the programs inthe mediumterm. An example of successful loadmanagementprogram(inChina) is given inBox 9.Abelow. BoxY A : Peak Load ManagementinBei,jing,China Bcijing began engaging in DSMactivities primarily for load inaiiagement purposes in response to rapidly escalating peak deiuand. The peak load grew from 3 GW in 1992 to nearly 4.5 GW in 1996, a yearly average load growth of 10.4 percent. The miniinurnload had increased slowly, while the daily max-min had grown quickly. decreasing the atiriuat system load factor by around 86 percent in 1992to 82 percent in 1996. This made it difficrtlt for Beijing to ensure the safe, stable and economic operation of the power system. In order to promote the toad factor increase, Heijing's main goal was to open LIPthe power market inoff-peak hours. The first step was to investigate the consumer power market. Before developing effective nieasures for peak load riunagement, Beijing curried out a survey to determine the condition of customers' electric equipment and consumption patterns. Models and software programs were developed, based on the load survey, to analyze the efficiency opportunities available from major customers inkey industries. The survey revealed that in 1996, industrial consumption accounted for over 55 percent of the typical lo9Such schemes involve the setting up o f incentives (and / or penalties) for participating consumers to shift their load when it coincides with peak demand. Basically the incentives are calculated based on the (avoided) costs of building a peak plant. -81- Islamic Republicof Iran Power Sector Note in order to improve productivity, and invest in technologies that shift usage from peak to valley periods, such as ice storage air conditioning and storage electric heaters; and * Provide financial assistancebased on actual upgradingand retrofitting needs. The net effect of these measures was a reduction in the peak demand of SO MW in 1997, an additional SO MW in 1998, and an improvement in the load factor because of the 150 CiWh increase in consumption during the valley load period. The investment to produce the peak load shift was 12.05 million RMB in 1997 and 5.67 million RMK in 1998. The annual benefit based on the avoided cost of` new generation capacity was esriniated at 24.8 million RMB. The Beijing DSM project was succzssful primarily because it focused on peak load managernent, which is generally easier to implement than other DSM programs. In tWrllny cnses. load iiianagement can be accomplished wirh properly designed and progressive tariffs, such as time of use and interruptible tariffs. After successfully completing the load management program, Be g has now gained practical experience that should prove useful for the development of DSM programs that result in long-term reductions in demand through efficient cnd use technologies. Beijing is now conducting a detailed study of DSM policy options and incentive mechanisms with the support of the Energy Foundation. Sources: f 1) Finamore. B. et a1 (2003) Derntc;ird-Sidc. Mnnngerncnt in China, Benefits, Burriem and Policy Reconzmenrlritions. Natural Resources Defense Council, New York, tJSA. Available on the China able Energy Programwebsite at httn:flw\Yw.cfi.l7ii~(December 6,2005). (2) Hu, 2. "Benefit Analysis on Application of Demand Side Management (DSM)in Beijing." htr,mation <#Electric Pntver Systenrs, Vol. 23, No. 13, JuIy 19139. Energy audits for energy intensive industries and development of an ESCOindustry Efforts should be pursued to use audit mechanisms and make them successful tools to promote demand side management measures in the industrial sector, for which ESCOs would be the key instrument. These efforts should be reinforced by important information campaigns and capacity buildingfor ESCOs. A good platform would be the development of a program (such as a public building energy efficiency program), through which ESCO could develop their hands-on expertise with audits and practical measures implementation inthe industry. -82- Islamic Republic of Iran Power Sector Note An example of a successful public buildingenergy efficiency program (in Mexico) is given in Box 9.B below. Rax 9.8: Energy Efficiency in Federal PublicBuildingsin Mexico Mexico's government sector energy conservation activities began in the early 1990s and have burgeoned into perhaps the broadest government end-use program in the world. impacting hundreds of government facilities. It started in the early 1940s under the "100 Public Buildings" pilot program, which later evolved essment of the 1 designed methodologies, conduct their own assessments, and follow up on measures, including permanent rnonitoring of energy LIS~,arid operation & maintenance of newly installed equipment. Consequently C'ONAEproposed to extend the program to the entire federal goverrirnent in 1998, and in 1999, all the federal agencies were mandated to participate in the Energy Savings Program. following the guidelines published in the Federal Official Gazette and establishing the program scope. The staff representing the agencies was trained through specific workshops on guidelines. operational mechanisms and activities to be perfornied as part of the program. primarily as a result of the increased load due to computer equipment as well as a lack of compliance with the shortened work schedule. Due to the previous year's results, the new guidelines for 2001-2002 established that the energy savings goals would be defined by each agency based on recommendations emitted by CONAE (and based on each agency's energy consumption index). In only three years of operation (1999-2002),the APF program achieved impressive results in terms of electricity and cost savings. It i s estimated that the energy siivings reached 100GWh. amounting to public sector savings of approximately US$ 7.4 million. The program also contributed to better cooperation among differenr governmerit agencies and widespreadtraining of personnel. -83- Islamic Republic of Iran Power Sector Note Distribution of subsidized Compact Fluorescent Lights and other energy efficient bulbs Collaboration with the RegionalElectricity Companies should be extended, so as to reach more customers with energy efficient bulbs. Innovative financing schemes for CFLs (or other energy efficient equipment) should be investigated. For example cooperative procurement schemes could be developed, supplemented by intensive education and information campaigns both at the utility and at the consumer levels. Box 9.C below summarizes the successful initiative developed inEgypt by the Alexandria Electricity Distribution Company for the diffusion of CFLs. Box 9.C: Alexandria Electricity Distribution Company's DSMexperience (Arab Republicof Egypt) Alexandria is the second largest city in Egypt and accounts fo 40% of Egypt's industrial activities. AEDC` has a maximum load of 2,100 MW and annual consumption of niore than 5,000 million kWh. Since their emergence on various lighting markets in the world, Compact Fluorescent Larnps ( W L s ) have created a revolution in the field of energy efficient lighting.Designed as cornpact versions of full- sized fluorescent (commonly used in industrial faciIities, schools, etc.), CFLs operate at relatively low temperatures, are highly efficient and Iast a long time. A CFL will last up to ten times Ion incandescent bulb, use a quarter of the energy, produce 913% less heat and more light. The initial cost of a CEL is usually much greaFer rhan an incandescent bulb. but the energy savings generated will more than offset the initial costs. Intypical applications, the energy savings will pay for the initial cost of the Cf;L inone year. In 1995, when Alexandria started it collaboration with the "Energy and Urban Environment in Mediterranean Countries" (EUEMC) project. there was no CFL on the light bulb iitarket in Egypt. The objective of the collaboration with the ETJEMC project in this phase was to replace traditional Iight bulbs in residential areas and scl~oolsby CFL bulbs in order to demonstrate iheir praciical use, and their impact on electricity bi1Is. However. and despite the successful resiilts of the pifotdemonstration, various barriers to the large-scale development of CFLs in andria still inhibited consumer ro buy them. The main barriers (which are in fact comiiionly encou d in many countries where CELs are not used) related to ~ f f o ~ d ~ b ~ I i ~ y , information, access and riskaversion. Following the ElEMC project, the Alexandria Electricity Distribution Company decided to address these barriers, and support the diffusion of CFLs for its customers. To do so, the co vative leasing scheme dedicated to CFLs. This scheme cov AEDC (thereby reducing the price for each unit), and the re-s can purchase thein at specitic retail locations. The leasing pr the CFL to the customer for a down payment representing 10% of its price, the remining amount being added to the electricity bill in equal installments over a period of 2 to 3 years. 111parallel, AEDC organized a systematic distribution of information leaflets on the benefits of using CELs instead of waditional -84- Islamic Republic of Iran Power Sector Note The implementation of efficient lighting should be extended to other sectors (industry, public lighting, etc.), especially those with an important impact on the peak load. Box 9.Dbelow summarizes the development of an ESCO/street lightingprograminLatvia. Box 9.D: ESCO EfficientStreet LightingProject inLatvia develop and i~nplementstreet am decided to foci .Latvenergu (thepower ut not cover the full * Lack of street lighting . . potential iitunicipiilities and competilions between niunicipiilities to see ivhicli one ~`oiildparticipate in -85- Islamic Republicof Iran Power Sector Note The dcvetopment of rhe project shows the important role not only of specialists but also the role that municipal leaders play. These kindsof projects are the result of the teamwork. -86- Islamic Republic of Iran Power Sector Note Development of mandatory energy performance labels for electrical appliances The expansion of the standards and labeling program to other energy intensive appliances should be considered. Complementary measures that involve appliance distributors and retailers should also be introduced (such as information / training, financial incentives or technology procurement), so as to make the program more effective. Finally, care must be taken to reflect changes in the market and technical progress, and to undertake activities to regularly reviseenergy efficiency classes on the labels Information, education and awarenesscampaigns and trainings Education, information and training programs are essential support mechanisms that should continue to be developed inthe near future. They will help buildingup on the momentum that has been initiated for the past years. In addition, such mechanisms are substantial tools to accompany other types of mechanisms as they are tackled through new programs. For example, the involvement of the general public through large awareness campaign efforts should be an integral part of any program dealing with demand-side management. The legislative framework in place to promote renewable energy in Iran i s embodied in the FourthFYDP. -87- Islamic Republic of Iran Power Sector Note Annex 10: Electricity Prices for Various Consumer Categories inIran 2003 97.00 IS2*oo 14.00 162.90 412.00 131.76 2004 107 175.89 16.01 198.82 446.96 151.06 -88- 0 I 0: h d H co UI Islamic Republicof Iran Power Sector Note Annex 12: Organization of the Electricity Sector iiam F?rs Shrrar Fars Giian ili(azzandarsn Normorgan Y Z d Source: Tavariir -92- Islamic Republic of Iran PowerSector Note __________________~ ~ Annex 13: Comparing SchedulingRegimes and Pool PricinginSpain and Scandinavia Comparing Scheduling Regimes in Spain and Scandinavia There are two main methods for coordinating generators in order to meet energy demand duringthe day: central scheduling and self scheduling. Under central scheduling, power is traded through a compulsory day-ahead market which serves to co- ordinate production for the following day. The SO determines each generator's entire production for the following the day and sets price using a central algorithm, usually at the System Marginal Price, i.e. the price of the most expensive generator that meets demand when placing generating units in ascending price order. The SO must have good scheduling skills in order to operate the market efficiently. Generators need only submit plant data and follow instructions. For example, in Spain, the day-ahead market is also centrally scheduled, by the market operator OMELbut as the bids are relatively simple (in most cases) the central algorithm i s very simple. OMEL matches generation and demand to give a "theoretical" day-ahead schedule. The SO reviews this and advises alterations to the schedule to make it feasible. Together, the market operator (MO) and SO produce a feasible schedule and the ex ante hourly market prices for next day. Generators can then adjust their positions by trading in the voluntary intra- day markets. Under self scheduling, there is no compulsory day-ahead market for energy trading. Generators and suppliers contract with each other, and generators schedule the production levels of their plant in order to meet their contracts. Such contracts may include obligations arising from voluntary power exchanges. The SO'Srole is limited to small changes to generation schedules in order to ensure system stability or meet transmission constraints using ancillary services or a balancing market. Prices are set by the bilateral trades, which could be between generators and suppliers, or with traders. In order to work efficiently, the market must be transparent, with accurate rules, and good liquidity. For example, NordPool uses self-scheduling, but any trades across transmission zones must take place through the day- aheadmarket. Comparing "Pool Pricing" Regimes in Spain and Scandinavia There are two approaches for the pricing of energy in a wholesale market: either (i)single price across a the market, or (ii) multiple prices for different zones, or even different nodes. Where there is a single price, the market i s treated as one energy hub, with the SO managing congestion through the use of constrained on, and sometimes constrained off, payments (or counter-trades). Transmission charges give signals for locating new generation capacity. In Spain, there i s a single energy price. The SO undertakes counter-trades to relieve transmission constraints. Where there are multiple prices, the market i s divided into several transmission zones or hubs, with a price for each zone (and this can be extended to a price for each node). Congestion i s market managed, with higher prices in the import constrained zone, and lower prices in the export constrained zone. These prices balance supply and demand in each zone, allowing maximum flow across the constrained lines. These different prices provide locationaI signals for new generation. In NordPool, zonal prices are calculated when transmission constraints bind. The market operator looks at the theoretical flows that would occur under supply and demand bids, and if transmission constraints bind, zones are created with corresponding prices. -93- Islamic Republic of Iran Power Sector Note A "capacity fee" is defined as the difference between the system price and the zonal price. Inthe surplus area, the capacity fee i s debited to the sellers and credited to the buyers. In the deficit area, the capacity fee i s credited to the sellers and debited to the buyers. -94-