Submitted to the World Bank by: Economic Consulting Associates Limited Economic Consulting Associates 41 Lonsdale Road, London NW6 6RA, UK tel: +44 20 7604 4545, fax: +44 20 7604 4547 email: peter.robinson@eca-uk.com Chișinău Heat and Electricity Supply Institutional and Financial Restructuring Study Phase 1 Report April 2011 Acknowledgement The report was produced by a team of experts consisting of consultants from Economic Consulting Associates. The World Bank team consisted of Shinya Nishimura (Task Team Leader), Gary Stuggins, Pekka Kalevi Salminen, Claudia Ines Vasquez Suarez, Alexander Sharabaroff, Sandu Ghidirim (ECSS2), and Pedzisayi Makumbe (ECSSD). Valuable comments on the draft report were received from Messrs. Maria Vagliasindi (Lead Economist, SEGEN), Alexander Berg (Program Manager, GCMCG) and Victor Loksha(Consultant, SEGES). The project team is grateful to the staff of the Ministry of Economy of Moldova and all other Moldovan counterparts for their cooperation. The study is jointly financed by the Energy Sector Management Assistance Program (ESMAP) and Public-Private Infrastructure Advisory Facility (PPIAF). ESMAP is a global knowledge and technical assistance partnership administered by the World Bank and sponsored by official bilateral donors - assists low- and middle- income countries, to provide modern energy services for poverty reduction and environmentally sustainable economic development. ESMAP is governed and funded by a Consultative Group (CG) comprised of official bilateral donors and multilateral institutions, representing Australia, Austria, Denmark, Finland, France, Germany, Iceland, the Netherlands, Norway, Sweden, the United Kingdom, and the World Bank Group. PPIAF is a multi-donor technical assistance facility aimed at helping developing countries improve the quality of their infrastructure through private sector involvement. For more information on the facility see the Web site: www. PPIAF.org. Disclaimer The findings, interpretations, and conclusions expressed in this report are entirely those of the authors and should not be attributed in any manner to the World Bank, or its affiliated organizations, or to members of its board of executive directors for the countries they represent, or to ESMAP and PPIAF. The World Bank and ESMAP/ PPIAF do not guarantee the accuracy of the data included in this publication and accept no responsibility whatsoever for any consequence of their use. The boundaries, colors, denominations, other information shown on any map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement of acceptance of such boundaries. II Economic Consulting Associates, May 2011 Contents Acronyms and abbreviations II Executive summary VIII 1 BACKGROUND 1 1.1 Basic Information 1 1.2 Assessment of energy supply infrastructure 2 1.3 Market analysis 4 1.3.1 Heat market in Chişinău 4 1.3.2 Electricity market in Moldova 8 1.4 Recent developments 9 2 GOVERNANCE 11 2.1 Institutional analysis 11 2.1.1 Ministry of Economy 11 2.1.2 Municipality of Chişinău 12 2.1.3 ANRE 12 2.1.4 Heat production and distribution enterprises and their suppliers 13 2.1.5 Heat consumers 15 2.1.6 Electricity consumers 15 2.1.7 Analysis and conclusions on past governance failure 15 2.2 Legal and regulatory framework 17 2.3 Energy Community and EU Directives 18 2.4 Tariff regime 19 2.4.1 Existing tariff setting methodology 19 2.4.2 Tariff calculation for 2010 21 2.4.3 Adjustments needed to the heat tariff methodology 23 2.5 Sub-summary of institutional and legal issues 24 3 FINANCIAL SITUATION AND PROJECTION ASSUMPTIONS 27 3.1 Current financial situation 27 3.1.1 Introduction and sources 27 3.1.2 Profit and loss accounts 28 3.1.3 Cash flows 29 3.1.4 Balance sheets – summary 30 Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study III 3.2 Financial analysis of current position 35 3.2.1 Balance sheets – impairments 35 3.2.2 Balance sheets – underlying net asset positions 38 3.2.3 Ratio and other analysis 40 3.3 Heat tariff assumptions for financial projections 44 3.3.1 Derogations for profit levels in ANRE calculations for 2010 46 3.3.2 2010 financial deviations in the gas transmission sector 46 3.3.3 The gas price at the border 47 3.3.4 Replacement level of capital expenditure 47 3.3.5 Termocom’s priority investment programme 48 3.3.6 Funding Termocom’s bad and doubtful debts 48 3.3.7 Funding Termocom’s working capital requirements 49 3.3.8 Repayments of Termocom’s Creditors’ Committee debts 50 3.3.9 Repayments of Termocom’s long-term debts 50 3.3.10 Transfer of Termocom’s long-term debts 50 3.3.11 Improvements in Termocom’s heat losses 51 3.3.12Improvements in Termocom’s operating efficiency 51 3.3.13 Procurement of modern cogeneration – CET-3 51 4 INTERNATIONAL DISTRICT HEATING EXPERIENCE 53 4.1 Questions relating to international comparators 53 4.2 International experience of different DH structures 53 4.2.1 Vertically integrated and unbundled DH systems 53 4.2.2 Heat dispatch 56 4.2.3 Wholesale competition 58 4.2.4 Comparative studies 59 4.3 Private sector participation in district heating 59 4.4 International regulation of district heat tariffs 61 4.4.1 Types of regulation of district heating tariffs 61 4.4.2 Benefits of moving to incentive-based regulation 62 4.5 Conclusions for Chişinău 63 5 AFFORDABLE AND SUSTAINABLE DISTRICT HEATING IN CHI Ş IN ĂU 67 5.1 Summary of technical, financial and governance issues 67 5.2 Progressive improvements 68 5.3 Debt restructuring 69 5.3.1 Introduction 69 5.3.2 Sources of funding for debt resolution 70 5.3.3 MoU parties: current position 71 5.3.4 MoU parties: consideration of debt resolution options 72 IV Economic Consulting Associates, May 2011 5.3.5 MoU parties: value injection by the government 74 5.3.6 Other Creditors’ Committee liabilities 76 5.4 Network upgrading and demand side management 77 5.4.1 Heat sources - existing cogeneration plants 77 5.4.2 Closure of CET-1 and review of CET-2 80 5.4.3 Imperative for a new cogeneration plant – CET-3 80 5.4.4 Small CHP plants 82 5.4.5 Network upgrading and demand side management 83 5.5 Network integration and heat dispatch system 84 5.6 Heat procurement 85 5.7 Financial projections 85 6 INSTITUTIONAL RESTRUCTURING 91 6.1 Liquidation of Termocom 92 6.2 Institutional restructuring 93 6.2.1 Option 1: Immediate vertical integration 95 6.2.2 Option 2: Separate management of Termocom with governance reforms under new ownership to facilitate investment in CET-3 100 6.3 Summary matrix table 104 7 RECOMMENDATIONS 107 7.1 Debt resolution 108 7.2 Investments 108 7.3 Network integration and heat dispatch system 109 7.4 Institutional restructuring options 109 A1 List of persons consulted 112 A2 CHP-2 site and plant details 112 A3 Analysis of modern co-generation 114 A4 Investments necessary to integrate the district heat network of Chişinău 118 A5 Financial projections 119 A5.1 Termocom 119 A5.2 CET-2 123 A5.3 CET-1 125 Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study V TABLES Table 1: Costs of heat and electricity IX Table 2: Affordability of heat in Chişinău in 2008 and 2010 IX Table 3: Long term debts X Table 4: Chişinău district heating infrastructure 3 Table 5: Affordability of heat in Chişinău in 2008 and 2010 7 Table 6: Termocom district heating tariff calculation for 2010 22 Table 7: Profit and Loss accounts 28 Table 8: Termocom Trade Receivables, 2009 29 Table 9: Cash flows 30 Table 10: 2009 balance sheets 32 Table 11: 2010 balance sheets 33 Table 12: Alternative presentation of balance sheets 34 Table 13: Comparison of book and regulatory values of fixed assets 37 Table 14: Underlying net asset positions 39 Table 15: 2009 current creditor and debtor day ratios 42 Table 16: Transition from Termocom’s 2010 tariffs to projection for 2020 45 Table 17: Classification of DH structures 58 Table 18: Examples of different DH ownership and management options 59 Table 19: Long term debts 69 Table 20: Estimate of long-term debt levels – MoU parties 72 Table 21: MoU parties – long term debt resolution options 73 Table 22: Termocom: Other Creditors’ Committee liabilities 76 Table 23: Costs of heat and electricity 78 Table 24: Implications in 2010 of closing CET-1 and CET-2 78 Table 25: Merger scenario analysis 99 Table 26: Summary of analysis of restructuring options 105 Table 27: Effectiveness of current cogeneration 114 Table 28: Illustrative example of residual heat costs from cogeneration 116 FIGURES Figure 1: Institutions in the Chişinău energy supply chain 14 Figure 2: Transition from Termocom’s 2010 tariffs to projection for 2020 45 Figure 3: Tariff trajectory 86 Figure 4: Projected financial indicators 87 Figure 5: The Termocom energy efficiency deficit 115 EXCHANGE RATE Early 2011 exchange rate approximately 12 MDL/$ Rate used by ANRE in May 2010 tariff round: 12.5 MDL/$ VI Economic Consulting Associates, May 2011 ACRONYMS AND ABBREVIATIONS AC alternating current AFS advanced for further study (table of options) ANRE National Energy Regulatory Agency CET Moldovan for CHP – the firms in Chișinău are CET-1 and CET-2 CHP combined heat and power (cogeneration plant) DC direct current DH district heat DHCAN District Heat in Candidate Countries DSM demand side management EBITDA earnings before interest, tax, depreciation and amortisation EC Energy Community (Vienna, Austria) ERRA Energy Regulators Regional Association (Budapest, Hungary) EU European Union FFO funds from operations HOB heat only boiler IMF International Monetary Fund kWh kilowatt hour, basic unit of energy used in the electricity sector. Mega-, giga- and tera-watthours for thousands, millions and billions of kWh respectively. MDL Moldovan Lei MoU Memorandum of Understanding SIDA Swedish International Development Cooperation Agency TOR terms of reference TSO transmission systems operator US United States - $ throughout is US dollar, c refers to US cents. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study VII Executive summary Comprehensive reforms are acutely needed to bring about the financial stabilization of the energy sector in Chişinău. Termocom, the district heating company, has accumulated an unsustainable debt, equivalent to 3.5% of the national GDP – large enough to become an issue of concern between the IMF and the Government of Moldova. The direct cause of the financial deficits and debt accumulation was a persistent failure of the Municipality, owner of Termocom, to set heating tariffs at cost-recovery levels. The financial burden has been passed on through the electricity and heat suppliers (Combined Heat and Power plants, CET- 1 and CET-2), which have in turn passed the debt to their ultimate gas supplier, Moldovagaz. The supplier demonstrated its impatience in 2008 with a two-week suspension of gas supplies in the middle of the winter, causing severe hardship to many of Chişinău’s residents. Unless concrete action is taken to reform the industry, this issue will continue to threaten the energy security of Moldova as a whole. The constraint on availability of resources for the energy sector has lead to lack of funds for rehabilitation and investments, resulting in high cost of heat and electricity supply. CET-1 is 55 years old and produces both heat and electricity at more than 100% above the import cost of electricity. CET-2 is 35 years old, and produces at 40% above the import cost (Table 1). Similarly, the piped network of Termocom is dilapidated. Heat losses are around 22%, which compares very unfavorably with a 10% benchmark in the industrialized countries of Europe and around 15% for transition economies. VIII Economic Consulting Associates, May 2011 Table 1 Costs of heat and electricity Source Heat generation cost Electricity cost Electricity cost MDL/Gcal MDL/kWh US c/kWh Termocom HOBs 543.2 CET-1 CHP plant 487.8 143.3 11.46 CET-2 CHP plant 403.8 104.5 8.36 Import price - 68.3 5.47 border Import plus 79.4 6.35 transmission Source: ANRE’s May 2010 tariff review, using an exchange rate of 12.5 MDL/$ In 2010, the poorest quintile of Chişinău has spent about 26% of their income on heat (Table 2). According to international affordability benchmarks, this is more than twice the proportion of expenditure on heat of total income (10%) that is deemed affordable. Further increases were announced by ANRE in February 2011 following the increase in the import price of gas from $265 per thousand cubic meters (TCM) to $295/TCM. ANRE anticipates that there will be a further increase in the import price to $310/TCM around May 2011, with possible further increases later in the year. Reforms are also needed to help address the affordability challenges by lowering the cost of heat and electricity. Table 2 Affordability of heat in Chișinău in 2008 and 2010 Quintile Family Monthly Proportion Family Monthly Proportion monthly heat cost in 2008 monthly heat cost in 2010 expenditure 2008 expenditure 2010 2008 MDL MDL 2010 MDL MDL I 1,731 286 16.5% 1,899 498 26.2% II 2,856 330 11.5% 3,134 579 18.5% III 3,926 412 10.5% 4,308 732 17.0% IV 5,417 556 10.3% 5,944 999 16.8% V 11,022 661 6.0% 12,094 1194 9.9% Source: ANRE, Termocom and Elena Gorelova and Anatolii Rojco (2010): Impact of Prices on the Well-Being of the Population, Centre for Strategic Studies & Reforms1 1 Data on aī ffordability are broadly comparable with results from the household budget survey, which reports that households in the lowest quinƟ tile in Chisinau spent around 22.5% of their total consumpti Ɵon spending in 2009 on uƟ ties. Aī tiliƟ Ɵles Ɵos in the other quinti ffordability rati are also similar to those in the table. 2010 household budget survey data are not yet available. The household budget survey does not allow Ɵnguishing between various uti disti Ɵlity payments. Further invesƟtigaƟ tion may thus be required to conĮ firm the numbers provided here. They do give a strong indicaƟ ffordability have been reached for the lower quinƟ tion, however, that limits of aī tiles. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study IX Lastly, the Law on the Accession of the Republic of Moldova to the Energy Charter Treaty (No 117 of 23.12.2009) is another driving force behind the reforms. The Law was approved by Parliament and Moldova formally joined the Energy Community (EC) in March 2010. As a party to the EC Treaty, Moldova is committed to putting in place a sound and transparent market structure in the field of energy, by implementing the core European Union (EU) Directives. The process presents both challenges and opportunities for Moldova. Assistance will be required in implementing the transition of the regulatory framework and capacity building, but the transparent market will also improve the Moldova’s attractiveness as investment destination in the energy sector. Debt restructuring The first step in financial stabilization reforms is to address the unsustainable debt stock issue, and the government has taken the first major steps by addressing the accumulation of debt. In June 2010, the responsibility of tariff setting was transferred from the Municipality of Chisinau to the National Energy Regulatory Agency (ANRE), the energy regulator, thus depoliticizing tariff setting in Chişinău. The government also signed a Memorandum of Understanding with the three main companies in the heating sector (Termocom and the co-generation companies, CET- 1 and CET-2), the main creditors (Moldovagaz and Chişinău-Gaz), and the Chişinău Municipality. The Memorandum of Understanding provides for payment of ongoing current liabilities and a resolve of the parties to develop a solution to the non-current portion of the debt. Further initiatives are needed to address the critically important long term debt (Table 3). Table 3 Long term debts Long term debts Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m MoU parties: Internal balances (1,770.1) 1,336.5 433.6 0.0 External balances (227.4) (1,249.0) (372.0) (1,848.4) Other Creditors' Committee parties (317.1) 0.0 0.0 (317.1) Total (2,314.6) 87.5 61.6 (2,165.5) X Economic Consulting Associates, May 2011 Because of affordability constraints mentioned above, long term debt cannot be addressed through tariff increases and an injection of equity by the Government is essential. Injection of equity by the Government in the form of assets and/or of cash is required to address the debt stock issue. The gas suppliers would most likely be interested in taking state-owned gas related assets (namely, natural gas distribution network) in lieu of the past debt stock. However, the value of the network in its current state is not enough to completely resolve the long term debt issue or to address financial viability issues of the utilities. In order to address the issue of reliability and efficiency of the energy sector in Moldova, additional initiatives are recommended: i) Transition to a more reliable, efficient CHP plant Considering the high cost of energy supplied by CET-1 and CET-2 (see above), replacement of the old inefficient plants with a new and efficient CHP plant would contribute towards restructuring the long term debt. CET-1 and CET- 2 operate at much lower thermal efficiency rate compared to newer plants used in more efficiently run utilities. In an analysis conducted under the scenario that (a) the heat would be supplied by Heat Only Boilers (HOBs), and (b) all electricity will be imported, net savings to the energy consumers could amount to MDL 134 million ($10.7 million). There would be a net balance of payment benefit of MDL 47 million ($3.8 million). This calculation is based on the fact that the efficiency of heat production at existing CHP plants and HoBs is comparable, while the electricity produced by the CHPs are assumed to be replaced by lower cost imports. However, closing both CET- 1 and CET-2 would leave the country without any electricity generating capacity and fully dependent on trans-boundary supply of electricity. Rather, a phased transition to more reliable and efficient electricity supply arrangement may be more appropriate. Under this plan, CET -1 (which has low capacity but much higher cost supply per unit) may be shut down immediately. CET- 2 may be replaced in due time with a modern cogeneration plant (which we refer to as CET-3) that could radically reduce the cost of heat and, at the same time, provide Moldova with greater capacity for electricity generation. CET-3 would reduce heat procurement costs by an estimated 22%, and reduce real tariffs to below 2010 levels by 2017. The estimated cost of a new cogeneration plant is expected to be around US$ 250 – 300 million. ii) Network upgrading and demand side management The surveys indicate that Termocom’s customers in Chişinău are mostly dissatisfied with the quality of heating. Due to high network losses, some consumers do not Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study XI receive necessary amount of heat, leading to under-heating. In addition, due to configuration of in-building heating piping system (vertical piping), heat consumers are not able to individually regulate their heat consumption, and thus indoor temperatures. Combined with poor thermal insulation of most of the buildings, this leads to low quality of heating. Support of international development partners would be required, as assessment made by World Bank staff indicated investment needs in internal controls and building envelope efficiency to be about US$ 880 million. Although the investment need is large, the indications are that return on these investments would justify the costs. On a smaller scale, modern heat exchangers have been connected to three buildings since 2008 as part of the pilot program on improving building efficiency. The assessment of energy savings of pilot Maria Drăgan project (2008) has shown that the efficiency improvements could be as high as 40-50% of the heat which would normally be supplied to a comparable building. Institutional restructuring options Institutional restructuring is needed to restore financial sustainability to the companies to ensure energy supply and to access sources of funding needed to implement the required investments to lower cost of energy supply and improve efficiency. The liquidation of Termocom is not a viable option since: o the capacity of gas distribution system in Chisinau will not allow for full transition to individual boilers in apartment blocks; o the poor and vulnerable population will not be able to afford individual boilers; o the ultimate creditor, Moldovagaz, will likely still seek some form of redress, and, given the size of the debt, this could prove costly for the Moldova economy. Two viable options are being considered, both involving transfer of ownership of Termocom to the Government. The transfer of ownership to the Government is required considering the following factors: o addressing governance issues that lead to the accumulation of debt stock; o consolidation of ownership expected to make coordination of energy production smoother; XII Economic Consulting Associates, May 2011 o sovereign guarantee is required to provide the access for resources for the required investments. On this basis, two options considered viable and analyzed are the following; (i) vertical integration of Termocom and CHP-2 and (ii) formation of new entity with Termocom and CET 3. i) Option 1: Immediate vertical integration of Termocom and CHP-2 with Government ownership This option involves integrating Termocom and CET-2 (assuming CET-1 is closed) and transferring ownership of the integrated company to the Government. It provides benefits from improved dispatch, streamlined overhead activities, and coordinated investment plan. However, the integration will involve some up-front costs and, for a while, it may distract management from more important operational and investment improvements. Additionally, bundling DH operations with an old, relatively inefficient cogeneration plant may make development of CET-3 less attractive to a private sector developer. ii) Option 2: Separate management of Termocom with governance reforms under new ownership to facilitate investment in CET-3 Transfer of Termocom’s ownership to Government and separate management of Termocom and CHPs is expected to involve significant improvements in performance and reduction in the risk of back-sliding in tariffs due to the change in ownership and the removal of the debt burden. In addition, keeping Termocom a separate state- owned entity could facilitate the entry of potential developers of CET-3, who may be interested in a stand-alone co-generation plant, or alternatively may seek to operate the DH system on an integrated basis once CET-3 is in place. Investments in network integration and heat dispatch system are also required. The report presents a detailed analysis of both options. The choice between these two options will depend mainly on the policy emphasis and the development plan for the energy sector of the government. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study XIII 1 XIV Economic Consulting Associates, May 2011 Background 1.1 Basic Information Termocom is the district heating company of Chişinău. It is currently majority owned by the Municipality of Chişinău. Termocom owns distribution systems for hot water and heating that extend across a substantial part of the city. The heat is mainly supplied by two co-generation plants within the city, CET-1 and CET-2 built in the 1950s and 1970s. Both are owned by the Government through the Ministry of Economy. The co-generation sources of supply are supplemented by using a number of gas-fired ‘heat only boilers’ (HOBs), principally in the city’s suburbs. For over a decade, Termocom’s financial performance and financial position have been major concerns, caused by its tariffs being persistently insufficient to cover its costs. It was consequently unable to pay its creditors out of revenues. Termocom was placed in administration in 2001, but the Municipality retained control over tariffs and continued to set tariffs below cost recovery levels. By the end of 2009, this business, with some MDL 1.3 billion of fixed and current assets reported in its accounts, had accumulated around MDL 2.3 billion liabilities to its suppliers, or around $ 180 million 2. In turn, the co-generation companies supplying Termocom had not received adequate payment and were thus unable to pay for their supplies of gas. The gas supplier is Moldovagaz, along with Chişinău-Gaz, majority owned by Russia’s Gazprom. Frustrated by the lack of progress in resolving outstanding debts, at the start of the 2008 heating season, in November, Moldovagaz suspended gas supplies to the co-generation plants and to Termocom. Chişinău’s residents went without heat for nearly two weeks. 2 $ throughout refers to United States dollars. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 1 It had been clear for some time that it would be necessary to de-politicise the tariff setting process for district heating in Chişinău to avoid further financial deterioration. The level of debt is large enough to be of concern from a macro-economic viewpoint, and has become an issue between the Government and the International Monetary Fund (IMF). The November 2008 crisis and growing macro-economic focus on the accumulated debt in the district heating sector appear to have prompted action. The energy regulator, National Energy Regulatory Agency (ANRE), has been given responsibility for tariff setting and raised tariffs significantly from MDL 541/Gcal to MDL 659/Gcal in January 2010 and again in May 2010 to MDL 821/Gcal, increases totalling 52%. The tariffs established in May 2010 appear to be at a level consistent with covering the company’s full costs during 2010. Further heat tariff rises were announced early in 2011 to MDL 898/Gcal, among other things to cover increases in gas prices, representing a small real increase from the May 2010 level. The heat tariffs are now at levels which make it difficult for the overwhelming majority of the residents to afford heat. The collectability of revenues has therefore replaced the tariff level as the main issue threatening the financial sustainability of Termocom. 1.2 Assessment of energy supply infrastructure The main point of a co-generation or combined heat and power (CHP) based district heat (DH) system is to utilise the heat associated with electricity is generation, the joint products making for high levels of energy efficiency and hence low financial costs and also low environmental emissions. On the generation side, the CHP plants in Chi şină u are 33-55 years old and today these plants produce both high cost electricity and high cost heat. These high costs are a recurrent theme of this report, and are analysed in detail in Section 5.4.1. Termocom’s heat sources are its own HOBs and heat from the two cogeneration plants. The capacities are shown in Table 4 below. 2 Economic Consulting Associates, May 2011 Table 4 Chișinău district heating infrastructure Entity Heat capacity Electricity Average Comments Capacity thermal ficiency efÀ Termocom CT West 91.4% In addition to the 2 large heat 400 Gcal/h, stations, Termocom has 19 CT South 200 small boiler plants (0.02 to Gcal/h 5 Gcal/h) and the Muncesti boiler (25 Gcal/h). CET-1 394 Gcal/h 66 MW 62.3% CET-2 1,200 Gcal/h 240 MW 71.0% CET-2 also has a 500 Gcal/hr HOB on site Source: Based on figures from SWECO reports on Termocom, 2008. A modern combined cycle gas turbine CHP plant would have a thermal efficiency of the order of 88%. Some key features of the district heating network are as follows: o Maximum hourly demand is of the order of 1,200 Gcal/hr, so that the existing HOBs could together just meet demand if the CHP plants were not available. o From the heat production points, hot water is pumped via 17 pumping stations, 6 on the supply line and 11 on the return line to around 500 central heating points. The maximum height difference in the network is 205 metres. The average power requirements are 8.6 MW. o Termocom’s primary network is 234 km double pipe system, of which 54 km are above ground, while the total network length is 730 km. o Other than the recent additions and upgrades to the pipe network, including the installation of local heat exchangers which permit a single pipe configuration, the infrastructure is antiquated and is operating beyond its economic life. The first sections of pipe, which were put into service in 1955, still represent around 70% of the network. o Heat losses in the piped network are around 22% which compares unfavourably with a 10% benchmark in the industrialised countries of Europe and around 15% for transition economies. To achieve these Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 3 benchmark levels, the old pipes will progressively need to be replaced by polyurethane pre-insulated pipes. o Water losses in the network have been declining. Between 2001-2006, for example, specific water consumption declined from 1.09 to 0.27 m³ per Gcal and added water consumption from 1.59 m³ to 0.83 m³ per Gcal. The above information is drawn from a number of sources, primarily World Bank and SIDA reports and information supplied by Termocom and InfoCom. Where there is conflicting data, the latest or most obviously reliable source has been chosen. The most recent comprehensive study of the district heating system of Chişinău was carried out for Termocom in 20073. This Modernisation Solutions study records and age and condition of the heat infrastructure in the city and lays out a strong case for retaining a centralised heating system in Chişinău, and hence for investing in its rehabilitation and modernisation. The case is based on the lower financial costs of heat from cogeneration, reduced greenhouse gas emissions from fuel that produces both heat and electricity, and greater security of supply of heat (a curtailment of gas supplies would be devastating for those dependent on autonomous heat, whereas the centralised system can switch to alternative fuels). 1. 3 Market analysis 1.3.1 Heat market in Chișinău Market size and growth Chişinău is both the capital and the main industrial and commercial centre of Moldova. The population living in the municipal area is estimated to be about 800,000 in 2011. The climate is such that heat is typically required from mid October to mid April, with the coldest month being January (daily average -2.5 oC, average low -6 oC, coldest recorded -28 oC). Termocom supplies 7% of its heat and hot water to state institutions, 9% to municipal institutions, 10% to businesses and 74% to domestic building. The latter category includes about 2,800 multi-storey apartment blocks in the city, which equates to about 170,000 apartments. These fall under the Municipal Housing Administration Enterprises, the Home Owners Associations and the Cooperative Associations. Individual household dwellings constitute less than 1% of Termocom’s total demand. 3 Prof. Dr. Arion Valentin (2007): Moderniza on Solu ons for the centralised supply of thermal energy in the Municipality of Chişinău 4 Economic Consulting Associates, May 2011 There is a consensus that heat supplied by Termocom is cheaper than heat from autonomous systems. It has proved impossible to obtain published comparative data to prove this point, but an informal survey indicates that as of February 2011, people with autonomous systems believe they are paying 20-30% more for heat than Termocom customers. The reasons people give for preferring autonomous systems despite the higher cost are that autonomous systems have been found to be more reliable and people greatly value the ability to have direct control over their heat provision. This applies both to the immediate issue of being able to raise or lower the temperature in different rooms, but also to the seasonal issue of when to start heating their flat and when to stop. In the case of centralized heating, people complain about having to live in cold conditions at the beginning of the heating season for about 2 weeks and at the end of the heating for another 2 weeks. This is thought to be a widespread problem, particularly in apartment blocks that are not well insulated. Heat is not retained in such blocks and there is variability across floors, with some floors being too hot while the others are freezing, but all of them having to pay same amount to Termocom. For these reasons, despite the higher costs, it is reported that the number of individual boilers is continuing to increase, with more than 20,000 gas-fired autonomous boilers having been installed by the end of 2010. There are limits to which this can continue to take place across the city, though, due to constraints in the city’s gas supply infrastructure. In addition, as Termocom’s performance improves, there may be fewer customers seeking to migrate. Population growth at 1.9% provides an underlying growth dynamic in the city, but unless and until Termocom extends its network, it is only through increased density of settlement within the area served by the piped network which would translate into demand growth for Termocom. Against this, there are significant reasons for foreseeing a reduction in effective demand: o Reduction in heat requirements due to reduced losses in the network, making it possible to deliver the same heat to the consumer from a smaller amount of heat being generated. o Reduction in demand from final consumers due to demand side management measures. Demand side management and related issues are discussed further in Section 5.4.5. Termocom’s network expansion intensions and recent success in connecting a few of the new apartment blocks to its network are also discussed in that section. Affordability Since the break-up of the Soviet Union, the economy of Moldova has undergone rapid structural change, from being dependent on agriculture and manufacturing to being Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 5 predominantly a service economy. GDP per capita at around MDL 29,000 or $2,300 is very low amongst ex-Soviet republics. Wages in the capital city are higher than elsewhere in Moldova but are still low by regional standards. The National Bureau of Statistics reports average wage levels in Chişinău for the period January-September 2010 to be MDL 3,653 ($292) per month. An information note by ANRE on 2010 tariffs indicates that a typical monthly tariff for a 3-room 37 m2 apartment would amount to MDL 498 per month across the year. This is made up of MD 837 (about $70) during the five months of the heating season and a monthly charge of MDL 255 for hot water during the rest of the year. This is the minimum monthly payment for a household. Those living in larger apartments with 1-3 bedrooms have to pay much more. For a three bedroom apartment of 94 m2, for example, the 2010 monthly heating and hot water payment is MDL 1,194 per month. Taking account of the changes in Termocom’s heat tariffs in recent years, the corresponding figure for monthly expenditure by a household in a small apartment in 2008 would have been MDL 286 per month, and in a 3 bedroom apartment MDL 661 per month4. The increase over two years is between 70% and 80%. The year 2008 is of interest because data is available for that year about monthly expenditure by quintile. Expenditure is considered a better proxy for actual incomes than reported income data. We propose therefore to use the quintile expenditure data, adjusted from the national level to Chişinău and increased between 2008 and 2010 by the national rate of inflation to assess affordability of heat. For this, we use the frequently used international benchmark that expenditure on heat should be less than 10% of household income5. If heat expenditure is above 10%, households are deemed to have affordability problems with respect to heat. The analysis is shown in Table 5. In the absence of data on the average apartment size for households in each quintile, the simplifying assumption has been made that low income households live in small apartments. In practice, some low income households will live in large apartments and will therefore have to pay an even higher percentage of their expenditure on heat than is shown in these figures. With the assumptions made, the results show that in 2008, it was only households in the highest quintile which were below the affordability threshold. Households in the lowest quintile had severe affordability problems (16.5% of expenditure needed to meet heat bills). By 2010, affordability becomes acute across all quintiles, with even households in the top quintile being on the edge of the 10% affordability criterion. Once account is taken of the factor that many higher income households have opted out of Termocom 4 It is assumed here that the tariff of MDL 540/Gcal applied in 2008. That was the official tariff for that year but the Municipality did try to have the tariff lowered to MDL 456 for January-April. This was contested by Termocom and the court ruled in favour of Termocom and set the tariff at MDL 540/Gcal for the whole of 2008. 5 Fankhauser & Tepic (2005), Can poor consumers pay for energy and water? An affordability analysis for transi on countries, EBRD Working Paper No. 92, page 5. 6 Economic Consulting Associates, May 2011 and have even more expensive heating, the 10% criterion would be breached for the top quintile as well. Households in the lowest quintile are having to pay more than a quarter of their income on heat, which is a very severe burden. When other basic household expenses are added (rent, electricity, gas and cold water), there can be very little left for other basic necessities such as food. Table 5 Affordability of heat in Chișinău in 2008 and 2010 Quintile Family Monthly Proportion Family Monthly Proportion monthly heat cost in 2008 monthly heat cost in 2010 expenditure 2008 MDL expenditure 2010 MDL 2008 MDL 2010 MDL I 1,731 286 16.5% 1,899 498 26.2% II 2,856 330 11.5% 3,134 579 18.5% III 3,926 412 10.5% 4,308 732 17.0% IV 5,417 556 10.3% 5,944 999 16.8% V 11,022 661 6.0% 12,094 1194 9.9% Source: ANRE, Termocom and Elena Gorelova and Anatolii Rojco (2010): Impact of Prices on the Well-Being of the Population, Centre for Strategic Studies & Reforms The analysis above is based on some heroic assumptions, so the precise values calculated should be treated with caution, but the general order of magnitude picture which emerges is alarming. By 2010, at least 80% of the residents of Chişinău would appear to be stretched as regards affordability of heat. Even if people are willing to pay their Termocom bills, they may simply be unable to do so. Raising Termocom’s tariffs to cost recovery levels is not in itself sufficient to ensure financial sustainability: the required revenues need to be forthcoming from the customers, and the risks of receivables growing goes up markedly whenever the tariffs are raised.6 The Municipality operates a subsidy scheme for poorer households, characterised as those with monthly income below MDL 1,450 per member of the household. With average wages at MDL 3,653 per month and average household size of close to 3, this in effect implies that a typical household which has only one wage earner would require a subsidy. At present, it is reported that only about 10% of households are 6 Data on affordability are broadly comparable with results from the household budget survey, which reports that households in the lowest quintile in Chisinau spent around 22.5% of their total consumption spending in 2009 on utilities. Affordability ratios in the other quintiles are also similar to those in the table. 2010 household budget survey data are not yet available. The household budget survey does not allow distinguishing between various utility payments. Further investigation may thus be required to confirm the numbers provided here. They do give a strong indication, however, that limits of affordability have been reached for the lower quintiles. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 7 being assisted. With the further increases in tariffs that we project will be necessary, a higher level of resources will need to be found to support the Municipality subsidy scheme if Termocom is to avoid major shortfalls in collectability. 1.3.2 Electricity market in Moldova In the electricity sector of Moldova, peak demand is about 1,300 MW, while nameplate generation capacity within the country is 496 MW, of which 306 MW is accounted for by CET-1 and CET-2. Available capacity is much lower, estimated to be 346 MW in the Energy Strategy of the Republic of Moldova to the year 20207. Annual electrical energy consumption in Moldova is around 4 TWh, with less than a third of this energy being produced by domestic generators located on the right bank of the Nistru River. In respect of national energy security, the Energy Strategy notes that there are a number of ‘weaknesses’ in Moldova’s energy situation which “pose considerable challenges with respect to security of energy supply” (pg 18): o almost total dependence on imported primary energy resources; o limited availability of oil and electricity import sources; o natural gas imported from only one supplier; o the natural gas share in the total energy balance amounts to around 52%; o lack of electricity generation capacities on the right bank of Nistru river to cover local consumption; o insufficient capacity of interconnection electricity lines with Southeast and West Europe; o the electricity transmission network requires upgrading. In the electricity sector, these concerns about security translate into policies both of strengthening interconnections with neighbouring countries and of investing in internal generation capacity. In the Energy Strategy, both elements are seen as necessary to develop open and competitive electricity markets. There is to be special emphasis on renewable energy sources. As already noted in Section 1.2, at present electricity is imported at 5.5 c/kWh (opportunity cost of around 6.4 c/kWh after adding transmission charges), while the lowest cost CHP plant in Chişinău (CET-2) produced electricity at 8.4 c/kWh in 2009. On the right bank of the Nistru River, electricity is supplied more cheaply 7 Republic of Moldova Decision No. 958, 2007. Data referred to is in Table 4.2. 8 Economic Consulting Associates, May 2011 than the CHPs from the 64 MW of hydropower capacity that is available, but future investment in renewable-based sources refers to options such as wind power and solar photovoltaics, which will produce electricity that is much more expensive than CHP electricity is today. The present low import price relative to the cost of electricity produced by the Chişinău CHPs (particularly CET-1) is a major barrier to transformative reform of the district heat sector. Whether such low electricity import prices will continue in future is a crucial issue to consider. The plant in Transnistria is old and will need replacement investment, but Ukraine will have excess baseload capacity from its nuclear plants for some time to come. Exports to Belarus are priced at 4.5 c/kWh. The long-term average price in the ENTSO-E system is estimated to be higher (around 8 c/kWh). 1.4 Recent developments The following recent developments provide an important context for this study: o Tariffs: A new tariff regime was implemented in May 2010, providing tariffs for district heat which are expected to enable Termocom to cover its recurrent costs in the present winter season. There was a further commitment from ANRE to increase tariffs in 2011 to levels consistent with the full application of the agreed methodology, that is tariffs which will recover all costs (including profits to move towards self-financed future investment). An increase was announced by ANRE in February 2011 following the increase in the import price of gas from $265/kcm to $295/kcm. ANRE anticipates that there will be a further increase in the import price to $310/kcm around May 2011, with possible further increases later in the year. In our analysis, we are assuming $310/kcm as the import price for 2011. o Short-term debt: The Memorandum of Understanding (MoU) on measures to improve the heating and power sector situation in Chişinău was signed by six key stakeholders (including the Mayoralty) in June 2010. Among other things, the MoU identified the components of payables as of 10 May 2010 that would be treated as current, provided for a process of payments to ensure that current arrears are paid for on an ongoing basis and provided for the unfreezing of bank accounts. Tariffs and the resolution of the short and long term debts are analysed in detail later in the report (Sections 3 and 5). Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 9 2 10 Economic Consulting Associates, May 2011 Governance 2.1 Institutional analysis The roles, rights and responsibilities of the main institutions and interest groups involved in the sector are described in the following sub-sections: 2.1.1 Ministry of Economy Prior to 2008, the energy sector with the Moldovan Government fell under the Ministry for Industry and Infrastructure and the Standardisation and Metrology Service. These structures were dissolved and energy functions were transferred to the current Ministry for Economy. The Electricity, Heat, Gasification and Energy Efficiency Divisions fall under the Energy Security and Efficiency Department of the Ministry. The prime roles and responsibilities of the Ministry of Economy in respect of energy are establishing policy and strategy for the sector, programme implementation and monitoring at both national and regional level, energy security, development of investment projects, energy efficiency, energy trade and international cooperation. In the district heat sub-sector, the Ministry of Economy is required to provide the governance framework for CET-1 and CET-2 which are owned by the Government. In practice, this means controlling the Boards of these companies and providing the governance framework for their operations. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 11 2.1.2 Municipality of Chișinău In the past, the Municipality was responsible for the setting the Termocom’s tariffs. The main governance failure was that the tariffs were persistently set at levels well below those necessary for cost recovery, with the result that Termocom and, in turn, the CETs built up significant levels of debt to the gas suppliers, Moldovagaz and ultimately Gazprom, the majority owner of Moldovagaz. Since the tariff-setting role was removed from the Municipality, it has had a much smaller role in the district heat system. The Municipality remains the owner of Termocom and as such dominates the Board. Besides setting the governance framework for Termocom, the Municipality is also a significant heat customer. Finally, the Municipality is also responsible for establishing and administering the subsidy scheme. The arrangement is that Termocom bills the Municipality for heat supplies to households on the scheme, absorbing the costs in the short term. The problem that has already arisen, and could worsen as demands for subsidies grow as tariffs continue to increase, is that the Municipality has been in arrears in subsidy payments. 2.1.3 ANRE The National Agency for Energy Regulation (ANRE), which was established in 1997, regulates and supervises the electricity, oil and natural gas sub-sectors. ANRE has been set up as an independent regulatory body, which is administered by a Board appointed by the Government. This regulatory body is in charge of issuing electricity, oil and natural gas licences and monitoring compliance with licensing conditions. It further develops tariff methodologies and approves transmission and distribution tariffs in the electricity and gas sector and monitors the quality of supply from distribution companies. ANRE sets service quality standards and seeks to safeguard consumers and promote competition in the energy markets. ANRE also regulates the renewable energy market, issues licences for the production of renewable energy sourced electricity, biofuels and renewable fuels and approves the tariffs for each type of renewable energy sources. ANRE also has some responsibilities for the heat sector: indeed, the most important change that has taken place in the governance of the DH sector in Chişinău is the 12 Economic Consulting Associates, May 2011 transfer of responsibility for the setting of heat tariffs from the Municipality to ANRE. The regulator, when it was established by a Government Resolution in 1997, had been given responsibility for heat tariffs in 1998, but this was removed when ownership of Termocom was transferred to the Municipality in the year 2000. Responsibility for the setting of heat tariffs was transferred back to the regulator in December 2009 (via Law #107, which made amendments to the Law on Public Communal Services). Since resuming tariff-setting responsibility, ANRE has significantly increased the tariffs and is committed to full implementation of the cost recovery methodology in 2011. ANRE’s recent tariff-setting and the methodology for heat tariffs are analysed in Section 2.4. Unlike the other energy sub-sectors, ANRE does not have licensing powers for the heating sub-sector. With all the entities presently in public hands, the lack of a licensing regime is not a problem at present, but would be an issue for attracting private sector investment into the sub-sector. 2.1.4 Heat production and distribution enterprises and their suppliers The energy supply chain for Chişinău is illustrated in Figure 1, which also shows the energy sector regulator ANRE. o Heat: As already discussed, Termocom, CET-1 and CET-2 are the main institutions involved in heat supply. As of 2010, approximately 76% of Termocom’s heat requirements were purchased from the two cogeneration plants, CET-1 producing about 13%, and CET-2 producing about 63%. The remaining heat (24%) is produced by Termocom’s 19 individual HOBs. Water is supplied to Termocom, CET-1 and CET-2 by the municipality owned Apa-Canal, which also has HOBs and is responsible for supplying some parts of the city with heat and hot water. Customer billing services are provided to Termocom by Infocom. Housing management companies deal with the management of communal heating within apartment blocks as well as apportionment of each block’s communally metered heat consumption. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 13 Figure 1 Institutions in the Chișinău energy supply chain Regional Electricity Market International Gas Market International Oil Market Regulator ANRE Gazprom Oil Wholesale Strategic Oil Stocks Moldelectrica Moldovagaz Oil Retail CET-1 RED Union Fenosa CET-2 Chişinăugaz Apa-Canal Termocom Infocom (Billing) Housing Management Companies (Apartments) Customers Regional or Moldova State Owned Joint Chişinău Municipality Shared Ownership International Private Ownership Stock Company Owned Note: Although CET-1 and CET-2 are separate entities, they are shown together for simplicity o Gas: The main gas companies Chişinău-gaz, Moldovagaz and Gazprom. The gas for the two CHPs is provided by Moldovagaz, in which Gazprom has a majority shareholding, and by the subsidiary Chişinău-gaz. The gas for Termocom’s own HOBs is also sourced from Moldovagaz and Chişinău-gaz. Gazprom provides gas mainly from Russian gas fields. Chişinău-gaz provides retail gas supplies to customers who have their own independent gas boilers. o Electricity: the main companies are Moldelectrica and RED Union Fensosa. Electricity production in Chişinău is from CET-1 and CET-2. This electricity production is dispatched by state owned Moldelectrica, the electricity transmission system operator (TSO). Electricity connection from CET-1 and CET-2 is to the RED Union Fensosa electricity distribution network at 110 KV. Red Union Fenosa has a license obligation to purchase all the output from CET-1 and CET-2 when these plants are being operated to produce heat for the city. In turn, Red Union Fenosa has the right to distribute and supply electricity only within its licensed area. Besides the CHP plants in Chişinău and Bălţi, the Kuchurgan plant in Transnistria, and seasonal CHPs at sugar beet processing factories provide the main other generation sources within Moldova. A small percentage of electricity is also produced from renewable energy sources, mainly hydro and biomass. There is international synchronous interconnection and therefore market access with Ukraine and also islanded interconnection with Romania. 14 Economic Consulting Associates, May 2011 2.1.5 Heat consumers In an earlier epoch, the CETs had large industries as customers as well as the district heating company. In recent years, industry has contracted sharply and there are very few industries which consume heat directly from the CETs. Their overwhelming dominant customer is Termocom. Termocom’s own customer base has already been described in Section 1.3.1. The institutional segment (state, municipal and business customers) is a little over one quarter of the total heat supplied, with three quarters going to domestic consumers. They expect to receive a consistent, high quality hot water and heat service throughout the year, for which they agree to pay the monthly charges. The problem is that for 99% of Termocom’s domestic customers heat delivery is mediated by Municipal Housing Administration Enterprises, the Home Owners Associations or the Cooperative Associations. These institutions have many different responsibilities, and their performance on hot water and heating issues is reported to be extremely variable. 2.1.6 Electricity consumers The CETs in Chişinău feed the electricity they generate into the national grid, so any issue affecting the electricity side of the co-generation plants in the capital city affect all electricity customers throughout the country. In particular, the high cost of purchasing co-generation electricity generated by the antiquated CETs, relatively to the currently low price of electricity imports, is imposed on electricity consumers throughout the country. The Electricity Law requires any electricity produced by a cogeneration plant to be purchased, so electricity consumers are not able to choose the least costs source of bulk supplies. 2.1.7 Analysis and conclusions on past governance failure As we identify in Section 1.1, the root cause of the unsustainable levels of debt accumulated in the Chişinău district heating sector has been a failure of governance, most directly a failure of the owner of Termocom to give due weight to the financial management of the company over other policy objectives, particularly Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 15 in relation to tariff levels. The fact that the scale of the accumulated debts of the company has become too great for a resolution at a local level highlights an inherent accountability issue: Termocom is too big an enterprise for the Municipality to be realistically held accountable for its financial sustainability. The prospect of a State-backed resolution to the current debt crisis underlines the economic hazard. The clear lesson is that the owner of Termocom should have the financial capacity to be held to account for a sustained failure of governance, and it appears that the Municipality has not had, and does not have, that financial capacity. The immediate symptom of this governance issue has been addressed by giving ANRE responsibility for tariff setting. However, that does not solve the underlying governance issue. Other tensions between local policy objectives, for example relating to employment or enforcement of consumer debt, may in future displace financial management as a primary objective for the owners. This leads us to the conclusion that an important condition for longer term financial sustainability of Termocom will be an owner with the financial capacity to underwrite the company’s governance, thereby ensuring the owner has an unambiguous interest in the company’s long term financial management. The current debt crisis can be attributed to the fact that Termocom has not had that owner. One of the consequences of the debt crisis has been to undermine longer term governance of the whole sector. The debt issue has certainly dominated analysis of the sector, the relationships between the parties and the context for longer term planning and investment. Critically, however, the governance weakness is primarily sourced in Termocom, the principal customer for heat in the sector and the party with the relationship with consumers. It would be natural for Termocom to play a central role in the strategic development of the sector, as it is best placed to focus on the implications for tariff levels and service levels for its own customers. A governance weakness in Termocom is therefore liable to translate to a governance weakness in the entire sector and vice versa. Our conclusion, which becomes the central theme of this report, is that remedying this governance weakness will require both the resolution of the debt issue and the transfer of Termocom to a more suitable owner (Government in the first instance) with the financial capacity to have an unambiguous interest in its long term financial sustainability. 16 Economic Consulting Associates, May 2011 2.2 Legal and regulatory framework The main legislation in the energy sector in Moldova is the Energy Law, the Electricity Law, the Natural Gas Law and the Law on Oil Products. The role of ANRE is defined within these laws and the Law on Licensing of Business Activities: ANRE does not have its own enabling legislation. The Statute of ANRE was approved by the Resolution of Government at the end of 2008. According to Electricity Law, the main competencies of ANRE in the field of electricity and heat production are: o issue licences for electricity generation, transmission, distribution and supply at regulated and non-regulated tariffs; o develop and approve methodologies for the calculation and application of regulated tariffs for electricity and heat generated by CHPs; o develop and approve, in consultation with the Government, methodologies for calculation of tariffs for public heat supply; o carry out monitoring of licensees implementation of the principle of necessary and reasonable costs while calculating and approving tariffs for heat generated by CHPs; o apply the principle of priority purchase and dispatch of electricity generated by CHPs; o provide priority status in the internal market for sale of electricity generated by CHPs (only when they are supplying heat to the centralized heating system); o set up the terms and conditions of connection and charge for connection of power plants to the electricity networks in order to ensure its objectivity, transparency and non-discrimination from the point of view of costs and income for different technologies of generation by CHPs (Article 8 of Electricity Law). The lack of a framework Heat Law is a gap at present in the legislative framework of the energy sector. A Draft Law on Heat Energy was discussed and put to Parliament in 2004, but was not passed into law. Such a law would be useful in elaborating the regulatory responsibilities of ANRE with respect to heat and providing a clearer framework for competition and investment. However, the sector is currently Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 17 operating without specific legal problems arising, and from this viewpoint a new Heat Law cannot be regarded as an urgent necessity. Heat laws are not common in industrialised countries, where district heat typically has to compete directly with customer-generated heat without tariff regulation, but is becoming more common in transitional economies such as Hungary, Estonia and Lithuania. These laws codify public policy on heat, providing an orientation towards competition, enhanced efficiency and investment. In Moldova’s case, the possible future involvement of the private sector adds momentum to calls for a Heat Law, as one aspect of the new law would be to empower ANRE to license district heat operators, in the same way it licenses operators in the electricity, gas and petroleum sub-sectors. 2.3 Energy Community and EU Directives The Law on the Accession of the Republic of Moldova to the Energy Charter Treaty (No 117 of 23.12.2009) was approved by Parliament and Moldova formally joined the Energy Community (EC) in March 2010. As a party to the EC Treaty, Moldova is committed to putting in place a sound and transparent market structure in the field of energy, by implementing the core European Union (EU) Directives. In respect of district heating, relevant directives include the Buildings Directive and the Energy Services Directive, but the main one is the so-called CHP Directive, 2004/8/EC, which seeks to “increase energy efficiency and improve security of supply by creating a framework for promotion and development of high efficiency cogeneration of heat and power”. Inter alia, the CHP Directive requires reporting on the status of CHP in each country and for this an associated Commission Decision from December 2006 is used (this established a harmonised efficiency reference values for separate production of electricity and heat). The preamble to the Directive notes that “it is important to take account of the situation of Member States in which most of the electricity consumption is covered by imports”, a situation that is very relevant for Moldova. The CHP Directive has been criticised from an EU perspective as lacking any teeth. Being required to report on the status of combined heat and power generation and being encouraged to remove obstacles to CHP is very different to be required to invest in CHP plants to meet pre-specified targets. From Moldova’s perspective, any 18 Economic Consulting Associates, May 2011 action that is taken which increases the use of CHP in the country would be viewed favourably by the EC and the EU, but there is no requirement or obligation to expand cogeneration. The strongest subsequent statement by the EU is to the effect that CHP should be an “essential criterion” in the decision by the authorities to grant planning permission for construction of a power plant8. It appears then that compliance aspects of the CHP Directive relate principally to reporting, which are unlikely to be material to the strategic issues that are the focus of this report. We are not aware of any current compliance issues in relation to the directive. The CHP Directive therefore stands in marked contrast to other energy directives which Moldova has to implement as a member of the EC. In particular, the Electricity Directive, 2003/54/EC, which establishes common rules for the generation, transmission and distribution of electricity, is demanding9. The Electricity Directive lays down the rules relating to the organisation and functioning of the electricity sector, access to the market, the criteria and procedures applicable to calls for tenders and the granting of authorisations and the operation of systems. The 2009 Law on Electricity transposed Directive 2003/54/EC into Moldovan Law. In respect of the liberalisation of the electricity sector and the gradual opening-up of the power market, Article 52 of the 2009 Electricity Law provides that the electricity market will be fully liberalised for non-household consumers by 1 January 2013 and for household consumers by 1 January 2015. 2.4 Tariff regime 2.4.1 Existing tariff setting methodology The formal methodology for the calculation, approval and application of tariffs for electricity and heat generation is set out in a decision by the Administrative Council of ANRE dated 25 August 2004. The decision provides for tariffs to be consistent with a cost-related revenue requirement based on a base-year (2004) assessment of general costs (labour, 8 European Commission, ‘Energy 2020: a strategy for competitive, sustainable and secure energy’, Communication from the Commission to the Council and the European Parliament, November 2010 – cited in Centre for European Reform Policy Brief by Stephen Tindall on Delivering energy savings and effic8ency, January 2011. 9 Cross-border exchanges of electricity are covered by the subsequent Regulation No. 714/2009, which defines access conditions for the network. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 19 administrative, commercial and production-related costs), indexed with reference to nominal GDP and the consumer prices index for Moldova, forecast fuel and other direct production costs, forecast levels of interest, a profit of 5% on operating costs and a rate of return on new investment (investment since 2003). There are no provisions for debt repayment in the tariff formula. The costs of fuel for co-generation are allocated between heat and electricity by ANRE on the basis of the energy produced. This is subject to the heat and electricity values being lower than either heat only plants or the fuel consumed for electricity generation in condensing mode. There are many possible allocations of variable costs which could be applied by ANRE, including: o Thermodynamic methods (energy method, work method, exergy method; o Alternative means of energy supply (alternative heat and electricity methods); o Proportional method; o Benefit distribution method. These different approaches are discussed in a World Bank paper10 which stresses choosing an allocation approach which “ensures the competitiveness of DH as compared to other heating alternatives (especially gas-fired building boilers). The selected methodology must also ensure that electricity costs are lower than in separate electricity generation”. The ANRE energy allocation approach fulfils these requirements and there is therefore no a priori reason to recommend changing to one of the other variable cost allocation approaches in current circumstances. ANRE’s policy identifies the natural upper bounds for prices for the two services: the cost of generating electricity alone and the cost of generating heat alone. Cogeneration should lead to a reduction in the combined cost, so it would be natural to price the individual outputs of cogeneration lower than these upper bounds. However, ANRE’s policy is not any more specific. The issue of pricing services from common facilities is a generic one, where Ramsey pricing principles are likely to be relevant11. In the context of Moldova, affordability is likely to be a significant factor in deriving an optimal (welfare maximising) pricing allocation. We consider ANRE’s policy, though loosely framed, is appropriate and provides ANRE with the scope to give due weight to the relevant economic factors. 10 Carolyn Gochenour (2003): Regula on of Heat and Electricity Produced in Combined-Heat-and-Power Plants Infrastructure and Energy Department, Europe and Central Asia Region, World Bank. 11 Ramsey showed that efficient outcomes involve setting prices according to the willingness of customers to pay, measured as the price elasticity of demand. 20 Economic Consulting Associates, May 2011 In Section 5, it will be argued that a new heat source is a fundamental requirement of a sustainable future for the district heat system in Chişinău, and at that stage, with an electricity price that is more competitive in relation to imported electricity, the CHP variable cost regulatory allocation mechanism could be reviewed. 2.4.2 Tariff calculation for 2010 The following table summarises the tariff calculation carried out by ANRE for 2010, documenting its May 2010 decision to set tariffs at 821 MDL/Gcal. We understand from ANRE that it did not apply the methodology in full in 2010. In particular, the calculation reflected a derogation from the requirement for a rate of return on new assets in ANRE’s formal methodology. However, we were reassured by two things. First, the level of tariffs established in the tariff decision for May 2010 would appear to be sufficient to recover Termocom’s full costs were it to have been in force for the full year. The calculation inferred an average requirement over the year of MDL 727, but a higher tariff (MDL 821) was required from May to compensate for tariffs being lower in the first quarter of the year. We calculate that the tariff level from May is higher than the average rate for the year implied under ANRE’s tariff methodology without any derogation. Second, we were reassured in our discussions with ANRE that it appears to be firmly committed to the principle of cost recovery in tariff calculations. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 21 Table 6 Termocom district heating tariff calculation for 2010 Description Units Total MDL/Gcal Heat produced 000 Gcal 439.0 Heat purchased 000 Gcal 1,412.0 CET - 1 000 Gcal 247.0 CET - 2 000 Gcal 1,165.0 Total heat network 000 Gcal 1,850.9 Energy losses 000 Gcal 383.5 % 20.7 The heat supplied to consumers 000 Gcal 1,467.4 Cost of heat produced 000 MDL 238,422 543.10 Cost of purchased heat 000 MDL 590,929 418.51 The cost of heat entering the network 000 MDL 829,351 448.08 Effect of heat losses 000 MDL 0 117.10 The cost of heat 000 MDL 829,351 565.18 The cost of transportation and supply 000 MDL 230,773 157.27 Energy and materials 000 MDL 57,503 39.19 Repairs and maintenance 000 MDL 14,030 9.56 Depreciation of fixed assets 000 MDL 60,763 41.41 Wages, social security, health 000 MDL 87,952 59.94 Interest and banking 000 MDL 2,512 1.71 Other expenses 000 MDL 8,013 5.46 Total expenses 000 MDL 1,060,124 722.45 Profit 000 MDL 6,923 4.72 Revenue requirement from tariffs 000 MDL 1,067,048 727.17 Effective quarter I 2010 Supplied useful heat 000 Gcal 849.1 Income 000 MDL 559,330 Average Rate MDL/Gcal 658.73 Proposed quarters II - IV 2010 Remaining heat supplied 000 Gcal 618.30 Remaining income requirement 000 MDL 507,718 Rate in force from 18.05.2010 MDL/Gcal 821.15 22 Economic Consulting Associates, May 2011 2.4.3 Adjustments needed to the heat tariff methodology The existing heat tariff setting methodology is in principle sound as a basis for cost recovery, but there are some material elements in Termocom’s cost structure which are not presently allowed for. Our financial analysis in Section 3 below highlights two important omissions. On our assumptions, both omissions will need to be remedied through changes in the stated methodology to ensure the financial sustainability of Termocom. Those omissions are o There is no provision for the cost of bad and doubtful debts (see Section 3.3.6 below), and o Insufficient provision for profits to support the financing of increased levels of working capital that will naturally arise from increases in tariffs (see Section 3.3.7 below) Without amendments to remedy these issues, we calculate that Termocom is liable to accumulate increasing, accelerating and ultimately unsustainable levels of financial obligations, which we assume will be in the form of bank or other lending, or alternatively direct or indirect subsidy. Our financial analysis also highlights a possible requirement for a further adjustment to the tariff setting methodology to permit repayment of certain long term debt not covered by any debt resolution scheme pursuant to the memorandum of understanding signed between certain parties in June 2010. We describe the financial and policy issues in Section 5. These adjustments highlight an underlying issue, which is that there is some discrepancy between ANRE’s detailed tariff setting methodology and what would be needed to ensure Termocom’s tariffs are consistent with its financial sustainability. To provide a permanent solution to this issue, we recommend the following: o An explicit duty for ANRE, established in law, to adopt tariff setting methodologies that ensure that a regulated company in the district heating sector is able to finance its activities, including its investment needs for the maintenance and approved enhancement of its assets. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 23 2.5 Sub-summary of institutional and legal issues The lack of a framework Heat Law is a gap in the current legislative framework of the energy sector. It is not essential for a Heat Law to be passed, but it would be an opportunity to elaborate the regulatory responsibilities of ANRE in respect of heat and provide a framework for competition and investment. With the possible future involvement of the private sector, the law should empower ANRE to license district heat operators. The most important change that has taken place in the governance of the DH sector in Chişinău is the transfer of responsibility for the setting of heat tariffs from the Municipality to ANRE. Since assuming that responsibility, ANRE has significantly increased the tariffs and is committed to full implementation of the cost recovery methodology in 2011. It is understandable that the resultant high tariffs are a focus of political concern, given the affordability implications analysed in Section 1.3.1. It is essential that the ownership of Termocom be transferred to a more suitable owner (Government in the first instance) with the financial capacity to have an unambiguous interest in its long term financial sustainability. Going forward, while consolidating its professionalism and independence, there is need for ANRE to augment the existing tariff methodology so as to properly incorporate all of Termocom’s material cost elements. In particular, provision should be made for the funding of any material increases in trade receivables, bad debts and Creditor Committee long-term debt repayments which are not presently allowed for when tariffs are set. In the longer term, ANRE can further develop the tariff methodology, with a view to introducing a multi-year incentive-based approach. As will be discussed in detail in Section 4.4, the regulator should also develop rules for the merit order dispatch of heat sources, subject to network and electricity sector constraints. If there is to be a Heat Law, it should make provision for such rule-setting by the regulator. 24 Economic Consulting Associates, May 2011 3 26 Economic Consulting Associates, May 2011 Financial Situation and Projection Assumptions 3.1 Current financial situation 3.1.1 Introduction and sources We have prepared a financial model of the three companies involved in the Chişinău district heating sector. The model is driven by appropriate cost and revenue drivers with reference to financial statements for the year to December 2009, the 2010 tariff calculations for the energy sector published by ANRE and ANRE statements on its tariff methodology. In the case of Termocom, we referred to 2009 IFRS financial statements, which were subject to an adverse audit opinion by KPMG. For the two CETs, we referred to unaudited financial statements for 2009. We have made assumptions where appropriate for the main cost and revenue driver variables. In the case of investment costs, efficiency improvements and improvements in heat losses for Termocom, we have calibrated assumptions to be consistent with earlier World Bank reports, and in particular a 2009 model prepared by SWECO International. In respect of the investment programme for Termocom, we have assumed the programme assumed in the SWECO model but delayed by one year. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 27 3.1.2 Profit and loss accounts Table 7 below summarises the profit and loss accounts, mainly inferred from ANRE tariff calculations for May 2010 for the three companies, Termocom, CET-2 and CET- 1. In addition, we have computed costs for two items not directly reflected in ANRE’s tariff calculations. These are bad debt costs in Termocom and interest costs. Table 7 Profit and Loss accounts Profit and loss 2010 Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m Sale of heat to ultimate customers 1,067.0 1,067.0 Sales of heat to Termocom 470.4 120.5 Sale of electricity 650.7 215.5 866.2 Other revenues 3.6 1.1 4.6 Bad debt costs (estimate) (42.7) (42.7) Operating revenues 1,024.4 1,124.7 337.1 1,895.2 Purchase of heat from CETs 590.9 Fuel for generation 194.2 998.8 229.4 1,422.4 Other fuel & water 52.4 52.4 HOB operating costs 44.2 44.2 Staff costs 88.0 43.0 26.3 157.3 Other costs 29.6 65.3 70.5 165.4 Operating expenditure 999.4 1,107.1 326.2 1,841.8 Depreciation 60.8 28.7 10.4 99.9 Operating profit (35.8) (11.1) 0.4 (46.5) Financing costs (0.7) (1.6) (2.2) Profit/(loss) for the year) (36.4) (12.7) 0.4 (48.7) Reserves/(accumulated losses) b/f (1,226.3) 1,098.4 555.8 427.9 Reserves/(accumulated losses) at year-end (1,262.7) 1,085.8 556.1 379.2 For bad debt costs, we have made an assumption to highlight the potential relevance of the issue in this report. Termocom’s audited financial statements for 2009 disclosed trade receivables and thermal sales in respect of different customer groups as follows: 28 Economic Consulting Associates, May 2011 Table 8 Termocom Trade Receivables, 2009 Trade Thermal Debtor receivables sales days MDL m MDL m MDL m Population 417.9 592.9 257 Compensation to be received from the City Hall 80.4 Subsidies from Ministry of Finance 14.8 Other state owned companies 148.5 185.8 292 Other companies 3.4 16.7 74 Total 665.0 795.4 305 Source: Termocom 2009 IFRS Financial Statements Those statements identify that there is a substantial delay between the sale of heat and recovery of cash from customers. Bearing in mind the affordability issues we discuss in Section 1.3.1, we consider it appropriate to recognise significant risk of non- recovery of amounts due to Termocom. For illustration, we have assumed that bad debt costs represent a simple 4% of sales. We compute interest costs in the financial model on the simplifying assumption that interest is payable on loan balances at the start of the year. For 2010, we compute that trade receivables increase significantly, in line with the increase in tariffs for 2010, and this would imply a significant funding requirement, but this is not yet reflected in interest costs for 2010. 3.1.3 Cash flows The following table shows the cash flows for 2010 computed in the financial model. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 29 Table 9 Cash flows Cash flows 2010 Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m Operating profits (35.8) (11.1) 0.4 (46.5) Add back depreciation 60.8 28.7 10.4 99.9 Reductions/(additions) in current assets (202.0) 21.3 (6.0) (186.7) Additions/(reductions in current liabilities (16.2) 0.0 0.0 (16.2) Normal operating cash flows (193.2) 38.9 4.9 (149.5) Investing cash flows (75.9) (28.7) (10.4) (115.0) Operating and investing cash flows (269.0) 10.2 (5.6) (264.4) 0 Interest (0.7) (1.6) 0.0 (2.2) Add'ns/(red'ns) in non-current liabilities (0.9) 0.0 0.0 (0.9) Movements in loans 275.8 (8.7) 5.6 272.7 Total cash flows 5.1 (0.1) 0.0 5.1 Cash at the start of the year 17.8 5.0 0.2 22.9 Cash at the end of the year 22.9 4.9 0.2 28.0 The cash flow statement indicates a significant cash flow requirement, driven by tariffs being still insufficient to cover costs and significant funding requirement arising from an increase in current assets (trade receivables) in Termocom. For 2010, we have assumed levels of investment little above depreciation, reflecting an assumed delay of one year in the major investment programme identified in the SWECO model. We should highlight that we have made a simplifying assumption in our financial model to compute interest on opening balances, implicitly assuming that movements in bank loans occur towards the end of a financial year. For 2010, this means that the financial model may understate the interest cost impact of Termocom’s funding requirement for the year. 3.1.4 Balance sheets – summary The following tables show the balance sheets for the three companies at 31 December 2009, as reported, and the balance sheet for 2010 projected in our financial model by 30 Economic Consulting Associates, May 2011 rolling forward the balance sheets for 2009, assuming levels of investment little above depreciation (as referred to in Section 3.1.3 above) and assuming increases in trade receivables and short-term trade payables consistent with changes in turnover and costs respectively. We set out in Table 10 and Table 11 presentations of the balance sheets of the three companies in the sector showing the net asset positions before and after taking account of the long term liabilities subject to creditor arrangements (MoU etc.). The principal features of the balances sheets, and our high level observations, are as follows: o Termocom’s net assets are very substantially negative, reflecting the build-up of unpaid liabilities for heat and gas. Termocom’s suppliers have funded a sustained period in which tariffs were too low to cover costs. o The balance sheets for CET-1 and CET-2 show significant positive net assets, but not substantially in excess of the respective book values of fixed assets. These book values have not been subject to an economic impairment review. o Amounts receivable from heat customers reflect an assumption that they will continue to represent a substantial proportion of revenues, increasing in line with the increases in tariffs determined by ANRE in 2010; this is assumed to be funded through increased borrowings. o Long term creditor balances to external parties represent amounts payable to parties to the MoU (principally Modovagaz and Chişinău-Gaz) and other creditor committee parties. Section 3.2 analyses the financial position of the three companies. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 31 Table 10 2009 balance sheets Balance sheets 2009 Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m Intangible fixed assets 2.6 0.5 0.0 3.1 Tangible fixed assets 566.5 1,273.6 577.9 2,418.0 Long-term investments 0.1 0.3 0.3 Non-current assets 569.2 1,274.3 577.9 2,421.4 MoU parties: current receivables 80.2 54.2 Municipality of Chiüşină Ću 80.4 80.4 Ministry of Finance 14.8 14.8 Heat customers (end-users) 569.8 569.8 Other receivables 46.0 128.1 29.4 203.5 Current trade receivables 711.0 208.3 83.6 868.5 Stocks of goods and materials 27.7 43.1 10.5 81.3 Cash and bank balances 17.8 5.0 0.2 22.9 Current assets 756.5 256.5 94.3 973.0 Total assets (excluding MoU etc.) 1,325.7 1,530.8 672.2 3,394.4 Bank loans payable > 1 year (12.6) (12.6) Deferred revenue - grants & subsidies (10.3) (10.3) Other long-term liabilities (38.0) (0.0) (38.1) Non-current liabilities (10.3) (50.7) (0.0) (60.9) MoU parties: current payables (159.5) (27.3) (69.6) (122.0) Other trade payables (16.2) (59.6) (25.6) (101.3) Other short-term liabilities (13.3) (11.8) (5.5) (30.7) Bank loans payable < 1 year (5.7) (5.7) Current liabilities (194.7) (98.7) (100.7) (259.7) Total liabilities (excluding MoU etc.) (205.0) (149.4) (100.7) (320.6) Assets less liabilities (excluding MoU etc.) 1,120.8 1,381.5 571.5 3,073.8 Non-MoU creditors committee liabilities (317.1) (317.1) MoU parties: internal (1,770.1) 1,336.5 433.6 MoU parties: external (227.4) (1,249.0) (372.0) (1,848.4) Total net assets/(liabilities) (1,193.9) 1,469.0 633.1 908.2 Equity Share capital 32.5 370.5 77.4 480.4 Reserves and accumulated losses (1,226.3) 1,098.4 555.8 427.9 Total equity (1,193.9) 1,469.0 633.1 908.2 32 Economic Consulting Associates, May 2011 Table 11 2010 balance sheets Balance sheets 2010 Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m Intangible fixed assets 3.8 0.5 0.0 4.3 Tangible fixed assets 580.4 1,273.6 577.9 2,431.9 Long-term investments 0.1 0.3 0.3 Non-current assets 584.3 1,274.3 577.9 2,436.5 MoU parties: current receivables 80.2 54.2 Municipality of Chiü ău şinĆ 103.6 103.6 Ministry of Finance 14.8 14.8 Heat customers (end-users) 727.4 727.4 Other receivables 59.3 107.0 35.4 201.7 Current trade receivables 905.0 187.2 89.6 1,047.4 Stocks of goods and materials 35.7 43.1 10.5 89.3 Cash and bank balances 22.9 4.9 0.2 28.0 Current assets 963.6 235.2 100.3 1,164.7 Total assets (excluding MoU etc.) 1,547.9 1,509.5 678.2 3,601.3 Bank loans payable > 1 year (270.2) (3.8) (5.4) (279.4) Deferred revenue - grants & subsidies (9.3) (9.3) Other long-term liabilities (38.0) (0.0) (38.1) Non-current liabilities (279.5) (41.8) (5.4) (326.8) MoU parties: current payables (159.5) (27.3) (69.6) (122.0) Other trade payables (59.6) (25.6) (85.1) Other short-term liabilities (13.3) (11.8) (5.5) (30.7) Bank loans payable < 1 year (11.3) (0.2) (0.2) (11.6) Current liabilities (184.1) (98.9) (100.9) (249.4) Total liabilities (excluding MoU etc.) (463.6) (140.7) (106.3) (576.2) Assets less liabilities (excluding MoU etc.) 1,084.3 1,368.8 571.9 3,025.1 Non-MoU creditors committee liabilities (317.1) (317.1) MoU parties: internal (1,770.1) 1,336.5 433.6 MoU parties: external (227.4) (1,249.0) (372.0) (1,848.4) Total net assets/(liabilities) (1,230.3) 1,456.3 633.5 859.5 Equity Share capital 32.5 370.5 77.4 480.4 Reserves and accumulated losses (1,262.7) 1,085.8 556.1 379.2 Total equity (1,230.3) 1,456.3 633.5 859.5 Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 33 We have presented the balance sheets, above, using a ‘net assets’ format to highlight the position before and after taking account of the long term balances subject to creditor arrangements. For reference, we set out an alternative presentation of the same balance sheets in an assets vs. liabilities plus equity format. Table 12 Alternative presentation of balance sheets Alternative presentation 2009 Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m Non-current assets 569.2 1,274.3 577.9 2,421.4 Current assets 756.5 256.5 94.3 973.0 Total assets 1,325.7 1,530.8 672.2 3,394.4 Current liabilities 194.7 98.7 100.7 259.7 Ordinary non-current liabilities 10.3 50.7 0.0 60.9 Non-ordinary: Creditors committee liabilities 317.1 317.1 MoU parties: internal 1,770.1 (1,336.5) (433.6) MoU parties: external 227.4 1,249.0 372.0 1,848.4 Equity: share capital and reserves (1,193.9) 1,469.0 633.1 908.2 Total liabilities and equity 1,325.7 1,530.8 672.2 3,394.4 Alternative presentation 2010 Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m Non-current assets 584.3 1,274.3 577.9 2,436.5 Current assets 963.6 235.2 100.3 1,164.7 Total assets 1,547.9 1,509.5 678.2 3,601.3 Current liabilities 184.1 98.9 100.9 249.4 Ordinary non-current liabilities 279.5 41.8 5.4 326.8 Non-ordinary: Creditors committee liabilities 317.1 317.1 MoU parties: internal 1,770.1 (1,336.5) (433.6) MoU parties: external 227.4 1,249.0 372.0 1,848.4 Equity: share capital and reserves (1,230.3) 1,456.3 633.5 859.5 Total liabilities and equity 1,547.9 1,509.5 678.2 3,601.3 34 Economic Consulting Associates, May 2011 3.2 Financial analysis of current position The main focus of our financial analysis is on the financial dynamics of the district heating sector over a longer time period, to 2031. It is our more dynamic analysis that identifies the principal factors that affect financial sustainability in the sector. However, this ‘static’ analysis of the snapshot financial positions of the companies in 2009 and 2010 helps to underline some of those factors. 3.2.1 Balance sheets – impairments The book values of fixed assets in the accounts of the three companies are large in relation to the levels of profits that appear likely to be generated by those assets. All three companies are subject to regulatory price control, which means that the scope for sustained profitability is dictated by the level of profits allowed for in the computation of allowed prices. ANRE’s tariff setting methodology for the sector specifies two components of profit, the main one of which is an allowed return on new investment, made since 2003. The second component is a profit allowance of 5% on non-fuel costs, which is relatively small. Since the regulatory methodology does not make allowance for profits on assets acquired up to 2003, those older assets have impaired economic value. We understand that the fixed assets for both CET-2 and CET-1 were revalued in the accounts for 2008, reflected in exceptional profits of MDL999 million for CET-2 and MDL549 million for CET-1 in that year. These figures represent the major part of the value of tangible fixed assets, which at the end of 2008 were MDL 1,307 million and MDL 587 million respectively. In any asset valuation, there is a choice of different valuation bases, broadly summarised as follows: The valuation basis is necessarily a function of the purpose of valuation. Paragraph 103 of the IASC’s ‘Framework for the Preparation and Presentation of Financial Statements’ (currently in the process of being updated collaboratively by the IASB Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 35 Choice of asset valuation basis Depreciated historical Current value cost Current cost Net realisable value (entry value) (exit value) Depreciated ‘Modern Value in use Depreciated Equivalent Asset’ (NPV of future cash replacement cost value flows) and FASB) describes the question as follows: “The selection of the appropriate concept of capital by an enterprise should be based on the needs of the users of its financial statements. Thus, a financial concept of capital should be adopted if the users of financial statements are primarily concerned with the maintenance of nominal invested capital or the purchasing power of invested capital. If, however, the main concern of users is with the operating capability of the enterprise, a physical concept of capital should be used. The concept chosen indicates the goal to be attained in determining profit, even though there may be some measurement difficulties in making the concept operational.” As regulated businesses, the ‘goal to be attained in determining profit’ is conditioned by ANRE’s methodology for allowing profits. For the purpose of this project, which is concerned with financial sustainability, we consider a financial concept of capital and a ‘value in use’ valuation basis are relevant. This leads to a well-recognised circularity in regulated industries whereby the ‘value in use’ valuation of a regulated asset becomes whatever the regulator determines it to be. The circularity is resolved by the context in which a policy decision is made on asset valuation, and that decision can be informed by information on historical or current cost valuations, affordability, investor expectations and political factors. In the case of the companies in the Chişinău district heating sector, ANRE’s tariff methodology ascribes value explicitly 36 Economic Consulting Associates, May 2011 only to new assets. ANRE provided us with information on the values ascribed for the 2010 tariff review, which we compare with the book values in the following table. Table 13 Comparison of book and regulatory values of fixed assets Fixed asset valuations Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m Accounting book values (2009) Intangible assets 2.6 0.5 0.0 3.1 Tangible assets 566.5 1,273.6 577.9 2,418.0 Total 569.1 1,274.1 577.9 2,421.1 Net value of new investments (per ANRE) 185.6 69.4 34.7 289.7 Proportion of book values not remunerated 67.4% 94.6% 94.0% 88.0% Regulatory convention indicates that there is no objectively ‘correct’ basis for a regulatory valuation of an asset base without reference to market, affordability, investor expectations and broader policy and political factors. This will include issues of financeability, which can only be assessed properly with reference to longer term financial projections. It is widely accepted by regulatory economists that the accounting measure of value that best avoids artefacts of accounting history is a ‘Modern Equivalent Asset Valuation’ (MEAV)12. Valuing assets at MEAV would help minimise any market distortions arising from regulation by ensuring regulatory pricing simulates a competitive market. Our analysis in Sections 3.3 and 5 below indicates that the current pricing of electricity and heat outputs from CET-2 and CET-1 would not compete with a modern equivalent CHP plant, and by a significant degree. The elimination of capital costs would not be enough to restore the CETs to relative competitiveness (the cost differentials we identify in our analysis are greater than the capital costs allowed by ANRE in CET tariffs, which represent a relatively small proportion of allowable revenues, for CET-2 around 3%). This indicates that the MEAV of these plants would be negative. The values ascribed by ANRE to CET assets are high in relation to this benchmark. 12 MEAV is determined as the cost of a modern, efficient asset that would provide the same service capability as the existing assets, adjusted for productive efficiency differences and remaining asset lives. An existing asset should be able to provide services priced at the levelised unit cost of a modern asset and provide a reasonable rate of return on the MEAV. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 37 For the economic purposes of our analysis, the values of fixed assets in the financial accounts of the three companies materially overstate their full impaired value. The overstatement is most substantial for the CETs. Of the current assets of the three companies, the most significant component is the amounts receivable from Termocom’s customers. Termocom’s auditors, KPMG, noted the following in their audit report on the 2009 IFRS financial statements: “The management has not made any estimates regarding the recoverability of these receivables. We were not able to obtain sufficient and appropriate audit evidence regarding the impairment of these receivables.” We have not been able to make a substantive assessment of the recoverability of accounts receivable. However, it appears likely that a significant adjustment for the impairment of Termocom’s current assets would be appropriate. We are not aware of any substantially valuable assets not essential for operations that could be sold. 3.2.2 Balance sheets – underlying net asset positions For the purpose of this report we have analysed the 2009 balance sheets of the three companies, the last year for which we have reported information, into three classes of assets and liabilities: o Assets that are subject to impairment, as we discuss in the above section o Liabilities that are subject to a formal creditor arrangement, including the MoU and other Creditors’ Committee liabilities, but excluding the current portion of liabilities for which payment is provided for under the MoU (note that CET-2 and CET-1 have net non-current amounts receivable under the MoU) o Other net assets, those not subject to creditor arrangement or impairment The following table summarises the positions of the three companies in this way: 38 Economic Consulting Associates, May 2011 Table 14 Underlying net asset positions Underlying net asset positions 2009 Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m Net assets not subject to arrangement or impairment Net new fixed assets (per ANRE methodology) 185.6 69.4 34.7 289.7 Long-term investments 0.1 0.3 0.3 Net current assets 561.8 157.8 (6.3) 713.3 less: amounts receivable from population (417.9) (417.9) Ordinary long-term liabilities (10.3) (50.7) (0.0) (60.9) Subtotal 319.3 176.8 28.3 524.5 Liabiliities subject to creditor arrangement Non-MoU Creditors' Committee liabilities (317.1) (317.1) Net long-term MoU liabilities (1,997.5) 87.5 61.6 (1,848.4) Subtotal (2,314.6) 87.5 61.6 (2,165.5) Assets subject to impairment Net old fixed assets (not remunerated) 383.5 1,204.7 543.2 2,131.4 Amounts receivable from population 417.9 417.9 Subtotal 801.4 1,204.7 543.2 2,549.3 Total net assets reported (1,193.9) 1,469.0 633.1 908.2 The above analysis shows that, setting aside the long-term liabilities subject to creditor arrangement, the underlying net asset position of the three companies is positive, even when we disregard all the assets which we consider should be subject to an impairment review, as we discuss in Section 3.2.1 above. However, we note that only part of this asset base is remunerated under ANRE’s tariff methodology. Any increases in the unremunerated part of the asset base would need to be financed without any additional allowance for financing costs. This is a potential issue for Termocom if tariff rises lead to increases in trade receivables that are not matched by increases in trade payables. We address this issue in Section 3.3.7. The level of non-MoU Creditors’ Committee liabilities is high in relation to the asset base. To finance repayment of these amounts from commercial lending would imply a level of borrowing that clearly exceeds the level of new investment remunerated under ANRE’s tariff methodology, and would thus be unsustainable without an explicit change in the tariff methodology. We discuss this issue in Section 3.3.8 below. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 39 The longer term MoU liabilities very substantially exceed Termocom’s remunerated asset base, and thus could not be repaid from Termocom resources without an explicit change in the tariff methodology. We discuss this issue in Section 3.3.9 below. Taking these issues together, it seems clear that the reported balance sheets of all three companies overstate the underlying economic value of their assets and that the three companies do not have asset bases that are consistent with supporting the level of external debt. 3.2.3 Ratio and other analysis We have considered two dimensions of financial analysis relevant to financial sustainability: financeability, including profitability, and working capital levels. Financeability and profitability Our main consideration of financeability issues is with reference to key financial indicators over the financial model projection period (to 2031), which we draw out in Section 3.3 below. This longer-term context is necessary since the companies have not hitherto been financed conventionally with commercial lending. At the end of 2009, the last year for which we have accounting data, bank loans totalled less than MDL 20 million. Instead, the companies’ cash flow requirements have been funded by deferring payments to trade creditors, principally Modovagaz. This arrangement cannot continue, and our projections assume that it will not. Our longer term analysis highlights a need for significant changes in tariff methodology for Termocom in order to maintain sensible financeability ratios as it makes its transition to a sustainably financed position. We discuss these changes in Section 3.3 below, and in particular in Sections 3.3.6 and 3.3.7. Conventional financeability ratios – ratios between interest costs and borrowing levels on the one hand and profits and asset levels on the other – are highly dynamic at the start of our financial modelling projection period as we assume Termocom, in particular, starts to become dependent on commercial debt to fund its working capital requirements (increases in trade receivables) and investment requirements. As a result, the conventional financial indicators for 2010 can only reflect the very earliest stage of this transition from reliance on trade creditors to commercial lending and will not provide reliable indicators of longer term financeability issues. 40 Economic Consulting Associates, May 2011 However, we would make the following observations: o The level of long-term external debt, nearly MDL 1.9 billion to MoU parties and a little over MDL 300 million to other parties, is nearly an order of magnitude greater than the asset base recognised in ANRE’s tariff methodology (about MDL 300 million, as set out in Table 13), and on which a financial return is provided. It is abundantly clear that paying commercial interest rates on these debts (either directly to the affected trade creditors or to commercial lenders funding any repayments) could not be supported out of operating profits without a significant change in tariff methodology and a consequent increase in tariffs. We discuss the potential scale of such changes in 3.3.8 and 3.3.9 below. o The two main drivers of funding requirement in 2010, highlighted in Table 9, are Termocom’s investment requirements (which we project will increase after 2010) and increases in the level of Termocom’s trade receivables (as heat tariffs continue to rise). While ANRE’s tariff methodology is designed to support the financing of new investment, it is not designed to support the financing of trade receivables. Termocom may not be able to support the financing of significant increases in trade receivables out of operating profits without a change in the tariff methodology and a consequent increase in tariffs. We discuss the potential scale of such changes in 3.3.7 below. o We do not project substantial funding requirements for CET-2 and CET-1: the cash flow position shown Table 9 is broadly representative of the underlying cash flow position for all the years of CET operation in our projection period. This reflects assumptions about ANRE’s removal of the 2010 derogation regarding profit allowances, an investment programme broadly consistent with the level of recent years (which would appear to be consistent with maintaining current asset performance levels) and normal trade creditors being broadly in balance with trade receivables. Working capital levels While the financeability issues for the three companies, mainly in Termocom, are highly dynamic and are affected by the necessary transition from funding by trade creditors to funding by commercial lending, we can draw inferences from the current levels of working capital, the levels of current trade payables and receivables. Our analysis of the position for 2009 and 2010 is affected by outstanding amounts between parties to the MoU and their allocation between long-term and current Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 41 portions. We have adopted the current portions identified in the MoU as reflective of the current portion in existence at the end of 2009. The following table shows the resulting current creditor and debtor day ratios for 2009. Table 15 2009 current creditor and debtor day ratios Working capital indicators 2009 Termocom CET-2 CET-1 Combined Current heat-related receivables MDL m 665.0 80.2 54.2 799.4 Other receivables MDL m 46.0 128.1 29.4 203.5 Trade receivables (excl. long-term) MDL m 711.0 208.3 83.6 1,002.9 Operating revenues MDL m 795.4 1,137.7 302.6 2,235.7 Debtor days days 326 67 101 164 Trade payables (excl. long-term) MDL m 175.7 86.9 95.2 357.7 Operating costs MDL m 1,040.6 1,098.4 273.4 2,412.3 Creditor days days 62 29 127 54 The indicator that stands out from the above table is the level of trade receivables in Termocom. We discuss this issue more fully in Section 3.1.2 above and with reference to Table 8. Table 15 differs from Table 8 by the inclusion of ‘other receivables’ of MDL 46.0 million, representing mainly amounts recoverable by court decisions and VAT recoverable. Other working capital indicators appear broadly reasonable, although we question whether the net balance of current trade receivables in excess of current trade payables in CET-2 would need to be maintained. The relatively high indicators for CET-1 would reflect the fact that the balance sheet date (or the date of the amounts identified in the MoU) lies within (or just after) the active season for CET-1. For our projections to 2010 and beyond, we assume a continuation of the debtor and creditor day indicators. 42 Economic Consulting Associates, May 2011 Other financial ratios We have reflected on a broad range of other possible financial indicators. We recognise that indicators calculated using the projected financial statements for 2010, at a point of transition for the sector, would be misleading if considered in isolation. We have therefore considered them in the context of forward-looking projections, which we describe in Section 3.3. Financial indicators can be categorised into indicators for profitability, liquidity and financial sustainability. o Profitability. Table 7 indicates very low levels of profits were projected for 2010 in ANRE’s tariff setting assumptions, which become losses after adjusting for our estimate for bad debt costs13. For 2010, profitability levels were clearly not sufficient to support future commercially-financed investment and thus not consistent with the continued financeability of the sector. Before our bad debt cost adjustment, interest cover ratios look strong at Termocom, but only because the company’s financial requirements have been funded by its suppliers rather than by interest- bearing loans. In 2010, the sector was at a point of transition towards full cost recovery and away from financial dependence on its suppliers. Securing financeability and financial sustainability for the sector going forward requires significant increases in profitability, and thus changes in tariff levels. We consider these in Section 3.3. The principal profitability measures we consider are operating profits as a percentage of net new investment (consistent with the basis for ANRE’s profit allowance) and an interest cover ratio, FFO interest cover14. Our projections indicate that longer term sustainability would be consistent with a profit percentage of about 22% of net new assets15 and an interest cover of close to and rising above 2.0 times FFO. o Liquidity. The two main companies have an apparently healthy ratio of current assets to current liabilities, but relatively low levels of cash resources. The ability of Termocom in particular to finance its working capital requirements is not assured without further funds being made available through tariff increases. Our tariff assumptions, looking forward, ensure that Termocom is able to fund projected increases in its working 13 In addition, projected profits for CET-2 were reduced by financial adjustments in respect of previous years in ANRE’s tariff calculations. These would not be expected to recur. 14 FFO is ‘funds from operations’ representing profits available for investors and self-financing. 15 This profit percentage reflects three components of regulatory profit allowance: profit on net new investment, profit on non-fuel costs and a further profit allowance for increased trade receivables which we discuss in Section 3.3.7. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 43 capital, but only by providing for additional profits to finance increases in trade receivables. Our projections for tariffs in Section 3.3 provide for cash resources that do fall below 2009 levels in real terms. o Financial sustainability. The usual measures relevant to financial sustainability relate assets (or equity) to debt levels or profits to interest levels. As the sector is at a point of transition away from financial dependence on its suppliers, and thus very low levels of commercial lending, these indicators for 2010 would give a misleading impression of financial strength. Looking forward, our tariff assumptions in Section 3.3 ensure that Termocom is able to fund its investment programme with a gearing ratio (debt/net new investment) that does not exceed 60%. This requires a continuing level of self-financing, indicated by the level of FFO interest cover and the inclusion of depreciation in ANRE’s profitability requirements. Our consideration of these financial indicators highlights further the importance of ANRE being subject to a duty related to financeability, as we discuss in Section 2.4.3. 3.3 Heat tariff assumptions for financial projections The financial model can be used to project forward the results, balance sheets and cash flows for the three companies for twenty years through to 2031. A key output is the average heat tariff for Termocom customers. This section analyses the cumulative effects of the primary drivers of heat tariffs, consistent with ensuring Termocom’s financial sustainability16. To inform our analysis and this section, we have developed a series of comparative static scenarios to identify the potential impacts of the principal cost drivers for Termocom on the dimensions of financial sustainability, tariffs and financial obligations. The scenarios and their impacts on heat tariffs are illustrated in the following chart, which we refer to later as the “waterfall” diagram. 16 Our steady state assumptions include stable demand for heat. Other assumptions we have modelled include a reduction in heat demand by some 12% over the medium term which, combined with an operating cost elasticity assumption of 0.3, leads to increases in tariffs of 3-4%. If such a reduction arises due to loss of customers, it would make tariffs less affordable. If it arises due to improved use, it would make tariffs more affordable. 44 Economic Consulting Associates, May 2011 Table 16 Transition from Termocom’s 2010 tariffs to projection for 2020 Tariffs waterfall data Projected 2020 tariffs Increase Reduction Incremental effects, 2010 price levels MDL/Gcal MDL/Gcal MDL/Gcal 727.2 743.2 16.0 794.2 51.1 856.2 62.0 885.3 29.1 913.6 28.3 Bad debts 951.7 38.1 983.4 31.7 1,002.9 19.5 1,116.6 113.7 1,002.9 (113.7) 962.3 (40.6) 922.1 (40.3) 685.4 (236.7) Figure 2 Transition from Termocom’s 2010 tariffs to projection for 2020 1,100 Real terms regulated tariffs, MDL/Gcal - 2010 prices 1,000 repayment LT debt transfer LT debt Cred. Committee heat losses repayment Improve Working capital efficiency funding 900 Improve Bad debts May 2010 tariffs investments Priority level of capex Replacement 800 Gas price at border Gas transmission 727.2 Withdrawn derogation 700 deviations Modern CET-3 for profit regulated tariff 2010 average 600 500 Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 45 In order to reflect the cumulative effects of investment programmes, improvements and other initiatives, the chart tracks the incremental impact of each scenario on the level of tariffs in 2020 – red bars indicate upward impacts on tariffs, green bars indicate downward impacts on tariffs. The progression of tariffs between 2010 and 2020 will depend on the timing of the initiatives, our assumptions and resulting financial results being presented in Section 5.7. The chart indicates that there are a number of factors that would in aggregate lead to a substantial real increase in regulated tariffs from their level in 2010 (MDL 727.17/ Gcal for the year on average, MDL 821.15/Gcal from 18 May 2010). The chart also indicates the factors that should help to offset those increases. The chart focuses on tariffs and does not capture wider environmental benefits from improvements in generation efficiency and reduced heat losses. Tariffs are expressed in real, constant 2010 money terms. For comparison with regulated tariffs for 2011, the results would need to be uplifted by the average rate of inflation for the year to 2011, which we estimate at 8%. In the following sections we describe these factors and their impacts, and examine the financial sustainability issues facing the sector. 3.3.1 Derogations for profit levels in ANRE calculations for 2010 In all three of the companies, Termocom, CET-2 and CET-1, ANRE allowed for a derogation in 2010 from the stated tariff methodology in the level of profits it incorporated into its tariff calculations. ANRE’s tariff methodology provides for two components of profit: a 5% allowance on non-fuel costs and a return on the value of new investments, defined as investments made since 2003. The financial model assumes that the tariff methodology will be applied in full in respect of the computation of profits from 2011. The impact on Termocom’s heat tariffs is projected to be 2.2%. 3.3.2 2010 financial deviations in the gas transmission sector ANRE’s calculations of gas tariffs 2010 included an adjustment of some MDL 328.3 million, identified as ‘devieri financiare’ in Anexa 3 to ‘Structura tarifului de 46 Economic Consulting Associates, May 2011 furnizare a gazelor naturale consumatorilor finali pentru anul 2010, actualizat din aprilie 2010’. We understand from ANRE that this represents financial adjustments in relation to variances in prior periods and affects only 2010. The adjustment represented an 8% one-time reduction of gas tariffs, which will tend to revert to their underlying levels. Our projections for gas tariffs assume such adjustments will not recur. Because of the relative importance of gas costs on the costs of the district heating sector, the impact on Termocom’s heat tariffs is projected to be 6.9% 3.3.3 The gas price at the border The gas price at the border assumed by ANRE for its 2010 tariff calculations was about US$ 249 per thousand cubic metres. We understand that the gas price has increased US$ 295 and ANRE is reported as predicting a gas price of US$ 310 for 2011, which we understand is close to the European market netback price. After taking account of Moldovan inflation and the movement in the MDL/US$ exchange rate (from ANRE’s assumption of $1 = MDL 12.50 to an assumption, based on current exchange rates, of $1 = MDL 12.00), this represents a real increase of some 10.7% in the cost of gas. The impact on Termocom’s heat tariffs is projected to be 7.8%. The importance of gas costs in Termocom’s cost structure, directly and indirectly as part of the cost of cogenerated heat, means that heat tariffs are exposed to changes in the border price of gas and to real dollar exchange rates, after taking account of relative inflation. For the purpose of this report, we have assumed no further real terms changes in the border price of gas, but highlight the inherent uncertainty in this assumption. The cumulative effect of the scenarios discussed so far takes tariff levels beyond the real terms level established by ANRE from 18 May 2010. 3.3.4 Replacement level of capital expenditure To model tariff stability at 2010 levels, we made an artificial assumption relating to levels of capital expenditure. For illustrative purposes, we have assumed an Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 47 underlying requirement for capital expenditure of some MDL 82 million per annum in order to maintain current asset performance. The impact on Termocom’s heat tariffs is projected to be 3.4%. 3.3.5 Termocom’s priority investment programme In order to reflect identified requirements for significant enhancements to Termocom’s distribution assets, we have reflected the assumptions in the SWECO model for ‘priority investments’. These included projects under the following headings: o Conversion of group heat substations into individual heat substations o Modernization of the distribution network, connection of individual heat substations o Replacement of the transmission network, including the installation of modern valves o Installation of variable frequency drives o Metering and Automation of the DH system These projects, as originally forecast in the SWECO model, average some MDL 178 million per annum for the six years from 2010 to 2015, with further costs projected to 2024. We have assumed a year’s delay in the programme and have inflated the costs accordingly. Reflecting the assumptions in the SWECO model, we have assumed these project costs are not in addition to the assumed replacement level of capital expenditure, but we have assumed the priority investment costs where the costs exceed the replacement level assumptions. The impact on Termocom’s heat tariffs is projected to be 3.2%. 3.3.6 Funding Termocom’s bad and doubtful debts ANRE’s tariff setting methodology does not allow for the recoverability of Termocom’s tariffs. ANRE’s response to our request for information included the following comment: 48 Economic Consulting Associates, May 2011 “ANRE’s view on bad debts is the same for all regulated sectors and not only for Termocom. Bad debts are not included in tariff and this is in line with the principle that good payers should not pay for bad payers.” This principle is not an economic principle. Someone has to pay. Either good payers of heating tariffs or, since Termocom is a publicly owned body, good payers of taxes will have to pay. The principle that Termocom should be financially sustainable means that the cost of bad and doubtful debts will in due course need to be covered in the tariff calculations, whether explicitly or implicitly through additional allowances for profits. For the purpose of this report, we assume a level of bad and doubtful costs of 4%of sales. We have not carried out a substantive examination of the collection issues at Termocom to determine whether this assumption is realistic, but it serves to highlight the issue. The impact on Termocom’s heat tariffs is projected to be 4.2%. 3.3.7 Funding Termocom’s working capital requirements The tariff increases for the scenarios discussed thus far accumulate to a total of 31% in real terms, above 2010 levels which were themselves substantially above 2009 levels. While Termocom can be projected to be financially sustainable on a steady state basis, assuming tariff levels remained at 2009 levels (and are fully collectable), the subsequent increases in tariff levels are projected to lead to corresponding increases in the levels of trade receivables. These increases need to be funded. At present, the tariff methodology does not provide for the funding of these balances and our projections show a rapid and accelerating accumulation of financial liabilities, with interest on interest, to the point where borrowings exceed MDL 4 billion by 2025. We are assuming interest of 4% in real terms (e.g. about 12% when inflation is at 8%). This is clearly inconsistent with the self-financing objective for Termocom. The logical remedy is for regulated tariffs to include an allowance for the cost of funding working capital. Our modelling indicates that an allowance of 6-8% on core net working capital balances (trade receivables less trade payables in respect of heat and gas) would provide for financial stability, with gearing and interest covers remaining at levels normally considered tight (gearing at 60% to 40%, FFO interest cover at 2.0 to 3.0 times). We have assumed an allowance of 6% on net working capital, which leads to a projected impact on Termocom’s heat tariffs of a further 3.3%. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 49 3.3.8 Repayments of Termocom’s Creditors’ Committee debts Not all of Termocom’s long term creditors would be protected by the debt restructuring scheme discussed in Section5.3.5. We are not clear as to the legal position of Termocom’s other long term creditors. We anticipate that there may be a legal difficulty implementing a debt restructuring scheme that unreasonably favours one class of creditors over other classes of creditors, in particular companies not owned by the state. The outstanding amounts of these creditors in the 2009 IFRS Financial Statements is set out in Table 22. The tightness of Termocom’s financial position means that there is no scope to repay such amounts, while retaining Termocom’s financial sustainability, without further allowances in the regulated tariffs. We have accordingly assumed allowances to support repayment of these amounts. We have computed repayments as a fixed real annuity over a period of 15 years with a real interest rate of 4%. The impact on Termocom’s heat tariffs is projected to be 2.0%. 3.3.9 Repayments of Termocom’s long-term debts The remainder of Termocom’s long term debts represents amounts payable directly or indirectly (via CET-2 and CET-1) to Moldovagaz and Chişinău-Gaz. As with the other Creditors’ Committee debt discussed above, the tightness of Termocom’s financial position means that there is no scope to repay such amounts without further allowances in the regulated tariffs. We have similarly assumed allowances to support repayment of these amounts, with repayments as a fixed real annuity over a period of 15 years with a real interest rate of 4%. The impact on Termocom’s heat tariffs is projected to be 11.3%. Extending the repayment period to 20 years would bring the impact down to 9.3%. Providing for no real interest rate would bring the impact down further to 6.3%. 3.3.10 Transfer of Termocom’s long-term debts This debt resolution option is discussed in more detail in Section 5.3.5 below. 50 Economic Consulting Associates, May 2011 The projected impact on tariffs is to reverse the projected increase of 11.3% identified in Section 3.3.9 above. 3.3.11 Improvements in Termocom’s heat losses We have assumed a progressive improvement in Termocom’s heat losses, broadly in line with the improvements assumed in the SWECO analysis, bringing heat losses down from 20.7% in 2010 to 16.7% by 2020, close to benchmark performance. Reductions in heat losses permit lower inputs, in terms of heat, water and affected operating costs (we have assumed a notional cost elasticity of 0.3). The impact on Termocom’s heat tariffs is projected to be a reduction of 4.0%. 3.3.12 Improvements in Termocom’s operating efficiency We have assumed sustained improvements in Termocom’s operating efficiency, covering its staff costs and other operating costs (excluding fuel, water and heat costs). We assume staff productivity will improve by 5% per annum through to 2020, with staff numbers falling from 1,363 in 2010 to 804 in 2020. These reductions will be offset by assumed real increases in costs per staff of some 3% per annum. We assume other operating costs fall by 2% per annum in real terms. The impact on Termocom’s heat tariffs is projected to be a reduction of 4.2%. 3.3.13 Procurement of modern cogeneration – CET-3 With reference to Annex A3 and the calculations in Table 28, we project that modern cogeneration plant of sufficient capacity to generate heat at 55% of the cost of heat from HOBs, and generate the same heat output as the two CETs currently generate, would lead to reductions in Termocom’s heat tariffs of about 22.2%. This is illustrated in the final bar in the waterfall chart, Figure 2 above, with the colour shading to white to reflect the strategic uncertainties involved. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 51 4 52 Economic Consulting Associates, May 2011 International district heating experience 4.1 Questions relating to international comparators The district heating system of Chişinău is long overdue for a major overhaul in order to put it onto a sustainable, cost-efficient and customer-oriented footing. Before getting into the detailed analysis of debt and institutional restructuring options in Section 5, this section seeks to answer the following questions: o From experience in comparable countries, is there an obvious structural model of a DH system for Chişinău to follow? o What role is the private sector playing in DH systems in the region? o What is international best practice in the regulation of district heating? 4.2 International experience of different DH structures 4.2.1 Vertically integrated and unbundled DH systems In formulating structural options for the DH system of Chişinău, one of the important issues is whether it is best to have a vertically integrated structure, with a single firm Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 53 responsible both for generating heat from CHPs and HOBs, or whether it is better to have separate unbundled entities responsible for heat production on the one hand and distribution and supply of heat via the DH network on the other. In Chişinău, the present model is one of partial unbundling, with the CHP plants managed by different firms (CET-1 and CET-2) to the DH network operator (Termocom), but with Termocom still controlling some heat sources (19 HOBs). Like Chişinău, DH systems in most developed and transitional European countries are also hybrids, but with varying degrees to which the DH network company in different cities also controls heat sources. To illustrate, an example of a successful DH system in Hungary is described in the box below. DEBRECEN CASE STUDY The municipally owned district heating company in Debrecen, Hungary started its restructuring in the early 1990s and underwent another reconstruction in 1999. The company’s managers worked closely with the municipality and the city council in its significant efforts to reduce costs and improve the quality of district heating. Measures taken include implementing a cost monitoring system, installing meters, raising customer awareness, introducing customer care, developing a marketing campaign, decreasing the number of employees and optimising staff work. These and other measures resulted in improved energy efficiency and lower costs, greater customer satisfaction, reduced non-payment rates (under 4%) and a 16.5% growth in market share over three years. The company’s tariffs grew only by 2.8% per year from 2000 to 2003 (below the average inflation level). The following box briefly describes the most prominent example of a fully unbundled, competitive district heat system (Greater Copenhagen). 54 Economic Consulting Associates, May 2011 COPENHAGEN CASE STUDY The most significant example of a competitive, fully unbundled district heat system, in which generation, transmission and distribution are handled by different entities, is in the Greater Copenhagen area. CTR and VEKS are wholesale transmission companies serving two separate but connected geographic areas. These companies purchase heat, transmit it to the localities in their service areas, and sell it to distribution companies covering each locality. Municipal waste incinerators, cogeneration plants (owned by the power utility Energi E2) and VEKS sell heat to the CTR system; dispatch is based on negotiated prices so that the cheapest heat is put on line first, which also creates an incentive for keeping costs down. VEKS also buys heat from cogeneration plants and incinerators and sells it to local distribution companies in its own service area, operating a parallel but geographically distinct system with a transmission interconnection with CTR. By law, heat producers cannot make a profit in Denmark, so they sell the heat at prices that are based on cost alone. The size of new heat capacity in greater Copenhagen is calculated in municipal energy plans. CTR procures medium and long-term heat supply contracts with cogenerators as well as waste incinerators, although actual dispatch is based on real- time demand according to least cost. CTR also owns peaking capacity made up of heat-only boilers; these boilers supply less than 1% of the total heat generated annually. This capacity is used to ensure reliability of supply, though if the wholesale company were private, it would have greater incentives to use this peaking capacity for additional income even if such use were not economical from a system perspective. Source: International Energy Agency (2004): Coming in from the Cold – Improving DH Policy in Transitional Economies, OECD A common problem in predominantly unbundled systems is that the DH company has a tendency to use its own heat sources first even when it can buy lower cost heat from external suppliers. This tendency undermines national energy efficiency and environmental objectives. Several countries (such the Czech Republic, Slovak Republic and Lithuania) have responded by legally requiring merit order dispatch of heat, but the problem of over-use of own resources may persist. The problem is said to be particularly severe when retail prices are regulated within publicly owned DH Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 55 systems – once the tariffs have been set, there is not sufficient motivation to buy heat from the cheaper sources. This is clearly a failure of governance, which is not ensuring an adequate combination of discipline and incentives for DH managers to respond to economic signals. International experience suggests, however, that vertical integration (VI) is not in itself a panacea which will ensure delivery of least cost heat to consumers. In VI systems, there is a risk that heat consumers will be loaded with costs in order for the price of electricity to be kept down. This problem has been observed in particular in situations where the electricity market has been liberalised and the cogenerators have to compete with other sources of supply and/or imports. Participants in an EU workshop on renewing district heating in the Baltic region concluded that “partial liberalisation of the energy market in favour of electricity and gas, in the absence of counterbalancing regulatory measures to ensure the sustainable development of the district heating sector, has a very negative effect on the latter”17. 4.2.2 Heat dispatch The problem of efficient dispatch in a district heating system is a complex one, because of the interplay between economic factors and the technical requirements of system operation. Temperatures and pressures in the network need to be continually adjusted to ensure adequate delivery of heat to meet demand which can change quite rapidly (diurnal temperature variations are often quite large in Chişinău). In the city of Riga, capital of Latvia, the district heat company JSC Rigas Siltums has an automatic dispatch control system, which improves efficiency through the system by optimising dispatch between its own heat sources and those owned by Latvenergo. The system is briefly described in the box below. 17 Quoted in International Energy Agency (2004): Coming in from the Cold – Improving DH Policy in Transi onal Economies, OECD 56 Economic Consulting Associates, May 2011 OPTIMAL DISTRICT HEAT CONTROL SYSTEM IN OPERATION IN RIGA Efficient operation of a modern district heat system requires the complete set of technological units for heat production, transmission and distribution to be operated in a coordinated and accurate manner on a continuous basis along the complete supply chain – from heat source to heat consumer. In order to improve operations, an automatic dispatcher control system was installed in Riga in 1983. This has been developed over the years and is now ‘Dispatch Service’ (DS) is one of the key departments of the district heat company JSC Rigas Siltums. by optimising dispatch between its own heat sources (HOBs and small CHP plants) and the large CHPs, owned by Latvenergo, which are its main source of bulk heat. The Dispatch Service operates 24 hours per day, performing continuous operative management of the heat sources and the network, supervising several hundreds of sites simultaneously. The heat sources available are HOBs and small CHP plants owned by Rigas Siltums and large CHP plants owned by Latvenergo, which provide around three quarters of the bulk heat. The dispatch system is based on optimising software that relies on a real-time Operative Technical Information Service (OTIS) which was developed by the utility. The Dispatch Service is credited with improving the quality of the heat service for consumers while reducing costs. It stabilises the hydraulic regimes, reducing the flow of heat carrier and power requirements. The system allows for cost-minimising operational strategies to be pursued – for example lowering the forward temperature of the heat carrier by 2-5 oC, thereby lower heat losses by 5%, the savings of which more than offset the additional power required for transportation of the lower temperature heat carrier. Heat losses in the Rigas Siltums network have been reduced to 13%. Source: Aris Žigurs et al, Improvement of Efficiency in the District Heating Systems of Lativa An automatic dispatching system is a long term goal for Chişinău, with some of the investment that is required being included in Termocom’s investment programme. Even without automatic equipment being in place, the adoption of the algorithms of an optimal control system can be used to guide manual operation. Installation of the equipment needed at all key nodes of the network for automatic monitoring and Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 57 data transmission, on the one hand, and operation of the system, on the other, can be progressively introduced. 4.2.3 Wholesale competition Under the influence of the competition-oriented energy policies of the EU, many European countries with DH systems are moving towards liberalising the heat sector as well as the electricity sector. The first step in that direction is to introduce wholesale competition in the heat generation segment. The model is one in which independent heat and power producers compete to supply heat to the DH network operator, usually via long-term heat purchase agreements. There are also some instances of heat producers having direct access to the network, but the nature of the heat market does not lend itself to a rapid move towards retail competition where final consumers are able to choose their supplier. Wholesale competition is compatible with using new environmental friendly forms of primary energy for district heating, such as biomass, solid waste, geothermal, solar energy and industrial waste heat. To be competitive, the model does necessarily entail unbundling, at least to some degree, together with dispatch rules. Table 17 divides developed and transitional countries into those where the DH systems are predominantly vertically integrated, those aspiring to achieve a greater degree of wholesale competition and those which already have significant examples of unbundling and competition. Table 17 Classification of DH structures Category Predominantly Wholesale ficant examples SigniÀ vertically integrated competition in of unbundling prospect Developed EU Netherlands Germany Denmark countries Norway United Kingdom Finland Sweden Transitional Belarus Czech Republic Hungary economies Bulgaria Latvia Lithuania Estonia Poland Russia Romania Ukraine Principal Source: International Energy Agency (2004): Coming in from the Cold – Improving DH Policy in Transitional Economies, OECD 58 Economic Consulting Associates, May 2011 4.2.4 Comparative studies A number of recent or on-going studies have attempted to identify success cases and make such comparisons through rigorous analysis across a number of different dimensions. Two studies in particular stand out: o The District Heat in Candidate Countries (DHCAN) project18 provides a number of useful guides to different aspects of district heating and systems in Hungary in detail (Debrecen and Budapest). o An on-going ERRA-Fortum co-project is entitled Benchmarking District Heating in Hungary, Poland, Lithuania, Estonia and Finland. Preliminary findings were released in October 201019, and the final report will be provided during 2011. 4.3 Private sector participation in district heating Private sector participation in district heating takes many different forms, as is shown by the classification and examples in Table 18. The range is from full public ownership (by municipalities or by the state), through different variants of public private partnerships (PPP) to full divestiture. To build on and enrich the discussion in the previous section, the table distinguishes between systems which are predominantly unbundled and those that are vertically integrated. Table 18 Examples of different DH ownership and management options Ref Option Examples 1 Full public ownership (a) Vertically integrated DH companies Czech Rep – small municipalities Hungary - Debrecen 18 Website is http://projects.bre.co.uk/DHCAN/index.html 19 Presentation at a conference in Tirana http://www.erranet.org/index.php?name=OE-eLibrary&file=download&id=7224 &keret=N&showheader=N ERRA is the Energy Regulators Regional Association, which is based in Budapest, Hungary Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 59 Ref Option Examples Ref Option Examples Germany – Stadtwerke München Germany – Stadtwerke München Finland – Helsinki Energia Finland – Helsinki Energia (b) Unbundled Romania – Termoelectrica owns large CHP plants, (b) Unbundled Romania – Termoelectrica municipalities owns large CHP plants, local DH systems municipalities local DH systems Denmark – smaller systems buy bulk heat from regional Denmark CHP plants, – smaller all ownedsystems either by bulk buy heat fromor municipalities regional local CHP plants, all owned consumer co-operatives either by municipalities or local 2 Public Private Partnerships – vertically consumer integrated co-operatives 2 (a) Public Private Partnerships – vertically integrated Operation and maintenance contracts Czech Rep – northern Bohemia (a) Operation and maintenance contracts Sweden Czech Rep – northern – Fortum Bohemia Services has O&M contract for Borås Sweden DH system – Fortum Services has O&M contract for Borås (b) Leasing DH system Estonia, Tallin – Dalkia has 30 year lease (b) Leasing Estonia, Lithuania,Tallin – Dalkia Vilnius – Dalkiahas has 30 year lease 15 year lease Lithuania, Vilnius – Dalkia has 15 year lease (c) Concession France, Paris – CPCU series of concessions since 1927 (c) (d) Concession Selected private minority equity France, Czech Paris Rep – CPCU – E.ON has series minorityof concessions stake in some since 1927 DH systems (d) Selected private minority equity LowerRep Czech – E.ON Austria has minority – EVN operates stake the DH in some DH with systems, systems Lower Austria – EVN operates the DH 51.5% ownership by the province, rest by private systems, with 51.5% ownership by the province, rest by private investors (e) Minority private equity via the stock investors Poland – Wroclaw DH system (e) exchange private equity via the stock Minority Poland – Wroclaw DH system exchange Italy – ASM Brescia is 30% owned by private Italy – ASM Brescia is 30% owned by private shareholders (f) Majority private ownership, shareholders Czech Rep – DH utilities in Prague, Brno and Ostrava (f) Majority private municipalities ownership, retaining minority Czech majorityRep – DHby owned utilities privatein sector Prague, Brno and Ostrava firms. municipalities retaining minority stake, in some cases with a ‘golden majority owned by private sector Àrms. Poland – Fortum owns 73% of a DH company serving share’ in some cases with a ‘golden stake, Poland 23 small Fortum –and owns medium 73% of towns inasouth DH company west andserving central share’ 23 small Poland and medium towns in south west and central Poland Macedonia – Skopje DH company is 70% owned by the employees – Skopje DH company is 70% owned by the Macedonia (g) Full private ownership with strong employees UK, Southampton – City Council promotes DH with (g) Full private municipal ownership with strong support UK, Southampton utility – City Council owned by Utilicom of Francepromotes DH with 3 municipal support Public private partnerships - unbundled utility owned by Utilicom of France 3 (a) Public ofpartnerships private Privatisation - unbundled heat generation Poland, Warsaw – Vattenfall owns the CHP plant, (a) Privatisation of heat generation Poland, Warsaw municipality the – Vattenfall owns distribution companythe CHP plant, (b) municipality the distribution company Private ownership in the DH network Latvia – Latvenergo owns the CHP plants, Rigas Siltums (b) Private company ownership in the DH network Latviathe DH Latvenergo –network andowns HOBs the CHP plants, Rigas Siltums (c) company Selected private minority equity the DH network and HOBs Czech Rep, Plzenská – E.ON has 16% interest in the CHP (c) Selected private minority equity Czech Rep, plant and Plzenská 34% – E.ON has 16% in the distribution interest in the CHP company (d) Majority private ownership plant and 34% in the distribution company Lithuania – NewHeat, engineering and financing support (d) Majority private ownership Lithuania – NewHeat, engineering and Ànancing support company 3 Divestiture – unreserved private ownership company 3 Divestiture – unreserved private ownership Czech Rep – City of Louny Czech Rep – City of Louny Germany – Vattenfall Europe owns DH systems in Berlin Germany and Hamburg – Vattenfall Europe owns DH systems in Berlin and Hamburg Principal Source: DHCAN District Heating Ownership Guide. Principal Source: DHCAN District Heating Ownership Guide. As with the structural issues, it is not possible to generalise about whether privately controlled DH companies are more efficient than public controlled companies. There are examples of very well managed and effective DH utilities both in private and public ownership that have competitive prices, energy efficient operation, and provide good quality services. The successful example of the publicly owned Debrecen was given in Section 4.2.1, while the box below describes the successful experience of the French firm Dalkia’s lease contract in Vilinius. 60 Economic Consulting Associates, May 2011 VILNIUS CASE STUDY The municipal government of the Lithuanian capital Vilnius signed a concession agreement with the French operator Dalkia International in 2002. In compliance with this agreement, Dalkia has made extensive investments in the network and reduced the heat tariff for households by 5%. The company has successfully introduced a management strategy focused on customer satisfaction (although about 75% of its staff are former employees of the old municipal district heating company). Better management, direct contact with clients and modernisation of networks has improved service quality, and the non-payment rate has stabilised at only 1-2%. The disconnections have stopped; moreover, the company now attracts new connections of 2% per year. Source: International Energy Agency (2004): Coming in from the Cold – Improving DH Policy in Transitional Economies, OECD 4.4 International regulation of district heat tariffs 4.4.1 Types of regulation of district heating tariffs In industrialised countries with district heating, regulation of heat tariffs is rare. District heat systems have to compete with heat generated on site by customer-owned equipment. The DH sectors are subject to technical and planning regulation (eg health, safety and environmental standards and related provisions) but are not subject to economic regulation. By contrast, in transition economies regulatory bodies empowered to set heat tariffs are the norm. These can be at the national, regional or municipal levels. In many countries, including Latvia and Romania, municipalities act as the regulator for heat produced from heat-only boilers, while a national regulator regulates heat produced from cogeneration20. In many transitional economies, the mode of heat 20 International experience cited in this section is drawn from Chapter 4 of International Energy Agency (2004): Coming in from the Cold – Improving DH Policy in Transi onal Economies, OECD Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 61 tariff regulation is onerous on the operating companies. The World Energy Council, amongst others, is calling for more flexible and less bureaucratic heat regulation. 4.4.2 Benefits of moving to incentive-based regulation Like many other countries, Moldova’s district heat tariffs are presently regulated on a cost-plus basis. This form of regulation has a number of drawbacks: o there is no incentive to reduce costs, but rather to overspend or overstate costs in order to be awarded a higher tariff and thereby have more financial room to manoeuvre; o in respect of investment, the cost plus approach encourages ‘gold plating’ and over-capacity investments, which make life easy for managers (the risk of not being able to meet demand is reduced) but at a cost which is excessive for customers; o poorly designed cost-plus formulae may deter investment in energy efficiency. For example, it is reported that Polish tariff regulation discourages cost-effective utility investment in demand-side management because it does not include such investments in the list of capital expenses that can be recovered through the rate base. Following the success of incentive-based regulation in electricity, gas, water and other infrastructure sectors, approaches such as price-cap regulation and benchmarking are becoming more widespread in district heating. Amongst transition economies, the Czech Republic, Estonia, Hungary, Lithuania and Poland have all introduced forms of incentive regulation. The price-cap approach, or ‘CPI-X’ where CPI is a measure of inflation, such as the consumer price index, and X is an efficiency factor, lends itself both to providing incentives for greater efficiency and to achieving the objective of greater simplicity and flexibility. Once the price cap has been set, typically for a 4-5 year period, the company is free to operate without constant recourse to the regulator. In Estonia, for instance, index-based price cap formulae for tariff calculation are in place which allow heat tariffs to be adjusted automatically for fuel price fluctuations and other changes in variable costs outside of the control of the companies. These formulae, which have to be approved by the Energy Market Inspectorate or by the local municipality for district heating companies producing less than 50 GWh per year, dispense with long pre-notification periods for setting new prices. 62 Economic Consulting Associates, May 2011 4.5 Conclusions for Chișinău It is very difficult to make comparisons across different district heating systems and draw general conclusions. The circumstances of DH systems in cities and countries of varying sizes and levels of development are quite different. In answer to the question posed in Section 4.1, is there an obvious structural model of a DH system for Chişinău to follow the answer regrettably is that there is no such model. Similarly the question about the role that the private sector is playing in DH systems in the region cannot be answered in a way which provides a definitive recommendation for Chişinău. This does not mean that the analysis of international experience is of no value. Three useful conclusions which emerge from the analysis are as follows: o Physical integration and optimal heat dispatch: Efficient district heating systems are highly integrated and are operated in a manner which facilitates merit order dispatch of heat sources. This is vital to cost minimisation as the bulk of DH system costs are the basic heat costs. Expending a huge effort to make efficiency savings elsewhere in operations and maintenance costs will never make a significant impact on the heat costs for customers. In Termocom’s case, heat costs were 78% of the assessed total costs in 2010, so a 35% reduction in O&M would have been needed if this was to have had the same effect on the customer tariff as a 10% reduction in heat costs. Once there is an integrated system which can in principle purchase heat on a merit order basis, the next challenge is to ensure that there is a system in place to achieve this. The best example of such a dispatch system is that of Riga, capital of Latvia, described in the box in Section 4.2.2. This system is operated by the network company JSC Rigas Siltums within an unbundled framework (only one quarter of the heat is supplied by the company’s own CHP plants and HOBs), but the dispatch system could be located elsewhere, for example could be combined with the electricity control agency. What has emerged as important is that an optimal dispatch system should be considered for Chişinău independently of whether there is an institutional restructuring or not (the institutional restructuring options are discussed in Section 6 below). The first step would be for ANRE to specify rules for the dispatch of heat, as has been done y regulators in other countries. The next step would be to establish the dispatch system necessary to ensure that the rules are adhered to and least cost heat procurement is achieved. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 63 o Strong and effective governance: The central element in the successful case studies, whether publicly or privately owned and/or operated, is strong and effective governance. The ownership structure is less important than the structure of accountability and the incentives to perform. Such structures attract competent utility managers, and the systems then begin to deliver benefits to the customers, which is the ultimate objective. In Chişinău, it is recommended that pursuing the private sector should be regarded as having more to do with accessing new sources of investment capital than with concerns about management. Bringing in a private sector investor provides an opportunity for the public sector to reduce its exposure, because in a well structured transaction the private investors will be required to take on a share in the risks commensurate with the expected benefits which are expected to accrue. o Regulation of district heating: where heat tariff regulation is still considered necessary, international best practice is some form of flexible incentive-based regulation, such as a multi-year price cap. In due course, ANRE should move away from cost plus regulation, which has a number of inherent weaknesses, adopting instead incentive-based regulation. 64 Economic Consulting Associates, May 2011 5 66 Economic Consulting Associates, May 2011 Affordable and sustainable district heating in Chişinău 5.1 Summary of technical, financial and governance issues Before identifying and analysing the debt resolution and restructuring options, it is worth reiterating the salient points about the technical, financial and governance situation of the district heating system of Chişinău: o The district heat network of the city is antiquated, heat losses are high and the system is not integrated, which means that there are physical constraints on dispatching heat on the basis of minimising costs. o The huge level of debt that has burdened the sector for more than a decade is the result of the Municipality systematically suppressing heat tariffs over an extended period. o As a result, Termocom’s net assets are very substantially negative. Resolution of the long-term debts and measures to ensure financial sustainability going forward (including ensuring that the Municipality heat subsidy scheme is adequately funded) are essential. o The heat tariff methodology needs to be augmented to properly incorporate all of Termocom’s material cost elements, notably making provision for trade receivables, bad debts and creditor committee long-term debt repayments. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 67 o The transfer of tariff-setting responsibility to ANRE and the resulting sharp increase in tariffs has put Termocom on a much firmer footing going forward, but resolution of the long term debt issue is still critically important. o Heat tariffs are already high in relation to household income or expenditure, and are projected to be even higher without a radical transformation of the cost base. Both affordability and revenue collectability are major concerns, and remain threats to Termocom’s financial sustainability. 5.2 Progressive improvements The objective of Section 5 of the report is to identify measures for Termocom which will, together and over time, result in an affordable and sustainable district heat system for the capital city. The main elements analysed below are as follows: o Debt restructuring o Network upgrading and demand side management o Network integration and heat dispatch system o Heat procurement We consider how institutional restructuring can best support these objectives in Section 6. The argument will be made that debt restructuring, a major investment programme and the installation of a heat dispatch system are essential, whatever institutional restructuring option is chosen. The outcomes and possible impacts of the institutional restructuring options have many different dimensions and therefore need significant elaboration and analysis before a decision can be made on which option to choose. Having analysed debt restructuring, investment requirements and an optimal heat dispatch system in Sections 5.3 to 5.5, the financial model is used to generate a scenario of future development of the DH system, the financial results being presented in Section 5.7. This is treated as the base case when considering the restructuring options in Section 6. 68 Economic Consulting Associates, May 2011 5.3 Debt restructuring The objective of this section is to document the extent of the inter-company debts and discuss strategies for resolution of these debts. Removing the main legacy debt would still leave Termocom with some debts to other parties, and the requirements for settling these debts are also analysed. 5.3.1 Introduction The following table summarises the long term debt balances in the three companies. Table 19 Long term debts Long term debts Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m MoU parties: Internal balances (1,770.1) 1,336.5 433.6 0.0 External balances (227.4) (1,249.0) (372.0) (1,848.4) Other Creditors' Committee parties (317.1) 0.0 0.0 (317.1) Total (2,314.6) 87.5 61.6 (2,165.5) Were external creditors to agree to set-off balances as part of a debt restructuring and resolution scheme, CET-2 and CET-1 would have no net long term liabilities. The company with net liabilities, Termocom, is the company where failed stewardship originally caused the problem. Two key external creditors, related companies, Moldovagaz and Chişinău-Gaz are parties to a memorandum of understanding (MoU) with the three companies and the Department of the Economy of the Government of Moldova, relating to the resolution of outstanding debt. The existence of the MoU means that the other parties with long term debt form a separate class of creditors. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 69 5.3.2 Sources of funding for debt resolution Sections 3.2.1 and 3.2.2 above discussed the balance sheets of the three companies. After taking account asset impairments, the discussion concludes that none of the three companies has a substantial asset base under current regulatory arrangements. The scope for regulatory change to increase the asset base would naturally be limited by customer affordability issues. As we describe in Section 3.2, financial modelling confirms that there is not enough financial headroom under the regulator’s current tariff setting methodology to provide financial sustainability for Termocom. We concluded in that section that adjustments will need to be made to the tariff setting methodology to remedy issues relating to bad and doubtful debts and the funding of increasing working capital balances. We are not aware of any non-essential assets owned by any of the companies that could have substantial value. We can conclude that repayment of any significant amount of long term debt from internal resources would require further adjustments to the tariff methodology for any or all of the companies (to permit special funding of repayments by heat or electricity customers). This insight leads to a clear analysis of the possible sources for funding the resolution of debt: o Funded by tariff increases for heat customers o Funded by tariff increases for electricity customers o Avoidance of debt (i.e. funded by creditors themselves) o Funded by the introduction of assets from outside the district heating sector (i.e. new equity or subsidy injected in to the sector) It is helpful to separate the question of who funds the resolution of debt issues from the mechanics of resolution. If, for example, it is decided that resolution should be funded by tariff increases for heat customers, there would be further options for the mechanics of resolution. An increase in tariffs would increase the business cash flows, which might permit either repayment of debt or the conversion of debt into valuable equity underpinned by those increased cash flows. The essential feature of 70 Economic Consulting Associates, May 2011 both options for the purpose of our report is that, in this example, resolution would be funded by heat customers. We consider these options separately in the following sections. We identify the scale of the debt problem and explain that resolving the debt issue internally, within the DH sector, would require substantial tariff increases for heat customers that would aggravate already critical affordability issues. We consider and reject the option of CETs raising electricity tariffs instead. We explain our conclusion that effective resolution of the debt issue can only be achieved through subsidy or other injection of value into the sector by the Government. We outline the possible mechanisms for achieving this outcome. 5.3.3 MoU parties: current position Recognising that the company’s financial position had been broadly stabilised by the setting of new tariff levels in 2010, a Memorandum of Understanding (MoU) was signed in June 2010 between the principal parties involved (the Ministry of Economy, Termocom, CET-1, CET-2, Moldovagaz and Chişinău-Gaz). We have seen but have not retained an original copy of the MoU, and understand that all parties evidenced their agreement thereon. Among other things, the MoU identified the components of payables as of 10 May 2010 that would be treated as current, provided for a process of payments to ensure that current arrears are paid for on an ongoing basis and provided for the unfreezing of bank accounts. The Memorandum of Understanding also noted that the parties agreed on the need to continue joint efforts to determine the mechanisms for paying historic debt. Due to relatively minor classification inconsistencies in the responses we received from Termocom, CET-1 and CET-2 to our information requests, we are not able to make a definitive assessment of the level of historic debt, the debt not treated as current for the purposes of the MoU. However, the following table outlines an estimate based on the 2009 accounts for the respective companies after deducting the current account levels identified in the MoU. The figures should be broadly correct. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 71 Table 20 Estimate of long-term debt levels – MoU parties Long term debts - MoU parties Termocom CET-2 CET-1 Combined MDL m MDL m MDL m MDL m MoU parties: Termocom:CET-2 (1,336.5) 1,336.5 0.0 0.0 Termocom:CET-1 (433.6) 0.0 433.6 0.0 Termocom:Chiü ă u-Gaz şinĆ (44.7) 0.0 0.0 (44.7) Termocom:Moldovagaz (182.8) 0.0 0.0 (182.8) CET-2:Chiü ă u-Gaz şinĆ 0.0 (66.4) 0.0 (66.4) CET-2:Moldovagaz 0.0 (1,182.6) 0.0 (1,182.6) üină CET-1:Chiş Ć u-Gaz 0.0 0.0 (3.0) (3.0) CET-1:Moldovagaz 0.0 0.0 (369.0) (369.0) Total (1,997.5) 87.5 61.6 (1,848.4) It can be seen from this that the net amounts payable are broadly directly or indirectly payable by Termocom to Moldovagaz. The net balances in the accounts of the other parties are relatively small. 5.3.4 MoU parties: consideration of debt resolution options We have considered the options in principle available for the resolution of outstanding debt, outlined in Section 5.3.4, against criteria relating to o the effectiveness of the resolution, including the affordability of resulting tariffs o the impacts on different interest groups o the impacts on the independence and credibility of the regulator and the regulatory regime o the impacts on credit worthiness of relevant bodies. The options and criteria are set out in Table 21 below, and have been informed in part by analysis set out in Sections 3.3.9 and 3.3.10. 72 Economic Consulting Associates, May 2011 Table 21 MoU parties – long term debt resolution options Option Impact on tariffs Effectiveness of Impact on different Impact on Impact on credit debt resolution interest groups credibility/ worthiness independence of regulator Repayment of Repayment over Tariffs would rise Today’s customers Changes in tariff Concerns over debt, funded by 15 years under a to such high levels of Termocom methodology could affordability and tariff increases 15 year annuity at that affordability would be paying be seen as precedent sustainability for heat realistic interest threshold would for the failed for future changes to of subsidy customers rates would require be breached for stewardship in the meet public policy arrangements increases in heat the majority of the Àtted and other objectives past, that benefi could damage tariffs of about population. This yesterday’s unrelated to the Termocom’s credit 11%. The impact approach may only customers. sector. Perceived worthiness. on tariffs could be be sustainable with Taxpayers may have independence of the reduced by longer extensive public to fund additional regulator liable to be term repayment and subsidy. public subsidy. undermined. reduced interest rates, implying some economic loss to creditors. Repayment of Repayment over Affordability issues Electricity Perceived Concerns over debt funded by 15 years under a may still arise. consumers would independence of the affordability, tariff increases 15 year annuity at Creditors may effectively be paying regulator liable to be sustainability for electricity realistic interest consider there is an additional tax. undermined. of any subsidy customers rates would require less security in a arrangements and increases in CET repayment scheme economic life of electricity tariffs that is dependent the business could by about 20% and on the longer term damage CETs’ credit result in an increase sustainability worthiness. in costs of electricity of relatively entering the uneconomic distribution system cogeneration plants of about 7% across that could be closed the country. down and replaced in the medium term. Avoidance of first Nil in the À Creditors may Creditors would first Nil in the À Could be widely debt instance. consider it suffer. Any major instance. seen as a sign appropriate to responses liable to of political risk respond with legal, have detrimental for investors in economic or political impact on interests Moldova, damaging means to protect of affected parties. credit worthiness their economic across the state- interests. owned sector. Repayment of Nil. This would be Any transferred Credibility could No negative impact. debt funded by an elegant and assets deemed be at risk if a Clear resolution of issue of new permanent solution valuable by an regulator is seen debt issue would equity, with economic regulator to be attributing restore credit consideration would have an unjustiÀfied value to worthiness. paid in the impact on users of transferred assets. form of cash those assets. The or valuable, Government’s transferable broader policy assets objectives would inform how it should best share the cost across the economy. Our analysis of the tariff impacts for Termocom in 3.3.9 identifies that the impact of funding debt resolution through tariff increases to heat customers could be of the order of 10%, assuming real interest rates at a relatively low commercial rate of 4% (nominal Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 73 interest rates would be higher by the rate of inflation). Lower impacts may be possible with lower interest rates, but this would imply a loss of economic value to creditors. This analysis combined with our analysis of affordability thresholds in Section 1.3.1 indicates that there could be severe limits to the effectiveness of this resolution approach without recourse to significant government subsidy to alleviate the pressure on households. Similar issues may also apply to the option of funding through electricity customers, although this would spread the burden across a broader customer base. In some respects, this option has the characteristics of an additional tax, but with added complexities arising from the uncertain status of the CETs as relatively uneconomic and replaceable in the medium term. The basis for charging electricity customers would be the generation of electricity, and there is no inherent guarantee that the CETs or any company owning the CETs (including potentially Termocom) will continue to generate electricity for the likely duration of a repayment scheme. The option to avoid debt altogether may be considered unacceptable. We conclude that the affordability constraints in the sector mean that effective resolution of the debt issue can only be achieved through subsidy or other injection of value into the sector. The only party that may both be able to and interested to support such an injection is the government. 5.3.5 MoU parties: value injection by the government In this section we consider the option of injecting value into the sector by the government. The last section indicated this may be the only tenable way of resolving the issue. In principle, the government may have a choice of lending Termocom the resources to permit repayment, providing a subsidy which would represent gifting resources to Termocom or subscribing to new equity capital for valuable consideration. Although these are separate options, they all achieve the same overall result and we believe it is appropriate to interpret them all as, effectively, an injection of equity capital21. The valuable consideration could take the form of financial resources, cash, or other valuable assets that the creditors would be content to have transferred to them in lieu of cash repayments. As the principal creditors are gas companies, in particular Moldovagaz, gas-related assets may be an attractive vehicle for such a debt resolution scheme. Such a scheme, if involving gas assets, would naturally involve: 21 A loan would have little prospect of being repaid (like equity) and a gift would have the same effect of increasing the value of net equity. 74 Economic Consulting Associates, May 2011 o the transfer of gas network assets not already owned by Moldovagaz as the main gas network owner, that are owned instead by state-owned bodies, to Moldovagaz as payment for historic arrears, o a recognition by ANRE of the value of the transferred assets in the regulatory asset base for the gas network of Moldovagaz, on which ANRE allows an annual rate of return in its regulated gas distribution tariff calculation, and o subject to Moldovagaz having reasonable assurance that the proposed regulatory treatment of transferred assets will endure for a suitable minimum period, acceptance by Moldovagaz that its claims against the three companies are satisfied by the transfer. We note, however, that the scale of the problem is large in relation to the value of gas distribution assets currently remunerated through gas tariffs. Annex 5 of ANRE’s 2010 tariff calculations for gas distribution identifies the total value of net new assets at MDL 410,731,200, on which ANRE computes a return of 13.5%. The resolution of Termocom’s debts in this way could, if valued at par, add nearly MDL 2 billion to this value and about MDL 250 million to the annual costs of gas consumers. This would represent an addition of some 6% to total gas costs. As previously analysed, the accumulation of debt is to be attributed to failings in the governance of Termocom. Although past consumers of heating services benefitted from artificially low tariffs, we accept it is not necessarily helpful or appropriate to focus the additional costs on future consumers of heating services. The policy question arises whether it is appropriate instead to focus the additional costs on consumers of gas. This raises a wider question of economic distortions arising from an artificial cost increase affecting choices by consumers between different sources of energy. For example, if gas is made artificially more expensive, it could make electricity generation (or cogeneration) appear artificially uncompetitive. There may some value in allocating the additional costs as widely as practical across the economy to minimise distortions and unintended consequences. Alternatively, it may be appropriate to consider the issue in the context of broader energy sector strategy and determine a way of allocating the additional costs that best advances the government’s economic and public policy objectives. Our assessment is that any mechanisms for dealing with current arrears and the historic debt, if they can be put into effect, would remove a major obstacle to the development of strategy for the district heating and wider energy sector in Moldova. Whether repayments are funded by cash or assets, they will be funded ultimately by heat customers, electricity customers, gas customers or by the general tax payer. The issue becomes an issue of wider public policy consequence, while non-resolution is not an option. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 75 For the purposes of modelling, we have assumed a mechanism would be effected by a multi-partite agreement that provides for the following steps: o Amounts payable to Moldovagaz (and Chişinău-Gaz) by CET-2 and CET-1 will be offset against amounts receivable from Termocom, so that all long term liabilities reside in Termocom o The government subscribes to an issue of new equity by Termocom, with consideration in the form of cash or transferable rights to income from designated assets (effectively diluting or cancelling current ownership by the Municipality) o Termocom transfers cash or those rights to Moldovagaz as consideration for its long-term liabilities o The Government transfers associated legal titles to any land and other property to Moldovagaz for nominal consideration. 5.3.6 Other Creditors’ Committee liabilities The analysis below identifies the parties and amounts involved in creditor committee liabilities outside of the MoU parties. Table 22 Termocom: Other Creditors’ Committee liabilities MDL million State-owned companies Apa Canal 19.3 MoldtransElectro 181.2 Moldova Trans Gaz SA 6.8 Total state-owned companies 207.3 Other companies ElectroSeti 45.1 Moldindcon-Bank SA 11.3 ClopotVest 8.1 Others 45.1 Total other companies 109.8 Total 317.1 76 Economic Consulting Associates, May 2011 Other Creditors’ Committee liabilities are rather smaller in scale than the MoU party liabilities and it is easier to envisage a repayment scheme being funded through increases in heat tariffs. Our financial analysis, described in 3.3.8 , indicates that the scale of impact on heat tariffs would be approximately 2%. Although this is a relatively small impact in percentage terms, the tightness of Termocom’s financial position means that, other things being equal, there would not be enough financial headroom to support repayments without some form of regulatory recognition of the repayments in the tariff base. Funding these repayments through tariffs may also have an impact on the cost of subsidy for poorer households. 5.4 Network upgrading and demand side management Investments are an essential component of putting the district heating system onto an affordable and sustainable basis. In this section we consider both investments in network upgrading and demand side management, which over the next decade will reduce costs and hence tariffs to some degree, and the more pressing need for investment in a new CHP plant, which would make possible a step reduction in heat costs of a much larger magnitude than the progressive efficiency improvement investments. 5.4.1 Heat sources - existing cogeneration plants Unfortunately, in the case of Chişinău, the high costs of the antiquated CHP plants, coupled with a low import price of electricity, imply that the country would actually be better off if CET-1 and CET-2 were to be shut down. In such circumstances, the heat which would have been derived from the CHPs would have to be produced from HOBs and the electricity imported. The present cost structure and the implications of closing down the CHPs are presented in the next two tables. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 77 Table 23 Costs of heat and electricity Source Heat generation cost Electricity cost MDL/ Electricity cost US c/ MDL/Gcal kWh kWh Termocom HOBs 543.2 CET-1 CHP plant 487.8 143.3 11.46 CET-2 CHP plant 403.8 104.5 8.36 Import price - border 68.3 5.47 Import plus 79.4 6.35 transmission Source: ANRE’s May 2010 tariff review, using an exchange rate of 12.5 MDL/$ Table 24 Implications in 2010 of closing CET-1 and CET-2 2010 Closure of Closure of Effect of closing both CETs situation CET-1 both CETs Energy consumers (MDL million) Heat 829 843 1,005 Additional cost to heat purchased consumers of MDL 176 million from ($14.1 million) Termocom Electricity 2,889 2,804 2,579 Savings to electricity purchased by consumers of MDL 310 million distribution ($24.8 million) companies Net position Net savings of MDL 134 million ($10.7 million) Balance of payments Gas imports 428 million 391 million 251 million Reduced imports of 177 m cu (related to cu m cu m cu m m, saving MDL 550 million Chiü ău DH) şinĆ ($44.0 million) Electricity 3,041 GWh 3,154 GWh 3,776 GWh Additional 736 GWh of imports imports at a cost of MDL 502 (national) million ($40.2 million) Net position Net savings of MDL 47 million ($3.8 million) Source: Derived from ANRE’s 2010 tariff review figures. The tables above show the costs of heat and electricity as determined, in the case of the CHP plants, by ANRE’s chosen method of allocating costs between the two 78 Economic Consulting Associates, May 2011 products22. Salient points arising from the tables and related analysis are as follows: o CET-1 produces electricity that is 80% more expensive than the import parity price for electricity, while its heat cost is only 10% less than heat from Termocom’s HOBs. o The corresponding figures for CET-2 are electricity that is 32% more expensive than import parity and heat that is 26% cheaper than heat from Termocom’s HOBs. o The disparities are so large that closure of CET-1 and CET-2, involving all heat being generated in HOBs and all electricity being imported, would provide net benefits to energy consumers of MDL 134 million ($10.7 million). Over half of these benefits would arise from closure of the much smaller but more thermally inefficient CET-1 plant. o Closure of the CETs would affect different interest groups differentially. The benefits of closing down the CETs would accrue to electricity consumers, who are presently required by law to purchase any electricity produced by CHP plants, irrespective of the cost. At the same time, closure of the CETs would entail Termocom’s customers having to pay higher tariffs for heat. The impact on heat consumers would be substantial, increasing tariffs by more than 20%. Another obvious group which would be adversely affected by closure of the CHP plants would be the employees of the two CETs. o There would be a net balance of payment benefit of MDL 47 million ($3.8 million). This arises from the fact that the gas requirements of the CHP plants is larger than the gas needed for producing the same amount of heat via HOBs, while the electricity produced by the CHPs can be replaced by low cost imports. o Without closing the CETs, electricity consumers could cease subsidising heat consumers in Chişinău if CETs were to sell the electricity they produce at an import parity price to the electricity distribution companies. If the costs of doing this are passed on to Termocom’s heat customers, heat tariffs would have to rise by 28%. Such an increase needs to be seen in relation to the fact that heat tariffs are already unaffordable for many residents of the capital city23. It must be emphasized that the tables and analysis above are based on 2010 figures. With the higher gas prices prevailing in 2011, and possibly a continuation of the 22 This is described in Section 2.3 below. 23 Affordability is analysed in more detail in Section 1.3.1 below. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 79 low electricity import price (contract expires in April 2011), the effects will likely be magnified. Higher negative impacts for heat consumers are expected, set against much larger savings from reduced gas imports. 5.4.2 Closure of CET-1 and review of CET-2 The implications of the above analysis of the state of the infrastructure are as follows: o CET-1 has an unacceptably low thermal efficiency (61%). Operating the plant imposes very high costs on both heat and electricity consumers. Consideration should be given to its being closed down as soon as possible. o CET-2 has higher thermal efficiency (71%) but still has very high costs, in part because it is operated as an electricity generator at a very low load factor (30% was planned for 2010). It does not make economic sense, however to operate the CET-2 at a higher load factor as long as imported electricity can be procured at a low price. o As is argued in the next section, the medium term solution has to involve the building of a modern CHP plant. Until a new plant is shown to be feasible, the project is financed and the new plant is commissioned, it would be prudent to retain the CET-2 plant, in part because without it there would be little or no spare heat generation capacity from the HOBs alone. Closure of CET-2 would also significantly reduce national electricity generation capacity, which would be critical if there were ever curtailment of imports of electricity. However, with the present structure of gas and electricity import prices, usage of CET-2 needs to be carefully justified to balance the interests of heat consumers in Chişinău and electricity consumers throughout Moldova. 5.4.3 Imperative for a new cogeneration plant – CET-3 The affordability analysis in Section 1.3.1 shows that in 2010 all the income quintiles were breaching the commonly accepted affordability threshold, which is that heat expenditures should not be more than 10% of income. The lowest quintile was on average spending 26% of their income on heat. 80 Economic Consulting Associates, May 2011 Even more alarming than these 2010 figures is the certainty that heat tariffs are going to have to rise even further. As shown in the ‘tariff waterfall’ diagram (Figure 2), even with the legacy debt being removed when higher border gas prices and the required corrections and additions to the tariff formula (for profits, priority investments, bad debts, working capital funding, creditor committee payments) are figured in, the real heat tariff will have to rise by approximately 38% (to around MDL 1,000/Gcal in 2010 prices). Such a significant increase on top of tariffs which already push all income quintiles above the affordability threshold will create an untenable situation. Urgent and concerted efforts are needed now to pre-empt heat in Chişinău becoming even more of a crisis than it is today. Termocom’s priority investment programme and the commitment to reducing operating costs will help, but the realistic assumptions we have made in the model are that heat loss reduction and lower operating costs will reduce tariffs over a 10 year period by about 8%. These assumptions may be too cautious, but even if performance in these two areas is twice as good as this, heat tariffs in 2020 would still be roughly 22% above 2010 levels in real terms. The only way to make a significant impact on heat tariffs – and to do so in a time frame that is less than a decade – is to directly address the dominant element of Termocom’s costs which is the cost of procurement of heat. As recorded in Section 3.3.13, on the basis of more detailed analysis in Annex A3, it is reasonable to assume that a new, modern CHP plant would make it possible to reduce bulk heat costs by 22%. This is again conservative assumption that is being made at this stage – more detailed analysis during the feasibility studies for the new plant may well show that a bigger reduction is possible. With a 22% reduction which might become available is say 2017, and the continued improvements in operational efficiency and heat losses, by 2020 the real heat tariff should be back down below the 2010 level. By 2020, income levels should have risen, so the affordability constricts should cease to be binding for the upper income quintiles, but will still be a major issue for the lower quintiles. If no CET-3 plant is built, the picture going forward is very gloomy. It must be emphasized that even with the new plant in place, the cost of heat will still be high in 2020, so a modern CET-3 is no panacea. All other strategies to reduce heat costs need simultaneously to be pursued. In addition, resources will have to be found to properly fund the subsidy scheme in Chişinău until CET-3 becomes available. Without this, collectability of revenues is bound to become a major issue threatening the financial viability of Termocom and re-starting the process of debt accumulation. The discussion so far in this section has been focussed on the lower cost heat that would be available from a modern co-generation plant, but equally important, if Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 81 not more so, in making the investment decision would be the electricity aspects. For analysis purposes, we have assumed that the new plant would be a combined cycle gas turbine (CCGT) co-generation plant which would have a thermal efficiency of the order of 88% and dual fuel capabilities to cater for any curtailment in gas supplies. The justification, sizing, and choice of technology would need to be made in relation to a number of factors, including expected import prices for gas and electricity. CCGT plants operate most efficiently as baseload generators, and if CCGT is the technology chosen for CET-3, the implication would be a much higher level of electricity generation through the year than is presently obtained from the existing CHPs. 5.4.4 Small CHP plants The study mentioned in Section 1.2 on Modernization Solutions for the centralised supply of thermal energy in the Municipality of Chişinău recommends investment in small CHP plants (up to 6 MW), using internal combustion gas-fired engines. In the South Western area, a larger cogeneration power plant (from 6-12 MW) is recommended with additional modules being added in response to increasing thermal loads. The report does, however, make clear that the economic and financial efficiency of each of the small cogeneration projects needs to be examined in more detail, with feasibility studies taking account of a number of factors such as the thermal and electrical load fed area, electricity and heat tariffs and fuel usage. The deployment of small, local CHP plants is favoured in the Modernisation report (eg in Section 2.3.3) without a robust analysis being given of the role and rehabilitation requirements of the existing CHP plants. If these plants are to remain in the system, then there is more than sufficient capacity available, so there is no a priori justification for investing in local CHPs, except perhaps to avoid the investments required to integrate the system so that all customers can access CHP-produced heat (as discussed in Section 5.5 below). The report also does not look at the impact of heat sector changes in the capital city on electricity consumers in Moldova, other than in Section 3.3.2 where indicative costs of electricity are given. These indicate very clearly the economies of scale which characterise electricity generation with plants of 12 MW providing electrical energy at a cost that is 22% lower than plants of 1 MW. There would be further reductions in indicative costs of electricity and of heat when scaling up to the much large capacity plant envisaged for CET-3. The arguments for small CHPs are compelling when tied to environmental concerns and the objective of making use of the energy content of waste, for example methane from landfill sites. Small, internal combustion-based CHPs would be well suited to 82 Economic Consulting Associates, May 2011 such applications. However, interventions of this kind would best be regarded as a complement to, not a replacement for, the large-scale heat supply investments needed to put the DH system of Chişinău onto an affordable and sustainable basis for the future. 5.4.5 Network upgrading and demand side management Customers in old buildings, with vertical pipes, have little control over their cost of heat. The cost to an individual household will depend on the quality of the building, in particular the quality of insulation, the way that heat is managed at the building level and on the behaviour of other households in the building, for example the extent to which they open windows to regulate room temperatures. The energy delivery and efficiency situation amongst Termocom’s customers in Chişinău at the present time is most unsatisfactory, with nearly all apartment blocks having vertical pipes and the great majority being very poorly insulated. Experience from World Bank supported projects in Lithuania, Poland and Bulgaria indicates that energy savings of between 20% and 40% can be made at the level of final consumers at relatively low cost24. A comprehensive demand-side energy efficiency strategy was developed by the World Bank in 2009, the overall estimated costs for internal and building envelope interventions across the city being estimated to be around $880 million. This is equivalent to unit costs of $51 (internal) and $34 (external) per m2. The total of $880 million is very large: experience in other countries suggests that a 10 year market penetration target of 25% would be reasonable, implying annual investments of around $22 million, covering about 70 blocks per annum. This would be a good area for support by international development partners. When the implications of a progressive reduction in heat requirements, finally reducing supply costs by 20% to 40%, are factored in, the economic payback of these energy efficiency investments are likely to be high, as are the social benefits to customers benefiting from modern, customer-regulated heating at lower costs than they are accustomed to paying. Donor pilot projects in this area at the present time would be very valuable, because government is in no position to finance such investments, as the immediate priority for recurrent public resources which can be found for the heat sector must be to bolster the subsidy scheme for an ever-increasing number of households needing support as heat tariffs continue to rise in real terms over the next 24 Material in this paragraph is based on the study that was carried out as an input to the World Bank’s 2009 Policy Note: Ac on Plan for the Financial Stabiliza on of the District Hea ng Sector in Chişinău. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 83 few years (see Section 5.7). Few households would be in a position to make these investments, as they are large in relation to incomes (even just the internal amounts would require $3,000 for an average 1 bedroom apartment). Another important efficiency intervention is the heat exchanger project which is supported by SIDA. This technology allows for a reduction in the number of pipes supplying each building, because there is no longer a need for a separate hot water delivery system, with resulting significant costs savings in maintenance, heat losses and network expansion costs. Modern heat exchangers are used for any new buildings which Termocom is connecting to its network. Since 2008, three newly constructed residential buildings have been connected and Termocom is about to connect a fourth block: o Maria Dragan, 38/2 - connected October 2008 o Milescu Spataru, 21/5 - connected December 2009 o Mitcea cel Bătrîn, 42 - connected December 2010 o Mihai Viteazul, 10 - expected to be connected September 2011 According to Termocom, the pilot Maria Drăgan project has shown that the efficiency savings could be as high as 40-50% of the heat which would normally be supplied to a comparable building. From the heat exchanger, the heat delivery arrangement inside each building is horizontal, allowing customers to have full control over their heating and to have individual direct accounts with Termocom. A further 14 such projects are currently being developed. 5.5 Network integration and heat dispatch system In order to integrate the network so that it could all be supplied from CET-2, Termocom has supplied the list of the necessary investments in pipes and pumping stations which is given in Annex A4. The costs of these investments need to be estimated and a cost-benefit analysis carried out to demonstrate their viability. This will revolve around reducing the costs of heat by optimal dispatch, and are linked to the further investments costs required to establish a real time dispatch system based on merit order principles, based on an appropriately simplified version of the Riga dispatch system. 84 Economic Consulting Associates, May 2011 Termocom will not be starting from scratch in setting up an optimal heat dispatch system. Termocom is already developing a computer information system called HeatGraph, which will allows networks and equipment to record their thermal characteristics, including mode of operation. An integrated management information system (SIIM) is also being established to facilitate the achievement of a number of strategic and operational planning and control objectives. 5.6 Heat procurement As we highlight in Section 3.3.13 and explore in Annex A3, the largest component of cost in Termocom’s business, and potentially the scope to have the biggest impact on tariff levels, is the cost of purchased heat. As Termocom’s relationship with its customers is normalised with tariffs being set at cost recovery levels, and recognising the affordability limits for those customers (Section 1.3.1), it should have a natural interest in procuring heat on the most cost effective terms. Accordingly, we envisage Termocom playing a central role in the development of the cogeneration sector, as its primary customer and as the counterparty to any heat purchase agreements supporting new investments in cogeneration. In Section 3.3.13 and elsewhere in this report, we have characterised a reformed cogeneration sector as a new ‘CET-3’, although we reiterated that further study is required to consider the complex engineering and energy market issues that we refer to in Annex A3. 5.7 Financial projections At this point, we present financial projections consistent with the measures outlined in the previous three sections – resolution of the legacy debt, investment in a new CHP plant, demand side management, network upgrading and integration and the installation of an optimal control system. The specific assumptions about the timing of major events are as follows: o 2012: a restructuring of debt occurs along the lines of the proposal discussed in Section 5.3.5. The mechanism is the injection of government equity into Termocom, with a transfer in ownership of Termocom from the Municipality to Government. The injection is assumed to be in the form of assets, which are in effect transferred to the ultimate creditor Modovagaz. The legacy debt is thereby removed from the books of Termocom, CET-1 Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 85 and CET-2. As discussed in Section 5.3.6, Termocom is left with the non- MoU related creditor committee debts. o 2014: Closure of CET-1. o 2017: the introduction of a heat purchase agreement with a new CET-3, which replaces CET-2. This allows a significant reduction in heat supply costs to take place from 2017, amplified by the integration of the network allowing for least cost dispatch. For modelling purposes, we are assuming that the investment in CET-3 takes place outside of Termocom or the CETs, for example a private investment in the form of an independent power producer (IPP). Other assumptions are the progressive introduction of the cost elements discussed in Section 3.3 into the tariff, notably a higher profit allowance, provision for bad debt costs, working capital funding of receivables and non-MoU debt repayments. Reductions in costs and hence tariffs are also assumed to occur as progressive reductions in heat losses and improvements in operational efficiency occur. The resulting trajectory of heat tariffs is illustrated in Figure 3. Figure 3 Tariff trajectory Real, 2010 price terms 1,200 1,000 Debt repayment Real terms heat price, MDL/Gcal W. cap. funding 800 Bad debt costs ANRE profit all. 600 CET heat HOB heat 400 Water, elec. etc. Depreciation 200 Other opex Staff costs 0 2010 2015 2020 2025 2030 86 Economic Consulting Associates, May 2011 The corresponding profit and loss, balance sheet and cash flow tables for Termocom, CET1 and CET-2 are given in Annex A5. The following chart shows the projection of two key financial indicators relevant to financial sustainability for the three companies. The first indicator (blue lines, left hand axis) is a balance sheet indicator, a gearing ratio of the value of commercial debt to the value of ‘core assets’ that exclude fixed assets not remunerated by ANRE’s tariff methodology. The second indicator is a financial performance indicator, the ‘funds from operations’ (FFO) interest cover ratio25. These indicators are commonly referred to by regulators in determining price caps, for example for the privatised regulated sectors in the UK. Figure 4 Projected financial indicators 100% 5.0 90% 4.5 80% 4.0 CET-2 70% 3.5 Gearing/Core Assets FFO interest cover 60% 3.0 50% 2.5 Termocom 40% 2.0 30% 1.5 20% 1.0 CET-2 10% 0.5 CET-1 0% 0.0 2010 2015 2020 2025 2030 Our high level commentary on the main features of these two charts follows: o We assume a satisfactory resolution of the long-term debts with MoU parties from resources outside the Chişinău district heating sector. The alternative scenario would require a level of tariff increase, illustrated in Figure 2 and described in Section 3.3.9. 25 The construction of FFO is, in the circumstances we are assuming for Termocom, which include a continuation of Moldova’s zero rate of tax on corporate profits, the same as for EBITDA. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 87 o The relative steady state assumptions for the investment programmes for CET-2 and CET-1, and their ability to recover costs through ANRE’s tariff methodology, mean that they do not build up substantial levels of commercial debt prior to the dates we assume for their closure (see Section 3.2.3). Interest cover ratios for CET-1 are too high to be shown on the chart. o CET-2 is however projected to show a spike of funding requirement following an assumed closure of CET-1 in 2014 and an assumed expansion of CET-2 output to compensate. This arises from our assumption that CET- 2 will continue to pay trade payables (creditors) over a rather shorter time scale than it receives payment from its debtors (as shown in Table 15). The impact of closing CET-1 can be seen in a small reduction in the heat tariff in 2014. o The FFO interest cover for Termocom in 2011 is dangerously low, reflecting our assumptions that it will need to fund increasing trade receivables as a consequence of tariff rises, while ANRE’s current tariff methodology does not provide revenue to cover the costs of financing those increases (or the cost of the doubtful debts arising). See Sections 3.3.6 and 3.3.7. This problem is assumed to be remedied in 2012 with changes in tariff methodology, reflected in further increases in tariffs. o The pattern of financial indicators for Termocom from 2012 to 2017 is tight but broadly stable, indicating heat tariffs are set at, or close to, sustainable levels. o In 2017, we assume that Termocom benefits from a long term heat purchase arrangement with an independent CET-3, as described in Section 3.3.13. This allows tariffs to fall, which also reduces the level of trade receivables that Termocom must finance. Thereafter, financial indicators follow a positive trend (increasing cover ratios and reducing gearing ratios). o The kink in 2027 reflects the ending of our assumed repayment period of 15 years for Termocom’s non-MoU Creditors’ Committee liabilities , and of the profit allowance that is necessary to permit Termocom to fund those repayments. See Section 3.3.8. 88 Economic Consulting Associates, May 2011 In considering financial indicators for the purpose of this report, we are concerned less with the level of financial indicators in any one year and more with the longer term direction. We have calibrated our assumptions about the changes to the tariff methodology that would be needed to underpin financial sustainability so that they lead to a positive longer term trend. To maintain a positive longer-term trend, tariffs would have to be increased beyond the levels we are assuming if real interest rates on borrowing exceeded 5% (above the rate of inflation – our central assumption is 4%), if the rate of tax on profits exceeded 30% (our central assumption is zero) or if any of our fuel cost, investment costs, heat losses or operating efficiency improvement assumptions turn out to be materially optimistic. Our projected tariffs after 2017 are fundamentally dependent on assumptions about the cost of a heat purchase agreement with a new and as yet unspecified CET-3. We highlight in Appendix A3 the inherent uncertainty in this assumption. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 89 6 90 Economic Consulting Associates, May 2011 Institutional restructuring Following the progressive improvement approach outlined in Section 5.2, we now turn from what improvements need to be made in respect of debt clearance and investment to what institutional restructuring is needed to best support these improvements. Two main options are considered, with each being analysed in separate sections. A summary table, which includes the status quo as a reference option and drawing together the different dimensions analysed, is given in Section 6.3. For completeness, we also consider in the next section the option of liquidating Termocom. Termocom owes its creditors a considerable amount of money and has persistently made losses. It might be argued that it is a creature of the old soviet order and has no place in a modern economy: it provides its customers with poor service, has become a burden on the rest of the country and should simply be terminated. We address this argument directly and conclude that the continued operation of a district heating business is essential. The real challenge is to turn it into a well-functioning business making a positive contribution to Chişinău and the Moldovan economy. Having concluded that the continued operation of a district heating business is essential, we then consider how the transfer of that business to state ownership should be implemented, whether as a business managed on an integrated basis with CET-2 (we concluded in Section 5.4.2 that CET-1 should be closed at the earliest opportunity) or as a separately managed business but subject to reformed governance. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 91 6.1 Liquidation of Termocom It has been proposed that one way to dispose of the problems arising from the persistent and burdensome debts of the district heating system would be to liquidate Termocom. Unless liquidation were simply a legal device to facilitate some other form of restructuring, this would be an extreme scenario. It implies a repudiation of the debt and would have immediate consequences for Termocom’s main creditors, which may force the CETs also into liquidation, thereby also removing domestic electricity generation capacity. Liquidation may be challengeable in the courts, so there is no assurance that the debt overhang problems would be obviated. The ultimate creditor, Moldovagaz, is likely still to seek some form of redress, and, given the size of the debt, this could prove costly for the Moldova economy. We do not speculate about this here, but instead analyse two possible outcomes of liquidation for the DH system of Chişinău. Abandonment of the DH network If liquidation of Termocom were to lead to the abandonment of the district heat network, all buildings currently supplied with heat and hot water by Termocom would be forced to install autonomous gas-fired heating systems. Alternatively, individual households could install their own gas-fired or electric heating. As has been made clear in past studies26, this situation is liable to result in a humanitarian crisis in the city. It would simply not be possible in the short term for all Termocom’s customers to adequately provide for themselves. o Many if not most households are struggling to pay heat bills from Termocom. On a recurrent cost basis, autonomous heat would be considerably more expensive (as discussed in Section 1.3.1), but in the short run the more serious problem would be a lack of savings or access to loans with which to make the necessary capital investments in autonomous heating systems. o The gas network in the city does not have the reserve capacity to accommodate a dramatic increase in autonomous gas-fired heating systems. Investment in modernising and expanding the capacity of the local network would be needed before the autonomous heating systems could be installed. 26 SwedPower and FVB (2001): Strategic Hea ng Op ons for Moldova Final Report, Stockholm and World Bank’s 2009 Policy Note: Ac on Plan for the Financial Stabiliza on of the District Hea ng Sector in Chişinău, Washington DC 92 Economic Consulting Associates, May 2011 Abandonment would thus be likely to impose intolerable burdens on low income households. This is not a politically, economically or socially feasible option and is not examined further. Formation of a new entity to manage the DH network As an alternative to the abandonment of the DH network, the liquidation of Termocom could perhaps create an opportunity for some new entity to take over the physical assets of Termocom and begin managing the DH network on a new basis, unencumbered by the legacy of debt. The new owner could be the Government or CET-2, in which case this option would emerge as being similar to Option 1 or Option 2 described in Section 6.2. Alternatively, the liquidation may provide an opportunity for divestiture, with a private investor becoming the owner of the DH network and Termocom’s HOBs. We do not think this likely in the short-term – we see private sector investor interest as emerging in some years time in connection with the building of CET-3. Conclusion on liquidation Liquidation might be proposed as some sort of deus ex machina for resolving the problems of Termocom. On the contrary, it runs the risk of proving very costly to the Moldovan economy and provoking a humanitarian crisis in the population of the capital city. If these two highly negative outcomes can be avoided and a new operator of the district heating network found, it is just possible that liquidation would provide an opportunity to re-vitalise the DH system freed of debts. If this were to occur, liquidation of Termocom would not constitute a distinct restructuring option, but rather would be a means to reach one of the other substantive options that we analyse subsequently. 6.2 Institutional restructuring As is evident from the discussion of international experience, many different ownership and structural options are possible for the DH system in Chişinău. In this part of the report, we focus on the two basic options – separately managed or jointly managed – and how these impact on the two principal entities in the sector, Termocom and CET-2, with CET-1 being phased out. The options are briefly described here and analysed in the following sub-sections. Summary tables are given in Section 6.3. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 93 We assume that ANRE will continue to be responsible for the regulation of heat and electricity tariffs, at both wholesale and retail levels. We further assume that an orderly resolution of the indebtedness of the sector is carried out, and that the transfer of ownership of Termocom from the Municipality to the Government is part of the debt resolution. We assume that, following such a transfer, Termocom, CET-2 (and CET-1) would all fall under the Ministry of Economy. The two options we consider are as follows: o Option 1: Immediate vertical integration and Government ownership This option envisages the creation of a vertically integrated enterprise in which CET-2, the HOBs and the district heat network all fall under single management. CET-1 would only be included if doing so facilitates its closure. o Option 2: Separate management of Termocom with governance reforms under new ownership to facilitate investment in CET-3 This option envisages keeping Termocom managerially separate from existing CETs and for governance to be focused on turning Termocom into a well- functioning, sustainable and efficient district heating business. Our analysis is independent of whether the Government chooses to own shares in the companies through a holding company or whether it owns them directly. The pertinent question is what boards are held to account for the performance of the companies. If the boards of the companies are held separately accountable, the holding company can be treated as a variant of Option 2. However, if the holding company board is held accountable for the combined performance of the businesses (as subsidiaries or as a single company assets and liabilities of one are transferred to the other27), then the Holding Company is to be treated as a variant of Option 1. A holding company is therefore not carried through as a separate option to be analysed. To draw out the implications of adopting either of the two main options, the following four categories and various sub-categories are analysed: o Governance o Reporting responsibility o Tariff setting o Management focus o Investment planning o Dispatch o Procurement of CET-3 27 We recognise that a transfer of assets and liabilities of Termocom and CET-2, and even CET-1, to a single company would allow receivable and payable amounts of long term debt to be cancelled. This would not affect ultimate creditors, who would still be owed money, and it would in principle make resolution of the debt issue no easier. An alternative, and more logical, debt offset would be achieved if the liabilities to Moldovagaz and Chişinău-Gaz were to be transferred to Termocom by agreement, allowing the CHP companies to offset the substantial part of the long term receivables and payables in their books. 94 Economic Consulting Associates, May 2011 o Procurement process o Attraction to developers of CET-3 o Potential for private sector participation o Short run o Medium to long run o Financial impact o Transactions costs o Synergies and economies of scale o Dispatch and cost of heat o Benefits of improved governance 6.2.1 Option 1: Immediate vertical integration As just mentioned, the outcomes and impacts of the two main options are analysed below in four main categories – governance, procurement of CET-3, private sector participation potential and financial impact. Governance o Reporting responsibility In the vertically integrated option, a single Board reports to Ministry of Economy. o Tariff setting For both options, as we highlight in in Section 2.1.7, transferring ownership of Termocom from the Municipality to the Government should significantly reduce the moral hazard of populist low heat tariffs in Chişinău being passed on ultimately to the nation as a whole. Within the vertically integrated enterprise, the costs of generation would need to be kept separate from the costs of operating the district heating network to support regulation of electricity tariffs. o Management focus There may be some dilution of management focus in a vertically integrated entity due to responsibility being taken on for different kinds of business and different customer bases (electricity as well as heat). During the transition period, management focus on business operations may also be disrupted by the process of integration. There may, however, be benefits in due course from a focus on integrated performance in the sector, overcoming any inefficiently priced or otherwise inadequately incentivised least cost transactions between CET-2 and Termocom, particularly in relation to dispatch. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 95 o Investment planning On the positive side, a major advantage would be integration of investment planning across the DH sector. o Dispatch Rational use of heat sources would be incentivised by the integrated financial performance objectives though, from a national viewpoint, the consequence could be suboptimal if performance measures are not adjusted to take into account the increased burden on electricity consumers of generating expensive electricity from CHPs. Procurement of CET-3 o Procurement process With CHP-2 being part of the vertically integrated enterprise, there could be a danger of managers with an interest in maintaining operations at CET-2 having undue influence in the procurement of CET-3, biasing procurement towards options that secure a continuing role for them. On the other hand, having detailed knowledge of what running a CHP plant involves, would make the vertically integrated company better informed and this may turn out to be a more important benefit in the procurement of CET-3. o Attraction to developers of CET-3 A potential developer of CET-3 will be interested in its relationship with the district heating network operator, currently Termocom. Some developers may see advantages in acquiring Termocom, integrating its business with CET-3 and having the primary relationship with ultimate heat customers. Other developers may instead see advantages in operating a separate CET:3: having a long-term heat purchase contract with possibly state-level guarantees or other mechanisms to help protect investors from regulatory risk in consumer tariffs; an efficient CHP plant may be more focused on electricity generation and may thus see heat generation as more of a by-product rather than its core business; and an investor in new generation plant would not necessarily have core competence in running district heating networks. For these reasons, we consider there is no a priori way of determining whether suitable private investors would be more interested in having a concession over the entire district heat system or in developing CET-3 as an independent power producer project, merely selling heat (via a long-term heat supply contract) to Termocom. Potential for private sector participation o Short run In the short-term, until the issues affecting the financial sustainability of the sector are resolved, private sector equity investment is most unlikely. 96 Economic Consulting Associates, May 2011 Private investors would be interested in seeing not just satisfactory resolution of the long-term debt problems of the sector, but a period of consolidation that demonstrates the commitment of ANRE to setting cost recovery tariffs and of mechanisms to be put in place to overcome affordability difficulties. At the national level, greater stability in the political governance of the sector would be needed in order to attract investment capital. However, some form of management contract that does not involve substantial investment in the short-term (for Termocom and/or CET-2) might be possible. Medium to long run In the medium term, it may be possible to attract private sector interests willing to put in their own capital and use their leverage to borrow to execute large projects. Given the national budget constraints on investment resources, it would be highly advantageous for the sector to be packaged to attract a private investor in CET-3 who may wish to have an option of operating CET-3 on an integrated basis. For such a developer, DH operations that are bundled with an old, relatively inefficient CHP plant may limit the sector’s attraction, but this could be offset for some other investors who seek the ability to control all aspects of the heat chain. This could, however, be achieved by merging CET-3 with Termocom at a later stage without at the same time having to be burdened by having CET-2 as part of the package. Financial impact of integration We have analysed the potential financial impact of integration. We present calculations below based on assumptions made in relation to each of the major factors. o Integration costs The integration of activities will involve significant costs, but these are uncertain at present. Apart from overheads, Termocom and CET-2 have non-similar operations. So the process of integration would be focused on any overhead operations that can be amalgamated and streamlined. We model transactions costs as a proportion of the overhead savings, choosing a range of values (30%, 70% and 120% of overhead savings). o Synergies and economies of scale With different core businesses, the operations of Termocom and CET-s do not have a lot in common, and the scope for synergies and economies Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 97 of scale may be limited to central functions and interactions between the businesses. Again we have taken a range of values for the potential savings (10%, 30% and 50%) of overhead costs. o Dispatch and cost of heat Under either option, we assume that the costs of procuring heat will progressively be reduced as the optimal control dispatch system becomes effective. Integration may, however, provide an additional benefit if, despite dispatch incentives and governance reforms under the alternative option, there is any residual bias for Termocom to use its own HOBs rather than lower cost heat from CHP plants. Ignoring the adverse impacts on electricity consumers, we model this as a reduction in HOB usage (from 23.7% in 2010 to a level as low as 1% of the total heat supplied). The really significant reduction in heat costs comes in when CET-3 becomes available (assumed to be in 2017). o Financial benefits from improved governance Once the reorganisation is complete, which may take some time, the new vertically integrated enterprise would be freed of the burden of the legacy debt, as in Option 2, and will be better able to focus on financial performance and on the technical challenges of reducing losses and lowering the costs of distribution and of heat procurement. We assume the same underlying progressive improvements in operating efficiency and continued investment in heat loss reduction as for Option 2, with these together resulting in an 8% reduction in heat tariffs by 2020. The combined impact of these assumptions is shown in quantitative terms in Table 25. An additional assumption that is needed to generate the numbers relates to the imported electricity price (0%-10%-20% increases), these being relevant when CET-2 under Option 1 produces more heat and therefore also more electricity. The proportion of HOB heat in ANRE’s 2010 calculations was 23.7%. We assume that Option 1 will involve reductions in HOB generation, with the additional heat being supplied by CET-2 without any operating or capacity constraints arising, and a consequential increase in electricity generation. We assume cost elasticities of 0.3 for CET-2 and HOB non-fuel operating costs, and CET-2’s fixed costs and profit allowances remaining the same. The effects on heat tariffs are calculated ion the assumption that 70% of the overhead savings and reorganisation costs will be attributed to Termocom and 30% to the CETs. The savings from the merger and the reorganisation costs are calculated as net present values in real terms over a five year 98 Economic Consulting Associates, May 2011 period (using a real discount rate of 4%). The final results – the impact on Chişinău heat consumers and on the country as whole, this including electricity consumers – are given as a proportion of the heat tariff. Table 25 shows that the highest benefits to the heat customers of Chişinău taken in isolation (heat tariffs going down by 4.1%) are achieved only through having quite extreme assumptions - 50% of overhead costs saved, only 1% of heat from Termocom’s HOBs, reorganisation costs limited to 30% of overhead savings. Table 25 Merger scenario analysis Merger scenarios Low case Mid 1 Mid 2 High case NPV over 5 years Main assumptions Proportion of CET overhead costs saved 10% 30% 30% 50% Real change in imported elec. price from 2010 level 0% 10% 20% 20% Optimised proportion of HOB heat 20% 10% 15% 1% Savings from merger Dispatch benefit to heat customers MDL m 23.6 130.2 76.9 226.2 Dispatch benefit/(cost) to elec. customers MDL m (35.8) (156.1) (67.5) (198.4) Net dispatch benefit/(cost) MDL m (12.3) (25.8) 9.4 27.8 Overhead savings MDL m 12.0 36.0 36.0 60.0 Total benefit/(cost), before reorganisation costs MDL m (0.3) 10.2 45.4 87.8 Reorganisation cost scenarios 1- 30% of overhead savings MDL m (3.6) (10.8) (10.8) (18.0) 2- 70% of overhead savings MDL m (8.4) (25.2) (25.2) (42.0) 3- 120% of overhead savings MDL m (14.4) (43.2) (43.2) (72.1) üină Chiş Ć u heat tariffs benefit Reorganisation cost scenario 1 0.5% 2.5% 1.6% 4.4% Reorganisation cost scenario 2 0.4% 2.3% 1.4% 4.1% Reorganisation cost scenario 3 0.4% 2.1% 1.2% 3.7% Moldova net benefit/(cost) as % of heat tariffs Reorganisation cost scenario 1 (0.1%) (0.0%) 0.6% 1.2% Reorganisation cost scenario 2 (0.1%) (0.3%) 0.3% 0.8% Reorganisation cost scenario 3 (0.2%) (0.6%) 0.0% 0.3% When the impact on electricity consumers is also brought into the calculations, the net benefit for Moldova as a whole is much smaller (equivalent to 1.1% of heat tariffs with again an extreme scenario assumption of the electricity import price going up 20%, which significantly reduces the opportunity cost of buying kWh from the CETs). Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 99 For less extreme assumptions, the benefits for the capital city heat consumers shrink and the net impact for the country as a whole becomes very small or, for many of the scenarios zero or negative. A more representative scenario would be ‘Mid 1’, in which the overhead cost savings are 30%, the optimised proportion of HOB heat is 10% and the real increase in electricity tariffs is 10%. If the reorganisation costs are only 30% of the overhead savings, the net benefit for Chişinău heat consumers would be a tariff reduction of 2.4%, but this would be counterbalanced by additional costs for electricity consumers, resulting in a net benefit for Moldova as a whole of zero. Option 1 summary To summarise, integrating Termocom and CET-2 may provide some benefits from improved dispatch and the streamlining of overhead activities, but these benefits may be relatively small. Integration will involve some up-front costs and, for a while, it may distract management from more important operational and investment improvements. Importantly, bundling DH operations with an old, relatively inefficient cogeneration plant may make development of CET-3 less attractive to a developer. 6.2.2 Option 2: Separate management of Termocom with governance reforms under new ownership to facilitate investment in CET-3 As with Option 1, we analyse the outcomes and impacts of this option in four main categories – governance, procurement of CET-3, private sector participation potential and financial impact. Governance o Reporting responsibility Once the transfer of ownership of Termocom has been effected, Termocom will no longer report to the Municipality. The Boards of Termocom, CET-1 and CET-2 will each report separately to the Ministry of Economy. o Tariff setting As for option 1, transferring ownership of Termocom from the Municipality to the Government should significantly reduce the moral hazard of 100 Economic Consulting Associates, May 2011 populist low heat tariffs in Chişinău being passed on ultimately to the nation as a whole. It is to be stressed that our analysis of the governance failures in Section 2.1.7 highlighted that Termocom’ s longer term financial sustainability could only be secured if it has an owner with the financial capacity to underwrite the company’s governance, and thus an unambiguous interest in the company’s long term financial management. While central governments are also not always immune to pressures for populist policies, some break on such tendencies arises from the reality the Ministry of Finance would recognise that forcing heat tariffs to below cost recovery levels would be in effect to create a contingent liability on the national budget. As budget pressure rises, irresponsible pricing would have to be curtailed. o Management focus In Option 2, Termocom and the CETs stay as separate entities. This means separate accounts and reporting structures through separate boards. This arrangement has the advantage of transparency and allows managers to focus on their respective, very different, core businesses. We envisage a commitment to establishing formal dispatch incentives and rules to ensure merit order use of heat sources to meet demand, and to developing an optimal dispatch control system. This would be similar to the one in place in Riga, which is another situation of a relatively unbundled DH system. The unambiguous interest of the new owner in the company’s long term financial management provides the foundation for effective governance, with a balanced focus on financial performance to underpin the company’s financial sustainability and to maximise the attraction of the sector for developers of CET-3.. o Investment planning With the unbundled options, there is a risk that no single operational entity capable of seeing the ‘bigger picture’ in the heat sector and able to coordinate development of the sector. Strategic planning may have to continue to be done within the energy department of the Ministry of Economy. However, as Termocom’s tariffs become fully cost reflective, it may naturally acquire a central and driving role as the principal customer of heat in the sector and the party with the direct relationship with ultimate consumers of heat. It would then be natural for Termocom to play a central role in developing the sector’s strategy, either through a leadership role in coordinated planning or through the negotiation of longer term heat purchase agreements. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 101 Procurement of CET-3 o With no in-house CHP capacity, under Option 2, Termocom could have a focused role in the procurement of CET-3 as its immediate customer and informed by its relationship with ultimate heat consumers. To the extent that affordability remains a key issue limiting the ability of Termocom to recover tariffs, it would have a strong financial interest in securing an efficient source of heat. Its focus would not be distorted by having its own CHP operations. o If CET-3 is procured as an IPP, to maximise benefits for the DH consumers and secure confidence of investors in CET-3 (and thus minimising the cost of capital), it would be important that the heat supply agreement is carefully formulated. Potential for private sector participation o Short run As with option 1, in the short-term, until the issues affecting the financial sustainability of the sector are resolved, private sector equity investment is most unlikely. Private investors would be interested in seeing not just satisfactory resolution of the long-term debt problems of the sector, but a period of consolidation that demonstrates the commitment of ANRE to setting cost recovery tariffs and of mechanisms to be put in place to overcome affordability difficulties. At the national level, greater stability in the political governance of the sector would be needed in order to attract investment capital. However, some form of management contract that does not involve substantial investment in the short-term (for Termocom and/or CET-2) might be possible. o Medium to long run In the medium term, it may be possible to attract private sector interests willing to put in their own capital and use their leverage to borrow to execute large projects. Given the national budget constraints on investment resources, it would be highly advantageous for CET-3 to be packaged to attract a private investor through some form of lease arrangement or concession. Although there may be some advantages for a private owner of CET-3 to be able to control the downstream business, and have the primary relationship with ultimate heat customers, there are three factors that lead us to be guarded about this: we anticipate the plant running under a long-term heat 102 Economic Consulting Associates, May 2011 purchase contract with possibly state-level guarantees or other mechanisms to help protect investors from regulatory risk in consumer tariffs; an efficient CHP plant may be more focused on electricity generation and may thus see heat generation as more of a by-product rather than its core business; and an investor in new generation plant would not necessarily have a core competence in running district heating networks. For these reasons, we consider there is no a priori way of determining whether suitable private investors would be more interested in developing CET-3 as an independent power producer project, merely selling heat (via a long- term heat supply contract) to Termocom, or whether the private investor would prefer to have a concession over the entire district heat system. We consider it is advantageous at this stage to avoid making a decision on the post CET-3 structure in advance, as such a decision could limit the number of private entities interested in investing in Chişinău’s DH system. Instead, the options of keeping Termocom separate from co-generation or of combining with co-generation at the stage that CHP-3 is built could be effectively tested by putting the options to bidders as part of the CHP-3 tender process. Financial impact o Transactions costs This option involves no structural change. The direct transactions costs associated with the change in ownership will be extremely small relative to Termocom’s overall cost base. o Synergies and economies of scale These do not apply in this case, as there is no structural change. o Dispatch and cost of heat The costs of procuring heat will progressively be reduced as the optimal control dispatch system becomes effective and will be reduced significantly when heat from CET-3 becomes available. o Financial benefits from improved governance Freed of the burden of the legacy debt, and with an owner unambiguously interested in longer term financial performance, Termocom will be better able to focus on financial performance, and on the technical challenges of reducing losses and lowering the costs of distribution and of heat Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 103 procurement. We assume progressive improvements in operating efficiency and continued investment in heat loss reduction, which together result in a 8% lower heat tariffs by 2020. Option 2 summary To summarise, Option 2 is expected to involve significant improvements in performance and reduction in the risk of back-sliding in tariffs due to the change in ownership and the removal of the debt burden. Termocom remaining a predominantly network company would also leave it well placed to play an objective role in the procurement of CET-3. Option 2 involves the least disruption and transactions costs. However, there is a view that organisations benefit from change, and that major change is periodically required. Change can be initiated in many ways and the benefits that may come from reinvention would not be precluded by this relatively straightforward restructuring option. However, its success (as with any option) depends on the new owners grasping the opportunity to reform governance of the sector, and in particular of Termocom. We envisage the following components: o a new board of directors for Termocom established with explicit short and longer-term objectives set by the Government and approved by ANRE; o the appointment of independent non-executive directors with relevant business experience, not necessarily in Moldova, including experience of effective financial management, of customer-oriented businesses and of procuring or financing major infrastructure or similar developments; o the appointment of a chairperson with experience of successful governance of complex commercial businesses; o a commitment by ANRE to develop regulatory incentives and a transparent performance reporting regime that reinforce the Government’s objectives for the business. 6.3 Summary matrix table The following table summarises the discussion in the text of Options 1 and 2, plus the status quo as a reference case. 104 Economic Consulting Associates, May 2011 Option Governance Procurement of CET-3 Potential for Private Financial Impact Reporting Tariff setting Management focus Investment planning Sector Participation responsibility Status quo - No organisational Termocom Board Higher risk of political Management focus Investment planning for Termocom would play None. Unsustainable financial restructuring or ownership reports to the interference in tariffs if distorted by debt DH sector falls under an objective role in the situation as long as change, no resolution of the Municipality, CET-2 Termocom remains overhang. Ministry of Economy. procurement of CET-3 debt overhang remains. legacy debt Board (CET-1 Board) under municipal report to Ministry of ownership and control. Economy Option 1: Immediate vertical Single Board reports to Lower risk of political Responsibility for Vertically integrated Vertical integration prior Limited short-term The financial impact of integration and Government Ministry of Economy for interference in tariffs as dissimilar activities may enterprise would be to procurement of CET- potential. In the integration is uncertain. ownership - the creation of a combined performance the Government has dilute management natural foundation for 3 could mean medium term, bundling Strategic objectives are vertically integrated enterprise of CET-2 and unambiguous interest in focus, and process of coordinated investment procurement is Termocom and CET-2 resolving debt issue, in which CET-2, the HOBs and Termocom. longer-term financial integration may be a planning for the DH enhanced by may limit the attraction improving performance the district heat network all fall performance distraction for a while. sector. experience of CHP to a private developer of of DH operations and Table 26 under single management. However, management operations, but transacting with, or procuring efficient heat could focus on overall managers with acquiring, the DH from CET-3. Early performance of the responsibilities for CET- operation. integration of CET-2 and sector and would 2 could have conflicted Termocom may create naturally aim to interests. obstacle for some of optimise dispatch. these objectives. Option 2: Separate Boards report Lower risk of political Potential for greater As principal customer Termocom could play Limited short-term Strategic objectives are management of Termocom separately to Ministry of interference in tariffs as transparency and and party with direct an objective role in the potential. In the resolving debt issue, with governance reforms Economy the Government has management focus relationship with procurement of CET-3, medium term, keeping improving performance under new ownership to unambiguous interest in through keeping ultimate customers, as and developers may Termocom separate, of DH operations and facilitate investment in CET- longer-term financial activities separate. it consolidates full cost prefer to transact with, while focusing procuring efficient heat 3 - keeping Termocom performance Cost-reflective pricing, recovery tariffs, or acquire, a clean, governance and from CET-3. Reformed managerially separate from externally specified Termocom would be specialised DH operator management on governance and existing CETs and for dispatch rules and n well placed to drive that is not burdened improving performance management focus on governance to be focused on optimal dispatch control upstream investment with old, relatively may help maximise creating clean, well-run turning Termocom into a well- system could help lead through heat purchase inefficient CHP plants. attraction to potential Termocom could functioning, sustainable and to optimal dispatch. agreements. private developers of facilitate achievement. efficient district heating CET-3. business. Summary of analysis of restructuring options Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 105 7 106 Economic Consulting Associates, May 2011 Recommendations In this section, we summarise the principal recommendations arising from the discussion of options in Sections 5 and 6. The progressive approach introduced in Section 5.2 applies – we start with the critical elements and move on to add further dimensions which together will ensure the efficiency and sustainability of district heating in Moldova’s capital city. The recommendations regarding the legislative and regulatory framework made in Section 2.5 need also to be reiterated here. These were firstly that consideration should be given to passing a Heat Law. This is not an absolute requirement, but would help to consolidate heat policy and guide current operation and future development of the sector. One specific area that needs to be addressed to cater for private sector involvement is to give the ANRE licensing powers in the heat sector. The final priority areas for immediate action lie with the regulator, ANRE. The second area relates to actions to be taken by ANRE in respect of augmenting the tariff methodology so as to properly incorporate all of Termocom’s material cost elements, notably making provision for trade receivables, bad debts and creditor committee long-term debt repayments and establishing the rules necessary to ensure economically efficient dispatch of heat. It is important for the regulator to specify the heat dispatch rules because these need to be set to balance the interests of heat consumers in Chişinău and of electricity consumers throughout Moldova. ANRE is uniquely placed to do this. In the longer term, it is recommended that ANRE move away from a simple cost plus approach to incentive-based multi-year regulation. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 107 7.1 Debt resolution The district heating system of Chişinău has been burdened for more than a decade by a crippling level of debt. For the sector to move forward, it is critical that this legacy debt burden be removed. The size of the debt is such that it cannot be paid off from within the district heating sector itself: an injection of outside capital is needed. One option, discussed in Section 5.3.5, may be for this to be in the form of gas assets which are in effect transferred to Moldovagaz, which is then able to operate these assets and benefit from regulated tariffs. A transaction of this sort would enable the long-standing inter-company debts to be cleared, freeing the three main entities in the district heat system (Termocom, CET-1 and CET-2) to focus on improving the efficiency of their operations and, in Termocom’s case, to improving its customer focus. 7.2 Investments Removing the debt burden would not itself reduce the very high heat tariffs which apply in Chişinău and which are due to rise further. To address the already severe affordability issues in the city, our analysis in Section 3.3 highlights the imperative of addressing the main element in Termocom’s cost structure, which is the cost of procurement of heat. Essential elements of putting the DH system onto a sustainable footing going forward will be: o Closure of CET-1 which due to its inherently low level of thermal efficiency imposes unnecessary burdens on both heat and electricity customers. The plant should be taken out of service at the earliest opportunity. There is sufficient heat generation capacity elsewhere in the system to do without both the current CHP plants. However, CET-2, which has much higher efficiency than CET-1, should be retained for the time being. o Procurement of a new CHP plant capable of generating both heat and electricity more efficiently than CET-2. This should be expedited: being a large project it will take some years to implement, but is urgently needed to reduce heat costs for Chişinău consumers. If possible, it should be packaged to attract a private sector equity investor. A modern, efficient CET-3 should result in a step reduction in heat tariffs of at least 108 Economic Consulting Associates, May 2011 22%. This will still leave tariffs at levels which are not affordable by the majority of the population. It is therefore important that complementary investments in network improvements, heat loss reduction strategies in the network and in customer premises be pursued at the same time and continued for at least the next decade. 7.3 Network integration and heat dispatch system The current situation is one in which heat only boilers are used more than they should be if the procurement cost of heat to Termocom were the only consideration. This is acceptable at present because higher usage of the CHPs would impose a burden on electricity consumers who would be forced to pay more for electricity than the alternative of importing power. The reason for relatively high HOB usage has in any case more to do with technical constraints, in particular the lack of integration of the DH network, than with relative costs. In preparation for making proper use of new CHP plant, it is important that the network be integrated. The physical requirements and costs involved in this are being investigated. It is also highly desirable that a heat dispatch system, based on merit order principles, be established, along the lines of but possibly not as sophisticated as the long-operating dispatch system in Riga, Latvia, which we discuss in Section 4.2.2. The heat dispatch system is particularly important in an unbundled configuration where, without good performance-focused governance, there may be a degree of bias towards own sources of heat, but it would also deliver benefits in a vertically integrated structure. A commitment to an optimal dispatch system should therefore be made irrespective of the institutional restructuring option chosen. 7.4 Institutional restructuring options Three options have been examined – liquidation, immediate vertical integration and separate management of Termocom with governance reforms to facilitate investment in CET-3.. In the last two cases it is assumed that the legacy debt issue has been resolved via a mechanism that involves transfer of ownership of Termocom from the Municipality to the Government. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 109 The first of the options considered - liquidation – could precipitate a humanitarian disaster. If this were to lead to abandonment of the DH network, it would force consumers to provide heat from their own ‘autonomous’ sources. A large proportion of the population of Chişinău is simply not in a position to make the necessary investments, or to pay the much higher recurrent costs thereafter. It is unthinkable that large swathes of the city would be without heat during the winter months. If, on the other hand, liquidation was simply a way of repudiating the debts, this would not be accepted by the creditors, so the effect would be to shift the problem from the Municipality to the Government. The result would be reversion to one or other of the other two options. These main options both involve a change in ownership of Termocom from the Municipality to the Government, which in our estimation will result in an improved governance environment and reduced risk of tariffs being suppressed in future. A strong new Board, which includes independent non-executive directors and members with experience and a chairperson with experience of successful governance of complex commercial businesses. Following the significant increases in heat tariffs that have been instituted since ANRE was given tariff setting responsibilities, the threat to the financial sustainability of the district heating system now comes from the problems of affordability, which translate into increases in uncollected revenues. Resources need to be found by the Municipality and/or the Government to adequately finance the subsidy scheme which is already in place, but which will need to be extended to a larger proportion of the population this year and in the next few years to come as tariffs are increased further in real terms. The choice between vertically integrating the network and the CHPs (a single entity absorbing Termocom and CET-2, assuming CET-1 is anyway closed) and keeping the present partially unbundled structure (keep Termocom and the CETs separate) depends on the relative weight to be given to a number of different factors. Leaving the existing unbundled structure in place involves the least disruption and leaves options open in respect of private sector CET-3 preferences. However, if change is considered to be progressive and necessary at the present time in the district heat sector, the option of vertically integrating Termocom and the CETs could be pursued as a way of forcing some reinvention. The financial analysis indicates that financial gains might arise from vertical integration, as measured by heat tariff reductions for heat consumers in Chişinău, but these are not likely to be very large and will be offset to some extent by increased tariffs for electricity consumers or by gains in efficiency that might be achieved with improved incentives and governance were there to be no integration. 110 Economic Consulting Associates, May 2011 If there are indications from private sector investors that they would prefer to take control of the whole DH system rather than to undertake CET-3 as an independent IPP, then vertically integrating now may be a good preparation for this. There is a risk, however, that CET-3 investment considerations could subsequently require the newly integrated system to be unbundled again. If this risk is considered to be significant, or if there is a preference for wholesale competition in heat supply in the future, it would be preferable to leave the system unbundled. This could be an interim decision, while debt resolution, investment strategies, network integration and a heat despatch system are pursued vigorously. The choice about structural options would benefit from more information becoming available about CET-3 investment feasibility, structuring options and possible investor interest. Our analysis in Section 6 indicates that the financial case for integrating the three existing companies in the district heating sector is not compelling. In addition, major reorganisations come with their own risks, the prospect of further reform in the cogeneration sector may mean there is insufficient time to recover the up-front costs involved in reorganisation, and the reorganisation may itself limit the strategic options for that further reform. While our analysis does not allow us to make a positive recommendation for integration, the case for a transfer of ownership of Termocom to the government is strong. Our recommendation is therefore that a transfer of ownership should be pursued, in the first instance without integration. As more information emerges with further study and exploration of the options for CET-3, a carefully planned and implemented integration at some later date may emerge as being warranted and would still be possible at that time. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 111 A1 List of persons consulted A1 First name Organisation Surname Ilorion Deputy Minister of Economy Popa Galina Ministry of Economy Thermal Energy Department Parsian Head Dorin Chirtoaca Chişinău Municipal Council Emil Gutu Chişinău Municipal Finance Officer Mihail Cernei Termocom General Manager Moiseev Tudor CTE-1 Director General Alexandru Comarov CTE-2 Director General Mihail Sorbala CTE-2 Tech Director Stepan Ciudac CTE-2 DG adjunct Alexandru Gusev Moldovagaz Board President Victor Parlicov ANRE Director General Mariana Botezatu ANRE Economics Director Leonid Belinschi ANRE Tech Director Ion Margineanu InfoCom Director Shinya Nishimura World Bank Sandu Ghidirim W Bank Chişinău Patrik Stalgren SIDA Gunnar Olvik Olvik SIDA Tokhir Mirzoev IMF Chişinău A2 CHP-2 site and plant details Site The area of the site is 60 ha, with a free unobstructed area available for additional development without any demolishment required, of 16 ha. The site has access to railway, road, electricity network, heat network, gas network and water. CHP plant There are 3 steam turbine generator sets each producing an output of 80MW electrical (MWe) (at 11 KV) and 200 Gcal/hr heat. The sets are 35, 33 and 31 years old respectively and require proximately 48 hours to run up from cold. There is one additional 500Gcal/hr heat only boiler (HOB) capable of being run up to full capacity in two hours. 112 Economic Consulting Associates, May 2011 There is no black start capability i.e. in the event of a total system black-out, a live electricity feed is required from the electricity distribution network in order to run the auxiliary plant to bring the generators back online one at a time. The plant can, however, operate in island mode. In other words, if the plant is running at the time of an electricity distribution system failure, it can operate an island network out of synchronism with the total electricity network. Two cooling towers on site provide sufficient cooling for up to 80 MWe output without the need for distributing heat into the Termocom network. The normal summertime regime it is for one set to run at up to 80 MWe, which then provides sufficient heat for hot water supplies for Termocom customers. CET-1 is shut down during the summer. There is a heat pipe interconnector between CET-1 and CET-2. Fuel The plant can run on natural gas or oil. The storage capacity of oil on site is 80,000 tonnes consisting of four 17,000 tonne tanks. This is sufficient to run the plant at full capacity for approximately 7 to 10 days. Oil is sourced from Ukraine, Russia, and Romania. Oil can be shipped in via Moldova’s own port on the River Danube and the port is linked by a new railway running all the way from the port to the CET-2 site. The gas feed is from the north and from the Balkans. Electrical connections 11 circuits connect to Red Union Fensosa 110 KV distribution system with a capacity of 400 MW, extensible to 640 MW. Most of the circuits are 35 years old. Transformation from the generation at 11 KV to 110 KV is via unit transformers i.e. one transformer dedicated to each generator. Electricity dispatch is by Moldelectrica. Water There is an adequate supply of drinking water and plant make up water, with a connection to the Apa-Canal water network. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 113 A3 Analysis of modern co-generation The following table indicates that the existing cogeneration plant providing heat for Termocom are operating below modern cogeneration standards. Indeed, it indicates that, in energy terms, the outputs of the two cogeneration plants for 2010 could have been more efficiently provided by benchmark stand-alone electricity plant and heat- only boilers. Table 27 Effectiveness of current cogeneration Co-generation benefits and inefficiency CET-2 CET-1 Total ANRE 2010 tariff calculations Energy outputs Electricity output MWh 622,600 113,023 735,623 Heat output MWh 1,364,315 289,587 1,653,902 Total energy output MWh 1,986,915 402,610 2,389,525 Energy inputs Gas volume m3 mil 294.512 68.215 362.727 Oil equivalent volume m3 mil 3.600 0.782 4.382 Total equivalent volume m3 mil 298.112 68.997 367.109 Calorific value (lower) MJ/ m 3 33.788 33.730 Energy content MJ million 10,073 2,327 12,400 MJ-MWh conversion MJ/MWh 3,600 3,600 Energy content MWh 2,797,947 646,461 3,444,407 Benchmark inputs (stand-alone electricity and heat plants) Electricity-only at 55.0% MWh 1,132,000 205,496 1,337,496 Heat using HOBs at 91.4% MWh 1,492,803 316,860 1,809,663 Total benchmark energy input MWh 2,624,803 522,356 3,147,159 Net savings % -12.7% -42.9% -18.0% (negative savings indicate inefficiencies exceed the benefits of cogeneration) To illustrate how modern cogeneration can be more efficient, the following chart characterises the relative energy efficiencies of the sector’s current outputs against benchmarks for stand-alone generation and benchmark cogeneration. 114 Economic Consulting Associates, May 2011 Figure 5 The Termocom energy efficiency deficit 4 HOB waste HOB heat Energy in fuel required to provide output CHP heat 3 Electricity Generation waste (million MWh) 2 Effectively free heat 1 0 Chişină u Benchmark Benchmark 2010 CCGT + HOBs CHP + HOBs Column 1 represents the current CETs and HOBs operating in the sector. Column 2 represents how stand-alone electricity generation and HOBs might provide the same outputs. Column 3 represents how benchmark cogeneration supplemented by HOBs might also provide the same overall output. The comparison between the first two columns illustrates the conclusions from Table 27 above: the thermal efficiency of the existing cogeneration plants appears to be poor in relation to modern standards, and poor enough to negate the potential benefits of cogeneration. Comparison between the second and third columns illustrates the potential benefits of cogeneration with more modern plant. By using the waste heat from electricity generation that would otherwise be lost, energy inputs can be significantly reduced. Plant optimised for cogeneration would need to be larger than a benchmark CCGT to generate the same electricity output, but there would still be a sizeable portion of the heat output that would be effectively free. However, it is too simplistic to consider only thermal efficiency and to take the existing 2010 production levels as fixed. As we discussed in Section 3.2.1 above, the fixed assets in the existing cogeneration plant are substantially impaired and no cost of capital is attributed to assets acquired prior to 2003 by ANRE in its tariff calculations. By contrast, new cogeneration plant would require financing and revenues from supplying heat and electricity would need to cover all new capital costs. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 115 The cost effectiveness of new cogeneration plant is dependent on load factors for electricity generation. Modern gas-based cogeneration plant, at high load factors, can generate electricity as cost-effectively as equivalent benchmark gas-based electricity- only plant (CCGT) and provide substantial savings in the provision of heat. The following table illustrates how. Table 28 Illustrative example of residual heat costs from cogeneration Benchmark Stand-alone electricity and heat costs CCGT HOB heat Border cost of fuel $/000m3 310 310 Gas transmission costs % 14.7% 14.7% Cost of 1000m3 fuel $/000m3 356 356 33.8 Calorific value (net) MJ/m3 33.8 33.8 MWh conversion MJ/MWh 3,600 3,600 MWh content MWh 9.38 9.38 Cost /MWh content US$/MWh 37.90 37.90 Thermal efficiency % 55% 91% Cost / MWh output US$/MWh 69.36 41.47 Fuel cost per kWh USc/kWh 6.94 4.15 Variable cost USc/kWh 0.60 Fixed cost USc/kWh 1.40 Unit cost of electricity USc/kWh 8.94 Electricity Co-gen Modern cogeneration plant only mode mode Total Electricity capacity 724 MW (Electricity efficiency in co-gen mode: 47.5%) Electricity generated MWh 3,564,998 1,939,754 5,504,752 Heat demand MWh 1,653,896 1,653,896 Total MWh 3,564,998 3,593,650 7,158,647 Thermal efficiency % 52% 88% Energy content of fuel MWh 6,802,781 4,083,693 10,886,474 Cost/MWh content US$/MWh 37.90 37.90 Fuel cost US$m 257.8 154.8 412.6 Var. cost /kWh elec. USc/kWh 0.60 0.66 Variable cost US$m 21.4 12.8 34.2 Fixed cost @90% load factor USc/kWh 1.45 Fixed cost US$m 82.7 Total CHP costs US$m 529.5 Elec. Revenues @ 8.94c US$m 318.6 173.3 491.9 Residual heat cost US$m 37.6 Unit cost of heat USc/kWh 2.27 Percent of HOB fuel cost % 55% 116 Economic Consulting Associates, May 2011 However, the cost effectiveness of cogeneration is also dependent on the value of electricity generated, affected by tariffs for alternative sources of electricity and any value attributed to energy security. At present, the cogeneration plant are able to supply electricity and recover regulated tariffs that are substantially higher than the cost of imported electricity – ANRE’s 2010 tariff calculations provided for electricity tariffs for CET-2 some 132% of the effective cost at the distribution system of imported electricity, and 181% for CET- 1. The cost of imported electricity would also be a relevant factor in the assessment of cogeneration options. The regional market for electricity at present appears to provide relatively cheap electricity, influenced by the availability of cheap sources of generation. As long as gas prices are structured with reference to the European market and electricity prices influenced by cheap generation in former Soviet Union countries, cost calculations will be tilted against new gas-based electricity generation, including cogeneration. In the short term, it could be cheaper to import electricity and generate heat using HOBs, as discussed in Section 1.2. However, the strategic calculations for a major sector reform may take into account broader considerations than the short-term cost of electricity. Longer term market or energy security considerations may make it appropriate to plan for new electricity capacity in Moldova. Should that be the case, the opportunity opens up for modern and cost effective cogeneration plant to offer substantial savings in the cost of heat. With reference to the calculations in Table 28 above, we project that modern cogeneration plant of sufficient capacity to generate heat at 55% of the cost of heat from HOBs, and generate the same heat output as the two CETs currently generate, would lead to reductions in Termocom’s heat tariffs of 22.2%. This is illustrated in the final bar in the waterfall chart, Figure 2 above, with the colour shading to white to reflect the strategic uncertainties involved. Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 117 A4 Investments necessary to integrate the district heat network of Chișinău Termocom has provided the following information about the measures needed to connect consumers to a unified heat source system based on the present CET-2: 1. Reconstruction of the SP-8 with changing elements PK-1 in the station and in CT-5L; 2. Reconstruction of the connection line by increasing the diameter to Dn1200, L = 2750m, CT-South 3. Reconstruction of the heating network on Otovasca Street PL-12/4 by increasing the diameter to Dn1000, L = 1136m; 4. Reconstruction of heating network sector PL-12 / 4 ÷ PL-123 by increasing the diameter to Dn1000, L = 1608m; 5. Reconstruction of the heating network sector ÷ SP-4 SP-5 by increasing the diameter to DN800, L = 1746m; 6. Reconstruction of SP-4 ÷ SP-5 by increasing the diameter of PK-1; 7. Reconstruction of the heating network sector SP-5 ÷CT-427 by increasing the diameter to Dn700, L = 240m; 8. Reconstruction of the heating network sector CT-427a.8 ÷ CT-208 by increasing the diameter to DN600, L = 850; 9. Construction of a pumping stations in the area CT-208, where G = 2000 m³ / h and H = 50m; 10. Reconstruction of the traffic/movement node SP- Radius 1 of CT-South 11. Reconstruction of the heating network sector CT-301÷ CT-13N by increasing the diameter to DN800, L = 1850m; 12. Reconstruction of the heating network sector CT-13, 14n ÷ CT-18N by increasing the diameter to Dn900, L = 1000m; 13. Design the heating network CT-23N ÷CT-West with the following dimensions Dn- 600 and L = 2300m; 14. The design of two pumping stations before CT-23N straight flow and return flow with G = 3500 m³ and heat flow of 75m and heat return flow of 40m. In summary, the pipeline requirements will be as follows: Diametrul, mm Lungimea, m 1200 2750 1000 2740 900 1000 800 3600 700 240 600 850 Total: 11180 118 Economic Consulting Associates, May 2011 Profit and loss Termocom 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Operating revenues A5.1 Termocom Sale of heat to ultimate customers 1,067.0 1,346.2 1,574.8 1,684.4 1,763.3 1,870.4 1,973.2 1,600.4 1,663.3 1,747.3 1,836.8 1,936.2 2,041.7 2,153.4 2,271.6 Sales of heat to Termocom Sale of electricity Other revenues Bad debt costs (estimate) (42.7) (53.8) (63.0) (67.4) (70.5) (74.8) (78.9) (64.0) (66.5) (69.9) (73.5) (77.4) (81.7) (86.1) (90.9) Total 1,024.4 1,292.4 1,511.8 1,617.0 1,692.8 1,795.5 1,894.2 1,536.4 1,596.8 1,677.4 1,763.4 1,858.8 1,960.0 2,067.2 2,180.7 Operating expenditure Purchase of heat from CETs 590.9 773.7 820.2 869.4 889.2 942.5 999.1 686.8 724.5 764.2 806.2 850.5 897.2 946.5 998.6 Fuel for generation 194.2 248.9 258.2 267.7 277.6 287.7 298.1 220.4 232.4 245.2 258.7 272.9 287.9 303.7 320.4 Other fuel & water 52.4 56.4 59.5 61.9 64.4 67.9 69.6 71.2 75.1 79.3 83.6 88.2 93.1 98.2 103.6 HOB operating costs 44.2 47.5 50.0 52.7 55.5 58.4 61.5 58.5 61.9 65.6 69.4 73.5 77.8 82.3 87.1 Staff costs 88.0 92.9 96.2 99.6 103.2 106.9 110.7 114.6 118.7 123.0 127.4 136.1 145.4 155.3 166.0 Phase 1 Report: ChiƔ şinĉ Other costs 29.6 31.3 32.5 33.7 35.0 36.3 37.6 39.0 40.5 42.0 43.6 45.2 46.9 48.6 50.4 A5 Financial projections Total 999.4 1,250.8 1,316.5 1,385.0 1,424.7 1,499.7 1,576.6 1,190.6 1,253.2 1,319.2 1,388.8 1,466.3 1,548.2 1,634.7 1,726.1 Depreciation 60.8 57.9 62.6 67.9 75.0 78.5 82.4 88.7 91.7 95.3 99.5 104.4 109.9 116.0 122.8 Operating profit (35.8) (16.3) 132.6 164.1 193.0 217.4 235.3 257.2 251.9 262.9 275.0 288.1 301.9 316.5 331.8 Investing gains/(losses) Financing costs (0.7) (35.0) (102.0) (133.0) (155.2) (170.7) (181.9) (195.7) (160.9) (159.6) (159.3) (158.5) (157.4) (155.6) (153.0) Exceptional results Profit/(loss) before taxation (36.4) (51.2) 30.6 31.1 37.9 46.7 53.4 61.5 91.0 103.3 115.8 129.6 144.5 160.9 178.8 Tax on net profits Net profit/(loss) (36.4) (51.2) 30.6 31.1 37.9 46.7 53.4 61.5 91.0 103.3 115.8 129.6 144.5 160.9 178.8 Reserves b/f (1,226.3) (1,262.7) (1,314.0) (1,283.4) (1,252.3) (1,214.4) (1,167.7) (1,114.3) (1,052.8) (961.8) (858.5) (742.7) (613.2) (468.7) (307.8) Reserves at the end of the year (1,262.7) (1,314.0) (1,283.4) (1,252.3) (1,214.4) (1,167.7) (1,114.3) (1,052.8) (961.8) (858.5) (742.7) (613.2) (468.7) (307.8) (129.0) ău Heat & Electricity Supply Institutional & Financial Restructuring Study 119 Balance sheets Termocom 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 120 Non-current assets Intangible fixed assets 3.8 4.8 5.8 6.6 7.3 8.0 8.7 9.3 10.0 10.7 11.4 12.1 12.9 13.7 14.5 Tangible fixed assets 580.4 725.4 864.8 1,025.8 1,098.7 1,168.0 1,274.7 1,301.6 1,332.6 1,367.4 1,405.7 1,447.4 1,492.4 1,540.6 1,591.8 Long-term investments 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Total non-current assets 584.3 730.3 870.6 1,032.5 1,106.1 1,176.1 1,283.4 1,311.1 1,342.7 1,378.1 1,417.1 1,459.6 1,505.4 1,554.3 1,606.4 Current assets MoU parties: current receivables Municipality of ChişüinĆ ău 103.6 130.6 152.8 163.5 171.1 181.5 191.5 155.3 161.4 169.6 178.3 187.9 198.1 209.0 220.5 Ministry of Finance 14.8 14.8 14.8 14.8 14.8 14.8 14.8 14.8 14.8 14.8 14.8 14.8 14.8 14.8 14.8 Heat customers (end-users) 727.4 917.7 1,073.6 1,148.3 1,202.1 1,275.1 1,345.2 1,091.1 1,133.9 1,191.2 1,252.2 1,320.0 1,391.9 1,468.0 1,548.6 Other receivables 59.3 74.8 87.5 93.6 98.0 103.9 109.6 88.9 92.4 97.1 102.0 107.6 113.4 119.6 126.2 Current trade receivables 905.0 1,138.0 1,328.6 1,420.1 1,485.9 1,575.3 1,661.0 1,350.1 1,402.5 1,472.6 1,547.3 1,630.2 1,718.2 1,811.4 1,910.0 Stocks of goods and materials 35.7 45.0 52.7 56.3 59.0 62.5 66.0 53.5 55.6 58.4 61.4 64.7 68.3 72.0 76.0 Economic Consulting Associates, May 2011 Cash and bank balances 22.9 28.9 33.8 36.2 37.9 40.2 42.4 34.4 35.7 37.5 39.4 41.6 43.8 46.2 48.8 Other current assets Total current assets 963.6 1,211.9 1,415.1 1,512.6 1,582.8 1,678.0 1,769.4 1,438.0 1,493.9 1,568.5 1,648.2 1,736.5 1,830.3 1,929.6 2,034.7 Current liabilities MoU parties: current payables (159.5) (208.1) (219.9) (232.3) (187.5) (197.9) (208.9) (28.5) (30.0) (31.7) (33.4) (35.3) (37.2) (39.3) (41.4) CET-3 (156.2) (164.8) (173.8) (183.4) (193.4) (204.1) (215.3) (227.1) Other trade payables Other short-term liabilities (13.3) (13.3) (13.3) (13.3) (13.3) (13.3) (13.3) (13.3) (13.3) (13.3) (13.3) (13.3) (13.3) (13.3) (13.3) Bank loans payable < 1 year (11.3) (27.2) (39.2) (47.8) (53.9) (58.4) (64.1) (50.8) (50.8) (51.3) (51.8) (52.4) (52.9) (53.4) (53.7) Total current liabilities (184.1) (248.6) (272.4) (293.4) (254.7) (269.6) (286.2) (248.8) (258.9) (270.1) (281.9) (294.4) (307.5) (321.2) (335.6) Net current assets/(liabilities) 779.6 963.3 1,142.7 1,219.2 1,328.1 1,408.4 1,483.2 1,189.2 1,235.0 1,298.4 1,366.3 1,442.1 1,522.8 1,608.4 1,699.1 Non-current liabilities: ordinary Bank loans payable > 1 year (270.2) (652.1) (940.0) (1,147.4) (1,294.2) (1,402.1) (1,537.6) (1,219.5) (1,218.9) (1,231.3) (1,243.6) (1,257.6) (1,270.3) (1,281.3) (1,289.9) Deferred revenue - grants & subsidies (9.3) (8.4) (7.5) (6.5) (5.6) (4.7) (3.7) (2.8) (1.9) (0.9) (0.0) Other long-term liabilities Total non-current liabilities: ordinary (279.5) (660.5) (947.4) (1,153.9) (1,299.8) (1,406.8) (1,541.3) (1,222.3) (1,220.8) (1,232.2) (1,243.6) (1,257.6) (1,270.3) (1,281.3) (1,289.9) Net assets/(liabilities) Ordinary net assets 1,084.3 1,033.1 1,065.9 1,097.7 1,134.3 1,177.7 1,225.3 1,277.9 1,356.9 1,444.3 1,539.8 1,644.2 1,757.8 1,881.4 2,015.7 Non-MoU creditors committee liabilities (317.1) (317.1) (319.3) (320.0) (318.8) (315.4) (309.5) (300.8) (288.7) (272.8) (252.6) (227.4) (196.5) (159.2) (114.7) Net assets before non-current MoU parties 767.2 716.0 746.6 777.7 815.6 862.3 915.7 977.2 1,068.2 1,171.5 1,287.2 1,416.8 1,561.3 1,722.2 1,901.0 MoU parties: internal (1,770.1) (1,770.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) MoU parties: external (227.4) (227.4) Total net assets/(liabilities) (1,230.3) (1,281.5) 597.5 628.6 666.5 713.2 766.6 828.1 919.1 1,022.4 1,138.2 1,267.7 1,412.2 1,573.1 1,751.9 Capital and reserves Termocom 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Capital and reserves Share capital 32.5 32.5 1,880.9 1,880.9 1,880.9 1,880.9 1,880.9 1,880.9 1,880.9 1,880.9 1,880.9 1,880.9 1,880.9 1,880.9 1,880.9 Reserves and accumulated losses (1,262.7) (1,314.0) (1,283.4) (1,252.3) (1,214.4) (1,167.7) (1,114.3) (1,052.8) (961.8) (858.5) (742.7) (613.2) (468.7) (307.8) (129.0) Total capital and reserves (1,230.3) (1,281.5) 597.5 628.6 666.5 713.2 766.6 828.1 919.1 1,022.4 1,138.2 1,267.7 1,412.2 1,573.1 1,751.9 Errors Financial indicators Debt/core assets 27.4% 48.2% 55.2% 58.3% 59.5% 59.7% 60.3% 53.0% 51.0% 49.2% 47.5% 45.9% 44.2% 42.5% 40.8% FFO interest cover 1.2 1.9 1.7 1.7 1.7 1.7 1.8 2.1 2.2 2.4 2.5 2.6 2.8 3.0 Fixed assets Termocom 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Intangible assets b/f 2.6 3.8 4.8 5.8 6.6 7.3 8.0 8.7 9.3 10.0 10.7 11.4 12.1 12.9 13.7 Additions 1.9 2.0 2.1 2.2 2.4 2.5 2.7 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.3 Depreciation (0.6) (0.9) (1.2) (1.4) (1.6) (1.8) (2.0) (2.2) (2.3) (2.5) (2.7) (2.9) (3.0) (3.2) (3.4) Intangible assets c/f 3.8 4.8 5.8 6.6 7.3 8.0 8.7 9.3 10.0 10.7 11.4 12.1 12.9 13.7 14.5 Total tangible assets b/f 566.5 580.4 725.4 864.8 1,025.8 1,098.7 1,168.0 1,274.7 1,301.6 1,332.6 1,367.4 1,405.7 1,447.4 1,492.4 1,540.6 Additions 74.0 201.9 200.8 227.5 146.2 146.0 187.0 113.5 120.3 127.5 135.2 143.3 151.9 161.0 170.6 Phase 1 Report: ChiƔ Depreciation (60.1) (56.9) (61.4) (66.5) (73.4) (76.7) (80.4) (86.5) (89.3) (92.8) (96.8) (101.5) (106.9) (112.8) (119.4) şinĉ Total tangible assets c/f 580.4 725.4 864.8 1,025.8 1,098.7 1,168.0 1,274.7 1,301.6 1,332.6 1,367.4 1,405.7 1,447.4 1,492.4 1,540.6 1,591.8 Inter-company accounts between MoU parties 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Long-term balances Termocom:CET-2 (1,336.5) (1,336.5) (87.5) (87.5) (87.5) (87.5) (87.5) (87.5) (87.5) (87.5) (87.5) (87.5) (87.5) (87.5) (87.5) Termocom:CET-1 (433.6) (433.6) (61.6) (61.6) (61.6) (61.6) (61.6) (61.6) (61.6) (61.6) (61.6) (61.6) (61.6) (61.6) (61.6) Termocom:Chiş Ć u-Gaz üină (44.7) (44.7) Termocom:Moldovagaz (182.8) (182.8) Net non-current balances (1,997.5) (1,997.5) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) (149.1) ău Heat & Electricity Supply Institutional & Financial Restructuring Study 121 Cash flows Termocom 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 122 Operating profits (35.8) (16.3) 132.6 164.1 193.0 217.4 235.3 257.2 251.9 262.9 275.0 288.1 301.9 316.5 331.8 Add back depreciation 60.8 57.9 62.6 67.9 75.0 78.5 82.4 88.7 91.7 95.3 99.5 104.4 109.9 116.0 122.8 Reductions/(additions) in current assets (202.0) (242.2) (198.3) (95.1) (68.5) (92.9) (89.2) 323.4 (54.6) (72.8) (77.7) (86.2) (91.5) (96.9) (102.6) Additions/(reductions in current liabilities (16.2) 48.6 11.8 12.4 (44.9) 10.4 11.0 (24.2) 10.1 10.7 11.3 11.9 12.6 13.3 14.0 Normal operating cash flows (193.2) (152.0) 8.7 149.3 154.7 213.4 239.5 645.1 299.1 296.0 308.1 318.2 332.9 348.9 366.0 Investing cash flows (75.9) (203.9) (202.9) (229.8) (148.6) (148.5) (189.7) (116.3) (123.3) (130.7) (138.5) (146.8) (155.7) (165.0) (174.9) Operating and investing cash flows (269.0) (355.9) (194.3) (80.5) 6.1 64.9 49.8 528.8 175.8 165.3 169.6 171.3 177.2 183.9 191.1 Interest (0.7) (35.0) (102.0) (133.0) (155.2) (170.7) (181.9) (195.7) (160.9) (159.6) (159.3) (158.5) (157.4) (155.6) (153.0) Additions/(reductions) in non-current liabilities (0.9) (0.9) (0.9) (0.9) (0.9) (0.9) (0.9) (0.9) (0.9) (0.9) (0.9) (0.0) Additions/(reductions) in creditor committee liabilit 2.2 0.7 (1.2) (3.4) (5.9) (8.8) (12.1) (15.9) (20.2) (25.2) (30.9) (37.3) (44.5) Economic Consulting Associates, May 2011 Additions/(reductions) in LT MoU liabilities (1,848.4) Tax Share capital 1,848.4 Movements in loans 275.8 397.8 299.9 216.1 152.9 112.4 141.1 (331.4) (0.6) 12.9 12.8 14.6 13.3 11.4 8.9 Dividends Total cash flows 5.1 6.0 4.9 2.4 1.7 2.3 2.2 (8.0) 1.4 1.8 1.9 2.1 2.3 2.4 2.5 Cash at the start of the year 17.8 22.9 28.9 33.8 36.2 37.9 40.2 42.4 34.4 35.7 37.5 39.4 41.6 43.8 46.2 Cash at the end of the year 22.9 28.9 33.8 36.2 37.9 40.2 42.4 34.4 35.7 37.5 39.4 41.6 43.8 46.2 48.8 Loans Termocom 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Cash requirement 22.9 28.9 33.8 36.2 37.9 40.2 42.4 34.4 35.7 37.5 39.4 41.6 43.8 46.2 48.8 Loans at the start of the year (5.7) (281.5) (679.3) (979.1) (1,195.2) (1,348.1) (1,460.6) (1,601.7) (1,270.3) (1,269.7) (1,282.6) (1,295.4) (1,310.0) (1,323.3) (1,334.7) Cash at the start of the year 17.8 22.9 28.9 33.8 36.2 37.9 40.2 42.4 34.4 35.7 37.5 39.4 41.6 43.8 46.2 Opearating and investing cash flows (269.0) (355.9) (194.3) (80.5) 6.1 64.9 49.8 528.8 175.8 165.3 169.6 171.3 177.2 183.9 191.1 Interest (0.7) (35.0) (102.0) (133.0) (155.2) (170.7) (181.9) (195.7) (160.9) (159.6) (159.3) (158.5) (157.4) (155.6) (153.0) Taxation MoU and share transactions (0.9) (0.9) 1.3 (0.3) (2.1) (4.3) (6.8) (9.7) (13.0) (16.8) (21.2) (25.2) (30.9) (37.3) (44.5) Cash at the end of the year (22.9) (28.9) (33.8) (36.2) (37.9) (40.2) (42.4) (34.4) (35.7) (37.5) (39.4) (41.6) (43.8) (46.2) (48.8) Loans at the end of the year (281.5) (679.3) (979.1) (1,195.2) (1,348.1) (1,460.6) (1,601.7) (1,270.3) (1,269.7) (1,282.6) (1,295.4) (1,310.0) (1,323.3) (1,334.7) (1,343.6) A5.2 CET-2 Profit and loss CET-2 2010 2011 2012 2013 2014 2015 2016 2017 Operating revenues Sales of heat to Termocom 470.4 616.0 652.9 692.1 889.2 942.5 999.1 Sale of electricity 650.7 835.4 882.4 932.2 1,165.5 1,232.5 1,303.6 Other revenues 3.6 4.7 5.0 5.3 6.8 7.2 7.6 Total 1,124.7 1,456.1 1,540.3 1,629.6 2,061.5 2,182.2 2,310.2 Operating expenditure Fuel for generation 998.8 1,301.5 1,379.6 1,462.4 1,878.8 1,991.5 2,111.0 Staff costs 43.0 45.5 47.2 49.0 53.8 55.8 57.9 Other costs 65.3 70.6 74.8 79.3 89.0 94.4 100.0 Total 1,107.1 1,417.6 1,501.6 1,590.6 2,021.6 2,141.7 2,268.9 Depreciation 28.7 28.2 27.8 27.6 27.5 27.6 27.8 1,246.3 Operating profit (11.1) 10.3 10.8 11.4 12.3 12.9 13.5 (1,246.3) Investing gains/(losses) Financing costs (1.6) (0.4) (4.3) (4.9) (5.6) (11.3) (12.9) (11.9) Exceptional results Profit/(loss) before taxation (12.7) 9.9 6.5 6.5 6.7 1.6 0.6 (1,258.2) Tax on net profits Net profit/(loss) (12.7) 9.9 6.5 6.5 6.7 1.6 0.6 (1,258.2) Reserves b/f 1,098.4 1,085.8 1,095.7 1,102.2 1,108.6 1,115.4 1,117.0 1,117.6 Reserves at the end of the year 1,085.8 1,095.7 1,102.2 1,108.6 1,115.4 1,117.0 1,117.6 (140.6) Net assets CET-2 2010 2011 2012 2013 2014 2015 2016 2017 Non-current assets Intangible fixed assets 0.5 0.5 0.5 0.5 0.5 0.5 0.3 Tangible fixed assets 1,273.6 1,273.6 1,273.6 1,273.6 1,273.6 1,273.6 1,245.9 Long-term investments 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 Total non-current assets 1,274.3 1,274.3 1,274.3 1,274.3 1,274.3 1,274.3 1,246.5 0.3 Current assets MoU parties: current receivables 80.2 105.0 111.3 118.0 151.6 160.7 170.3 Other receivables 107.0 137.3 145.0 153.2 191.6 202.6 214.3 Current trade receivables 187.2 242.3 256.4 271.2 343.2 363.3 384.6 Stocks of goods and materials 43.1 43.1 43.1 43.1 43.1 43.1 43.1 43.1 Cash and bank balances 4.9 6.4 6.7 7.1 9.0 9.5 10.1 99.1 Other current assets Total current assets 235.2 291.8 306.2 321.4 395.3 415.9 437.8 142.2 Current liabilities MoU parties: current payables (27.3) (35.6) (37.7) (40.0) (51.3) (54.4) (57.7) Other trade payables (59.6) (59.6) (59.6) (59.6) (59.6) (59.6) (59.6) Other short-term liabilities (11.8) (11.8) (11.8) (11.8) (11.8) (11.8) (11.8) Bank loans payable < 1 year (0.2) (1.7) (1.9) (2.2) (4.4) (5.1) (4.7) Total current liabilities (98.9) (108.7) (111.0) (113.6) (127.2) (130.9) (133.8) Net current assets/(liabilities) 136.3 183.1 195.1 207.9 268.1 285.0 304.0 142.2 Non-current liabilities: ordinary Bank loans payable > 1 year (3.8) (40.7) (46.2) (52.5) (106.0) (121.3) (111.9) Deferred revenue - grants & subsidies Other long-term liabilities (38.0) (38.0) (38.0) (38.0) (38.0) (38.0) (38.0) Total non-current liabilities: ordinary (41.8) (78.7) (84.2) (90.5) (144.0) (159.3) (149.9) Net assets/(liabilities) Ordinary net assets 1,368.8 1,378.7 1,385.2 1,391.7 1,398.4 1,400.0 1,400.6 142.5 Non-MoU creditors committee liabilities Net assets before non-current MoU parties 1,368.8 1,378.7 1,385.2 1,391.7 1,398.4 1,400.0 1,400.6 142.5 MoU parties: internal 1,336.5 1,336.5 87.5 87.5 87.5 87.5 87.5 87.5 MoU parties: external (1,249.0) (1,249.0) Total net assets/(liabilities) 1,456.3 1,466.2 1,472.7 1,479.2 1,485.9 1,487.6 1,488.2 230.0 Phase 1 Report: ChiƔ ău Heat & Electricity Supply Institutional & Financial Restructuring Study 123 şinĉ Capital and reserves CET-2 2010 2011 2012 2013 2014 2015 2016 2017 Capital and reserves Share capital 370.5 370.5 370.5 370.5 370.5 370.5 370.5 370.5 Reserves and accumulated losses 1,085.8 1,095.7 1,102.2 1,108.6 1,115.4 1,117.0 1,117.6 (140.6) Total capital and reserves 1,456.3 1,466.2 1,472.7 1,479.2 1,485.9 1,487.6 1,488.2 230.0 Fixed assets CET-2 2010 2011 2012 2013 2014 2015 2016 2017 Intangible assets b/f 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.3 Additions 0.1 0.1 0.1 0.1 0.1 0.1 Depreciation (0.1) (0.1) (0.1) (0.1) (0.1) (0.1) (0.1) (0.3) Intangible assets c/f 0.5 0.5 0.5 0.5 0.5 0.5 0.3 Total tangible assets b/f 1,273.6 1,273.6 1,273.6 1,273.6 1,273.6 1,273.6 1,273.6 1,245.9 Additions 28.6 28.1 27.7 27.5 27.4 27.5 Depreciation (28.6) (28.1) (27.7) (27.5) (27.4) (27.5) (27.7) (1,245.9) Total tangible assets c/f 1,273.6 1,273.6 1,273.6 1,273.6 1,273.6 1,273.6 1,245.9 Cash flows CET-2 2010 2011 2012 2013 2014 2015 2016 2017 Operating profits (11.1) 10.3 10.8 11.4 12.3 12.9 13.5 (1,246.3) Add back depreciation 28.7 28.2 27.8 27.6 27.5 27.6 27.8 1,246.3 Reductions/(additions) in current assets 21.3 (55.2) (14.0) (14.9) (71.9) (20.1) (21.3) 384.6 Additions/(reductions in current liabilities 8.3 2.1 2.3 11.4 3.1 3.3 (129.1) Normal operating cash flows 38.9 (8.4) 26.8 26.4 (20.7) 23.5 23.3 255.5 Investing cash flows (28.7) (28.2) (27.8) (27.6) (27.5) (27.6) Operating and investing cash flows 10.2 (36.6) (1.0) (1.2) (48.2) (4.1) 23.3 255.5 Interest (1.6) (0.4) (4.3) (4.9) (5.6) (11.3) (12.9) (11.9) Additions/(reductions) in non-current liabilities (38.0) Tax Share capital Movements in loans (8.7) 38.4 5.7 6.5 55.7 15.9 (9.8) (116.5) Dividends Total cash flows (0.1) 1.4 0.4 0.4 1.9 0.5 0.6 89.0 Cash at the start of the year 5.0 4.9 6.4 6.7 7.1 9.0 9.5 10.1 Cash at the end of the year 4.9 6.4 6.7 7.1 9.0 9.5 10.1 99.1 Loans CET-2 2010 2011 2012 2013 2014 2015 2016 2017 Cash requirement 4.9 6.4 6.7 7.1 9.0 9.5 10.1 Loans at the start of the year (12.6) (4.0) (42.4) (48.1) (54.7) (110.4) (126.3) (116.5) Cash at the start of the year 5.0 4.9 6.4 6.7 7.1 9.0 9.5 10.1 Opearating and investing cash flows 10.2 (36.6) (1.0) (1.2) (48.2) (4.1) 23.3 255.5 Interest (1.6) (0.4) (4.3) (4.9) (5.6) (11.3) (12.9) (11.9) Taxation MoU and share transactions (38.0) Cash at the end of the year (4.9) (6.4) (6.7) (7.1) (9.0) (9.5) (10.1) (99.1) Loans at the end of the year (4.0) (42.4) (48.1) (54.7) (110.4) (126.3) (116.5) 124 Economic Consulting Associates, May 2011 A5.3 CET-1 Profit and loss CET-1 2010 2011 2012 2013 2014 Operating revenues Sales of heat to Termocom 120.5 157.8 167.2 177.3 Sale of electricity 215.5 428.4 451.5 476.1 Other revenues 1.1 1.4 1.5 1.6 Total 337.1 428.4 451.5 476.1 Operating expenditure Fuel for generation 229.4 299.3 317.3 336.3 Staff costs 26.3 27.9 28.9 30.0 Other costs 70.5 76.2 80.8 85.6 Total 326.2 403.4 426.9 451.9 Depreciation 10.4 17.2 16.4 15.7 562.2 Operating profit 0.4 7.8 8.1 8.4 (562.2) Investing gains/(losses) Financing costs (0.6) (3.0) (2.7) (0.8) Exceptional results Profit/(loss) before taxation 0.4 7.3 5.2 5.7 (563.0) Tax on net profits Net profit/(loss) 0.4 7.3 5.2 5.7 (563.0) Reserves b/f 555.8 556.1 563.4 568.6 574.3 Reserves at the end of the year 556.1 563.4 568.6 574.3 11.3 Net assets CET-1 2010 2011 2012 2013 2014 Non-current assets Intangible fixed assets 0.0 0.0 0.0 0.0 Tangible fixed assets 577.9 577.9 577.9 562.1 Long-term investments Total non-current assets 577.9 577.9 577.9 562.2 Current assets MoU parties: current receivables 54.2 71.0 75.2 79.7 Municipality of ChiüinĆ u Ministry of Finance Heat customers (end-users) Other receivables 35.4 70.4 74.2 78.3 Current trade receivables 89.6 141.4 149.4 158.0 Stocks of goods and materials 10.5 10.5 10.5 10.5 10.5 Cash and bank balances 0.2 0.2 0.2 0.3 16.6 Other current assets Total current assets 100.3 152.1 160.2 168.8 27.1 Current liabilities MoU parties: current payables (69.6) (90.8) (96.3) (102.0) Other trade payables (25.6) (25.6) (25.6) (25.6) Other short-term liabilities (5.5) (5.5) (5.5) (5.5) Bank loans payable < 1 year (0.2) (1.2) (1.1) (0.3) Total current liabilities (100.9) (123.1) (128.4) (133.4) Net current assets/(liabilities) (0.6) 29.1 31.8 35.3 27.1 Non-current liabilities: ordinary Bank loans payable > 1 year (5.4) (27.8) (25.3) (7.4) Deferred revenue - grants & subsidies Other long-term liabilities (0.0) (0.0) (0.0) (0.0) Total non-current liabilities: ordinary (5.4) (27.8) (25.4) (7.4) Net assets/(liabilities) Ordinary net assets 571.9 579.2 584.4 590.1 27.1 Non-MoU creditors committee liabilities Net assets before non-current MoU parties 571.9 579.2 584.4 590.1 27.1 MoU parties: internal 433.6 433.6 61.6 61.6 61.6 MoU parties: external (372.0) (372.0) Total net assets/(liabilities) 633.5 640.8 645.9 651.6 88.7 Phase 1 Report: Chişinău Heat & Electricity Supply Institutional & Financial Restructuring Study 125 Capital and reserves CET-1 2010 2011 2012 2013 2014 Capital and reserves Share capital 77.4 77.4 77.4 77.4 77.4 Reserves and accumulated losses 556.1 563.4 568.6 574.3 11.3 Total capital and reserves 633.5 640.8 645.9 651.6 88.7 Fixed assets CET-1 2010 2011 2012 2013 2014 Intangible assets b/f 0.0 0.0 0.0 0.0 0.0 Additions 0.0 0.0 0.0 Depreciation (0.0) (0.0) (0.0) (0.0) (0.0) Intangible assets c/f 0.0 0.0 0.0 0.0 Total tangible assets b/f 577.9 577.9 577.9 577.9 562.1 Additions 10.4 17.2 16.4 Depreciation (10.4) (17.2) (16.4) (15.7) (562.1) Total tangible assets c/f 577.9 577.9 577.9 562.1 Cash flows CET-1 2010 2011 2012 2013 2014 Operating profits 0.4 7.8 8.1 8.4 (562.2) Add back depreciation 10.4 17.2 16.4 15.7 562.2 Reductions/(additions) in current assets (6.0) (51.8) (8.0) (8.6) 158.0 Additions/(reductions in current liabilities 21.2 5.4 5.8 (133.1) Normal operating cash flows 4.9 (5.5) 21.9 21.4 24.9 Investing cash flows (10.4) (17.2) (16.4) Operating and investing cash flows (5.6) (22.7) 5.5 21.4 24.9 Interest (0.6) (3.0) (2.7) (0.8) Additions/(reductions) in non-current liabilities (0.0) Tax Share capital Movements in loans 5.6 23.3 (2.5) (18.7) (7.7) Dividends Total cash flows 0.0 0.0 0.0 0.0 16.3 Cash at the start of the year 0.2 0.2 0.2 0.2 0.3 Cash at the end of the year 0.2 0.2 0.2 0.3 16.6 Loans CET-1 2010 2011 2012 2013 2014 Cash requirement 0.2 0.2 0.2 0.3 Loans at the start of the year (5.6) (28.9) (26.4) (7.7) Cash at the start of the year 0.2 0.2 0.2 0.2 0.3 Opearating and investing cash flows (5.6) (22.7) 5.5 21.4 24.9 Interest (0.6) (3.0) (2.7) (0.8) Taxation MoU and share transactions (0.0) Cash at the end of the year (0.2) (0.2) (0.2) (0.3) (16.6) Loans at the end of the year (5.6) (28.9) (26.4) (7.7) 126 Economic Consulting Associates, May 2011