Energy Market Liberalization and the New Trends in the Sector

Dear Madam Minister,

Dear Chairman (of the regulator),

Distinguished participants and guests:

Thank you for inviting me and the World Bank to attend this event and to contribute to the discussion of Bulgaria’s energy sector reform. While I am not an energy expert, I represent an international institution that is strongly committed to two important features of this reform:

• First, we believe, and our analytical work confirms, that this is a crucially important sector for the economy and it is essential that it is brought back onto a stable and sustainable financial footing. Transitioning to a competitive market model is the way to ensure that the benefits of reliable and affordable electricity can translate into higher economic growth and shared prosperity.
• Second, it is the World Bank mandate to work for the elimination of poverty and to protect the vulnerable. As the Minister mentioned earlier, it will be particularly important to ensure that the most vulnerable people in Bulgaria can afford electricity supplies.

In this context, the Bulgarian government has a clear plan for moving forward and is taking specific measures to achieve these two goals - transitioning to a competitive market and ensuring protection of the vulnerable people. We are happy to have the opportunity to support the government and to work with other partners to realize the goal of liberalization of the power market.

While our analysis and our recommendations are still to be finalized, let me mention three aspects that I believe are important elements of the reform program.

The first element has to do with the transition to a competitive electricity market. As part of the transition it would be mandatory for State Owned generators to participate fully in the exchange. The State would lead by the example and make all State-Owned Enterprises participate in IBEX for 100% of their output. They would be able to choose which window is best suited for them (i.e. long-term OTC, day ahead, intraday window) in order to optimize their portfolio.

In addition to bringing much needed liquidity to the market, we believe it will contribute to greater transparency and will help to address some of the long standing concerns of governance in the sector.

Such a transition could start immediately (or as soon as IBEX has its platform for bilateral contracts in place). It may take up to one year for all output to be offered through IBEX. This would be adequate to create the space and the time for generators to learn and adapt to the new market circumstances.

The second element is related to the integration into the competitive market of major private sector generators with whom NEK has long-term contractual (AES and Contractor Global) and legal obligations (Renewable Energy producers). Given the relatively small market and the limited number of players, integrating major electricity generators into the organized wholesale market (IBEX) can bring about significant benefits in terms of improving liquidity, creating a transparent price and a credible price signal for efficient contracting.

One of the options being considered is the introduction of the so called “contracts for difference”. These financial instruments have been introduced in many different systems which have transitioned to competitive markets. Some form of “contracts for difference” have been used in Europe, including in the UK and Finland (for Renewable Energy) and Poland (Purchasing power agreements). Other countries in the world also have opted for this instrument (Australia, Korea, etc.)

While the design of the “contracts for difference” can vary significantly, the main principle holds: they are financial instruments aimed at reducing the exposure to volatile energy prices for the party who receives the contracts for difference. This creates security and stability in form of fixed energy prices or certain revenues so that the key financial parameters agreed upon in a long-term contract or by providing feed-in tariffs remain unchanged.

The timing for the implementation of this measure can vary substantially, based on international experience. In Poland for instance, it took several years to be put in place. One of the key determinants for success will be the degree by which it could be implemented in a ‘concerted and participatory way’, in full respect of the contractual and legal obligations by all parties.

The third important element of the reform is the process of de-regulation for end-consumers. This process has two dimensions:

• First is the protection of vulnerable consumers. The Government has set-up a working group with DG Energy to analyze options to protect the vulnerable population and we are supporting this effort with our analytical work. While our teams are still working on the data, let me just briefly outline what we know so far from our previous estimates based on data from 2008. It is a fact that Bulgarian households are more reliant on electricity than households in other EU Member States, and on average electricity expenditures of Bulgarian families account for over 60% of the total households’ expenditures in energy, compared to about 40% in Hungary, Lithuania, Latvia, and Poland. Therefore, putting in place a system that would be able to adequately protect the vulnerable consumers’ needs to go hand in hand with the process of liberalization. And here I would like to commend the Minister for her strong leadership on this topic.
• Second is price de-regulation for all household consumers. This is really the last step in the implementation of market liberalization. Full price de-regulation should be seen as a process with a transitory period during which consumers will be gradually moved towards market based pricing. This would ensure a smooth transition (price wise) for consumers.

In principle such a process could take 3 to 5 years since the pre-requisites to this are the existence of a competitive wholesale market and a system to protect vulnerable consumers. So these need to come before the transition for consumers to market based pricing.

I know that many of the people in this room are eager to find answers to their very practical questions. Here let me commend the Minister for her strong commitment to undertake broad public consultations once she gets all of our input. We are fully committed to support her efforts and trust that we will be in a better position to answer your questions at that time.