Turkish electricity reform

Utilities Policy 17 (2009) 144–152 Contents lists available at ScienceDirect Utilities Policy journal homepage: www.elsevier.com/locate/jup Turkish electricity reform Necmiddin Bagdadioglu a, *, Necmi Odyakmaz b,1 a b Department of Public Finance, Hacettepe University, 06800 Ankara, Turkey E.ON Holding, Armada Business Centre, 06520 Ankara, Turkey a r t i c l e i n f o a b s t r a c t Article history: Received 31 August 2007 Received in revised form 14 January 2008 Accepted 28 February 2008 Turkish electricity reform has progressed slowly due to internal resistance against privatisation, and gained momentum after Electricity Market Law of 2001, prepared in line with EU Energy Acquis and established required institutional and legal framework. Although the eligibility threshold has reached 39% market opening rate, the dominant position of public both as owner and decision-maker is still the major problem in the sector. Currently Turkey is self-sufficient in electricity, but likely to face shortages in 10 years if the growing demand is not met by either speeding the liberalisation process, or joining the South East Europe Electricity Market. Ó 2008 Elsevier Ltd. All rights reserved. Keywords: Electricity reform Industrial organisation Government policy Regulation JEL classification: L94 Q40 Q48 1. Introduction Turkey’s longstanding ambition of joining the European Union (EU) came a step closer as a result of its recognition as an accession country in October 2005. Since the establishment of official ties in 1959, Turkey has sought to harmonize with EU rules, progressing faster in some areas than some others. In the electricity sector, a reform programme was initiated in 1984, but gained momentum only after 2001 with the announcement of the Electricity Market Law (EML), prepared in line with the EU Energy Acquis. The EML Abbreviations: EML, Electricity Market Law; EU, European Union; Strategy Paper, Electricity Sector Reform and Privatisation Strategy Paper; KCETAS, Kayseri Electricity Distribution Company; MENR, Ministry of Energy and Natural Resources; TEK, Turkish Electricity Authority; BOT, Build-Operate-Transfer; BOO, Built-Operate-Own; TOOR, Transfer of Operating Rights; TEAS, Turkish Electricity Generation Transmission Company; TEDAS, Turkish Electricity Distribution Company; EUAS, Electricity Generation Company; TEIAS, Turkish Electricity Transmission Company; TETAS, Turkish Electricity Wholesale Company; EMRA, Energy Market Regulatory Authority; TPA, Third Party Access; PA, Privatisation Administration; PPA, Power Purchasing Agreement; UCTE, Union for the Coordination of Transmission of Electricity in Europe; DSI, State Water Works; SEEEM, South East Europe Electricity Market. * Corresponding author. Tel.: þ90 312 2978675; fax: þ90 312 2992063. E-mail addresses: [email protected] (N. Bagdadioglu), necmi.odyakmaz@ eon.com (N. Odyakmaz). 1 Necmi Odyakmaz was Energy Expert at the Turkish Energy Market Regulatory Authority at the writing stage of this paper. 0957-1787/$ – see front matter Ó 2008 Elsevier Ltd. All rights reserved. doi:10.1016/j.jup.2008.02.001 aims to ensure the development of a financially sound and transparent electricity sector operating in a competitive environment under provisions of civil law to ensure delivery of sufficient, high quality, low-cost and environment-friendly electricity to consumers, and subject to autonomous regulation and supervision of this market. The EML is supported by comprehensive secondary legislation addressing all types of market activities, as well as the rights and obligations of market participants. The newly created South East Europe Electricity Market (SEEEM) envisages Turkey’s integration into the European Electricity Market. Due to environmental concerns, Turkey has not yet signed the Energy Community Treaty of 2005 but has signalled its intention to participate by publishing the Electricity Sector Reform and Privatization Strategy Paper (Strategy Paper) in 2004. The Strategy Paper detailed the procedure for privatization due to start by the end of 2006 and to conclude by 2011 (CEC, 2006; World Bank, 2006). Privatization has not commenced as planned since 2007 has been a politically sensitive year due to parliamentary and presidency elections in Turkey. In light of the political sensitivity of privatization, the government has postponed privatization of electric facilities until 2008. Turkey’s electricity sector is presently dominated by public companies, and the country’s deep-rooted statist tradition is likely to slow privatization even after the elections. Nevertheless, Turkey has had to deal with problems of inefficiency in publicly owned and managed state electricity enterprises, a high ratio of network N. Bagdadioglu, N. Odyakmaz / Utilities Policy 17 (2009) 144–152 losses, rapid growth in electricity demand, substantial investment requirements both to expand generation capacity and for the extension of the grid, high maintenance costs of the transmission grid and of generation plant, combined with inadequate public sources of capital for investment. Furthermore, the electricity industry faces a legacy of poor technical and commercial security, low quality, substantial cross-subsidies and external costs, combined with the challenge of compulsory harmonization with EU Acquis, and global energy trends. Turkey has two possible options for reform: either creating its own national electricity market, or joining SEEEM. Turkey is the largest of all the countries in the region both in terms of population (around 73 million) and in terms of the number of accounts. The former option is therefore feasible, but only if internal resistance to privatization and liberalization is surmounted. Not only does Turkey’s obligations to the EU require it to take the second course, but this may also help to overcome the internal resistance to reform by opening electricity market to external competition. Turkey, covering 781 000 km2, is located at the crossroads of energy flows between Asia and Europe,2 making it an important territorial bridge between the growing energy needs of the EU, and the desire of Middle Eastern and Hazarian energy sources to satisfy this demand. Turkey is currently self-sufficient in electricity, but likely to face shortages in the coming decade if electricity demand continues to grow at the current pace of around 10% annually. As other papers of this special issue point out, integration might be a mutually beneficial move, since Turkey can access electricity surpluses likely to emerge in SEEEM. Turkey’s historical ties with countries of this region from the time of the Ottoman Empire might help ease integration and trade. In the light of these arguments, this paper assesses the progress of Turkey’s electricity reform programme in six sections. Section 2 provides the background to the Turkish electricity sector, Section 3 evaluates Turkey’s progress against the benchmarks of reform outlined in Jamasb et al. (2004), Section 4 looks at the recent performance of the sector, Section 5 discusses progress to date and the impact of reforms, and Section 6 offers recommendations and prescriptions for future reform. 2. Background to electricity sector3 The electricity sector has developed historically in accordance with two different economic transformation strategies pursued in Turkey since its establishment in 1923 following the defeat of Ottoman Empire at the end of World War I. The first, an import substituting development strategy, dominated the period until 1980, and was characterized by widespread public entrepreneurship, cross-subsidization between sectors, and soft budgeting. This protective approach collapsed as the increasing oil prices of the 1970s worsened the structural deficits of Turkey’s current account, elevating the consumer price index to triple digits, creating political turmoil and bringing economic transactions to a standstill. Since the 1980s, an export-oriented alternative followed has produced better, yet still unsatisfactory results. Disappointing results from this export-oriented approach have been due partly to a number of internal and external economic crises, two unfortunate earthquakes, as well as partly to persistent state control and intervention in economic activities, strong resistance against privatization from the public, from bureaucrats, workers unions, and political parties. 2 Turkey is bordered by Bulgaria, the Black Sea to the North, Georgia, Armenia, Azerbaijan, and Iran to the East, Iraq, Syria and the Mediterranean Sea to the South, and Greece and the Aegean Sea to the West. 3 A detailed account of development of Turkish electricity sector is available in Hepbasli (2005), Ozkivrak (2005), and Atiyas and Dutz (2003). 145 The development of Turkey’s electricity sector reflects these streams of economic development, both in ideology and practice. The first years of the Turkish Republic were spent rebuilding the war-torn country and revitalising economic activities. Financial resources were scarce, forcing Turkey to rely for its electricity provision (mainly to large cities such as Istanbul) on private, predominantly foreign companies, including German (MAN&AEG in Ankara), Belgian, Italian and Hungarian (Ganz Corporation) firms.4 As nationalization flourished during the 1930s, all energy related activities were entrusted to public entities. The first interconnection was provided between Istanbul and Çatalağzi thermal power plant in 1952. The Ministry of Energy and Natural Resources (MENR) was created in 1963 while the Turkish Electricity Authority (TEK) was founded in 1970 as an integrated monopoly, incorporating all electricity activities other than distribution, which was assigned to municipalities until 1982. Electrification of the country accelerated during this period, while investment in generation capacity was given priority to meet growing demand. However, due to unfavorable economic conditions of the period, necessary investment for renewal and maintenance, as well as for new projects, could not be provided from the central budget. Following the adoption of an export-oriented development strategy in 1980, various models for reorganization and investment have been introduced in order to attract private investors into electricity sector. In 1984, the monopoly power of TEK was removed by allowing private entities to undertake generation, transmission and distribution activities of electricity. Three different financial models were tried to satisfy urgent investment needs of electricity sector, namely Build-Operate-Transfer (BOT), Built-Operate-Own (BOO), and Transfer of Operating Rights (TOOR) models. These models all required the Treasury’s guarantee, with contracts signed on a take-or-pay basis. Consequently, none of these reduced the financial burden on the public purse. A more fundamental approach for easing this burden on the public budget was introduced with the enactment of Electricity Market Law, no. 4628 in 2001, in line with EU Energy Acquis. This new law was accompanied by the Strategy Paper of 2004, covering procedures for privatization of distribution and generation assets, measures peculiar to the transition period ending at 2011, and security of supply mechanisms. We now turn to an assessment of the Turkish electricity reform programme, as initiated in 1984, following the framework provided by Jamasb et al. (2004).5 3. Electricity reform programme As of today all public electricity utilities are corporatized. The first major corporatization was accomplished in 1993, with the splitting of TEK into two separate public utilities, the Turkish Electricity Generation Transmission Company (TEAS) responsible for both generation and transmission activities, and the Turkish 4 For the first time electricity is generated in Tarsus by 2-kW dynamo connected to watermill under Italian–Swiss joint venture in 1902. In the year 1913, a bigger _ generation plant was set in Istanbul, Silahtaraga. The longest serving private utility, the Kayseri Electricity Distribution Company (KCETAS), which is still distributing electricity today in and around Kayseri province, was established during this period (in 1926), as well. 5 These are as follows: (1) corporatization of state owned utilities, (2) enactment of electricity reform law, (3) regulatory reform, including adaptation of incentive regulation for natural monopoly network activities, (4) establishment of an independent regulator, (5) unbundling of vertically integrated utilities into generation, transmission, distribution and supply activities, and where necessary horizontal splitting, (6) provision of Third Party Access to networks, (7) establishment of a competitive wholesale generation market, (8) liberalization of the retail supply market, (9) privatization of electricity assets, and (10) definition of rules governing consumer protection, allocation of energy subsidies, and stranded costs. We do not take these benchmarks in order. 146 N. Bagdadioglu, N. Odyakmaz / Utilities Policy 17 (2009) 144–152 Electricity Distribution Co (TEDAS) responsible for distribution and retail sale activities. The EML of 2001 further splits TEAS into three public entities, namely EUAS, which inherited generation plants, TEIAS, which was assigned duties of transmission and system operation, and TETAS being made responsible for electricity trading. Although corporatized, all electricity utilities remain under government control in terms of decision making, and enjoy little managerial autonomy. Legal ownership unbundling has not yet been achieved, but accounts have been separated. Participants in the generation, transmission, distribution, import–export, wholesale, and retail markets required a license. The minimum term for generation, transmission, distribution, and retail sale and service licenses is 10 years, with a maximum of 49 years. The EML also established the Energy Market Regulatory Authority (EMRA) as an independent and financially autonomous entity, supervised by the Energy Market Regulatory Board. The Board comprises nine members including president and vice president, appointed by the Council of Ministers. The President chairs the Board and governs EMRA, which is responsible for preparing and implementing secondary legislation, authorising market participants, approving and publishing tariffs, monitoring and supervising market participants, conducting technical, legal and financial audits, settling disputes, approving, amending and enforcing performance standards, and, where necessary, applying sanctions. To create appropriate incentives, EMRA has adopted a performance-based regulatory framework for naturally monopolistic activities. Tariffs are regarded as an instrument for maximization of social welfare, and have been evaluated as a pricing policy instrument that balances interests of various types of customers, license owner producers, transmission companies, distribution companies, sector employees and third parties (e.g. environmental factors). Legal infrastructure of tariffs consists of one code (Electricity Market Tariff Code) and six Communiqués, which require a nondiscriminatory conduct between equal parties. Cross-subsidies between activities and customer classes are forbidden, and the tariff framework requires unbundling of accounts and sets minimum requirements of financial liquidity for companies. Tariffsetting includes cost reflective parameters in price and revenue cap calculations, customers groups in terms of their load factors or cost structures, and aims to suppress under/over tariff implementation, exclude costs not directly related to market operations, and support consumers in need by direct subsidy (universal service principle), while promoting competition and performance-based incentives. In this context, transmission, distribution, retail sale of electricity and capacity to non-eligible customers, retail sale service and wholesale price have all been regulated according to different principles (see Table 1). However, retail sale electricity and capacity, retail sale service and wholesale activities are to be deregulated at the end of interim period since they do not have natural monopoly features. The EML obliges transmission and distribution companies to allow open, guaranteed, and non-discriminatory access to their Table 1 Methods of regulation Activity Regulated price/charge Method Transmission (TEIAS) Distribution Connection charge Use of system price System operation price Connection charge Retail service Retail Wholesale (TETAS) Use of system price Retail service price Average retail price Average wholesale price Project based Revenue cap Revenue cap Project based and standard connection charge Hybrid Price cap Price cap Cost based Source: EMRA (2003). networks by third parties to ensure a competitive environment. Third Party Access (TPA) to the transmission grid and distribution networks, connection fees and system usage tariffs are all subject to EMRA regulation. The TPA requirements are included in the Transmission and Distribution Grid Codes and in the Electricity Market Licensing Regulation. Where connection to the system is not possible at the proposed connection point, and where an alternative is not proposed or is not deemed to be feasible, a legal entity is permitted to construct private direct transmission lines between its generation facility and its partners and/or customers. Disputes among related parties are settled by EMRA. Transmission system capacity for export–import activities is allocated by TEIAS on a pro-rata basis, making use of a tendering process only if demand exceeds currently available capacity. The new market structure provided for by the EML is in many aspects fundamentally different from the previous monopolistic and centralized regime. The EML envisages a bilateral contracting market complemented by a residual balancing mechanism. All generation capacity is sold to wholesalers, retailers, and consumers either directly or via a spot market. The balancing and settlement market, which complements the bilateral free market, is managed by TEIAS. The balancing rules as set by the regulation envisage a two phase operation of the balancing mechanism. The balancing market is a compulsory market and every generator above 20 MW has to submit bids and offers to TEIAS. The first phase of the market operation is a Day-Ahead scheduling by TEIAS based on the bid/offer prices. The hourly prices for the next day are also calculated by TEIAS. Every generator gets the price of the marginal generator required to meet the forecast demand. The next phase is the within the day and real-time bid and offer acceptances by TEIAS to meet the fluctuations in supply and demand. Real-time offers and bids are paid at their offer price. Following the real-time bids, trades are settled by TEIAS using system marginal prices, offer/bid prices and system imbalance price. System imbalance price is calculated as the weighted average of system marginal price calculated for every hour within the particular settlement period. There are three settlement periods: day, peak and night periods. The settlement calculations are performed every month and market participants are invoiced monthly according to their trading and imbalance positions. As of 3 March 2003, eligible consumers have become free to choose their suppliers. Eligible consumers were initially identified as those directly connected to the transmission grid or with annual consumption of more than 9 GWh. EMRA has the authority to lower the eligibility threshold over time, with the intention that eventually all customers would be free to choose their suppliers. The latest Board decision reduced the eligibility threshold of annual consumption from 7.8 million kWh to 6 million kWh per customer. This eligibility threshold corresponds to a 39% market opening rate. Although the secondary legislation does not contain a timeframe for the full eligibility, EMRA has been working to lower those limits by continuous monitoring and assessment of the market development. Full eligibility is expected by 2011. The complete privatization of the sector is envisaged by 2011, with the exception of the transmission ownership and operation functions. According to the EML, MENR shall provide the Privatization Administration (PA) with proposal and opinions regarding the privatization of the assets belonging to TEDAS and EUAS, and their subsidiaries, affiliates, partnerships and operational units and facilities. The privatization process shall be executed by PA according to the provisions of Privatization Law no. 4046.6 Foreign real persons and legal entities engaged in the market activities within the scope of privatization activities are not permitted to 6 Privatization methodology adopted for distribution and generation assets is explained in Section 5.2. 147 N. Bagdadioglu, N. Odyakmaz / Utilities Policy 17 (2009) 144–152 acquire a controlling market share in the generation, transmission and distribution sectors. Due to the existing contracts,7 the power purchase obligations from private generators constitute a ‘‘stranded cost’’ element in the new system, and the government, via TETAS, undertakes responsibility for recovering these contracts as a type of vesting contracts. The chosen approach is to mitigate stranded costs by offsetting them via bundling high existing contracts prices with low-cost (hydro) generators, resulting in an acceptable average price. According to this system, the ‘‘off-setting’’ role of TETAS should be reduced as existing contracts mature, but the extension of preparation and transition periods, and unexpected delays in market implementations and new requirements are likely to strengthen the raison d’etre of TETAS rather than leading to its gradual disappearance. Where consumers require support in certain regions and/or in line with certain objectives, a subsidy can be provided in the form of direct cash refunds to consumers without affecting prices. The amount, procedure and principles of these refunds are determined by the Council of Ministers upon the proposal of MENR. Distribution companies holding retail licenses are obliged to act as a supplier of last resort in accordance with the Electricity Market Licensing Regulation. Distribution companies are obliged to obtain a retail license and serve consumers who cannot get retail electricity and/or services from another supplier, or whose suppliers cannot provide service temporarily due to legal reasons or permanently due to ending its activities. As the foregoing shows, the legal and institutional framework for privatization and liberalization is in place in Turkey, awaiting the government’s decision to go ahead. 4. Recent performance of the electricity sector 4.1. Generation As of February 2007, Turkey’s total generation capacity is 40 161 MW. Of this, 23 356 MW is provided by EUAS while 9201 MW comes from BO, BOT and TOOR type plants, with a further 6882 MW produced by auto-producers and private generation companies. Thus, state owned generation plants dominate with a 58.2% share of all generation. As far as primary sources used for generation are concerned, 13 063 MW is based on hydro power whereas 12 735 MW and 7851 MW are based on natural gas fired power plants and lignite fuel plants, respectively. The remaining 6513 MW of the total capacity consists of electricity generated from petroleum products, hard coal, geothermal, wind and other renewable sources. In 2006, annual total electricity production reached 176 billion kWh, an 8.6% increase compared to the previous year. Meanwhile, total electricity consumption was 174 billion kWh, corresponding to an 8.3% annual increase. 131 billion kWh of total production was provided by thermal plants, whereas 44 billion kWh and 344 million kWh were provided by hydro plants and other renewables, mainly wind turbines, respectively. In terms of ownership structure, 48% of total production is realized by EUAS and its affiliates while 35% is provided by electricity generation companies under vesting contracts. The rest is provided by auto-producers and private generation companies competing freely in the market (see Table 2). 7 As stated in the Law of 2001, existing contracts are the contracts and concession and implementation agreements signed by the private companies and the government before the enactment of the Law of 2001 in accordance with the terms and conditions of Laws no. 3096, no. 3996, no. 4283 and no. 4501 and related regulations. Table 2 Installed capacity (2006) Companies MW EUAS EUAS’s affiliates TOR Gencos Mobile Gencos BO Gencos BOT Gencos Private Gencos Auto-producers 19 521.91 3834 660.1 721.8 6101.8 2449 2781.9 4100.6 Share (%) 48.61 9.55 1.62 1.80 15.19 6.10 6.92 10.21 Total 40 160.97 100.00 Source: TEIAS (2006). Turkey’s electricity generation is mainly based on thermal plants. Their share in total electricity production was 75% in 2006. The remaining quarter of total electricity is produced by hydro power plants. Wind power is negligible, amounting to less than 1% of total generation despite the priority given to renewables, especially wind power, in the government’s new energy policy. Natural gas fired power plants are the largest single source of generation, amounting to 44% of total electricity generated. This is followed by hydro power plants with 25% share, and by lignite fuel plants with 18%. As of 2006, 44% of primary sources that are used for electricity generation are imported (see Table 3). In 2006, Turkey exported 2.2 billion kWh electricity to Iraq, Georgia, Nahcivan (Autonomous Republic of Azerbaijan) and Syria. Turkey’s main electricity trading partner is Iraq (75% of all trade in electricity). Around 573 million kWh of electricity was imported from Georgia and Turkmenistan in 2006. Security of supply is a priority in Turkey’s energy strategy. As a result of the growth in demand, installed capacity has increased nearly 2000 times since 1923, but this has been outpaced by energy demand, which has increased more than 3000 times since 1923. The growth rate in electricity demand is about 10% per annum on average, requiring new capacity in the short and medium term. According to the latest demand forecast of 2004 by MENR, Turkey’s electricity consumption will increase by around 7.8% (6.4%), that is, 499 489 GWh (406 530 GWh) according to the high (low) demand growth scenario in 2020 (TEIAS, 2006). As realized consumption in 2007 shows, growth in the annual electricity demand rate is far above expected growth. According to ‘‘the XI Five Year Development Plan’’ published in 2007, at least 72.8 billion US $ and Table 3 Generation based on primary sources (2006) Primary sources Total (KWh) Share (%) Fuel-Oil Motorin Coal Imported coal Lignite Geothermal LPG Nafta Natural gas Biogas Others 5 363 975 918 17 335 799 2 854 133 976 11150 123 075 32 302 831805 94 085 740 436 740 317 1889 565 566 77 386 943 885 39 662 983 80 880 698 Total thermal 131 606 269 761 74.83 With reservoir River type 41 247 308 621 2 910 344 672 23.45 1.65 Total hydro 44 157 663 293 25.10 129 358 021 176 893 281 075 0.07 100.00 Wind Total generation Source: TEIAS (2006). 3.04 0.01 1.63 6.34 18.37 0.05 0.25 1.07 44.00 0.02 0.05 148 N. Bagdadioglu, N. Odyakmaz / Utilities Policy 17 (2009) 144–152 at most 102.4 billion US $ will be needed to meet electricity sector investment requirements. A good investment climate is required to meet this capacity through the private sector. In terms of demand side management, Energy Efficiency Law no. 5584, approved by the Turkish Grand National Assembly in 2007, approved a number of instruments to support energy efficiency both at the micro- and macro-level. These instruments include undertakings such as energy management, monitoring, utilization of heat and temperature control, the use of individual metering systems for the central heating of buildings, energy performance certificates for buildings, co-generation and micro-co-generation, research and development activities as well as a number of incentives namely, projects for improving energy efficiency on existing industrial plants, co-generation and promoting central heating systems in buildings. 4.2. Wholesale The Turkish wholesale electricity market is based around a bilateral contract market supplemented by a real-time balancing market. TETAS is taking over all purchasing obligations arising from the contracts with generators operating under BOT, BOO and TOOR schemes. TETAS also performs import and export activities. There are currently 24 licensed companies operating in the wholesale market, of which 20 actively take part in the balancing and settlement market. The market share of TETAS is 78%, with the remaining share belonging to private Gencos, auto-producers and auto-producer groups. Roughly 50% of electricity is provided by EUAS and its affiliates. Within the scope of its wholesale license, the tariffs of TETAS covering energy sales and purchase agreements, taking over existing contracts, the selling of electricity power to directly connected eligible consumers and the activities of import and export are subject to regulation. The wholesale tariff of TETAS is set on the basis of a cost-based tariff approach and is subject to the approval of EMRA. This means that during the determination of wholesale tariffs all financial liabilities of TETAS will be taken into consideration. 4.3. Transmission and UCTE TEIAS is responsible for the construction, operation, and maintenance of the electricity transmission grid. It is also responsible, as system operator, for dispatch, frequency control, monitoring realtime system reliability and for the purchase and provision of ancillary services. TEIAS is also responsible for the running of the electricity market in the form of Day-Ahead balancing and settlement market. Transmission grid and market activities are completely unbundled from other market and regulated activities. The transmission system is the backbone of the whole electricity system in Turkey, since most generation is undertaken in the eastern regions where the big hydro plants are located, while most of the consumption takes place in industrialized and urbanized western cities. TEAIS performs its duties through one national and seven regional load dispatch centres. Its transmission assets consist of 1089 transformers with total capacity of 71 219 MVA and 45 896 km of lines. Most lines are 380 kV and 154 kV transmission lines. Transmission system losses are 3.2% in 2006 (which were 2.9% and 2.8% in 2005 and 2004, respectively). Turkey attaches prime importance to the interconnection of the Turkish power system with the European power network, and recent progress has been achieved in this respect. Turkey is not a member of the Union for the Coordination of Transmission of Electricity in Europe (UCTE) but wished to join by the end of 2007. Turkey is accordingly undertaking necessary investments required for joining UCTE, upgrading its system control and load dispatching abilities, implementing market management software and constructing cross-boundary interconnections with Greece and Georgia. Turkey’s interconnection to UCTE is expected to impact positively on the security of supply both in the South East European region and in Turkey through consolidated electricity trade (UCTE, 2005). Turkey is already interconnected with Bulgaria (400 kV), Georgia (220 kV), Armenia (220 kV), Iraq (400 kV), Iran (154 kV and 400 kV), Syria (400 kV), Nahcivan (154 kV) and Turkmenistan (154 kV). 4.4. Distribution Distribution companies operate as regional monopolies with distribution licenses granted by EMRA subject to regulation. Turkey’s distribution network is divided into 21 distribution regions based on geographical proximity, managerial structure, and energy demand, as well as legal concerns and other technical/financial factors as set out in Strategy Paper (2004).8 Twenty regions have been placed on the privatization agenda, and transferred to PA. The geographical coverage of distribution regions is provided in Table 4. Twenty distribution regions representing 98% of the total distribution in Turkey are currently operated by 20 different discos based on TOR agreement with TEDAS. Kayseri (region number 18) is the only region in which a private company distributes electricity, following the transfer of operating rights to KCTEAS in 1990.9 The Kayseri region accounts for approximately 2% of net electricity distributed in Turkey. In 2005, the distribution network in Turkey consisted of around 842 393 km of lines (roughly 40% mid-voltage (MV) and 60% lowvoltage (LV), of which around 94% is airborne, with the remaining 6% underground). There are 285 175 distribution transformers with a total capacity of 90 000 MVA and around 13.5 millions poles. TEDAS owns approximately 92% of existing distribution lines and 56% of transformers as of 2005, and provides services to nearly 28.5 million customers. Electricity losses in transmission and distribution networks amounts to some 20.2 TWh in total, which means that 17.8% of total electricity generated in Turkey has disappeared or has been stolen. In 2005, winter and summer peaks were 25 174 MW and 23 887 MW, respectively. In 2005, 1 393 853 interruptions corresponding to a total of 1 346 406 h were experienced in the distribution system, excluding Kayseri. The roughly equal winter and summer peaks may be explained by growing incomes and increasingly hot summers in recent years. Last summer, Turkey experienced blackouts in 13 provinces for the first time in years due to excessive usage of cooling electrical appliances. Within the framework for performance-based regulation, a hybrid revenue cap approach has been devised for regulating distribution activities. Revenue requirements of distribution companies are calculated based on a ‘‘building block approach’’ dealing separately with operational expenditures and capital expenditures. Performance-based components, such as benchmarking operational expenses, technical losses, and service quality targets are determined by EMRA for each utility. The main component of the market structure is the balancing mechanism. The rules of the balancing mechanism are set by the Balancing and Settlement Code, published at the end of 2004, which took effect from August 2006. Four hundred and fourteen participants, controlling 40 750 MW capacity, are registered to the balancing and settlement market on the supply side while 630 8 Eighteen of these are created through the merger of 79 separate public distribution organizations owned by TEDAS. The results of a study by Bagdadioglu et al. (2007) indicate potential for considerable efficiency gains from these mergers. 9 KCETAS was awarded with concession rights for electricity generation, transmission, distribution and sale for 50 years in 1926, and has been operating as a private company since then. In 1982, all KCETAS assets were transferred to State due to the expiry of the concession agreement, and later in 1990 KCETAS gained operating rights in Region 18 with a TOOR agreement. 149 N. Bagdadioglu, N. Odyakmaz / Utilities Policy 17 (2009) 144–152 Table 5 Balancing and settlement market average prices (YTL/MWh) Table 4 Number of customers and energy and projections of discos (2007) Forecast Number of customers Energy Months Shoulder Peak Valley Dicle Edas Van Golu Edas Aras Edas Coruh Edas Firat Edas Camlibel Edas Toroslar Edas Meram Edas Baskent Edas Akdeniz Edas Gediz Eda Uludag Edas Trakya Edas Anadolu Y. Edas Sakarya Edas Osmangazi Edas Bogazici Edas Kayseri (Kcetas) Menderes Edas Goksu Edas Yesilirmak Edas 974 047 379 674 686 838 977 018 630 774 687 953 2 617 639 1 465 275 2 832 863 1 349 638 2 319 745 2 233 246 780 606 1 994 282 1 313 819 1174 778 3 769 358 503 287 1 419 133 464 175 1 387 939 4 606 033 857 731 1 463 243 1 699 709 1 631 224 1 512 630 9 907 736 4 471755 8 009 033 4 789 585 10 979 878 6 459 643 3 575 893 7 282 926 3 795 446 3 151 452 16 355 227 2 282 083 4 029 187 2 275 484 2 776 755 2006–01 2006–02 2006–03 2006–04 2006–05 2006–06 2006–07 2006–08 2006–09 2006–10 2006–11 2006–12 91.4 108.6 91.4 86.3 86.1 96.5 111.2 141.29 138.23 99.79 111.62 111.89 165 197.2 158.6 121.1 119.4 127.1 153.5 132.56 131.49 96.87 130.55 159.85 65.1 66.3 64.7 62.4 62.1 63.7 65.8 111.34 116.66 98.54 94.68 74.14 Source: EMRA (accessed at www.epdk.org.tr). participants comprise the demand side of the market. Prices in the balancing and settlement market can be seen in Table 5. The retail sale of electricity and the provision of retail sale services to non-eligible customers are conducted by retail branches of distribution companies operating under retail sale licensees granted by EMRA. These arrangements are transitional, and are set to continue until 2011. Price caps, augmented with an X-efficiency factor and gross profit margin, as well as revenue cap mechanisms, have been used for regulation of retail activities, all of which allow distribution companies to pass through their energy cost to end users. In the end user tariff structure,10 there are five main tariff groups, which differ according to connection type, level and ownership situation. There are also single term and double term options, and medium voltage and low voltage separation is available for industrial users. Time of use tariffs can be applied to end customers depending upon their choices and availability of metering infrastructure. In the tariff menu, time of use options are valley (22:00–06:00), shoulder (06:00–17:00), and peak (17:00– 22:00), while the main customer groups are industrial, residential, commercial, agricultural irrigation and lighting. 5. Progress and impact of reforms 5.1. Strategy Paper The Strategy Paper outlines the steps for further liberalization of the internal electricity sector. According to the strategy drawn, current distribution activities were reorganized on the basis of 21 distribution regions, and their revenue requirements were determined ex ante. It is also envisaged that a national tariff11 will be implemented. Any differences that may occur between ex ante revenue requirements of distribution companies and real incomes collected via the national tariff is expected to be reimbursed by means of a price equalization mechanism. The Strategy Paper promises the introduction of transitory vesting contracts, through 10 According to the tariff proposal made by TEDAS and approved by the Board decision number 578 dated on August 2007. 11 ‘‘National Tariff’’ corresponds to an end user tariff which is the same for all customer groups all over Turkey, covering energy prices, transmission, distribution, retail sale services, taxes, and of course cost differences stemming from regional or consumption characteristics, such as non-technical losses. Source: TEIAS (accessed at www.teias.org.tr). which generation either from existing contracts (via TETAS) or from public companies will be allocated to distribution companies based on their weighted share in total demand, to compensate for the demand of captive consumers. The main purpose of these contracts is to provide for a smooth transition by ensuring predictability of electricity prices and supply during the transition period, and to cover stranded costs that are taken by TETAS. These contracts have been designed to cover more than 85% of the energy demand of the captive customers in each distribution region. Publicly owned thermal and hydro power plants will be reformed on a portfolio basis, and are then to be privatized. 5.2. Privatization of distribution and generation assets As set out in the Strategy Paper, TEDAS, with its 20 regional distribution companies, was transferred to PA on 1 April 2005. PA decided to commence the privatization of the electricity distribution sector with the concurrent tender of three companies, namely, Başkent Disco, Sakarya Disco and Ayedas Disco (operating in the _ Anatolian side of Istanbul). Privatization of distribution companies is planned to be executed using a TOOR approach backed by a share sale model (TSS model). According to this model, the investor will be the sole owner of the shares of the distribution company which will be licensed for distribution and retail sale and to perform related activities in a designated region. On the generation side, EUAS is to be split into portfolio companies holding hydroelectric, lignite and gas fired plants, so as to give each company an equally balanced cost structure. Whilst the major hydro plants, which are to be transferred from the State Water Works (DSI), are expected to remain under EUAS ownership to compensate system stranded costs, the thermal power plants and the smaller hydro plants are to be privatized. 5.3. Interim period and tariffs The Strategy Paper introduces a tariff structure that aims to provide a smooth transition from a national to a genuinely regional cost-based approach, so that sudden price fluctuations may be avoided, since regional cost-based end user tariffs vary significantly due to wide variation of distribution cost centres. In line with the priorities and structural requirements for a smooth and gradual transition, the first implementation period (the interim period) is set at five years from 2006 to 2011. The pre-determined revenue requirements and their conversion into the tariff menu prepared by TEDAS have been approved by EMRA, and came into force in 1 September 2006 (Table 6). These allowed revenues have also been enforced through certain operating performance parameters, such as the loss and Xefficiency targets embedded within the end user tariff components. The total investment amounts and their amortization have also 150 N. Bagdadioglu, N. Odyakmaz / Utilities Policy 17 (2009) 144–152 Table 6 Interim period national tariffsa (Krs/KWh) Industrial-MV Industrial-LV Commercial Residential Agricultural irrigation Lightening 2006 2007 2008 2009 2010 11.98 11.98 15.20 12.78 11.53 12.33 11.87 11.98 14.94 12.78 11.53 12.36 11.75 11.98 14.58 13.03 11.53 12.40 11.64 11.98 14.29 13.28 11.53 12.43 11.53 11.98 14.03 13.53 11.53 12.47 Source: EMRA (accessed at www.epdk.org.tr). a Single term tariffs valid throughout the day. Excluding VAT and municipality tax. Excludes any adjustments to be made throughout years (e.g. inflation adjustment) and assumes no change current wholesale energy costs. been calculated and included in the revenue requirements. Within the framework of the proposed tariffs, fewer customer groups are defined compared with the number of previous customer classes, and tariffs for each customer group and cross-subsidization between groups are set for a five year period in a transparent manner. Since the tariff proposal is in some respect at variance with current regulations set by of EMRA, new rules have been published by EMRA, updating revenues in line with inflation and adjusting in order to take account of demand fluctuations. 5.4. Basic principles of price equalization mechanism The implementation of a national tariff scheme during the transition period is expected to create regional revenue imbalances arising mainly from different loss ratios and operational expenses. Some regions are expected to collect more than their ex ante calculated revenue requirements while others are anticipated to collect less. The tariff equalization scheme set out in the Strategy Paper is designed to balance these differences in regional revenues and to ensure that all regions collect their approved revenue requirements by requiring cash transfer across regions. In effect, the price equalization scheme enables crosssubsidization across regions to distribute cost differences uniformly within the system. The customers in low-cost distribution regions are to subsidize customers in high-cost regions. Even so, the price equalization mechanism ensures that the pre-determined and approved revenues of the distribution companies will remain as if regional tariffs had been applied since it is a demand side application rather than supply side one. The application details of the tariff equalization scheme are published by EMRA as a form of subordinate legislation. According to this subordinate legislation, the price equalization mechanism is designed for 20 distribution companies, not including Kayseri, depending on TEDAS’s tariff proposal and based on interim article number 9 of the EML, and it will be administered by TETAS. The activities included in the price equalization mechanism are retail energy sale, energy sales for non-technical and technical losses, distribution, transmission, and retail sale services. A long-term privatization plan with fair auction of generation plants, according to which purchases of higher quality plants reflect that in their bids, would address at least some of the issues involved in inter-regional cost differences.12 The total amount which is subject to the price equalization mechanism for 2007 is roughly 550 million Euros. 5.5. Renewables and energy efficiency13 Renewables are an important potential source of energy in Turkey, offering an opportunity to reduce fossil fuel dependency. 12 We thank Russell Pittman for reminding us of this. 13 We thank Murat Durak for allowing us to utilize information from his unpublished paper on Turkish renewable energy market while writing this section. Aside from hydro, Turkey also has potential to make use of geothermal and wind energy. Turkey has an annual biomass potential of approximately 32 million tonnes of oil equivalent (TOE), a gross annual hydro potential of 433 TWh which is almost 1% of the total world potential, solar energy potential which is estimated to be 26.4 million TOE (thermal) and 8.8 million TOE (electricity), and geothermal potential of approximately 38 000 MW. Compared to other parts of Turkey, the Aegean Coast, Marmara, and the eastern Mediterranean regions have relatively higher wind power potential. The estimated wind power potential of Turkey is around 40 000 MW; however, only 10 000 MW is regarded as economically and technically feasible. As far as hydro potential is concerned, Turkey is able to use only 36% of its total potential which means that roughly 5 billion US $ worth of water power is wasted. The first renewable energy law ‘‘Concerning the Use of Renewable Energy Resources for the Generation of Electrical Energy Law No. 5346’’, prepared to comply with EU regulations, came into force on 18 May 2005. Renewables are defined in the Law as generation facilities based on wind, solar, geothermal, wave, tide, biomass, biogas and hydrogen energy, and canal or run-of-river types, or those with a reservoir area of less than 15 km2. The Law also includes price and purchase guarantees for electricity generated from facilities which have a renewable energy resources certificate (the RER Certificate) granted by EMRA. The applicable price for electricity energy purchased in pursuance of this Law in each calendar year shall be the average wholesale electricity price in the previous year determined by EMRA. The Council of Ministers is authorized to raise this price up to 20% at the beginning of each year as a further incentive. The Turkish average electricity wholesale price was determined to be 9.13 YKrs/kWh for the year 2006. The EML gives authorization to EMRA to take the necessary measures to promote the use of renewable energy resources. The Electricity Market Licensing Regulation also sets forth a number of provisions aiming at promotion of renewable energy resource use, such as demanding only 1% of the license acquisition fee, or providing exemption from the annual license fee payment requirement for a period of eight years from the completion date of the construction, as well as granting priority to facilities generating electricity from renewable energy resources in terms of their connection to the transmission and/or distribution systems. The Law on Energy Efficiency approved by the Turkish Grand National Assembly on February 2007 provides a number of instruments to support energy efficiency on both a micro- and macro-level. This Law also envisages some changes in the Renewable Law promoting the utilization of small scale renewable energy resources, and providing for the development of a guaranteed tariff for electricity generated from renewables by defining a price range (5–5.5 Eurocent/kWh), increasing the price guarantees period to the first 10 years operation from eight years, and increasing the reduction rates for land use permission for the first 10 years of operation. As far as project capacity that is under construction is concerned, the wind power capacity is set to reach 200 MW by the end of 2007 and 450 MW by the end of 2008. The additional hydro power capacity is expected to rise to 4300 MW by the end of 2010, of which 1800 MW is produced by private investors while 2500 MW will be generated by the State Hydraulic Works. A favorable climate of investment is attracting entrepreneurs into the renewable market (Table 7). 6. Implementations and suggestions for future reform The Turkish Electricity sector has made remarkable progress in terms of deregulation of market-based activities and regulation of naturally monopolistic activities. At the same time, there are still some issues that need to be solved in order to provide for a sound, N. Bagdadioglu, N. Odyakmaz / Utilities Policy 17 (2009) 144–152 Table 7 Generation licenses issued by February 2007 Hydraulic Wind Geothermal Gas from waste Biogas 179 Projects 37 Projects 5 Projects 7 Projects 1 Project 5511.0 MW 1219.5 MW 82.3 MW 30.8 MW 0.3 MW Total 229 Projects 6843.6 MW Source: EMRA (accessed at www.epdk.org.tr). credible and smoothly running market system. Arguably, the most serious problem in the sector is the dominant position of the public sector, and its role both as owner and decision-maker. Within the limitations of the current position, it is almost impossible to launch a consummate electricity market reform without first reducing the pre-eminence of the public sector (other than in transmission activities). Although regulation and deregulation initiatives in the electricity sector have to be considered and evaluated primarily at micro-level, it must be recognized that they also have inevitable side effects and externalities at the macro-level. As long as such initiatives produce discrepancies in terms of meeting macroeconomic targets and achieving current economic policies, it is normal for some tensions to arise in the process of implementation. With the latest amendment of the EML,14 the earlier restriction on the sale of retail electricity15 by distribution companies in their area of responsibility is removed, provided there is account separation and also that the purchasing price cap is less than Turkey’s wholesale average electricity price. This restriction was lifted in order to ease privatization of both distribution and generation assets. This provides an opportunity for companies to create vertically integrated utilities on a regional basis which runs counter to the objectives of electricity market reform. Moreover, the latest international and domestic developments indicate a general trend towards a horizontal restructuring through merger and acquisition activities in electricity and natural gas sectors, including both deregulated and regulated ones. EMRA should be wary of these potential market developments, and needs to be very careful in terms of regulation, monitoring and control of such mergers, and this may require it to take efforts to enhance its institutional abilities. The Turkish electricity market reform has been criticized for being imitative of the UK’s approach to regulation and market reform, and for failing to take account of Turkey’s own individual circumstances. In some respects the Turkish regulatory system has drawn heavily from the UK model; however, the regulatory framework is in significant respects tailored to Turkey’s unique circumstances. The need to adapt to national circumstances is one of the main reasons for the establishment of the ‘‘interim period’’, during which time adaptation of policies can take place. It is desirable for a developing and very dynamic country such as Turkey to take an incremental approach to reform, in order to allow all aspects of the inherited system and structure to adapt to new circumstances. At the same time, the transition period should not be extended beyond agreed dates, since the expectations and strategies of 14 Amendment made by the Law no. 5496 on 10 May 2006. In addition to distribution and retail sale activities, private sector distribution companies shall be entitled to construct generation facilities in the region specified in their licenses provided they obtain a generation license and the amount of the annual electricity generated by them does not exceed 20% of the total amount of electricity offered for consumption in the relevant region within the previous year. Distribution companies may not purchase more than 20% of the electricity that they have distributed during the previous year in the area specified in their license form generation companies that they own or are affiliated with. 15 151 market participants as well as the credibility of the regulatory agency depend on meeting this commitment, which has been agreed upon by key stakeholders including the government. A strong commitment to ending the transitional arrangements may help Turkey to avoid the problems she experienced during 1960s, when an import subsidization growth model designed to protect and support infant industries as a means to promote development ended up maintaining high custom tax rates which indefinitely protected firms against foreign competition. The cost of this approach has been paid by customers in the form of expensive and low quality goods prior to the trade liberalization which has taken place since the 1980s. Furthermore, the market design is based on the presumption that there is an excess supply in electricity that can be exchanged between seller and purchaser. This presupposes a market equilibrium in the electricity sector. Accordingly, an interim period longer than that planned may mean that security of supply concerns will negatively affect the willingness of market participants to engage in any bilateral contracting as long as market conditions create price pressure. Long-term security of supply still seems to be an unsolved problem in the design of the market since bilateral agreements cannot guarantee a stable market price. Therefore, it is essential for the Turkish market to develop a liquid and financially solvent longterm capacity market and to support this market by means of financial derivative instruments. Otherwise, it will be very difficult to avoid sudden and destructive price spikes and to ensure a dependable and well functioning electricity market. As a rule of thumb in economics, you cannot trade anything without measuring it. The development of metering infrastructure is accordingly very important for the success of market implementation reforms. In Turkey, metering infrastructure, especially for low voltage electricity, is unsatisfactory. To remedy this situation will require both legislative measures and financial investment. The main pillar of both the ex ante regulation and the DayAhead balancing and settlement mechanism is accurate and sound demand forecasts, made for different time frequencies, in line with system requirements. A demand forecast methodology based on a bottom-up approach has been published by EMRA, and this methodology is to be used for preparing capacity and investment projections for generation, transmission and distribution activities. Diversification of demand projection and inclusion of almost all stakeholders in the process are very important for a balanced risk sharing of the system. Artificially determined shadow prices, in other words, prices that are determined by the intervention of government in line with central planning and shaped according to populist concerns, send misleading signals to the market and increase pressure on generation. This pressure can be relieved by the cash-based implementation of a balancing and settlement mechanism. Price differences, reflecting also the profit margin, between the market and regulated wholesale prices encourage generators and wholesalers to drop their customers from their bilateral agreement portfolio and to directly sell to the market. This trend is inappropriate in terms of the market design: not only does it create extra cost because of demand forecast deviation for distribution companies but such distortions also cause delays in investment decisions. New amendments to the regulations have been introduced by the EMRA extending the scope of the price cap formula for retail sale that enables the passing through of energy costs of retail branches of distribution companies to consumers. Another common problem in terms of regulation is that of balancing the interests of different stakeholders in implementing electricity market reform. Almost all regulatory decisions will meet with opposition from among the different interest groups, since regulation is a dynamic bargaining procedure. Regulatory agencies must try to mediate between the interests of consumers, 152 N. Bagdadioglu, N. Odyakmaz / Utilities Policy 17 (2009) 144–152 government and producers. EMRA has to overcome its inadequacy in the area of public relations, transparency and accountability by arranging public hearings, by using mass media channels and of course by publishing consultation papers. Authority for these activities is currently absent in its secondary legislation. Neither deregulation of the electricity market, nor regulation of grid activities, can be achieved in a satisfactory manner in the face of public resistance, and EMRA must be able to make efforts to generate public support for its activities. Finally, the implementation of market and regulatory reforms exhibits serious divergences from the initial design of the regulatory framework and market system. These differences are mainly stemming from the lack of commitments, contributions and participation on the public and government side. The interim period gives an opportunity for smoothing undesired and unexpected effects of changeover if and only if necessary steps are taken during this interim period. Improving coordination between public authorities, private market participants and regulatory authority together with full commitment will be the key determinant of success of Turkey’s electricity market reforms. Otherwise, uncertainty rather than risk will prevail in the market and manipulation rather than speculation will be dominant type of market behavior. Acknowledgements We are grateful to Russell Pitman, Lindsay Stirton, Kathryn Wright, Catherine Waddams, two anonymous referees, and participants of the CCP South East European Energy Reform Workshop in Sinai, Romania in July 2007 for their valuable comments and suggestions. This paper was initiated while Necmiddin Bagdadioglu was a visiting researcher, under the 2005/06 Jean Monnet Scholarship programme, at the ESRC Centre for Competition Policy of the University of East Anglia. The financial assistance of European Union is gratefully acknowledged. The content of this paper is the sole responsibility of the authors and cannot be regarded as reflecting the views of their institutions or European Union. References Atiyas, I., Dutz, M., 2003. Competition and regulatory reform in the Turkish electricity industry. 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