3 pillars for long-overdue energy reforms in Central Asia

Published on Thursday, 12 July 2018

Published by Rafayil Abbasov on Thursday, 12 July 2018

Central Asian power utilities need to dramatically overhaul their operating and business models.
Central Asian power utilities need to dramatically overhaul their operating and business models.

In Central Asia, states play a dominant and very visible role in the energy sector, leading structural reforms and improvements. However, electricity utilities in this region remain very weak.

Power utilities work with poor supervision, insufficient capital budget, tend to be overstaffed, and are operationally inefficient. Without proper cost recovery tariff settings, they experience financial losses to such an extent that they hardly cover even operating costs.

But last month, Uzbekistan broke the silence on this issue by hosting a regional conference attended by CEOs of major state-owned electricity utilities from Afghanistan, Kazakhstan, Kyrgyz Republic and Tajikistan. The event in Tashkent was the first of its kind and dedicated exclusively to energy sector reforms. CEOs shared lessons learned from decades of pursuing energy reforms in their countries.

At the core of the discussions were two questions: what role should the government have in the energy sector, and which reform actions should be prioritized to make power utilities financially sustainable?

Participants unanimously recognized that business-as-usual is no longer viable. Due to poor collection of receivables as well as policy interventions via insufficient liquidity gap financing and capital investment, utilities fail to deliver on financial sustainability and corporate governance.

  Business-as-usual no longer viable for Central Asian power utilities

The trajectory of poor performance has been ongoing for over a decade now, and future improvement and investments look unlikely unless action is taken. While governments are concerned with widening fiscal gaps and a continuous increase in energy subsidies, end-users and customers now expect a quality of service similar to telecommunications and banking.

Given the increasing cost of energy quantified by public subsidies and free capital, governments have become even more concerned about the sustainability of the energy sector, and seem to be open to major structural changes.

To overcome these challenges and emerge as a new generation of corporate utilities, state-owned electricity companies in Central Asia need to dramatically overhaul their operating and business models, even more extensively than the overhaul triggered by the collapse of the Soviet Union in the 1990s. Corporate transformation on such a scale requires significant planning, commitment and effort by the governments.

In my experience, regardless of the business model selected, power utilities can only succeed by developing a new corporate strategy based on three pillars of consensus with governments.

Pillar #1: New government role must be clearly defined.

CEOs of all Central Asian states acknowledged that there is no standard reform model or best practice for regulation, tariff and pricing control in the energy sector. The most appropriate approach will depend on the context and tariff objectives of the governments and available public funds for social safety net programs.

  Central Asian power utilities must develop new corporate strategies

However, regardless of contextual background, the role of government must evolve from exclusive energy service provider to policy maker, regulator and facilitator of sector development and private investments. Only then will power utilities (regardless of their ownership structure) be able to develop and adapt their corporate strategy to increasing demand by end-users for high-quality, reliable electricity supply.

For governments, this evolution involves three discrete, but interrelated objectives:

  1. Modifying the structure of the power sector to enhance prospects for market competition.
  2. Changing ownership patterns and creating various forms of public-private partnerships to provide stronger incentives for efficiency and growth.
  3. Establishing a transparent regulatory framework to balance private and public interests.

Pillar #2: Full cost recovery with predictable, transparent tariff settings.

Achieving full cost recovery is essential to the sustainability of the energy sector. The aim should be to ensure that the regulated state-owned electricity utilities recover the cost of investing in, operating, and maintaining capital assets to earn a reasonable return.

Unfortunately, in Central Asia the regulations that set tariffs to cover the replacement value of the electricity assets are complicated, and don’t recognize the full set of electricity value delivered by utilities. Subsequently, utilities’ financial positions are undermined by a mix of poor collection and lack of investment, although losses can be somewhat hidden by indirect subsidies for fuel and operating expenses.

  Transparency key to Central Asian power utilities’ financial sustainability

Complex tariff structures and cross-subsidies increase administrative burdens as well as national fiscal risk. To correct this, the tariff regime needs to be clear and transparently set, with explicit rules. Transparency is a prerequisite for successful implementation of cost recovery setting and acceptance by end-users, which ultimately enhances the financial sustainability of power utilities.

Pillar #3: Regulatory framework is a key to mitigate risks.

Designing an adequate regulatory framework is fundamental to energy sector reform. While transitional arrangements—such as creating a ministerial agency for electricity regulation—can help lower the perception of regulatory risk, they cannot mitigate all sources of regulatory risk.

Whether through evolving regulation or the development of new markets, utilities need guidance from governments to capture the value they bring to the table.

Furthermore, to ensure the transformation of utilities is commercially viable, countries must develop regulatory and market models. Utilities must then decide on the right strategic approach to tackle the new regulatory environment.

Predicting what the new environment will look like is one thing, but today's utilities need a roadmap to get there. The first steps will be difficult, but end-users, shareholders, and regulators will welcome the results of a successful transformation for decades to come.