From Crisis to Stability in the Armenian Power Sector

1. Denzel Hankinson, Castalia Strategic Advisors Gevorg Sargsyan, Senior Infrastructure Specialist, ECA RegionAni Balabanyan, Operations Analyst, ECA Region From Crisis to Stability in the Armenian Power Sector Funded by PPIAF March 6, 2006

2. Crisis in the Armenian Energy Sector: 1993-1995 • Crisis triggered by physical supply interruptions: • Embargo by Azerbaijan and Turkey • Sabotage of new gas pipeline through Georgia and Northern Caucasus • Absence of Medzamor Nuclear Unit • Disintegration from former Soviet Union Power Grid • But underlying, long-term problems were administrative and structural: • Low tariffs: 10% of cost-recovery level in 1992-1993 • Low collections: 40% of billed amount • High losses: over 40% of which more than 25% theft

3. Crisis in the Armenian Energy Sector: 1993-1995 • Resulted in: • Fiscal and quasi-fiscal subsidies reached to roughly 11% of GDP (over $140 million) by 1995 • Electricity supplied for as low as 2 hours per day • Collapse of gas and heat supply • Deforestation • Depletion of lake Sevan • Increased number of accidents (e.g. fire) • Economic recession

4. Early Reforms: 1994-2001 • Technical and operational reform • Efforts to combat commercial losses and improve collections • Re-location of existing meters to common areas • Installation of new meters where necessary • Installation of AMDAS

5. Early Reforms: 1994-2001 • Structural reform • Transition to cost-based tariffs • Unbundling of Armenergo • Imposition of new regulatory framework • “Psychological” reform • Electricity is a commodity • Measures to link service quality and price in minds of consumers • Realization that PSP was the only option; hired transaction advisors in 1998

6. The Road to Privatization • First attempt in 2000-2001: • Faced considerable political resistance • Suffered from flaws within regulatory & legal framework, and tender documents • Government quickly rectified these flaws: • Removed any requirement that bidders commit to fixed investment amount • Bundled 2 distribution companies into 1 • Limited risk of bidders on contingent liabilities of distribution entities • Second attempt in Autumn 2001, amidst a “perfect storm” for international energy investors

7. The Road to Privatization • Third tender launched in summer 2002 after Midland Resources Holdings (MRH) a dark horse bidder expresses interest • All previously prequalified firms also invited to bid • MRH: • Trading company; mostly a financial investor • Had no substantive power sector operating experience • Is an offshore company, based in UK Channel Islands • But, had influential and knowledgeable local partner • MRH wins the bid and Government imposes additional safeguards in tender documents • Prohibition of >25% of shares of distribution company without government approval • Requirement that a management contractor be hired with power sector operational experience • Creation of reserve account and bank guarantee to ensure that generators are paid first and in full, before revenues become available for other uses

8. Results of the Reforms • Fiscal and quasi-fiscal subsidies are completely eliminated

9. Generalizing the Lessons Learned • Political will is paramount and • Personalities matter • Donors can enable champions of reform through early and substantive contact • Government should do as much work as possible before privatization • Standard bidding procedures needed to accommodate a new kind of strategic investor

10. THANK YOU