Energy sector price regulation and investment:

a company perspective

Ludek Horn
Trading, Front Office Head
CEZ, a. s.

March 5th, 2013

ERRA Training Course on Price Regulation and Tariffs
 AGENDA

Introduction of CEZ
Role of Market Participants
Force Majeure and State of Emergency
Czech Photovoltaic Fairy Tail
Solar Energy
Wind Energy
CEZ Wind Farms in Romania
RES and Impact of Subsidies on Market Price
Consequences of Price Decline
Recent Bulgarian Crises
CEZ Albania Story
Future of EU Energy Markets Regulation
Conclusion

1
 CEZ GROUP
International Utility with a Stable Position in Domestic Market and
Growing Portfolio in CEE and SEE Regions

CEZ Group in Poland Energy Assets Markets of conditional

(100% stake in Skawina, 100% in Elcho) interest CEZ Group in Romania
Trading Activities (100% stakes in CEZ Distributie, CEZ Vanzare)

Electricity generation, gross (TWh) 2.3 Active subsidiary

Electricity sales, net (TWh) 3.3

Market share 1.5%

Number of connection points (million) 1.4

Installed capacity (MW) 730

Market share 17%

Market share 2.1%

Number of employees 2,151

Number of employees 530

Sales (EUR million) 367

Sales (EUR million) 160
CEZ Group in Bulgaria
CEZ Group in Germany (67% stake in CEZ Razpredelenie Bulgaria, CEZ
(50% stake in MIBRAG) Electro Bulgaria, 100% in TPP Varna )

Annual coal extraction (m t) 19.7
Electricity sales, net (TWh) 8.7

Lignite reserves (m t) 530
Number of connection points (million) 2.0
CEZ Group in the Czech Republic
Market share 39%

Electricity generation, gross (TWh) 60.8
Installed capacity (MW) 1,260

Market share 74%
Market share 11%

Number of connection points (million) 3.5
Number of employees 4,154

Market share 61%
Sales (EUR million) 730

Installed capacity (MW) 12,405

CEZ Group in Turkey

Number of employees 19,970 (44.3% stake in SEDAS through AkCez, 37.36%

Sales (EUR million) 5,847 stake in Akenerji)

Electricity sales, net (TWh) 8.8
CEZ Group in Albania

Number of connection points (million) 1.3
(76% stake in OSSH)

Market share 6.5 %

Number of connection points (million) 1.1

Installed capacity (MW) 373

Electricity sales (TWh) 4.1

Market share 1.1%

Number of emplyees 6,086
Source: CEZ, national statistics, data for 2009, CZK/EUR 26.45 2
 MARKET PARTICIPANTS HAVE DIFFERENT INTERESTS

End consumers want to cover their expected consumption for minimum price

c Consumer

Example of off-take diagram

Power Exchanges and Broker Platforms have similar function as traders

Trader 1 Trader 2 Power Exchange Export

Import

Traders match contradictory interests of consumers end producers by means of taking open positions

Generator 1 Generator 2

Example of annual availability

Generators want to maximize income from utilization of availability

3
 FORCE MAJEURE AND EMERGENC Y SITUATION
Be Careful in Interpretation and Legal Definitions

August 2003:
400 kV line owned by CEPS was destructed by the storm and out of operation for several months

Prunerov
Power Plant TSO ČEPS
1000 MW

CEZ intended declare a Force Majeure and decrease delivery both domestic and exports

but
Counterparties in Germany strongly objected
Legal opinion showed a different approach to Force Majeure in western countries:
Force Majeure situation is not an excuse for fulfilling contractual obligation supposed company has
resources and possibility to fulfill contractual obligation in a different way

4
 INSTALLED CAPACITY OF SOLAR POWER PLANTS
is stabilized around 2000MW in the Czech Republic
There were practically zero additions after 2011

Data source: ERU

 CZECH SOLAR STORY IN SHORT

Once upon a time….

Czech state wanted to attract investment into renewable energy sources (RES)
There was no strategy what capacity in what type of RES state wants to have
There was no limit neither in MW to be built nor in money to be spent (and paid….)
Law empowered Energy Regulatory Office to set a feed in tariffs fixed for 15 years
Law set a cap for year-on-year adjustment of feed-in-tariff (FiT) for new projects (5%)

What happened then?

One day investors recognized decrease of investment cost of solar power plants
Projects for several thousands of MW asked for connection to distribution grids overnight
and in most cases received a permission
There was no reporting system in place to know how many projects could materialize
Once regulatory office recognized the boom it could only decrease FiT for new projects!
The boom was then stopped by TSO based on Grid Code on technical grounds
It took almost year to change the law empowering regulatory office to decrease FiT
substantially

6
 CZECH SOLAR STORY IN SHORT II

Result:
Czech consumers has to pay one way or another (in distribution tariff or taxes)
approximately 500 €/MWh x 2 TWh/year x 15 years = 15 billion €

In order to mitigate temporarily the price shock for end consumers government
subsidizes the FiT from the state budget funded partially by
- special income tax paid by solar producers (international arbitrages expected)
- special EUA tax paid from emission allowances allocated free of charge (NAP II)
- and from regular taxes, of course
…. and till today:

Political and state institutions are blaming each other who caused the disaster

WHAT WAS WRONG? BAD GOVERNANCE

7
 DID THE REST OF EU AVOID THE SOLAR TRAP?
In 2011 the solar capacity in Europe increased by around 21000 MW

+21000

Installed PV Capacity in 2011 in EU (in MW)

Country end of year y-on-y change

Germany 24700 7500

Italy 12500 9000

Spain 4200 400

France 2500 1500

Czech Rep. 2000 0

Belgium 1500 550

Data source: EPIA, www.epia.org

 DID THE REST OF EU AVOID THE SOLAR TRAP?
In 2012 the solar capacity in Europe increased already in the handful
of countries by more then 15000 MW

+15000

Installed PV Capacity in 2012 in EU (in MW)

Country end of year y-on-y change

Germany 32300 7600

Italy 17000 4200

France 4000 1300

DISCLAMER: EPIA did not

published the report yet.

Data source: EPIA, www.epia.org

 CZECH SOLAR POWER OUTPUT
since the start 2011

Czech PV Output: Generated (daily max) verus Installed

2500

PV output in 2012: 2.1TWh

PV utilization in 2012: 12%
2000

Coverage of consumption in 2012:
3.3%
1500
MW

1000

500

0
Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13
generated - daily max installed

Data source: ERU& CEPS

 THERE IS NOTHING WRONG WITH SOLAR POWER EXCEPT OF COST
Impact of the 32 300 MW PV capacity on the German residual load in Q2 -
WEEKDAYS

Residual Load in Q2, week days

(cons-PV output)
80000

75000

70000

65000

60000 cons
solar_25%
MW

55000
solar_50%
50000 solar_75%
solar_100%
45000
Consumption as of 2012
40000
Assumed PV capacity of 32300MW
35000

PV output percentiles calibrated on
2012
30000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
THERE IS NOTHING WRONG WITH SOLAR POWER EXCEPT OF COST
Experience of the German solar output after 2011: some statistical properties
with the installed capacity normalized to 32 000 MW

Box Whisker Plot for Daily Maxima of PV Power Output

(data since 2011, installed capacity normalized to 32000MW)

Max
75%
Median
25%
Min
WIND GENRATION IS SUITABLE MATCH TO SOLAR
Experience of the German wind output since 2010: some statistical
properties with the installed capacity normalized to 31 000 MW

Box Whisker Plot for Daily Averages of Wind Power Output

(data since 2010, installed capacity normalized to 31000MW)

Max
75%
Median
25%
Min
 EVEN BUT PERMANENT GROWTH
Germany keeps the lead in the installed wind capacity with more than
31 000MW at the end of 2012

Data source: EWEA

 WIND POWER PLANTS ARE NOT SO EASY TO BUILT
In 2012 the wind capacity in Europe increased by around 12000 MW
– strongest y-on-y increase ever

+12000

Installed Wind Capacity in 2012 in EU (in MW)

Country end of year y-on-y change

Germany 31300 2200

Spain 22800 1100

UK 8400 1900

Italy 8100 1400

France 7600 800

Portugal 4500 400

Data source: EWEA

 CEZ WIND FARMS IN ROMANIA
Green Certificate Story

In Spring 2012 wind farm Fantanele (337,5 MW) put in operation

In Winter 2012 wind farm Cogealac (262,5 MW) put in operation

In Romania construction of RES is incentivized by Green Certificates

Feasibility and bankability of projects depends on price and amount of certificates.

Wind farms were supposed to get allocated 2 certificates for the first years of
operation till 2017 and then 1 certificate for another 9 years.

Issues:
- the second certificate was set by law which was adopted with a delay
- the future market value of certificates is jeopardized by the unclear „state
demand for RES“ and huge number of projects under preparation
- destructing effect of RES on the wholesale electricity price
- destruction of the wholesale electricity market by the recent modification of
Energy Act (obligation to sell power on the exchange which does not exist yet)

16
 DESTRUCTING EFFECT OF RES ON WHOLESALE POWER PRICE
Market Concept Is Systematically Disrorted Due to Increasing Portion of
Subsidies to RES

Impact of Growing Generation from RES on Wholesale Power Price

Variable costs, €/MWh
Demand

100

Supported RES
Gas generation brings volatile
and less predictable
Hard coal
supply
75 Lignite

The spot prices decline

(not the final price for the
consumer!) damages
50
non-RES generation

Nuclear
One more negative

25 impact – lower utilization
of non-RES generation
RES

0 Available
0 20 40 60 80 100 Capacity (GW)

17
ELECTRICITY MARKET WORKS!
But is distorted by subsidies for RES
 CONSEQUENCE OF PRICE DECLINE
The CEE Convential Generatio Portfolio Is Aging and Has to Be Renewed
in Order to Maintain System Stability

The generation portfolio in Installed capacity* by age and type

Central and Eastern

80
European region is ageing
70

New costly 60
generators/rehabs will be Gas/Oil
Capacity (GW)
50
required in order to maintain Hard Coal

system stability 40 Lignite

Nuclear
30

Yet there is no substantial Hydro

investment planned due to 20

unfavorable market 10

environment 0
41+ 31-40 21-30 11-20 0-10
Age

*Conventional generation capacity in Germany, Austria, Visegrad countries, Balkans 19

 LOW CARBON PRICE DOES NOT INCENTIVIZE INVESTMENT TO
REPLACE OBSOLETE HIGH-EMISSION PLANTS

Illustrative construction and generation full costs

EUR/MWh Low CO2 price
10 EUR/t
Obsolete generators
are best positioned on
the residual market

New low-emission
generators cannot compete
on the market with old
depreciated generators

Construction costs
disqualify RES on the
CO2 market which thus need
Fuel subsidies and preferrential
Investment treatment
Investment
Subsidies limit the
covered by competitive volume and
subsidies inhibit further EU efforts in
Obsolete New Various CO2 emission reductions
generator* generator** RES

* Hard coal generator efficiency 30% (depreciated construction cost), ** Hard coal generator efficiency 46% 20
 EFFECTIVE CARBON PRICE WILL ACHIEVE THE EU GOALS
INCLUDING THE SUPPORT FOR COMPETITIVE RES

Illustrative construction and generation full costs

EUR/MWh Effective CO2 price
New generators including 30 EUR/t
-
RES compete successfully
on the market

Higher CO2 price ensures

low-emission generator
porfolio renewal

Advanced RES compete
successfully on the market
without additional support,
CO2 developing technogies will
Fuel be forced to compete even
Investment with a premium
Investment
The investment better
covered by supports the mix needed
subsidies in the system
Obsolete New Various
generator* generator** RES
* Hard coal generator efficiency 30% (depreciated construction cost), ** Hard coal generator efficiency 46% 21
 NON-MARKET BASED REGULATION AND SUBSIDIES INHIBIT
LIBERALIZATION, CAUSE INEFFICIENCIES AND POSE A RISK TO
THE SECURITY OF SUPPLY

Inhibited liberalization and market integration PV installed capacity growth in the Czech Republic,
Spain (left axis) and Germany (right axis) MW

State specific environment

Cross-border capacities reserved for renewables
4000 18 000

Protective measures in some countries CZ

Inefficiency ES
15 000
DE

Rigid and artificial state regulations and subsidies 3000
are distorting traditional market incentives and
12 000
signals

Regulation often lags behind market trends creating 2000 9 000
extremely favorable conditions for inefficient
investment in RES that can grow exponentially
6 000

High costs transferred to the end- consumers
1000

Inefficient geographical location means high 3 000
additional infrastructure costs

Threatened security of supply 0 0

Excessively quick development of renewables 1.1.2007 1.1.2008 1.1.2009 1.1.2010 1.1.2011

without infrastructure strengthening jeopardizes

system stability

Lack of incentives for investing in traditional stable
power sources
22
 CALIFORNIAN CRISES IN ALBANIA 2012
Another example of the price regulation

national generator national DSO and supplier 98 €/MWh state owened

cosumeres
Korporata
regulated price CEZ
Elektroenergjitike growing unpaid bills
Shperndarje
Shqiptare (KESH)
10→20 →15 sh.a.
sh.a. households
€/MWh
50 – 60 €/MWh growing unpaid bills
CEZ Trade private
Albania companies
sh.p.k.

Opearatori i Sistemit te Transmetimit OST sh.a. Albania

Example of calculation
purchase from KESH 70% 15 €/MWh
Import Import purchase from market 30% 55 €/MWh
from from average price of power 100% 27 €/MWh
abroad abroad TSO,DSO,Sales Margin 40 €/MWh
for for
total cost 67 €/MWh
market market
surcharge for unpaid power 142,86% 95,7 €/MWh
prices prices

23
 RECENT BULGARIAN CRISES:
Once Again RES Subsidies….

So far there is a monthly invoicing of power supply for residential consumers in Bulgaria
based on monthly reading of meters

In 2008 CEZ implemented annual invoicing with one reading of meters per year
based on flat monthly pre-payments and a one annual settlement

Regulatory Office penalized CEZ for that and forced CEZ to restore monthly invoicing.

In February 2012 people went to street to protest again electricity prices

because the recent invoice was of doubled amount compared with previous one

The Prime Minister called for a revocation of CEZ license despite the fact that all
components of power price are set by regulator.

The increase of the invoiced amount was caused by the increase of RES subsidy, lower
average temperature and more days between reading.

The whole government resigned (but might survived if annual invoicing in place)

24
BULGARIAN INVOICES
January 2013 December 2012

All components of price are regulated

Regulatory period in Bulgaria is July – Jun
Last price increase was in July 2012 and was 13%

25
BULGARIAN INVOICES
November 2012 October 2012

BULGARIAN INVOICE
November October

26
 METERING PERIOD, WEATHER AND HOLIDAYS MATTER
Metering Period, KWh, Amount Due

400 373
metering period (days) 342
350
KWh / period
291
300 Amount due (BGN)

250
219
200

150

100
67.14 61.27
55.25
41.87 33 33
50 28 30

0
01.11.2012 04.12.2012 03.01.2013 05.02.2013
05.10.2012 02.11.2012 05.12.2012 04.01.2013

27
ELECTRICITY BILL CHECK ON-LINE in BG
http://www.cez.bg/en/customer-service/households-and-business-
customers/account-information.html

Search by client
Number

28
READING METERS IN GERMANY BY EON I
Paper Form or Internet
READING METERS BY EON II
Read the Meter Yourself, Fill the Form and Send
REGULATORY RISK IS GROWING
And Is Currently the Major Risk for Investors

The less price regulation the better

1

2 Promote renewables in a fair and efficient way

Avoid changes in regulatory rules at short notice

3
or even ex-post

Integrate markets to enhance system efficiency and

4
competitiveness

5 Maintain standard, stable and predictable markets

31
 THE EUROPEAN ENERGY POLICY NEEDS TO STRENGTHEN THE
SINGLE ENERGY MARKET OTHERWISE IT WILL BREAK UP INTO
27 NATIONAL SYSTEMS

Single energy market restored as a clear EU priority

Re-unify, strengthen and stabilize power markets

Foster and maintain long-term CO2 market credibility

Set up a unified and efficient RES support system (green
certificates)

Further integrate market via market coupling

If required, set up a single and controlled reserve generator
support scheme (capacity mechanisms)
EU energy policy is
at crossroads
EU energy market breaks up into 27 national systems

National markets implement their own rules that negatively
interfere with each other

The energy market cannot work like up to now, more
regulation is introduced

Higher power price for end consumers

Other sector might follow in the disintegration – the principle
of unified EU is at risk

32
 THANK YOU FOR YOUR ATTENTION!
ludek.horn@cez.cz

Common features of succesful nations

Law and order

Centralized power
Inclusive economical and political institutions
(apart of extractive institutions)

Critical juncures and contingency

Vicious circle and virtuous circle
Creative destruction

One of the best books I ever read on the governance and regulation!