Gov't sacks PSE board amid calls for new strategy

The government's decision last week to replace the four-member management board of power grid operator Polskie Sieci Elektroenergetyczne (PSE) will only be seen as a good move if it's part of a wider plan to speed up the sector's liberalization, industry insiders said.

"PSE is seen by many as a major stumbling block to liberalization in the power sector," said Michael Davis, a lawyer at Allen & Overy in Warsaw. "I'm not sure if this move will fill the market with a great deal of confidence," he said.

Treasury Minister Wiesław Kaczmarek appointed former defense minister and leading Peasants Party (PSL) member Stanisław Dobrzański as the new president of PSE. Dobrzański has no experience in the power sector. Kaczmarek also sacked one of the key architects of industry reform, Deputy President Marek Zerka.

Apart from running the grid, PSE is also an important buyer of power via long-term contracts with generators, energy it resells to distributors. Industry insiders blame the long-term deals for the delay in the emergence of a modern electricity market here. "PSE should be quickly unbundled and discharged of any responsibility in the trade of energy," said Jean-Claude Dorcimont, head of the local office for Belgian power concern Eltractebel. "The government should first of all break the monopoly of PSE over power purchases by prohibiting its role as an agent on the energy market," he said.

Tale of the tape

PSE logged a healthy net profit of zł. 60 million ($15 million) on sales of more than zł. 13 billion ($3.25 billion) in 2000. As part of the sector's liberalization, a chunk of PSE is set for flotation on the Warsaw Stock Exchange (WSE).

The previous government's power sector reform strategy - ambitiously aimed at tackling both liberalization and privatization at the same time - ground to a halt in 2001. The government kicked off the privatization of 17 of Poland's 34 power plants in 1999, which have a combined book value of about zł. 12.3 billion ($3.07 billion). So far, only a handful have been sold. The previous treasury minister wanted to sell 20-35% of each of Poland's 33 generators and 20-40% of all heating stations by the end of 2002. According to the previous government's European Union (EU) accession timetable, full liberalization of the power sector is planned for Jan. 1, 2005. If restructuring isn't completed by then, analysts predict that the sector will face competition from EU rivals, which could bankrupt about half of Poland's power generators - many of which are unprofitable and in need investment.

Early this month, Kaczmarek outlined his government's philosophy for privatizing the sector, though he offered few details. "Some hard facts are driving the privatization process in Poland," Dorcimont said. "Due to the overcapacity in the system and the way coal issues are managed, the margins for generators have been tightly squeezed, which continuously undercuts their market value and expected privatization revenues. Distributors, on the other hand, are seen as a kind of sweetener precisely because of the lack of effective liberalization of the sector, and for this reason, their market value is going up."

Lack of consensus

The previous government also wavered on how to coordinate the sector's privatization. It was torn between the demands of the Treasury Ministry, which wanted to sell distributors before generators to bring in higher revenues in the shorter term, and the Economy Ministry, which preferred to sell both simultaneously or consolidate them. It said the strategy for selling the power sector should focus on creating "vertically integrated entities," like in the case of generator Południowy Koncern Energetyczny (PKE), which would give Polish firms a chance to compete with similar multi-utilities in Western Europe after Poland joins the EU.

As for the current government, its strategy for the sector may depend on the outcome of PKE's appeal this month to the Treasury Ministry to expand its holding to include distributors and mines - and also which direction it takes in the privatizations of the G-8 group of power distributors and the Stoen plant in Warsaw. Earlier this month, the government canceled the tender for the G-8 and invalidated the preliminary bids for distributor Stoen.

Industry insiders said last week that horizontal consolidation would lead to economies of scale, while vertical consolidation would be attractive only before the system is fully liberalized and if it was monitored by the Energy Regulation Office (URE). Vertical consolidation is a combination of generators and distributors, intended to offset the volatility of the former with the stability of the latter. Horizontal consolidation involves either a combination of several generators - which gives a flexible portfolio - or combining distributors, to allow economies of scale in overheads and maintenance.

"But the lack of effective liberalization and the weakness of URE still allows the vertically integrated businesses to cross-subsidize coal purchases, grid and distribution costs and energy supply costs, as the coal sector is subsidized by the state," Dorcimont said. "Vertical integration, coupled with lack of control, means that this cross-subsidization covers the whole value chain. In an effectively liberalized market, there would be no benefit to vertical integration, other than balancing the various operational risks."

Others noted the Economy Ministry's strong links with the coal industry. They said government policy toward power-sector sales was driven by a concern to protect the coal sector during its restructuring. They also said many generators were interested in vertical integration with distributors as a way of using the distributors' leverage to buy into the coal sector. They said this form of cross-subsidization was not in the interest of the consumer or the treasury and was against EU directives.

"Given the variety of plans to combine different entities, ongoing uncertainty as to the final structure of the industry may negatively impact pricing of privatizations," said Josef Pospisil, corporate analyst at Fitch ratings agency in London. "It makes marginally more sense to sell the distributors first so that the customer base of the generators is established."

Joe Harper