R 100855Z JUL 08
FM AMEMBASSY ULAANBAATAR
TO SECSTATE WASHDC 2351
INFO AMEMBASSY SEOUL 
AMEMBASSY MOSCOW 
AMEMBASSY ASTANA 
AMEMBASSY BEIJING 
AMEMBASSY MANILA 
AMEMBASSY LONDON 
AMEMBASSY TOKYO 
AMEMBASSY BANGKOK 
AMEMBASSY OTTAWA 
AMEMBASSY CANBERRA 
AMCONSUL SHENYANG 
AMCONSUL VLADIVOSTOK 
AMCONSUL OSAKA KOBE 
DEPT OF ENERGY WASHINGTON DC
MILLENNIUM CHALLENGE CORP WASHINGTON DC
DEPT OF COMMERCE WASHINGTON DC
NSC WASHINGTON DC
SECDEF WASHINGTON DC
DEPT OF TREASURY WASHINGTON DC

UNCLAS ULAANBAATAR 000340 
 
 
STATE FOR EAP/CM AND EB/IEC 
STATE PASS USTR, EXIM, OPIC, AND EPA 
STATE PASS AID/ANE D. WINSTON 
MILLENNIUM CHALLENGE CORP WASHDC FOR F. REID 
TREASURY PASS USEDS TO IMF, WORLD BANK 
MANILA AND LONDON FOR USEDS TO ADB, EBRD 
 
E.O. 12958: N/A 
TAGS: ENRG ECON EFIN PGOV EPET MG
SUBJECT: June Elections Could Jeopardize Recent Reforms of 
Mongolia's Creaking Energy Sector 
 
REF:  A) ULAANBAATAR 0169, B) 07 ULAANBAATAR 0426 AND 0427 
 
 
SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION 
 
1.(SBU) SUMMARY: In what amounts to a major breakthrough for 
donor-agency efforts to promote reform of Mongolia's deteriorated 
energy sector, Government of Mongolian (GOM) reps have for the first 
time publicly conceded that the sector is financially bankrupt and 
in wretched shape.  The impetus for these statements and for the 
organization was provided by USAID and the Economic Policy Reform 
and Competitiveness Project (EPRC) starting in April 2007.  Since 
that time, eight monthly meetings of the GOM/donor Energy Working 
Group (EWG) have been held and discussions of critical issues and 
problems facing the sector have been handled openly and candidly. 
The new Minister of Fuel and Energy (MoFE) has expressed support for 
the reform initiatives outlined and promoted by USAID/EPRC starting 
about two years ago and the EWG is in concurrence.  The Energy 
Working Group (EWG) is a coalition of donor reps (USAID, ADB, World 
Bank, EBRD and GTZ) and GOM stockholders and stakeholders including 
the MoFE, the State Property Committee (SPC), the Ministry of 
Finance (MoF) and Energy Regulatory Authority (ERA).  The EWG has 
continually encouraged closer cooperation between the EWG and the 
various GOM organizations on such issues as the need for an increase 
in coal prices and the methodology to determine appropriate prices; 
the need for a significant and immediate increase in both 
electricity and heat tariffs; the need for the MoFE to encourage the 
execution of Performance Agreements, a form of incentive regulation, 
between the ERA and the three largest energy enterprises;  increased 
collaboration and integration of the ERA and MoFE; and the first 
steps toward building a new and badly needed large Combined Heat and 
Power Plant (CHP).  The momentum gained in recent months slowed when 
politicians abandoned Ulaanbaatar to campaign in their districts 
ahead of the June 29 Parliamentary elections.  Continuation (or 
possible curtailment) of the process depends heavily on the 
yet-to-be-announced results of the June 29 parliamentary election. 
END SUMMARY. 
 
The Energy Sector is Bankrupt 
----------------------------- 
 
¶2. (SBU) Since April 2006 the Energy Working Group of donor 
organizations and GOM energy sector stakeholders, brought to life 
thanks primarily to the efforts of USAID Mongolia, has been pushing 
the GOM to implement desperately needed reforms to prevent the 
sector from certain electricity and heat shortfalls within the next 
one to two years. (See reftels for the state of the crisis.) Yet as 
late as December 2007 politicians have blocked all attempts by the 
ERA to significantly increase tariffs and EWG entreaties to fund 
large sectoral subsidies from the state budget rather than placing 
the burden on the energy companies, as is now the case has been 
ignored. The former Minister of Fuel and Energy (February to 
December 2007) saw no (self-) interest in increasing energy tariffs 
and in fact made outrageous and false statements on radio, TV and in 
the print media that tariffs would be going down. 
 
FIRST STEP: ADMITTING YOU HAVE A PROBLEM 
----------------------------------------- 
 
¶3. (SBU) Things began to change in December 2007 when Ch. 
Khurelbaatar, former State Secretary in the Ministry of Finance and 
former Director of Mongolia's Millennium Challenge Account National 
Council, became Minister of Fuel and Energy in Prime Minister S. 
Bayar's government. Khurelbaatar immediately recognized the decrepit 
state of Mongolia's energy sector and signaled his desire to 
implement USAID/EPRC and EWG recommendations. In January, he 
publicly announced that the energy sector, so vital to Mongolia's 
economic development and national security, was bankrupt. The 
Minister of Finance and the former Prime Minister followed suit at 
the very same meeting. On January 29 the MoFE and the ERA signed a 
memorandum of understanding, based on language from the USAID 
contractor EPRC, which laid out common strategies and objectives. 
For the very first time in the energy sector, the Ministry and the 
ERA were collaborating on energy matters, and continue to do so. 
 
First steps taken for Tariff Reform 
----------------------------------- 
 
¶4. (SBU) The EPRC, a key member and driving force in the EWG, 
presented its retail tariff reform plan to the ERA and received 
their concurrence. The Plan will be distributed to other 
stakeholders, including the EWG, in mid June for review, comment and 
discussion. First proposed to the ERA in 2006, the two-part 
generation tariff methodology, separating tariffs on the fixed 
(capacity) and variable (energy) costs involved in energy 
generation, became effective on May 1. Next steps include the 
introduction of incentive-based regulation and economic dispatching 
of electricity and heat (a process of allocating the required load 
demand between the available generation units based on the lowest 
operating costs first), so that the cost of operation is minimized, 
less coal is consumed again reducing costs and also air pollution 
and creating the incentive for higher cost producers to reduce their 
costs. Consequently, system efficiency will be improved. 
Transmission and distribution tariffs will also be subject to 
incentive regulation. 
 
Performance Agreements gaining momentum 
---------------------------------------- 
 
¶5. (SBU) With EPRC guidance first, and later with EWG guidance, the 
ERA established Performance Agreements (PA) with three of the 18 
Central Energy System licensees. PA's create incentives for 
licensees to improve efficiency and lower costs with the prospect of 
obtaining monetary rewards for good performance. The ERA uses 
financial ratios, and in some cases technical and operational 
benchmarks, to track and reward the performance of licensees. 
Examples of financial ratios used include: liquidity ratios; 
profitability ratios and capital structure ratios. In a sign that 
the ERA's strategy appears to be working, the ERA finalized terms of 
a third PA for 2008 with the Erdenet-Bulgan Electricity Distribution 
Network.  Negotiations continue with CHP #4 and other major energy 
companies. 
 
Coal Prices and CHP #5 
---------------------- 
 
¶6. (SBU) Effective December 1st, 2007, the government sanctioned 
price at which the privately-owned Sharyn Gol Coal Mine (SG) must 
sell coal to Mongolian power plants increased from 13,600 to 16,600 
Tugruks (about $11 to $15) per ton. Coal prices of the two other 
coal mines supplying the energy sector, where the GoM is the 
principal owner, were also increased but the increase was far less 
than SG. The move was crucial to keeping the coal mine solvent. 
Following long-standing recommendations of the EPRC and later the 
EWG, Minister Khurelbaatar has made building a fourth combined 
heating and power (CHP) plant in Ulaanbaatar (CHP #5) a top 
priority. The tender announcement was scheduled for May 20th, with 
bid submittals required 90 days thereafter. Unfortunately, the date 
has passed without an announcement and upcoming elections 
effectively guarantee that no further actions will take place until 
at least late summer. 
 
Public Information/Public Education (PI/PE) Campaign 
--------------------------------------------- ------ 
 
¶7. (SBU) Energy sector reform efforts have suffered from a 
traditional lack of public discussion and awareness of the subject, 
and the negative public reaction towards proposed tariff increases 
has not helped. Since mid-2007 EPRC has been engaging journalists 
and the media with energy sector entities such as power plants, an 
electricity  distribution company, the heat distribution and supply 
company and a coal mine and has made great strides distributing 
information in the past six months. There has been at least one 
television slot, one radio show, and numerous print articles aired 
after each of the six workshops held so far, with more to come. The 
campaign has educated the media and increased public awareness of 
the problems facing the energy sector. The EWG is fully briefed on 
the PI/PE campaign status, progress and plans at every EWG meeting. 
 
Uncertainty amid summer elections 
--------------------------------- 
 
¶8. (SBU) While some positive steps have been taken towards much 
needed reforms in the energy sector, more remains to be done. 
Upcoming June elections have the potential to threaten to jeopardize 
the EWG's new-found momentum, but the situation could also improve 
even further. There will be one more EWG meeting in late June and 
then all meetings will be suspended until the new government is 
formed. There is some concern that election results could yield a 
new political landscape less accepting of EWG initiatives. Already 
some politicians are suggesting that the MoFE (along with the 
Ministry of Roads, Transport and Tourism, among others) be rolled 
into an all encompassing Ministry of Infrastructure. This move has 
the potential to diminish the MoFE's and the EWG's influence on 
energy matters and add yet another layer of bureaucracy to a sector 
already burdened by excessive government involvement. On the other 
hand, if the new head of the energy sector (in whatever form) has 
the desire to continue to tackle the critical issues and problems 
facing the sector that will be yet another breath of fresh air, such 
as Minister Khurelbaatar provided when he was appointed. 
 
Minton