VZCZCXRO1319
RR RUEHLN RUEHVK RUEHYG
DE RUEHTA #1617/01 2420233
ZNR UUUUU ZZH
R 290233Z AUG 08 ZDK
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC 3135
INFO RUCNCIS/CIS COLLECTIVE 0615
RUEHAST/USOFFICE ALMATY 0689

UNCLAS SECTION 01 OF 03 ASTANA 001617 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ENRG ECON EAID EINV PGOV KZ
SUBJECT:  GOVERNMENT OF KAZAKHSTAN EXPLORES OPTIONS FOR EXPANDING 
ELECTRICITY GENERATION 
 
ASTANA 00001617  001.6 OF 003 
 
 
SUMMARY 
------- 
 
¶1. In response to a request from Kazakhstan's Ministry of Energy and 
Mineral Resources, on August 21, USAID completed and presented a 
study on options for stimulating investment in new electricity 
generation capacity through the use of capacity markets.  The study 
will be presented to stakeholders in a workshop as one of the 
culminating activities of the first phase of the Regional Energy 
Market Assistance Program (REMAP).  REMAP has established a strong 
rapport with Kazakhstani counterparts critical to the establishment 
of a regional market capable of increasing market-based trading 
within Central Asia, Afghanistan and Pakistan.   End Summary. 
 
BACKGROUND 
---------- 
 
¶2.  Kazakhstan has enviable economic growth and vast energy 
resources and yet many parts of the country face frequent blackouts. 
 Even some urban areas in Kazakhstan are facing power shortages and 
possible brown outs.  Current electricity generation and 
distribution assets need to be managed more effectively and 
incentives need to be provided for adding generation and 
distribution assets.  In both areas, there is a potentially large 
role for private sector investment and asset management techniques. 
 
¶3.  Private sector investment in new generation capacity has not 
taken place or has been stymied due to restrictive government 
policies to limit exports to meet domestic demand at a highly 
unattractive domestic pricing cap.  The pricing cap does not take 
into account the cost of constructing new generation facilities. 
Unless market mechanisms to address pricing issues are implemented 
and transparent regulation to access the grid for unlimited export 
of electricity to neighboring countries in Central Asia and 
Afghanistan is allowed, it will be difficult to access 
private-sector investment. 
 
¶4.  The Kazakhstani electricity market is evolving, but it is far 
from complete.  For example there are no market-based arrangements 
to deal with transmission congestion, and various instruments to 
allow market participants to manage risks, such as "contracts for 
differences," and other options and futures contracts, are not 
available yet.  More importantly, due to price caps, the majority of 
distribution companies in Kazakhstan cannot make the investments in 
metering and communications needed for improving electricity 
distribution.  Companies continue to face high technical losses and 
theft.  There is a need to separate market operation from 
transmission, and make both subject to economic regulation. 
 
¶5.  Despite weaknesses, the Kazakhstani government is showing some 
leadership in electricity sector restructuring, promotes the idea of 
creating a regional power exchange, and supports the operation of 
the regional Coordination Dispatch Center in Tashkent. 
 
REMAP: A CATALYST FOR REGIONAL COOPERATION 
------------------------------------------ 
 
¶6.  The USAID REMAP activity, financed jointly by the Kazakhstani 
government and the USG under the umbrella of USAID's Program for 
Economic Development, focuses on fostering: a) increased electricity 
exchange and trade; b) a transparent, competitive electricity 
market; and c) a market-based regulatory framework for regional 
cooperation.  As REMAP winds down over the next few months, it will 
focus on completing activities in the below areas. 
 
TRANSMISSION 
------------ 
 
¶7. Kazakhstan has a limited high voltage transmission network and 
capacity within the country.  This limitation impacts cross border 
electricity trade. The Kazakhstan Grid Operating Company (KEGOC) has 
a program to rehabilitate existing transmission lines and build 
several new transmission lines to remove these constraints.  There 
are several high voltage lines under construction and there are 
plans to construct additional lines in the near future. 
 
¶8.  In order to enhance operation of the regional transmission grid, 
REMAP has established a regional Power System Planning Model based 
on the country models of transmission companies in Kazakhstan, 
Kyrgyzstan, Tajikistan, Uzbekistan and the Coordination Dispatch 
Center in Tashkent.  The model was established through the formation 
of the CARTRANS Working Group (comprising transmission system 
operators from the region with participation from Afghanistan), 
which held a series of policy discussions.  All five Central Asian 
countries have installed USAID funded improved software. 
 
¶9. The final meeting of the CARTRANS Steering Committee is scheduled 
to be conducted on September 26 in Astana.  During this meeting, the 
CARTRANS Working Group will present to the Steering Committee for 
its approval the final 2007 and 2012 national and regional models 
and the analysis and findings of the CARTRANS final report. 
 
ASTANA 00001617  002.2 OF 003 
 
 
 
GENERATION 
---------- 
 
¶10.  Despite Kazakhstan's program of industry restructuring, the 
introduction of competitive power markets, and establishment of 
regulatory institutions, Kazakhstan has not attracted investment in 
new generation facilities and remains a net importer of electricity 
from Central Asian electricity suppliers.  Old generation plants 
with low operating costs supply most electricity at prices that are 
far below the price needed to attract investors to build new plants. 
 Aware of this problem and the resulting shortages of electricity, 
representatives of the Ministry of Energy, the Agency for Regulation 
of Natural Monopolies, and the Agency for Competition Protection 
have all stated that a high priority for Kazakhstan is the need to 
provide incentives for investment in the generation sector. 
 
¶11. In response to a request from the Ministry of Energy and Mineral 
Resources, REMAP prepared a white paper on approaches to ensuring 
resource adequacy and the international experience in stimulating 
investment in new generation capacity through the use of capacity 
markets.  The paper reviewed various administrative and market based 
approaches to resource adequacy, with a particular emphasis on the 
structure, operations and results to date of capacity markets.  In 
so doing, the paper reviews the interplay between energy and 
capacity markets and highlights the institutional roles of 
regulators and market participants in the operation of such 
markets. 
 
¶12. The overall conclusion that can be drawn from the report is that 
due to specifics of electricity markets, "one for all products" 
pricing in many competitive power markets does not provide adequate 
price incentives for investment in new generation, therefore 
additional payment mechanisms need to be developed.  The report 
describes a variety of options employed in power markets around the 
world and analyzes advantages and shortcomings of each of these 
options. Since one of the most prevalent options is an installed 
capacity market, the report also contains an overview of the 
operations of the installed capacity market in the U.S. (PJM, New 
York ISO, ISO-New England) and in the Russian Federation (which was 
launched in early July). 
 
¶13. Once counterparts have had a chance to comment on the paper, the 
findings will be presented to stakeholders in a workshop scheduled 
for September and entitled "Power Sector Resource Adequacy Plans 
within a Market Environment and the use of Capacity Markets to 
Stimulate Investment." 
 
PRIVATE MARKETS 
--------------- 
 
¶14. REMAP support to on-going national market development and sector 
reform processes will go a long way to help develop market-based 
trading arrangements between all Central Asian countries and 
increase exports available to Afghanistan and Pakistan.  One of the 
first activities that REMAP completed was a study tour for 
Kazakhstani government specialists Ministry of Energy and Mineral 
Resources (MEMR), the Competition Protection Committee (CPC), the 
Kazakhstan Grid Operating Company(KEGOC), and Kazakhstan Market 
Operator of Electricity and Capacity(KOREM) to the most progressive 
electric power market in the United States, PJM. 
 
¶15.  The annual policy speech President Nazarbayev gave in February 
2007 included support for regional energy cooperation and called for 
the creation of a regional power exchange.  In a related issue, 
REMAP worked with KOREM to streamline its operations and strengthen 
its capabilities to make it more accessible to cross-border trading. 
 Electricity trading on the KOREM market has steadily increased 
since inception and now stands at 15 percent of the total energy 
generated in Kazakhstan. 
 
¶16.  As a final activity in this area, on May 21-22, REMAP concluded 
an analysis and organized a regional workshop on specific market 
barriers in the area of the legal and customs frameworks in Central 
Asia to see how these regimes can more effectively support 
cross-border power trading. 
 
REGIONAL COOPERATION HAS SIGNIFICANT BARRIERS 
--------------------------------------------- 
 
¶17. Development of the electricity sector in Central Asia is closely 
related to water/energy sharing issues and the irrigation regime. 
As Kyrgyzstan and Tajikistan are planning to increase the 
utilization of water resources for the production of electricity to 
meet market demands, 
the economic valuation of water as a commodity and the more 
effective use of water for both electricity and agriculture are of 
great importance.  These issues have become even more critical due 
to the current low water year. 
 
¶18. Ancillary services, such as reserve capacity and regulation 
 
ASTANA 00001617  003.2 OF 003 
 
 
energy, are not procured using market-based mechanisms and 
arrangements for market monitoring by a qualified regulatory agency 
are weak.  This results in distorted market pricing of electricity 
which does not reflect true market costs of ancillary services. 
 
¶19. The countries of Central Asia have to work together to develop 
common policies and must be provided with the technical resources to 
implement shared decisions. Consistent with best practices used in 
other countries, there is an immediate need to harmonize legal and 
regulatory issues facing the market and to support trade between 
within and between Central Asia and Afghanistan and Pakistan. 
 
USAID REMAP II 
-------------- 
 
¶20. USAID has designed and is in the process of procuring a 
three-year $16 million follow-on to the REMAP activity.  The bulk of 
the funding for the activity in Kazakhstan will be financed under 
the Program for Economic Development. 
 
¶21.  The following is an illustrative list of activities for 
Kazakhstan that may be implemented by REMAP II: 
 
- Advice/implementation of incentives for the development of new 
generation capacity. 
 
- Policy facilitation/training on market development/ modification; 
legal and regulatory issues, market design, energy economics, and 
economic regulation. 
 
- Support for on-going national market development and sector reform 
processes in ways that help to develop market-based electricity 
trading arrangements between all Central Asian countries and 
increase exports available to Afghanistan and Pakistan. 
 
-Implementation of a regional transmission planning model for 
transmission system analysis and planning work. 
 
- Technical support for harmonization of national legislation and 
regulations related to electricity trade. 
 
- Development of a new regional methodology for pricing of ancillary 
services. 
 
- Development of a regional grid code and transmission pricing 
arrangements. 
 
- Development f ways for managing transmission congestion in the 500 
kV regional grid to provide the necessary pricing signals for 
additional transmission and generation. 
 
¶22.  While Kazakhstan's contribution to an efficient regional energy 
market will not be achieved without continued reforms, it does have 
the potential to play a significant leadership role. Kazakhstan has 
undergone a first round of energy sector reforms and is potentially 
a model for the development of the other Central Asian countries. 
It is also a likely investor in generation and transmission in the 
region. Over the long term, Kazakhstan could be a potential exporter 
of energy to the region and further south.  It is in the U.S. 
interest to advance international energy security by ensuring 
reliable access to global markets including regional energy 
integration and the Central Asia South Asia Regional Energy Market 
(CASAREM).  Kazakhstan's active involvement in developing the 
regional energy market is essential. 
 
ORDWAY