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DE RUEHPS #0404/01 2581528
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O 151528Z SEP 09
FM AMEMBASSY PRISTINA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 9287
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RUCNDT/USMISSION USUN NEW YORK PRIORITY 1730
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RUEAWJA/DEPT OF JUSTICE WASHDC PRIORITY
RUZEJAA/USNIC PRISTINA SR PRIORITY

UNCLAS SECTION 01 OF 04 PRISTINA 000404 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EUR/SCE, EUR/ACE, DRL, INL, S/WCI; NSC FOR HOVENIER, USUN 
FOR SGEE, USOSCE FOR AHYDE 
 
E.O. 12958: N/A 
TAGS: ENRG EAID ECON EFIN ETRD ETTC PREL KV
SUBJECT:  KOSOVO:  URGENT DECISIONS NEEDED IN NKPP PROCESS 
 
SENSITIVE BUT UNCLASSIFIED - PLEASE PROTECT ACCORDINGLY 
 
¶1. (SBU) SUMMARY:  In July 2009, the Government of Kosovo (GOK) 
publicly announced its decision to move forward with the World 
Bank-funded New Kosovo Power Project (NKPP).  The announcement, made 
in close consultation with key international donors, was 
long-awaited.  After years of delay, it appeared that the GOK would 
finally realize new power generation in the near future.  Almost 
immediately after the announcement, one of four pre-qualified 
consortia withdrew from the NKPP process; by mid-August, a second 
consortium withdrew.  With only half of the qualified bidders 
remaining, the NKPP tender can continue as envisioned this summer 
but serious questions have been raised about the viability of the 
project in its current form. 
 
¶2. (SBU) SUMMARY CONTD:  Three years have passed since the start of 
the NKPP process and the current situation is unsustainable.  The 
Kosovo Consolidated Budget (KCB) risks being consumed by continuing 
subsidies to the existing power plants - Kosovo A and B - and costs 
of energy imports.  The Kosovo Energy Corporation's (KEK) equipment 
is facing catastrophic failure, outages are a daily occurrence, and 
existing mines will run out of coal by 2011.  At this critical 
juncture, it is vital that the GOK take decisions to ensure a tender 
that will result in investment in the energy sector by the end of 
¶2010.  While the USG would like to honor the announcement that was 
made earlier this summer with the World Bank (WB), the current deal 
is unraveling.  It is time for a fresh look at the most feasible 
options available to secure a reliable source of energy and 
investment for Kosovo as soon as possible.  END SUMMARY. 
 
SLOW START FOR NKPP 
------------------- 
 
¶3. (SBU) In early 2006, the WB bank began discussions with the GOK 
on the NKPP project, initially called "Kosovo C".  WB technical 
assistance to this project was approved shortly thereafter, and a 
call for expressions of interest (EOI) in NKPP was launched the same 
year.  After the initial EOI period concluded at the end of 2006, 
resulting in four consortia pre-qualified to bid on the NKPP 
project, decisions on how the eventual tender would be structured 
moved slowly.  This, in turn, increased the urgency of opening a new 
mine to feed the existing generation (Kosovo A and Kosovo B), and to 
alleviate the growing drain on the KCB from subsidizing the aging 
power plants and covering electricity imports.  Coal from the 
existing mine will run out at the end of 2011, and capital 
expenditures on failing equipment and power imports range from 
10-12% of the budget.  This summer's announcement by the GOK to move 
forward with a coordinated and integrated approach to Kosovo's 
energy sector reform was welcomed by all.  With the full support of 
the USG, the European Commission (EC) and the WB, Prime Minister 
Thaci outlined a NKPP structure focusing on new mine development and 
a staged approach to new generation.  The USG agreed to support 
coordinated privatization of Kosovo B, and the EC agreed to review 
options for the early closure of Kosovo A. 
 
¶4. (SBU) Almost immediately after the GOK announced the new NKPP 
approach, one of the four pre-qualified consortia, led by German 
company RWE AG, withdrew from the process.  By mid-August a second 
group, led by German utility EnBW partnering with the American 
Washington Group International, also withdrew.  There is speculation 
that a third consortium will also pull out.  While the NKPP tender 
process can continue with only two bidders, or even one, confidence 
in the project has been shaken.  Regardless of whether another group 
pulls out, the GOK must make a serious decision about how to ensure 
the substantial investment needed to open and operate the new mine 
and to operate the existing generation facilities to ensure power 
for Kosovo until new generation can be brought online.  This 
decision cannot be postponed any longer.  Further delays increase 
the already high risk of catastrophic failure of the existing 
generation equipment, the risk of running out of coal before a new 
mine can be opened, and further burdens the KCB. 
 
Current Situation 
----------------- 
 
¶5. (SBU) In the next week, the NKPP transaction advisor is 
anticipated to complete discussions with the two remaining 
 
PRISTINA 00000404  002 OF 004 
 
 
pre-qualified consortia to determine their interest in continuing 
with the project as currently outlined.  If both consortia remain 
interested, the structure announced this summer will remain the 
guiding plan.  The USG will continue to support the NKPP and to 
coordinate Kosovo B privatization, collaborating closely with the WB 
and EC to ensure our combined efforts lead to a successful outcome. 
 
¶6. (SBU) If only one NKPP bidder remains interested, the GOK can 
either declare the NKPP process as currently constituted over, or 
proceed into direct negotiation with the remaining bidder.  There is 
no legal impediment to direct negotiations with a single bidder. 
Although it can be argued it will be difficult for Kosovo to secure 
value in such a situation, significant negotiation is part of any 
successful contract, no matter what the structure.  Given that 
movement on developing essential NKPP contract documents and other 
decision making has been extremely slow to date, all of this could 
proceed much faster through direct negotiation.  This would also 
allow the GOK to explore the possibility of the bidder operating 
Kosovo A and B, in order to ensure Kosovo's power supply while 
waiting for new generation to come online.  Given the urgency of the 
situation, if only one bidder remains, we would recommend that the 
GOK proceed to negotiate directly. 
 
¶7. (SBU) If both remaining consortia withdraw, the GOK has a number 
of options to consider.  The sector assets, including the new mine, 
existing generation (Kosovo A and B) and new generation development, 
could all be bundled together or offered in various combinations. 
Any and all alternatives must be evaluated in terms of what will be 
the most timely and effective in ensuring Kosovo's power supply 
needs and minimizing the budget impacts.  In this situation, the GOK 
could choose to re-visit all four original pre-qualified consortia 
to gauge interest in the revised package - whatever the composition 
- or to open a new EOI to pre-qualify potential bidders.  No matter 
how many bidders ultimately remain, if a well-defined transaction 
structure were taken back to all of the consortia, including the two 
that have withdrawn, significant interest in the project might be 
regenerated.  Opening a new EOI would add considerable time to the 
process. 
 
Recommendation for a Way Forward 
-------------------------------- 
 
¶8. (SBU) The NKPP transaction advisor has identified nine options, 
from among the many possible, that the GOK could explore if one or 
no bidders remain.  The most viable option is a structure that will 
seek one investor to develop the new mine to supply all generation 
(Kosovo A, Kosovo B, and new generation), while rehabilitating and 
expanding Kosovo B.  This option, among other things, improves the 
reliability of Kosovo B and its environmental performance, ensures 
adequate investment in the new mine, allows the investor to 
coordinate both mining and power plant operations to serve Kosovo's 
domestic energy needs, and will generate export earnings.  Both the 
financial risks to the investor and the project's complexity are 
reduced, allowing for one partial-risk guarantee. 
 
¶9. (SBU) This option assumes that the GOK will continue to own and 
retain ultimate financial responsibility for Kosovo A, raising the 
possibility that some donor assistance will be needed in the event 
of equipment breakdowns.  Including Kosovo A as an asset for sale in 
the package is possible, but the facility is substantially older and 
less efficient than Kosovo B and has other associated environmental 
liabilities, so its inclusion is likely to complicate matters for 
the investor.  However, although selling Kosovo A is likely not a 
viable option, proper oversight of Kosovo A operations is needed 
until the plant is eventually retired, both to ensure demand for 
lignite and more reliable power for Kosovo. 
 
¶10. (SBU) In order to provide the greatest amount of flexibility to 
the investor, an optional and well-structured Operation and 
Maintenance agreement for Kosovo A should be included in the offer. 
This would allow the investor to reduce their direct operational 
risks through increased control of all generation assets and limit 
their financial risks by reducing the number of transactional 
relationships required.  Inclusion of a properly-constructed 
Operation and Maintenance Agreement would also minimize the impact 
on the KCB until the plant is closed.  By making the proposed 
Operation and Maintenance agreement optional, if the bidder 
 
PRISTINA 00000404  003 OF 004 
 
 
perceives inclusion of responsibility for Kosovo A as too 
complicated and risky, they could choose to decline this portion of 
the offer without damaging the overall project framework. 
 
Potential Hurdles 
----------------- 
 
¶11. (SBU) A likely objection to the proposed integrated structure is 
that it would create a private monopoly situation.  Numerous 
countries have a dominant generator, and the small size of Kosovo's 
national market means that effective regulation can substitute for 
public ownership.  A more likely issue will be the GOK's frequent 
inability to make and implement the timely and firm decisions needed 
to allow any structure for this transaction to proceed.  While it 
appears Prime Minster Thaci has acknowledged that failure to ensure 
a successful outcome to this transaction in 2010 is politically 
unacceptable, whether or not the GOK maintains enough political 
capital to achieve this feat remains to be seen. 
 
¶12. (SBU) It is possible, even likely, the WB will insist on 
remaining engaged with both the sector and the NKPP transaction, 
while not agreeing to the recommended course of action.  Although 
the suggested guidance to the GOK is not risk-free, Kosovo cannot 
afford further delays to energy sector reform.  Key issues in the 
failure of NKPP to reach a conclusion to date include not only the 
slow preparation of main project documents by the NKPP transaction 
advisor and the global financial crisis, but also the 
risk-increasing complexity of the current structure.  Further 
complications, such as re-opening the process to new expressions of 
interest and including a large requirement for new generation size, 
will certainly limit the chances of near-term success.  In the event 
the WB does not agree to pursue the transaction in a timely manner 
that will fulfill Kosovo's energy needs, the USG must consider 
whether the WB's interests still coincide with its equities in 
Kosovo and our on-going assistance to the energy sector. 
 
¶13. (SBU) The GOK must now make some serious decisions to ensure 
that a new energy sector transaction structure will succeed in 
attracting investors by the end of 2010.  The transaction must meet 
Kosovo's need for reliable power supply and at the same time 
minimize the potentially catastrophic exposure of the KCB to the 
sector's insatiable demands for current and capital expenses.  If no 
transaction were to happen by the end of 2010, equipment costs and 
energy imports could balloon to 40% of Kosovo's entire budget. 
Resources demanded by the energy sector come at the expense of 
Kosovo's vast social and economic development needs. 
 
Comment and Recommendation 
-------------------------- 
 
¶14. (SBU) The USG is making all good faith efforts to work with the 
WB to find a way forward on NKPP, however facts on the ground are 
rapidly changing the circumstances under which the USG agreed to 
move forward this summer.  Action now needs to be focused on a path 
that will attract private investors to develop the new mine, while 
ensuring generation investment that will meet Kosovo's energy needs 
in both the short and long term.  Further delay jeopardizes this 
process.  An approach that is narrowly focused on development of the 
new mine and overly-prescriptive on the size of new generation, will 
work against the USG's assistance to Kosovo's energy sector.  In 
that case, it may prove increasingly difficult to remain partnered 
with the WB. 
 
¶15. (SBU) Given the USG's commitment to Kosovo's energy sector 
reform, the GOK will inevitably ask us for guidance on the current 
situation.  Our recommendation is to urge the GOK to instruct the 
NKPP transaction advisor to prepare a tender to open the new mine in 
conjunction with Kosovo B.  The tender should include either a 
requirement or the option for expanded generation within Kosovo B at 
an economically justifiable size.  It should also include the 
possibility of a well-structured Operation and Maintenance Agreement 
for Kosovo A until its closure.  Kosovo A's closure should not be 
delayed any further as a result of this approach, but this bloc will 
continue to be part of the power generation equation until new 
capacity comes on-line.  The transaction advisor should re-visit all 
pre-qualified consortia with this package to obtain a market test of 
their interest.  If only one consortium were to remain interested, 
 
PRISTINA 00000404  004 OF 004 
 
 
the GOK should direct the transaction advisor to proceed to direct 
negotiation.  Both Kosovo's budget and future development depend on 
swift action and strong commitment by the GOK to see this process 
through.  END COMMENT. 
 
DELL