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Reforming the Energy Sector in Transition Economies: Selected Experience and Lessons


The common economies of the former Soviet Union (FSU) and Central and Eastern Europe (CEE) had a large capacity to supply energy from gas and oil produced in Russia, as well as from locally produced poor quality coal and nuclear energy. Energy demand has dropped with the contraction of economic activity and the recent increase of energy prices, but there is significant scope for increased energy efficiency. There is large potential to expand exports of gas and electricity form FSU and CEE to western Europe. However, expansion of such trade in the near term is likely to be small due to transmission constraints, difficulties in agreeing on transit arrangements, and slow progress in western Europe on liberalizing energy trade. The oil sector in Russia is quite different as it faces a serious supply crisis, which will require improved regulation and large investment in flows to stabilize production. Most energy utilities remain state owned but partial privatization using voucher privatization has occurred in the Czech Republic and Russia, and Hungary is planning privatization sales. In many CEE and FSU countries there is ample supply and stagnant, or slow growth, in demand for the output of most utilities, particularly energy utilities. This, combined with the absence of long-term debt, has created a situation where most countries maintain relatively low energy prices, especially for households, and owners who are not remunerated for the large asset base. In some countries, arrears to energy suppliers are large. Governments, in most cases, have not established a framework for operation of these utilities which encourages true commercial operation. The result has been to perpetuate allocative inefficiencies, dynamic and productive inefficiencies and lost fiscal revenues. The costs of continuing such policies are significant. However, commercialization can be made more efficient, while also generating increased fiscal resources and encouraging capital market development, by putting in place transitional regulation, by conversion of utility equity to debt, and by continuing to increase energy prices, with selective compensation to poor energy consumers. This framework for commercial operation is an important pre-requisite for efficient privatization. Fiscal resources derived from debt injection, taxes and dividends may be used to support stabilization, or other urgent needs. Reform of the energy sector can have important link to pension reform and capital market development. The benefits of CEE and FSU countries are likely to be potential benefits of over a hundred billion dollars during the next decade. Without such a reform strategy the risk of waste and inefficiency is high - either dissipation of potential benefits and misallocation of scarce capital to uses which provide little contribution to economic growth or sustainable reform.