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Cablegate: Czech Electricity Giant's Murky Government Connection Means

VZCZCXRO3287
RR RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHPG #0992/01 2411453
ZNR UUUUU ZZH
R 291453Z AUG 07
FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC 9542
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RHEBAAA/DEPT OF ENERGY WASHDC

UNCLAS SECTION 01 OF 02 PRAGUE 000992

SIPDIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ENRG ECON EFIN ETRD PREL PGOV EZ

SUBJECT: CZECH ELECTRICITY GIANT'S MURKY GOVERNMENT CONNECTION MEANS
MIXED SIGNALS ON ENERGY POLICY AND PRACTICE

REF: PRAGUE 77

1. (SBU) SUMMARY AND COMMENT: Rising electricity prices, increasing
demand from a robust economy, and a low cost generation fleet have
led Czech electricity company CEZ Group (67.61% state owned) to
become the most profitable company in the Czech Republic for the
last two years. The lack of transparency in CEZ-GOCR relations and
in CEZ operations, however, makes it difficult to discern where
government political interests end and CEZ business interests begin.
Therefore, future CEZ capital investments and expansion are an
important and often the only yard stick available for determining
the direction of energy policy for the mid- to long-term. The
unified message from the Czech energy industry is that nuclear
generation is the only option available to the Czech Republic that
reduces carbon emissions, increases energy security, and effectively
meets growing domestic demand. Energy industry representatives'
support for increased utilization of nuclear energy, however, runs
counter to the views of the current coalition government, which
includes the Green Party.

2. (SBU) SUMMARY AND COMMENT CONTINUED: CEZ is marching forward with
its nuclear expansion plans without the official endorsement of the
current government, its majority owner. CEZ is hedging given the
weakness of the current government that throws in to question its
longevity, as well as past open support for nuclear expansion from
both sides of the isle (Civic Democrats -- ODS & Social Democrats --
CSSD). In fact, the Chairman and Vice Chairman of the supervisory
board are either current or former members of ODS. CEZ also points
out that planning for expansion of nuclear energy production
requires a 20-year time line, with only the final five years
involving physical construction, which means they can stick with
future plans without any visual expansion. Therefore, in the
absence of a more overt opposition by the government, CEZ is
following industry opinion. Whoever is in government in 2019 will
have to contend with whether to bring 15 years of nuclear power
planning online or facing a possible power shortage. The situation
may result in a state-owned company dictating policy to the
government. END SUMMARY AND COMMENT.

------------------------------------------
CEZ DOMINATES DOMESTIC AND REGIONAL MARKET
------------------------------------------
3. (U) CEZ is the eighth largest utility company in Europe, both in
terms of customers (6.8 million) and in market capitalization ($29.7
billion). It also has the lowest debt/EBITDA ratio (0.8) of any
electrical utility in Europe and Standard & Poor's gives CEZ an A-
credit rating. In 2005, CEZ dividends contributed CZK 3.6 billion
($180 million) to the government budget and its dividend payout per
share grew tenfold in six years (CZK 2 or $.10 in 2000 to CZK 20 or
$1 in 2006). CEZ is a vertically integrated company, which means
they have stakes in every facet of electricity production except for
transmission, which is controlled and regulated by the GOCR. In
2006, CEZ Group companies produced 22.5 million tons of lignite
coal, 46% of the country's total and 73.5% of total electricity in
the CR (62.0 TWh). They also own five of the eight distribution
companies in the CR, which account for 62% of all customers.

4. (U) Regionally, CEZ owns two generation units in Poland with a
combined capacity of 830 MW, distribution services in Romania
reaching 1.4 million customers, distribution services in Bulgaria
reaching 1.9 million customers, and generation in Bulgaria with a
total capacity of 1,260 MW. They have also signed joint venture
agreements to build new generation facilities in Bosnia and
Herzegovina and in Russia. CEZ anticipates further economic growth
in the Balkans and southern Europe and a corresponding expansion of
energy use, which will raise electricity prices closer to Western
European levels. This, combined with CEZ's own experience in the
Czech transition economy, has motivated its enthusiastic regional
expansion.

5. (SBU) CEZ has a supervisory board, half of which, including the
chairman, are appointed by the government. Currently, former ODS MP
Martin Kocourek is Chairman and Deputy Minister of Trade and
Industry for Energy Tomas Huner (ODS) is Vice Chairman of the
12-member supervisory board. While the supervisory board must
approve the actions of the board of directors, CEZ representatives
could not recall a recent instance of the supervisory board
overriding the board of directors. CEZ representatives stressed
that CEZ's primary objective is to make money for shareholders,
which it does quite well.

------------------------------
WHY NUCLEAR IS THE ONLY ANSWER
------------------------------
6. (U) Given that two-thirds of CEZ thermal generation capacity is
between 30-40 years old, major capital investments are needed to
keep capacity running and to meet increasingly stringent EU carbon
emissions standards. The amount of capital required for compliance
and general maintenance of older plants is not known. However, most

PRAGUE 00000992 002 OF 002


plants approaching 40 years of service need substantial upgrades,
which can almost double the average cost of producing 1 MW of
electricity. 2008-2014 is CEZ's timeframe for major coal asset
renewal and they are estimating total costs at CZK 140 billion ($7
billion). In light of likely capital cost increases, an uncertain
regulatory climate for emissions, and increasing fuel prices, CEZ
representatives believe that coal fired plants cannot be a long term
solution for growing energy consumption.

7. (U) Renewable energy sources have limited applicability in the CR
and are not reliable enough to satisfy the EU-mandated 12% of a
country's energy portfolio by 2010. Hydro-electric power consists
of just under 4% of 2006 total CEZ output. CEZ representatives
state that hydro-electric resources have been maximized and that
capacity cannot be expanded within the CR. Wind and solar power are
not viable for significant energy production in the CR. CEZ does
operate a wind farm in Southern Moravia and an experimental solar
farm at Dukovany. However, these are experimental and symbolic
forays into renewable energy sources. The one renewable that CEZ is
utilizing to some degree of effectiveness is biomass, which is
burned with coal in certain facilities. Biomass is not efficient
enough to take the place of coal and the CR does not have enough
land available for keeping a large sustainable biomass crop. On top
of these drawbacks, furniture makers have been protesting the use of
biomass because it increases the price of wood chips used in the
creation of particle boards.

--------------------------------------------
RUSSIA WILL BE SOLE SUPPLIER OF NUCLEAR FUEL
--------------------------------------------
8. (U) CEZ is banking heavily on nuclear energy to bolster its base
load production in the mid-term. In 2006, nuclear generated
electricity accounted for 42% of total CEZ generation (26 TWh out of
62 TWh total). Temelin and Dukovany are the two nuclear plants
operating in the CR. Dukovany began operating in 1985 and Temelin
came online in 2004, and both are Soviet designed reactors and will
operate under current conditions until 2027 and 2042, respectively.
Those dates are not firm, however, and both plants could have their
life-spans extended further with appropriate legislation and
upgrades. Dukovany, which uses a type of fuel only produced in
Russia and Spain, has a long term fuel contract with the Russian
company TVEL. TVEL also won a recent bid to supply Temelin with
fuel from 2010-2020, which Westinghouse currently supplies through
2009.

9. (SBU) Concern over complete Russian control of nuclear fuel
supplies is not justified in the short-run but could be a concern in
the long term. Dukovany keeps a one year reserve of fuel on site
and both stations only replace 1/5 of their fuel once a year.
Therefore, if Russia were to cut off nuclear fuel supplies to the
CR, it would not/not have the same effect as gas or oil supplies.
Sufficient time would be in place to negotiate with alternative fuel
suppliers. Nuclear generation has large costs associated with
construction, security, and waste disposal, but once built, it has a
very low marginal cost, steady fuel supplies, and no carbon
emissions. From the view point of public finances, energy
efficiency, and emissions reductions, nuclear power makes perfect
sense for CEZ and the CR. The real question, however, is whether
the domestic and European political situations come to value the
security and emissions benefits of nuclear over the potential
hazards.

---------------------
PRAGUE POWER EXCHANGE
---------------------
10. (SBU) In 2007, CEZ consented to create the Prague Power Exchange
(PX) where it will sell roughly 30% of its capacity. The other 70%
is sold directly to its subsidiaries for distribution to consumers.
PX CEO David Kucera acknowledges that if CEZ did not agree to sell
this capacity on the exchange, then the whole project would not have
proceeded. The PX's objective is to bring transparency to the
energy market by replacing an annual energy auction with an exchange
that allows people to gauge electricity prices daily. Businesses
will be able to view and financially secure power prices for two
years out and this helps with effective planning. Industry believes
popular fear of steadily increasing prices on the exchange is
invalid. The previous once yearly auction increasingly involved the
same percentage increase, but because it only occurred once a year,
the auction and prices simply faded from memory rather than being
constantly reminded with daily and even hourly price readouts.
Therefore, some argue that yearly auctions actually inflate the
price of electricity because firms would bid high in fear of getting
frozen out of the auction allocation. The problem with the PX is
that CEZ has market power because it is the largest player in the
market so CEZ could manipulate this market in a variety of ways to
avoid speculation. Nevertheless, the PX is a too-tempting-to-resist
venue to exercise market power for CEZ profit, which happens to fill
government coffers.
Graber

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