US embassy cable - 04YEREVAN1453

UNCLAS SECTION 01 OF 02 YEREVAN 001453 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR EUR/CACEN FOR SIDEREAS, EUR/ACE FOR LONGI, EB/ESC, 
PASS TO USAID EGAT FOR WALTER HALL 
 
E.O. 12958: N/A 
TAGS: ECON, ENRG, AM 
SUBJECT: ARMENIA RELUCTANT TO DISSOLVE ARMENERGO: RIGHTFULLY 
SO? 
 
 
SENSITIVE BUT UNCLASSIFIED. PLEASE PROTECT ACCORDINGLY 
 
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SUMMARY 
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1. (SBU)  An IMF conditionality and commitments to other 
donors, including the United States (as part of the USATF 
action plan), oblige the Government of Armenia to eliminate 
by July 31 ArmEnergo, a state-owned enterprise that is the 
single buyer of midstream electricity. Once ArmEnergo is 
eliminated, the electricity distribution company, 
Electricity Networks of Armenia (ElNetArm), must negotiate 
contracts with all of Armenia's generating enterprises, as 
well as the calculating center, national traffic management 
and high-voltage power networks.  Because the Public 
Services Regulatory Commission has not yet established 
market rules for the energy sector or adopted an energy 
adjustment clause, premature dissolution of ArmEnergo would 
put private energy companies in an untenable situation. 
Sources close to the Ministry of Energy say that, despite 
press reports to the contrary, ArmEnergo will necessarily 
exist until there is a viable alternative in place, almost 
certainly past the July 31 deadline.  End Summary. 
 
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ARMENERGO: GUARANTOR OF THE ARMENIAN ENERGY SECTOR 
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2. (SBU) Since privatization of its electrical distribution 
function, ArmEnergo has acted as a single-buyer single- 
seller mediator of electricity, in effect making the 
Government of Armenia the guarantor of the Armenian energy 
sector.  The Ministry of Energy has used adjustments in the 
profits of ArmEnergo to keep end-use prices stable when 
generation costs have fluctuated.  Due to lack of 
transparency in its operations, it has also been subject to 
political interference and funds diversion.  The Government 
of Armenia committed to the IMF to dissolve ArmEnergo by 
July 2004.  The commitment also appears in the May 2004 U.S. 
Armenia Task Force Draft Action Plan. 
 
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THE BUCK STOPS WHERE? 
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3.  (SBU) It remains unclear what system will replace 
ArmEnergo.  Armenia has committed to a system whereby the 
privately owned electricity distributor, Electricity 
Networks of Armenia (ElNetArm) independently negotiates 
contracts with Armenia's generating enterprises as well as 
the national traffic management.  This does not eliminate a 
single-buyer from the system but rather transfers that 
unenviable role to ElNetArm, who currently must provide 
electricity at a tariff comprising a weighted average of 
supply costs based on a mix of hydro, nuclear and thermal 
generation.  The Public Service Regulatory Commission (PSRC) 
has been reluctant to adopt an energy adjustment clause, 
which would give the distributor the right to raise 
electricity prices for end-users when the average costs from 
generation rise.  Without adjusting its tariff to account 
for a change in the composition of generation, ElNetArm 
loses USD 4 million each month that the Armenia Nuclear 
Power Plant does not operate.  (Note: The ANPP shuts down 
annually for maintenance and refueling.  Longer closures due 
to lack of fuel have also occurred in the past.  End note.) 
ArmEnergo is also vulnerable to significant drops in cheap 
hydroelectric production during an unusually dry year. 
Without an adjustment clause and without rules that control 
ElNetArm's energy costs, ElNetArm would operate in the red 
and quickly use its cash reserves in the (not unlikely) 
event that generation costs exceed the tariff.  In the worst- 
case scenario, ElNetArm would buy and distribute only that 
electricity it could purchase for less than the tariff, an 
understandable but undesirable outcome that would lead 
immediately to power outages and would be potentially very 
damaging to the government.  (Note: Armenian consumers can 
currently count on reliable power supplies throughout the 
country.  Almost all power interruptions are brief and 
caused by short-term technical problems.  End note.) 
 
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PSRC RESISTING THE ADOPTION OF MARKET-BASED REGULATION 
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4.  (SBU) The PSRC has argued to preserve ArmEnergo for now 
and has resisted the adoption of rules governing tariff 
adjustment.  The PRSC has also resisted putting market rules 
governing these transactions into a regulatory framework, 
instead preferring to include rules in independent licenses 
and contracts.  Dispatch, import and export rules, which 
govern the seasonal swap with Iran and export to Georgia 
among other things, would affect ElNetArm's bottom line 
following the dissolution of ArmEnergo, and would affect end- 
user electricity costs if ElNetArm had an adjustment clause. 
Comment: Hiding such rules in a web of contracts and 
licenses creates a weak base on which a private network of 
generators, distributors, and customers cannot reasonably 
rely.  End Comment. 
 
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COMMENT 
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5. (SBU) The PSRC's actions indicate a desire to leave the 
government as the guarantor of both steady supply and steady 
prices in the energy sector.  The government seemingly finds 
the continued existence of ArmEnergo to be the most 
convenient way to do so, as it allows the government to 
absorb energy sector profits as well as losses (although 
there is justified suspicion that profits are diverted 
before reaching the government's coffers--another possible 
factor in the reluctance to eliminate ArmEnergo).  Until the 
government is committed to establishing market relations 
between the private players in the energy sector that may 
result in price rises, the elimination of ArmEnergo alone 
could cause more harm than good.  The establishment of rules 
by contract and license rather than law will lend itself to 
abuse, non-transparency, and distorted incentives.  In the 
absence of ArmEnergo, the lack of rules and of an adjustment 
clause would put private energy firms, especially ElNetArm, 
in an untenable situation, and could give private companies 
an incentive to produce, buy or distribute too little 
electricity. 
ORDWAY