Central Asia Regional Economic Cooperation

Strategy for Regional Cooperation in the Energy Sector of CAREC Countries

Good Neighbors • Good Partners • Good Prospects

ABBREVIATIONS

ADB          Asian Development Bank

AKFED          Agha Khan Foundation for Economic Development

AREO          Alternate and Renewable Energy Options

bbl          Barrel

BCM          Billion Cubic meters

BTC          Baku-Tbilisi-Ceyhan Oil Pipeline

BTE          Baku-Tbilisi-Erzerum Gas Pipeline

CAPS          Central Asian Power System

CAREC          Central Asia Regional Economic Cooperation

CDM          Clean Development Mechanism

CPC          Caspian Pipeline Consortium

CASAREM          Central Asia-South Asia Regional Electricity Market

CASA-1000          Central Asia-South Asia 1000 MW Export Project

CNPC          Chinese National Petroleum Corporation

DSM          Demand  Side Management

FSU          Former Soviet Union

GWh          Million kWh

GNI          Gross National Income

GDP          Gross Domestic Product

HPP          Hydro Power Project / Hydro Power Plant

HVDC          High Voltage Direct Current

IFIs          International Financing Institutions

KgOE          Kilogram Oil Equivalent

IFRS          International Financial Reporting Standards kV          Kilo volt

km          kilometer

OECD          Organization of Economic Cooperation and Development

OTL          Overhead Transmission Line

PPP          Purchasing Power Parity /Public Private Partnership

RAO UES          United Energy System of Russia

SS          Substation

TCF          Trillion Cubic feet

TAPI          Turkmenistan-Afghanistan-Pakistan-India gas pipeline

T and D          Transmission and Distribution

TWh          Billion kWh

TPP          Thermal Power Project/Thermal Power Plant

XUAR          Xinjiang Uyghur Autonomous Region of China

TABLE OF CONTENTS

1. Introduction           4
2. Long Term Vision of the Energy Sector           4
3. Strategic Approach           4

Drivers for regional cooperation           4

Principles of regional cooperation           4

Forms of regional cooperation           5

Benefits from regional cooperation           5

1. Strategy Elements           6

Investment measures for regional cooperation           6

Capacity building and knowledge sharing           6

Policy measures           7

1. Strategy Implementation           9

Implementation dimensions           9

Costs of financing           10

(i)       Investment measures      10

(ii)        Capacity building Measures     10

(iii)         Studies to be carried out    11

Progress indicators and monitoring framework           11

Risks and mitigation measures           12

Appendices

1.          Current Energy Inter-relationships among CAREC countries          14

2                Evolving Energy Inter-relationships among CAREC countries  15

3                Suggested Dimensional View for regional Cooperation  16

4                Bold Stroke Projects – Oil and Gas  17

5                Bold Stroke Projects - Electricity  18

6                Illustrative list of studies to be carried out  19

7                List of Investment Projects  20

8                Key International Agreements and Programs relevant to energy and  33

transboundary river cooperation and respective membership of CAREC countries

REGIONAL COOPERATION STRATEGY

IN THE ENERGY SECTOR OF CAREC COUNTRIES

1. INTRODUCTION

1. The member countries participating in the Central Asia Regional Economic Cooperation Program embrace the Program’s mission of development through cooperation and join efforts to bring to fruition the shared vision of “Good Neighbors, Good Partners and Good Prospects”.

1. The regional economic cooperation is an important vehicle for enhancing national development strategies of the participating countries and realizing the countries’ immense development potential in the context of increasingly integrating Eurasia. Infrastructure is a key pillar  supporting the participating countries’ drive for development through cooperation, where energy infrastructure is vital in ensuring overall economic growth and prosperity.

1. This energy strategy has been developed in accordance with the Comprehensive Action Plan endorsed at the 5th Ministerial Conference on CAREC. The strategy seeks to enable the development of best solutions to meet future energy demand and promote development of new energy resources for the region and for exports by exploiting the potential for mutually beneficial gains among the participating countries

1. LONG TERM VISION FOR THE SECTOR

1. The long term vision of the region’s energy sector is to ensure: (a) energy security through the balanced development of the region’s energy infrastructure and institutions, stronger integration  of the region’s energy markets to make available adequate volumes of commercial energy (and energy services of acceptable quality) to all physical and juridical persons in a reliable, affordable, financially sustainable and environmentally sound manner; and (b) economic growth through energy trade.

1. STRATEGIC APPROACH Drivers for regional cooperation
   1. The regional energy cooperation is driven by the need to (i) overcome, through increasing integration of the energy markets, the impact of uneven distribution of energy resources among the CAREC countries; (ii) optimize existing energy interrelationships (see Appendix 1) and achieve least-cost solutions to energy constraints. The energy cooperation process is further stimulated by external factors such as the availability of new attractive energy markets in eastern and southern China, Pakistan, India and Iran, along with new strategic transit opportunities for oil and gas through Turkey, Georgia, and Russia, coupled with strong interest in the region from Chinese, Russian and other investors. Also, rising global energy prices enhance the attractiveness of the large hydropower project options in Kyrgyzstan and Tajikistan, especially in the context of regional energy market development taking into account the interests of all the countries situated along transboundary watercourses and the availability of export markets beyond Central Asia.

Principles of regional cooperation

1. Regional energy cooperation will be promoted in good faith and in observance of the following principles:

• sustained political will for reforms and cooperation;
• bilateralism and multilateralism;
• mutual benefits for all;
• gradualism, voluntarism, and consensus;
• prudent, marginal and diversified dependence on outside energy resources to maintain adequate energy security;
• mutually compatible regulatory arrangements based on evolving experience, including specific legal and regulatory framework for each cooperation venture based on international cooperation practices;
• pursuit of sector reforms, governance and operations conducive to regional cooperation on a commercial basis;
• adherence to adequate level of transparency and disclosure standards:
• respect for environment through collective action with regards to clean energy, transboundary watercourses; climate change and littoral space;
• fair and rational use of natural resources, including transboundary watercourses, and minerals, and
• consideration of the concerns of the neighboring countries.

Forms of regional cooperation

1. Regional energy cooperation will be advanced through the development of market relations, transit arrangements, investments, relationships under agreements on the joint use and protection of trans-border rivers and sea-bed resources as well as knowledge sharing.

Benefits from regional coooperation

1. Through regional cooperation the participating countries will pursue benefits from developing new energy market opportunities, receiving transit revenues and achieving least-cost development solutions through a rational sharing of resources.

1. In this context the participating countries look forward to evolving medium-to long-term inter- relationships resulting in:

(i)                            states with sufficient energy resources for exports (Azerbaijan, Kazakhstan, Uzbekistan) securing access to export markets and earning export revenues to support their energy1  export - led growth;

(ii)                          states rich in hydropower resources, but lacking fossil fuels (Kyrgyz Republic and Tajikistan), gaining access to export markets for hydroelectricity and earning export revenues to secure import of fossil fuels to meet their winter energy deficits

(iii)                        transit countries (such as Afghanistan and Mongolia) earning valuable transit and transmission fees, and Mongolia becoming an alternative energy transit route between Russia and China and exporting coal and possibly electricity in the future to China;

(iv)                       China importing oil and natural gas from Kazakhstan, and natural gas from Uzbekistan and Turkmenistan,

(v)                         Azerbaijan trading larger volumes of power with Russia, Georgia, and Iran; and

(vi)                       Central Asian countries exporting power and natural gas to South Asia (see Appendix 2).

1 Energy exports include exports of electricity, oil, gas and coal.

1. STRATEGY ELEMENTS

1. The achievement of the long-term vision for the energy sector in the region will be pursued through economically and financially sound investment measures for regional cooperation taking into account the interests of all states in the region. To enable identification and implementation  of such projects capacity building and knowledge sharing measures will be pursued. To ensure sustainability of investments, sound and appropriate policy environment will be maintained.

Investment Measures for Regional Cooperation

1. The improved performance of the national energy sectors of the participating countries is of critical importance for the achievement of greater benefits from regional energy cooperation. Therefore both domestic and cross-border investments will be pursued.

1. The domestic investments will focus on energy efficiency and clean energy. Energy efficiency investments will encompass efficiency improvements in energy production, transportation, distribution and energy use and will cover such areas as: (i) loss reduction; (ii) rehabilitation of existing assets; (iii) least-cost system expansion and operation; (iv) appropriate heating options; (v) commercialization of energy operations; and (vi) upgrading end-use equipment, facilities and buildings (including other demand side management measures). Clean energy investments will include such aspects as: (i) retrofits for mitigation of pollution; (ii) reduction of fuel resources used per unit of goods produced; (iii) elimination of gas flaring; and

(iv) developing alternative and renewable energy sources,

1. The cross-border investments will focus on production of ecologically clean energy and energy trade and will be pursued with mutual agreement among all relevant parties in the following key areas: (i) cross border energy transmission, (ii) facilitation of access/transit to third country energy markets; (iii) production for export, (iv) development of energy resources on a joint/cooperative basis respecting the laws of relevant states for protecting nature; (v) integration of energy markets, (vi) capacity building for energy trade, (vii) projects under Clean Development Mechanism and carbon finance, and (viii) investments abroad to access energy resources there. (Key prospective “bold stroke” projects of regional importance are shown in Appendices 4 and 5)

Capacity building and knowledge sharing

1. The new responsibilities and functions of the participating countries in the regional cooperation context will be supported by enhancing their institutional capacity through exchange of knowledge and experience among participating countries and with recognized international sources of best practices.  The capacity building will focus on the following knowledge areas:

• Commercial operation of the sector: focus on negotiations, contracting (power purchase, power wheeling and transmission services), regional dispatch and system control, metering, billing and collections, and utility accounting and audit, modern corporate governance techniques, tariff adjustments, operational efficiency, and consumer relations.
• Sector regulation: focus on ensuring transparency, stability and predictability and consistent fairness.
• Public Private Partnership arrangements: focus on forms and regulation.
• Demand Side Management, energy efficiency and energy conservation: focus on integrated resource planning, energy service companies and financing mechanisms.
• Alternative and renewable energy: focus on resource surveys, devising promotional and incentive arrangements.
• Riparian issues: focus on international experience in transboundary river  management and protection.

Policy measures

1. The policy measures will focus on enhancing (i) energy trade and security; (ii) financial viability of energy supply entities and the sustainability of energy services; (iii) social protection in the energy sector; (iv) sector restructuring and commercialization; (v) sector regulation; (vi) promotion of private sector participation; (vii) cooperation in international river basins; (viii) littoral agreements; 2 (ix) alternative and renewable energy options; and (x) energy efficiency and initiatives under Clean Development Mechanism (CDM) and other (successor) carbon financing mechanisms.

1. The choice and sequencing of these policy measures will be in accordance with the circumstances of each country and planned forms of cooperation. The pursuit of such chosen policies will be to the extent they are politically and administratively feasible.

Energy trade and security

1. Energy trade will be pursued to increase the available forms and sources of energy to complement in an effective and reliable way the domestic energy resources of the CAREC countries thus enhancing energy security and or to develop the energy exports potential as a driver of economic growth.

Financial viability of energy supply entities and sustainability of energy services;

1. Regional energy trade will be sustainable only when it takes place among financially viable and solvent entities. The financial viability of the energy entities will be ensured through (i) adjusting tariffs to cover costs, including cost of capital, (ii) reducing losses to minimize costs  and improve efficiency of supply; (iii) improving system and consumer metering, billing and collection practices to industry standards, and (iv) adopting least cost planning, construction and operation.

Social protection in the energy sector

1. Efforts to develop adequate social protection systems for energy consumption will continue by improving the targeting of the compensation mechanisms to the needy and eliminating non- payments and discounts to a wide range of privileged consumers. Realistically designed and efficiently implemented lifeline tariff will be the second best option.

Sector restructuring and commercialization

1. Wherever feasible sector restructuring and commercialization will be pursued to enhance energy trade through (i) independent and solvent transmission business, separated from  generation and distribution businesses, (ii) transmission service charge to all system users on the basis of a reasonable return on transmission investments, and (iii) regulated or open third party access to transmission (subject to technical availability and capacity).

2 For example, agreements on protection and use of sea-bed resources by littoral states

1. There are large opportunities for further improvement in commercializing the energy entities and trade transactions. The trading entities such as generating companies, distributing entities or trading companies will pursue a clear commercial orientation through (i) applying enforceable and standard energy purchase or sales contracts, (ii) ensuring transparency of transactions and operations including also internationally acceptable accounting, audit and disclosure standards (such as IFRS) to the extent feasible.

Sector regulation

1. Sector regulation will improve to enable meaningful energy cooperation. Fair, transparent  and stable regulation will be pursued through (i) separation of the regulatory functions from ownership, policy making, operations and maintenance in the energy sector.

1. Regulatory principles will be embodied in regulatory laws and regulatory practices will follow published rules and regulations by the regulatory body under the law. The regulatory body will have reasonable functional and financial autonomy. Its accountability will be ensured by provisions for appeals against its rulings to the high courts and accountability to parliament through detailed annual reports.

Private sector participation

1. Private sector involvement in the energy sector will be facilitated through promoting public- private partnerships and enhancing the enabling framework, including membership in the Energy Charter Treaty, which provides safeguards for private investment against nationalization and  other restrictive measures. Most CAREC participating countries have already become members  of the said Treaty.

Cooperation in using transboundary watercourses

1. Modern approaches to benefits-sharing will be pursued to enable an ecologically sound exploitation and protection of transboundary water courses in a manner that safeguards not only the regular irrigation, power and drinking water interests but also the economic, environmental, cultural and social interests of all riparian states along important river basins such as Amu Darya and Syr Darya. Carrying bilateral and multilateral negotiations and possibly concluding relevant riparian agreements will enable, inter alia, the design, construction and operation of large storage hydro power plants in many CAREC countries such as Afghanistan, Kyrgyz Republic and Republic of Tajikistan. These power plants will focus on generation for export to outside destinations, apart from helping to meet winter power shortages in the domestic markets of those or other Central Asian states by adhering to mutual responsibilities of riparian states in using transboundary watercourses and without inflicting significant harm to the use of water resources by riparian states3. The CAREC countries may also draw on relevant experience of other inter- governmental bodies in managing transbounadry river basins in Central Asia and elsewhere in the world. Further, improvement of the treatment of riparians’rights and obligations will be considered through relevant international rules as well as conventions, which have been already joined by some of the CAREC participating countries. These conventions have been summarized in Appendix 8. However, it is recognized that not all CAREC states are signatories of all these conventions, and not all conventions have entered into force and that seeking accession to these and similar conventions is a sovereign right and choice of the states. When a state is not a

3 Uzbekistan and Kazakhstan are concerned of harm to the use of water resources and this must be considered in line with principles of cooperation outlined in Paragraph 6.

signatory to the relevant convention bilateral negotiations and adoption of the procedures under the safeguard policies of the IFIs may help.

Littoral agreements

1. Further expansion of the scope of the littoral agreements will be pursued among the Caspian Sea countries to enhance opportunities for exploration and protection of seabed resources and laying gas and oil pipelines under the sea.

Alternative and renewable energy options (AREO)

1. Opportunities for alternative and renewable energy investment options will be pursued, complemented by international incentives offered through the Clean Development Mechanism and similar carbon finance facilities. In order to ensure level playing field between AREO and conventional commercial energy the possibility of minimizing the subsidies on the conventional energy will have to be explored.

Energy Efficiency

1. Energy efficiency improvements allow for rational and economic use and trade of energy resources, introduction of advanced technology and infrastructure and improve the financial viability of energy utilities. Operations under Clean Development Mechanism or similar carbon finance mechanisms contribute to environmental improvements in the participating countries. Policies for promoting energy efficiency and energy conservation and carbon  finance mechanisms need to be adopted.

1. STRATEGY IMPLEMENTATION Implementation Dimensions
   1. In view of the current opportunities and dynamics in the region, the participating countries will focus on implementation of the regional cooperation strategy along the following main dimensions (energy corridors):

(i)                            Central Asia-China: this dimension focuses on energy trade and investments between China and the Central Asian Republics.

(ii)                          Central Asia-South Asia: emerging and potential electricity trade between Central Asian Republics and South Asia.

(iii)                        Cooperation opportunities within Central Asia.

(iv)                       Central Asia-Russia: most of the oil and gas exports till now have been oriented to Russia or through Russia to western destinations. Russia has been investing in exploration and production in the Central Asian countries as well as in rehabilitation, expansion and operation of pipeline systems (also in large and complex hydro power projects) and is therefore involved in the energy export efforts of the Central Asia countries.

(v)                         Central Asia-EU: the EU dimension focuses on facilitating exports of Central Asian and Azeri exports of energy to Europe. Azeri oil and gas are already flowing towards the west On account of its geographical location and its own abundant hydrocarbon resources, Azerbaijan has the potential to emerge as an energy corridor between Central Asia and EU in the near future not only in relation to oil and gas but also in relation to electricity transit.

1. The implementation of the regional energy strategy will be pursued through the above dimensions in consideration of geo-political realities, need to diversify export markets, and the inherent economics and risk profiles of the dimensions. (See Appendix 3)

Costs and Financing

(i)    Investment Measures

1. Available information on the capital costs of the investment schemes and their possible sources of financing have been compiled and indicated in Appendix 7. The overall costs and possible financing are summarized in Table 1. The list in Appendix 7 is neither exhaustive nor authoritative. It is at best indicative or illustrative. The inclusion of any project in this list does  not necessarily imply commitment or approval on the part of any government.

1. Capital costs of investment proposals are tentative due to scarce cost information on projects pursued by the private sector under production sharing or concession contracts for exploration  and production of hydrocarbons and coal. Similarly, information is not readily available for many of the dedicated oil and gas pipelines built, or to be built by consortiums of governments and the private sector.

1. Nevertheless, the cost estimates indicated provide private investors and IFIs with a broad idea of the lower bound of the financing needs.

1. Excluding 10 items for which cost data is not readily available, the capital cost of the remaining items are estimated at about $20.6 billion. Possible financing could be self financing ($5.1 billion), IFIs ($ 3.8 billion) and others ($11.7 billion).

1. Self financing level of about 20-30% is needed to ensure financial viability, leverage debt and secure other forms of project finance.4 Other sources of financing include: (i) private and commercial sources, (ii) bilateral sources, (mostly Chinese and Russian), (iii) international hydrocarbon investors, and (iv) IFIs.

(ii)    Capacity Building Measures

1. Capacity building measures will be pursued in various forms such as (a) on-site training of local experts by international consultants (b) pilot projects, (c) exchange of experience among CAREC utilities and with outside utilities (d) regional training courses and conferences, seminars or workshops. The scope of the activities within the CAREC regulatory forum will expand.

1. One regional workshop is to be organized in the short to medium term for each of the six topics indicated in Section D above, followed up by technical assistance in each country with  pilot projects demonstrations. The participating countries will seek donors and IFI’s support to finance the estimated relevant costs as follows:

4 In the case of existing operating entities, 30% of the new project cost is assumed to be raised through internal cash generation. In the case of new entities established to execute own and operate new projects, 30% of the project cost is assumed to be raised as equity from sponsors as well as the public and private equity markets. In either case 70% of the project cost is assumed to be secured as long term debt from public (including IFIs) and private sources of debt.

• $1.5 million for the six international workshops, in addition to a contribution from the participating countries at 10% of total cost
• $10.5 million for follow up TA activities

1. Additional costs, if needed, (especially those in local currencies) will be met by contributions in kind by the relevant CAREC government. (see table 1 on Costs and Financing further in the text)

(iii)    Studies to be carried out

1. Analytical and research work needs to be undertaken for identification of specific investments and in support of key strategic and policy decisions in the energy sector. In addition to contributions from the participating countries support of the donors and IFIs support is needed for carrying out such studies, estimated at $ 10,85 million (See Table 1 on Costs and Financing and Appendix 6)

1. In respect of studies and capacity building programs about 10% of the costs are assumed to be met by the countries, while the remaining costs are for possible IFI and bilateral assistance.

Table 1: Indicative Costs and Financing of Regional Cooperation Program ($ million)

Progress Indicators and Monitoring Framework

1. Progress Indicators (PI) have been provided for each of the investment proposals in Appendix

7. Wherever possible it also indicates the base line value. In addition, use of some broader indicators may be useful to monitor progress in respect of the overall Regional Energy Cooperation program.

1. The indicators will be compiled in the format given in Table 2 below for each country on the basis of official information to be given by each country and information from other sources and  a regional table prepared on the basis of the country tables. It is recognized that reporting data for the indicators will be voluntary on the basis of the best national efforts.

1. Indicators, 5, 6, 7 and 8 relating to energy imports and exports should cover only transactions among CAREC countries and those of CAREC countries with Russia, Iran, Georgia, Turkey, and South Asia (Pakistan and India). It is assumed that exports to and from Europe will take place through Turkey or Russia and would be included within the data reported for Turkey and Russia. The data for China will include exports to and imports from all CAREC countries, but not from any other country. Further the term “energy” consists of oil, natural gas, coal and electricity (in the context of this table) and each country needs to have separate rows for each item relevant to its economy. These numbers could help monitor the growth in energy trade and the energy flow

in the respective energy corridors such as CA-SA, CA –China, Intra-Central Asia, CA-Turkey (EU), and CA-Russia

Table 2: Progress Indicators for the Regional Energy Cooperation Program

Risks and mitigation measures:

1. Risks to the strategy can be related to project sites, investments, trade, security, country performance and geo-politics.

1. Project site - related risks such as those relating to geology, hydrology and seismic factors and security will be avoided to a large extent by careful site investigations and by choosing flexible project parameters.

1. Investment related risks will be minimized by (i) adopting sound macroeconomic and commercialization policies, (ii) securing IFI’s financing and guarantees programs. (iii) Energy Charter Treaty membership (as applicable) and (iv) bilateral investment agreements (as applicable) (See Appendix.8 outlining key International Agreements and Programs and the respective membership status of the CAREC countries).

1. Trade - related risks such as supply risk, market risk and payment risk will be handled through appropriately written trade contracts providing for “take or pay”, “supply or pay” clauses and providing for appropriate guarantees for payment obligations and suitable commercial international arbitration clauses.

1. Resolution of internal conflicts and avoidance of regional conflicts can help to mitigate a range of country - related risks and security risks for the regional cooperation.

1. Geo-political risk related to diverging positions of major players in the region can be handled through appropriate diplomatic channels.

1. In addition to observance of the basic rules of International Law, adherence to relevant UN international conventions would provide venue for dispute resolution between CAREC  countries

5 Water sharing agreements (following international standards) among riparian states in respect of international rivers are needed to raise funds from IFIs and commercial sources for major hydropower projects

6 This applies only to states adjoining Caspian Sea.

and countries outside CAREC. (See Appendix 8 outlining key International Agreements and Programs and the respective membership status of the CAREC countries). It is recognized that bilateral and multi-nation dialogues are respectively preferred by CAREC countries to solve disputes.

1. Application of IFIs safeguard policies provides a sound basis for avoiding the occurrence of disputes and grievances.

1. Next Steps

After the approval of the proposed strategy, future meetings of the Energy Sector Coordinating Committee (ESCC) will pursue the development of an action plan and related measures to promote further implementation of the Strategy based on contributions from the CAREC countries.

Appendix 1: Current Energy Inter-relationships among CAREC Countries

Appendix 2: Evolving Energy Inter-relationships among CAREC Countries

Appendix 3

Suggested Dimensional View for Regional Cooperation

(List of some Prominent Projects)

Some of the prominent project proposals (referred to as Bold Strokes) and currently being pursued or considered are listed in first three columns in this Table. Two maps indicating the location of most of the prominent projects listed above are given in Appendix 4 and 5.

Appendix 4          CAREC Regional Energy Cooperation

Appendix 5          CAREC Regional Energy Cooperation

Appendix 6

Illustrative List of Studies to be carried out

Appendix 7

Note: The information in this list has been gathered from many sources. The list is indicative or illustrative and is not exhaustive or authoritative. The inclusion of any project in this list does not necessarily imply that the relevant governments have approved them or committed to them in any way.

Items relating to China

Appendix 8 Key International Agreements and Programs relevant to energy and transboundary river cooperation and respective membership of CAREC countries.

Bilateral Investment Agreements Among CAREC countries

Note: all dates refer to entry into force unless indicated otherwise

Source: United Nations Conference on Trade and Development (UNCTAD)

Status of membership of CAREC countries in multilateral instruments for disputes resolution and investment guarantees

Central Asia Regional Economic Cooperation

Strategy for

Regional Cooperation in the Energy Sector of CAREC Countries

Good Neighbors • Good Partners • Good Prospect

ABBREVIATIONS

ADB          Asian Development Bank

AKFED          Agha Khan Foundation for Economic Development

AREO          Alternate and Renewable Energy Options

bbl          Barrel

BCM          Billion Cubic meters

BTC          Baku-Tbilisi-Ceyhan Oil Pipeline

BTE          Baku-Tbilisi-Erzerum Gas Pipeline

CAPS          Central Asian Power System

CAREC          Central Asia Regional Economic Cooperation

CDM          Clean Development Mechanism

CPC          Caspian Pipeline Consortium

CASAREM          Central Asia-South Asia Regional Electricity Market

CASA-1000          Central Asia-South Asia 1000 MW Export Project

CNPC          Chinese National Petroleum Corporation

DSM          Demand  Side Management

FSU          Former Soviet Union

GWh          Million kWh

GNI          Gross National Income

GDP          Gross Domestic Product

HPP          Hydro Power Project / Hydro Power Plant

HVDC          High Voltage Direct Current

IFIs          International Financing Institutions

KgOE          Kilogram Oil Equivalent

IFRS          International Financial Reporting Standards

kV          Kilo volt

km          kilometer

OECD          Organization of Economic Cooperation and Development

OTL          Overhead Transmission Line

PPP          Purchasing Power Parity /Public Private Partnership

RAO UES          United Energy System of Russia

SS          Substation

TCF          Trillion Cubic feet

TAPI          Turkmenistan-Afghanistan-Pakistan-India gas pipeline

T and D          Transmission and Distribution

TWh          Billion kWh

TPP          Thermal Power Project/Thermal Power Plant

XUAR          Xinjiang Uyghur Autonomous Region of China

TABLE OF CONTENTS

Page

1. Introduction           4
2. Long Term Vision of the Energy Sector           4
3. Strategic Approach           4

Drivers for regional cooperation           4

Principles of regional cooperation           4

Forms of regional cooperation           5

Benefits from regional cooperation           5

1. Strategy Elements           6

Investment measures for regional cooperation           6

Capacity building and knowledge sharing           6

Policy measures           7

1. Strategy Implementation           9

Implementation dimensions           9

Costs of financing           10

(i)       Investment measures      10

(ii)        Capacity building Measures     10

(iii)         Studies to be carried out    11

Progress indicators and monitoring framework           11

Risks and mitigation measures           12

Appendices

1.          Current Energy Inter-relationships among CAREC countries          14

2                Evolving Energy Inter-relationships among CAREC countries  15

3                Suggested Dimensional View for regional Cooperation  16

4                Bold Stroke Projects – Oil and Gas  17

5                Bold Stroke Projects - Electricity  18

6                Illustrative list of studies to be carried out  19

7                List of Investment Projects  20

8                Key International Agreements and Programs relevant to energy and  33

transboundary river cooperation and respective membership of CAREC countries

REGIONAL COOPERATION STRATEGY

IN THE ENERGY SECTOR OF CAREC COUNTRIES

1. INTRODUCTION

1. The member countries participating in the Central Asia Regional Economic Cooperation Program embrace the Program’s mission of development through cooperation and join efforts to bring to fruition the shared vision of “Good Neighbors, Good Partners and Good Prospects”.

1. The regional economic cooperation is an important vehicle for enhancing national development strategies of the participating countries and realizing the countries’ immense development potential in the context of increasingly integrating Eurasia. Infrastructure is a key pillar  supporting the participating countries’ drive for development through cooperation, where energy infrastructure is vital in ensuring overall economic growth and prosperity.

1. This energy strategy has been developed in accordance with the Comprehensive Action Plan endorsed at the 5th Ministerial Conference on CAREC. The strategy seeks to enable the development of best solutions to meet future energy demand and promote development of new energy resources for the region and for exports by exploiting the potential for mutually beneficial gains among the participating countries

1. LONG TERM VISION FOR THE SECTOR

1. The long term vision of the region’s energy sector is to ensure: (a) energy security through the balanced development of the region’s energy infrastructure and institutions, stronger integration  of the region’s energy markets to make available adequate volumes of commercial energy (and energy services of acceptable quality) to all physical and juridical persons in a reliable, affordable, financially sustainable and environmentally sound manner; and (b) economic growth through energy trade.

1. STRATEGIC APPROACH Drivers for regional cooperation
   1. The regional energy cooperation is driven by the need to (i) overcome, through increasing integration of the energy markets, the impact of uneven distribution of energy resources among the CAREC countries; (ii) optimize existing energy interrelationships (see Appendix 1) and achieve least-cost solutions to energy constraints. The energy cooperation process is further stimulated by external factors such as the availability of new attractive energy markets in eastern and southern China, Pakistan, India and Iran, along with new strategic transit opportunities for oil and gas through Turkey, Georgia, and Russia, coupled with strong interest in the region from Chinese, Russian and other investors. Also, rising global energy prices enhance the attractiveness of the large hydropower project options in Kyrgyzstan and Tajikistan, especially in the context of regional energy market development taking into account the interests of all the countries situated along transboundary watercourses and the availability of export markets beyond Central Asia.

Principles of regional cooperation

1. Regional energy cooperation will be promoted in good faith and in observance of the following principles:

• sustained political will for reforms and cooperation;
• bilateralism and multilateralism;
• mutual benefits for all;
• gradualism, voluntarism, and consensus;
• prudent, marginal and diversified dependence on outside energy resources to maintain adequate energy security;
• mutually compatible regulatory arrangements based on evolving experience, including specific legal and regulatory framework for each cooperation venture based on international cooperation practices;
• pursuit of sector reforms, governance and operations conducive to regional cooperation on a commercial basis;
• adherence to adequate level of transparency and disclosure standards:
• respect for environment through collective action with regards to clean energy, transboundary watercourses; climate change and littoral space;
• fair and rational use of natural resources, including transboundary watercourses, and minerals, and
• consideration of the concerns of the neighboring countries.

Forms of regional cooperation

1. Regional energy cooperation will be advanced through the development of market relations, transit arrangements, investments, relationships under agreements on the joint use and protection of trans-border rivers and sea-bed resources as well as knowledge sharing.

Benefits from regional coooperation

1. Through regional cooperation the participating countries will pursue benefits from developing new energy market opportunities, receiving transit revenues and achieving least-cost development solutions through a rational sharing of resources.

1. In this context the participating countries look forward to evolving medium-to long-term inter- relationships resulting in:

(i)                            states with sufficient energy resources for exports (Azerbaijan, Kazakhstan, Uzbekistan) securing access to export markets and earning export revenues to support their energy1  export - led growth;

(ii)                          states rich in hydropower resources, but lacking fossil fuels (Kyrgyz Republic and Tajikistan), gaining access to export markets for hydroelectricity and earning export revenues to secure import of fossil fuels to meet their winter energy deficits

(iii)                        transit countries (such as Afghanistan and Mongolia) earning valuable transit and transmission fees, and Mongolia becoming an alternative energy transit route between Russia and China and exporting coal and possibly electricity in the future to China;

(iv)                       China importing oil and natural gas from Kazakhstan, and natural gas from Uzbekistan and Turkmenistan,

(v)                         Azerbaijan trading larger volumes of power with Russia, Georgia, and Iran; and

(vi)                       Central Asian countries exporting power and natural gas to South Asia (see Appendix 2).

1 Energy exports include exports of electricity, oil, gas and coal.

1. STRATEGY ELEMENTS

1. The achievement of the long-term vision for the energy sector in the region will be pursued through economically and financially sound investment measures for regional cooperation taking into account the interests of all states in the region. To enable identification and implementation  of such projects capacity building and knowledge sharing measures will be pursued. To ensure sustainability of investments, sound and appropriate policy environment will be maintained.

Investment Measures for Regional Cooperation

1. The improved performance of the national energy sectors of the participating countries is of critical importance for the achievement of greater benefits from regional energy cooperation. Therefore both domestic and cross-border investments will be pursued.

1. The domestic investments will focus on energy efficiency and clean energy. Energy efficiency investments will encompass efficiency improvements in energy production, transportation, distribution and energy use and will cover such areas as: (i) loss reduction; (ii) rehabilitation of existing assets; (iii) least-cost system expansion and operation; (iv) appropriate heating options; (v) commercialization of energy operations; and (vi) upgrading end-use equipment, facilities and buildings (including other demand side management measures). Clean energy investments will include such aspects as: (i) retrofits for mitigation of pollution; (ii) reduction of fuel resources used per unit of goods produced; (iii) elimination of gas flaring; and

(iv) developing alternative and renewable energy sources,

1. The cross-border investments will focus on production of ecologically clean energy and energy trade and will be pursued with mutual agreement among all relevant parties in the following key areas: (i) cross border energy transmission, (ii) facilitation of access/transit to third country energy markets; (iii) production for export, (iv) development of energy resources on a joint/cooperative basis respecting the laws of relevant states for protecting nature; (v) integration of energy markets, (vi) capacity building for energy trade, (vii) projects under Clean Development Mechanism and carbon finance, and (viii) investments abroad to access energy resources there. (Key prospective “bold stroke” projects of regional importance are shown in Appendices 4 and 5)

Capacity building and knowledge sharing

1. The new responsibilities and functions of the participating countries in the regional cooperation context will be supported by enhancing their institutional capacity through exchange of knowledge and experience among participating countries and with recognized international sources of best practices.  The capacity building will focus on the following knowledge areas:

• Commercial operation of the sector: focus on negotiations, contracting (power purchase, power wheeling and transmission services), regional dispatch and system control, metering, billing and collections, and utility accounting and audit, modern corporate governance techniques, tariff adjustments, operational efficiency, and consumer relations.
• Sector regulation: focus on ensuring transparency, stability and predictability and consistent fairness.
• Public Private Partnership arrangements: focus on forms and regulation.
• Demand Side Management, energy efficiency and energy conservation: focus on integrated resource planning, energy service companies and financing mechanisms.
• Alternative and renewable energy: focus on resource surveys, devising promotional and incentive arrangements.
• Riparian issues: focus on international experience in transboundary river  management and protection.

Policy measures

1. The policy measures will focus on enhancing (i) energy trade and security; (ii) financial viability of energy supply entities and the sustainability of energy services; (iii) social protection in the energy sector; (iv) sector restructuring and commercialization; (v) sector regulation; (vi) promotion of private sector participation; (vii) cooperation in international river basins; (viii) littoral agreements; 2 (ix) alternative and renewable energy options; and (x) energy efficiency and initiatives under Clean Development Mechanism (CDM) and other (successor) carbon financing mechanisms.

1. The choice and sequencing of these policy measures will be in accordance with the circumstances of each country and planned forms of cooperation. The pursuit of such chosen policies will be to the extent they are politically and administratively feasible.

Energy trade and security

1. Energy trade will be pursued to increase the available forms and sources of energy to complement in an effective and reliable way the domestic energy resources of the CAREC countries thus enhancing energy security and or to develop the energy exports potential as a driver of economic growth.

Financial viability of energy supply entities and sustainability of energy services;

1. Regional energy trade will be sustainable only when it takes place among financially viable and solvent entities. The financial viability of the energy entities will be ensured through (i) adjusting tariffs to cover costs, including cost of capital, (ii) reducing losses to minimize costs  and improve efficiency of supply; (iii) improving system and consumer metering, billing and collection practices to industry standards, and (iv) adopting least cost planning, construction and operation.

Social protection in the energy sector

1. Efforts to develop adequate social protection systems for energy consumption will continue by improving the targeting of the compensation mechanisms to the needy and eliminating non- payments and discounts to a wide range of privileged consumers. Realistically designed and efficiently implemented lifeline tariff will be the second best option.

Sector restructuring and commercialization

1. Wherever feasible sector restructuring and commercialization will be pursued to enhance energy trade through (i) independent and solvent transmission business, separated from  generation and distribution businesses, (ii) transmission service charge to all system users on the basis of a reasonable return on transmission investments, and (iii) regulated or open third party access to transmission (subject to technical availability and capacity).

2 For example, agreements on protection and use of sea-bed resources by littoral states

1. There are large opportunities for further improvement in commercializing the energy entities and trade transactions. The trading entities such as generating companies, distributing entities or trading companies will pursue a clear commercial orientation through (i) applying enforceable and standard energy purchase or sales contracts, (ii) ensuring transparency of transactions and operations including also internationally acceptable accounting, audit and disclosure standards (such as IFRS) to the extent feasible.

Sector regulation

1. Sector regulation will improve to enable meaningful energy cooperation. Fair, transparent  and stable regulation will be pursued through (i) separation of the regulatory functions from ownership, policy making, operations and maintenance in the energy sector.

1. Regulatory principles will be embodied in regulatory laws and regulatory practices will follow published rules and regulations by the regulatory body under the law. The regulatory body will have reasonable functional and financial autonomy. Its accountability will be ensured by provisions for appeals against its rulings to the high courts and accountability to parliament through detailed annual reports.

Private sector participation

1. Private sector involvement in the energy sector will be facilitated through promoting public- private partnerships and enhancing the enabling framework, including membership in the Energy Charter Treaty, which provides safeguards for private investment against nationalization and  other restrictive measures. Most CAREC participating countries have already become members  of the said Treaty.

Cooperation in using transboundary watercourses

1. Modern approaches to benefits-sharing will be pursued to enable an ecologically sound exploitation and protection of transboundary water courses in a manner that safeguards not only the regular irrigation, power and drinking water interests but also the economic, environmental, cultural and social interests of all riparian states along important river basins such as Amu Darya and Syr Darya. Carrying bilateral and multilateral negotiations and possibly concluding relevant riparian agreements will enable, inter alia, the design, construction and operation of large storage hydro power plants in many CAREC countries such as Afghanistan, Kyrgyz Republic and Republic of Tajikistan. These power plants will focus on generation for export to outside destinations, apart from helping to meet winter power shortages in the domestic markets of those or other Central Asian states by adhering to mutual responsibilities of riparian states in using transboundary watercourses and without inflicting significant harm to the use of water resources by riparian states3. The CAREC countries may also draw on relevant experience of other inter- governmental bodies in managing transbounadry river basins in Central Asia and elsewhere in the world. Further, improvement of the treatment of riparians’rights and obligations will be considered through relevant international rules as well as conventions, which have been already joined by some of the CAREC participating countries. These conventions have been summarized in Appendix 8. However, it is recognized that not all CAREC states are signatories of all these conventions, and not all conventions have entered into force and that seeking accession to these and similar conventions is a sovereign right and choice of the states. When a state is not a

3 Uzbekistan and Kazakhstan are concerned of harm to the use of water resources and this must be considered in line with principles of cooperation outlined in Paragraph 6.

signatory to the relevant convention bilateral negotiations and adoption of the procedures under the safeguard policies of the IFIs may help.

Littoral agreements

1. Further expansion of the scope of the littoral agreements will be pursued among the Caspian Sea countries to enhance opportunities for exploration and protection of seabed resources and laying gas and oil pipelines under the sea.

Alternative and renewable energy options (AREO)

1. Opportunities for alternative and renewable energy investment options will be pursued, complemented by international incentives offered through the Clean Development Mechanism and similar carbon finance facilities. In order to ensure level playing field between AREO and conventional commercial energy the possibility of minimizing the subsidies on the conventional energy will have to be explored.

Energy Efficiency

1. Energy efficiency improvements allow for rational and economic use and trade of energy resources, introduction of advanced technology and infrastructure and improve the financial viability of energy utilities. Operations under Clean Development Mechanism or similar carbon finance mechanisms contribute to environmental improvements in the participating countries. Policies for promoting energy efficiency and energy conservation and carbon  finance mechanisms need to be adopted.

1. STRATEGY IMPLEMENTATION Implementation Dimensions
   1. In view of the current opportunities and dynamics in the region, the participating countries will focus on implementation of the regional cooperation strategy along the following main dimensions (energy corridors):

(i)                            Central Asia-China: this dimension focuses on energy trade and investments between China and the Central Asian Republics.

(ii)                          Central Asia-South Asia: emerging and potential electricity trade between Central Asian Republics and South Asia.

(iii)                        Cooperation opportunities within Central Asia.

(iv)                       Central Asia-Russia: most of the oil and gas exports till now have been oriented to Russia or through Russia to western destinations. Russia has been investing in exploration and production in the Central Asian countries as well as in rehabilitation, expansion and operation of pipeline systems (also in large and complex hydro power projects) and is therefore involved in the energy export efforts of the Central Asia countries.

(v)                         Central Asia-EU: the EU dimension focuses on facilitating exports of Central Asian and Azeri exports of energy to Europe. Azeri oil and gas are already flowing towards the west On account of its geographical location and its own abundant hydrocarbon resources, Azerbaijan has the potential to emerge as an energy corridor between Central Asia and EU in the near future not only in relation to oil and gas but also in relation to electricity transit.

1. The implementation of the regional energy strategy will be pursued through the above dimensions in consideration of geo-political realities, need to diversify export markets, and the inherent economics and risk profiles of the dimensions. (See Appendix 3)

Costs and Financing

(i)    Investment Measures

1. Available information on the capital costs of the investment schemes and their possible sources of financing have been compiled and indicated in Appendix 7. The overall costs and possible financing are summarized in Table 1. The list in Appendix 7 is neither exhaustive nor authoritative. It is at best indicative or illustrative. The inclusion of any project in this list does  not necessarily imply commitment or approval on the part of any government.

1. Capital costs of investment proposals are tentative due to scarce cost information on projects pursued by the private sector under production sharing or concession contracts for exploration  and production of hydrocarbons and coal. Similarly, information is not readily available for many of the dedicated oil and gas pipelines built, or to be built by consortiums of governments and the private sector.

1. Nevertheless, the cost estimates indicated provide private investors and IFIs with a broad idea of the lower bound of the financing needs.

1. Excluding 10 items for which cost data is not readily available, the capital cost of the remaining items are estimated at about $20.6 billion. Possible financing could be self financing ($5.1 billion), IFIs ($ 3.8 billion) and others ($11.7 billion).

1. Self financing level of about 20-30% is needed to ensure financial viability, leverage debt and secure other forms of project finance.4 Other sources of financing include: (i) private and commercial sources, (ii) bilateral sources, (mostly Chinese and Russian), (iii) international hydrocarbon investors, and (iv) IFIs.

(ii)    Capacity Building Measures

1. Capacity building measures will be pursued in various forms such as (a) on-site training of local experts by international consultants (b) pilot projects, (c) exchange of experience among CAREC utilities and with outside utilities (d) regional training courses and conferences, seminars or workshops. The scope of the activities within the CAREC regulatory forum will expand.

1. One regional workshop is to be organized in the short to medium term for each of the six topics indicated in Section D above, followed up by technical assistance in each country with  pilot projects demonstrations. The participating countries will seek donors and IFI’s support to finance the estimated relevant costs as follows:

4 In the case of existing operating entities, 30% of the new project cost is assumed to be raised through internal cash generation. In the case of new entities established to execute own and operate new projects, 30% of the project cost is assumed to be raised as equity from sponsors as well as the public and private equity markets. In either case 70% of the project cost is assumed to be secured as long term debt from public (including IFIs) and private sources of debt.

• $1.5 million for the six international workshops, in addition to a contribution from the participating countries at 10% of total cost
• $10.5 million for follow up TA activities

1. Additional costs, if needed, (especially those in local currencies) will be met by contributions in kind by the relevant CAREC government. (see table 1 on Costs and Financing further in the text)

(iii)    Studies to be carried out

1. Analytical and research work needs to be undertaken for identification of specific investments and in support of key strategic and policy decisions in the energy sector. In addition to contributions from the participating countries support of the donors and IFIs support is needed for carrying out such studies, estimated at $ 10,85 million (See Table 1 on Costs and Financing and Appendix 6)

1. In respect of studies and capacity building programs about 10% of the costs are assumed to be met by the countries, while the remaining costs are for possible IFI and bilateral assistance.

Table 1: Indicative Costs and Financing of Regional Cooperation Program ($ million)

Progress Indicators and Monitoring Framework

1. Progress Indicators (PI) have been provided for each of the investment proposals in Appendix

7. Wherever possible it also indicates the base line value. In addition, use of some broader indicators may be useful to monitor progress in respect of the overall Regional Energy Cooperation program.

1. The indicators will be compiled in the format given in Table 2 below for each country on the basis of official information to be given by each country and information from other sources and  a regional table prepared on the basis of the country tables. It is recognized that reporting data for the indicators will be voluntary on the basis of the best national efforts.

1. Indicators, 5, 6, 7 and 8 relating to energy imports and exports should cover only transactions among CAREC countries and those of CAREC countries with Russia, Iran, Georgia, Turkey, and South Asia (Pakistan and India). It is assumed that exports to and from Europe will take place through Turkey or Russia and would be included within the data reported for Turkey and Russia. The data for China will include exports to and imports from all CAREC countries, but not from any other country. Further the term “energy” consists of oil, natural gas, coal and electricity (in the context of this table) and each country needs to have separate rows for each item relevant to its economy. These numbers could help monitor the growth in energy trade and the energy flow in the respective energy corridors such as CA-SA, CA –China, Intra-Central Asia, CA-Turkey (EU), and CA-Russia

Table 2: Progress Indicators for the Regional Energy Cooperation Program

Risks and mitigation measures:

1. Risks to the strategy can be related to project sites, investments, trade, security, country performance and geo-politics.

1. Project site - related risks such as those relating to geology, hydrology and seismic factors and security will be avoided to a large extent by careful site investigations and by choosing flexible project parameters.

1. Investment related risks will be minimized by (i) adopting sound macroeconomic and commercialization policies, (ii) securing IFI’s financing and guarantees programs. (iii) Energy Charter Treaty membership (as applicable) and (iv) bilateral investment agreements (as applicable) (See Appendix.8 outlining key International Agreements and Programs and the respective membership status of the CAREC countries).

1. Trade - related risks such as supply risk, market risk and payment risk will be handled through appropriately written trade contracts providing for “take or pay”, “supply or pay” clauses and providing for appropriate guarantees for payment obligations and suitable commercial international arbitration clauses.

1. Resolution of internal conflicts and avoidance of regional conflicts can help to mitigate a range of country - related risks and security risks for the regional cooperation.

1. Geo-political risk related to diverging positions of major players in the region can be handled through appropriate diplomatic channels.

1. In addition to observance of the basic rules of International Law, adherence to relevant UN international conventions would provide venue for dispute resolution between CAREC  countries

5 Water sharing agreements (following international standards) among riparian states in respect of international rivers are needed to raise funds from IFIs and commercial sources for major hydropower projects

6 This applies only to states adjoining Caspian Sea.

and countries outside CAREC. (See Appendix 8 outlining key International Agreements and Programs and the respective membership status of the CAREC countries). It is recognized that bilateral and multi-nation dialogues are respectively preferred by CAREC countries to solve disputes.

1. Application of IFIs safeguard policies provides a sound basis for avoiding the occurrence of disputes and grievances.

1. Next Steps

After the approval of the proposed strategy, future meetings of the Energy Sector Coordinating Committee (ESCC) will pursue the development of an action plan and related measures to promote further implementation of the Strategy based on contributions from the CAREC countries.

Appendix 1: Current Energy Inter-relationships among CAREC Countries

Appendix 2: Evolving Energy Inter-relationships among CAREC Countries

Appendix 3

Suggested Dimensional View for Regional Cooperation

(List of some Prominent Projects)

Some of the prominent project proposals (referred to as Bold Strokes) and currently being pursued or considered are listed in first three columns in this Table. Two maps indicating the location of most of the prominent projects listed above are given in Appendix 4 and 5.

Appendix 4          CAREC Regional Energy Cooperation

Appendix 5          CAREC Regional Energy Cooperation

Appendix 6

Illustrative List of Studies to be carried out

Appendix 7

Note: The information in this list has been gathered from many sources. The list is indicative or illustrative and is not exhaustive or authoritative. The inclusion of any project in this list does not necessarily imply that the relevant governments have approved them or committed to them in any way.