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This report is prepared by CEPOR’s expert ANA MARIA BOROMISA (Ph.D., CroatianEnergy Regulatory Council, Zagreb)

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I. Ekonomika energije -- Hrvatska

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Support to promotion of reciprocal understandingbetween the European

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National report

ENERGY SECTORunder

The Specific Grant Agreement RELEX I-2 190202 REG 4-14

ANA MARIA BOROMISA (Ph.D., Croatian Energy Regulatory Council, Zagreb)

Last update September 2004

CEPORSME's Policy Think Tank Centre

4

About the author:

AAnnaa-MMaarriiaa BBoorroommiissaa has been a member of the Croatian Energy Regulatory Council1

since 2001. where she is currently employed.

1. The author participates in the project as an independent researcher. The views expressed herein are those of the author and do not necessary coincide with the official views of the CERC.

About the author Energy sector

Content:

Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .61. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72. Country Energy Strategy (goals and achievements) . . . . . . . . . . . . . . . . . . . . . .83. Competitive market structures and rules . . . . . . . . . . . . . . . . . . . . . . . . . . . .10

3.1. General framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103.2. Competitive market structures and rules in the electricity sector . . . . . .113.2.1. Existing deficits and obstacles in the implementation

processes of EU requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113.2.2. Comparison of main issues delivered in the Background and

the results from the current analyses. Priorities . . . . . . . . . . . . . . . . .163.2.3. Good practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .173.3. Gas sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .173.3.1. Existing deficits and obstacles in the implementation

processes of EU requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . .173.3.2. Comparison of main issues delivered in the Background and

the results from the current analyses. Priorities . . . . . . . . . . . . . . . . .203.3.3. Good practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

4. Support reforms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .224.1. Existing gaps deficits and obstacles in the implementation

processes of EU requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .224.1.1. Tariff reforms necessary to achieve cost reflective prices . . . . . . . . . .224.1.3. Reduction of non-technical losses; . . . . . . . . . . . . . . . . . . . . . . . . . .234.1.4. Ecological issues and increase in energy efficiency . . . . . . . . . . . . . .244.1.5. Security of supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .254.2. Comparison of main issues delivered in the Background and the

results from the current analyses. Priorities . . . . . . . . . . . . . . . . . . . . .274.3. Good practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28

5. Investments in the energy sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .295.1. Privatisation processes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .295.2. Private investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .305.3. New capacities and revitalisation programmes . . . . . . . . . . . . . . . . . .305.4. International donor programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31

6. Final recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34

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Energy sector Content

Abbreviations

Art. ArticleCAS Country Assistance StrategyCEER Council of European Energy RegulatorsCEM Country Economic MemorandumCEN/CENELEC Comité Europeén de Normalisation/ Comité Europeén de

Normalisation Electrotechnique (European Committee for Standardisation/ European Committee for Electrotechnical Standardisation)

CERC Croatian Energy Regulatory CouncilCIF cost, insurance and freight CROISMO Croatian Independent System and Market Operatord.d. dioni~ko dru{vo (joint-stock company)d.o.o. društvo s ograni~enom odgovornoš}u (limited liability company)DSO Distribution System OperatorEC European Commission EIHP Energy Institute "Hrvoje Po`ar"ERRA Energy Regulators Regional AssociationEU European UnionHEP Hrvatska elektropriveda (national electricity utility)HRK Croatian KunaINA national gas companyp. pagePar. ParagraphRES Renewable energy sourcesSECI South East Europe Cooperative Initiative SEEREM South East Europe Regional Energy MarketTENs Trans-European NetowrksTSO Transmission System OperatorUCTE Union for Coordination of Transmission of ElectricityUSAID United States Agency for International Development

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Introductory remarks on organized crime Energy sector

This report reviews the primary leg-islation in Croatia and its alignment withthe requirements of the energy sector-spe-cific requirements of the EU - primarily theDirective 2003/54/EC (for electricity) and2003/55/EC (gas), the Athens memoranda,energy efficiency measures, and EU'sRenewables Directive (2001/77/EC). It alsodefines some technical aspects regardingCroatian readiness to be integrated in theTENs.

Croatian energy sector is charac-terised by majority state ownership, withthe exception of natural gas distribution.2The reform of the energy sector in Croatiathat provides for gradual privatisation andintroduction of market principles waslaunched in 2001, when a "package" offive energy laws was adopted.3 A year later,the Parliament adopted Energy strategy fora 10-year period. After a quite intensivestart, the implementation of the reform hasslowed down. Generally, reform implemen-tation in the oil and gas sector has been

satisfactory, while the progress in thepower sector has been slower and warrantsclose attention by the Government. This isthe result of less "market exposure" of theelectricity sector, legal gaps, weaknesses ofinstitutions that should implement reforms,and the strength of the energy sectorlobby.

By signing the Athens Memo-randum, Croatia took a decisive step andjoined the South East European PowerMarket, with the ultimate goal of incorpo-rating Croatia into the European InternalEnergy Market. The negotiations build onthe 'Athens Memoranda', signed in 2002and 2003, which provided political backingfor the idea to open the region's electricityand gas markets between 2005 and 2007.Coupled with negotiations with the EU,scheduled for 2005, this should speed upthe process of gradual alignment of domes-tic legislation with EU energy directives andenvironmental standards.

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Energy sector Summary

1. Summary

2. The analysis is limited to electricity and gas sectors. Energy Law and regulation Law in Croatia, as opposed to the energy related acquis, deal also with oil and oil derivatives market, but not with solid fuels sector, since 1997 therehas not been any slolid fuels production in Croatia.

3. Energy Law, Law on Electricity Market, Law on Regulation of Energy Activities, Law on Oil and Oil Derivatives Marketand Gas Market Law

A series of energy laws (EnergyLaw, Law on Electricity Market, Law onRegulation of Energy Activities, Law on Oiland Oil Derivatives Market, and Gas MarketLaw) were passed in July 2001 (OfficialGazette 68/01) to launch the reform of theenergy sector. The Parliament adoptedEnergy Strategy in 2002 (Official Gazette38/02). Energy Law stipulates the content of ener-gy planning documents, the bodies passingthem, the procedure for their passing, andthe terms of their validity. It also regulatesmeasures to ensure a secure and reliableenergy supply, efficient power generationand its use; and the enforcement of actsthat will stipulate, and on the basis ofwhich, energy policy and energy strategywill be designed. Energy Law also regulatesthe carrying out of energy activities basedon market principles or pursuant to publicservice obligations. Energy Law defines that the EnergyStrategy is a basic act that outlines theenergy policy and planning of the develop-ment of the energy sector. Energy Strategyis passed by the Parliament upon proposalof the Government for a 10-year period inMarch 2002. The principal goals of theenergy policy, as stated in Energy Strategy,are: • improvement of energy efficiency, • safe energy provision and supply, • diversification of sources,• support to the development of

renewable sources,

• increased security of supply, • development of a better pricing

policy, and • ensuring environmental protection.

Energy Strategy also provides for energysector reform.

Based on Energy Strategy, theGovernment shall pass the StrategyImplementation Programme. This pro-gramme should be prepared for a minimumperiod of three years and define the meas-ures to be implemented, entities responsi-ble for the implementation of plannedactivities, and the time schedule for therealisation of the energy policy and theimplementation of National Energy Pro-grammes; cooperation with local andregional administration and institutions inthe area of development planning in theenergy sector; and cooperation with energycompanies and international organizations. The energy law package has only definedthe deadlines for the implementation of thefirst stage of the energy sector reform, butthese deadlines have not been met. TheStrategy Implementation Programme hasnot been passed4. Some of the implement-ing measures are identified by the NationalPlan for EU Integration, as well as in theStabilisation and Association AgreementImplementation Plan. However, thesemeasures are integration-related, focusedon accepted international obligations, andlack the "local" dimension, i.e. measures

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Country Energy Strategy Energy sector

2. Country Energy Strategy (goals and achievements)

necessary on regional and local levels. Themissing "local" measures and timetable fortheir implementation are needed to estab-lish a coherent framework for the imple-mentation of energy strategy and energyreform. Delays, coupled with the vaguewording of some legal provisions andstrong lobbies opposing the reform are themain reasons for partial implementation. Still, in spite of difficulties and delays, thereform is gradually proceeding, pursuant tothe "package" of energy laws. The mainachievements of these are:

• creation of new legal framework, enabling gradual establishment ofmarket mechanisms in the energy sector and private / foreign investments,

• establishment of new institutions (such as Croatian Energy Regulatory Council, Energy Efficiency Fund, System and

Market Operator) necessary for thecreation of market,

• gradual alignment with EU rules, • increase of general understanding

of necessary reforms, and• participation in regional initiatives.

Croatia is gradually aligning with EUrequirements and preparing for participationin regional and EU energy markets. Croatiahas signed the European Energy CharterTreaty, and Athens Memoranda, which pro-vide the basis for long-term international co-operation in energy sector.Measures that are to be implementedinclude revision and completion of legalframework (corrections of existing laws inline with EU requirements), preparation andadoption of secondary legislation, definitionof scope and timing of support reforms (pri-vatisation, market opening, pricing reform)and their effective implementation.

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Energy sector Country Energy Strategy

4. There is a programme called "National Energy Programme" that is being implemented by Energy institute "Hrvoje Po`ar", financed by the Ministry of Science and the Ministry of Economy. The "National Energy Programme" is a basic research project of this Institute. This means that it is proposed by the research institution and accepted by the appropriate (scientific) board. As such, it cannot be considered as National Energy Programme as defined by Energy Law.

The "package" of five energy laws(Energy Law, Law on Electricity Market, Lawon Regulation of Energy Activities, Law onOil and Oil Derivatives Market, and GasMarket Law) adopted and published in July2001 defined which energy-related activi-ties are considered as market-based. Inmarket-based activities, competition is tobe gradually introduced. "Public services"are the second type of activities and aresubject to specific rules aimed at minimisingthe risk of abuse of monopolistic marketposition.

The implementation of such legalframework was scheduled to start onJanuary 1st, 2002, and all secondary legis-lation was supposed to be adopted withinsix months.Pursuant to the Law on Regulation ofEnergy Activities, Croatian Energy Regu-latory Council (CERC) was established inMarch 20025 as an independent regulator6.

CERC is designed as a regulatory body inelectricity, gas and oil sector. It issueslicences for carrying out energy activities,monitors tariff systems and market.7

Energy Law defines basic unbu-ndling rules, tendering and authorisationprocedures, transparency of accounts,third party access to the networks, andmarket opening. It also defines proceduresfor the adoption of some of the technicalrules. It also sets framework rules for tariffdesign, allows the protection of vulnerableconsumers, reduction of non-technicallosses, improvement of energy efficiencyand security of supply. However, the provi-sions regulating these issues are vague andspecific procedures for their implementa-tion are lacking. The Energy Law and sec-tor-specific laws (Law on Electricity Market,Gas Market Law) do not explicitly recognizethe function of transmission system opera-tor and distribution system operator.8 Next,

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Competitive market structures and rules Energy sector

3. Competitive market structures and rules

3.1. General framework

5. The date of establishment is the date of registration in the court register. The Law provided the basis for its establishment in July 2001.

6. The Law on Regulation of Energy Activities explicitly states that CERC is an independent legal entity. It consists of five Commissioners, appointed by the Parliament upon the proposal of the Croatian Government. Still, it is the Governmentthat appoints a non-profit legal entity that assists CERC in preparation of proposals of acts to be passed by the CERC andcarries out other expert assignments, and the CERC is obliged to use its financial means for financing this appointed non-profit legal entity (Article 9 (2)). The Government appointed Energy Institute Hrvoje Po�ar (EIHP) as the non-profit legal entity. This institute is owned by the Government and, according to its statue, it is designed and works for CERC (whichis obliged to finance it), the Government, and energy enterprises. Hence EIHP is designed to perform activities that areconsidered to be conflict of interest for the Commissioners.

although the package of five energy lawsforesees a number of technical rules andsecondary legislation that should bebrought by different institutions, technicalrules are defined by service providers. Such"standards" are therefore subject to unilat-eral changes, since they have the status ofinternal acts of energy services providers.They are not always published and there isno third party ("neutral") control of theirimplementation, and they also do not allowconsumer protection.

The State Office for Standardisa-tion and Metrology is the institution incharge of the adoption of European stan-

dards. In spite of the fact that a number ofEuropean standards are already adopted,these relate mainly to specific equipment,while general conditions and rules impor-tant for investors and consumers are stillmissing.9

As for the privatisation proce-sses, two laws important for the energysector reform were adopted in March2002: the Law on Privatisation of INA d.d.(national gas company) and the Law onPrivatisation of HEP (national electricitycompany). The international donors pro-grams are also of significance for invest-ments in energy sector.

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Energy sector Competitive market structures and rules

7. CERC is established mostly as advisory body, without implementing powers. This is dealt with in more detail inchapters dealing separately with electricity and gas.

8. This issue is dealt with in more detail in electricity and gas sections.9. For more see Government (2003), p. 48. Framework laws allowing the adoption of European standards in Croatia,

in line with the "new approach", were adopted at the end of 2002. For more about this, see: Ott (2004).

3.2 Competitive market structures and rules in theelectricity sector

3.2.1.Existing deficits and obstacles in theimplementation processes of EU requirements

RegulatorAccording to the Directive 2003/54/EC concerning common rules for the internal marketin electricity ("the Directive"), the primary role of the Regulator is defined by Article 23(Frame 1).

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Frame 1

Article 23Regulatory authorities

1. Member States shall designate one or morecompetent bodies with the function of regulatoryauthorities. These authorities shall be wholly inde-pendent form the interests of electricity industry. They shall, through the application of this Article,at least be responsible for ensuring non-discrimination, effective competition and theefficient functioning of the market, monitoring inparticular :

a) the rules on the management and allocation of interconnection capacity, in conjunction with the regulatory authority or authorities of those Member States with which interconnection exists;

b) any mechanisms to deal with congested capacitywithin the national electricity system;

c) the time taken by transmission and distribution enterprises to make connections and repairs;

d) the publication of appropriate information by transmission and distribution system operators concerning interconnectors, grid usage and capacity allocation to interested parties, taking into account the need to treat non-aggregated information as commercially confidential;

e) the effective unbundling of accounts, as referred to in Article 19, to ensure that there are no cross-subsidies between generation, transmission, distribution and supply activities

f) the terms, conditions and tariffs for connecting new producers of electricity to guarantee that these are objective, transparent and non-discrimi-natory, in particular taking full account of the costs and benefits of the various renewable energy sources technologies, distributed genera-tion and combined heat and power ;

g) the extent to which transmission and distributionsystem operators fulfil their tasks in accordance with Articles 9 and 14 ;

h) The level of transparency and competition. The authorities established pursuant to this Article shall publish an annual report on the outcome oftheir monitoring activities referred to in points a) to h).

2. The regulatory authorities shall be responsible forfixing or approving, prior to their entry into force,at least the methodologies used to calculate or establish the terms and conditions for:

a) Connection and access to national networks, including transmission and distribution tariffs. These tariffs, or methodologies, shall allow the

necessary investments in the networks to be car-ried out in a manner allowing these investments to ensure viability of the networks ;

b) The provision of balancing services.3. Notwithstanding paragraph 2, Member States

may provide that the regulatory authorities shall submit, for formal decision, to the relevant body in the Member State the tariffs or at least the methodologies referred to in that paragraph as well as the modifications in paragraph 4. The relevant body shall, in such a case, have the powerto either approve or reject a draft decision sub-mitted by the regulatory authority. These tariffs orthe methodologies or modifications thereto shall be published together with the decision on formaladoption. Any formal rejection of a draft decisionshall also be published, including its justification.

4. Regulatory authorities shall have the authority to require transmission and distribution system operators , if necessary, to modify the terms and conditions, tariffs, rules, mechanisms and methodolo-gies referred to in paragraphs 1, 2 and 3, to ensure that they are proportionate and applied ina non-discriminatory manner.

5. Any party having a complaint against a transmis-sion or distribution system operator with respect to the issues mentioned in paragraphs 1, 2 and 4may refer the complaint to the regulatory authority which, acting as dispute settlement authority, shall issue a decision within two months after receipt of the complaint. This period may be extended by two months where additional information is sought by the regulatory authority.This period may be further extended with the agreement of the complainant. Such a decision shall have binding effect unless and until overruled on appeal.Where a complaint concerns connection tariffs formajor new generation facilities, the two-month period may be extended by the regulatory authority.

6. Any party who is affected and has a right to complain concerning a decision on methodologies taken pursuant to paragraphs 2, 3 or 4 or, wherethe regulatory authority has a duty to consult, concerning the proposed methodologies, may, atthe latest within two months, or a shorter time period as provided by Member States, following publication of the decision or proposal for a decision, submit a complaint for review. Such a complaint shall not have suspensive effect.

7. Member States shall take measures to ensure that

regulatory authorities are able to carry out their duties referred to in paragraphs 1 to 5 in an effi-cient and expeditious manner.

8. Member States shall create appropriate and effi-cient mechanisms for regulation, control and transparency so as to avoid any abuse of a domi-nant position, in particular to the detriment of consumers, and any predatory behaviour. These mechanisms shall take account of the provisions of the Treaty, and in particular Article 82 thereof.Until 2010, the relevant authorities of the Member States shall provide, by 31 July of each year, in conformity with competition law, the Commission with a report on market dominance,predatory and anti-competitive behaviour. This report shall, in addition, review the changing ownership patterns and any practical measures taken at national level to ensure a sufficient variety of market factors or practical measures taken to enhance interconnection and competition. From 2010 onwards, the relevant authorities

shall provide such a report every two years.9. Member States shall ensure that the appropriate

measures are taken, including administrative action or criminal proceedings in conformity withtheir national law, against the natural or legal per-sons responsible where confidentiality rules imposed by this Directive have not been respected.

10. In the event of cross-border disputes, the decidingregulatory authority shall be the regulatory authority which has jurisdiction in respect of the system operator which refuses use of, or access to, the system.

11. Complaints referred to in paragraphs 5 and 6 shallbe without prejudice to the exercise of rights of appeal under Community and national law.

12. National regulatory authorities shall contribute tothe development of the internal market and of a level playing field by cooperating with each otherand with the Commission in a transparent manner.

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Basically, the Directive requires thedesignation of one or more competentbodies with the function of regulatoryauthority. The Regulator shall be whollyindependent from the interests of the elec-tricity industry, and the member state shallallow the Regulator to carry out its dutiesefficiently and expeditiously.

In Croatia, CERC is the regulatoryauthority. However, it cannot be consideredas competent and independent from theinterests of electricity industry. Specifically,CERC does not have its own staff sufficientto perform core activities. Expert staff isassigned to the CERC by Governmentdecree (the staff of the Energy InstituteHrvoje Po`ar- EIHP) which is not independ-ent from interests of electricity industry. Thestatute of the EIHP defines that it shouldwork for the Government, energy industryand CERC. EIHP hence prepares documentsfor electricity utility, and CERC is obliged tofinance the Energy Institute. Such manda-tory link between CERC and EIHP was iden-tified as an impediment to effective inde-pendence in the EC opinion on Croatian

application EU membership.

Next, Article 23 of the Directivelists specific functions that the Regulatorshould carry out. Of these, CERC has noauthority for at least fixing or approving themethodologies used to calculate or estab-lish the terms and conditions for connec-tion and access to national networks priorto their coming into power, and the provi-sions of balancing service and dispute set-tlement are also lacking.10 So, in addition toclarifying provisions of the law so as tomake it explicit that CERC has the power tocarry out its functions, the main obstaclefor effective performance of the Regulatoris the lack of power to implement its deci-sions; i.e., CERC does not have any author-ity to implement sanctions if the regulatedentities do not comply with its requests.It should also be noted that CERC has theauthority to collect data as needed to per-form its functions. Therefore, CERC canargue that it should collect monitoring dataas defined by Article 23 paragraph 1 pointsa) to h) of the Directive. However, should adispute arise as to CERC monitoring rights,

it would be a court that would decide towhich extent such data should be collected.

Designation and unbundling TSOArticle 2 of the Directive defines

TSO as private or legal entity responsible foroperating, ensuring the maintenance of,

and developing the transmission system ina given area and its interconnections withother systems, and for ensuring long-termability of the system to meet reasonabledemands for the transmission of electricity.The main tasks of TSO are defined byArticle 9. (Frame 2)

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Frame 2

Article 9Tasks of Transmission System Operators

Each transmission system operator shall be responsible for

a) ensuring the long-term ability of the system to meet reasonable demands for the transmission ofelectricity;

b) contributing to security of supply through adequate transmission capacity and system reliability;

c) managing energy flows on the system, taking intoaccount exchanges with other interconnected systems. To that end, the transmission system opera-tor shall be responsible for ensuring a secure, reli-able and efficient electricity system and, in that

context, for ensuring the availability of all necessary ancillary services insofar as this availability is independent from any other trans-mission system with which its system is interconnected;

d) providing to the operator of any other system with which its system is interconnected sufficientinformation to ensure the secure and efficient operation, coordinated development and interoperability of the interconnected system;

e) ensuring non-discrimination as between system users or classes of system users, particularly in favour of its related enterprises.

f) providing system users with the information theyneed for efficient access to the system.

10. Although there are some dispute settlement provisions, they are narrower than required by the Directive.

In Croatia, tasks of the TSO aredivided between transmission companyand the system operator. Transmission com-pany is responsible for the construction andmaintenance of the transmission network,and the generation of a portion of reactionpower. System operator shall prepare plansfor the development and construction oftransmission network and should, in co-operation with transmission and distribu-tion company, draft the Grid Code. TheGrid Code shall specifically regulate techni-cal and other criteria for interconnectionand operation of networks, for access tothe network, and safe operation that canensure reliable supply of the market withquality electricity.

Hence, system operator and trans-mission company should co-operate in per-forming the tasks of TSO. The challenge is,however, to ensure the unbundling of theTSO. The unbundling requirements are in

the scope of Article 10 of the Directive.

The Directive requires that TSOshould be independent, at least in termsof its legal form, organization and deci-sion-making, from other activities notrelated to transmission. According toElectricity Act, the system operator wassupposed to be independent by January2003. The transmission company was sup-posed to be organized as one of the relat-ed, legally independent companies withinHEP Group. The system operator is stillwithin HEP Group. Thus, minimal criteriadefined by Article 10 paragraph 2 of theDirective are not met, since:

• persons responsible for the systemmanagement are not independentfrom other activities not related totransmission (basically production,trade and supply),

• management of the transmission

company directly influences day-to-day operation of generation, distribution and supply within the

HEP Group, and • system operator has neither the

decision-making rights nor an independent budget. The parent company gives instructions regarding day-to-day operations.

Next, the requirements regardingthe unbundling and transparency ofaccounts established by the Energy Lawdiffer from the requirements regarding theunbundling of accounts as stated inChapter VI of the Directive. Firstly,Croatian law is more restrictive as regardsthe legal form of electricity enterprises.The Directive defines TSO as private orlegal entities, while Energy Law does notallow private entities to appear at theenergy markets. Next, the Directive statesthat annual accounts should be drawn up,submitted to audit, and published accord-ing to the regulations of the national law.Croatian Energy Law obliges energy enter-prises to keep separate accounts and pre-pare financial reports for each of its activ-ities, independently and separately.However, it does not provide the differen-tiation in their internal accounting fromgeneral accounting rules, nor the distinc-tion between consolidated and non-con-solidated accounts, and the differencesresulting from different size and organiza-tion of the companies and related auditand publication requirements according tonational law. The formal obligation forunbundling and transparency of accountsis not implemented because there are noimplementation guidelines nor effectivemonitoring and sanctions.

Designation and Unbundling DSOIn Croatia, the tasks of DSO are

distributed between distribution companyand system operator. The distribution

company is responsible for the construc-tion and maintenance of the distributionnetwork. The main obstacles for efficient alignmentwith EU directive are vague provisions ofElectricity Act. First, as opposed to the pro-visions of Article 14 of the Directive,Croatian law does not define the area ofthe distribution company. Distribution isdefined as a public service obligation.Since neither the scope of public serviceobligation nor the geographic area inwhich a distribution company should pro-vide public service are defined, the plan-ning of the development of the distribu-tion network is not sufficiently transpar-ent.

The second shortcoming relates tothe unbundling of the DSO, which facesthe same challenges as TSO. It should benoted, however, that system operatordoes not perform as combined operator interms of Article 17 of the Directive.Namely, it does not have the technicalcapacity to dispatch at the distributionnetwork level. It should also be noted that,according to the provisions Electricity Law,the system operator could not perform theduties defined by Article 14, paragraph 5of the Directive. Namely, the system oper-ator may not be engaged in electricitytrading activities, which prevents the pur-chase of the energy to cover the losses.

The most striking issue in the design of theDSO is the transparency of its functionsand unbundling from vertically integratedutility, the same as for TSO.

The Directive requires that DSOshould be independent, at least in termsof its legal form, organization and deci-sion-making from other activities not relat-ed to distribution. Formally, the sameapplies to the DSO as to the TSO. Namely,according to Electricity Act, the systemoperator was supposed to be independent

15


by January 2003 and perform as combinedoperator according to the Article 17 of theDirective. In reality, DSO tasks are per-formed on the level of distribution compa-ny. The distribution company is one ofcompanies within HEP Group, which is bydefinition not independent from the par-ent company. The management of the dis-tribution company participate in companystructures of the integrated utility respon-sible for daily operation of the generation,transmission and supply. In addition, thesupply company, which was supposed tobe set up according to the Electricity Act,does not operate. Its tasks are performedby distribution company. Hence, althoughthe legal solutions for TSO and DSO arecomparable within the scope of theDirective and Electricity Act, the obstaclesfor implementing EU rules in distributionare greater than in transmission. This isbasically the result of certain technicalsolutions in place, but also of the lack ofunbundling between distribution and sup-ply, and its position within HEP Group.

Technical rulesAccording to the Electricity Act,

the System Operator should draft the GridCode in co-operation with transmissionand distribution companies. The GridCode shall specifically regulate technicaland other criteria for interconnection andoperation of networks, for access to thenetwork, and for the safe operation thatcan ensure reliable supply of the marketwith quality power. The Grid Code wasdrafted and sent to the procedure in 2003.The procedure requires that the Grid Codebe passed by the Minister, subject to prioropinion of the Regulator. The Regulatoradopted an opinion in October 2003 inwhich it underlined the discrepancies inwording and content with the Energy Law,

the Electricity Act and the Regulation Law.The Regulator also noted that it is notacceptable that utility should unilaterallyadopt and change technical rules, or applyinternal technical norms that are not pub-lished. There is no indication that theSystem Operator adopted or rejected anyof these remarks and drafted a new pro-posal.

Since there are at the moment notechnical rules establishing the minimaltechnical design and operational require-ments, the alignment with the Article 5 ofthe Directive is a challenge.

Tendering and authorization procedure for building new capacities

Article 9 of the Electricity Act pro-vides ground for authorisation and tender-ing procedures for new generation capaci-ties. Comparable with the Article 6 of theDirective, the authorisation procedure isapplied for eligible customers. This meansthat an energy enterprise may make thedecision on the construction of plants forpower generation for eligible customers atits own discretion, provided it has a licencefor carrying out power generation activity.This basically implies that licence equalsauthorisation procedure. The licence condi-tions, however, do not correspond with thecriteria for authorisation illustrated byArticle 6 of the Directive. Licence conditionsare related to legal form, financial, techni-cal and staffing requirements. However,technical rules do not exist, nor do preciserequirements regarding any of these issues.Next, the existing generation licences arenot geographically limited, nor is there adifference in generation licence for eligibleand tariff customers. Since the conditionsare not defined, the authorisation proce-dure is neither objective, transparent nornon-discriminatory. Also, it is not clear

16


11. This issue basically relates to allowing the Regulator to have its own staff. On the other hand, since the electricity utility is State-owned, this requires certain independence from the Government, too.

whether the producer has to sell all theelectricity produced to the eligible cus-tomers, or can partially (or occasionally) sellit to the "public" network (i.e. to captivecustomers). Namely, the System Operatorshall ensure the supply of electricity to tar-iff costumers from eligible producers, gen-erators that have contracts for supply pur-suant to public service obligation and elec-tricity market. This implies that a generatorcan sell to tariff customers, and that it cancontract for supply pursuant to public serv-ice obligation. However, since these criteriaare not developed and market operator isnot independent from the interests of HEP,such provisions do not provide solid groundfor opening the market. Therefore it isunclear whether any other generator (otherthan HEP Generation) can build generationplant for captive consumers, and what apublic tender means if the final provisionsof the Electricity Act grant this exclusiveright to public service generator. TheMinistry, on the other hand, can limitexports of electricity through energy bal-ance. Therefore, it is not clear when toapply the tender, and when the authorisa-tion procedure.

The tender procedure is foreseenfor tariff customers, and the terms of refer-ence for the tenders should contain the cri-teria comparable with those in the authori-sation procedure defined by Article 6 of theDirective. The Electricity Act also states thatthe Regulator shall issue the approval forthe construction of power generationplant, and that the Regulator will beresponsible for the organisation, monitor-ing and control of the tender procedure.This is comparable with the requirements inArticle 7 of the Directive. However, as men-tioned earlier, the Regulator has no staff,and the mandatory link with the EnergyInstitute makes it dependant on the inter-ests of HEP, i.e. the domestic monopolistproducer. Also, the final provisions of the

Electricity Act (Article 29) define that HEPwill carry out the generation of electricityfor tariff customers. HEP is also the only onewith access to locations foreseen for theconstruction of generation capacities.Therefore, it is very unclear what remainsfor the tender procedure, since HEP is theonly enterprise that can produce electricityfor tariff customers, and there is notimetable for reducing the thresholdbetween tariff and eligible customer.

Transparency of accountsAs mentioned earlier, the Energy

Law requires that energy company thatperforms two or more energy activities, orperforms some other activity in addition toan energy activity, shall keep separateaccounts and prepare financial reports foreach activity independently and separate-ly, in accordance with accounting regula-tions for entrepreneurs. However, the lawdoes not designate a competent authoritythat shall have the right to access theaccounts. The Regulator argues that itshould have access to the data, since it isfinanced from the income of energy com-panies, and there is provision in theRegulation Law enabling access to thedata necessary to carry out its functions.Also, there is no obligation in line withArticle 19 paragraph 4. of the Directive,that defines certain specific audit criteria.

Third party access to the networksThere is legal ground for third

party access to network. Namely, theElectricity Act states that the system oper-ator and/or distribution company shall beobliged to allow access to the network topower generators and eligible customerson a non-discriminatory basis, based onthe principle of regulated third-partyaccess (Article13, paragraph 1 of theElectricity Act).

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3.2.2.Comparison of main issues delivered in theBackground and the results from the currentanalyses. Priorities

As the analysis shows, the generallegal framework is generally in line with EUrequirements. However, the laws allow theimplementation of EU principles only theo-retically (for more, see Boromisa, 2002). The main obstacle for effective implemen-tation of existing legislation is the lack ofclarity, vaguely defined jurisdictions of dif-ferent authorities, and their procedures.This, coupled with strong lobbies and inef-fective judiciary, led to slowing down ofreform.

The following is necessary in orderto pursue market opening:

• Managerial and functional unbundling of TSO/DSO

• Defining technical criteria for thirdparty access for transmission and istribution networks, both

• Improving competence and inde-pendence of the Regulator fromindustry.11These measures can be imple-

mented within the present legal frame-

work. However, for effective alignmentwith EU rules, law revisions are needed.These revisions should be sufficiently pre-pared, so that mistakes and difficultiesemerging from different wording and def-initions are not repeated. Namely, the leg-islation in force does not define some ofthe basic terms (e.g. the scope of publicservice obligation), and some of the defi-nitions are not in line with EU acquis. Also,the Regulator is established as an inde-pendent legal body, but the Governmentdefines its priorities through the process ofgiving consent to the Regulator's budget.The Government also influences theRegulator's decisions. So, the status of theRegulator should be clarified: either itshould act as an independent legal entityor as part of state administration. If theRegulator is an independent legal entity,its procedures and competences should beprecisely defined.Basically, the main obstacles for efficientimplementation are organisational and, tocertain extent, due to a strong lobby oppos-ing the introduction of market principles.

Market openingAccording to Article 23, an eligi-

ble customer in Croatia is a customer withannual consumption exceeding 40GWh.There is no schedule for changing thisthreshold, but it is defined that theGovernment may prescribe a lower con-sumption level for gaining the status ofeligible customers. There are 15 such cus-tomers, but none has so far exercised the

right to choose a supplier.However, it should be noted that Croatiajoined the Athens Memorandum in June2001 and by doing so politically acceptedthe REM timetable for market opening.This implies that customers should havethe option to choose suppliers by 2005,and that the network rules, as well asUCTE standards, were to be adopted by2003.

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The basic preconditions for align-ment with EU rules are set. The legal frame-work allowing the gradual introduction ofmarket principles is in place, and basic insti-tutions are created. Co-operation with sim-ilar institutions in Central and EasternEurope, as well as in "old EU-memberstates" (EU-15) is established, as well aswith EU institutions (EuropeanCommission, CEER). Croatia is member ofUCTE, Zone II. Technically, it is capable to

operate in different synchronous zones,which gives it an important role in re-con-nection.

Also, various regional initiativeshave helped increase the "general under-standing" of market issues, which shouldhelp in building institutional capacity.Institutional weaknesses are connectedwith general weaknesses of public adminis-tration in Croatia, and should not beregarded as sector-specific.

3.2.3. Good practices

3.3. Gas sector

3.3.1.Existing deficits and obstacles in the implementation processes of EU requirements

Regulator

According to the Directive2003/55/EC concerning common rules forthe internal market in natural gas ("theDirective") the primary role of theRegulator is defined by Article 25.12

This requires the designation ofone or more competent bodies with thefunction of regulatory authority. These shallbe wholly independent from the interestsof gas industry.

In Croatia, CERC is the regulatoryauthority. As mentioned in the electricitysection, the Regulator lacks the capacity(staff) and authority to perform as foreseenby the directive. Next, Article 25 of theDirective lists specific functions that theRegulator should carry out. As is the case

for electricity, the monitoring function asdefined by Article 25, paragraph 1, pointsa) to h) of the Directive is not explicitlydefined as part of CERC tasks. Therefore,although CERC can try to perform thesetasks within the present legal framework,this function might be challenged beforethe court. Furthermore, CERC does nothave the authority to approve methodolo-gies used to calculate or establish the termsand conditions for connection and accessto national networks, nor to require themodification of these terms.

Designation and unbundling TSOArticle 2 of the Directive defines

TSO as private or legal entity responsible foroperating, ensuring the maintenance ofand developing the transmission system in

12. The tasks of the Regulator are comparable with those in electricity sector, with some sector-specific changes. Therefore the full text of this article is not cited here.


a given area, its interconnections with othersystems, and for ensuring the long-termability of the system to meet reasonabledemands for the transportation of gas. Themain tasks of TSO are defined by Article 8. The Gas Market Law does not recognizethe function of transmission system opera-tor as a separate function form transmis-sion. Transmission is defined as transporta-tion of gas from intake point to the off-takemeasurement-reduction station, and trans-mission company is the legal entity carryingout the transport and transit of gas.Functions of transmission company include,inter alia, functions of TSO in the sense ofthe Directive.

The transmission company (Plina-cro) was established in January 2001 as aseparate company within vertically integrat-ed INA Group. In March 2002, INA trans-ferred all its shares to the State, so that,since then, Plinacro is 100% owned by theState, and complies with independence andunbundling criteria of directive.

Designation and Unbundling DSOSimilarly as for TSO, the law in

Croatia does not recognize the functions ofDSO as separate from other distributionactivities. The main challenge in meetingEU criteria emerges from the relatively bignumber of distribution companies (39 inCroatia) which are very different (bysize/turnover, ownership structure etc.).Namely, distribution networks are built andfinanced very differently (by municipalities,system users/citizens themselves, or privateinvestors) so the main challenge is the def-inition of objective, transparent and non-discriminatory rules for charging system

users and developing the terms and condi-tions, including rules and tariffs for provi-sions of balancing services in line withArticle 12 (5) and Article 25 (2) of theDirective.

In addition, some distribution com-panies are owned by INA, and are thereforenot sufficiently unbundled according to therequirements of Article 13(2) of theDirective.13

Technical rulesAccording to the Gas Market Law

(Article 8), transmission company is obligedto publicly announce the basic terms andconditions of access to the transportationsystem and make them available to allinterested parties by publishing them in thepress and the Energy Regulatory CouncilNewsletter. The basic terms and conditionswere published in the Official Gazette andalso in the CERC Newsletter. So the basiccriteria prescribed by Article 6 of theDirective are met (without notification tothe Commission, which should probably bedone in the more advanced stage of EU-integration process).

Tendering and authorization procedurefor building new capacities

Authorisation procedure Article 4 of the Directive defines

the principles of the authorisation proce-dure. In Croatia, a licence issued by CERC isnecessary for each of the activities per-formed in the gas market (transmission,distribution, trade14). Construction of trans-mission and distribution facilities demandsa permission in compliance with the Law on

13. This probably does not represent a major incompliance with the Directive, since distribution companies are rather small, so those owned by INA are probably within the scope of allowed exception, i.e. serving less than 100 000 connected customers. However, precise data on this are not available.

14. I do not mention supply, since there is confusion in wording. Supply in gas business, according to Croatian law , means production or import of gas, and the term "provision of gas" is used in the sense of "supply" as used in theDirective. This confusion is not only a translation issue; there is confusion in Croatian as well, and the terms are notaligned in Electricity Act and the Gas Market Law.

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Construction. Concession is necessary forgas distribution. This is result of the factthat, in the period 2001-2004, gas distri-bution was regarded as an energy activity,i.e. one to which Energy Law, Gas MarketLaw, Regulation Law and related secondarylegislation applied, as well as Law onConcessions and Law on Communal/Municipal Activities. Pursuant to the recentchanges of Law on Communal Activities(Official Gazette 82/04) gas distribution isno longer regarded as communal activity,but only an energy activity. This was done inan attempt to avoid multiplying proceduresand to simplify them. There was also a riskof an emerging situation in which one com-pany can get a concession (issued bymunicipality, local or regional administra-tion) but not a licence (issued by theRegulator). Since both permits are neces-sary to work as a distributor, such proce-dure should be clarified. Therefore, changesin Gas Market Law as regards concessionsare necessary, and present rules cannot beregarded as efficient and aligned with therequirements of the Directive. For transmission, the government approvesdevelopment plans (for the construction ofnew lines), after which a licence is needed.Since the licence has no geographicalscope, the extension of pipelines does notrequire amendments in the licence issuedby CERC.

Transparency of accountsAs mentioned earlier, the Energy

Law requires that an energy company thatcarries out two or more energy activities, orcarries out some other activity in addition toan energy activity, keeps separate accountsand prepares financial reports for eachactivity independently and separately, inaccordance with accounting regulations forentrepreneurs. However, the law does notdesignate a competent authority that shallhave the right to access the accounts. TheRegulator is not explicitly authorized to

monitor the unbundling, as foreseen byArticle 25(1) of the Directive. Still, theRegulator argues that it should have accessto the data in order to ensure non-discrim-ination, effective competition and efficientfunctioning of the market. In distribution companies that are part ofmunicipal companies (dealing also withgraveyards, water, waste etc.) unbundlingfrom these activities was not effective.Unbundling and transparency was achievedin transmission and partially in distribution.Also, there is discussion as to where distri-bution "ends" and how accounts shouldbe separated if distribution company alsoperforms, for instance, installation works inhouseholds.

Storage is not yet unbundled from otheractivities.

Third party access to the networks andstorage

As opposed to the electricity sec-tor, the system enabling third-party accessto transport network is in place. The trans-port tariff system applicable to eligible cus-tomers and distribution companies is inplace, and this is the base for third-partyaccess which should be negotiated. TheNetwork Rules defining terms and condi-tions for access to the gas transport systemare passed by the Minister, after approvalby CERC (Official Gazette 126/03). Thetransmission company also published thebasic terms and conditions of access to thetransportation system, which are the basisfor negotiations the results of which are theprovisions of a contract (Official Gazette49/04). Negotiations define specific provi-sions of the contract as regards the dura-tion of contract, capacities, metering condi-tions, quality of gas, capacity and pressure,provision of balancing services, paymentmethods and insurance, etc.

The system allowing third-partyaccess to the distribution system has not yet


21


been put in place. This is connected withthe fact that there is no tariff system for dis-tribution in place. According to the EnergyLaw, a tariff system should be proposed bythe distributor; the Ministry and CERCshould give their prior opinion; and finally itshould be approved by the Government.This procedure is quite lengthy and expen-sive. Also, a significant number of very dif-ferent distributors makes it difficult todesign a smaller number of similar tariff sys-tems that can be individualised in terms ofspecific elements. A significant number ofsmall distributors that have no capacity topropose a viable tariff system, coupled withvarious ownership structure (private,municipal, system-built and paid by users),size and organizational issues (concessionsfor private companies, municipalities as dis-tributors, or private companies that ownnetworks) make drafting of the tariff sys-tems quite a complicated and lengthy task.

Market openingAccording to Article 12 of Gas

Market Law, eligible customers in Croatiaare customers that use gas for gas-poweredpower generators, customers that use gasfor the production electricity and heat in acombined cycle. This is irrespective of theirannual consumption. Also, eligible are con-sumers with annual consumption exceed-ing 100.000.000 cubic meters of gas.Hence, roughly 50% of the gas market isopen (CERC annual report, p. 42).

The Gas Market Law states thatthe Government may prescribe additionalor different criteria for gaining the status ofeligible customers. In July 2004, theGovernment adopted a Regulation (OfficialGazette 101/04) defining that producers ofiron, steel, and alloys of iron whose annualproduction of iron exceeds 50.000 tons arealso eligible.

3.3.2.Comparison of main issues delivered in theBackground and the results from the current analyses. Priorities

As the analysis shows, the generallegal framework in the gas sector is simpli-fied in comparison with the EU directive. Itallows functional operation basically in linewith EU rules, but without recognizingsome of the functions in the system. Themain issues to be tackled are definition ofTSO/DSO, revised definition of supply, andalignment with EU rules at distribution level(downstream from transmission pipeline).

Also, the role of the Regulator should bebrought in line with directive.

From the implementation point ofview, the main obstacle is the "legal gap"defining distribution activities. According tothe law, prices should be based on a tariffsystem adopted by the Government.However, the system in place relies on deci-sions of municipalities. This discrepancy

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At the transmission level, withoutexplicit legal obligation, effectiveunbundling was put in place. All the neces-sary elements that allow market opening(market rules, network rules, tariff system)are in place.

Although the present solution has deficien-cies (especially tariff system), it is imple-mented, and it represents a starting pointfor further measures, i.e. the developmentof transparent and non-discriminatory sys-tem.

3.3.3. Good practices

causes significant obstacles for distributorsand challenges the work of the Regulator. The following is needed in order to alignwith EU legislation: a) Clarification of legal framework at

distribution and downstream levels: clarification of authorizationprocedure and its alignment with he Directive,

b) Alignment of the Regulator's tasks

with the Directive, which should beaccompanied by the strengtheningof the Regulator's institutional capacity (by allowing it to have its own staff),

c) Defining technical criteria for third-party access to distribution networks, and

d) Defining storage tariffs and TPA provisions for storage.

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Support reforms Energy sector

The Energy Law defines basic rules for tariffreform. In electricity and gas both, the tar-iff system shall be non-discriminatory andtransparent, and provide incentives for thepromotion of energy efficiency and man-agement of the demand side, includingpromotion of the use of renewable energysources. The prices shall be based on justi-fied costs of operation, maintenance,replacement, construction or reconstruc-tion of facilities and environmental protec-tion costs, taking into account a reasonablerate of return on investment in powerplants, facilities and network or system.Elements for the calculation of the price ofenergy shall be specified in the tariff sys-tem. According to the Energy Law (Article28), tariff systems shall be passed by theCroatian Government upon the proposal byenergy enterprises to whose services thetariffs will be applied, based upon the opin-ion obtained from the Ministry andCroatian Energy Regulatory Council. Theseprocedures should be brought in line withthe electricity and gas directives, i.e. theRegulator should have the authority todefine, at a minimum, the methodologiesfor calculation.

In the electricity sector, prices forgeneration of electricity (apart form elec-tricity generation for eligible customers),transmission of electricity, distribution of

electricity, retail supply of electricity, opera-tion and control of the electricity system,and organisation of the electricity marketprices shall be set by the application of tar-iff systems.

For captive customers belonging tothe same category, the price of electricityshall be equal throughout the entire territo-ry of Croatia. The price shall also containelements of compensation for services pro-vided by energy enterprises under publicsector obligations, compensation for carry-ing out the regulation of energy activities,and compensation for stranded costs. Electricity transmission fees and distributionfees shall be set by the Energy RegulatoryCouncil upon the proposal of the energyenterprise carrying out the transmission ordistribution of electricity, respectively (Lawon the Electricity Market, Article 12, para-graph 3). The electricity transmission feeand distribution fee will be set on the basisof network development and constructionplans for a 3-year period. These plans aresubject to prior approval of the EnergyRegulatory Council.

However, at the moment, there isonly one, all-inclusive price. Transmissionand distribution fees are set by theRegulator, but development and construc-tion plans have not been approved. In order

4. Support reforms

4.1. Existing gaps, deficits and obstacles in the implementation processes of EU requirements

4.1.1.Tariff reforms necessary to achieve cost-reflective prices

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Energy sector Support reforms

to define prices for each of the activities,they should be effectively unbundled first.At the moment, different companies withinHEP Group have been created, but theyhave no assets. Therefore, it is a complicat-ed task to define transparent criteria andmethodology for the definition of justifiedcosts of replacement, construction, recon-struction and maintenance.

In the gas sector, the tariff systemfor supply (defined as import and produc-tion of gas) and transport are in place. Thebasic elements of the calculation of gasprices are average oil-product prices pub-lished in Platt's European Marketscan onthe CIF Mediterranean parity (for importedgas), the price of domestic gas (defined bythe Ministry), and average selling exchangerate for US$. As mentioned above, tariffsfor distribution should be defined.

Furthermore, an efficient price-set-ting mechanism should be put in place toallow for the implementation of polluterpay principle, to allow statistical monitor-ing, and to ensure confidentiality of individ-ual data.

Next, there are significant invest-ment requirements, identified by theGovernment and main energy companies,to upgrade facilities to conform to EU stan-

dards, extend energy networks, and meetrequirements regarding keeping 90-daysstock. Given those investment needs, it isessential that the energy reform createincentives for investments, which requiresthe establishment of credible pricing andregulatory regime.

Protection of vulnerable consumersAccording to Article 24 of

Electricity Law, the Government may, with-in the scope of a special economic or socialprogram, set discounted electricity prices inthe area of generation for specific cate-gories of tariff customers. Since categoriesof tariff customers are specified in the tariffsystem, it implies that the generator shouldpropose special category of such con-sumers, so that the Government may exer-cise its rights. After approval of the present tariff system(Official Gazette 101/02), the Governmentadopted changes of the system (OfficialGazette 121/02 and 129/02) that loweredthe price for specific categories of con-sumers. However, this was neither donewithin a special social program, nor in linewith the foreseen procedure. This was oneof the examples when the Government(acting also as owner of the electricity com-pany) (ab)used its power. This shows thatthe responsibility of players at all levelsshould be increased.

The electricity distribution compa-ny launched an initiative aimed at reducingnon-technical losses, which should enterinto practice in October 2004. The initiativeincludes defining rules and responsibilitiesfor employees of distribution company and

consumers both. Employees will facestronger sanctions if they participate inactions leading to increase of non-technicallosses, while, on the other hand, there areawards foreseen for those who help identi-fying and reducing non-technical losses.

4.1.3. Reduction of non-technical losses

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According to the Energy Law, effi-cient energy use is of interest to theRepublic of Croatia (Article 12). Energy effi-ciency programmes shall be passed by theCroatian Government in compliance withthe Energy Strategy and the Programme onthe national level, and on the local level bylocal or regional administration or self-gov-ernment bodies.

Pursuant to a special law (OfficialGazette 107/03), an EnvironmentalProtection and Energy Efficiency Fund wasestablished.15

The Fund finances projects, pro-grammes and actions aimed at sustainableuse and protection of environment. It alsoco-finances national energy programmesfocused on energy efficiency and use ofrenewables.

In addition to special national pro-grammes, energy efficiency and use ofrenewables should be promoted by theapplication of tariff systems. The tariff sys-tem, according to the Energy Law, shouldprovide incentives for the promotion ofenergy efficiency and management of thedemand side, including the promotion ofthe use of renewable energy sources.However, since tariff systems are applied forpublic service activities, special rules (orduties) should apply for market-based activ-ities.

Pursuant to Article 8 of theElectricity Act, energy co-generators thatproduce electricity and heat in a singleplant and that use waste or renewableenergy resources in an economically viable

way and in compliance with environmentalprotection measures can gain the status ofeligible (preferential) producer. The Ministerprescribes conditions for the status of eligi-ble producer. Market operator shall ensurethe purchase of total produced electricityvolumes form eligible producers under con-ditions at least equal to those currentlyeffective at the organized market. Also, themarket operator will give preference to eli-gible producers within the procedure ofselecting the most successful tenders formeeting the demand for electricity.

Energy companies themselves areinvolved in energy efficiency programmes.HEP has established HEP ESCO Ltd., anenergy service company which prepares,finances and implements energy efficiencyprojects on a commercial basis. The compa-ny was established with the aim of becom-ing a key creator of the market for energyefficiency projects in HEP Group andCroatia.

HEP ESCO's objectives are toinvolve domestic small and medium sizedenterprises in the implementation of energyefficiency projects, to employ domesticequipment manufacturers, to allow con-struction of plants of higher energy effi-ciency, as well as to allow procurement andinstallation of energy-efficient equipment,all in order to reduce consumption, costsand imports of energy and pollution ofenvironment.

Its projects include the moderniza-tion, reconstruction and renewal of existingplants and facilities in order to improve

4.1.4.Environmental issues and increase in energy efficiency

15. The Energy Law (Official Gazette 68/01.), Article 11, also defines the need to establish a special fund, as does the Environment Act (Official Gazette No 82/94 and 128/99), Article 60(5).

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technological solutions and use energy inan efficient manner. The funds invested arepaid back from energy savings. The projectsare selected on the basis of market criteria,where the key indicator is the payback peri-od.

HEP ESCO finances the entire proj-ect, which means project development,preparation and implementation. HEPESCO's clients (electricity and heat con-sumers) repay the investment out of energyand maintenance savings achieved as aresult of the use of the project, or as aresult of the installation of new, more effi-cient, equipment. The clients therebyobtain new equipment of higher energyefficiency without additional costs orinvestments. HEP ESCO uses World Bankloans and Global Environmental Facilitygrants for the realisation of energy efficien-cy projects and development of market.The estimated market potential in Croatia is400 000 000 US$.

Similarly, INA also supports energy-efficiency projects, and publishes annualreports on the protection of environment. The scientific project "National EnergyProgrammes" is conducted by EnergyInstitute "Hrvoje Po`ar". The goals of thisproject are better use of existing technolo-gies, use of renewable energy sources, andincreased energy efficiency. It consists ofseveral sub-projects, including:

• PLINCRO (Croatian gas pipeline

installation programme)• ENWIND (use of wind energy)• GEOEN (use of geo-thermal

energy)• KUEN (building) (energy efficiency

in buildings)• KUEN (cts) (energy efficiency in

central heating stations)• COGEN (co-generation of

electricity and heat)• MIEE (network of energy efficiency

in industry)• MAHE (small hydro-power plants)• SUNEN (solar energy)• BIOEN (biomass energy and waste

utilisation)• CROTOK (energy efficiency

of islands)• TRANCRO (energy efficiency

in transport)

In the years 2002 and 2003, theseprogrammes were supported by the Ministryof Economy with 2.8 million HKR p/a.

However, these measures do notcomply with the aims of EU's RenewablesDirective (Directive 2001/77/EC) to increasethe share of electricity produced fromrenewable energy sources (RES) in the EU to22.1 percent by 2010, thus helping theUnion reach the RES target of overall ener-gy consumption of 12 percent by 2010. Asalready identified, national programmesand strategy have comparable goals, bylack concrete implementation measures,including timetables and relevant analyses.

4.1.5.Security of supply

According to Article 29 of theEnergy Law, the Government shall prescribeGeneral Conditions of energy supply forend-users following the proposal by theMinister and after obtaining opinions fromthe Regulator and the Ministry. These shall

define the obligations of granting connec-tion to the network and supply of energy,conditions of connection and supply, condi-tions of energy delivery, constrains and inter-ruptions, and issues relating to conditionsunder which the connection will be effected.

27


Electricity or heat generators andenergy enterprises that produce or importoil and oil derivatives have to keep strategicstock, according to a special law (OfficialGazette 87/2002). In addition to strategicstock, the Minister prescribes the necessaryoperational energy stock, which specifiesthe manner in which storage capacity hasto be ensured, the manner and conditionsfor the use and renewal of such stock, andoperators' rights and liabilities concerningoperational stock. The Government prescribed the conditionsof keeping stock of oil and oil derivatives(Official Gazette 27/2003) and defined thatprivate and legal entities that have, in thepreceding year, imported 25 tons of oil andderivatives, have to keep stock equalling25% of their net import in the precedingyear.

In the electricity sector, it is the sys-tem operator that guarantees regular andreliable supply of electricity. In the gas sec-tor, the Ministry is responsible for long-termplanning and development of the gastransmission system in order to ensure thepermanent and secure supply of naturalgas, while the producer and importer areresponsible for the availability of sufficientvolumes of gas.

These measures, combined withadequate generation (related to tenderingand authorisation procedures), demandside-management through promotion ofenergy efficiency, monitoring and planningare in line with EU requirements.

Furthermore, the Energy Law pre-scribes specific rules applicable in excep-tional circumstances. First, the Regulatorcan pass a resolution ordering the energyenterprise to transfer its plants, facilities,appliances, network of system to anotherenergy enterprise to operate them whenthis is absolutely necessary to ensure reg-ular and secure supply of energy, in orderto prevent or remove serious damage inthe operation of legal entities and in thelife and health of citizens.

Second, in case of a significantdisturbance in the domestic market dueto unexpected or continual shortage ofenergy, in case of immediate threat tosovereignty and integrity of the country,and in case of serious natural disasters oremergency situations, the Governmentcan impose constraints on trading withspecific energy sources, prescribe specialtrading conditions, limit or prescribe spe-cial conditions for exports and imports ofenergy, prescribe obligatory energy gen-eration, or impose obligations to deliverenergy only to selected customers.

As concerns the alignment withthe "new acquis", such as Directive2004/67/EC concerning measures to safe-guard security of natural gas supply, somemeasures are already in place (e.g. cur-rent practice is in line with Article 4), butsome additional measures will be needed(e.g. to meet the requirements of Article5 d).

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To ensure that Croatian energy sec-tor is sufficiently aligned with EU regula-tion, basic legal acts should be amended. Itseems, however, that the legal frameworkalready in place does not significantly devi-ate from EU rules. The challenge ahead isits successful implementation and accom-panying measures, mainly relating to insti-tution-building (as concerns sector-specificinstitutions, but also "general" institutions)and standardisation.

Steps to be taken can be separatedinto two wide categories. The first one isthe creation of a market-based sector, withpolicies and legal framework compatiblewith the EU (institutional and legal reform),while the second relates to technical capac-ities (infrastructure).

Institutional and legal reformsinclude amendments of laws and alignmentwith EU directives. Missing secondary legis-lation should be adopted that would allowthe removal of existing barriers to enter themarket. For example, in electricity, thismeans the definition of grid code, transpar-ent and applicable rules for using intercon-nection capacities, definition of rules allow-ing third-party access to distribution andtransmission network both. The enforce-ment of many of those is pending for thepower sector restructuring and energy reg-ulation. Therefore, measures should be pri-oritised and sequenced.

Also, operational standards shouldbe developed (such as quality of supplystandards, metering code, CE sign,CEN/CENELEC standards) and rules formutual recognition (with the EU and withinthe region) should be implemented.

Amendments to laws should alsoinclude provisions that are not directly EU-integration related, but clarify the responsi-bilities of each of the subjects, especiallythe Government, the Regulator, the stan-dardisation office and utilities.

Accompanying measures, such asreform of the tariff system, including defini-tion of measures supporting energy effi-ciency and use of renewables, should bedeveloped in co-operation with relevantbodies, such as the Agency for theProtection of Market Competition (which isalso the relevant body for state aid), TheEnvironmental Agency and The EnergyEfficiency Fund.

For the success of energy sectorreforms, some "general" reforms, such ascadastre and judicial system, are also need-ed. This is necessary to increase the securi-ty of investments, and allow the enforce-ment of contracts, so that investors canhave confidence that they will recover thecosts associated with their investment overthe life of the asset.

Technical measures relate to invest-ments in the necessary post-war recon-struction of parts of the electricity, naturalgas and oil networks, and upgrading facili-ties to conform with EU standards, maxi-mizing the utilization of resources, diversi-fying sources of supply and enhancingsecurity of supply, and extending energynetworks both nationally and with neigh-bouring countries, to develop trans-European networks and regional energymarkets. This is inter-related with institu-tional changes. Namely, given Croatia'sinvestment needs, it is crucial that the

4.2. Comparison of main issues delivered in the Background and the results from the current analyses. Priorities

29


country provide incentives for privateinvestment in energy networks. This willrequire the creation of an incentive frame-work with the following key features:

• transparency and predictability of the industry and market structuresand regulatory framework, minimizing the risks perceived by potential investors. This requires completing the ongoing

restructuring of energy companies;• credibility of the regulatory system,

through clear division of responsibilities between the Government, the Parliament and the Regulator;

• efficient, cost-reflective tariffs thatprovide adequate signals to investors and customers; and

• improving energy efficiency, network maintenance and charges system.

4.3. Good practices

Basic EU requirements, as concernstransparency and market opening, areimplemented in domestic laws. Impleme-ntation measures follow the experience ofmore developed countries.International co-operation has been estab-

lished, and regional co-operation as well.

As mentioned above, a reform waslaunched that allows gradual alignmentwith the EU. However, the challenge is tospeed up the process.

30

Energy sector Investments in the energy sector

Gas sector

Rules for privatisation of INA aredefined by a separate Law on INAPrivatisation (Official Gazette 32/2002).According to this law, the privatisation ofINA d.d. shall be carried out as follows:

1. by transfer of 7% of shares, without compensation, to CroatianHomeland War veterans and members of their families;2. by sale ofmaximum 7% of INA d.d. shares topresent and former employees of the companies within the INA Group, with special benefits to bedetermined by the Government ofthe Republic of Croatia;

3. by sale of maximum 25% plus oneshare to INA's strategic investor;

4. by sale of minimum 15% of sharesby way of public offer, in compli-ance with separate regulations governing the issuance and tradingin securities to:- Croatian citizens, with such pre-emptive right and such preferences and under such conditions as may be determined by the Government of the Republicof Croatia, on listing of INA d.d. shares on the stock exchange,- Croatian legal entities and foreigninvestors, without any preferentialtreatment by way of public offer,

5. by sale or swap of the remaining shares to a strategic investor in accordance with market conditions

or on the capital market, as per thedecision of the Government of theRepublic of Croatia and subject toprior consent of the Croatian Parliament;

6. a necessary number of shares shallbe taken from the remaining shares as compensation for formerowners.

At least 25%+1 share of INA d.d.will be kept in direct State ownership, andthis shall be privatised in accordance with aseparate law upon accession of Croatia tothe EU.

In April 2002, the Governmentdecided on the sequencing and timetablefor privatisation. In the first stage, 25%+ 1 share was sold tostrategic investor. This stage of privatisationwas launched in 2002, and finalised in July2003, as the Government decided to sell25% +1 share (a total of 2,500,001 shares,nominal value 900 HRK per share) to strate-gic partner MOL (Hungarian Oil and Gasplc.).

Next, it was decided that sharesreserved for the Homeland War veteranswill be transferred to the special HomelandWar veterans' fund, within 7 days from theestablishment of the fund. The fund wasestablished pursuant to the special law(Official Gazette 163/03, 82/04).

According to the sameGovernment decision, shares to theemployees and former employees will be

5.1. Privatisation processes

5. Investments in the energy sector

31

Investments in the energy sector Energy sector

sold to them within 30 days from the firstpublic offer of shares. Public offer of 15%shares was scheduled to start within 6months after the initial sale of 25%+1share.

Electricity

Hrvatska elektroprivreda d.d (HEP)is a State-owned vertically integrated elec-tricity utility. Separate Law on HEPPrivatisation (Official Gazette32/2002)defines the privatisation plan. According tothis law, HEP has to hold ownership in itscompanies that carry out transmission ofelectricity, distribution of electricity, supplyof electricity to tariff customers, or owntransmission or distribution network, untilCroatia enters the EU. More precise, theState will keep 51% of HEP shares untilCroatia becomes EU-member.

Pursuant to the Hrvatska elektro-privreda d.d. Privatisation Act, draughtercompanies (HEP Generation, HEPTransmission, HEP Distribution, HEP Supply,

and CROISMO) shall not be privatised indi-vidually. They will be part of HEP d.d.(mother company). Also, HEP d.d. shallretain exclusive ownership of itsTransmission and Distribution subsidiaries.The privatisation of HEP d.d. shall be carriedout as follows:• 7% of shares shall be transferred

free of charge to Croatian Homeland War veterans and their family members;

• up to 7% of shares will be offeredto employees and former employees , under privileged conditions;

• at least 15% of shares will be soldto Croatian citizens, with preference, and to domestic legalentities or foreign investors, upon public offer;

• the residual shares shall be sold under market conditions on capitalmarkets16.

It was announced that HEP privati-sation will start in 2005.

5.2. Private investments

In the electricity sector, privateinvestments are limited. The vague legalframework and monopolistic position ofHEP discourage private investors. Severalcompanies registered their offices, planningto build and exploit wind power, mostly on

the seaside. However, since secondary leg-islation is missing, the projects are not oper-ational yet.

In the gas sector, there are severalprivate companies operating as distributioncompanies.

HEP management board is plan-ning to launch the investment necessary toensure 1220 MW in the system. During the2004-2008 period, it is planned to install

350 MW of new gas-powered plants:cogeneration unit in Zagreb - TE-TO Zagreb(100 MW) and thermal power plant in Sisak- TE Sisak (250 MW). War damages are still

5.3. New capacities and revitalisation programmes

16. Law on HEP Privatisation, Official Gazette 32/2002

32

Energy sector Investments in the energy sector

being repaired, and in November 2003 theErnestinovo transformer station 400/110kVwas repaired. The project value was 60 mil-lion euro.

A gas pipeline is being constructedpartially through the loan of the EuropeanInvestment Bank. The EIB loan covers 90

million euro, out of the total of 187 million.For the period 2006-2010, it is estimatedthat investments of 21,577 million HRK(fixed prices in 2002) are necessary. Of this,15 million should go to electricity supplysystem, 2,980 to the gas system, 2,095 tooil and oil products, 38 to heat, and 1,411in renewables (Government, 2003, p. 20).

5.4. International donor programs

USAID, World Bank, EC as well asinternational financial institutions havebeen supporting some projects in energysector.

World Bank has supported Croa-tia's efforts to ensure an efficient energysupply. World Bank has been providing investmentand grant support to the energy sector inCroatia through: (a) Energy EfficiencyProject - promoting greater efficiency inenergy use (i.e. modernization) and facili-tating the creation of an energy efficiencymarket (i.e. market development/attractingprivate investments); (b) Renewable EnergyResources Project - help in developing arational policy framework for renewableenergy (i.e. regulatory framework develop-ment) and promoting the development ofthe market for renewable energy resources.Further support is also provided through (c)analytical and advisory services, as support-ed by the Country Economic Memorandum(which, among others, analyses the situa-tion in the energy sector in Croatia and rec-ommends future strategy): CEM identifiesenergy and infrastructure as key buildingblocks of development in Croatia.

It was announced that the 2004-2007 Country Assistance Strategy (CAS) forCroatia will offer opportunities to discusspossibilities for further cooperation in theenergy sector in Croatia. Possibilities

include the Bank supporting: (a) implemen-tation of Croatia's commitments underSEEREM; (b) development of district heat-ing companies and the rehabilitation ofheating systems in Zagreb and Osijek. TheMinistry of Economy proposed GEF/WorldBank project of Renewable Energy Sources,the objective of which is the developmentof sustainable market of renewable energysources, (c) including a chapter on efficientprovision of energy into 2004-2007 CAS.World Bank has financed two energy effi-ciency projects, the beneficiary of which isHEP, and includes 2 components: service ofmanagement consultant to enhance thedevelopment and performance of HEPESCO, in the total amount of 555,000 US$,and market assessment and monitoringframework, amounting to 41,000 US$.

USAID has from the outset sup-ported institution building and creation ofthe new legal framework under the region-al project Energy Sector Restructuring. Inresponse to requests from the Ministry ofEconomy, USAID assisted in drafting apackage of four major energy sector laws,passed in July 2001, which created a statu-tory regulatory framework for energy sec-tor regulation and establishing an inde-pendent regulatory authority, CroatianEnergy Regulatory Council (CERC). USAIDhas been focused on the electricity sector,assisted CERC in assuming its responsibili-

33

Investments in the energy sector Energy sector

ties, joining a regional regulators associa-tion (ERRA), and signing a partnershipagreement with the New York State publicutilities regulator. Through technical assis-tance, USAID assists the restructuring ofHEP into affiliated daughter companieswith full separation of accounts. Majorareas of support include assistance withgrid codes, various tariffs, economic andtechnical aspects of the regional powermarket, Independent System and MarketOperator (CROISMO), fees and variousissues related to HEP restructuring.

USAID also supports Croatia'sinvolvement in regional electricity marketplanning activities. Through the South EastEurope Cooperative Initiative (SECI), Croatiaparticipates in two USAID-funded projects:(a) Development of Modern Teleinfo-rmation System among National DispatchCentres; and (b) Regional TransmissionPlanning. This program works with munici-pal officials on energy planning and energy

efficiency improvement (with emphasis onschools, hospitals and district heating). Thecity of Rijeka is the first pilot city to endorsea comprehensive energy planning method-ology, developed with USAID assistance,which will also be implemented in otherCroatian cities.

The European Union has also pro-vided help for the energy sector in Croatia.In 2001, 3.8 million euro was allocatedunder CARDS programme for energy infra-structure rehabilitation. The Ministry ofEconomy, with a partner institution, ispreparing or implementing a number ofbilateral and multilateral programmes, suchas those relating to energy efficiency:National CARDS 2003 includes the projectEstimation of Wind and Solar EnergySources in Croatian Pilot Region, and alsoproject proposals related to development ofinstitutional and legal framework for ener-gy effectiveness.

34

Energy sector Final recommendations

Steps to be taken can be separatedinto two wide categories. The first one isthe creation of a market-based sector, withpolicies and legal framework compatiblewith the EU (institutional and legal reform),while the second relates to technical capac-ities (infrastructure).

Institutional and legal reformsinclude adjustments in laws. This is neces-sary for alignment with the acquis, butshould also include provisions that are notdirectly EU-integration related, but clarifyresponsibilities of each of the subjects,especially the Government, the Regulator,Standardisation Office, and utilities. Missingsecondary legislation should be adopted,which would allow the removal of existingbarriers to enter the market. Existing legalgaps should be resolved, which requireswide preparation and is closely related withpower sector restructuring and energy reg-ulation. Therefore, measures should be pri-oritised and sequenced.

Such reforms should also encour-age investments, since transparent and pre-dictable framework is a necessity forattracting potential investors. This requirescompleting the ongoing restructuring ofenergy companies, and increased credibilityof the regulatory system through clear divi-sion of responsibilities between theGovernment, the Parliament and theRegulator.

Accompanying measures, such asthe reform of the tariff system, includingthe definition of measures supporting ener-gy efficiency and use of renewables, shouldbe developed in co-operation with relevantbodies, such as the Agency for theProtection of Market Competition (which isalso the relevant body for state aid), theEnvironmental Agency and the EnergyEfficiency Fund. Implementation of suchmeasures is a necessity for investors andconsumers both.

6. Final recommendations

35

References Energy sector

Websites:

European Union official websites:http://www.europa.eu.int/comm/energy/index_en.html;http://www.europa.eu.int/comm/external_relations/see/index.htm; http://www.europa.eu.int/eur-lex/en/index.html

Delegation of the EC in Croatia: http://www.delhrv.cec.eu.int

Economic Reconstruction and Development in South-East Europe http://www.seerecon.org/

Union for the Co-ordination of Transmission of Electricity http://www.ucte.org/

Croatian Energy Regulatory Council, http://www.vred.hr

Energy Institute Hrvoje Po`ar: www.eihp.hr

Hrvatska elektroprivreda, http://www.hep.hr

INA d.d. http://www.ina.hr

Plinacro http://www.plinacro.hr

Official gazette: http://www.nn.hr

Croatian government, www.vlada.hr

USAID; http://www.usembassy.hr/usaid/regional.htm

Boromisa, A. (2003) , Energy in European Union and in Croatia, in: Croatian Accession to the European Union, vol. 1.(ed. K. Ott), Institut za javne financije, Friedrich Ebert Stiftung, Zagreb, pp. 181-200

HEP Vjesnik, various issues

Ott, K. (2004), ed. Croatian Accession to the European Union, vol.2 Institut za javne financije, Friedrich Ebert Stiftung, Zagreb

Ministry of Economy, Energy in Croatia, various issues

World Bank (2003) Croatia: Country Economic Memorandum

References

36

Zakon o energiji, NN 68/01. Zagreb: Narodne novine.

Zakon o regulaciji energetskih djelatnosti, NN 68/01, 108/01. Zagreb: Narodne novine.Zakon o trì{tu elektri~nom energijom, NN 68/01. Zagreb: Narodne novine.

Zakon o trì{tu naftom i naftnim derivatima, NN 68/01. Zagreb: Narodne novine.

Zakon o trì{tu plinom, NN 68/01. Zagreb: Narodne novine.

EurActiv http://www.euractiv.com/cgi-bin/cgint.exe/2410664-236?204&OIDN=2000763&-tt=eg

Government (2003) Answers to the Questionnaire of the European Union. Chapter 14, Energy. Available at www.vlada.hr

37

Energy sector References

38

Partners in the project "Support to promotion of reciprocal under-standing of relations and dialogue between the European Unionand the Western Balkans" are:

ALBANIAInstitute for contemporary studies, www.icls-al.org

BULGARIAEUROPEAN INSTITUTE Foundation, www.europeaninstitute.net

BOSNIA AND HERZEGOVINAMozaik - Community Development Foundation, www.mozaik.ba

CROATIACEPOR, SME's Policy Think Tank Centre, www.cepor.hr

SERBIA AND MONTENEGROBelgrade Centre for European Integration (BeCEI), www.becei.org

REPUBLIC OF MACEDONIAEuroBalkan, www.euba.org.mk

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