Vesselin Gentchev, head of legal and compliance at AES Energy, speaks with John Crabb about the challenges facing Bulgaria’s energy sector, from the country’s erratic regulatory regime to its dependence on Russian imports, and the government’s shale exploration ban
Can you tell me a little about AES Energy and why the company established itself in Bulgaria?
We thought Bulgaria was a promising market at the time, particularly the energy sector. The climate was good and there were prospects for entering NATO and, in the long term, the EU.
We operate two major projects in Bulgaria. One of them is a lignite power plant which has about 600 MW capacity in the middle of the country, the other large project is a 156MW wind farm on the coast. For us it all started with the power plant, Maritza East 1.
The area of Maritza has a long history; the current plant was initiated in 1998 when it was thought that the country would need extra lignite power capacity. There were other plants, but the initial Maritsa Iztok Complex was constructed in the 1950s and was nearing the end of its life. It was thought that extra capacity would be needed in Bulgaria because of the state's energy needs.
Maritza was attractive because it was the kind of project AES had been involved with historically. Once the initial issues with financing had been resolved - the original company went through a restructuring process - we bought the shares and proceeded with the project. The agreement was signed in 2006 and the final round of construction started soon after. We first got involved in the development and construction of the wind project in 2010.
Are there any challenges that consistently arise when working in Bulgaria?
While Bulgaria as a whole is not the easiest place to work, it very much depends on the industrial sector you are is involved in. For example, IT and outsourcing have been doing rather well and there are quite a few foreign companies and individuals who have moved to the country as a result. But investing and working in the highly regulated Bulgarian energy sector is not for the faint-hearted. There are many multi-faceted challenges which we as a company have encountered and continue to encounter when dealing with the government and all levels of the administration since making our first investment in the country.
Political factors give rise to most of these challenges. For example, and this does not apply only to the energy sector, the enforcement of the rule of law is not as strong as that which one can observe in fully developed democracies such as the UK or the US. This problem has been a frequent cause of criticism in the European Commission’s regular monitoring reports, issued under the Cooperation and Verification Mechanism, which assess the country’s progress with judicial reform and the fight against corruption and organised crime.
Bulgaria continues to lag behind other new EU members on these important development benchmarks and this naturally creates a perception of a lack of contractual security, and uncertainty in the business environment. Contracts are not always regarded as sacrosanct and the rules can sometimes be bent to suit certain individuals. For example, there have been reported attempts to take over companies through the abuse of the legal system. In particular through the appointment of rogue administrators and the allocation of cases, by design, to judges of dubious reputation. Add to that the generally slow speed of dispute resolution in the courts, and an investor might well feel that it is not worth using the legal system at all in case of a dispute.
Have you faced any challenges specific to the energy sector?
In the energy sector, political developments, such as frequent changes of government in the past three years and, as a consequence, changing political priorities, have caused a lot of turmoil. This has been reflected in the actions of parliament, the government, the National Electricity Company (NEK, our off-taker), the energy regulator (EWRC) and the transmission system operator (ESO).
Following the residing government’s resignation in 2013, the next (socialist led) coalition government, which only lasted 13 months, rolled back feed-in tariffs, ignored other governmental guarantees and imposed a lot of decisions that were quite obviously politically motivated. They did this through legislative changes and by introducing new fees and taxes imposed by the (not-so-independent) EWRC on the income of renewable energy producers.
This course of action has more or less been followed by the latest government, which came to power in 2014. As a result, investors in the sector have seen their investments substantially fall in value. They have fought back through the local courts, with varying degrees of success, and two of them have chosen to start investor-state arbitration cases against the state. This, together with the continuing delay in the sector’s full liberalisation, has been the greatest challenge for many of the market players.
What do you think can be done to make Bulgaria a healthier country in which to do business?
I am afraid that I will have to repeat again what has been said too often by too many people; Bulgaria has been consistently slow in addressing, and making specific progress on, the issues of judicial reform, corruption and organised crime. There is still too much red tape in government, the legislative environment is unpredictable and the employment legislation dates back to the communist era. One of the few positive things for businesses in the country - the low flat rate income and corporate tax - does not sufficiently outweigh the problems.
Businesses need to know that they can operate in a stable and predictable political environment where the law is respected, and that in case of a breach they can turn to an unbiased and expert court, obtain the necessary remedy and enforce it. This is not necessarily the case in Bulgaria. Without going into specific details, it is still the case that officials at all levels of the administration, central or local, can make an investor’s life difficult in the hope of extracting advantages, and that a company may not be able to do much to obtain a proper remedy against them.
Naturally this affects investment levels. If businesses do not feel secure, if it is not certain that they can rely on the legal system to protect its assets, then they will be hesitant to invest in the country. So, first and foremost, Bulgarian politicians need to complete the reform of the country’s legal and judicial system, ensure the freedom of the judiciary from executive powers, and enable the enforcement of the rule of law. Unfortunately, the political class continues to demonstrate a strong reluctance to executing the necessary reforms, and serious question marks remain over the independence, accountability and integrity of large sections of the judiciary.
You mentioned the liberalisation of the energy sector. Can you tell me more about this?
Let me give some background. The NEK purchases electricity from companies like us, from other producers of renewables, and from other coal generators. They then sell it on to the distribution companies, who in turn sell it to the customers. As the state regulator, the NEK determines the price. There is also a smaller free market, but this is still being developed.
The liberalisation of the energy sector has taken too long, and is still to be completed. Although consumers have been able to change supplier since 2011, the electricity grid has been transferred from the vertically integrated NEK to ESO, and the share of clients who buy electricity on the regulated market has decreased to around 34% of net production. So, key prerequisites for full liberalisation and deregulation of prices for households are still to be met.
In addition, the ongoing process of liberalisation, the oversupply of renewable energy projects and general mismanagement have led to growing system costs. Further to this there has been more than a 35% drop in demand for electricity on the regulated market, which, between 2013 and 2015, resulted in a tariff deficit within the sector of €600 million to €800 million a year.
Instead of undertaking proper measures to complete the sector’s liberalisationand recapitalise it, populist policies and decisions imposed during 2013 and 2014 dictated that consumer’s prices should be kept low. Producers with long-term power purchase agreements (PPAs) were also targeted, with the helpful assistance of the energy regulator, by imposing availability reductions that were contrary to the contractual agreements made with the off-taker. Further to this, they requested that the European Commission declare the agreements as illegal state aid, despite the fact that their share of the market is low and had not caused the sector’s problems in the first place.
Is the current government attuned to the sector’s problems?
The current government has acted in a more sensible and constructive way. They will support the NEK through the creation of a security fund, which is to be financed by the imposition of a 5% tax on all of the energy producers’ monthly revenues, by the sale of government emission allowances, by seeking a sensible renegotiation of some long term PPAs, and by proceeding with the balancing market created in 2014. I also expect that further steps will be taken to complete the yet unfulfilled requirements of EU’s Third Energy Package.
At the moment the World Bank is also conducting a study on the electricity sector, and is preparing a model for the liberalisation of the whole sector. On paper it's all supposed to be liberalised by next year, this is what the government is saying, but we know liberalisation actually takes years to achieve, so we'll just have to see how it goes.
If it were up to you, are there any laws or regulations that you would like to see changed in Bulgaria?
I would not necessarily start changing the law, although I am sure that there are things in the law that could be improved.
The energy act is the main piece of legislation affecting the sector in Bulgaria and it has already seen a lot of changes in the last year - amendments to the renewable energy act, for example. These amendments come quite often as the government seeks to achieve its own aims.
Most of the issues in the last two years have really been with the actions of the regulator. For example, under the renewable energy directive of the European Union, Bulgaria committed to the binding target of producing 20% of its energy from renewables by 2020.. The Bulgarian regulator then approved and built so many renewable plants, both solar and wind, during the following two or three years that they actually achieved the 2020 target by 2014.
This was done by subsidising energy and giving very high tariff's, so all of a sudden the energy became far too expensive. The price of energy in Bulgaria is still the lowest in the EU but, relative to earnings and income, it is very high.
The government found itself with lots of renewables on its hands. On top of that our plants, another US owned plant, a number of other coal generated plants and central heating companies were all able to sell electricity out with the regulated market at very high prices.
All of a sudden they found that the national regulator could not pay for that electricity, even though it was obliged to purchase that electricity under each project agreement, because the prices were that high.
The regulators then started passing amendments which imposed certain fees and taxes on the producers, which did not appear to be legal. So mostly it's not the legislation that has been the issue, but the decisions of the regulators.
The government recently banned exploration for shale gas in Bulgaria. What are your thoughts on this?
It has not affected operators like us. The reason for banning shale exploration and fracking was mostly a populist decision. Essentially the current government tends to act in a populist way, and when they first announced the possibility of fracking there were demonstrations all around the country. Of course it was speculated that this may have been organised with Russia's help and so on, but again that is pure speculation. In my opinion it was a populist decision.
And what do you think wil be implications of this for the development of the energy sector?
Well you could say that if that had happened then there would have been new jobs for Bulgarians. There would have been the need for new suppliers, consumables and everything else around that; it would have provided for the country. So in terms of the loss of potential jobs and income and so on it has had an effect, but I wouldn't say that any particular businesses were affected directly.
You mentioned speculation about Russian influence. Do you think Bulgaria needs to diversify the source of its energy supplies?
Oh yes, obviously this government should be looking at achieving security of supply, I think this is very important.
Bulgaria currently only obtains gas from Russia. In 2009 Russia cut off the gas supply that was going through the Ukraine and Bulgaria had a two or three week period with no heating. This is a problem that is being reiterated time and time again by the US government and the EU.
For this reason our lignite power plant is very important. Even though Bulgaria may not realise it fully, it is essential that we use the local lignite supply. Our plant has been specifically designed to use the local coal, which cannot be exported because it has a very low calorific value and can only be used in local plants like ours. This is an important element in the security of supply that our company provides to Bulgaria.
What else is being done to diversify the source of supply?
Bulgaria has been discussing gas interconnectors with Greece, Romania and elsewhere. Bulgaria has been quite slow in doing this but I think it is starting to happen now.
Historically they have always wanted to develop a big nuclear power plant, but they should not be relying on this. Bulgaria already has one Russian built nuclear plant called Kozluduy, and there were plans to build a second one called Belene, but construction was stopped. Projects like this should not really be happening because they will only increase Bulgaria’s reliance on Russian fuel.
How often does AES Energy use external legal counsel?
We only have a small team so rely heavily on external legal counsel. We normally work with Spasov & Bratanov. The energy partner, Vassil Hadjov, is our main contact. I also use Boris Boyanov [Boyanov & Co] who is also very good in the energy area.
As a rule do you tend to prefer fixed rate or hourly rates?
We have worked with one firm as our main project advisor on both our large projects. We would expect a fee increase if the work load had been particularly heavy, but in general it's on a basic fixed rate.
We sometimes use other law firms and because we use them to a lesser extent they are working on an hourly rate. I will always ask for an estimate beforehand.
Why do you continue to work with Spasov & Bratanov over other firms?
In Bulgaria it is not just about knowing the law, it is also knowing the whole environment and the set up within which the laws operate and decisions are taken. What is important is knowing who the decision makers are, and helping us to make the correct decisions. You do not always have to make the decision which is correct in law, sometimes you just have to take a business decision, and they have been very good at that.
When I joined five years ago they were already working on the Maritza project with us, and I have since got to know them quite well, and have been more than happy to retain their services. They are a very business orientated firm and they - Vassil in particular - know the sector very well.
They are also very down to earth, easy going guys. They are not stuffy lawyers who are difficult to work with. They are very flexible and clued-up to our needs as a business, and very prepared to discuss our particular requirements.
I would say that they are very responsive and I can absolutely rely on them for anything, irrespective of the time, day or night.
As a local in-house counsel for a large international company, can you give me your impressions of the legal market in Bulgaria?
For a large international company there probably are not many law firms to turn to, but then again there are quite a lot of law firms that have been able to build a good reputation here.
I would not say that it's just Boyanov & Co, Djingov Spasov & Bratanov and a few other firms which dominate the market. If lawyers have the right experience and knowledge, there are opportunities out there for them to build that position and to grow as a firm.
International firms need to be very aware of the environment and the cultural specifics here, and they need to be able to operate at a local level. There are not many Western firms that have been able to survive here, I think it is just CMS Cameron McKenna and a couple of Austrian firms. Although they have been probably as successful as they would like to be, they probably have not been able to charge as much as they would have liked.
How do you think CMS, Schoenherr and Wolf Theiss have fared in Bulgaria, and what may have deterred other international firms from entering the jurisdiction?
Following the initial enthusiasm and high hopes in the early 1990s when some of the better known international firms established a presence, either directly or through a formal association with local firms, the economy’s performance and foreign investment has not been at the level needed to support that type of model.
As a result, most of those firms withdrew from the Bulgarian market or terminated their local associations. CMS, Schoenherr and Wolf Theiss managed to establish a presence in Bulgaria based on incoming work from international clients, but they have increasingly been taking on work from local clients in order to maintain a credible presence.
To credit the local firms, many of them display the expertise, high-level of professionalism, business-mindedness and strong work ethics typical for many of their top colleagues in the City of London or Wall Street. Also, most of them have preferred to remain independent, allowing them to take on referrals from abroad whenever possible, which has so far suited all transaction parties well. This is a well-established model now, and I do not expect to see any changes to it in the foreseeable future.
Does AES have any plans for further expansion across CEE or the EU?
We have been developing projects in Asia and are continuing to develop in the US, where we are actively looking at developing so-called innovative projects. For example, AES has been instrumental in the evolution of battery storage. It is in its early days in Bulgaria, but we have been developing battery storage projects in Spain, the Netherlands and also in the UK, particularly Northern Ireland.
What is your vision for the future of AES’s operations in Bulgaria over the next few years?
It is no secret that the NEK owes us and another US owned power plant around €700 million. The government is trying to find funding. At the moment they are negotiating with banks to finance the payment of receivables to us and the East Maritsa 3 plant. This is our main aim at the moment.
Hopefully by next year we will resolve this and also have a liberalised energy sector. After that we will be looking at how to develop battery storage in Bulgaria, if possible. Hopefully that will be possible, because it would be very useful for Bulgaria to help balance the energy supply.
How do you think the Bulgarian energy sector will evolve in the near future?
Hopefully it will change for the better. I can only see an improvement in the next few years, it is not going to happen immediately, but things are definitely moving in the right direction. The government has indicated that it will take the right actions and, in that respect, I believe that it will happen.
I expect to see deregulation of electricity prices continue, and the size of the regulated market should decrease as businesses connected to the low voltage network go to the open market.
Bulgaria should proceed with the liberalisation of the sector through the EU’s Target Models, implementing day-ahead and daily markets, synchronising the day-ahead markets and balancing markets, and creating a platform for long-term bilateral agreements.
Traditional style long-term PPAs, which sit uneasily in a fully liberalised market, will probably be transformed into contracts for difference or the like. These developments will take place both as a result of the need to comply with the requirements of the Third Energy Package, and the resolution of various EU infringement proceedings against Bulgaria aiming to stop practices contrary to EU law. For example, the recently resolved antitrust case against the Bulgarian Energy Holding (BEH) initiated by the commission in 2012, which focused on contract clauses between BEH and its customers, and prevented BEH from selling electricity outside Bulgaria.
The government knows that they have to liberalise the sector. Once the sector is fully liberalised, we will have a more normal environment in which to operate, and where other companies will be able to operate fully.
Vesselin Gentchev
Legal Counsel and Compliance Officer
AES Energy
Sofia
Biography
Vesselin Gentchev is AES Bulgaria’s legal counsel and compliance officer, looking after the legal needs of the company’s business in Bulgaria. Gentchev deals with the commercial, regulatory and corporate matters related to the operation and management of the corporation’s electricity generating coal and renewable power plants, as well as its EMEA shared services centre in Sofia. In addition, he implements AES Corporation’s ethics and compliance programme in Bulgaria, ensuring full compliance with the FCPA, managing the due diligence of business partners and stakeholders, conducting ethics and compliance training, and implementing the corporation’s policies in the country.