89695 Heat Tariff Reform and Social Impact Mitigation Recommendations for a Sustainable District Heating Sector in Belarus JUNE 2014 contents Acknowledgmentsv Introduction  1 1 What Are the Government’s Plans for the Sector?  3 2 Why Is Tariff Reform Necessary?  5 3 What Is the Likely Impact of Tariff Reform?  13 4 How Can Tariff Reform Best Be Implemented? 21 Appendices Appendix A: Overview of the District Heating Sector in Belarus Appendix B: The Impact of Tariff Reform on Households and Industries Appendix C: Distribution Impacts of energy cross-subsidization in Belarus Appendix D: Methodologies of Focus Group Discussion and In-depth Interviews Appendix E: Cost Allocation between Heat and Electricity in CHP Plants Reform of District Heating Tariff Setting Principals and Lessons Appendix F:  Learned in the Baltic Countries and Poland  ommunicating Heating Tariff Reform to Households Lessons and Appendix G: C Experience from Eastern European Countries and Russia Appendix H: Overview of Social Assistance Programs in Belarus Protecting the Poor from Tariff Increases – Experiences and Lessons Appendix I:  from Eastern Europe and Central Asian Countries Energy Efficiency Appendix J:  Tables Table I.1: Policy Matrix for Tariff and Subsidy Reform in District Heating  2 Table 1.1: National Cost-Recovery-Level Targets for Residential Heat and Electricity Services of BelEnergo  4 Table 3.1: Tariff Reform Options, 2015–2020  13 Table 4.1: Poverty Impact of GASP and H&U Benefits  24 Table 4.2: Benefit Coverage, Targeting Accuracy and Fiscal Cost of GASP and H&U Benefits  25 Table 4.3: Advantages and Disadvantages of GASP and H&U Benefits  26 Table 4.4: Economic Analysis of Supply-Side EE Measures in Case Study Towns  30 iii iv Heat Tariff Reform and Social Impact Mitigation Table 4.5: Economic Analysis of Network Renovation in Case Study Towns  31 Table 4.6: Economic Analysis of Demand-Side EE Measures under Current Tariff  32 Table 4.7: Economic Analysis of Demand-Side EE Measures under Different Tariff Increase Scenarios  33 Table 4.8: Average Annual Household Savings after implementation of EE Measures  34 Table 4.9: Reform Packages with Positive Fiscal Savings  35 Figures Figure 2.1: Declining Cost-Recovery Levels of Residential Heat Service  5 Figure 2.2: Import prices of Russian Natural Gas has sharply increased  6 Figure 2.3: Comparison of Tariffs and Production Costs or ZhKHs and Belenergo  7 Figure 2.4: Belenergo Industrial Electricity Tariffs as a Percentage of Cost of Service 8 Figure 2.5: Use of Cross-Subsidies from Belenergo’s Non-Residential Electricity Sales to Finance Residential Heat  8 Figure 2.6: Comparative Energy Costs—Where Belarus Stands  9 Figure 2.7: Increase in Output Prices Due to Implicit Electricity Tax Levied on Industrial Consumers  9 Figure 2.8: Expenditure Shares by Consumption Category and Income Decile  10 Figure 2.9: Extra Expenditures from Imposing Implicit Tax on Industrial Consumers  10 Figure 2.10: Distribution of Heat Subsidies  11 Figure 3.1: Affordability at Different Cost-Recovery Levels by Income Group and Price Scenario  14 Figure 3.2: Vulnerability of Different Populations Under a Uniform Pricing Regime  15 Figure 3.3: Vulnerability of Different Populations Under a Differentiated Pricing Regime 15 Figure 3.4: Impacts of Tariff Increases: Highest in Q4 and Q1  17 Figure 3.5: Coping Strategies in Response to Tariff Increases  17 Figure 3.6: Fiscal Savings Generated from Uniform and Differentiated Price Scenarios  18 Figure 3.7: Shares of Exports of Different Sectors  19 Figure 4.1: Substantial Variation in the Costs of Heat Supply Among Oblasts  27 Figure 4.2: Distribution of Housing Stocks by Heat Consumption (2012)  28 Figure 4.3: Heat and Hot Water Consumption by Building Type  28 Figure 4.4: Recommended Road Map for Implementing Reforms  36 acknowledgments This work was carried out under the direction of Ranjit Lamech, Sector Manager for the Energy Unit of the Europe and Central Asia Region, and Qimiao Fan, Country Director for Belarus, Moldova, and Ukraine. The team would like to thank them for their generous guidance, insights, and encouragement. This report was prepared by Fan Zhang and Denzel Hankinson, based on substantial con- tributions from a large number of World Bank staff and consultants from Social Protection, PREM, Energy, Social Development and External Affairs Units. Julia Smolyar and Vlad Grigoras contributed to the social protection analysis. Sebastian Eckardt contributed to the fiscal analysis. Murat Alehodzhin and Irina Voitekhovitch prepared a detailed background study on energy efficiency. Ecaterina Canter, Izabela Leao and Klavdiya Maksymenko con- ducted extensive work on the qualitative social impact analysis and stakeholder analysis. Corbett Grainger and Bonsuk Koo contributed to the quantitative social impact analysis. Irina Oleinik led the communication study and training. Bonsuk Koo, Yating Chuang, and Andrew Schreiber provided valuable research assistance. Maryna Sidarenka and Irina Voitekhovitch worked tirelessly to obtain household survey and administrative data. Karuna Phillips helped draft an appendix on social protection programs in neighboring countries. Valdas Lukosevicius provided background studies on tariff setting methodolo- gies and tariff reform experiences in the Baltic countries and Poland. Dianne Snyder edited the report, and Carol Siegel designed the format. Rozena Serrano provided timely admin- istrative assistance. The study received substantial support from the ECA management team. The team would particularly like to thank Elisabeth Huybens in the Social Development Unit, Carolina Sanchez-Paramo in the Poverty Reduction and Economic Management Unit, and Andrew Mason in the Social Protection Unit. The team is also grateful to representatives of the joint working group from the Ministries of Finance, Economy, Energy, Housing and Utilities, Labor and Social Protection; as well as from Belenergo, Eltopgas, the Energy Efficiency Department, and the oblast executive committees, for their productive discussions and feed- back throughout the project. The team is also grateful to the National Statistical Committee for providing essential data. The report benefited greatly from Elena Klochan who worked tirelessly to coordinate with the government, provided important guidance on country issues, and supported the establishment of the joint working group. Pekka Salminen has nurtured and led the Bank’s engagement in the district heating sector in Belarus. The team is greatly indebted to Pekka v vi Heat Tariff Reform and Social Impact Mitigation for generously providing his guidance and insights on technical and policy issues of the sector. The peer reviewers for this report are Sameer Shukla, Jonathan Sinton, Emil Tesliuc, Maria Vagliasindi and Yadviga Viktorivna. Ani Balabanyan and Caterina Laderchi care- fully reviewed the report at multiple stages and provided comments on both the substance and presentation of the report. The team would like to thank all reviewers for their valu- able inputs and suggestions at various stages of the study. Special thanks also go to Nicolas Perrin and Michelle Rebosio, who supported and coordinated the qualitative field survey and the stakeholder analysis. In addition to the contributors of the background papers and peer reviewers, many people at the World Bank provided helpful comments, suggestions, and other inputs along the way. The team would particularly like to thank Tamara Sulukhia, Alejandro Cedno, Young Chul Kim, Uwe Deichmann, Kari Nyman. Sunil Khosla, Jas Singh, Claudia Vasquez Suarez, Sophia Georgieva, Heather Worley, Stephane Dahan, and Nithin Umapathi. We wish to apologize to anyone inadvertently overlooked in these acknowledgements. Finally, the team would like to thank ESMAP ABG and Subsidies Trust Fund and ECA PSIA Trust Fund for their generous financial support. Introduction The Government of the Republic of Belarus (GoB) plans to increase district heating (DH) tariffs to cost-recovery levels and gradually phase out subsidies, replacing them with social assistance programs. Residential DH tariffs in Belarus are currently at roughly 10–21 per- cent of cost-recovery levels. DH subsidies are highly regressive, add costs to business, and create significant fiscal risks and macroeconomic vulnerabilities. The purpose of this report is to analyze the social, sectoral, and fiscal impacts of the pro- posed tariff reform, and to identify and recommend measures to mitigate adverse impacts of DH tariff increases on the households. The analysis shows that: • The burden of higher DH tariffs will fall most heavily on low-income groups. • The current system of subsidies is unfair, benefitting wealthy customers more than the poor. • Cross-subsidies undermine the competitiveness of industries in Belarus • Underpriced residential heat places an increasing fiscal burden on the GoB and risks macroeconomic instability. The analysis shows that a negative social impact is manageable if a tariff increase is accom- panied by countervailing measures to compensate for the loss of purchasing power, in par- ticular of the poor, through targeted social assistance and energy efficiency programs. The reform is more likely to be successful if communication campaigns to address consumer concerns are carried out before significant price increases, and consumer engagement and monitoring systems are established. When tariff reform and mitigation measures are prop- erly sequenced and coordinated, the reform will become more socially acceptable, consum- ers will benefit from better quality of services, the government will achieve positive fiscal savings, and the DH sector will become sustainable in the long term. A sustainable DH sector means: • Financially viable DH service providers—Belenergo and ZhKH—that can afford to maintain and invest as much as required to provide the services customers want • The independence of DH service providers from excessive direct fiscal subsidies, and • Well-targeted social assistance for customers struggling to afford the cost of heating. Table I.1 summarizes the challenges facing the DH sector and the recommended policy options. 1 2 Heat Tariff Reform and Social Impact Mitigation The rest of the report is organized as follows: Section 1 describes the GoB’s plans for the sector. Section 2 analyzes the principal challenges in the sector that necessitate tariff reform. Section 3 discusses tariff reform options and the likely impact of pursuing each of these options. Section 4 concludes by recommending a reform action package that includes cus- tomer communication and engagement, social protection measures and investments in energy efficiency. The appendices contain material supporting the analysis in each section. Table I.1: Policy Matrix for Tariff and Subsidy Reform in District Heating Recommended Measures Challenges Expected Impact 2014–2015 2016–2017 2018–2020 Residential tariffs are Achieve 30% cost-re- Gradually increase the cost-recovery Belenergo and ZhkH can continue to well below cost of covery for Belenergo for Belenergo and ZhKH provide reliable, good quality service service and fiscal burden and ZhKH by 2015 with limited fiscal impact on the GOB continues increasing Possible customer resis- Roll out consumer com- Customer acceptance of tariff tance to tariff increases munication campaign Continue improving the transpar- increases Establish consumer ence and accountability of utility monitoring mecha- services nisms Tariff increases will hurt Better social protection measures established Targeted relief for vulnerable custom- the poor more than the Demand-side ers; Limited impact on affordability of Provide preferential loan/grants to low-income rich energy effi- heat supply households for demand-side energy efficiency ciency fully Supply- and demand-side EE measures imple- scaled up mented 1 What Are the Government’s Plans for the Sector? The GoB has set national targets, planned investments, and continued to enact tariff reform in the DH sector. National and energy The GoB’s Strategy for Energy Potential Development sets national targets for the energy sector programs sector up until 2020. The overall objective of the strategy is to ensure Belarus’s energy inde- outline specific invest- pendence and promote the efficient use of energy resources. The GoB targets relevant to the ments and targets for DH sector include: the DH sector, § Increasing the share of domestic fuel in the energy mix to 28–30 percent by 2015 and 32–34 percent by 2020 from 17 percent in 2010, thus reducing dependence on imported natural gas, § Reducing the share of natural gas in the energy balance to 64 percent in 2015 and to 55 percent by 2020, § Reducing the energy intensity of GDP by 50 percent by 2015 and 60 percent by 2020 (from 2005 levels), § Phasing out subsidies and cross-subsidies, and § Restructuring heat tariffs. In line with this strategy, the GoB has enacted a number of DH sector-specific policies and laws described below. …such as increasing One of Belarus’s richest natural resources is its forests, which cover 40 percent of the coun- the use of biomass in try. The GoB intends to increase the share of electricity and thermal energy generated from heat generation, biomass to 14–15 percent so that, by 2020, at least 32 percent of the fuel used in boilers comes from locally sourced fuels.1 …increasing cost- The GoB has also set national cost-recovery targets for the residential DH operations of recovery levels in the Belenergo, a major heat provider in Belarus. Belenergo is expected to achieve 30 percent DH sector, cost-recovery levels in its residential heating operations by 2015. In 2012, Belenergo’s cost-recovery level for residential heat services was only 17.2 percent. Table 1.1 summarizes national cost-recovery targets for the DH sector. 1. National Program of Local and Renewable Energy Sources Development for 2011–2015. 3 4 Heat Tariff Reform and Social Impact Mitigation Table 1.1: National Cost-Recovery-Level Targets for Residential Heat and Electricity Services of BelEnergo 2011 2012 2013 2014 2015 (actual) (actual) Cost recovery rate for heat (distributed by Belenergo 21.4 17.2 18.7 21 30 suppliers, %) Prime cost of 1 Gcal of heat, BYR/Gcal 202,185.50 329,273.90 359.649.60 406,217.80 453.138.40 Source: State Program on the Energy Sector Development by 2016. …improving supply At the municipal level, the GoB has enacted the Program for Housing and Utilities of the side energy efficiency, Republic of Belarus 2015, which aims to reduce heat losses by 6.7 percent in the heat net- work by 2016 by replacing old and inefficient heat network, introducing more energy-effi- cient generation facilities, reducing subsidies and cross-subsidies, and increasing the use of local fuels. … and restructuring From an organizational standpoint, the GoB also plans to centralize the DH sector, trans- the DH sector. ferring municipal ownership to national ownership under Belenergo to extract efficiency gains.2 Specific legislation More recently, to simplify the system of cross-subsidies between the electricity and DH sec- phases out subsidies tors and between residential and industrial customers, the GoB has phased out preferential and cross-subsidies heat tariffs for legal entities and individual entrepreneurs and is gradually increasing resi- dential tariffs each financial quarter. These increases are indexed by the growth of house- hold income, which does not exceed the growth of nominal wages. However, tariff increases for all energy utilities cannot increase by more than 5 USD per year without approval from the president (Decree 550). As a mitigation measure, households in urban areas whose income on utilities exceeds 20 percent and those in rural areas whose income exceeds 15 percent will receive social assistance. Appendix A provides an overview of the DH sector in Belarus. 2. Heat Supply Development Concept for the Period until 2020. 2 why is tariff reform necessary? Residential tariffs for DH are well below the cost of service in Belarus. Since 2003, production costs have risen sharply while the cost-recovery levels of residential heat service have dropped by 50 percent. Incremental increases in residential tariffs have been eroded by inflation and depreciation of the Belarusian ruble to the US dollar. Even if tariffs were increased by 5 USD per year, the limit before presidential approval is necessary, they would not meet the 30 percent cost-recovery target set by the GoB. A system of subsidies and cross-subsidies between customer classes and between the electricity and the DH sectors have resulted in an increasing fiscal burden, which worsens as the cost of service continues to increase. Residential tariffs are Residential tariffs are currently at roughly 10 to 21 percent of cost-recovery levels. The well below the cost of range depends on factors that include the size of the DH system, fuel used, efficiency of pro- service duction, condition of the networks, and technical characteristics of the customer connec- tion. Figure 2.1 shows how the cost-recovery levels of residential heat service have changed over time in Belarus. Figure 2.1: Declining Cost-Recovery Levels of Residential Heat Service 80 Residential heat cost recovery rate (%) 70 60 50 40 30 20 10 0 2005 2006 2007 2008 2009 2010 2011 2012 Belenergo ZhKH Source: Ministry of Energy, Ministry of Housing and Utilities. Note: Belenergo and ZhKH are the two major DH providers in Belarus. See Appendix 1 for a background of the Belarusian DH sector. 5 6 Heat Tariff Reform and Social Impact Mitigation Costs faced by suppliers of heating have risen substantially in recent years and are higher than the “economically efficient” level assessed by the Council of Ministers.3 The cost of fuel for use in combined heat and power plants and boilers is the most significant cost faced by suppliers, not least because it is paid in US dollars. The price of importing natural gas from Russia has increased sharply in the past decade, from USD47/tcm in 2005 to USD263/tcm in 2011. Over the same period, the value of the ruble has fallen considerably. This is offset only slightly by the reduction in technical losses in the transmission and distribution sys- tems—currently 16.3 percent for ZhKH and 10 percent for Belenergo. Figure 2.2 shows the rapid increase in the price of natural gas imports since 2005. The import price of natural gas accounts for roughly 60 percent of total heat production costs. The cost of heat production and distribution by ZhKH is thought to be about double that of Belenergo. Contributing factors are (i) economies of scale (Belenergo serves customers in Minsk city and the oblast capitals while ZhKH serves customers in smaller towns and rural areas), (ii) Belenergo’s use of efficient combined heat and power plants (in contrast to the use of heat-only boilers by ZhKH), and (iii) the higher transmission and distribution losses in the ZhKH systems as a result of aging ZhKH assets. Figure 2.3 shows the increase in production costs for ZhKH and Belenergo, as compared to the increase in tariffs. Figure 2.2: Import Prices of Russian Natural Gas Has Sharply Increased 500 1,400 000 BRY/TCM, constant 2007 prices USD/TCM, constant 2007 prices 450 1,200 400 350 1,000 300 800 250 200 600 150 400 100 200 50 0 0 2005 2006 2007 2008 2009 2010 2011 2012 NG border prices, left axis, USD/TCM NG import prices, right axis, 000 BYR/TCM Source: Ministry of Energy, OECD. 3. The Council of Ministers makes a resolution on a quarterly basis establishing the subsidized residential heating and hot wa- ter tariff. The most recent, N 1166, set the tariff at 80,570 BYR per Gcal against an ”economically justifiable” tariff of 300,000 BYR per Gcal. No information is publicly available on the methodology applied for determining the economically justifiable tariff, but it is thought to be a tariff that reflects the actual costs of heat production and delivery. why is tariff reform necessary? 7 Figure 2.3: Comparison of Tariffs and Production Costs of ZhKHs and Belenergo ZhKH Belenergo 350 180 Constant BYR 2007, (thousand), per Gcal Constant BYR 2007, (thousand), per Gcal 160 300 140 250 120 200 100 150 80 60 100 40 50 20 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 Average-weighted heat tariffs Residential Non-residential Cost of heat production Source: Ministry of Energy, Ministry of Housing and Utilities. Cross-subsidies are In order to cover costs in an environment where household tariffs are con- used to fill most of strained, Belenergo and ZhKH have needed to make up the loss from supplying the gap between residential heat consumers from other sources. Belenergo, which on average residential tariffs and achieves 17.2 percent cost recovery from residential heat consumers, does not actual cost. receive state subsidies and so must make up the entire shortfall by cross-sub- sidization.4 As a result, Belenergo’s non-residential energy consumers, mostly nonresidential electricity consumers, pay tariffs that are substantially above cost in order to keep heating prices low for residential consumers. Figure 2.4 compares industrial electricity tariffs with the cost-of-service of industrial elec- tricity since 2005. It shows that Belenergo’s industrial customers are paying a 50 percent premium on electricity to support underpriced residential heat. The situation for ZhKH, whose cost recovery from residential heat sales is about 10 percent, is similar, except that ZhKH have compensated for the falling value of residential revenue with substantial increases in state subsidies, together with cross-subsidization from nonresidential consumers (Figure 2.5). 4. Resolution 220 mandates cross-subsidization between types of utility service and between customer classes to recover costs. 8 Heat Tariff Reform and Social Impact Mitigation Figure 2.4: Belenergo Industrial Electricity Tariffs as a Percentage of Cost of Service 16 180 14 160 12 140 120 10 US cents/kWh 100 Percent 8 80 6 60 4 40 2 20 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Industrial electricity tariff, right axis Price/cost of service, left axis 100% cost recovery, left axis Source: Ministry of Economy. Figure 2.5: Use of Cross-Subsidies (CS) from Belenergo’s Non-Residential Electricity Sales to Finance Residential Heat 2.00 Cross- and direct budgetary subsidies 1.80 1.60 1.40 (% of GDP) 1.20 1.00 0.80 0.60 0.40 0.20 0.00 2005 2006 2007 2008 2009 2010 2011 2012 CS from non-residential electricity sales (Belenergo) CS from non-residential heat sales (ZhKH) CS from non-heat sales (ZhKH) Direct subsidy from local govt (to ZhKH) Source: Ministry of Finance, Belenergo, ZhKH, Beltopgas, and World Bank staff estimates. Cross-subsidies By charging higher tariffs to nonresidential customers, cross-subsidies also impose an undermine the implicit tax on industries and could undercut the competitiveness of the economy. If indus- competitiveness of trial electricity tariffs are reduced to cost-recovery levels at about US 9.25 cents/kWh, the industries… energy cost of manufacturing in Belarus could be reduced by roughly 24 percent, making it a lower-cost producer than the EU average. Figure 2.6 compares the unit energy cost per US dollar of industrial value added with and without cross-subsidies with those of its neighboring countries. Appendix B details a sector- by-sector analysis of potential gains if nonresidential electricity prices dropped to cost-recovery levels. why is tariff reform necessary? 9 Figure 2.6: Comparative Energy Costs—Where Belarus Stands 0.8 Unit energy cost of manufacturing ($/manufacturing value added) 0.7 0.6 0.5 0.4 0.3 Average of EU countries 0.2 0.1 0 Ky Se ia Es nia M ux ak ia eo ou . ni rg Ge FYR yz a Bu stan La ia Fi via Tu nd Ru ol key ia va m d. rtu a Be gal Po rus hu d ed a Be en ov s Sp ia n Au ly lg a ite Hu ium ng ry m ba y Fr n Ir ce nm d k ed mb p Sl laru ar er an rg rbi Po ani Sw ni Be stri ai ija Lit lan De elan g Ita ov an ar en Ro Fe ac e Re Ki a Ge do an ss do a t or a to la d ng r Az rm lg nl Sl Alb a, n M L Un At current electricity and gas prices At cost-recovery electricity and current gas prices Source: Calculation based on IEA World Energy Statistics and Balances , ERRA Tariff , Eurostat and UNIDO Industrial Statistics Databases. Note: Calculation is based on 2009 Data. … and increase prices Since electricity is required to produce and distribute goods from all sectors in an economy, of consumer goods an implicit tax on industrial electricity use will likely impact the price of nearly all goods and services and services. To the extent possible, firms facing an electricity tax will pass the tax burden on to consumers or other firms in the form of higher output prices. Based on an input-output analysis, Figure 2.7 shows the increase in output prices across con- sumer expenditure categories as a result of the current high tax rates on industrial electricity use. The impacts range from a 1 percent increase in the output price in the banking and finance sector to an almost 3 percent increase in the output price for household articles. For food and beverages, the sector with the largest share of total expenditures for most house- holds (Figure 2.8), output prices increased by roughly 2 percent. Appendix C describes the methodology for analyzing the distribution impacts of energy cross-subsidization in Belarus. Figure 2.7: Increase in Output Prices Due to Implicit Electricity Tax Levied on Industrial Consumers 3.0 2.5 Percent 2.0 1.5 1.0 0.5 0.0 ce ra nd tio n/ g ng s s e n an le ice r in io ica tio ca ve a hi tic ge n us at fin rv be ood th un ta ot ar uc Ho se g/ m or al Cl HH Ed F He in m sp nd nk co an sa Ba Tr od Go Source: Estimate based on HBS2009 and Belarusian Input-output Table 2009. 10 Heat Tariff Reform and Social Impact Mitigation Based on the household consumption patterns shown in Figure 2.8, Figure 2.9 shows how the tax burden is distributed across different income groups. Every income group would see a cost increase on key consumption goods, such as food, clothing, and household articles. The extra expenditure in absolute terms is the highest for households in the top income decile, but the impact appears to be modestly regressive, as the percent of expenditures increased is slightly higher for lower-income households. Figure 2.8: Expenditure Shares by Consumption Category and Income Decile Decile 1 Decile 6 0.5 Decile 2 Decile 7 0.45 0.4 Decile 3 Decile 8 0.35 Decile 4 Decile 9 0.3 0.25 Decile 5 Decile 10 0.2 0.15 0.1 0.05 0 tio n/ od o re g y s ng s s n re ce el le ice cit cc io in ica tio tu ca an Fo hi fu tic n at us ba tri rv ul th un ta ot fin ar uc g Ho ec se to ric m or al in Cl g/ Ed HH El He m sp nd Ag at nd in he co ran sa la nk d ho od Ba T an co Go at Al He Source: Estimate based on HBS2009 and Belarusian Input-output Table 2009. Figure 2.9: Extra Expenditures from Imposing Implicit Tax on Industrial Consumers 100,000 1.94 90,000 1.93 80,000 70,000 1.92 60,000 Percent 1.91 50,000 40,000 1.90 30,000 1.89 20,000 1.88 10,000 0 1.87 1 2 3 4 5 6 7 8 9 10 e e e e e e e e e cil cil cil cil cil cil cil cil cil e cil De De De De De De De De De De Extra expenditures Percent of extra expenditures Source: Estimate based on HBS2009 and Belarusian Input-output Table 2009. why is tariff reform necessary? 11 … while creating a The direct and cross-subsidies have imposed rapidly increasing fiscal and quasi-fiscal costs. growing fiscal burden, As a result of declining cost recovery rates, both ZhKH and Belenergo incurred growing and significant fiscal operational losses in the residential DH business. The total fiscal and quasi-fiscal costs, risks and macroeco- measured by the cumulative operating losses on residential DH services provided by both nomic vulnerabilities Belenergo and ZhKH, have risen from about 0.7 percent of GDP in 2005 to about 1.6 per- cent in 2012. Of this, ZhKH accounts for about 40 percent and Belenergo for the remainder. Figure 2.5 shows the cost of heat subsidies as a percentage of GDP. Underpriced residential utility tariffs also create significant fiscal risks and macroecnomic vulnerabilities. Because Belarus continues to benefit from subsidized import prices for gas (less than half of the economic price imputed from the European gas price), current finan- cial imbalances in the utility sector -while fiscally costly and harmful in terms of energy effi- ciency- have had a limited macroeconomic impact. However, the lack of tariff adjustments and low cost recovery of utility tariffs create significant risks. In case of price hikes for gas imports the existing imbalances would amplify and likely induce fiscal and macroeconomic instability. At current tariff and consumption levels, financial losses in the district heating sector could more than double if Belarus were to import gas at market prices, imposing a significant fiscal and macroeconomic risk. …and are highly Although heat subsidies are expensive, they are poorly targeted and regressive; wealthy regressive and unfair households benefit more than poor households from the subsidies. Rather than identifying to poor customers the poorest households and allocating subsidies accordingly, they are given to all residential consumers regardless of income level. Because higher income households tend to occupy larger living areas which require more energy for heating purposes, they receive a larger por- tion of overall heat subsidies: the top two income quintiles receive 42.1 percent of the overall heat subsidy, while the lowest two quintiles receive only 24 percent. Poor households and those in rural areas also receive a smaller portion of the heat subsidies: 3.5 percent to the poor and 10.4 percent to rural households. Figure 2.10 shows the distribution of heat subsidies. Figure 2.10: Distribution of Heat Subsidies 90 80 78.6 71.7 70 60 Percent 50 40 30 23.5 22.1 20 18.6 14.1 15.9 9.9 10.0 11.2 12.3 10.1 10.4 9.5 7.0 10 3.5 0 Q1 Q2 Q3 Q4 Q5 or or t sk el no ity st v an l ra es ile la m ba po Po kC b Ru od Br Ob og Go Ur te n- Gr s M in Vi No sk M in M Source: World Bank Staff Estimates. 3 What Is the Likely Impact of Tariff Reform? The impact of tariff The impact of tariff reform depends on how the GoB decides to implement it. To be consis- reform depends on tent with the government’s vision to gradually phase out heat subsidies, this report explores how it is implemented three tariff increase scenarios in the medium to long term: one under a differentiated pric- ing regime (where customers of Belenergo and ZhKH are charged different tariffs) and two under a uniform pricing regime (where all customers are charged the same tariff). Table 3.1: Tariff Reform Options 2015–2020 describes the three tariff reform options and cost-re- covery targets for 2015, 2017, and 2020. The financial burden Because 61 percent of households, 81 percent in urban and 14 percent in rural areas, are on households will connected to the DH network in Belarus, a tariff increase will have a profound impact on increase, many households. …and the poor will Specifically, increasing tariffs to 60 percent and full cost-recovery levels will significantly suffer the most reduce the affordability of DH for households in the poorest quintile. At full cost-recovery levels under the uniform price scenario, 30 percent of households in the poorest quintile living in urban areas would spend more than 20 percent of their income on heating com- pared to 0.2 percent under the 2012 price. Under the differentiated price scenario, 12 per- cent of households in the poorest quintile living in rural areas would spend more than 15 percent of their income on heating. Figure 3.1 shows the impact of tariff increases under different price scenarios by income group. Table 3.1: Tariff Reform Options, 2015–2020 2015 2017 2020 Goal Pricing Goal Pricing Goal Pricing Scenario I 30% cost recovery Uniform 60% cost recovery Differentiated 100% cost recovery Differentiated Scenario II 30% cost recovery Uniform 60% cost recovery Uniform 100% cost recovery Uniform Scenario III 30% cost recovery Uniform 45% cost recovery Uniform 60% cost recovery Uniform 13 14 Heat Tariff Reform and Social Impact Mitigation Figure 3.1: Affordability at Different Cost-Recovery Levels by Income Group and Price Scenario Percent of Urban HHs Spending more than 20% Percent of Rural HHs Spending more than 15% of Annual Income on DH of Annual Income on DH 35 (uniform price scenario) 14 (differentiated price scenario) 30 12 25 10 20 8 Percent Percent 15 6 10 4 5 2 0 0 Current 30% cost 45% cost 60% cost 100% cost Current 30% cost 45% cost 60% cost 100% cost 2012 recovery recovery recovery recovery 2012 recovery recovery recovery recovery Bottom 20% 2nd quintile 3rd quintile 4th quintile Top 20% Source: Simulation based on Household Budget Survey (HBS) 2012. …in both rural and The results are somewhat different for rural and urban customers depending on whether a urban areas differentiated or uniform pricing regime is adopted. Rural poor households in the poorest quintile that rely on DH services for heating are most vulnerable under the differentiated pricing scenario and are expected to spend 23 percent of their income on DH at full cost-re- covery levels. This is because the cost of DH service provided by ZhKH is about double that of Belenergo’s. ZhKH needs to raise tariffs to a much higher level in order to reach the targeted cost-recovery rate. In contrast, the urban DH consumers in the poorest quintile will be most heavily affected under the uniform pricing scenario. They are expected to spend 21 percent of their incomes on DH services at full cost-recovery levels. On average, urban households spent more than rural households on DH, possibly because rural households are more likely to use and have access to substitutes such as wood, peat, and coal. Figure 3.2 and 3.3 show affordability lev- els of DH services for households who are connected to DH under various pricing scenarios by income group and settlement type. What Is the Likely Impact of Tariff Reform? 15 Figure 3.2: Vulnerability of Different Populations Under a Uniform Pricing Regime 25 Share of income on DH (%) 20 (uniform pricing) 15 10 5 0 Rural Urban Rural Urban Rural Urban Rural Urban Rural Urban Bottom 20% 2nd quintile 3rd quintile 4th quintile Top 20% 2012 price 30% cost recovery 45% cost recovery 60% cost recovery 100% cost recovery Source: Simulation based on HBS2012. Figure 3.3: Vulnerability of Different Populations Under a Differentiated Pricing Regime 25 20 Share of income on DH (%) (differentiated pricing) 15 10 5 0 Rural Urban Rural Urban Rural Urban Rural Urban Rural Urban Bottom 20% 2nd quintile 3rd quintile 4th quintile Top 20% 2012 price 30% cost recovery 45% cost recovery 60% cost recovery 100% cost recovery Source: Simulation based on HBS2012. 16 Heat Tariff Reform and Social Impact Mitigation …during the coldest The impact of higher heating tariffs will be most acutely felt in winter. The heating season in times of the year, Belarus normally begins in October and ends in April. Accordingly, household expenditure on heat tariffs spikes in the first and last quarter of the year. In 2012, households that were connected to DH spent, on average, 1.5 percent of their monthly income on DH services in the fourth quarter and 4.5 percent in the first quarter. At full cost recovery levels, urban households in the bottom 40 percent income group, under the uniform price scenario, will spend approximately 23 percent of income on DH services in the first quarter; rural house- holds in the bottom 40 percent, under the differentiated price scenario, will spend 21 per- cent. Figure 3.4 shows the impact of tariff reform by price scenario, location, and time of year on households in the lowest two quintiles. In addition to added heating expenses in winter months, fruits and vegetables are more expensive; and electricity bills also go up due to shorter daylight time. Finally, penalties for delay in paying utility bills are more likely to occur in winter months. All of these have made the financial situation of low-income households most stressful during the winter season. To cope with a heat tariff increase, poor households are more likely to cut back on con- …and they are forced sumption of food and clothes than on heat. In focus group discussions, 90 percent of the to cut expenditure on participants from poor households without social benefits, 67 percent of those from poor other essential goods. households with social benefits, and 53 percent of those from middle income households said they would reduce food expenditures to cope with a tariff increase. Figure 3.5 describes various coping strategies indicated by focus group participants in case of an increase. Appendix D details the methodology and scope of focus group discussion. The majority of buildings (92 percent) in Belarus are not equipped with apartment-level meters and heat regulators. Participants in the focus group also complained about their inability to control heating costs. In case of overheating, householders prefer to open windows rather than report to service providers, in order to avoid conflict with neighbors What Is the Likely Impact of Tariff Reform? 17 Figure 3.4: Impacts of Tariff Increases: Highest in Q1 and Q4 Uniform Price, Urban Households Differentiated Price, Rural Households 60 60 50 Average quarterly income Average quarterly income 50 40 40 on DH (%) on DH (%) 30 30 20 20 10 10 0 0 1 2 1 2 1 2 1 2 1 2 1 2 1 2 1 2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2012 price 30% cost recovery 45% cost recovery 60% cost recovery 100% cost recovery Source: Simulation based on HBS2012. Note: The number 1 below each graph refers to the HHs in the bottom 20% income quintile; the number 2 refers to the HHs in the 2nd income quintile; Q1-Q4 refers to quarters 1 – 4. Figure 3.5: Coping Strategies in Response to Tariff Increases 90 Cutting down expenditures on food 67 52 83 Cutting down expenditures on clothes 61 23 67 Receiving help (as gift) from relatives and friends 18 11 37 Borrowing money from friends and relatives 25 5 10 Additional job 8 16 30 Farmland, dacha 16 14 23 Delays and non-payments 6 0 0 10 20 30 40 50 60 70 80 90 100 Percent Poor with social benefits (n=30) Poor without social benefits (n=51) Middle-income households (n=44) Source: Focus group discussions February – March, 2014. 18 Heat Tariff Reform and Social Impact Mitigation Women are expected Tariff increases are expected to have a more pronounced impact on women than men as to be more vulnerable they are typically paid less and have fewer job employment opportunities. Moreover, single to tariff increases. parent families are more often headed by women, including single female pensioners, and women with young children often have difficulty finding part-time work. In the first quar- ter of 2012, 62 percent of women were employed compared to 69 percent of men. In 2011, women in Belarus earned 26.3 percent less than men. In addition, focus group discussion reveals that there are noticeable gender differences in coping strategies. While men report they would work more or change jobs in response to higher utility payments, women are more likely to reduce their expenditures on food or to seek help from relatives and friends. Women are generally more sensitive about potential tariff increases and report strong insecurity about their future well-being in case of tariff increases. On the other hand, On the positive side, the proposed tariff increase would generate large fiscal savings and tariff increases will utility revenues. It is expected that, with the increase in tariffs to the full cost-recovery level, generate fiscal savings the total fiscal savings will amount to 1.6 percent of GDP by 2020. Tariff reform under the and utility revenues differentiated pricing scenario will also make Belenergo heat sales profitable, allowing for more investments in new infrastructure and energy efficiency measures. Figure 3.6 shows the fiscal savings from each pricing scenario. …while lower Lowering cross-subsidies would also open fiscal space to allow for reductions in electricity cross-subsidies will tariffs for nonresidential consumers. If nonresidential electricity prices are decreased to the improve industry level of cost of service, the average unit energy cost of manufacturing could decrease by about competitiveness. 24 percent. The wood, textile, food, and paper industries, which have some of the lowest export share in output (Figure 3.7), would benefit the most because they use more energy to Figure 3.6: Fiscal Savings Generated from Uniform and Differentiated Price Scenarios Scenario 1: 100% Cost Recovery Scenario 2: 100% Cost Recovery Scenario 3: 60% Cost Recovery in 2020,Differentiated Pricing in 2020, Uniform Pricing in 2020, Uniform Pricing 1.80 1.80 1.00 1.60 1.60 0.90 0.22 0.12 1.40 0.80 0.37 1.40 0.15 0.08 0.70 1.20 1.20 Percent of GDP Percent of GDP Percent of GDP 0.24 0.60 1.00 1.00 0.08 0.50 0.05 0.80 0.80 0.12 0.21 0.08 0.40 0.60 0.14 0.60 1.25 0.68 0.30 0.04 0.98 0.03 0.40 0.40 0.20 0.47 0.04 0.04 0.68 0.03 0.51 0.03 0.20 0.20 0.10 0.25 0.25 0.25 0.00 0.00 0.00 2015 2017 2020 2015 2017 2020 2015 2017 2020 Fiscal savings LG budget subsidy Fiscal savings CS ZhKH Fiscal savings CS Belenergo Source: World Bank Staff Estimate. What Is the Likely Impact of Tariff Reform? 19 Figure 3.7: Shares of Exports of Different Sectors 80 73 75 70 60 Share of export in total output (%) 46 47 50 39 39 40 29 30 23 20 16 10 0 l lp o el d er t ry s ica en al cc oo e ne pu th er em st m ba w a hi in nd d le ip to ch d ac m an qu d an ra tro M d an lic n te an pe d Iro al pe ile oo or Pa od et xt nd sp W m Fo Te an n- la no Tr ica em Ch Source: Belarus Foreign Trade Database, 2009 data. produce one dollar of manufacturing value added and use more electricity (rather than gas) for production than other sectors. The energy cost of manufacturing for the four industries would be reduced by between 25 and 28 percent after the removal of cross-subsidies. Appendices E and F describe common methodologies used for allocating costs between Heat and Electricity in Combined Heat and Power Plants, and an overview of DH tariff setting methodologies in western European countries, respectively. 4 How Can tariff reform Best Be Implemented? How can the reform How can the proposed tariff reform be implemented so that it is socially acceptable and fis- best be implemented? cally beneficial and does not impose undue hardship on poor and vulnerable households? We recommend the following three approaches: 1. Enhancing customer communications and engagement 2. Improving social protection mechanisms, and 3. Encouraging investments in supply and demand-side energy efficiency The paragraphs below describe each of the approaches in more detail. The sequence of the reforms is important to its success. Promoting customer understanding and winning trust is a critical first step which can then run in parallel with the medium to long-term efforts to improve social protection mechanisms and encourage investment in energy efficiency.5 1. Improve communi- Focus group discussion and stakeholder analysis reveal that there is limited support for tar- cation and consumer iff reform among residential consumers because of their lack of knowledge and awareness engagement by of tariff setting and reform processes. The lack of information has been identified as one of the most aggravating factors for residential consumers as they often learn about tariff increases only after receiving the bill. Infrequent and insufficient interaction between DH providers and the customer base has also contributed to consumers’ lack of trust in service providers, which further undermines support for reform. The key to increasing public acceptance of DH tariff increases is devel- oping a comprehensive communication and consumer engagement strategy that fosters a culture of inclusion, along with a public awareness campaign explaining the need for reform. Focus group discussions reveal that the public is more likely to support a tariff increase if there are corresponding increases in wages and other benefits (such as pensions and social assistance), an upgrade in DH service (utilization of new technologies and modernization of equipment), greater transparency from service providers reflected in clearer bills, and introduction of individual metering and heat controls. 5. Appendix F provides examples of how DH reform has been implemented in neighboring countries. 21 22 Heat Tariff Reform and Social Impact Mitigation …developing a com- Communication strategies should address the public’s concerns by explaining the ratio- prehensive communi- nale for a tariff increase, the government’s plans for protecting the poor, and the means by cation strategy and which it will improve the transparency and accountability of the DH sector. Similar efforts in the neighboring former Soviet Union countries present useful examples of a reform strategy in which communication was the key to reform implementation (Appendix G). Communication efforts should also focus on motivating people to save energy and gaining public support for the development and upgrading of the energy system. Communication activities should involve all key government institutions (at both national and local level) and utilities in a systematic manner and target consumers at the regional, city, district and village level. This would require a national agency to coordinate various ministries and agencies to develop guidelines on the best methods of interacting with dif- ferent consumer groups. Messages from various organizations should be consistent and complementary, rather than contradictory. The national agency could offer such ready- made messages to communicate with the public. Public information products, such as social advertisements, posters, leaflets, and brochures should be developed at the national level. This is more cost effective than doing it locally and ensures that the public hears a “single voice”. The consumers’ most preferred channels of communication for information on utility services are utility bills, national and local mass-media, tenants meetings, hotlines, information boards, and internet. Appendix H offers recommendations for specific measures to improve public outreach about heat tariff reform. …improving con- Residential consumers’ engagement in policy debates and decision-making could also con- sumer engagement tribute to a culture of shared responsibility in the governance process while providing use- and the governance of ful feedback on the reform. Such measures would make people feel they are owners of the utility services. reform and share responsibility for its outcome. Since public sentiment reflects a sense of exclusion from the policy debate, various strategies could be applied to address this issue. For example, people could be invited to comment on the reform process through feed- back mechanisms, such as public surveys and online consultations. Institutional arrange- ments could be made to ensure citizen’s feedback is processed, analyzed, and factored into decision-making. Communication campaigns and consumer engagement efforts should particularly target women as focus group discussions reveal that women are more involved than men in man- aging utility bills and interacting with service providers regarding the quality of services. Providing more and better information and feedback mechanisms would also help improve the transparence and accountability of utilities and address consumers’ key concerns. In addition, consumer monitoring mechanisms could be established by introducing perfor- mance benchmarks and key performance indicators, such as fuel efficiency and the cost of production. 2. Improve social pro- The existing social protection mechanisms in Belarus are not well suited to protecting poor tection mechanisms by and vulnerable groups if tariff reforms are implemented. This is because most of the social How Can tariff reform Best Be Implemented? 23 protection benefits are categorical, poorly targeted, and inadequate. Appendix I provides a review of existing social protection programs in Belarus. The only income-tested program is the Public Targeted Social Assistance Program (GASP), which provides short-term (6 months of the year) income support to financially distressed families. It remains tiny: in 2012, its maximum coverage was 2.8 percent of population; its budget was 0.08 percent of GDP. The government has considered reintroducing the Housing and Utility (H&U) Subsidies Program that existed until 2009. The program provides social assistance to house- holds whose housing and utility expenses exceed 15 of their income (in rural areas) and 20 percent (in urban areas). However, the scheme does not account for income disparities and therefore is not sufficient to protect the poor. There are two ways in which the targeting and coverage of social protection mechanisms could be improved to mitigate the adverse impact of tariff increases on the poorest 20 per- cent of the population: a. Expanding or topping-up GASP, and/or b. Refining the H&U program In addition, introducing levelized payment plans presents another cost-effective strategy to help households manage the seasonality of utility expenses. …linking mitiga- The first option to mitigate the impact of tariff reform is to expand or restructure (top-up) tion measures to the existing poverty-targeted cash transfers program, GASP. To reach the target coverage the existing transfer of the poorest 20 percent, GASP would need to be expanded 10 times, and the income program… threshold greatly raised to allow more households to qualify for the benefit. As a result, the program budget would considerably increase to reach as much as 1 percent of GDP in 2015 and stay high in the following years. On the other hand, the program would yield a high reduction in poverty: the poverty rate among the poorest 10 percent would drop twofold after the transfer (Table 4.1). To reduce the program’s cost, GASP may be augmented by a supplemental flat benefit. The supplement would be paid on top of the regular GASP benefit received by those who pass the income threshold. Such a flat benefit could also be offered to other households affected by the tariff increase with incomes above the regular GASP threshold but below a separate threshold established specifically for the top-up. Given the low coverage of GASP, however, such a supplemental benefit would significantly exceed the “base” benefit program and would look more like a separate program. In addi- tion, the current restrictive eligibility criteria in GASP may impede households in the 2nd decile from getting the top-up benefit, even with a higher income threshold. Therefore, it would be important to combine the supplemental benefit with some expansion of GASP, including reconsidering GASP’s ability to be more inclusive without compromising on the targeting accuracy of the benefits. 24 Heat Tariff Reform and Social Impact Mitigation Table 4.1: Poverty Impact of GASP and H&U Benefits     Total Population 1st Decile 2nd Decile     2015 2017 2015 2017 2015 2017 Before transfers 1.8 4.3 18.2 42.4 0 0 Expand GASP 0.9 2.1 8.6 20.6 0 0 National poverty line Top up GASP 0.8 1.6 8.02 15.91 0 0 Old H&U benefit 1.8 4.1 18.1 41.4 0 0 Refined H&U benefit 1.8 3.9 17.5 38.9 0 0     Total Population  1st Decile 2nd Decile     2015 2017 2015 2017 2015 2017 Before transfers 1.1 5.9 5.3 18.9 1.4 7.7 Expand GASP 0.8 4.1 3.1 8.3 0.9 3.8 Incidence of households with H&U costs Top up GASP 0.5 3.5 0.8 2.5 0.6 1.9 above 15% of total incomes per year Old H&U benefit 1 4.9 4.9 16 1.4 6.1 Refined H&U benefit 0.5 3.5 0.7 1.3 0.5 3.9 Source: Simulation based on HBS 2012. Note: National poverty line in November 2012: BYR 880030 per capita per month. Welfare indicator: total income per capita. At lower cost, the GASP top-up option would have a poverty impact comparable to its expansion scenario and would be more efficient. Table 4.2 summarizes the simulation results under a scenario when the regular GASP benefit is expanded to cover the first decile while the supplemental flat energy benefit is provided to the population in the second decile. This way, the entire program ensures the target coverage of the bottom 20 percent population but incurs half the cost (0.5 percent of GDP) of the GASP expansion scenario. It achieves a similar poverty reduction impact with better targeting accuracy. Several other considerations should be taken into account for GASP adjustment. First, the eligibility rules would need to be revisited to allow quick response and inclusion of more households. Second, according to stakeholder analysis and focus group discussions, the GASP program is associated with the stigma of poverty. The program would need to be rebranded to improve its image. Third, the current 6-month payment period of GASP lim- its the program’s efficiency. The payment period for benefits and/or top-ups should be 12 months for the time of the tariff reform or be specifically linked to the heating season. Fourth, administration of the benefits is fully handled at the local level with local authorities determining the eligibility and paying the benefits from their budget. This means that the budget pressure on poorer regions would be higher as the demand for benefits would be higher there. Furthermore, in their combined roles of checker and payer, the local author- ities could restrict access to the benefits to offset increased spending. To mitigate this risk, the central budget may guarantee additional transfer for the regions in case the demand exceeds available budget resources. Finally, the oversight and control functions should be strengthened to mitigate the risk of system abuse by both providers and beneficiaries. How Can tariff reform Best Be Implemented? 25 Table 4.2: Benefit Coverage, Targeting Accuracy and Fiscal Cost of GASP and H&U Benefits Budget per Year, Benefit Coverage Targeting Accuracy % GDP 2015 2017 2015 2017 2015 2017 Expand GASP (20% of population) 1st decile 52 51 42 41 0.43 0.36 2nd decile 48 52 21 24 0.22 0.22 3rd-10th deciles 12 12 37 35 0.38 0.31 Total 20 20 100 100 1.03 0.89 Expand GASP (10% of population)+ Top up GASP (10% of population) 1st decile 100 100 59 59 0.26 0.25 2nd decile 81 83 20 23 0.09 0.1 3rd-10th deciles 2 2 21 18 0.09 0.08 Total 20 20 100 100 0.44 0.43 Old H&U benefit 1st decile 5 21 48 25 0.002 0.01 2nd decile 1 10 15 12 0.001 0.01 3rd-10th deciles 1 5 37 63 0.002 0.03 Total 1 7 100 100 0.005 0.05 Refined H&U benefit 1st decile 27 61 84 60 0.012 0.04 2nd decile 3 18 12 16 0.002 0.01 3rd-10th deciles 0 3 5 25 0.001 0.02 Total 3 10 100 100 0.014 0.07 Source: Simulation based on HBS 2012. …re-introducing the The H&U subsidy program was phased out in 2009. Some advantages to re-introducing the H&U subsidy benefit, H&U subsidy include public familiarity with the program and its specificity to energy tar- or iffs. Furthermore, if reintroduced, the GoB will be able to learn from past lessons to create a more efficient and streamlined program. However, the design of the program does not differentiate consumption patterns and income levels of households. Therefore an import- ant drawback of this program is that it does not provide any support to a large share of gen- uinely poor households who use alternative fuels for heating or who are too poor to afford to spend 15 or 20 percent of their income on heating. Empirical evidence suggests that this type of programs is also quite regressive, with the majority of the benefits going to middle and upper income households. To improve the coverage of the poor with H&U benefits, households may be compensated for a share of the heating bill based on their per capita income. Such a refined formula would use an income-test to determine eligibility and to differentiate benefit payments based on income levels. For example: • Households from the 1st and 2nd deciles would be compensated for the expense above 10 and 15 percent of their income, respectively 26 Heat Tariff Reform and Social Impact Mitigation • Households from the 2nd and 3rd quintiles would be compensated for the expense above 20 percent of their income. The simulation results presented in Table 4.2 suggest that the refined H&U benefit would cover more households in the lowest deciles as compared to the “old” benefit (84 and 60 percent vs 48 and 25 percent in 2015 and 2017, respectively) and fewer funds would be leaked to better-off households (5 and 25 percent vs 37 and 63 percent of benefits going beyond the bottom quintile in 2015 and 2017, respectively). Spending for the refined ben- efit would be higher in 2015 but still remain at a sustainable level of 0.014 percent of GDP; in 2017 the two programs would require a similar budget. The refined H&U benefit would significantly reduce the incidence of households with high H&U related costs (H&U expenses above 15 percent of annual income) among those belonging to the bottom decile (from 18.9 to 1.3 percent in 2017). In comparison, the “old” H&U benefit would only reduce the percentage of households in the bottom decile who spent more than 15 percent of annual income on H&U from 18.9 to 16 percent in 2017 (Table 4.1). Table 4.2 compares the old H&U subsidy program to the refined program in terms of benefit coverage, targeting accuracy and fiscal cost for 2015 and 2017. Although it is more convenient for households to receive the in-kind benefit (no need to collect cash transfers every month), H&U benefits are less transparent than GASP and distort incentives for energy efficiency once household expenditures are above the 15/20 percent threshold. Table 4.3 compares the advantages and disadvantages of the GASP and H&U programs. Appendix J lists social assistance programs implemented in other Eastern Europe and Central Asian countries to buffer the impact of heating tariff reform. Table 4.3: Advantages and Disadvantages of GASP and H&U Benefits Advantages Disadvantages Expand GASP  igh poverty impact: targeted to the poor by • H • Dramatic increase in program costs design (means-test) • Implementation infrastructure is in place  ystem administrators may limit entry and hence budget • S expenses   • Social stigma to accept assistance from the program Top up GASP • Less costly than GASP expansion  iven the very low coverage of GASP, top-up would need • G to be combined with some expansion of GASP “Old” H&U • Relevant to energy consumption by design • Less transparent benefit • Providing larger coverage  eak targeting accuracy and possible leakage to • W better-off households • Lower poverty impact  umbersome administration outside of social protection • C system   • Distorting incentives for energy efficiency  edefined R • Stronger poverty impacts • Less transparent H&U benefit • More accurate targeting  umbersome administration outside of social protection • C   system     • Distorting incentives for energy efficiency How Can tariff reform Best Be Implemented? 27 The H&U benefits could be further streamlined if administered under the Ministry of Labor and Social Protection rather than the Ministry of H&U. It is not the role of H&U service to determine vulnerability and thus eligibility for social assistance. The Ministry of H&U could help social protection units to calculate/verify H&U costs and to check eligibil- ity and determine the benefit. In fact, relatively simple software may offer a technological solution to checking eligibility and determining the benefit size. That would also reduce the workload for the social workers. Applying for income support in a single unit makes even more sense given the similarity of information/data collected for GASP and H&U benefits. It would also provide a more client-centered approach, allowing clients to apply for any benefit in a single place. Administration of both GASP and H&U benefits is currently fully handled at the local level with local authorities determining the eligibility and paying the benefits from their budget. This means that the budget of poorer regions would be put under higher pressure because of higher demand for benefits. The literature suggests that centrally financed social protection programs generally work better while locally financed ones typically suffer from low coverage, payment arrears, and poor protection offered in poor localities. For the above discussed mitigation measures to work it is recommended that the financing arrangements be switched from local to central financing, with complementary investments in a stronger oversight and control system. …adopting levelized Customers’ energy bills are the highest in winter months and lowest in summer months. payment plans. This can be hard for households to manage from a cash-flow perspective. Under a lev- elized payment plan, customers make identical, fixed payments every month, regardless of their actual consumption in any given month. Levelized payment plans help ease the cost of heating during the coldest months and recoup utility revenues during the sum- mer months. A levelized payment plan would average annual energy consumption over a 12-month period, basing monthly charges on past energy usage and estimated future rates. Bills may be adjusted every six months to minimize the difference between actual costs and plan amounts. 3. Foster investments Investments in energy efficiency can further reduce consumer bills, and they offer long- in energy efficiency term recurrent assistance to energy affordability. Despite recent achievements in energy efficiency improvement in Belarus, there are, nevertheless, more improvements that can be made on both the supply- and demand-sides in the DH sector. It is important to note that many of the measures described below have a cost. A tariff increase will therefore be needed to fund many of the measures. Appendix K provides a more detailed analysis on the barriers and opportunities of energy efficiency investment in Belarus. … to realize large The heat losses of both Belenergo and ZhKH have consistently declined; however, the cost energy savings poten- of heat supply still varies widely among the oblasts, indicating opportunities for further tial in the DH sector improvement. For example, in 2012, Gomel oblast had the lowest cost at 55.2 USD/Gcal, which is less than half of that in the Grodono Oblast at 117.3 USD/Gcal. The difference between the lowest and highest cost of heat supply within one oblast is also substantial and ranges from 24 to 51 percent (Figure 4.1). 28 Heat Tariff Reform and Social Impact Mitigation Figure 4.1: Substantial Variation in the Costs of Heat Supply Among Oblasts 140 Cost of heat supply, USD/Gcal 120 100 80 60 40 20 0 Brest Vitebsk Gomel Grodno Minsk Mogilev Oblast Oblast Oblast Oblast Oblast Oblast Average cost Minimum cost Maximum cost Source: Ministry of Housing and Utilities. On the demand-side, 84 percent of the residential buildings in Belarus were built before 1993 based on Soviet norms (Figure 4.2). The average heat energy consumption of these buildings (for both heating and hot water) is around 230 kWh per m2 per year, almost twice as much as new building stocks developed under new thermal insulation standards and energy-efficient engineering systems (Figure 4.3). Retrofitting and upgrading old building stocks therefore presents potentially large energy savings. Recommendations to improve the EE incentives on the supply side are as follows: …by improving incen- • Improve the incentives of the DH companies to increase their production efficiency. tives for supply-side EE A pilot project launched by Brest Oblast in January 2014 provides an example of how to uptake, improve such incentives. The pilot foresees that all savings (measured by actual results Figure 4.2: Distribution of Housing Stocks by Heat Consumption (2012) 300 250 Total housing stocks, mln m2 200 130 kWh/m2 150 160 kWh/m2 100 230 kWh/m2 50 0 11 95 00 01 02 03 05 06 07 08 09 10 12 04 20 19 20 20 20 20 20 20 20 20 20 20 20 20 How Can tariff reform Best Be Implemented? 29 Figure 4.3: Heat and Hot Water Consumption by Building Type 250 200 KWh/m2-year 150 100 50 0 Before 1993 1993–2009 After 2009 EE buildings Hot water Heating Source: Ministry of Housing and Utilities. as compared with an initial plan) achieved by the company at the end of the year can be kept by the DH companies rather than returned to local government. The savings may be used for additional investments or for financial reward of the personnel who contrib- uted to the improvement in energy efficiency. • Gradually reduce the subsidies and cross-subsidies related to heat production. Reducing subsidies will, to some extent, motivate the DH companies to reduce costs. Whereas many improvements in energy efficiency require capital expenditure, some can be achieved through low-cost (or no-cost) changes in management. • Make additional financing available to the DH companies. Such financing could include financing by multilateral development banks, like the World Bank, or by government. • Publicize and disseminate results achieved by other DH companies in improv- ing energy efficiency. Disseminating the results of other efforts helps DH companies improve their own performance. Publicizing the results also helps owners and custom- ers understand how their DH service provider compares in performance to others. … investing in DH Based on the case studies of three representative towns and analysis of technology gaps infrastructure in western DH systems (Appendix K), the following supply-side EE measures are recom- mended to improve production efficiency. The investments also contribute to improving the efficiency, quality, and sustainability of urban utility network and infrastructure upgrading. • Replacing old, low efficiency boilers with newer, more efficient ones. Many DH plants and boilers in Belarus are in need of rehabilitation. Some boilers have been running for more than 30 years and are past their technical life span. As a result, these boilers are running at 50 – 60 percent efficiency levels. • Converting from natural gas boilers to boilers using renewable fuels. Heat gener- ated in state-of-the-art wood-fueled boilers is estimated to be about 10 percent more cost effective than traditional natural gas fired boilers at today’s prices. Since natural gas import prices are expected to increase more than the price of wood, the cost efficiency of wood-fueled boilers is likely to improve over time. 30 Heat Tariff Reform and Social Impact Mitigation • More rational boiler sizing. Some boilers in Belarus run at only 30 – 40 percent of their design capacity, especially during the summer months when typically only hot water service is needed. This results in higher fuel use because boilers running at lower capacity factors typically are also less efficient. Such inefficiency could be avoided if more smaller-capacity boilers are installed. Some of these units could therefore be shut down completely during the summer months, leaving a smaller number of units to run at relatively high capacity factors. The units shut-down in summer could be restarted in winter to meet heating demand. • Replacing steam with hot water boilers. In some areas, steam boilers are still used, a legacy of times when there was a larger industrial load. These steam boilers are now used primarily to serve residential customers (for example, in Starye Dorogi). Steam boilers are less efficient in serving the needs of residential customers than hot water boilers. • Replacing networks. Replacement of worn-out network parts, where the heat losses and water losses are high, with pre-insulated pipes is one of the most important investment priorities. Payback periods for networks are usually longer than paybacks for other DH investments, but investment in the network is essential to keeping the DH system oper- ating in a sustainable way. • Reduction of the network dimension and optimization of the network routes. Due to the reduction in heat loads over (last decades), the routing and dimensions of some network parts need to be changed. As in other transition countries, consumption has dropped as some consumers have left the DH system and energy efficiency measures have been introduced. In such cases the dimension of the DH pipes should be reduced and a more direct route from the heat generation plant to the consumers considered in order reducing heat losses in networks. For instance, in Volkovysk one consumer with a capacity of 0.4 Gcal is connected with the DH through a 1.5 km network (one pipe counting), without any other consumers connected to this network branch. • Replacing pumps. Replacement of old, low efficiency network pumps, which are often oversized, has a big potential to reduce electricity costs. The economic rates of return of the above investments depend on site- specific details, such as the efficiency of old boilers and the number of operating hours per year. Table 4.4 describes the economic performance of some of the recommended investment components based on the data of the case study towns. Table 4.4: Economic Analysis of Supply-Side EE Measures in Case Study Towns Efficiency Efficiency Annual Reduction Investment of Old of New Total Heat of Boiler investment Cost Boilers boilers Capacity Production Gas Use ERR NPV Investment 000 USD % % MWh Gcal 000 m3 % US$ million Replacement of base 522 85% 94% 9 54 990 569 49% 1 load NG boiler Replacement of peak 522 85% 94% 9 11 526 119 4% 20.17 load NG boiler Replacement of NG boil- 8 520 n/a 84% 19.5 38 088 5 303 13% 1.49 ers to woodchip boilers Source: World Bank Staff estimates. How Can tariff reform Best Be Implemented? 31 Table 4.5: Economic Analysis of Network Renovation in Case Study Towns Losses Losses Investment before after Network Cost Length Project Project Gas Saving ERR NPV Investment US$ million km % % 000 m3 % US$ million Replacement of old pipes with PI 0.82 1.77 19 16.3 333 12.60% 0.12 pipes Replacement of old pipes with PI 3 8.5 8.5 5.6 490 0.30% 1.46 pipes Source: World Bank Staff estimates. Network renovation projects are usually high cost investments with long payback periods. The investment cost per km and achieved savings depends very much on the diameters of the installed network parts. However, replacement of the network is often a technical must in order to keep the whole DH system operational. Table 4.5 shows results of the economic analysis of network renovation programs in the towns studied. … and putting in Demand-side EE measures reduce household energy consumption and expenditures, which place demand-side in turn allow service providers to reduce production and, in the long run, capital invest- measures ment. Demand-side measures can also save customers money, limiting the impact of tariff increases on monthly bills. Demand-side measures that the GoB can put in place include: • Changing from CTPs to ITPs. Replacing CTPs with ITPs can lead to substantial sav- ings. With CTPs, temperature is controlled at the CTP, which provides heat to a group of buildings. The supply of heat to each single building depends on the average demand of the buildings connected to the CTP. With building-level ITPs, temperature is controlled independently in each building, and the heat supplied to the building depends on the actual consumption of each. • Building thermal renovation. Most buildings in Belarus were constructed according to Soviet norms, and heat losses though the building construction elements are high. The highest potential for energy savings lies in insulating external walls, replacing windows, and insulating roofs. • Apartment-level heat metering and regulation. Heat is currently metered at the build- ing level, and residents do not have the ability to measure and control heat consumption in their flats. Internal piping in most buildings is vertical, making flat-level heat meter- ing complicated since all customers take heat from the same pipes. It is assumed that, in parallel with increases in heating tariffs, the incentives to have flat-level heat regulation, metering, and billing will increase. At the current level of the residential heat tariff, however, none of the suggested EE mea- sures would be feasible. As shown in Table 4.6, payback periods of all investment compo- nents are very long, with the payback of the whole investment more than 75 years. 32 Heat Tariff Reform and Social Impact Mitigation Table 4.6: Economic Analysis of Demand-Side EE Measures under Current Tariff Unit Total Investment in Simple Cost a Typical Building Payback Energy Savings EE Measures Unit (USD) (USD) Period IRR NPV Potential (Gcal) Windows replacement             185.6 Double pane windows m2 100 62480 70.5 20.106 249253   Triple pane windows m2 150 93720 73.2 20.108 274298   External wall m2 65 157625 106.7 20.133 2130717 214.1 Roof insulation m2 30 31170 105.5 20.132 225821 42.8 Radiator thermostatic valves piece 40 7176 29.1 20.037 24427 35.7 House level heat substation (ITP) piece 15 000 15000 20.3 20.002 27347 30 Total investment     367171 75.4 20.11 2242610 508.2 Source: World Bank staff estimate based on data of an average building in the case study towns. As shown in Table 4.7, by increasing tariffs to reflect cost, installation of thermostatic valves and ITPs would become most profitable. The NPVs of these investment components are positive, starting from 2017, under all price increase scenarios. Under a full cost recov- ery tariff, the simple payback of these investments is only two to five years. The whole investment package also becomes economically feasible under 100 percent cost-recovery scenarios. How Can tariff reform Best Be Implemented? 33 Table 4.7: Economic Analysis of Demand-Side EE Measures under Different Tariff Increase Scenarios Scenario 1, Belenergo 2015 2017 2020 Simple Simple Simple Payback Payback Payback EE Measures Period IRR NPV Period IRR NPV Period IRR NPV Windows replacement                    ouble pane windows D 29 23% 238175 20 0% 230742 12 0.06 212921  Triple pane windows 30 24% 258297 21 0% 247171 13 0.06 221819 External wall 43 27% 2112253 31 24% 299416 18 0.01 270163 Roof insulation 43 27% 222128 30 24% 19561 18 0.01 213710 Radiator thermostatic valves 12 6% 21350 8 12% 790 5 0.25 5665 House level heat substation (ITP) 8 12% 1885 6 20% 8303 3 0.4 22930 Total investment 31 24% 2192143 22 21% 2157055 12 0.05 277098 Scenario 1, ZhKH 2015 2017 2020 Simple Simple Simple Payback Payback Payback EE Measures Period IRR NPV Period IRR NPV Period IRR NPV Windows replacement                    ouble pane windows D 29 23% 238175 11 7% 28626 7 17% 23490  Triple pane windows 30 24% 258297 11 7% 215616 7 16% 30774 External wall 43 27% 2112253 17 2% 263006 10 9% 29479 Roof insulation 43 27% 222128 17 2% 212278 10 9% 21573 Radiator thermostatic valves 12 6% 21350 5 28% 6858 3 57% 15779 House level heat substation (ITP) 8 12% 1885 3 46% 26508 2 110% 53272 Total investment 31 24% 2192143 12 6% 257535 7 15% 88772 Scenario 2 2015 2017 2020 Simple Simple Simple Payback Payback Payback EE Measures Period IRR NPV Period IRR NPV Period IRR NPV Windows replacement                    ouble pane windows D 29 23% 238175 14 4% 219549 9 12% 5284 Triple pane windows  30 24% 258297 15 3% 231394 9 11% 4477 External wall 43 27% 2112253 22 21% 281211 13 5% 239821 Roof insulation 43 27% 222128 21 21% 215919 13 5% 27642 Radiator thermostatic valves 12 6% 21350 6 20% 3824 4 39% 10722 House level heat substation (ITP) 8 12% 1885 4 32% 17406 2 68% 38101 Total investment 31 24% 2192143 15 3% 2107295 9 10% 5837 (continued on the following page) 34 Heat Tariff Reform and Social Impact Mitigation Table 4.7: Economic Analysis of Demand-Side EE Measures under Different Tariff Increase Scenarios (continued) Scenario 3 2015 2017 2020 Simple Simple Simple Payback Payback Payback EE Measures Period IRR NPV Period IRR NPV Period IRR NPV Windows replacement                    ouble pane windows D 29 23% 238175 19 1% 228862 14 4% 219549 Triple pane windows  30 24% 258297 20 0% 244845 15 3% 231394 External wall 43 27% 2112253 29 24% 296732 22 21% 281211 Roof insulation 43 27% 222128 28 23% 219024 21 21% 215919 Radiator thermostatic valves 12 6% 21350 8 13% 1237 6 20% 3824 House level heat substation (ITP) 8 12% 1885 5 22% 9645 4 32% 17406 Total investment 31 24% 2192143 20 0% 2149719 15 3% 2107295 Source: World Bank staff estimate based on data of an average building in the case study towns. EE investment can If supply- and demand-side EE measures are implemented, households would spend, on aver- reduce household age, 41-46 percent less than they currently do for heat energy. Supply-side measures account energy costs. for about 9 percent while demand-side measures contribute an additional 35 percent of energy savings. Table 4.8 outlines the average annual household expenditures on heat energy and pro- jected savings from the implementation of EE measures under different tariff increase scenarios. Table 4.8: Average Annual Household Savings after implementation of EE Measures After Supply Side After Supply Side EE and Demand Side       Before EE Measures Measures EE Measures       2015 2017 2020 2015 2017 2020 2015 2017 2020 Heat consumption of average household Gcal/y   9.2 9.2 9.2 9.2 9.2 9.2 5.9 5.9 5.9 Scenario 1 (Belen- USD ergo) 156 220 367 142 200 334 92 130 217 Heating cost of average   Scenario 1 (ZhkH) 156 403 672 130 336 559 84 218 364 household     Scenario 2 156 312 519 136 272 453 88 177 294       Scenario 3 156 234 312 136 204 272 88 132 177 Scenario 1 (Belen- % ergo)       9% 9% 9% 41% 41% 41%   Scenario 1 (ZhkH)       17% 17% 17% 46% 46% 46% Reduction     Scenario 2       13% 13% 13% 43% 43% 43%       Scenario 3       13% 13% 13% 43% 43% 43% Source: WB staff estimate. Note: assumptions used in the above estimates are: Heat production cost (present):65.4 USD/Gcal (weighted average of Baranovichi, Volkovysk and Starye Dorogi, average size of household: 65 square meters. How Can tariff reform Best Be Implemented? 35 Targeting EE mea- Energy efficiency assistance in the form of preferential loans and grants to low-income sures to low-income households can be an effective policy response to improve energy affordability. One such households can buffer example is the US Weatherization Assistance Program. The program, which provides low the impact of tariff income households with weatherization services, initially targeted heating (insulation and increases in the long heating systems) but has been broadened over time to include cooling, appliances, and light- term. ing. Eligibility for the program is mainly based on income levels, using thresholds defined according to the national poverty guidelines. The weatherization services are managed by local agencies and include a visit by an energy auditor, installation of the chosen ener- gy-saving measures, and finally verification of the work by an inspector. A recent cost-ben- efit analysis suggests that for every $1 invested under the program, $1.80 is returned in reduced energy bills and $0.71 is returned to ratepayers, households, and communities through increased local employment, reduced uncollectible utility bills, improved housing quality, and better health and safety. Use fiscal surplus to The expected yearly fiscal savings from tariff increases are approximately US$ 0.41 billion. fund social assistance These fiscal savings can be allocated to fund social protection programs and energy-effi- programs and EE ciency investments to mitigate the impact of tariff increases on the poorest households. investments… Fiscal savings can also be used to reduce commercial electricity tariffs to improve busi- ness competitiveness. The results in Table 4.9 show that when an effective social assistance package, together with the removal of heat subsidies, is properly designed and sequenced, it is possible for government to achieve positive fiscal gains while protecting the poorest households. Table 4.9: Reform Packages with Positive Fiscal Savings Fiscal Savings (US$ bln) Budget of Social Industry Net Fiscal EE Grant Local Industry Protection Rebate Savings (US$ bln) Year Total Budget CS (US$ bln) (US$ bln) (US$ bln) 2015 0.15 0.02 0.13 refined H&U 0.01 0.12 0.02 2016 0.15 0.02 0.13 refined H&U 0.01 0.12 0.02 refined H&U + Expand GASP 0.30 0~0.11 2017 0.29 ~0.41 0.04 ~ 0.1 0.25~0.31 refined H&U + Expand +top up GASP 0.19 0.09 ~0.21 2020 0.42~0.76 0.06~0.18 0.37~0.59       0.37~0.59 0.06~0.18 Source: World Bank staff estimate. Note: Fiscal savings in 2017 and 2020 reflect the range under three tariff increase scenarios. 36 Heat Tariff Reform and Social Impact Mitigation A recommended road- The above analysis shows that the burden of higher DH tariffs falls most heavily on map for heat tariff low-income groups. However, the negative social impact is manageable if the government reform. improves existing social protection systems and scales up energy efficiency programs. It should be recognized that, while a number of easy-to-achieve opportunities might be avail- able, addressing energy efficiency comprehensively also requires longer term investments and it takes time for the benefits to reach the households. An effective social assistance package should therefore consist of both welfare transfers that offer immediate relief and an energy efficiency program that provides a sustainable long-term solution. As noted above, the sequence of the reform is critical. The reform program will be most effective if the GoB: 1. Leads with a consumer communication campaign while 2. Putting in place better social protection mechanisms, including grants to demand- side energy efficiency targeting at low-income households, and 3. Taking measures to encourage investments in supply and demand-side energy efficiency. When mitigation measures are properly coordinated, the heat tariff reform will become more socially acceptable, consumers will benefit from better quality of services, and the government will achieve positive fiscal savings. Figure 4.4 illustrates a proposed timeline for implementing the package of reforms described in this note. How Can tariff reform Best Be Implemented? 37 Figure 4.4: Recommended Road Map for Implementing Reforms 2015 2017 2020 30% cost recovery Scenario 1: 60% cost recovery Scenario 1: 100% cost recovery Uniform price for Different price for Belenergo Different price for Belenergo Belenergo and ZhKH and ZhKH and ZhKH Scenario 2: 60% cost recovery Scenario 2: 100% cost recovery Uniform price for Belenergo Uniform price for Belenergo and ZhKH and ZhKH Scenario 3: 45% cost recovery Scenario 3: 60% cost recovery Uniform price for Belenergo Uniform price for Belenergo and ZhKH and ZhKH 2020 2019 2018 2017 2016 Demand-side EE takes Demand-side effect 2015 EE fully 2014 scaled up Supply-side EE takes effect Improved SP put in place Rolling out Consumer monitoring consumer mechanism communication established campaign