By Kimberly Heimert and Ender Özeke

Large additional investments in the Turkish power sector are fairly unlikely in the near future.

However, investors who want to establish a foothold in a market that undoubtedly will be extremely important in the future may consider investing, in the meantime, in inside-the-fence power plants that serve factories that produce for the export market.

Turkey adopted a new electricity law in February 2001 that provides for a new licensing regime and permits bilateral contracts. The new law also sets in motion a transition to a liberal and competitive market environment for the power sector. However, several factors make Turkey a tough place to do a project at the moment. These include the collapse of the Turkish economy, the lack of implementing and regulatory legislation for the new electricity law, the unavailability of government guarantees for virtually all projects, a decline in power demand projections, the declared illegality of certain ownership rights, and a corruption scandal.

Implementation

The legislative framework required to implement the new electricity law has not taken shape as quickly as previously expected. Although the new law contemplates a transition period of two years, it is widely acknowledged that this period actually will be substantially longer. A number of steps must be taken before the new law can be fully implemented. A new regulatory body, called the Energy Market Regulatory Authority, must first be established and then it must issue a number of implementing regulations. TEA, the state-owned electricity generation and transmission company, must be restructured by separating its generation, transmission, and trading functions into new companies.

At this time, no regulatory body has been formed, no regulatory framework is being discussed seriously and the restructuring activities have been delayed.

Government Guarantees

The Turkish government is not expected to issue any additional guarantees for power projects.

The government had been expected for the past several months to stop issuing guarantees in response to International Monetary Fund demands and other pressures. However, until recently, the government was nevertheless expected to issue guarantees for approximately 20 identified projects, all of which are underway. With the deepening financial crisis, the government has had to tighten its belt. Latest indications from the government are that it is very unlikely to provide guarantees for any projects with long-term take-or-pay obligations, although there is some hope that it will provide guarantees for one or two projects that are already fairly developed.

Demand Projections

The projections for huge increases in power consumption for Turkey now appear to have been overstated.

Over the last several years, Turkey has been touted as a huge growth market for power consumption. The original projections for increased power needs were based on the Turkish economy continuing to grow. However, the country’s financial crisis has affected the expansion of many industries, including those that are major power consumers. The effect has been severe enough that many now believe that the BO, or build-own, projects currently under construction — including the Intergen projects, which have a total capacity of 3,850 megawatts — will provide enough capacity for Turkey until at least 2005 and possibly beyond.

With the current economic downturn, it is very difficult for anyone to predict what the power needs will be in the next five years and beyond. However, there is concern that if some of the transfer of operating rights, or TOR, projects do not progress, and, therefore, do not receive an infusion of new investor capital, many of the plants that are part of those projects will be forced to close because of severe environmental, safety, and maintenance problems. Obviously, if those are closed, their production will have to be replaced by other projects.

Ownership Issues

A number of distribution TOR projects have been canceled because of their owners’ interests in radio or television outlets. Turkey’s radio and television law prohibits anyone with more than a 10% share in a radio or television company to participate in a tendered contract with the government. Developers involved in approximately 10 to 15 projects that are affected by this prohibition have challenged the law. One developer has recently exhausted the legal appeal process unsuccessfully.

In addition, the new electricity law requires that the transfer of rights in all TOR projects must occur no later than June 30, 2001. That transfer is impossible for the affected projects until this ownership restriction is removed. Although there is some discussion that the relevant legal provision may be repealed, it is generally believed that none of the affected projects will be able to meet the deadline established by the electricity law.

Corruption

Indictments were issued against several government officials and business people in the energy sector earlier this year, adding to the disarray. Turkey, like most emerging markets, has struggled to rid itself of corrupt business dealings. Although these recent developments have caused some additional uncertainty, there is hope that they will transform the way business is done in the Turkish power industry. Unfortunately, the effect in the short term is to cause an already slow bureaucratic machine virtually to cease all activities in connection with negotiating and developing power projects.

Industrial Projects

Despite all the problems, investments in smaller power plants adjacent to existing factories that produce for the export market may make sense as an interim step for developers who hope to play a more major role in Turkey once the economy recovers.

Although exact projections are impossible at this time, there is little doubt that Turkey’s power consumption will continue to increase and will increase dramatically at some point in the future. Developers who are already in the market may be in much better positions to invest in attractive projects.

Turkey has industrial zones in almost every large and medium-sized city, which creates consolidated potential consumer bases throughout the country. Many industrial zone companies export a substantial percentage of their production and, therefore, may be sufficiently creditworthy to justify the financing of a project.

Also, we understand that many of the companies in those industrial zones buy electricity off the grid at approximately $.08 per kilowatt hour. Of course, every project has unique economic requirements, but independent power producers often are able to provide electricity from inside-the-fence projects at substantially lower rates.

Finally, a large majority of new generation that will come on line over the next year relies solely on natural gas for fuel. The ever-changing landscape of the potential gas pipelines to Turkey from Russia, Azerbaijan, Turkmenistan and Iran means that a sufficient gas supply is anything but certain. Therefore, the Turkish government should be very receptive to additional production provided by dual fuel capable plants, or plants that are able to run on more than one fuel.

Unfortunately, obstacles to inside-the-fence projects also exist. First, no licensing body currently exists to issue the required licenses. Second, any excess capacity cannot currently and easily be sold into the grid because transmission arrangements are unclear and certain volume limitations exist. Third, because of the financial crisis, many companies in Turkey — including large industrial companies — are downsizing dramatically.

Several existing auto-production facilities are looking for strategic partners to help them expand. Investing in such an existing project may eliminate several of the obstacles facing other investments in the Turkish energy sector. For example, existing projects should have the required licenses, the right and ability to sell power into the grid, and customers with a credit history that justifies such an expansion.