Project written for the course "Financing for Development - Millions to Trillions to Action"

1. General considerations
Eastern Europe has a long tradition in energysubsidies,that goesback to the socialist regimes inplace
before 1990. Even if most Eastern European countries have now embarked on a „quest” for
democracy, energy subsidies still remain an integral part of their economy.
In Romania, subsidies may take a variety of forms and are addressedto both companies and individual
consumers. A number of companies have benefitted from subsidies for electricity and natural gas, but
investigations carried out in the past years showed that in many cases subsidies were granted by
government officials in exchange for bribery. The production of clean energy – from wind, water and
solar sources – is also subsidized, utilities receiving green certificates for the energy they produce.
Utilities now get two certificatesper megawatt-hour of wind power, three for hydro and six for solar,
although a plan is in place to cut subsidies by half starting with 2017.
Home heating may also be subsidized by the state. Local councils have to authority to award subsidies
to producers and distributors of home heating so that the price paid by final consumers for public
utilities is considerably lower than the market price. Paradoxically, Bucharest is one of the cities in
Romania where the cost of home heating is still heavily subsidized although it is also the city with the

2. highest GDP per capita in Romania and by far the city with the highest living standards in the country.
Its inhabitants are on average wealthier, better educated and therefore have a much better capacity
to support the cost of the energy they consume than inhabitants from poorer regions. Still, home
heating continues to be subsidizedby over 50 percent by the localauthorities, which translates into
a cost of approximately 112 million euros per year for the municipality – almost 10 per centof its total
annual budget!
Case under scrutiny: Subsidizing heating costs in Bucharest
The subsidy is paid directly to the main heating distributor, which is a state company controlled by the
local council and who buys heating agent from power plants across the city. At the time being, this
company(RADET)has adebt of over700 million eurosto be paid to the main energyproducer(ELCEN)
and another 8 million euros to suppliers of natural gas and water. Thisdebt was incurredover the past
25 yearsand is expectedtorise evenmore due to penalties. This puts RADET ina very delicate position
since ELCEN recently threatened to stop the provision of heating agent if the distributor fails to pay
its debt in the following months. Moreover,the large debt prevents the company from making highly
neededinvestments in the distribution system. The piping system now in place for the distribution of
heating agentto the local population dates back to 1963 and it is estimated that approximately40 per
cent of the heating agent is lost on its way from the plant to the final consumer due to the
infrastructure’spoor condition.This meansthat in the case of a major breach in the piping system the
companywould not have the resourcesto repair the breachand home heating insome neighborhoods
may cease to be provided. Since the company currently provides heating to over 1.2 inhabitants in 0.6
million apartments, as well as to over300 companies,100 schools, 76 kindergartens andday care units,
22 hospitals, 42 high schools and 27 universities, the consequences of such breaches could be
profound.
Proposals have been put forward in recent years to privatize the company and cut back on the
subsidies. However,politicians continue to use subsidies as a leverage to gain votes from the poorer

3. population and several left-wing MPs publicly asserted their support for heating subsidies. Still, data
published by A.T. Kerney consulting firm shows that the cost of energy would be up to 25 per cent
lower if inefficienciesin the production and distribution systemswould be eliminated.This means that
if at least part of the money spent on subsidies would be invested in the renewal of the current
infrastructure, inefficiencies and losses would be drastically reduced and the price paid by the final
consumers would remain affordable since the costs of production and especially distribution would
decrease significantly.
The company estimated that in order for losses to be eliminated, approximately 100 million euros per
year would have to be invested in infrastructure, over the course of 10 to 12 years.Since the company
is not profitable (it incurs losses of approximately 70 million euros per year), investments are put on
hold. Moreover, investments in the house heating sector are not eligible to be funded from European
structural funds under the current financing framework.
Possible solutions
First of all, privatization and/or employing private management would make the company more
market-oriented since private investors are motivated by economic returns and would thus be more
likely to work towards reducing inefficiencies and costs;
Secondly,a long-term loan, guaranteed by the state, could be used for investments in the distribution
(piping) system.The loan can be contractedeven if the company remains under state property; in this
case,the loan will be contracted from the treasury and not from a commercial bank. At the time being,
the annual turnover of the company is of approximately 160 million euros,but losses ofover 70 million
are incurredannually. The goal is to raise the efficiencyofthe distribution process so that the company
would become profitable on long term;
Thirdly, as distribution costs decrease and losses are cut down (following investments in
infrastructure), subsidies could be gradually decreased (e.g. by 5-15 per cent annually). Moreover,
statistical data (data on poverty, social exclusion and housing is currently available at the regional
statistics bureau) could be used to assess the need to grant subsidies for the population that cannot
afford to pay for the heatingat real market prices. Animpact study should also be carried out to assess
the social and economic effects of such subsidies on long term (for example, if families who benefit
from subsidies are more likely to send their children to school);
Last but not least, the partnership agreement for European funding (between Romania and the
European Commission) for the period 2021-2027 should include provisions for investments in energy
distribution. The Regional Operational Program (financed underthe European Regional Development
Fund) could be used to fund suchinvestments so as to increase energyefficiencyand prevent climate
change (the heating agent distributed by RADET and other heating agent distribution companies in
Romania is generally produced with the use of fossil fuels).