A Two-Pronged Approach to Improving the Sustainability of Kazakhstan’s Heat Sector

Beset by aging equipment, inefficiencies, and financial troubles, the heating sector faces the added challenge of transitioning to a more climate-friendly system. Photo credit: ADB.

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Gradual tariff adjustment combined with a heating allowance for vulnerable consumers can support the transition to sustainable heating.

Introduction

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Many countries experience chronic underfunding of the heating sector. Authorities keep tariffs low and subsidize the sector, overlooking the damage such policies cause to heat generation, distribution, and supply operations in the course of time.

When district heating systems start to fail on a massive scale, as in the case of Kazakhstan over the past years, the backlog in repair, maintenance and replacement of assets must be addressed immediately. Moreover, there is the added challenge of transitioning to a more climate-friendly heating system while ensuring continued service delivery to homes and other end users. This requires not only new investments but also state-of-the-art technology and knowledge to make the path to sustainability less painful.

The ultimate solution is to increase tariffs to economically justified levels in one way or another. However, this poses problems for policymakers, and indeed tariff increases must always be well considered and accompanied by specific support measures for vulnerable customers. International experience offers a range of options and methods for making higher tariffs acceptable.

Two Complementary Measures

A project supported by the Asian Development Bank (ADB) analyzed the heating sector in Kazakhstan and studied two complementary approaches for raising tariffs to support sustainable district heating operations. One is to provide a heating allowance for low-income households and the other is to gradually increase tariffs to optimal levels.

The analysis showed that the country’s heating sector is characterized by outdated technologies, unreliable service, and low quality of heat supply. Energy efficiency is lacking on both the heat demand and supply sides. The reason for this situation is the lack of innovation and investment, caused by the long-standing policy of artificially lowering prices for thermal energy and cross-subsidizing between different categories of consumers. Low tariffs fail to not only attract investments but also do not even cover operating costs and depreciation in some cases. To keep heat supply companies running, local councils resort to ad hoc subsidies, which drain public resources and do not result in lasting efficiency gains, long-term operational improvements, or sustainability of heat supply.

The transition to sustainable development of the heat and power sector requires a review of tariff methodology and regulatory practice. This is recognized by most stakeholders, including regulators and central authorities. However, when the economically justified tariffs are calculated, the task seems daunting: how can the required multiple increases—which often mean the doubling or tripling of tariff rates in the cities analyzed by the project—be managed?

The project explored two measures: the Heat Benefit, a targeted social assistance mechanism, and the Tariff Adjustment Path, a managed, gradual increase of heat tariffs to economically justified levels. A model was developed to estimate and compare the budget required for implementing tariff adjustments in different scenarios. The results of the study may be used by policymakers to decide on the best way to finance the transformation of the heating sector, given the country and local contexts.

What are the main elements of the proposed Heat Benefit system?

A targeted, specific benefit payment for vulnerable heat customers is a key part of alleviating “heat poverty” in many countries. The design of such a system is challenging because of multiple factors determining eligibility to receive assistance and how much. These include income levels, dwelling size and type, and outside temperature.

The proposed system for Kazakhstan draws on the experience of countries, such as Germany, Lithuania, the Ukraine, and the United Kingdom. It has the following features:

  • Households with a monthly average per capita income lower than a certain level (for example, at 200% of the subsistence minimum) will be identified as vulnerable consumers eligible for the Heat Benefit, provided they do not have overdue debts for housing and communal services. Also, households with very large apartments and with members who have large sums of money in banks or who have acquired real estate, land, or a car worth a significant amount in the last year will not be eligible for social assistance.
  • For each applying household, affordable monthly heating expenses are defined based on internationally applied norms. These may be set at 5% of the household’s average monthly income:
    Affordable heating expenses for the household = 5% * the household's average monthly income / subsistence minimum
    Affordable monthly heating bill for the household = Affordable heating expenses for the household * Household's average income / 100
    The above formulas show that the affordable monthly heating bill will be lower for households with lower monthly income. For instance, if the household's average monthly income is at the subsistence minimum level, the payment will be set at 5% of the average monthly income, whereas for the household with an average monthly income at twice subsistence level, it will be 10%.
  • The monthly amount of Heat Benefit will be determined as the difference between the actual heating bill payable by the household and the calculated affordable monthly heating bill.
  • The Heat Benefit is proposed to be paid monthly, directly to the recipients' bank accounts.
  • Applications for Heat Benefit will be submitted once a year through the electronic government portal or directly to local executive bodies.
  • The calculation and control of the Heat Benefit will be carried out by the relevant departments of local executive bodies.

The main objective of the proposed mechanism is to create the right conditions for raising heat tariffs to economically justified levels, which is vital to attracting investments and improving efficiency, quality, and reliability of heat supply.

At the same time, the mechanism is expected to have other positive effects. First, it ensures social equity. Well-to-do citizens will pay the full cost of heating. Assistance for vulnerable customers will be the greater the poorer the household.

Second, if social housing norms and heat consumption standards, rather than actual bills, are used to calculate heat costs, households will have a strong incentive to save and reduce their heating bills. This will not affect the Heat Benefit amount, and the savings will remain at the disposal of the recipients. Third, the mechanism will encourage full and timely payment of utility bills, as the absence of arrears is a condition for receiving the assistance.

Fourth, calculations show that the transition from providing subsidies to heat supply companies to giving direct support to vulnerable customers will result in significant budget savings, which can be spent on other programs, including social assistance.

How are the costs of the proposed system projected?

Before introducing the Heat Benefit system, policymakers will want to have an idea of the number of possible beneficiaries and the budgetary resources needed. Estimates can be calculated based on the following:

  • data on decile distribution of average monthly income of the population,
  • data on average monthly heat consumption and/or average monthly heating costs per person (according to consumption norms and applicable prices or, in their absence, the actual cost), and
  • decisions on social parameters:
    • the level of average monthly per capita income that entitles a household for the Heat Benefit (for example, 200% of subsistence minimum),
    • the level of affordable heat expenses of a household with monthly average per capita household income at the subsistence minimum (for example, 5%).

The estimation then proceeds as follows:

  • For each decile group of the population, the level of affordable monthly heating bill per person is estimated.
  • For each decile group, the annual Heat Benefit is calculated as the product of the number of persons in the group, the number of months in the heating season, and the difference between the monthly heating costs and the affordable monthly heating bill per person.
  • The number of potential beneficiaries is defined as the number of persons in decile groups for whom the difference between the average monthly heating costs and the affordable monthly heating bill per person is greater than zero.
What is the Tariff Adjustment Path, and when is it needed?

Undoubtedly, on economic efficiency grounds, the tariff adjustment should happen as soon as possible. Only adequate tariffs can ensure efficient use of resources and investments, both on the supply side—by the heat utilities—and on the demand side—by consumers, incentivizing them to attain efficient levels of energy savings.

In terms of distributional fairness, there is no justification for relatively well-off parts of the society from receiving subsidized heating. Kazakhstan households spend on average as much money on heating as they spend on cigarettes. Central heating is affordable to most of the population and would continue to be affordable with the required tariff adjustments. And for vulnerable consumers, the Heat Benefit system would provide the necessary assistance.

Nevertheless, even with the Heat Benefit mechanism in place, a one-off increase in heat tariffs to an economically justified level may appear impossible. Consumers, whose heating expenses will be considered affordable under the new rules, might still need some time for adjustment, and those that come under the Heat Benefit system need to understand and master it. Local authorities must create administrative resources, both for administering the Health Benefit payments and ensuring the correct application of the mechanism.

For these and other reasons, policymakers might opt for a Tariff Adjustment Path, a pre-agreed, gradual increase of tariffs to an economically justified level. Figure 1 compares a gradual increase with a one-off increase.

Figure 1: Heat Tariff Adjustment Options

Source: Pilot Masterplan Shakhtinsk.

The features of the Tariff Adjustment Path approach are as follows:

  • A target period and/or a tariff dynamics parameter must be set (for example, 3 to 7 years and/or an annual tariff increase level of between 15% to 30%).
  • There must be a clear regulatory commitment to the Tariff Adjustment Path to realize efficiency incentives for the heat utility operators and attract investments during the adjustment period.
  • Budgetary commitment for amounts necessary to cover the difference between the estimated income of heat supply entities at economically justified tariffs and the income of heat supply entities at tariff levels consistent with the adopted tariff adjustment increase is crucial to keep the utilities operating during the adjustment period.
  • The Heat Benefit system needs to be set up in parallel with the allocation of the necessary budgetary funds.
Comparing policy options

Adjusting heat tariffs to economically justified levels will ultimately lead to significant budgetary savings. For this reason, it is necessary to focus on making this possible. If it requires a gradual approach, i.e., the Tariff Adjustment Path, this is still much better than nothing.

During the initial stages, the gradual approach requires significantly more budgetary resources. As illustrated in Figure 2, this is because in the interim period, the budgetary assistance to the heat utilities would continue, so that operations and reliability are ensured. But this would be gradually replaced by the budget funds for the Heat Benefit. As tariffs approach the economically justified level, the total amount of budget support decreases to the level of budget support for vulnerable consumers.

Figure 2: Budget Expenditures for the Two Different Approaches

Source: Pilot Masterplan Shakhtinsk.

Ilka Lewington
Head of Markets & Regulation, Dornier Power and Heat GmbH

Dr. Lewington has 25 years’ commercial, academic, and consultancy experience in energy economics, specializing in energy sector reform in economies in transition. These include developing primary legislation for energy sector reform, renewable energy, and regulation as well as secondary legislation in Azerbaijan, Belarus, Kazakhstan, Ukraine, and Tajikistan. She received a Master in Finance from Moscow Finance Institute, a PhD in Economics from the University of Sussex, and a Master of Chinese Studies from the University of Edinburgh.

Oleksandr Rogozin
Senior Tariff Expert, Dornier Power and Heat GmbH

Mr. Rogozin has 39 years' engineering, commercial, regulatory and legislative experience in the energy sector, including key positions in state-owned and private power companies. Since 2015, he has worked as a vice-president of NGO First Energy Association of Ukraine and as a consultant in Azerbaijan, Belarus, Kazakhstan, Kyrgyz Republic, Tajikistan, and Ukraine. He has a PhD in Electric Power Plants and Systems from Kyiv Polytechnic Institute and an MA in Finance and Credit from Donetsk Academy of Management.

Nana Gurgenidze
Energy Specialist, Energy Sector Office, Sectors Group, Asian Development Bank

Nana Gurgenidze is working on the Central and West Asia development agenda, supporting the low-carbon transformation of the energy sector in Afghanistan, Kazakhstan, and Uzbekistan. She is an experienced lawyer and an expert negotiator with a Master of Science in Energy Management. Before joining ADB, she was a government relations director/corporate secretary and a member of the management team at Clean Energy Georgia LLC, a renewable energy developer, investor, and long-term asset manager headquartered in Norway.

Asian Development Bank (ADB)

The Asian Development Bank is committed to achieving a prosperous, inclusive, resilient, and sustainable Asia and the Pacific, while sustaining its efforts to eradicate extreme poverty. Established in 1966, it is owned by 68 members—49 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance.

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