Turkish Energy - Industry Report

Executive Summary

The Turkish energy sector is widely seen as the most promising and attractive investment area in the Turkish economy. The market is experiencing a transition towards a competitive market structure in order to attract private sector investment. The energy market is witnessing rapid growth and a liberalization process with the recent privatizations, licence tenders and strategic partnerships. The sector has been remarkably active recently and offers major opportunities to investors. Turkish energy consumption is low compared to Western European countries. However, the large, young and increasingly urban population in Turkey represents a growth potential. Currently, Turkey is a major energy importer, as its energy consumption growth has outpaced domestic production. Substantial investment in the energy sector will be required in the near future in order to meet the increasing demand in Turkey. The energy consumption in Turkey reached a level of 102 tonnes of oil equivalent, or 1,415 kg of oil equivalent per head in 2008 (which is still below Western levels) with an increasing trend between 2004 and
2008. Given the slowdown in the economy since mid-2008, energy consumption growth slowed from 5.3% y-o-y in 2007 to 1.4% in 2008. The decline is expected to continue in 2009 with a 5.5% decrease; however a recovery of 2.5% annually is expected between 2010 and 2013 . The Turkish electricity market was one of the fastest growing in the world. Installed capacity has continued to rise regularly in the last decade from 23,354 MW to 41,817 MW with a CAGR of 7.8%. As a result of the increase in the share of natural gas fired power plants, natural gas constitutes the highest share of primary energy resources with 39% of the total followed by lignite (30%), hard coal (7%) and fuel oil (6%) in 2008. Turkey’s domestic oil and gas production meets less than 3% of its energy requirement leaving Turkey a
major importer of oil and gas. 90% of Turkey’s crude oil is imported, mainly from Saudi Arabia, Iran, Iraq and Russia. 70% of domestically produced oil is obtained from the state-run Turkish Petroleum Corporation (TPAO) with the remainder produced mainly by Royal Dutch/Shell. As for natural gas, Turkey is dependent on imports from Russia which corresponded to 63% of the total in 2007. Other suppliers include Iran which accounted for 17% and Azerbaijan for 4% of the total. A competitive gas market in Turkey is shaped by the Natural Gas Market Law which was issued in 2001. Accordingly a gas release program was initiated and the transfer of the rights under 4.75 bcm of BOTAŞ’s contracts (14% of actual gas imports) was completed. These rights were acquired by four private sector companies which won the public tender and which have now started gas imports. The State-owned pipeline operator and gas supplier BOTAŞ previously handled all oil and gas import and owns the distribution infrastructure, though its dominant share of the market is planned to be further reduced in coming years in line with the Natural Gas Market law. The share of the private sector in gas import and wholesale activities should thus rise as the share of the State (BOTAŞ) falls. Coal is mainly used for power generation in Turkey. 30% of total primary energy consumption in Turkey is derived from coal. Only one-half of the coal used is produced domestically in Turkey which makes Turkey's coal market dependent on imports. The coal market is considered as largely a monopoly operated by the Turkish Hard Coal Enterprises (TTK) although minor parts of production, processing and distribution
activities are contracted to the private sector. On-going transformation and liberalization of the energy markets has led to increased private investment, from both domestic and foreign investors. There are a great deal of investment opportunities in the Turkish energy sector. State-owned generation and distribution assets are to be privatised, new power plants are to
be built by the private sector, tenders for licences in natural gas distribution are held and certain natural gas import agreements of the state are (as described above) transferred to the private sector. In the past five years, Turkey has accommodated a lively investment environment as many foreign investors have made greenfield investments, entered into partnerships with local players and acquired state-owned and private companies. Turkey has also a significant potential for renewable energy. Due to substantial renewable energy resources and recent developments in renewables legislation and liberalization in the electricity market, there is a suitable environment for renewable investments. The renewable energy sector is further analyzed in ISPAT’s “Environmental Technologies & Renewable Energy Industry Report”.

Sector Overview

Global Sector

Global energy consumption reached a level of 10,465 million tonnes oil equivalent in 2008 with a CAGR of 2.4% between 2004 and 2008. Coal consumption has shown the highest growth in 2008 with a growth rate of 3.7%. Energy exporting regions such as the Middle East and Africa have also experienced growth in energy consumption . However, energy consumption is expected to experience a decrease in 2009 due to the global economic crisis. The fall in the consumption is expected to affect oil, natural gas and coal consumption. Oil has the highest share within the global energy consumption corresponding to 35% of the
total followed by coal, natural gas and hydroelectricity .


Oil
Strong growth in demand together with the reduction in spare capacity between 2003 and 2007 has led to rapid growth in oil prices, which culminated in a peak of over US$140/barrel in July 2008 . The peak was followed by even more rapid decline as the impending global recession took shape. From early 2009 onwards, however, oil prices have resumed their upward trend.

Natural Gas
In 2008, the demand for natural gas has started to decline with countries hit by recession reducing their energy usage. This trend continued in 2009. Although the consumption of natural gas was declining, at the same time new gas resources such as liquefied natural gas (LNG) from Middle East and Indonesia have emerged. Despite the global economic downturn, total natural gas production increased by 4.1% in 2008, Russia and the US being the main producers.

Coal
Coal production is expected to increase by nearly 60% between 2009 and 2030 with most of the growth expected in China and India . The World’s largest coal consumer is China which is expected to dominate 38% of world capacity by 2011. Another country in which coal is the primary source of energy is India, where 62% of the country’s electricity generation is obtained from coal-fired stations. The demand from these two big coal consumers has shaped the growth in the coal market with an annual increase in global demand of 5% from the beginning of the century .

Nuclear
The nuclear energy industry has become attractive due to the demand of many countries to diversify their energy sources and the high level of alternative energy costs. Russia and France are major players in nuclear power in Europe, where nuclear energy comprises more than 44% of total electricity generation. Concerns over the global warming effect of carbon-based electricity generation, together with concerns over the security of oil and gas supply, have reawakened interest in other countries such as the UK and Sweden. China is planning to construct capacity of more than 20,000 MW by 2015 .

The Domestic Sector

Sector Overview
Turkey is one of the fastest growing energy markets in the world, with significant further growth potential. Turkish energy demand was affected by an economic downturn experienced in Turkey in 2001 but picked up in 2002 and continued to grow thereafter, reaching the pre-crisis consumption level in 2003. The energy consumption increase continued between 2004 and 2008 equalling 102 tonnes of oil equivalent, or 1,415 kg of oil equivalent per head, which is still below Western standards. Together with the global economic crisis, the energy consumption slowed down since mid-2008 with an annual growth rate of 1.4% in 2008, compared to a rate of 5.3% in 2007. The decline is expected to continue in 2009 with a fall of 5.5% however a recovery of 2.5% annually is expected thereafter between 2010 and 2013.


Electricity
The Turkish electricity market is currently going through a liberalization process and rapid growth. The market is experiencing a transition towards a competitive electricity market in order to attract private sector investment and maximise efficiency. Electricity demand in 2008 equalled 198 TWh, representing 4.3% annual growth from 2007. The CAGR of electricity demand between 2004 and 2008 was 7.2% . Electricity demand has been growing in parallel
with the urbanization and industrialization level and economic development. Also supported by the population increase, the Turkish electricity demand shows great potential for further growth. Electricity demand is expected to be affected by the global economic downturn where there is a 4.7% decrease in the first ten months of 2009. However, there is a sign of recovery in demand in the following months and the demand turns to increase in October by 6.5% .
Installed capacity has continued to rise gradually in the last decade between 1998 and 2008 from 23,354 MW to 41,817 MW respectively with a CAGR of 7.8%. In line with the increase in share of natural gas fired power plants, natural gas constitutes the highest share in primary energy resources with 39% followed by lignite (30%), hard coal (7%) and fuel oil (6%) in 2008 . The current energy supply including the existing power plants, the licensed plants and those under construction was expected to be insufficient to cover the Base Energy Demand starting from 2009 . On the other hand, the decline in economic activity which has affected electricity demand has also delayed the electricity imbalance. After a recovery in electricity demand, there will be the requirement for further capacity to balance supply and demand. The estimated investment required for the period of 2009-2017 is approximately US$ 35-50 bn .
The top 15 generators by installed capacity ranking as of December 2008 are shown in the following table.



The state owned generation company EÜAŞ currently owns c.58% of total installed capacity. Due to the ongoing liberalization process in the Turkish electricity market the state owned generation assets are expected to be privatized Apart from state owned EÜAŞ, the other top players are: ENKA, a leading construction company in Turkey owning the Adapazari, Gebze and Izmir combined cycle gas turbine (CCGT) plants. Isken owns an imported coal power plant and Baymina is the fourth largest player with 798 MW CCGT. Birecik owns one of the largest HEPPs (Hydro Electric Power Plants). There are basically two types of prices in the Turkish electricity market defined as: market prices and regulated tariffs approved by EMRA. A comparison of the system imbalance prices (SIPs) and TETAS whole sale prices is presented in the below chart.

System imbalances prices are set in the Balancing Market where upward and downward regulation offers to cover the long or short position of the market are accepted by the system operator, TEIAS. TEIAS accepts the offers in accordance with the daily demand forecast and daily generation schedule defined on an hourly basis. Prior to July 2008, the gap between regulated tariffs and market prices was high. The Automatic Pricing Mechanism, based on reflecting cost fluctuations onto the energy prices of state owned enterprises was introduced as of July 1, 2008 and had an immediate impact on the TETAS price. The Automatic Pricing
Mechanism affected the TETAS price and the gap started to close. The Turkish electricity markets regulatory structure is as follows: General principles are set by the Law. The
Council of Ministers and/or the High Planning Council make decisions in line with the spirit of the law. Detailed rules are set by secondary regulations and finally detailed operational matters such as tarif approvals and the issuance of licences are defined by EMRA Board Decisions. The Electricity Market Regulatory Authority established as per Law no. 4628 was later renamed the Energy Market Regulatory Authority. EMRA acts as a supervisory and regulatory body for the energy market. These laws aim to establish a stable and transparent energy market functioning in a competitive environment. The market chain can be divided into four sections; generation, wholesale, distribution and retail market (or consumers). There is a monopoly for transmission in between wholesale and generation. The general market value chain and structure is illustrated in the following figure.

Oil & Gas
Turkey’s known oil and gas reserves correspond to 300mn bbl and 8.0bcm, respectively. Oil production is far lower than the estimated consumption of c.673,000 b/d in 2008. Oil comprised c.31.5% of total primary energy consumption in Turkey in 2008, showing a slight increase compared to 2007 (30.2%) whereas natural gas comprised 31.6% of the total in 2008, almost stable compared to 2007 (31.2%). Natural gas prices have risen in line with global prices . Demand for natural gas is increasing rapidly as it is preferred as the fuel for industrial use as well as for power generation. 55.5% of natural gas was used for power generation, 22.5% for residential use and the remaining 22% for industrial use in 2008. Although relatively low compared to others, industrial usage has nearly doubled since the beginning of the decade . The network of the State-owned pipeline operator and gas supplier Botaş covered 63 cities by the end of 2008, increased from 54 at the end of 2007. The improvement in the distribution network is expected to increase natural gas availability. Turkey’s domestic extraction of oil and gas meets less than 3% of its energy requirement leaving Turkey a
major importer of oil and gas. 90% of Turkey’s crude oil is imported, mainly from Saudi Arabia, Iran, Iraq and Russia. 70% of domestically produced oil is obtained from the state-run Turkish Petroleum Corporation (TPAO) whereas the remainder is produced mainly by Royal Dutch/Shell. As for natural gas, Turkey is dependent on imports from Russia corresponding to 63% of the total in 2007. Other suppliers included Iran accounting for 17% and Azerbaijan for 4% of the total . Turkey has a strategic location between European markets and major oil and gas-producing countries in the Middle East and around the Caspian Sea. Although the Bosphorus is a major oil shipping route between the Black Sea and the Mediterranean, heavy oil tanker traffic through the Bosphorus is restricted due to environmental concerns. The legal framework for the EU-backed Nabucco pipeline project was signed by Turkey and four EU transit countries in mid-July 2009. Accordingly, the 3,300-km pipeline will carry gas from the Caspian region and the Middle East through Turkey, Bulgaria, Romania and Hungary to Austria, with the gas further distributed to other EU countries through existing pipelines. The project is expected to reduce the dependence of EU countries on Russian gas .

Coal
30% of total primary energy consumption in Turkey is derived from coal. Coal consumption of 92.8m tonnes in 2008 declined by c.2.3% compared to the prior year , whereas total coal production in 2008 amounted to 1586.2m tonnes, up from 76.6m tonnes in 2007 . Hard coal is mainly mined by TTK in Zonguldak in the western Black Sea region. Lignite is mined mostly by the state-owned Turkish Coal Works (TKI) in various parts of the country. TKI controls mining in Afsin-Elbistan located in South-East Anatolia, where most lignite coal is produced.
Only one-half of the coal used is produced domestically in Turkey. This makes Turkey's coal market dependent on imports. The domestic coal market is largely considered as a monopoly operated by Turkish Hard Coal Enterprises (TTK) with minor parts of production, processing and distribution activities contracted to the private sector.

Nuclear
Turkey does not produce electricity from nuclear sources. A tender for building a 1,000-MW nuclear-power plant by 2005 was cancelled in 2000. In subsequent years, a tender was developed for the first nuclear plant with a combined capacity of 5 GW and was announced on September 24, 2008. However, with only one consortium submitting a bid, namely Russia's state-owned nuclear export company Atomstroyexport and Turkey's Park Teknik Group, the tender was cancelled by TETAŞ in November 2009. As the energy demand
grows in Turkey, nuclear energy could provide an important supply source and will remain on the agenda in the coming years.

Main Players

Electricity
Before the 1990s, a state owned company, the Turkish Electricity Authority (TEK), dominated the Turkish electricity industry. TEK was established in 1970 and in order to move towards market liberalisation and privatisation it was separated in 1993 into TEAS for generation, transmission and wholesale power supply and TEDAS for distribution. In 2001, TEAS was further separated into EUAS for generation, TETAS for wholesale and TEIAS for transmission; each being established as a separate legal entity with the introduction of the Electricity Market Law. EUAS operated 91% of Turkey’s power supply before the electricity reform in 2001 . Most of EUAŞ’s power plants are to be privatized according to the privatization plan.

Oil & gas
BOTAS, the state-owned gas supplier and pipeline operator, handled all gas and oil import and distribution infrastructure until recently. However, its monopoly position is changing from 2009. A competitive gas market in Turkey is shaped by the Natural Gas Market Law which was issued in 2001. According to the Law, a gas release program was started and a tender was completed for the transfer of the gas import rights under 4.75 bcm of BOTAŞ’s contracts (14% of actual natural gas imports). Following the program, the four private sector companies which won the tenders started to import gas and sell it wholesale to major customers in Turkey. In the coming years, further tenders are expected which should reduce BOTAS’s market share in imports to the limit of 20% set by the Natural Gas Market Law as the maximum for any one market player. The private sector’s market share should thus increase correspondingly. The companies which successfully tendered to take over the agreements and their corresponding volumes were Enerco 2.5 bcm, Bosphorus Gas 750 million Sm , Avrasya Gas 500 million Sm and Shell 250 million 3Sm . Bosphorus and Shell have completed the take-over process earlier and have started importing in 2008, whereas Enerco and Avrasya Gas started their operations in April 2009. There are 60 licensed natural gas distribution companies in the Turkish gas market of which 4 are owned by municipalities and the remaining 56 are private companies. The privatization tender for İzgaz was completed; Başkentgaz and Igdaş are to be privatized. Tenders for the remaining cities are planned to be completed by the end of 2011 . 78% of the Turkish fuels and lubricants supply market is controlled by Tüpraş and the biggest fuels retailer in Turkey is POAS, a former state company. BP, Shell and ConocoPhillips are the other active companies . In the petroleum refining market, Tüpraş has a strong monopoly position with 4 sites located in Izmit, Izmir,
Kırıkkale and Batman. Total combined capacity of Tüpraş is over 600,000 b/d. In September 2005, a 51% stake in Tüpraş was acquired by a consortium led by domestic group Koç Holding and Shell Co for US$4.4 billion.Turkey has one non-Tüpraş refinery which is the Ataş plant in Mersin. The plant is owned by BP (68%), Shell (27%) and domestic fuels supplier Turkpetrol (5%) .

Sector Outlook
Driven by high industrialization and urbanization, electricity demand has exceeded electricity production and largely resisted even the global financial crisis. The increase in demand is expected to continue with the population growth and economic development in future and Turkey is expected to outpace its European peers. TEIAŞ projections for 2009-2018 include 4 different scenarios. The high demand scenario accompanied by high capacity has been considered and presented below. There are also three other scenarios with lower demand and capacity estimates. Electricity demand is expected to exceed electricity generation with a CAGR of 7% between 2009 and 2018. The reliable electricity generation is expected to increase by 3.2% CAGR while installed capacity is expected to increase with 3% CAGR in the coming decade. While thermal capacity formed 64% and HEPP 34% of the total installed capacity in 2009, the share of thermal capacity is expected to slightly decrease to 60% whereas HEPP capacity increases to 38% by 2018. The oil import level is expected to rise in line with demand and increasing prices assuming an average of US$ 80 /barrel in Turkey by 2013 . On the other hand, growth in natural gas is expected to exceed petroleum and coal consumption. The natural gas consumption is expected to increase with a CAGR of 7%
between 2010 and 2013. In 2008, coal consumption in Turkey was 92.8 million tons which was mainly used for power generation. Coal consumption in Turkey is expected to decrease by c. 5.5% in 2009 and recover with an increase of 2.5% between 2010 and 2013.

SWOT Analysis

Strengths

-Well-organized and structured legal framework in the energy sector
-EMRA operating as an independent market regulator
-High growth potential of the Turkish Energy sector compared to other European countries.
-Advantage of Turkey operating as an energy hub between Europe and the Middle East.

Electricity

-Increase in the weight of the private sector through the privatization of state owned generation assets
-Probable horizontal and vertical mergers of electricity, natural gas and water distribution, to allow synergy and regional utility companies

Natural Gas
-High gas demand growth potential
-Favorable gas supply geography and infrastructure
-Potential role as a transit corridor and potential for development of trading hubs

Weaknesses

-Electricity
-Coal is the only energy source with significant domestic availability, leavingth ecountry
increasingly import-dependent

Natural Gas

-Requirement for gas storage for system security reasons

-Import dependence on natural gas supplies

Opportunities

Electricity

-Privatization of regional distribution companies (to be finalized by 2010) will allow for an independent merchants’ market
-Synergy expected to be created between electricity, natural gas and water distribution
businesses
Natural Gas
-Tenders for the remaining cities, gas requirements to be met by end of 2011
-Privatization of municipality owned natural gas distribution companies.
-Restructuring of Botaş and competitive market structure transition to a Interest of foreign investors in the natural gas distribution market.

Threats

-No new contract releases are announced/expected in the short term
-Shortage of electricity supply against electricity demand.


Investment Opportunities

Turkey is a major energy importer with energy consumption exceeding its production. For Turkey to meet its energy demand, significant investments are necessary in the energy sector. The transition of the Turkish electricity market to a liberalized market has already attracted private investment from both domestic and foreign investors and further opportunities will occur. Among the investment opportunities, the state owned generation and distribution assets together with new power plant establishments can be indicated. Turkey has experienced a lively investment environment in the last five years in which many foreign investors have made greenfield investments, entered into partnerships with local players and acquired state-owned and private companies. Below is a list of M&A transactions by foreign investors in the Turkish energy industry between 2004 and 2009:

The Turkish government is in the course of privatization of the distribution companies as a step towards full liberalization of the energy market. There are 101 assets with total capacity of 15,594 MW which are to be privatized:

-18 thermal power plants (11,769 MW)
-27 hydro-electric power plants of EUAS (3,677 MW)
-56 run-of-the-river power plants (148 MW)

There are 21 distribution regions under the Turkish privatization portfolio. Kayseri region was the only private region and currently, the privatization tenders for 4 DisCo’s have been finalized, although one has been cancelled by the Council of State. The competitive environment as a result of the privatizations is expected to accelerate electricity generation investments .






























Abbreviations
b/d - Barrels per day
Bcm - billion cubic meters
BMI - Business Monitor International
CAGR - Compound Annual Growth Rate
CCGT - combined cycle gas turbine
DisCo - Distribution Company
EIU - Economist Intelligence Unit
EMEA - Europe, Middle-East and Africa
EUAS - Electricity Generation Co.Inc.
EUR - Euro
GDP - Gross Domestic Product
HEPP - Hydro Electricity Power Plant
IEA - International Energy Agency
ISE - Istanbul Stock Exchange
ISPAT - Republic of Turkey Prime Ministry Investment Support and Promotion Agency (ISPAT)
KCETA - Kayseri Region Electricity Company (Kayseri ve Civarı Elektrik T.A. )
LNG - liquefied natural gas
OPEC - Organization of the Petroleum Exporting Countries
PED - primary energy demand
Rmb - Chinese yuan
US - United States
US$ - US Dollars
TEAS - Turkish Electricity Generation and Transition Co.
TEIAS - Turkish Electricity Transmission Company
TEK - Turkish Electricity Authority
TETAS - Turkish Electricity Trading Company
TPAO - Turkish Petroleum Corporation