14. A green recovery in the Western Balkans

The Initial Assessment of this Multi-dimensional Review (MDR) of the Western Balkans identified a green recovery from the Covid-19 pandemic as one of the priorities for all economies in the region (OECD, 2021[1]). Energy and air pollution are complex challenges and significant obstacles to future economic development and the well-being of citizens and the environment. Coal accounts for a very large share of energy supply across Western Balkan economies, with the exception of Albania, which relies almost exclusively on hydropower. Many coal power plants are old and should be decommissioned, or require significant investments to ensure reliable electricity supply. At the same time, levels of energy efficiency in the Western Balkan region are low, particularly, in buildings due to inefficient heating systems, which are frequently fired by fuelwood, and poor insulation. Coal, particularly when burned with old technologies, in combination with inefficient heating systems, cause significant air pollution and are drivers of climate change, both of which rank among the region’s foremost environmental burdens.

A green recovery in the Western Balkans requires energy sector reforms to make the region healthier and more attractive to live in, to return to, and to invest in. A cleaner environment, in particular less air pollution, especially in the major urban centres, is a top desire of residents. A rapid phase-out of coal, and of fuel wood in urban areas, would dramatically reduce air pollution. At the same time, successful energy sector reforms that dismantle monolithic structures in the state-owned utilities would enhance their productivity and open up space for dynamism in the sector from new companies. Cleaner air and new opportunities for employment would follow, and make the region more attractive for young people.

In the longer-run, a greener trajectory for the region can create opportunities through broad transformation. Beyond the energy sector itself, transformation towards more resource-efficient modes of production and entirely new manufacturing and service activities will have to follow as next steps. Such a longer term vision of a greener future will require modernisation across many sectors, and links to the education and skills framework that will lead the transformation, induce innovation, and create next generation business and employment opportunities.

Economic recovery from the COVID-19 pandemic is an opportunity to “build back better”, a strategy being adopted by many governments around the world, with a particular focus on leveraging post-pandemic growth in energy demand and investment to drive the low-carbon transition. While the pandemic has spurred aggressive action, governments need to recognise that global environmental emergencies – such as climate change and biodiversity loss – could cause far larger social and economic damage. In this regard, “building back better” means governments should design economic recovery packages that trigger investments and societal changes to both reduce the likelihood of future shocks and improve resilience when they do occur, whether from disease or environmental degradation. At the heart of this approach is the transition to more inclusive, more resilient societies with net-zero greenhouse gas (GHG) emissions and much-reduced impacts on nature (OECD, 2020[2]) (Box 14.1). A green recovery in the Western Balkans should leverage opportunities to modernise and upgrade the region’s energy systems, which would dramatically reduce GHG emissions.

This report builds on an extensive peer-learning process with practitioners in the region and expert assessment to provide suggestions for a green recovery in the Western Balkans. Building on the Governmental Learning Spiral methodology (Blindenbacher and Nashat, 2010[4]), two peer-learning workshops brought together experts and practitioners from across the region and beyond to prioritise among challenges and solutions, develop ideas for action, and learn from each other (Box 14.2).

This chapter is divided into seven sections. Section 14.1 analyses energy sector and environmental challenges in the Western Balkan economies. Sections 14.2 elaborates a credible vision and the institutional foundations for the transition towards low-carbon energy. Section 14.3 considers options to boost renewables while Section 14.4 examines requirements for increasing investment in energy efficiency. Section 14.5 considers reforms to energy pricing, including the challenges and opportunities associated with removing fossil fuel subsidies and introducing carbon pricing. Section 14.6 covers regional integration of energy markets. Section 14.7 concludes with options to mobilise the public and private financial resources necessary to finance a green recovery.

The Western Balkans’ coal-heavy energy mix, coupled with low levels of energy efficiency, results in high levels of air pollution. On the supply side, the ageing fleet of coal-fired power plants drives pollution while on the demand-side, low energy efficiency in buildings and heating contributes to pollution. Renewables in Western Balkan economies’ energy mix remain dominated by hydropower and biomass while solar and wind power are almost absent in the region’s energy mix. As a consequence, air pollution is high in Western Balkan economies compared to other parts of Europe and has an important health impact. To finance electricity prices below production costs, dominant state-owned enterprises (SOEs) in the Western Balkan region are subsidised in a variety of ways, mainly for electricity generation from coal, locking in public financial resources that would be required for a clean energy transition.

Economies of the Western Balkans region have committed to ambitious climate and energy goals and a regulatory overhaul, but full implementation remains the challenge. The Energy Community Treaty, the EU Green Deal and Nationally Determined Contributions (NDCs) in the context of the UNFCCC COP process provide the main frameworks for ambitious commitments by the region’s economies. Significant challenges remain, however, with implementation, capacity and political interference in energy markets.

Pollution is perceived as an increasingly serious problem by a majority of the population in all Western Balkan economies. In 2021, 74% of people in the region considered pollution a “serious” or “somewhat serious” problem (Figure 14.1), up from 64% in 2019. This could indicate both, a higher degree of awareness of pollution in the region as well as a rapidly deteriorating situation is in the eyes of the public (RCC, 2021[6]).

People in the Western Balkans region suffer more from exposure to fine particle pollution than elsewhere in Europe (European Environment Agency, 2020[7]). In an analysis of years of life lost due to air pollution (exposure to fine particles or particulate matter below 2.5 micrograms [PM2.5]), among 40 European jurisdictions, Kosovo ranked 2nd, Serbia 3rd, Albania 4th, North Macedonia 5th, Bosnia and Herzegovina 11th, and Montenegro 12th (Figure 14.2). The same study reported that, in 2016, an average of 130.1 people per 100 000 inhabitants in the Western Balkan region died prematurely as a consequence of air pollution (European Environment Agency, 2020[7]).

The region exhibits low energy efficiency, which is a cause of significant CO2 emissions. In relation to economic output in the Western Balkans, both energy use and CO2 emissions remain high (Figure 14.3). While economies in the region have (since 2010) reduced their energy- and carbon-intensity per unit of GDP, they are still well above the averages for most regional peers and for EU and OECD countries. Carbon-intensity levels in Serbia, Kosovo, and Bosnia and Herzegovina are two to three times the OECD average. Albania is the region’s positive outlier, thanks to its hydropower electricity generation. In contrast, CO2 emissions per capita are below the EU and OECD averages, reflecting lower levels of industrial activity per capita. Increasing such activity within the current energy systems would be undesirable and highly polluting.

Pollution and emissions intensity will both continue to pose challenges to the region’s EU integration process. In recent years, the Energy Community Secretariat (ECS) brought forward several dispute settlement cases against the Western Balkan economies, reflecting disregard of pollution limits set out in National Emission Reduction Plans (NERPs). Going forward, quick progress within the EU on carbon pricing, and a possible carbon border adjustment tax, will likely have significant effects on electricity and other energy exports from the Western Balkans to the EU (Box 14.3).

The region’s heavy reliance on burning coal, combined with outdated technology for power generation and heating, are the main drivers of high pollution and low efficiency. Combustion technologies (coal, oil, wood) make up the lion’s share of energy supply in the region and are responsible for pollution (Figure 14.4). In 2015, burning coal and wood in homes (for cooking and heating) generated about half of PM 2.5 emissions in Kosovo and North Macedonia, and almost 60% in Bosnia and Herzegovina (World Bank, 2020[13]). Ageing coal-fired power plants are the region’s main source of electricity generation, except in Albania. Power generation from coal is, in turn, the region’s largest source of CO2 emissions (Figure 14.5). Coal combustion is also the second-largest source of PM 2.5 emissions nationally and, by far, the leading source of transboundary pollution.

Many coal-fired power plants in the Western Balkans emit massively more harmful substances than allowed. In 2020, the 18 coal-fired power stations in Serbia, Kosovo, Bosnia and Herzegovina, North Macedonia and Montenegro produced 2.5 times as much harmful sulphur dioxide (SO2) emissions as all of 221 coal plants in the EU combined. In Bosnia and Herzegovina, North Macedonia and Serbia, this SO2 pollution represents six to seven times the legal limit that economies committed to under the NERPs (Figure 14.6). The region’s worst offender, the Ugljevik plant in Bosnia and Herzegovina, has plans for an additional 70 megawatts (MW) of new lignite-fired capacity. The existing facility has a desulphurisation system that has not yet been put to use (CEE Bankwatch Network, 2021[9]).

Air pollution continues to worsen with no improvement yet in sight. In 2020, emissions of nitrous oxide (N2O) grew by 6.5%, SO2 by 8.7%, and of dust by 4% over 2019 (Energy Community Secretariat, 2021[11]). Air pollution from Western Balkan coal plants was responsible for 19 000 deaths in the three-year period to 2020. Nearly 12 000 of the deaths resulted from breaches of legally binding pollution limits. According to these estimates, breaches of pollution limits at Western Balkans power plants caused between EUR 6.0 billion and 12.1 billion in health costs in 2020 (CEE Bankwatch Network, 2021[9]).

In spite of the aging fleet of thermal power plants (TPPs), few plants are scheduled for decommissioning and new plants are in the pipeline. Installed TPP capacity has remained constant since 2016, although due to some increase in renewables capacity, the share of fossil fuels in total installed capacity fell from 52% in 2016 to 48% in 2020. In Serbia, a 350-MW unit in the Kostolac B3 TPP is scheduled for completion by the end of 2022. Planned construction of a new 450-MW unit at the Tuzla TPP in Bosnia and Herzegovina has not yet been officially cancelled by the state-owned utility, EPBiH, despite an infringement case brought by the ECS. The Secretariat launched a second infringement case in April 2021, concerning Montenegro’s Pljevlja plant, which does not meet the standards of the Industrial Emissions Directive (IED) and has therefore reached the end of its useful life. Although new TPPs are still in the pipeline, some projects have been cancelled. In Kosovo, the state-owned production company Energy Corporation of Kosovo (KEK) cancelled (December 2020) a tender for a feasibility study on rehabilitation of the Kosovo A plant. In Serbia, the government instructed the state-owned production company Elektroprivreda Srbije (EPS) to halt the building of a new 350-MW unit in the Kolubara B TPP (Energy Community Secretariat, 2021[11]). North Macedonia’s Oslomej TPP was scheduled for decommissioning in 2021 but is still operating.

Technical losses (transformation, transmission and distribution) add to the challenge of low energy efficiency. In 2019, distribution and transformation losses in Western Balkan economies amounted to almost 29% of primary energy consumption, compared with an EU average of 23% (Figure 14.7). In 2014, average transmission and distribution (T&D) losses across the region were as high as 16.6% of total electricity output, almost tripling the EU (6.2%) and OECD (6.3%) averages (World Bank, 2021[15]).

On the demand side, high energy intensity reflects low levels of energy efficiency, particularly in residential and commercial buildings. Households account, on average, for 32.4% of final energy consumption in Western Balkan economies compared with 26.9% in the EU (2019) (Eurostat, 2021[14]). According to the IEA and the World Bank, potential energy savings in the region could be as high as 10% in the transport sector, 10-35% for households, 35-40% in the public sector, 10-30% in services and 5-25% in industry and commerce. The share of energy consumption corresponding to buildings ranges from 30% in Bosnia and Herzegovina to almost 50% in North Macedonia (World Bank, 2018[16]), with estimated potential energy savings ranging from 20% to 40% (World Bank, 2018[16]).

Buildings in Western Balkan economies are poorly insulated, while space heating is often based on outdated and polluting devices. The vast majority of the housing stock in the region is outdated, having been built in the 1950-80s before proper energy efficiency standards were established. In turn, many buildings constructed since 1990s were built without regard to energy efficiency standards (EBRD, 2016[17]). A large share of buildings are heated with inefficient stoves and boilers that use wood, lignite and coal and other solid fuels such as waste (Figure 14.8), and many buildings are poorly insulated (World Bank, 2020[18]; Eurostat, 2021[14]). The share of households equipped with central heating systems or having access to district heating ranges from less than 10% in Montenegro to over 40% in Serbia (Đurić, Krstić and Jović, 2019[19]). Penetration of heat pumps remains negligible.

The Western Balkans region boasts a significant share of renewable energy. Based on the definition of the 2009 EU Renewable Energy Directive (RED) (2009/28/EC), renewables (including biofuels) account for 18.2% of final energy consumption in the Western Balkans in 2019, against only 10.2% in the EU (Eurostat, 2021[14]). This puts most of the region close to or even above the EU-wide target of 20% of renewables in gross final energy consumption set out in the RED, which the regional economies adopted in 2012 (Figure 14.9 - Panel A).

Fuel wood – a major pollutant – accounts for a large share of this renewable energy. Some 60% of the region’s renewable energy supply stems from biofuels – mainly fuelwood used for heating and cooking (Figure 14.9 - Panel B). In terms of final energy consumption, this share climbs to 88% (Eurostat, 2021[14]). Although counted as a (traditional) renewable energy source, outdated equipment (stoves and ovens) and current practices (e.g. burning undried wood) render biomass (fuel wood) a major contributor to PM2.5 emissions, which are associated with heavy air pollution and high premature deaths in the region (World Bank, 2017[20]).

Modern, cleaner biomass offers potential, but remains untapped. The share of modern biomass in final energy consumption is very small in the Western Balkans (World Bank, 2018[16]). While woody biomass is widely used, additional biomass supplies could be tapped through woody biomass residues, agriculture, and energy crops. Agricultural biomass alone is estimated to be able to cover 25% of heat demand in the region (World Bank, 2017[20]). To date, EU provisions on the sustainability of biofuels have been transposed only in Serbia and Montenegro; none of the Western Balkan economies have established an operational system for verifying biofuel sustainability. Through such a mechanism, producers or users of biofuels or bio-liquids could show compliance with the sustainability regime of the EU Directive 2009/28/EC (Energy Community Secretariat, 2021[11]; Energy Community Secretariat, 2020[12]).

Hydropower is the second-largest renewable source (after biomass) and has been heavily prioritised by planning and incentives. Across the region, hydropower accounts for 36% of total renewable energy supply (Figure 14.9 - Panel B) and makes up a full 93% of renewables in electricity generation (Figure 14.10 - Panel A). Total installed hydropower capacity is about 8.2 GW, with 7.4 GW from large plants and 0.8 GW from small hydropower plants (SHPPs). Renewable energy action plans, formulated following a 2012 decision by the Energy Community Ministerial Council, lean heavily on hydropower, with targets ranging from 79% of planned power from renewable sources in Kosovo to 96.5% in Albania (Figure 14.10 - Panel B). To meet these targets, the economies introduced incentives schemes directed largely at hydropower, not wind or solar (WBIF, 2019[21]). In North Macedonia and Serbia, for example, there is no limit on the number of SHPPs that can benefit from feed-in tariffs (FiTs), while the solar capacity allowed to benefit such incentives is very limited (CEE Bankwatch Network, 2019[22]).

Hydropower incentives have particularly benefitted SHPPs, causing significant environmental and governance challenges. With renewable energy action plans predominantly aimed at expanding hydropower, the Western Balkans have experienced an SHPP boom: the number of such plants more than quadrupled over the last decade (CEE Bankwatch Network, 2019[22]). While SHPPs remain secondary in electricity generation, they create significant environmental destruction and absorb financial incentives that could otherwise be directed to other types of renewables. They are also often liked to corruption and illicit permitting (Box 14.4).

Use of wind and solar power remain much below potential, despite these technologies having become far cheaper in recent years. Together, wind and solar account for only 3% of total energy supply (Figure 14.9) and 6% of renewable electricity generation across the region (ranging from 1% of renewable electricity generation in Albania to 30% of renewable electricity generation in Kosovo). In 2020, total installed capacity amounted to 674 MW of wind power and 109 MW of solar, representing only small shares of the estimated, cost-competitive potential of 12.2 GW (5.5%) for wind and 4.4 GW (2.5%) for solar (IRENA, 2017[29]; World Bank, 2018[16]). Albania and North Macedonia have introduced auctions of renewables; the other economies have yet to launch such schemes. Particularly slow growth of renewables in 2020 may be related to the COVID-19 crisis (Energy Community Secretariat, 2021[11]). The role of both wind and solar in current renewable energy plans does not yet reflect dramatic cost reductions for both types of energy, which, since 2010, have dropped by 39% for wind power and by 82% for solar (IRENA, 2019[30]).

Electricity prices charged to households in the Western Balkans are often below production costs, generating significant deficits of between 1% and 6% of GDP.1 Contrary to practice in the EU, electricity prices for households in the region are generally lower than those charged to industry – and often lower than the operating expenses per unit of energy. At EUR 0.0679 per kilowatt hour (/kWh) on average in the Western Balkan region before taxes (which are minimal in the region) in 2020, prices were significantly below the EU average of EUR 0.127/kWh (Figure 14.12 - Panel A). This results in deficits for electricity producers: Albania and Montenegro had the largest revenue shortfalls, at 6% of GDP, driven mainly by below-cost recovery tariffs. Overall, below-cost recovery tariffs represented about 70% of the revenue gap, with distribution losses ranging between 10% and 30% and underbilling responsible for the remaining shortfall (World Bank, 2018[16]).

Despite artificially low prices, the cost of electricity for households as a share of income is relatively high, making price increases politically unpalatable. For a typical Western Balkan household, annual electricity consumption of 5 000 kWh costs 7.4% of annual GDP per capita, compared with only 3.6% across the EU (both including taxes and levies). This implies a higher cost burden on household budgets in the Western Balkans (Figure 14.12 - Panel B). Bringing the average household electricity price in the region in line with the EU average would push the annual households electricity cost up to 11% of GDP per capita, excluding taxes – and to 19% if the EU tax burden were to be applied. Under these circumstances, increasing electricity prices carries a high social cost, which helps explain current political resistance to taking this step.

To compensate state-owned producers for losses linked to below-cost prices, governments subsidise these enterprises in a variety of ways. Subsidies typically fall across three categories: fiscal support (debt write-off, tax concessions, state loans and direct budget transfers); public finance support (state guarantees for the construction of new coal-fired TPPs); and enterprise investment support (pass-through costs in regulated tariffs or shareholder contribution for investment). Subsidies may also include the toleration of non-payment of taxes and other liabilities to the state (Miljević, 2020[34]). The largest share of public finance support to power-sector SOEs is in the form of loans from state-controlled institutions and loans guaranteed by the state. In Serbia, guarantees and loans to power-sector SOEs are most prevalent; over the period 2018-19, guarantees for coal-based electricity generation alone reached almost EUR 1.2 billion. In Bosnia and Herzegovina, such loan guarantees amounted to more than EUR 742 million in 2019. This type of support represents a fiscal risk for the region’s governments in the case of insolvency of the SOEs (Miljević, 2020[34]).

Most of this government support to SOEs in the Western Balkans subsidises coal (except for Albania). Direct subsidies to coal amounted to EUR 73 million in the region in 2019 (Figure 14.13). While this is significantly down from 2015, it does not suggest that governments have abandoned the use of subsidies. Rather the decline reflects lower interest rates on government bonds and commercial loans used in calculating direct subsidies as well as the absence, in 2019, of write-offs of debts and receivables in the coal sector (Miljević, 2020[34]).

Subsidies and artificially low electricity prices have locked in public resources and continue to prevent fair competition for alternative electricity. When electricity prices are below production costs, it has the negative effect of disincentivising private investment in electricity generation capacity. It also prevents the establishment of a level playing field that ensures market competition and liquidity (UNDP, 2011[35]). Such subsidies also generate wasteful spending of public resources (Miljević, 2020[34]). In addition, electricity prices below operating expenses lead to a shortage of financial resources for the maintenance of energy infrastructure. As a result, electricity markets in the Western Balkans are heavily dominated by incumbent state-owned electricity companies, with a downward trend visible only in North Macedonia (Energy Community Secretariat, 2020[12]). The share of electricity produced by the largest supplier in each market varies from 37% in Albania to 100% in Kosovo (Figure 14.14). These monopolistic market structures impede competition among various suppliers and make it difficult for new enterprises (e.g. those generating from renewable sources) to enter the market.

With infrastructure aging, and commitments made to boost competition and improve regulation, pressure will increase to reform subsidies and SOEs in the Western Balkans. Article 18 of the ECT generally prohibits practices that impede free competition among undertakings.2 Economies in the region have committed to further deregulation of domestic wholesale markets and the establishment of organised power markets. Meanwhile, the infrastructure of state-owned utilities continues to age. Without real competitors and benefitting from continuous state support, governance of SOEs has become inefficient, for example through overemployment or illiquidity. Going forward, to become viable corporate entities, these companies will need to reform (World Bank, 2018[16]).

Within the context of the Energy Community, the Western Balkan economies have committed to reform and adopt EU legislation on energy. The Energy Community, founded in 2006, provides the framework for the region’s energy transition in the context of European integration. Through the Energy Community, the Contracting Parties have committed to implement the relevant EU energy acquis communautaire as well as the accumulated legislation, legal acts and court decisions that constitute the body of European Union law.

The EU’s Third Energy Package of 2009, the Sofia Declaration of 2020 and the Clean Energy for All Europeans Package of 2021, form the basis for bold commitments towards reform and climate neutrality (Box 14.5). The Third Energy package is a core element of the legislation to which Western Balkan economies have committed through the Energy Community Treaty. It encompasses the following five areas: unbundling, independent regulators, co-operation among regulators, cross-border co-operation, and open and fair retail markets. Through the Sofia Declaration on the Green Agenda for the Western Balkans, the region has also committed to concrete actions towards the EU’s 2050 climate neutrality target. The 2020 Sofia Declaration foresees the alignment of the Western Balkans with the future European Climate Law, which proposes a legally binding target of net zero GHG emissions for the EU by 2050. Key legislative acts of the Clean Energy for All Europeans Package as well as the Energy Community Decarbonisation Roadmap were adopted by the Energy Community’s Ministerial Council on 30 November 2021. They will strengthen the legal basis for decarbonisation (Energy Community Secretariat, 2021[11]).

Within the broader context of the UNFCCC COP process, several economies in the region have put forward increasingly ambitious emissions reduction targets, but more will be necessary. Nationally Determined Contributions (NDCs) summarise how economies plan to reduce GHG emissions under the COP21 Paris Agreement. The NDCs originally submitted by Western Balkan economies lacked ambition: with the exception of Montenegro, all pledged to increase their GHG emissions as compared to 1990 levels - and some even against current levels.3 In 2021, in line with the Paris Agreement’s call for economies to submit updated NDCs ahead of COP26 (November 2021), Bosnia and Herzegovina, North Macedonia, Albania and Montenegro submitted more ambitious NDCs (Table 14.2). However, targets in these NDCs are not yet sufficiently ambitious to achieve climate neutrality by 2050. Serbia is the only economy in the region that has not yet submitted a more ambitious enhanced NDC while Kosovo is not a party of the UNFCCC and therefore does not have a NDC.

While obstacles remain, Western Balkan economies have made progress towards harmonising their legal and regulatory frameworks with the EU Internal Energy Market, particularly in deregulating wholesale and retail energy markets. Since signing the Energy Community Treaty in 2005, Western Balkan governments have made significant progress towards establishing a competitive and integrated electricity market. With the exception of Bosnia and Herzegovina, and Serbia, the economies have transposed most EU legislation related to establishing an independent transmissions systems operator (TSO) and independent distribution systems (Table 14.3). Remaining obstacles in unbundling tend to be with functional implementation. In Serbia, for example, while the distribution system operator is legally unbundled, functional unbundling requires government approval of amendments to the founding act of the distribution system operator.

Western Balkan economies have accelerated their establishment of day-ahead markets, a prerequisite for market coupling and for connecting the region’s small electricity markets into a competitive regional one. Serbia’s South East European Power Exchange (SEEPEX) has already been operational for five years; with the exception of Bosnia and Herzegovina, other economies in the region are close to setting up day-ahead markets. In June 2021, ALPEX (the Albanian power exchange company) launched a new tender for a service provider of a day-ahead and intraday market platform in Albania and Kosovo. North Macedonia also recently launched a tender (closed in July 2021) for the provision of a day-ahead trading platform (Energy Community Secretariat, 2021[11]). In 2020, day-ahead market price and electricity prices for industrial customers (not counting taxes and levies) converged to equivalent prices in the EU while household prices remained below 50% of the EU average. The Clean Energy Package, and reciprocal application of the capacity allocation and congestion management (CACM) regulation (Box 14.6), provide the foundation for a legally binding framework for market coupling. It would be important to adopt such a framework as soon as possible (Energy Community Secretariat, 2021[23]; Energy Community Secretariat, 2021[11]).

Overall, progress on transposing legal and regulatory frameworks contrasts with low levels of implementation and enforcement, as well as the limited capacity of Western Balkans institutions to manage the transition. Factors that limit the rate of implementation include the diversity of economy-wide markets and the ability of Western Balkan governments to address key challenges in their domestic markets. That includes aforementioned market structures that may not favour competition, such as vertical and horizontal concentration by SOEs, limited access to guaranteed primary energy supplies, differences in investment strategies and/or priorities, and below-cost pricing policies. Political tensions among Western Balkan economies have also constrained regional energy co-operation (World Bank, 2018[16]).

Western Balkan governments have frequently adopted energy and environmental legislation that later is only partially enforced. Examples include the previously mentioned lack of compliance with air quality standards and with integrated prevention and pollution control (IPPC) permits,4 poor enforcement of European state-aid rules pertinent to coal subsidies, and slow progress in establishing fully integrated and competitive electricity markets – and, to some extent, gas markets (CEE Bankwatch Network, 2020[50]; Energy Community Secretariat, 2020[12]). Strategic documents for a low-carbon transition often languish without being implemented. National institutions in Western Balkan economies rarely sanction this lack of enforcement, or breaches of adopted energy and environment legislation.

Political interference, particularly in SOE governance, plays an important role in the slow pace of reform. Evidence suggests that white-collar corruption and rent-seeking inhibit attempts to reform SOEs, as do clientelist relationships among SOEs, ruling political parties and industrial lobbies. There is insufficient application of the corporate governance principles of separation of ownership, policymaking and oversight (World Bank, 2018[16]). Similarly, despite progress towards regulatory independence, extensive political interference remains a persistent obstacle to the full independence of regulatory authorities (European Commission, 2020[51]).

Even in economies in which the legal framework governing the activities of the energy regulator is in line with the acquis, the regulator may lack de facto independence or adequate authority. Albania’s Energy Regulatory Authority (ERE), for example, lacks the right to impose measures that promote competition, to require transmission and distribution system operators to change their terms and conditions, and to raise the level of penalties it can impose. In another example, North Macedonia’s government has challenged the Energy Regulatory Commission’s independence to define prices for the universal electricity supplier. Other Western Balkan governments are similarly hesitant to provide their energy regulators with full independence (Energy Community Secretariat, 2020[12]).

Lack of institutional capacity remains a challenge for regulatory authorities across the region. Lack of capacity, including qualified human resources, is a challenge for both energy regulatory authorities and environmental inspectorates. In turn, this poses challenges for effective enforcement of energy and environmental regulation. Although the Energy Agency of the Republic of Serbia (AERS) is legally and functionally independent, its staff capabilities remain insufficient to implement regulatory responsibilities under the Third Energy Package and newer elements of the acquis (European Commission, 2020[52]). To date, AERS has been unable to enforce the unbundling and certification of network operators or third-party gas access (Energy Community Secretariat, 2020[12]).

As Western Balkan governments do not perform regulatory performance reviews, the region lacks a comprehensive analysis of the current capabilities of regulatory institutions. A core premise of EU energy legislation is the assumption that competitive internal energy markets cannot exist without independent regulators who ensure application of the rules. Table 14.4 provides an overview of some of the most common challenges for energy regulators in the Western Balkans.

Building on the peer-learning process of this Multi-dimensional Review, this and following sections explore priorities for action (Box 14.2). The recommendations and suggestions aim to address the challenges outlined in the previous section, drawing on insights from experts and practitioners from across the region, as well as relevant experiences from elsewhere.

Adopting credible NECPs emerged from the peer-learning process as the top priority for the region’s energy transition, hoping that they will serve as fulcrums for action (Box 14.2). NECPs are part of the Clean Energy for All Europeans package adopted in 2019.5 This package aims to establish a new energy rulebook, to move away from fossil fuels towards cleaner energy and to deliver on the EU’s commitments for reducing GHG emissions under the COP21 Paris Agreement. NECPs address energy efficiency, renewables, GHG emissions reductions, interconnections, and research and innovation (European Commission, 2021[53]). Western Balkan economies are at different stages of the process of developing NECPs, North Macedonia and Albania being the most advanced (Table 14.5).

To fully play their role, NECPs must provide the basis for a convincing, credible vision that addresses key challenges. Alternatives must be put in place to allow for the decommissioning of coal. Subsidy regimes must be reduced and energy efficiency investments prioritised. Renewables will have to play a much larger role in the energy mix, which imposes infrastructure needs, such as more flexible electricity systems and plants (operating on natural gas) that can be fired or ramped up quickly, as well as more regionally integrated electricity markets that enhance flexibility. All of this will imply higher energy and electricity prices, as well as job reductions in coal-dependent industries, which will need a social policy response. Last but certainly not least, investors must be able to trust in the direction of momentum and the rules to be applied.

A credible vision would need to recognise that, whereas intermittent renewables are a key part of the solution in the Western Balkans, baseload capacity is also required. The question of how to replace coal fired baseload in the region remains unresolved (see Section 14.3.1). Policy makers need to address - up front – the challenge of either converting or replacing existing coal-fired plants to serve as sources of baseload. Aside from natural gas, few existing technologies offer cleaner options for baseload in the region.

Large capital investments are needed to either convert or replace existing coal plants with cleaner alternatives. Energy infrastructure requires large up-front investments, amortised over several decades. This holds true for converting or replacing existing coal plant with natural gas fired plants and for creating a transport infrastructure for natural gas (see Section 14.7). For less mature baseload technologies, such as deep geothermal energy, capital costs will be higher at least until these technologies mature.

A credible vision would need to strike a balance between radically strengthening regional integration, and to retain control of domestic energy supply. This is no different from the priorities of other European countries; few countries wish to be entirely reliant on energy imports. Until cleaner options are available for implementing a minimum level of low-carbon domestic energy production, coal fired plants are likely to remain the norm for this role in the Western Balkans.

Defining a holistic approach to the role of energy sector within the fiscal structure of each economy is necessary; this approach would need to be clearly communicated to citizens. While current energy subsidy regimes in the Western Balkan economies reduce energy costs for citizens, they come at an enormous fiscal cost – 1% to 6% of GDP. In turn, this significantly reduces the ability of governments to provide other services to citizens. Citizens will need to be convinced that more efficient, means-tested ways of reducing energy costs will strengthen provision of services.

Governments will need to ensure that energy reform brings clarity and cohesiveness to the body of existing laws, plans and strategies. All Western Balkan economies have either adopted or drafted a low-carbon development strategy. However, these often remain at odds with other frameworks, such as energy strategies that allow for building new coal rather than phasing it out (as in the case of some economies in the region such as Kosovo). Most National Energy Efficiency Action Plans and Renewables Development Strategies (except for North Macedonia and Serbia) are outdated and have not been updated or replaced by new strategic documents (Table 14.6).

For a credible transition, Western Balkan governments will need to reform or eliminate policies and practices that work against deregulation and liberalisation. Western Balkan economies have implemented many of the formal structures of a deregulated, liberalised and regionally integrated energy market. In reality, entrenched policies and practices often hinder full implementation of these market reforms. Importantly, unbundling, third-party access and market liberalisation are unlikely to be effective as long as incumbent state-owned utility companies continue to have production costs covered by different forms of subsidies that allow them to sell energy below cost.

A broad and inclusive public consultation process can help ensure that a vision is well designed and widely accepted by society. A good vision should secure buy-in from governments, citizens, the private sector and civil society alike, and should help generate motivation for climate action. Participatory dialogue with all stakeholders in society combined with investment in new skills and qualifications is also crucial to ensure that there is a “just transition” and that nobody is left behind in this process. Western Balkan governments have committed to adopt and implement relevant EU energy and climate legislation, including energy efficiency, renewable energy and climate targets. However, regional and local consultations have played only a limited role in the process and more can be done. The EU’s own consultative process towards the EU Green Deal could serve as an example for developing and securing support for such a vision (Box 14.7).

Broad participation remains to be further developed across the region. At present, the private sector is not sufficiently included in energy and climate policy making in Western Balkan economies or in the design and adoption of strategic documents, including NECPs. Fora for public-private dialogue exist in some economies such as the National Economic Council (NEC) in Albania, the National Council of Economic Development of Kosovo (NCED) and the National Council for Sustainable Development in North Macedonia. However, these institutions tend to discuss a variety of topics rather than dealing exclusively with energy and climate policies. They also lack visibility (Green Development Republic of North Macedonia, 2018[54]; NCED, 2019[55]; UNECE, 2019[56]; Varfi, 2015[57]).

Representatives of civil society and academia are rarely included in these fora or are underrepresented. An exception is North Macedonia, where the National Coordinative Body for collaboration with civil society organisations (comprising more than 100 CSOs) is active in the field of environmental protection and is consulted regularly by the Ministry of Environment and Physical Planning.6 There is a lack of public consultations on strategic documents and legislation on energy and climate policies, including the development of NECPs, and public consultations lack visibility and impact.

Parliaments could also play a more proactive role. To date, parliaments are often not sufficiently consulted and involved in decision-making processes related to energy and climate, such as the development and adoption of NECPs and setting targets for emissions reduction and climate neutrality. As a consequence, such policies and documents risk not being based on a sufficiently broad consensus of all stakeholders and having a lack of public support.

Full implementation of the Aarhus convention could improve public consultations and the role of civil society in a green recovery. The United Nations Economic Commission for Europe (UNECE) Convention on Access to Information, Public Participation in Decision-Making and Access to Justice in Environmental Matters (Aarhus Convention) was adopted on 25 June 1998 in the Danish city of Aarhus (Århus) at the Fourth Environment for Europe Ministerial Conference. It aims at empowering the role of citizens and civil society organisations in environmental matters. The Aarhus Convention establishes a number of rights for individuals and civil society organisations with regard to the environment (UNECE, 2021[58]). The Aarhus convention has been ratified by all Western Balkan economies, except Kosovo.

A credible vision must be based on a bottom up approach. Such a vision should start with commitments made at the city and municipality level. 76 cities in the five Western Balkan economies have already joined the Global Convent of Mayors for Climate and Energy (five in Albania, 49 in Bosnia and Herzegovina, five in North Macedonia, three in Kosovo and 14 in Serbia). The Global Convent of Mayors for Climate and Energy is a global coalition of city leaders, established in 2016, seeking to address climate change through local action at the city level and by pledging to cut GHG emissions at the city level (Global Convent of Mayors for Climate and Energy, n.d.[59]).

Raising awareness and helping citizens become involved is an important pillar for achieving a credible vision for the low-carbon transition in the Western Balkans. Public campaigns on climate change and the advantages of renewables and energy efficiency could improve public awareness of these topics in Western Balkan economies. Communication campaigns at economy-wide and local levels should be organised to target specific groups on specific issues such as the benefits of heat pumps over fuel wood. Low-income households, youth and women are particularly important target groups. Energy, climate and environment issues also need to be more present in the media. Bosnia and Herzegovina already organises informational-motivational public campaigns on energy efficiency and renewable energies, financed by the Federation of Bosnia and Herzegovina’s Environmental Protection Fund and Republika Srpska’s Environmental Protection and Energy Efficiency Fund (Ministry of Foreign Trade and Economic Relations of Bosnia and Herzegovina, 2017[63]). In Kosovo, the Kosovo Green Festival has been organised annually since 2016. Originally established by USAID, it is now led by the private sector. The festival allows local companies to display their green products and services, mainly related to renewable energies, energy efficiency and recycling. The largest green energy event in Kosovo, the festival makes important contributions to raising awareness on the benefits of renewable energies, energy efficiency and recycling (USAID, 2021[64]). Public campaigns on energy efficiency, including educational activities for the public sector, have also been organised in Serbia in 2021-22.To raise awareness and help citizens get involved in the low-carbon transition, beyond public campaigns, it is important to inform citizens and organisations about the specific costs of pollution and benefits of a clean energy transition for them. For example, parents and caregivers should be informed about the impacts of air pollution on their children’s health and life-long development (this could, for example, be done by health care practitioners). Public officials should be informed about the necessity and benefits of biodiversity and healthy ecosystems. Cities and municipalities need to be made aware of the economic costs of not adapting to climate change.

Improved teacher training on energy, climate and environmental education and better incorporation of these topics in school curricula could contribute to emphasizing the climate transition in schools. It is important to better incorporate energy, climate and environmental education in both primary and secondary school curricula. In parallel, teacher training – both initial teacher education (ITE) and continuous professional development (CPD) – on these topics needs to be improved. Continuous and regular training for teachers is required in order to keep teachers informed about the latest technological and scientific developments. At present, CPD for teachers is limited in many Western Balkan economies (Meha, Idrizi and Sjediu, 2019[65]).

To deliver on commitments, Western Balkan economies require both GHG inventories and effective GHG reporting, monitoring and verification mechanisms. Currently, only Montenegro has an effective up-to-date GHG inventory. Western Balkan economies either completely lack GHG reporting, monitoring and verification mechanism (Albania, Kosovo, Serbia, Bosnia and Herzegovina) or face challenges in effective management of existing mechanisms (North Macedonia). GHG inventories and GHG reporting, monitoring and verification mechanisms are both prerequisites for the development, implementation and monitoring of NECPs and for meeting GHG emissions reduction targets.

Government co-ordination and co-operation in energy and climate policy making needs to be improved. Effective energy and climate policy making, including for GHG emissions reduction, cannot rely solely on energy and environment ministries. It requires effective co-ordination and collaboration across all parts of governments and must be taken into account and integrated in finance, labour, taxation, transport, industry and agriculture policies (IEA, 2021[66]). The responsibilities of different institutions and sectors in meeting energy and climate targets need to be clearly defined.

Establishing an independent body for energy and climate policy making and co-ordination is one option. Western Balkan economies should consider establishing a Green Deal Council (or similar independent body) for energy and climate policy making and co-ordination, for organising public consultations and dialogue with stakeholders, and to inform and inspire nation-wide debate on such policies. The UK’s Climate Change Committee (CCC) is an example of such an entity. Established under the UK’s Climate Change Act of 2008, the CCC is an independent, statuary body tasked with advising the government and citizens on emissions reduction targets and reporting to parliament on progress in GHG emissions reduction and adaptation to climate change impacts. To ensure that bodies for energy and climate policymaking and co-ordination in Western Balkan economies have an impact, they must have sufficient political backing and visibility.

It would also be important to develop a system for regular monitoring and evaluation of implementation and compliance with energy, climate and environmental legislation. Such a system should include appropriate monitoring indicators and sanctions for non-compliance. Improving intra-institutional collaboration and co-ordination between government institutions and collaboration with civil society is key for successful monitoring and evaluation of implementation and compliance with energy, climate and environmental legislation. There is also a need to increase transparency by developing open access to key data such as supply, demand and transmission data.

To set the agenda for energy policy, Western Balkan governments need to strengthen energy regulators, while curbing the power of SOEs. As long as SOEs have the de facto last word on energy policy, energy sector reforms will remain incomplete. Fully functional liberalised energy markets require that regulators have the authority and capacity to enforce regulations vis-à-vis SOEs and other market participants. There is a need to strengthen regulatory authorities through training and capacity building, and legislating reporting requirements that aid decision-making.

Ensuring that energy sector regulators are entirely independent, vested with full authority to regulate market participants, and have the resources to do so is critical. Western Balkan governments need to ensure that regulators have the ability, as well as financial and human resources to implement their mandate. The independence of regulators is needed to be sure they are insulated from formal and/or informal exercise of political power designed to affect their decisions.

Deregulation and market liberalisation should be accompanied by measures to protect vulnerable customers (Energy Community Regulatory Board, 2020[67]). Protection of vulnerable energy consumers is embedded in the EGD. As an example, in the UK, suppliers and electricity distribution companies are required to maintain a Priority Service Register (PSR) for vulnerable customers while gas distribution companies must set up and maintain practices and procedures to identify domestic customers who may be eligible for additional services (Ofgem, 2019[68]).

Phasing out coal and fossil fuel subsidies in the Western Balkans is likely to result in job losses and social challenges that must be managed. Across five of the six Western Balkan economies (Albania does not have coal production), the coal industry employs more than 30 000 people. The majority – over two-thirds – work in open-pit coal mining and the remainder in power plants. While this is a small share of the 14.5 million people living in the five economies, mining and TPPs have for decades been the dominant employment options in regions that depend on coal (CEE Bankwatch Network, 2020[10]). Many small companies in those regions also depend directly on these industries, for example through links to supply chains of coalmines and TPPs. Almost half of coal-related employment in the Western Balkans is located in the Kolubara and Kostolac regions of Serbia (around 16 500 workers), followed by Bosnia and Herzegovina (Table 14.7).

The number of jobs in the coal and traditional power sector is already declining. In Serbia, more than 3 000 jobs disappeared in the Kolubara mining basin between 2017 and 2019; in the Kostolac mining area, the number fell from 2 000 in 2009 to about 1 500 in 2019 – despite new mines opening and increased production capacity. In Montenegro, the number of mineworkers has plunged by nearly half, from 1 200 in 2010 to 670 in 2019 (CEE Bankwatch Network, 2020[10]).

International experience shows that combining re-skilling programmes with financial compensation for coal workers is an effective policy option. Other countries may provide useful experiences with regard to handling the socio-economic consequences of phasing out coal (Box 14.8). A key takeaway is that re-skilling programmes show much better long-term results than simple payments. Possible job and training categories that correspond with the skills of former miners and workers include thermal retrofitting in the buildings sector, or other relevant jobs in construction and manufacturing.

A drive for renewable energy and energy efficiency promises to offer new employment opportunities. Compared to oil and gas sector investments, renewables and energy efficiency investments are more labour-intensive, and tend to be located closer to consumers. As such, the employment creation potential is estimated to be between 2.5 to 4 times larger for energy efficiency and 2.5 to 3 times for renewable energy (enervis, 2021[69]). This job potential could be tapped to offer new opportunities in current mining regions. In that process, the “Just Transition Plans” for Greece, Poland and Bulgaria, developed by the World Wildlife Fund (WWF)’s Regions Beyond Coal initiative – roadmaps for achieving a just transition through transforming coal regions and creating new, sustainable employment opportunities – could serve as inspiration for Western Balkan economies (WWF - Regions Beyond Coal, 2022[70]).

The Initiative for Coal Regions in Transition in the Western Balkans and Ukraine could support Western Balkan economies in tackling social challenges and job losses as a consequence of phasing out coal and mine closures. The Initiative for Coal Regions in Transition in the Western Balkans and Ukraine (launched in December 2020) aims to help economies and regions phase out coal to advance towards carbon-neutrality – while ensuring this transition is just. The initiative will deliver technical and financial support to coal regions in EU neighbouring economies, namely Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, Serbia and Ukraine. It is managed by the European Commission and six collaborating international partners7 (European Commission, 2021[71]). The initiative aims at providing an open platform that allows for region-wide, multi-stakeholder dialogue; as well as sharing of experiences, knowledge and best practices on transition-related issues.

Increasing the share of modern renewables in the energy supply requires market-based support mechanisms for both large-scale projects and self-consumers. The potential of wind and solar power remains largely untapped in the Western Balkans. While hydropower has a dominant role in renewable energy action plans, and receives a substantial share of incentives for renewables (e.g. feed-in tariffs), wind and solar energy are, so far, subordinate. Moving to market-based support mechanisms for renewables, by replacing FiTs with auctions, is a key component for scaling-up cost-competitive renewable energy sources. Establishing day-ahead and balancing energy markets is also key for successfully integrating renewable energy. In parallel, uptake of rooftop PV systems (still largely neglected throughout the region) could be boosted through improved support mechanisms for self-consumers.

Electricity production from renewables is variable and requires new approaches to system balancing. Unlike power plants that continuously generate electricity from controlled burning processes, or geothermal energy, electricity from wind and solar depends on weather and daylight conditions. As such energy is not continuously available, it cannot be dispatched at will. Fluctuations in electricity demand compound this challenge, as fluctuations in renewables supply and electricity demand do not always correspond (Pommeret and Schubert, 2019[75]). This disconnect means the generation system as a whole must be able to adjust production quickly in response to large fluctuations in electricity supplied from renewables (REKK Foundation, 2019[76]).

Current electricity systems in the Western Balkans lack the flexibility and baseload capacity to support a significantly increased share of renewables. The region’s coal-fired TPPs are largely outdated and slow to shut down and restart. In addition, intraregional trade in electricity remains limited. Albania is the only economy to make significant use of exports and imports for balancing its hydropowered electricity supply, which is sensitive to the availability of water resources and rainfall, both of which are highly variable. North Macedonia is the region’s only economy with a significant share of flexible natural gas in its electricity mix (16.3%) (Eurostat, 2021[14]). A regional study should be carried out to provide clear paths for baseload replacement, reflecting alternative options and economy interests (Box 14.9).

In the context of a regional solution for boosting renewables, Albania could serve as a “battery” of clean baseload. The most immediately feasible option to provide clean baseload in the Western Balkans may be a regional solution in which the hydropower potential of Albania (the only economy with significant reservoir capacity) provides energy storage services. To enhance this battery potential, Albania’s natural hydroelectric capacity could be supplemented with pumped hydro.

In the longer run, improved natural gas supply and infrastructure could be one option for altering the energy mix and baseload capacity in the Western Balkans, but comes with its own challenges. Quickly dispatchable power from gas-fired plants could possibly replace – in a much more flexible form – the baseload capacity currently provided by coal (Energy Community Secretariat, 2021[11]; REKK Foundation, 2019[76]). However, natural gas reduces emissions relative to coal by only 50% when producing electricity and by 33% when providing heat (IEA, 2019[77]). Moreover, significantly increasing the use of natural gas would require large investments in new pipelines and associated infrastructure, especially as care would have to be taken not to create over-dependence on a single supplier. The Trans-Adriatic Pipeline (TAP) has been operational since 2020, bringing 10-20 billion cubic meters per year (bcm/yr) from Azerbaijan (through Greece and Albania to Italy) via the Trans-Anatolian Natural Gas Pipeline. Completion of the TAP enables the potential construction of the proposed Ionian Adriatic Pipeline (IAP) from Albania (through Montenegro and Bosnia and Herzegovina) to Croatia, which would bring gas to the Adriatic part of the Western Balkans. The IAP is currently on the Energy Community’s list of Projects of Mutual Interest (PMI), which means it may benefit from streamlined permitting, regulatory incentives, cross-border cost allocation procedures and funding under the EU’s Instrument for Pre-Accession Assistance and the Neighbourhood Investment Facility.

Modern biomass could offer another baseload alternative, particularly in Serbia, Bosnia and Herzegovina and Montenegro. Large tracts of abandoned land could represent an opportunity to establish energy plantations. As forestry management and biomass production from wood require skills similar to those needed in mining, this could be a means to employ jobless coal miners. Diligent spatial planning and stringent environmental policies are required to guarantee the sustainability of biomass, to prevent excessive logging and deforestation, and to facilitate cultivation of energy crops on arable land. Also, reforestation efforts are required to increase forest productivity in the region. If mismanaged, biomass production for energy purposes can threaten biodiversity, water supply, food production and emission reduction goals. A carbon tax could help ensure that the positive effects of modern biomass outweigh the negative ones. Finland’s experience in advanced combined heat and power (CHP) production plants and integrated forest management could provide an example (IRENA, 2018[78]).

Flexible electricity systems would need more interconnections and a reinforced grid with storage solutions. Improved interconnection with neighbouring economies would allow for balancing through export and import. However, it would be important to make better use of existing interconnectors in the Western Balkan region before building new ones. In parallel, to absorb large volumes of electricity generated from renewables, the region’s T&D grids need to be modernised and combined with storage. Strategic planning of energy storage (including through electric vehicles [EVs]) and demand-response policies could make the region’s electricity systems more flexible. Germany, Norway and the United Kingdom are among the European leaders in terms of establishing energy storage facilities (Data Europa EU, 2021[79]).

Balancing markets must be liquid and competitive. Incorporating a large share of highly variable and intermittent renewable sources in the electricity mixes of Western Balkan economies will increase system balancing needs. As such, liquid, well-functioning and competitive intra-day balancing markets are a key ingredient for a low-carbon transition (Box 14.10) (Energy Community Secretariat, 2021[11]).

At present, Western Balkan economies have deregulated balancing markets, but they remain dominated by incumbents. To prevent dominant players from exercising market power, Western Balkan economies have pursued deregulation – with the exception of balancing capacity in Montenegro and Serbia. Procurement of balancing services is done in a market-based procedure in all Western Balkan economies. Price caps still apply, except in Albania and Kosovo. However, despite having established market-based balancing models, incumbent generation companies continue to be the dominant – or even the only – balancing service providers in domestic markets (Energy Community Secretariat, 2021[11]). Further liberalising balancing markets would lead to in a higher number of market participants, resulting in lower electricity prices in the long run.

Cross-border balancing co-operation could enhance competition and liquidity in balancing markets and improve their functioning, thereby reducing end-user electricity prices in the long run. The TSOs of Albania and Kosovo already signed an agreement to establish a common control block and are in the process of creating one integrated market for frequency restoration reserve (FRR). Bosnia and Herzegovina has started to establish an integrated market in the control block with Slovenia and Croatia. The TSOs of Serbia, Montenegro and North Macedonia have not yet started such processes (Energy Community Secretariat, 2021[11]). Closer regional co-ordination could improve the liquidity and stability of balancing markets, increase diversity of trade partners and create opportunities for trade of variable renewables amongst neighbouring systems.

Once liquid intraday markets have been established, it would be important to ensure that renewable producers are responsible for balancing. According to EU State Aid Guidelines, renewable producers with an installed capacity above 500 kW have full balancing responsibility (i.e. ensuring supply meets demand) once a liquid intraday market exists. Since liquid intraday balancing markets have not yet been established in Western Balkan economies, renewable energy producers in the region remain exempted from balancing responsibility. Most Western Balkan economies have introduced the balancing responsibility for renewable producers in legal frameworks, but the provision is not yet fully operational and effective (Energy Community Secretariat, 2021[11]).8

An efficient, regional certification system for renewable energy, compatible with the EU system, would help market development and future integration with EU energy markets. Such a certification system would allow guarantees of origin9 to be issued and traded among Western Balkan economies, and could be a first step towards integration with the EU certification systems and energy markets. At present, only Serbia has implemented an electronic system for the issue, transfer and cancelation of guarantees of origin; Montenegro is in the process of developing one (Energy Community Secretariat, 2020[12]; Energy Community Secretariat, 2020[83]). The Energy Community Secretariat is supporting Western Balkan economies in the development of a regional system of guarantees of origin through the project "Regional system of guarantees of origin in the Energy Community" launched in early 2022.

Western Balkan economies are gradually introducing market-based support mechanisms for renewables. Market-based support mechanisms such as renewable auctions and FiPs can improve transparency in the selection of investors for renewable projects, ultimately helping to bring down prices and reduce government costs for paying subsidies. Currently, FiTs exist in all regional economies, but some are gradually phasing them out or maintaining them only for small renewable producers. This is the case in Albania, which shifted to auctions for large producers (The Assembly of the Republic of Albania, 2017[84]; Energy Community Secretariat, 2020[12]). North Macedonia uses both FiTs and FiPs, and has been conducting renewable energy auctions since 2019 (Energy Community Secretariat, 2021[11]). Serbia adopted a Law on the Use of Renewable Energy Sources in 2021, which introduces auctions for large-scale projects but maintains FiTs for small renewable producers (Energy Community Secretariat, 2021[11]). Kosovo, and Bosnia and Herzegovina, have already adopted the legislative framework for auctions but not operationalised those yet. To date, none of the Western Balkan economies has established renewable quotas or a long-term auction schedule (Table 14.8).

At present, demand tends to outstrip incentives available for solar and wind. Given the lack of fully market-based support mechanisms and past preference for hydropower, the number of investors interested in solar and wind has been found to be higher than available incentives in Western Balkan economies, for example in Serbia and Bosnia and Herzegovina (CEE Bankwatch Network, 2019[22]).

Well-functioning, day-ahead electricity markets are a key prerequisite for market-based support mechanisms for renewables (Box 14.11). To fully operationalise market-based support mechanisms, in particular, sliding premium systems, day-ahead electricity markets are required. This would allow market participants to know the market price, and how much premium needs to be paid to top it up to the agreed amount (CEE Bankwatch Network, 2019[22]). At present, the Serbian power exchange (SEEPEX) is the only operational day-ahead market in the region (Energy Community Secretariat, 2021[11]) (see Section 14.1.5). In the long run, well-functioning day-ahead markets could result in lower end-user electricity prices (Energy Community Regulatory Board, 2020[67]).

Self-consumption, particularly from photovoltaic installations, remains in its infancy in the region, but must play an increasingly important role in the region’s energy transition. Self-consumers or “prosumers” are households that produce energy for their own consumption, while also feeding into and buying from the grid. Expanding self-consumption can mobilise significant solar power supply and provide additional income opportunities for households, especially in rural areas. However, so far installed renewable capacities by self-consumers remain negligible in the region, with 119 registered self-consumers in Kosovo, 42 in North Macedonia, 6 in Montenegro, 1 in Bosnia and Herzegovina and none in both Albania and Serbia (amounting to an installed capacity of 2.5 MW in total by the end of 2020).

The up-front costs of renewable energy infrastructure and artificially low electricity prices for households restrain self-consumers. Subsidised electricity prices for households in most Western Balkan economies (except Albania), discourage households from investing in solar PV rooftop systems and becoming self-consumers to reduce their electricity bills. At the same time, the up-front investment required - while associated revenues accumulate slowly – discourages investments in renewable energies.

Support schemes for self-consumers are in place across the region, but have scope for improvement. Net-metering and, preferably, net-billing schemes provide the basis for connecting rooftop PV power to the grid and enabling its economic use case. Such schemes exist in Albania, Kosovo and North Macedonia, and Serbia recently introduced the secondary legislation for such a scheme based on its Law on the Use of Renewable Energy Sources. At present, Albania’s support scheme for self-consumers is not fully operational. Scope exists to improve Kosovo’s support scheme for self-consumers by extending eligibility to more consumers and replacing net-metering with net-billing (Table 14.8).

The public often lacks awareness of the benefits of renewable energy and of relevant support schemes for self-consumers. This lack of awareness prevents renewable self-consumption from reaching its full potential (Energy Community Secretariat, 2021[11]).

In practice, connecting with the grid and feeding-in remains time-consuming, complex and cumbersome. Administrative procedures for authorisation, permitting and licensing to invest in renewables, for both self-consumers and large-scale projects, typically involve several procedures across multiple institutions and tend to be complex, cumbersome and time-consuming. Information on investment procedures is not always easily available. In Kosovo, it can take up to three years to execute the procedure, from getting preliminary authorisation for a renewable project to obtaining final authorisation and connection to the grid (E3 Analytics, 2020[85]; Energy Community Secretariat, 2020[12]; Ministry of Economic Development, 2020[86]). Similarly, in North Macedonia, procedures for land usage approval and obtaining construction permits for larger scale renewable projects can be slow. In Serbia, connecting rooftop PV systems to the grid is cumbersome and time-consuming, with information on the procedure being difficult to obtain (Energy Community Secretariat, 2021[11]). In Bosnia and Herzegovina, the procedure for installing renewables for self-consumption involves multiple institutions, several steps and a large amount of documentation; here again, detailed information on the procedure is not available.

One-stop shops could simplify, streamline and accelerate administrative procedures for investment in renewables. Improving processes and removing unnecessary administrative burdens and taxation could encourage more investment, particularly by self-consumers. One-stop shops could also improve co-ordination among the different institutions involved. Kosovo has adopted the legal basis for establishing such a one-stop shop, but has not yet established and operationalised it (Energy Community Secretariat, 2020[12]). Albania adopted the legal basis for a simplified procedure for investing in renewables for self-consumption, but has not yet operationalised it. Improving the availability of information on procedures is vital, for example by publishing detailed information in accessible formats on government websites.

Promoting energy communities is another way to facilitate collective investment in renewables for self-consumption, particularly in multi-apartment buildings. In multi-apartment buildings, legal and regulatory barriers, lack of clear ownership structures, poor definition of responsibilities and complicated decision-making processes hamper renewable self-consumption (see also Section 14.4). Energy communities and co-operatives could allow households and apartment owners in multi-apartment buildings to jointly invest in renewables for self-consumption. Energy communities already exist in North Macedonia and Croatia (Box 14.11) (Energy Sector and Investment Monitoring Center, 2021[87]).

Western Balkan economies require solar cadastres that calculate the electricity production potential of each roof, and detailed data on grid capacities including load profiles of different parts of grids. Solar cadastres could help identify where the potential for electricity generation and self-consumption is highest, and where self-generated electricity can most easily be fed into the grid. Consuming electricity as close as possible to generation reduces T&D losses. Several municipalities in Europe have demonstrated effective procedures that promote uptake. The city of Lyon (France) has a solar cadastre that maps the potential for 10 000 roofs (Grand Lyon, n.d.[88]). To determine where the potential for distributed renewables is largest, the city of Salzburg (Austria) combined its solar cadastre with information on its electricity grid. Solar cadastres are also essential to effectively integrate renewable energy policies in urban planning.

More human capital with skills and expertise required for investment in renewables is needed in the Western Balkans. To build such capacity, Western Balkan economies need appropriate curricula on renewable energy at technical, vocational and tertiary institutions (E3 Analytics, 2020[85]; IRENA, 2021[89]). There are shortages of skilled workers for installation, maintenance and quality assurance, in particular of solar panels and wind power (E3 Analytics, 2020[85]; IRENA, 2021[89]).

Enhancing energy efficiency in Western Balkan economies requires effective strategies for energy efficiency improvements, the mobilisation of sufficient financial resources and the development of less carbon-intensive heating systems. Western Balkan economies require comprehensive and widely accepted strategies for energy efficiency improvements, most importantly, in the building sector. In addition, there is a need for better incentives and frameworks to mobilise financing for energy efficiency improvements in buildings, including energy efficiency funds endowed with sufficient financial resources. The regulation for multi-apartment buildings, including the quorum for decision-making of homeowners associations and reserve funds, need to be reformed to facilitate energy efficiency improvements and rennovations in these buildings. The expansion of modernised district heating systems could replace inefficient heating devices. There is also a need to improve energy efficiency standards and energy efficiency skills in Western Balkan economies.

Western Balkan economies require comprehensive and widely accepted strategies for energy efficiency, along with clear designation of institutions responsible for implementing relevant policies and appropriate accountability mechanisms. Existing EU directives (Box 14.12), a widely accepted, shared vision and broad consensus on a low-carbon transition are the basis for designing effective strategic and institutional frameworks. Effective energy efficiency strategies would further need to be aligned with broader urban planning, since both are closely linked and go hand in hand.

At present, most economies in the region have failed to designate and hold accountable specific institutions and actors to oversee energy efficiency improvements, including whether strategic documents are implemented and targets are met. As a result, energy efficiency policies are not centralised at one institution and often remain fragmented. A lack of co-ordination among the different actors involved in policy making and implementation is also problematic, as is the fact that institutions in charge of energy efficiency policies often lack financial and human resources.

Energy efficiency laws have been put in place, but implementation lags. Energy efficiency legislation, including energy efficiency laws and laws on the energy performance of buildings, have been adopted in all Western Balkan economies. Actual implementation of these laws and adoption of secondary legislation has been slow. So far, none of the region’s economies have adopted a building renovation strategy. Some (with the exception of Kosovo and Serbia) have established building inventories and building typologies, including a classification of existing buildings according to different characteristics and estimates of their energy consumption. Only North Macedonia has adopted an up-to-date energy efficiency action plan. Dedicated institutions for energy efficiency have been set up only in Albania and Kosovo. Several of the economies have established energy efficiency funds, but their financial resources and scope of activities remain limited (Table 14.9).

Scope exists to improve regulations and policies that support energy efficiency in the public sector, and to strengthen implementation of existing policies. The possibility to incorporate energy efficiency criteria in public procurement processes exists in legislation in most Western Balkan economies, but this is rarely done in practice. As yet, none of these economies has embarked on an energy efficiency programme through utility companies (World Bank, 2018[16]).

Energy efficiency standards for equipment and buildings can be an important tool to enhance energy efficiency. Up-to-date energy efficiency standards for heating and cooling systems in Western Balkan economies could prevent future proliferation of inefficient devices (European Commission, 2020[52]). Adopting energy efficiency standards and principles for regular maintenance and renovation of buildings would ensure that repairs and renovation include energy efficiency improvements (USAID, 2020[91]).

Standards can only be implemented where the necessary expertise is available. Policy and training options must focus on overcoming shortages in technical expertise related to energy efficiency improvements and skilled professionals such as energy auditors and managers. While some progress has been made in capacity building programmes for energy auditors and managers, these need to be broadened and carried out in a sustained manner (Energy Community Secretariat, 2021[11]). There may also be a need to train maintenance and renovation providers (USAID, 2020[91]).

The financing gap for energy efficiency in the region remains large; at present, budgets depend largely on donor support. Total investment needs for energy efficiency improvements in buildings in Western Balkan economies amounted to EUR 3.5 billion between 2011 and 2020; however, only EUR 1.4 billion of financing were secured between 2010 and 2021 (Energy Community Secretariat, 2021[11]). As such, the financing gap remains large across the region, with the exception of Montenegro (Figure 14.16). Within government budgets, financial resources devoted to energy efficiency improvements tend to be limited, leaving these economies very dependent on donor support.

Financing the purchase of energy efficient equipment or energy retrofits is also challenging for households, which face high costs and limited incentives. In relation to local salaries, energy efficiency investment costs are high. Financial incentives and subsidies for energy efficiency improvements generally cover only a very limited amount, and often depend on donor funding. These programmes (often focused on improved insulation and replacement of inefficient heating devices with more efficient ones) tend to remain fragmented and do not scale-up. In addition, subsidised electricity prices limit the incentive for households to invest in energy efficiency improvements and energy savings. As a result, privately financed energy efficiency improvements in buildings remain limited.

Little experience with this kind of investment means access to finance remains limited for energy efficiency projects. Financing from financial institutions for energy efficiency improvements remains difficult to access, and is often subject to high interest rates. This reflects the limited creditworthiness of many households, and the fact that many financial institutions lack knowledge and are unfamiliar with energy efficiency lending - and thus perceive such lending as risky (World Bank, 2018[16]).

There is a need to improve access to public financing for energy efficiency measures. Western Balkan economies should scale up financial incentives for energy efficiency improvements in buildings, particularly those directed towards vulnerable households. Programmes and associated financing should be implemented on a national scale to increase the pace of energy efficiency improvements, benefit from economies of scale and create markets for energy efficiency goods and services. Programmes should become self-sustaining in the long run and expand as markets develop. Western Balkan economies should also prioritise the use of public funds for energy efficiency measures in unserved markets (e.g. low-income households, less credit-worthy public entities such as poorer municipalities) through higher subsidy levels. Economies in the region should further operationalise and improve the scope of operations and functioning of existing energy efficiency funds. Those funds’ low financial resources could be scaled up through revenues from environmental taxes, including a future carbon tax.

To mobilise private financing for energy efficiency improvements, Western Balkan economies could explore guarantee and regulatory options, such as energy efficiency service companies (ESCOs). Private financial institutions could be encouraged to increase energy efficiency lending through credit guarantees and other public support schemes. ESCOs, companies that deliver energy efficiency improvements financed through the cost savings derived from projects, are an effective option. Energy performance contracts commit ESCOs to install the necessary equipment, provide a performance guarantee, and establish the terms of up front and ongoing payments by customers. The energy service company (ESCO) model is based on calculations that the financial energy savings realised by the project will more than offset the cost (IEA, 2018[92]). To facilitate the development of ESCOs, Western Balkan economies should adopt and fully implement an appropriate legislative and regulatory framework. District heating companies could act as public ESCOs. As an example, Croatia started energy efficiency improvements of public buildings through ESCOs, with a pilot programme in 2012. Initial financing for the renovation of multi-apartment buildings was provided to ESCOs through the country’s Environmental Protection and Energy Efficiency Fund (EPEEF). This pilot programme triggered significant levels of investment, lowered the administrative burden, and enabled the entry of new companies in the ESCO market (EBRD/Energy Community Secretariat, 2020[93]). Private investment in energy efficiency could be promoted by facilitating partnerships among businesses to support energy efficiency measures (see Box 14.13).

Multi-apartment buildings make up a large share of residential housing in the Western Balkans, much of which exhibits poor energy performance. Some 39% of residential buildings in these economies are multi-apartment buildings (Energy Community Secretariat, 2021[95]). Most were constructed in the 1960s to 1980s under obsolete building standards and have been poorly maintained: as such, their energy performance tends to be poor. Many occupants of such buildings lack awareness of the financial and other benefits of energy efficiency improvements, and are unwilling to invest in the maintenance of common areas or refurbishment of those buildings (USAID, 2020[91]).

Homeowner associations face cumbersome decision making, low funding and limited capacity. Within multi-apartment buildings, homeowner associations determine how common activities will be managed. Generally, the collective decision making requires either a two-thirds majority or even unanimous consent for some matters. In the case of energy efficiency improvements, support is often quite low. At the same time, reserve funds for such buildings are either non-existent, have very limited financial resources or have strict rules that such funds can be used only for regular maintenance expenditure but not for energy efficiency improvements and renovation. Many or most owners have low income levels. Enforcing the collection of regular maintenance fees from homeowners often proves difficult (hence the low reserve funds) and seeking additional funds is next to impossible. Further, homeowner associations lack the institutional capacities for managing, designing and implementing the complex investment projects required for renovation and energy efficiency improvements (USAID, 2020[91]).

Unsurprisingly, commercial banks in Western Balkan economies are reluctant to lend to homeowner associations. Because of the absence of collateral and a credit history, banks perceive homeowner associations as highly risky borrowers. The involvement of multiple individuals (members) in decision making and the complexities of collecting regular contributions from members for loan repayment are additional disincentives (Regional Environmental Center, 2016[96]; USAID, 2020[91]).

Reshaping the rules on decision making and fee collection for homeowner association can reduce the perceived risk level. The experience of reforms in the Slovak Republic (Box 14.14) shows that an effective regulatory framework for homeowner associations – based on ease of decision making and effective collection of fees – can improve their standing in relation to financial institutions. It is necessary to adjust the regulations for self-governance, the quorum required for decision making (including for the adoption of energy efficiency measures), create and manage functioning reserve funds, and secure collateral for loans. The collection of mandatory fees for energy efficiency improvements and renovation in reserve funds could increase the down payment available and serve as collateral, thereby increasing the creditworthiness of the homeowner associations.

Credit guarantees and technical assistance for homeowner associations could further support energy efficiency improvements in multi-apartment buildings. State credit guarantees could improve access to loans for homeowner associations in the short and medium term. Energy efficiency improvements in multi-apartment buildings could also be financed by ESCOs. In addition to improved access to financing, homeowner associations may require technical assistance and capacity building to design and implement energy efficiency improvements and to increase the confidence of commercial banks to lend to homeowner associations (USAID, 2020[91]).

District heating plays an important role in some parts of the Western Balkans. Such heating systems represent around 14% of total heat demand in the region, compared with about 10% for the EU10 as a whole. It is particularly developed in Serbia, with 25% of households connected. In North Macedonia, Kosovo, and Bosnia and Herzegovina the share of households covered ranges from 6.7% to 12%. Albania and Montenegro have no district heating systems.11

Predominantly based on fossil fuels, district heating systems represent a challenge for the green transition in the Western Balkans. Existing systems in the region rely heavily on natural gas (67%), coal and/or lignite (21%), and petroleum products (9%). Systems in North Macedonia and Serbia rely largely on natural gas while coal is the main fuel in Kosovo and an important contributor in Bosnia and Herzegovina (where such systems are often fed by heat generated in power plants). Renewable energy, such as biomass and waste heat, represents only about 3% of total district heating production in the region (mainly in Bosnia and Herzegovina where biomass represents 25% of district heating) (Energy Community Secretariat, 2021[11]; Energy Community Secretariat, 2020[12]).

In their current configuration, district heating systems have high technical losses and billing provides no incentives for efficiency. Billing for district heating systems is often based on lump sums per square meter of heated space rather than on actual consumption. Some economies in the region, such as Kosovo and Serbia, have begun to renovate and decarbonise their district heating systems.

Modernised district heating systems could run on renewable energy and offer viable solutions for clean urban heat. Experiences from Sweden and Germany show that heat from renewable sources can be efficiently fed into district heating and become an important element of energy efficiency for buildings (IRENA, 2017[97]). To optimise existing district heating networks, Western Balkan economies should modernise them to incorporate clean energy, improve energy efficiency and reduce technical losses. Metering and billing should be based on actual consumption, to create incentives for households to adopt energy saving behaviours.

Incentivising installation of heat pumps and more efficient biomass stoves and boilers is an alternative in areas without access to district heating or the natural gas grid. Financial incentives could promote the uptake of heat pumps to replace inefficient stoves and boilers used for heating in such areas. Where this option is not feasible, the adoption of more efficient biomass stoves and boilers and the use of upgraded biomass fuels such as wood chips, pellets and briquettes could also been encouraged.

Public resources locked into coal subsidies, combined with below-cost low electricity prices, are arguably the most important policy hindrances to a low-carbon transition of the energy sector. Peer-learning participants identified ending coal subsidies among the top priorities across the Western Balkans region (Box 14.2). As discussed above, below-cost recovery tariffs, financed through a range of explicit and implicit subsidies, generate important costs for public sectors in the Western Balkan region. In parallel, continued “propping up” of inefficient coal-based SOEs is a major obstacle to moving the region onto a low-carbon pathway (Section 14.1.4).

To reduce the share of energy produced from lignite and coal, and the associated emissions and pollution, there is no alternative to removing subsidies and introducing carbon pricing. Scenario analysis shows that coal and lignite will persist in power generation and district heating, unless Western Balkan governments introduce carbon pricing and eliminate subsidies. Similarly, without realistic electricity prices that cover production costs and an appropriate carbon price,12 development of natural gas and renewable energy sources will remain limited. The region’s aged, inefficient and polluting fleet of coal and lignite plants would continue to be dominant. At present, uncertainties regarding the continued operation of these plants translate into reluctance to invest in their refurbishment. That, in turn, could threaten the security of energy supply (Kantor; E3M;, 2021[98]).

The region has committed to phasing out subsidies and introducing carbon pricing; to date, only Montenegro has introduced a carbon price. In the context of the EGD and the Sofia Declaration (Box 14.5), economies in the region have committed to phase out coal subsidies, align with the EU ETS and carbon pricing, and work with the EU towards the 2050 target of a carbon-neutral continent. So far, only Montenegro has started recognising the cost of CO2 emissions, applying from 2020 a carbon price starting at EUR 24 /t CO2. But about two-thirds of the emissions covered by the carbon price are exempted through free allowances (Energy Community Secretariat, 2021[11]). Some Western Balkan economies are planning the introduction of carbon pricing, such as Bosnia and Herzegovina which recently finalised a roadmap for the introduction of a carbon pricing scheme and emissions trading. Between 2016 and 2021, the EU ETS CO2 price increased 15-fold, from EUR 4.41 to over EUR 60 /t CO2; it is expected to average EUR 84 /t CO2 in 2022 and EUR 92 /t CO2 in 2023 (Reuters, 2022[99]). By not having to pay for CO2 emissions under the EU ETS, TPPs in the Western Balkans avoided costs of EUR 3 billion over the period 2016-20 (measured at the average EU ETS price) (Energy Community Secretariat, 2021[11]).

The EU’s proposed Carbon Border Adjustment Mechanism makes action urgent. Over the period 2023-26, the EU will be phasing-in a carbon border tax for imports of energy-intensive products, initially including electricity, iron and steel, aluminium, fertilisers, and cement. This will expose Western Balkans economies to significantly higher trading costs, particularly given its high level of trade with the EU and the structure of its exports, which includes many on the energy-intensive list. In the case that phasing out subsidies and introducing carbon pricing does not happen soon enough to avoid the EU carbon border adjustment, governments in the Western Balkans would need to prepare contingency plans (Young, 2020[100]).

As social acceptance is important, energy price reform must include support for vulnerable households. According to definitions in individual Western Balkan economies, the share of vulnerable customers for electricity ranges from 2% in North Macedonia to 7% in Kosovo (Energy Community Secretariat, 2021[11]). Other sources indicate substantially higher levels of energy poverty in the Western Balkan region than in EU countries. The EU Statistics on Income and Living Conditions (EU-SILC) show that 10% to 40% of Western Balkan households were unable to keep homes adequately warm in 2019 (Eurostat, 2021[101]). As removing fossil fuel subsidies and introducing carbon pricing are expected to negatively affect vulnerable households, appropriate policy measures will be needed.

Reforming coal subsidies requires a whole-of-economy approach and extensive evaluation. As the effects of fossil-fuel support typically spread far beyond the energy sector and its consumers, reform requires careful consideration of all desired changes and their potential adverse effects.

Four steps can help structure the reform effort and identify solutions that take account of those who stand to gain and those who will consider they have something to lose. Based on its global monitoring of fossil fuel subsidies, the OECD has developed a four-step reform process, each step of which can be tailored to fit economy contexts and underpin individual reform processes (OECD, 2021[102]). The framework proposes several analytical tools to facilitate each step, from identifying the most distorting government support measures to crafting alternative or complementary policies to mitigate any adverse impacts of reform. Including a full suite of assessments when designing reform measures should minimise the risk of political backlash that too often accompanies reform. The modular, sequential approach allows governments to undertake different steps in isolation, as they identify specific needs while building capacity to conduct analysis (Table 14.10).

Scenario analysis demonstrates that gradual introduction of carbon pricing combined with full market integration is most effective. Without the key benefit of market integration – i.e. cross-border sharing of balancing and reserves – governments undertaking wider reform would need to maintain domestic coal and lignite-based power production for baseload capacity. In turn, this would severely undermine development of renewable energy sources and the potential for new investments in natural gas. Additionally, market integration helps bring prices down through competition and optimisation of capacity use. By taking a gradual approach, with a transitional scheme during which different rates and timeframes for auctioning allowances apply, economies can accommodate different levels of flexibility to carbon pricing, smoothing the transition for emitters and consumers alike (Box 14.15) (Kantor; E3M;, 2021[98]).

A gradual introduction of carbon pricing would begin with emissions allowances, followed by domestic and regional trading, leading to full integration in the EU ETS (Table 14.11). Governments should consider cap-and-trade as the likely first and best policy option for introducing carbon pricing in power and district heating sectors. In turn, they should apply cap-and-trade in five stages. The usual first stage is to launch internal carbon pricing by emitters, involving issuance of internal certificates. This can then be expanded to include internal carbon pricing with introduction of trading at national level. Bilateral agreements between economies in the Energy Community can then facilitate cross-border trading. The fourth and fifth stages are adherence to the EU ETS under a transitional regime that allows for free allowances in parallel with auctioning, followed by full integration with the EU ETS and abolishment of free allowances (Kantor; E3M;, 2021[98]). Stable and reliable systems for monitoring, reporting and verification of GHG emissions are a pre-condition to implementing carbon pricing (Energy Community Secretariat, 2021[11]).

To support energy poor households efficiently, Western Balkan economies need to improve mechanisms to identify potential beneficiaries and increase coverage. By signing (in 2020) the Sofia Declaration, Western Balkan governments have committed to developing programmes to address energy poverty. The majority of economies in the region have defined vulnerable customers in legislation and have put in place measures for their protection. To identify beneficiaries, current energy support programmes generally build on existing social support programmes, with funds provided through government budgets. These programmes often have low coverage and suffer from implementation challenges, which means they sometimes do not reach those in need (Energy Community Secretariat, 2021[11]).

Means-tested support for vulnerable households is far less costly and more efficient than blanket subsidies for electricity prices. Fossil-fuel subsidies in the Western Balkans are not typically means-tested. As a result, they tend to benefit wealthier groups that consume more energy, while only a limited fraction benefits poor and economically disadvantaged groups. In Albania in 2018, only 22% of people in the lowest quintile were eligible for energy benefits – and only 16% of energy benefits accrued to such households (World Bank, 2018[16]). Instead of low electricity prices for everyone, subsidies should target those who struggle to afford electricity. Ukraine’s Housing and Utility Subsidy (HUS), which was extended to a large number of vulnerable and poor households in the context of the removal of energy subsidies, provides an interesting example for Western Balkan economies (Box 14.16).

Governments should include measures to address energy poverty in the preparation of NECPs. Given the magnitude of energy poverty in the region, separate programmes and policy documents to eradicate it need to be developed at local national and regional levels. Governments should develop bottom-up plans through participatory and transparent approaches that align with local development plans. Means-tested support for vulnerable households could include income-based support, such as social benefits or vouchers for a monthly allowance of electricity consumption. Other options include support for energy efficiency improvements, such as low-carbon heating technologies and insulation of residential buildings. In addition to reducing household consumption and energy bills, this would offset the negative impact removing fossil fuel subsidies is likely to have on disposable income. In addition to helping the poor, such compensation can enhance the political acceptability of subsidy and carbon pricing reforms (OECD, 2020[103]).

Welfare implications need to be taken into account when designing carbon pricing schemes. If introducing carbon taxes comes along with a reduction in other taxes, including those on labour and capital, this can stimulate job creation and investment. It can also improve economic efficiency, since carbon taxes are less distortionary than taxes on labour and capital (OECD, 2020[105]). Carbon pricing can also offer a source of public revenues that can be used to fund investment in clean technologies and mitigate negative effects of a carbon price for vulnerable populations.

Analysis of successful implementation of carbon taxes shows that several policy goals need to be considered in parallel. Carbon pricing pushes up electricity prices, which would negatively impact the competitiveness of export-oriented firms located in the Western Balkans (Muth, 2021[106]). Sweden, as a small, open economy with companies that could easily relocate, shielded export-oriented sectors from losses in competitiveness. When introducing its carbon tax in 1991, to provide these industries with predictability and time to adjust, Sweden taxed them at a lower rate than households and built several exemptions into the policy (Criqui, Jaccard and Sterner, 2019[107]).

To effectively recycle revenues from carbon pricing, it is important to consider the characteristics and challenges of each socio-economic system at a given point in time. Analysis by the Energy Community (Kantor; E3M;, 2021[98]), evaluates options for recycling carbon pricing revenue according to their economic performance and their social implications, using input-output multipliers to rank the different options (Table 14.13). A particularly interesting case is the “carbon-tax-and-dividend” scheme in the Canadian province British Columbia (Box 14.17).

An integrated and competitive regional electricity market would help with pricing, reliability, capacity utilisation and integration of renewables in the Western Balkans. Critically, a competitive regional market would increase efficiency in cross-border electricity trading and boost competition in electricity markets. In turn, this would lead to more efficient utilisation of electricity generation and storage facilities across the region – including across borders – thereby enabling balancing of generation surpluses and deficits. In creating capacity to better balance highly variable energy sources, regional integration of electricity markets could also facilitate a higher share of renewables in the region’s electricity mix. In the long run, regional integration would result in lower electricity prices - thereby countering the removal of subsidies - improve the reliability of electricity supply and reduce the need for new generation facilities (Energy Community Regulatory Board, 2020[67]). Successful regional integration would not only include better interconnection but also power exchanges and price coupling (Energy Community Regulatory Board, 2020[67]).

Within the WB6 Initiative, or Berlin Process, Western Balkan governments committed to develop a regional electricity market. Through the Initiative, which seeks to seeks to facilitate investments and regional market development, Western Balkan economies committed (in 2014) to implement essential preconditions for a regional electricity market, notably: i) establish power exchanges; ii) set up a regional balancing market; and iii) allocate interconnection capacity regionally through the Coordinated Auction Office in Southeast Europe (SEE CAO).13

The Western Balkan region has ample electricity interconnection capacity, a significant portion of which is largely underutilised. In all economies, the existing nominal transmission capacity of interconnectors is significantly higher than the installed generation capacity and system peak load. As such, they all satisfy the EU target of 10% net transfer capacity with respect to total production capacity (Energy Community Secretariat, 2021[11]). However, net transfer capacities14 in these economies were less than 30% of nominal transmission capacities for a major part of 2020 – significantly below the EU minimum target of 70% for electricity interconnector capacity for cross-zonal trading. As a result, overall physical energy flows among the economies remain limited (Table 14.14). Strengthening energy transmission would have several benefits (Box 14.18).

Low utilisation and net transfer capacities limits potential for cross-border baseload and reflects low competition and market dominance. This situation has negative implications for decarbonisation as low net transfer capacities limit the potential for cross-border electricity exchange to serve as baseload that supports integration of renewables. It also undermines the potential to foster competition in electricity markets across borders (Energy Community Secretariat, 2021[11]). The low levels of exploitation of trans-border interconnectors in the region reflect a lack of competition in electricity and gas markets, given their domination by SOEs.

To optimise capacity and investment, Western Balkan economies should focus on efficient usage of existing interconnectors, rather than on building new ones. National regulatory authorities, competition authorities and TSOs should build new cross-border connectors only where existing interconnectors are insufficient. To this end, before building any new cross-border projects, governments should implement cost-benefit analysis based on assumptions that existing interconnectors are fully utilised – and applying the highest possible net transfer capacity values in the calculations (Energy Community Secretariat, 2021[11]). As economies develop more renewable energy production capacity, the ratio between the interconnectors’ nominal transmission capacity and installed renewables generation will also become critical.

By re-evaluating – and potentially increasing – net transfer capacity values at borders, Western Balkan economies can support the integration of renewables and the decarbonisation of electricity sectors. Net transfer capacity values at all borders should be calculated more frequently through co-ordinated processes – and potentially increased. Alternatively or in parallel, markets should be coupled to fully benefit from market competition. TSOs should identify critical network elements that restrict the net transfer capacity values and propose solutions to relieve internal bottlenecks. Governments can boost net transfer capacity values by reinforcing internal networks (where internal congestion limits the net transfer capacity) (Energy Community Secretariat, 2021[11]).

Co-ordinated capacity calculation, as well as mechanisms to allocate and use this capacity, are important steps to creating efficient day-ahead and intraday markets. To advance regional integration, neighbouring control and market areas should be linked. In parallel, the Western Balkan bidding zone borders should be gradually integrated into EU capacity calculation regions.15 Key elements of this process would be to define technical standards and institutional arrangements such as settlement and payment mechanisms and dispute resolution.

Other European countries provide useful examples of measures to enhance the efficiency of cross-border trade in electricity, while also optimising production costs and electricity prices. One example is the Price Coupling of Regions system (launched in 2010), followed by the market coupling of 15 European countries (in 2014) to create a harmonised single electricity market. Through the submarine interconnector Nord Link, which became operational in mid-2021, Germany and Norway have set up a mutually beneficial co-operation strategy: electricity surpluses from wind farms in Germany can be sold on the Norwegian market; in exchange, when there is little wind, Germany can draw on Norwegian hydropower (European Commission, 2021[110]; Tennet, 2021[111]).

Co-operation among electricity TSOs in the region and the application of directives from the Energy Community are a prerequisite for regional electricity market integration, while co-operation would support regional economies in the energy transition. Holding regular meetings is one way to enhance TSO co-operation in the region. Collaboration should also be enhanced between neighbouring economies, in activities such as training electrical engineers, R&D, sharing expertise on system operations and planning and establishing regional co-operation among national regulatory authorities. Strong political will and regional solidarity are both required to successfully integrate regional electricity markets.

Countries in the Baltic region provide an example of successful TSO co-operation. The Baltic power system is highly integrated in terms of interconnection (a heritage from the Soviet era) and system stability. Successful market integration at this level created a base to expand co-operation in the wider region. In September 2020, eight Baltic Sea countries (Latvia, Lithuania, Estonia, Denmark, Finland, Sweden Germany and Norway) signed a joint declaration to co-operate on and accelerate the build-out of offshore wind projects in the Baltic Sea. Through intensified joint work in offshore wind development, the collaboration aims to strengthen political, economic and technological integration of the region (European Commission, 2020[112]; Wind Europe, 2020[113]).

The Western Balkans transition to a low-carbon society will be capital-intensive. As these economies have not yet completed their NECPs (or similar documents) to define their transition goals, it is challenging to estimate the volume of financial resources needed to reduce the carbon intensity of the region as a whole. Nonetheless, various agencies have made estimates, with the World Bank calculating the following figures: USD 15 billion of investments is needed before 2035, with about USD 10 billion for generation, and USD 5 billion for T&D (in 2010 dollars) (World Bank, 2018[16]).

By economy, investments needs range (on average) from 0.1% to 0.5% of GDP, with the type of investment differing. One breakdown (Kantor; E3M;, 2021[98]) details investment requirements over the period 2020-40 across the Energy Community countries, including Western Balkan economies, under five different scenarios: i) baseline; ii) baseline with a carbon border adjustment tax; iii) carbon pricing with market fragmentation; iv) carbon pricing with market integration; and v) gradual carbon pricing with market integration. The last scenario, which the study recommends, suggests that economies adopt carbon pricing in a co-ordinated way, under a transitional regime that allows different rates and timeframes for applying auctioning allowances. Under this scenario, investments are estimated to reach about EUR 800 million in each of Albania and Montenegro, while Serbia requires the largest investment -- EUR 3.8 billion.

Revenues from the elimination of below-cost tariffs, pricing carbon emissions and taxing polluters could potentially provide capital for public low-carbon investment. Eliminating fiscal losses from below-cost electricity tariffs would cancel about 70% of energy-related fiscal deficits, equivalent to 1% to 6% of GDP, depending on the economy. Reducing distribution and collection losses would capture the remaining 30% (World Bank, 2018[16]). Fiscal revenues from carbon pricing and taxes levied on polluters could be a source of revenue for public investment in low-carbon energy infrastructure. To ensure that revenues from carbon pricing are used for the energy transition, the introduction of carbon pricing should be accompanied by measures that foment transparency in the use of these revenues. In Québec, Canada, revenues from the emissions trading system are used to implement the Climate Change Action Plan, including measures designed to help the industrial sector become more innovative and energy efficient – and, thus, less carbon-intensive (Quebec Ministère de l'Environnement et de la Lutte contre les changements climatiques, 2021[114]).

Multilateral support will remain an important component of the financing required for to “build back better” from COVID-19 pandemic, and provide investment for a green recovery. Key initiatives include the European Commission’s EUR 9 billion Economic and Investment Plan for the Western Balkans, the EU’s Western Balkanas Guarantee Facility, the EBRD’s Green Economy Financing Facility (GEFF) and the Platform Initiative for Western Balkans and Ukraine (Box 14.19).

To date, private investment in the Western Balkans power sector is slow to emerge. Between 2002 and 2015, private sector investment was only about USD 3.9 billion across the region, of which 30% was in Albania. Hydropower attracted most of private sector investment; other renewable energy investments included wind in Serbia and Montenegro. On a somewhat positive note, the only private investment in coal mining was in the Stanari complex in Bosnia and Herzegovina (World Bank, 2018[16]).

At present, private investors perceive Western Balkan governments as uncommitted to the clean energy transition. As long as this perception persists, investors are likely to remain hesitant. They also perceive that, under current regimes, they would be competing on unequal and unpredictable terms with SOEs.

To boost private sector energy investment, Western Balkan economies will need to demonstrate a stable and predictable policy, legal and regulatory environment, supported by a firm political commitment. Slow implementation of energy policy instruments undermines the credibility of government commitments to the clean energy transition, making investment unattractive. Necessary frameworks to attract low-carbon energy investment include: the completion of ambitious NDCs and NECPs; ending fossil fuel subsidies; pricing carbon; and strengthening legal and regulatory frameworks for energy sector investment. The Energy Community Decarbonisation Roadmap and the Clean Energy Package will strengthen the legal basis for decarbonisation, starting with the adoption of targets for 2030 and NECPs (NECPs) (Energy Community Secretariat, 2021[11]). Progress in adopting new regulation has been made in other areas as well, but gaps still remain in areas such as energy efficiency in buildings.

Delays in establishing an integrated and competitive regional energy markets are stalling the clean energy transition in the Western Balkans. As long as the transition is domestic and the market remains fragmented, progress will be slow – not least because the small size, limited institutional capacity, lack of competition and low logistical maturity of domestic markets deter investment. These conditions constrain future expansion of variable renewable energy sources. Continued market fragmentation would drive up annual capital expenditures in the medium term, as governments invest to reduce emissions while keeping sub-optimal resources in operation to guarantee a stable electricity supply (Kantor; E3M;, 2021[98]).

Similarly, local implementation challenges undermine financing of energy efficiency measures. Many international financial institutions (IFIs) and donors are keen to invest in energy efficiency; however, they rely on local financial intermediaries to identify and implement projects. At present in the Western Balkans, about 45 local commercial banks or financial institutions offer financial products for energy efficiency to corporations, SMEs, households and the public sector. But even if such financing is available, it may not be accessible to beneficiaries on affordable terms. This reflects challenges of creditworthiness, short loan tenors, restrictions on public borrowing, and perception of high risk as well as general unfamiliarity with energy efficiency lending on the part of financial institutions (World Bank, 2018[16]).

Local financial institutions hesitate to lend to renewable energy projects, which restricts access to finance. Financial institutions perceive renewables projects to be higher risk and more capital- intensive than conventional projects. Moreover, low understanding of the characteristics of renewables results in a relatively high cost of capital for renewables finance. Disrespect of environmental standards by many SHPPs – and their negative impacts on the environment and local communities – tarnishes the image of renewables held by financial institutions and the general public (IRENA, 2021[89]). Capacity building for local banks could improve financing for renewable energy projects.

Western Balkan economies need to take steps to streamline procedures for energy infrastructure permitting and licensing, standardise project documentation, and establish safeguarding policies. Mechanisms such as standardised power purchase agreements, including specific clauses on monitoring and safeguarding policies, can improve monitoring. In turn, this would reduce the perception of renewables being high risk currently held by financing institutions (IRENA, 2021[89]).


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← 1. This estimate stems from a World Bank study that uses the “cash needs” and “rate-of-return” approaches, both commonly use by regulators to estimate revenue requirements for utilities (World Bank, 2018[16]). This analysis found that three factors drive revenue shortfalls for government-owned utility companies: i) below-cost tariffs; ii) technical and non-technical losses; and iii) under-collections. The aggregate revenue shortfall from these factors indicates the total amount of implicit and explicit deficit, amounting to the “quasi-fiscal deficit” in the sector.

← 2. The state aid rules are meant to be applied and enforced by national authorities of the Contracting Parties, which under the Treaty are obliged to assess compliance of any state aid measure before it is granted (Miljević, 2020[34]).

← 3. Kosovo is not a member of the United Nations Framework Convention on Climate Change (UNFCCC), did not ratify the Paris agreement and does not have an NDC nor any other kind of GHG emission reduction target.

← 4. IPPC permits for industrial installations in Western Balkan economies are not in compliance with the EU Directive on Industrial Emissions (2010/75/EU). Moreover, the process of issuing these permits is often inefficient and governed by political considerations. According to the directive, permit conditions (including emissions limit values) must be based on the best available techniques (BATs) and permits must take account of the environmental performance of the plant with respect to several criteria: emissions, pollution, waste generation, the use of raw materials, energy efficiency, noise, the risk of accidents, and restoration of the site upon closure.

← 5. Energy Community contracting parties are subject only to a recommendation but not to an obligation to adopt NECPs. Still, all economies of the region opted for developing a NECP.

← 6. Information from fact-finding in North Macedonia from expert consultants from CENER21.

← 7. The World Bank; the Energy Community Secretariat; the European Bank for Reconstruction and Development (EBRD); the European Investment Bank (EIB); Poland’s National Fund for Environment Protection and Water Management (NFOSiGW); and the College of Europe.

← 8. Serbia’s Law on the Use of Renewable Energy Sources foresees the conversion to full balancing responsibility once the intraday balancing market is liquid. According to Albania’s renewable energy law, new renewable energy producers are responsible for balancing while incumbent priority producers will become responsible as soon as a balancing market is established – but not later than 31 December 2022. However, these regulations are not applied in practice in Albania. The Federation of Bosnia and Herzegovina’s renewable energy law (from 2013) envisages the adoption of a methodology for allocating balancing costs. This methodology was never finalised, however, and renewable energy producers under FiTs remain exempted from balancing responsibility. In Republika Srpska and in Kosovo, renewable producers under support schemes bear 25% of balancing costs. In North Macedonia, only renewable producers under administratively set FiTs are exempted from balancing responsibility; those receiving support through auctions have balancing responsibility. For long-term contracts, this exemption must be phased out as soon as liquid balancing markets are established.

← 9. An electronic system for the issue, transfer and cancelation of guarantees of origin ensures that each unit of energy from renewable sources is taken into account only once, thereby preventing double counting.

← 10. EU figure from (Werner, 2017[118]). For comparison, district heating accounts for about 14% of heat delivered in Germany and 5% in France (Euro Heat & Power, 2019[119]).

← 11. Information from fact-finding in the Western Balkan region from expert consultants from CENER21.

← 12. Carbon pricing integrates the real costs of CO2 emissions, thereby raising the cost of carbon-intensive assets. In turn, these higher costs steer consumption and investment – by both households and firms – towards low-carbon assets and goods, encouraging energy savings, improvements in energy efficiency, and scale up of renewable energies and other low-carbon technologies (Miljević, 2020[34]).

← 13. With regard to regional capacity allocation, the SEE CAO has been described as “a great example of regional coordination between transmission system operators” (World Bank, 2018[16]).

← 14. Net-transfer capacity = the levels of cross-border capacity provided to market participants for commercial use without jeopardizing the security of supply (EU Regulation 2019/943).

← 15. Capacity calculation regions are defined as geographic areas in which co-ordinated capacity calculation is applied. Co-ordinated capacity calculation defines cross-zonal transmission capacities for day-ahead, intraday and long-term timeframes to ensure an optimal capacity of the electro-energetic systems is made available to the market.

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