The Context for Reform and a Suggested Roadmap
Residential tariffs for district heating (DH) in Belarus are well below the cost of service. Production costs have risen sharply since 2005, driven by the cost of imported natural gas and depreciation of the Belorussian Ruble against the US dollar. Residential tariffs are currently at 11 to 25 percent of cost-recovery levels, depending on the provider and technologies used.
Cross-subsidies undermine industry competitiveness and increase the cost of goods and services in Belarus. If industrial electricity tariffs were reduced to cost-recovery levels at about US 9.25 cents/kWh, the energy cost of manufacturing in Belarus would be reduced by roughly 24 percent, making it a lower-cost producer than the average EU country. The impacts of high energy cost on end-user prices for goods and services could range from a 1 percent increase in the output price in the banking and finance sector to an almost 3 percent increase in the output price for household goods. For food and beverages, the sector with the largest share in total expenditures of most households, output prices increase is roughly 2 percent.
Cross-subsidies are also highly regressive. Residential customers are heavily cross-subsidized by non-residential customers but the cross-subsidies benefit wealthier residential customers more than poor. The top two income quintiles receive 42.1 percent of the overall heat subsidy, while the lowest two quintiles receive only 24 percent. Poor households and those in rural areas also receive a smaller portion of the heat subsidies: 3.5 percent to the poor and 10.4 percent to rural households.
Higher tariffs will have the most impact on the poorest households, and households in rural areas. Urban customers in the poorest quintile can be expected to spend, on average, 21 percent of their incomes on DH services if tariffs are set at full cost-recovery. Rural customers in the poorest quintile will spend 23 percent of their income on DH services. Households headed by women will be more vulnerable than men, as employment is lower for women than men in Belarus, and wages are lower.
Reform begins with better customer communications and engagement. Focus group discussion and stakeholder analysis reveal that there is limited support for tariff reform among residential consumers because of their lack of knowledge and awareness of tariff setting and reform processes. A comprehensive communications strategy, coupled with efforts to better engage consumers in the governance of DH providers, can help mitigate some of the resistance to higher tariffs and engender support for the reform.
The coverage and targeting of social protection mechanisms must then also improve. Increasing tariffs will achieve substantial fiscal savings, as costs are shifted from Government budgets to customers. The fiscal savings could be used to fund social protection mechanisms with better coverage and targeting. Options include: Expanding or topping-up the existing Public Targeted Social Assistance Program (GASP); and/or refining the Housing and Utilities (H&U) subsidies program discontinued in 2009. Introducing levelized payment plans which allow customers to spread out payments evenly over 12 months, can also make cash flow management easier.
Investments in energy efficiency can help further mitigate tariff increases. Lower consumption means lower monthly bills. On the supply-side, savings can come from replacing older, low efficiency boilers with newer ones; converting from natural gas to renewable fuels (such as biomass); replacing steam with hot water boilers; replacing networks to reduce losses; replacing pumps; and optimizing the sizing of boilers and routing of networks. On the demand side, the priority investments should be the replacement of central substations (CTPs) with individual substations (ITPs); building insulation measures (building enveloping, and replacing windows); and apartment-level heat metering and regulation.
Better social protection mechanisms and investments in energy efficiency (EE) can be funded through fiscal savings and utility revenues. As tariffs increase, the ZhKH will require less direct fiscal subsidy. This savings can be used to fund better social protection mechanisms. Higher tariffs will also allow the DH companies to fund some of the supply-side investments using higher tariff revenue. Government can also contribute to EE, using some of the fiscal savings for concessional lending or grant funding of demand-side energy efficiency measures targeting at low-income households.
 This assumes that rural customer tariffs are set at different levels than tariffs for urban customers. Because of the technologies used in rural areas, the costs of serving rural customers is typically higher than serving urban.