State-owned Bulgarian Energy Holding (BEH) will terminate a stalled €650mn fundraising procedure and proceed with direct talks with each of the 12 banks that indicated preliminary interest in providing a loan or managing a bond issue,

BEH needs the funds urgently, mainly to support its indebted subsidiary, Bulgaria’s public electricity supplier National Electricity Company (NEK), which is forced to buy electricity at above market rates but is not allowed to pass its costs on to consumers by raising tariffs.

NEK has to repay its outstanding debts of BGN900mn (€460mn) to two US-owned coal-fired power plants - AES Galabovo and Contour Global’s Maritsa East 3 - by the end of this month. In April, NEK renegotiated its long-term power purchase agreements with AES and Contour Global on terms that were expected to save the indebted utility some BGN100mn annually. However, a key condition for the agreement to enter into force is that the debt repayment must be completed by end November.

Previously, BEH received two binding bids to arrange a bond issue and provide bridge funding - one from Italian investment bank IMI, part of Intesa Sanpaolo Group, and the other from a consortium comprising Citibank, HSBC, ING, Societe Generale, and Unicredit.

However, both offers required a state guarantee for the credit, which is not forthcoming at present. While presenting the 2016 budget bill on October 30, Finance Minister Vladislav Goranov said he was reluctant to provide a state guarantee for a new €650mn bridge loan to BEH, as the energy sector continues to accumulate debts and tariff deficits are widening.

Sofia has therefore cancelled the tender procedure and will instead start direct talks with banks, Energy Minister Temenuzhka Petkova told a parliament committee on November 12, according to Dnevnik.

“Under market conditions, no bank is likely to agree to grant BEH a loan without a state guarantee,” Vladislav Panev, chairman of the board at Sky Asset Management told bne IntelliNews. “Probably, the state will agree to provide some guarantee as it pushed NEK into loss by approving the purchase of electricity from various suppliers at higher than market prices.”

Among those suppliers are renewable energy producers, cogeneration plants, and coal-fired plants – not only the two US-owned plants, but also several others owned by local businessman Hristo Kovachki.

NEK recorded a nine-month loss of BGN311mn, which is expected to widen to BGN400mn by the end of 2015, the company's CFO Rumyana Krasteva told the Bulgarian Commission on Energy Regulation in October. Last year, NEK posted a loss of BGN586.5mn on sales of BGN2.97bn. Its total debts stood at BGN3.6bn at end-August, having risen from BGN3.48bn at end-2014.

NEK’s dismal financial performance reflects two factors. Firstly, the authorities are very reluctant to raise electricity prices. The first government of the centre-right Citizens for European Development of Bulgaria (GERB) party resigned in February 2013 following mass protests over high electricity prices, monopolies and low wages. GERB is now back in power as the senior partner in Bulgaria’s ruling coalition, and will be unwilling to risk another popular backlash should it attempt to raise prices.

Secondly, NEK has to purchase electricity from some producers at above market rates under legislation intended to stimulate the renewables sector and long-term purchase agreements with some thermal power plants.

On September 16, Fitch cut BEH's ratings by one notch to BB- with a negative outlook, saying that group credit ratios will remain weak in 2015-2016, mainly due to the accumulated power tariff deficit at NEK. Fitch highlighted the sharp increase in NEK’s EBITDA loss, from BGN46mn in 2013 to BGN500mn in 2014.

“The widened tariff deficit of NEK has created liquidity issues for the company and an increase of overdue trade payables to its suppliers…Large overdue trade payables by NEK has created late payment problems for the whole energy sector in Bulgaria, including some counterparties of the BEH group,” the rating agency added.

Several legislative and regulatory changes were made in 2015, aimed at narrowing NEK's tariff deficit. In addition to the renegotiated contracts with the US-owned power plants, the company no longer has to buy such a large share of its electricity from renewable sources. This was criticised by the European Bank for Reconstruction and Development (EBRD), which said in its latest transition report for Bulgaria, published on November 10, that such “stop-go political interventions … have an adverse effect on the investment climate.”

Moreover, a fund has been set up to pool a 5% charge on electricity producers’ sales, as well as revenue from the sale of CO2 allowances by the state, which will co-fund NEK’s deficit.

A hike in the regulated electricity prices for businesses by some 15% to 20% was implemented as of August 1, and softened only slightly as of November 1 after widespread protests and threats of job cuts.

In addition to the EBRD, which highlighted that efforts to improve competition and efficiency in the energy sector should be intensified, the IMF said on November 9 that Bulgaria needs to clarify how it plans to mitigate contingent fiscal risks related to state-owned firms in the energy sector.

If the government agrees to provide a state guarantee for the loan sought by BEH, this will push up the ratio of state and state-guaranteed debt to GDP by about 1.5pp from 26.7% as of end-September.