Analysis. Electric power system of Russia, which had been developed for decades, happened to be sold out over a short period of time. When concluding transactions, the new owners have promised to expand vigorous activity directed to construction of capacities, but so far they are in no haste to do it.

The electric power industry reform which followed the reorganization of RAO “UES of Russia” was developed with a view to economic growth, in general, and power consumption growth, in particular. Moreover, that growth had to be quite considerable – 4–5% per annum. The government could not even anticipate such negative scenario as damping of demand for electricity. Transition to the market electric energy prices, as per the reformers’ conception, should provide fair tariffs based on balance between supply and demand. After all, one of the key goals of the reform was creation of the competitive electric power market. Thereto, RAO “UES” started to sell the business related to power generation, sales and repair to private investors, spun off from the holding structure. Competing against each other, the market participants had to decrease costs and prices for consumers. How come the reform did not prove its value?

Unrealized plans. The world crisis disrupted all forecasts. According to information provided by the Ministry of Energy (Minenergo), during IV quarter of 2008 the power consumption in Russia declined by 3,6% against the same period of 2007. In the first quarter of 2009 the indicator dropped by 6,7% already. The most substantial fall (8,9% year-on-year) was observed last May, and the consequential recovery was extremely slow. Reduction in electric power consumption created array of problems. Thus, the government’s grand project, provided for construction of new capacities and putting them into service, in the absence of demand and funds for the project implementation, actually turned out to be on the brink of collapse.

When effecting a sale, the new owners of energy companies, spun off from RAO, undertook obligations on substantial investments into the new energy facilities and reconstruction of the old ones. In case of failure to perform the obligations, the companies would face a considerable penalty – 25% of the project cost. However, in return, the government was due to secure recovery of investments placed in the industry through launching of the long-term capacity market. Nearly two years have passed, but the market does not start working yet. In actual fact, it granted the investors the formal right to raise the question on revising the programs for capacities construction in order to decrease the capacities or, as minimum, to postpone putting some of the facilities into service for one or two years.

But most of all, the sales business suffered from the crisis. A lot of major consumers had to reduce their production and, accordingly, electric power consumption. Against this background, the retail companies, in an effort to hit the target, raised the tariffs in order to avoid losses. The rise in electricity prices coupled with decrease of consumers’ solvency led to the rapid non-payments increase. The retail companies had to translate the debt to the wholesale market due to their inability to borrow easy money. In response to the accruing debts, NP “Market Council” took the unprecedented decision: it denied three Rostov retail companies the right to sell in the wholesale electricity market and deprived them of the status of a last resort supplier. The reform did not justify hopes again.

A new giant. The backbone of RAO “UES” reorganization completed in summer 2008 can be neutralized now as well. In the near future the place of a former monopoly can be occupied by other state energy (power) holding of Russia which consolidates at present nearly all the state-owned stakes in the industry’s main participants.

Initially it was planned that “InterRAO UES” would be an intermediary company engaged in energy sales abroad. However, the government changed the company’s strategy when decided that the assets should be kept in one “basket”. The consolidation process was launched last March when “InterRAO” obtained 61,9% of stake of WGC-1 belonging earlier to “FGS UES” and “RusHydro”. The next object of acquisition was 32,7%-share in TGC-11, which the energy holding got for the stake in TGC-12 belonging to SIBENCO. At the end of 2009 the Federal Antimonopoly Service granted the company’s application for purchase of 100% voting shares of TGC-11, but FGS, owning 27% in generating company, refused to sell the state-owned stake under the offer presented by “InterRAO”. The grid company was not satisfied with the repurchase price – it turned out to be by 30% lower than the current quotations.

Nevertheless, “InterRAO” will achieve the set task in any case. The securities of TGC-11, apart from other state-owned stakes, will be exchanged against shares of the holding itself. The list of contingent assets for acquisition numbers 43 positions, covering nearly all the industry: all WGCs, almost all TGCs, “RAO Eastern Energy Systems”, FGS, “Irkutskenergo”, “Novosibirskenergo”, “Bashkirenergo”, stakes in 11 retail companies (including “RN-energo, as an affiliate company of “Rosneft”, and “Rusenergosbyt”), design institutes and an engineering company “EMAalliance”. Their total cost amounts to about USD 10 billion. No doubt, most of the assets, which will belong in future to “InterRAO”, represent delinked minority stakes. However, they can be used as quite a good “bargaining chip” for getting control of the assets.

The changes which the industry undergoes can be explained not only by the government’s will, but the crisis as well. During the period of economic instability the state sector looked more steady than the companies belonging to the private investors, since the considerable part of them was not capable to attract funds required for the investment program implementation. In that conditions, some of the investors could not even pay off the assets acquired from RAO UES by installments. “KES Holding” lost the stakes in TGC-6 (23,6%) and TGC-7 (28,3%), but at the same time it retained the operating control over the companies, and “Group Å4” lost stakes in - and control over TGK-11 (28,5%). Due to financial stringency and serious disparity in prices (current and repurchase), blocks of shares, which have been sold by installments, are still remained with “FGS UES”, and soon they will refill a “money box” of “Inter RAO”. Among the generating companies belonging to foreigners, only WGC-4, “Enel WGC-5” and “Fortum” (TGC-10) were under reliable shelter of the owners. Among the retail companies, as players, won those ones that operated for the large consumer, and those companies were: Kuzbass retail company, supplying power to such enterprises as “Mechela” and Lipetsk retail company covering needs of Novolipetsk metallurgic plant ( NLMK).

How to entice an investor. Nevertheless, one undertaking has been a success. Since January 1, 2009, nine “pilot” distribution companies have transited to the new system of long-term tariff regulation (RAB – Regulatory Asset Base), directed to attraction of the investments to construction and renewal of the grid infrastructure. The period of transition to RAB shall be completed by early 2011. The system encourages the players for cost reduction, since the saved funds remain within the company, as opposed to the former “cost-plus” system according to which the infrastructure monopoly’s tariffs were historically set in Russia. As far back as the Soviet times, the regulating authority (Federal Tariff Service) had been revised the distribution companies’ operating costs annually and forecasted their level for the next year. It was believed that revenue generated by the company within the year should reimburse for the predictable operating costs and, in addition, provide for small profits. The RAB method is based on the different system of tariff calculation: it allows to pay back invest funds gradually, including interest on capital raised. The tariffs are set for the period of five years. The parameters used for their calculation and calculation methodology are well-known. It enhances transparency of the distribution grid companies’ activity and provides for reliable predictability of their financial indicators dynamics.

Why the government went the length of changes? The crisis was a reason again. As opposed to generating companies, where the issue on investments was settled by means of assets sale to the new owners, the grids, that were remained under the state control, obtained a quite contested and inefficient source of financing - as the crisis actually proved – payment for technological connection to the grids. Decline of demand for the capacities caused by the industry and construction sector downturn reduced the inflow of payments from technological connection to the grids. In this context, RAÂ is to be a key source of financing of the massive investments required for the worn grid infrastructure. Nowadays, the electricity losses in distribution electrical grids amount to nearly 12% as compared to the world indicator of 5–6%. Besides, RAB-based rate policy will result in increase of operating efficiency and reduction of financial charges.

Probably, making the retail companies’ assets more attractive for investors has a definite reason. The representatives of the Ministry of Energy (Minenergo) have repeatedly stated that, perhaps, they will attract the strategic partners to this sector of energy market. But there is another scenario for development of the distribution grid companies, and this scenario is mostly discussed among the industry’s participants: consolidation of all IDGCs (Interregional Distribution Grid Companies) within “Holding IDGC” and their transfer to the unified share, that allow the state to strengthen its control over the segment.