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Unified Energy System

December 26, 2003

RAO UES Board of Directors holds its December meeting

Moscow. 26 December 2003. At its regular meeting held today, the Board of Directors of RAO "UES of Russia" heard and noted the progress report on the measures being taken to reform the electricity industry relating to the decisions taken by the Board of Directors.

In 2003, as part of the electricity reform, measures were taken to reorganize the Holding of RAO "UES of Russia" and the regional energy systems, and to prepare them for operation in a competitive market environment.

The adoption of the Electricity Reform Laws in April 2003 made it possible to start development of regulatory documents setting out the particulars of energy enterprises' work during the transition period and after the completion of the reform process, as well as the specifics of electricity market operation during the transition period. In late May 2003, the Board of Directors of the Company unanimously approved the Concept of RAO UES Strategy for the years 2003-2008.

By 1 December 2003, the Board of Directors had approved 38 draft plans for regional energos' reorganization out of the 70 plans to be approved by the management bodies of RAO "UES of Russia". The reform implementation has been launched at 31 regional energos to carry out separation by line of business. The Board of Directors also approved the plans to spin off the repair and maintenance businesses and establish R&M subsidiaries of 14 regional energos and 9 AO-power plants.

As part of the effort to streamline the vertical organization of the operational dispatching system, work is being done to transfer the functions performed by the regional dispatch authorities of the regional energos to the Regional Dispatch Authorities (RDAs) that are branches of OAO "UES SO-CDA". By 1 December 1, 2003, 58 regional energos out of 75 had completed the transfer of the operational dispatch functions to the branches of OAO "UES SO-CDA".

Preparations are underway to transfer to OAO "UES FGC the property that is included in the Unified National Electricity Grid (UNPG) pursuant to the Resolution of the Russian Government of 21 December 2001. By 1 December 2003, 54 regional energos out of 57 had approved lists of the property to be transferred. Said property will be divested to the regional energos' subsidiaries (to date, decisions have been taken to establish 49 subsidiaries out of the 53 subsidiaries planned to be founded).

Pursuant to Resolution of the Government of the Russian Federation No. 526 dated 11 July 2001 and the Concept of RAO UES Strategy "5+5", 10 wholesale generation companies (WGCs) are to be established. A pilot WGC is expected to be spun off in late 2004 early 2005, with the remaining WGCs to be established in 2005-2006 before the reorganization of RAO "UES of Russia".

On 1 November 2003, a competitive electricity trading segment was launched on the Federal Wholesale Electricity Market (FOREM). As of 25 December this year, there were 30 competitive market participants. In January 2004, the number of participants of the competitive segment is expected to increase, as most subsidiaries of RAO "UES of Russia" located in the territory covered by the 5-15 segment are expected to enter the competitive electricity market. The Board of Directors gave the Management Board of RAO "UES of Russia" a task to work out and present their proposals regarding the ways to regulate the entry of consumers into the wholesale electricity market.

The Management Board has also been instructed to prepare a progress report in respect of H1 2004 on the measures being taken to reform the electricity industry relating to the decisions taken by the Board of Directors, and submit the report for consideration by the Board of Directors in August 2004.

The Board of Directors has approved the "Concept of parallel operation of the UES of Russia with energy systems of the European Union for the Co-ordination of Transmission of Electricity (UCTE) and NORDEL" and gave the Management Board of RAO "UES of Russia" a task to prepare, jointly with Russia's Ministry of Energy, the Concept in accordance with established procedure and submit it, within one month, for approval by the Government of the Russian Federation. After this document is approved by the Russian Government, the Concept is to be prepared and presented for approval to the Council of CIS heads of governments (via the CIS Electricity Energy Council) and the governments of the Baltic republics.

The Concept for parallel operation of the energy systems of the CIS and Baltics (UES/IES) with the UCTE and NORDEL energy pools is a system of views regarding the possibilities of cooperation between the electricity industries of Russia and other European countries, and the basis for consolidating the efforts by energy companies and government authorities to establish a common energy system and a single electricity market in Europe.

The idea of parallel operation of the UES/IES and the EU energy systems has been discussed at different levels on various occasions. The preparation for interconnecting the UES/IES with the European energy systems has received political support from the authorities in Russia and the EU.

The UCTE and UES/IES are expected to be synchronized in 2007.

Europe has three large energy pools UCTE, NORDEL, and UES/IES. Expansion of cooperation among them is part of the European integration process which will help diversify energy sources, more efficiently use the generation facilities, and promote the use of efficient technologies, etc.

Parallel operation of the energy systems will promote large-scale cooperation among the partners, enhance reliability of the energy systems and electricity quality, and help reduce expenses needed to further develop the technological infrastructure.

The main principles of parallel operation are equal partnership, preventing the spread of power outages, defining minimum requirements for parallel operation regarding external characteristics of the energy systems and the interface.

The Board of Directors of RAO "UES of Russia" has reviewed the information on the cost reduction efforts undertaken in the Holding.

RAO "UES of Russia" started developing costs management programs for its subsidiaries and dependent companies (SDCs) in 2000. The costs management programs were developed by all regional energos and AO-power plants that are part of the RAO UES Holding.

In 2001-2002, as a result of implementation of the cost management programs, the energy companies' reduced their costs by RUB 26.8 billion, which makes nearly 3% of the commercial output and over 4% of the commercial output less the "irreducible" expenses (depreciation, taxes, subscription fee, cost of energy purchased less network transmission losses, dividends).

In 2003, the cost reduction targets have been tightened. The minimum cost reduction target for AO-power plants has been set at 7-10%, whereas that of regional energos has been set at 6-8%. In 2003, cost reduction programs have been worked out by 99 companies. Under these cost management programs, the cost reduction target for 2003 is RUB17.6 billion, which makes 4.4% of the commercial output and 5.2% of the commercial output less irreducible expenses.

The actual cost savings achieved by Holding's SDCs in the first 9 months of 2003 totalled RUB12.3 billion, or 3.5% of the commercial output. The annual cost reductions anticipated in 2003 are RUB18 billion.

A pilot cost reduction project was launched in 2003. This project was initiated in order to conduct an in-depth analysis of energy companies' costs structure and develop benchmarking mechanisms for cost reduction. The task group established for this purpose worked in energy companies to analyse the companies' costs by cost centres, with active involvement of the energy companies' staff. It has been demonstrated, with OAO "Konakovskaya TPP" and OAO "Permenergo" used as an example, that additional savings may be achieved through implementation of special cost reduction measures.

In 2004, in connection with the expected introduction of a tariff cap for a term of three years, RAO "UES of Russia" will switch to setting cost reduction targets based on the actual savings achieved during the reference period, rather than the planned costs included in the tariffs. The aggregate operational cost reduction target across RAO UES Holding is anticipated at 7-10% of their actual level in 2003.

The Board of Directors has instructed the Management Board to make the relevant changes to the proposals for organizing the management accounting and the system of indicators, and to submit these proposals for consideration by the Board of Directors in Q1 2004.

The Board of Directors has approved the work done by Deputy Chairman of the Management Board of RAO "UES of Russia" Yakov Urinson to organize the costs management efforts in the Holding of RAO "UES of Russia".

The Board of Directors has discussed the draft of the Regulation on Information Policy of the Company.

The Regulation on Information Policy has been drafted in accordance with the recommendations of the Corporate Governance Code worked out by the Federal Commission for the Securities Market of the Russian Federation (FCSM of Russia) and approved by the Government of the Russian Federation on 28 November 2001, as well as the "Plan of top priority measures to implement the Strategy of RAO "UES of Russia" for the purpose of increasing the Holding's capitalization" approved by the Chairman of the Management Board of RAO "UES of Russia".

The need to create the Regulation is primarily due to the policy pursued by RAO "UES of Russia" to enhance the corporate governance standards in the Company.

The Regulation contains documents and materials which the Company discloses (makes available) to interested parties pursuant to the Federal laws "On Joint Stock Companies" and "On Securities Market", the requirements of the FCSM of Russia, and the additional information disclosure practices used in the Company.

The Regulation is a public document provided to the Board of Directors, wherein the Company takes responsibility for the quality, timeliness, and completeness of the additional information being disclosed.

The Regulation also establishes the procedure for information disclosure both for members of the Board of Directors and the Board Committees, and for the Company's top executives.

The Regulation introduces terms "insider" and "insider information" and provides their definitions.

The document has been reviewed by specialists and experts from the FCSM of Russia and the Investor Protection Association.

The Board of Directors has decided to have the draft Regulation finalized within 2 weeks and approve it using the absentee voting procedure.

The Board of Directors has approved the financing of the project to upgrade the third generation unit at Dzerzhinskaya CHPP owned by OAO "Nizhnovenergo" with a RUB2.3 billion loan from Savings Bank of Russia (Sberbank). The loan will be provided for a term of 7 years at the interest rate up to 16% per annum. The Board of Directors has also approved the pledge of property the construction in progress assets at generation unit No. 3 of Dzerzhinskaya CHPP as collateral for the loan.

The project envisages modernization of the 3rd generation unit at Dzerzhinskaya CHPP by installing a combined-cycle gas turbine (CCGT) as part of the 150 MW gas-turbine unit manufactured by Siemens and Interturbo JV, a Russian-made steam turbine of 42-45 MW capacity, and a 320 t/h waste heat boiler. The modernization is being carried out in the power plant's main building and uses the existing its engineering networks and systems. The old equipment of the generating unit has been dismantled. The site has been cleared, and the foundation of the gas-turbine unit installed in 1995 has been rebuilt.

After the modernization project is completed, the annual output of Dzerzhinskaya CHPP will increase twofold to 3.2 TWh of electricity, whereas the heat supply will remain the unchanged at 3.1 million Gcal annually.

In June 2003, the Management Board and the Board of Directors of RAO "UES of Russia" approved the funding of the project to modernize unit 3 of Dzerzhinskaya CHPP with a loan from ZAO "GUTA-BANK". However, for three and a half months ZAO GUTA-Bank consistently refused to fulfil the terms and conditions of funding the project undertaken by the Bank in the tender held by RAO "UES of Russia". In this connection, the Company's management requested Sberbank of Russia to provide funding for the project to modernize generation unit No. 3 at Dzerzhinskaya CHPP.

The Credit and Investment Committee of Sberbank of Russia approved the establishment of an RUB2.3 billion credit line for OAO "Nizhnovenergo" for a term of 7 years at 16% interest annually, which loan is to be used to fund the modernization project at unit 3 of Dzerzhinskaya CHPP.

In December 2003, the Property Commission of RAO "UES of Russia" approved the pledge of property consisting of construction in progress assets of generation unit No. 3 at Dzerzhinskaya CHPP at the market value of at least RUB1,189,424,000, for a term of 7 years, as collateral for the loan provided by Sberbank to fund the modernization of the generation unit.

The Board of Directors has approved the purchase by RAO "UES of Russia" of 6,238,141 ordinary shares in OAO "UES SO-CDA", par value RUB1.00 per share. According the report prepared by an independent appraiser, the shareholding is valued at RUB6,250,000.

As consideration for the shares, RAO "UES of Russia" will contribute assets valued at RUB6,250,000 according to the independent appraiser's report.

The Board of Directors has also approved the Contract to exchange the property of RAO "UES of Russia" for the shares in OAO "UES SO-CDA". The difference between the value of property of RAO "UES of Russia" and the value of shares in OAO "UES SO-CDA" RUB22,000 shall be paid by OAO "UES SO-CDA" in cash.

The Board of Directors has heard the information on the procedures for holding auctions to sell heating Wholesale Generation Companies (WGCs).

The Board has approved the following principles for organizing auctions for heating WGCs:

  • shareholders of RAO "UES of Russia" shall be unconditionally entitled to pro-rata shareholdings [in the heating WGCs];
  • market-driven pricing for WGC shares;
  • disclosure of information on the actual beneficiaries of the auctions and the buyers of large stakes (over 25%) in the WGCs;
  • maximum achievable transparency and simplicity of procedures;
  • protection of rights and interests of RAO UES shareholders.

RAO "UES of Russia", together with its investment advisers the Consortium of Alfa-Bank and Merrill Lynch will continue exploring the possible ways and mechanisms for holding such WGC auctions. It is expected that the Board of Directors will take this issue up again in Q1 2004.





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