Russia will always remain a mystery. Over the last 15 years, the nation has evolved from one that is tightly regulated to one that is more open -- and then partially back again. The nation's electricity sector, however, is about to be largely privatized.
Shareholders of RAO Unified Energy Systems just voted to liquidate the company, in a process that will be completed by July 1, 2008. The state will still own about 52 percent of the enterprise but 45 percent of it will be sold to investors on the London Stock Exchange. That's a major move for the Russian government, which has decided to expand its influence in certain economic sectors and namely in natural gas and aerospace.
Electricity in Russia could soon be a scarce commodity. Power use in Russia is rising at about 5 percent a year at a time when the infrastructure there is outdated and unable to handle the added capacity. In 2005, a massive blackout hit Moscow. So, while President Vladimir Putin has been moving away from free enterprise, he has made an exception with respect to the electricity industry there.
State subsidized electric prices have not only led to improvidence but it has also rendered RAO UES unable to recover its costs tied to infrastructure and equipment. To ease the situation, the Russian government approved rate hikes in both the electric and natural gas industries, allowing them to rise by 10 percent and 15 percent, respectively.
The goal is to attract outside capital. Estimates are that $100 billion is needed to bring the power structure there up to speed. Still, the government is trying to be careful and use a go-slow approach. It reasons that if it allows rates to rise too quickly, it would create economic upheaval -- something the United States knows a little about as some regions in this country have endured huge price increases.
Created in 1992, RAO UES comprises 72 percent of the installed capacity, 69 percent of power production and 71 percent of customer sales. It's simply too big and too inefficient especially for a country that is growing at 7 percent a year. In exchange for their shares in this behemoth, stockholders will get ownership in regional generation companies.
The process toward deregulation has been underway since 2004 and was supposed to be completed already. In October 2006, one of the regional generation companies was spun off. Specifically, nearly 15 percent of the shares in the Wholesale Generating Co. raised $459 million. Among the buyers: Italy's Enel, Finlands Fortum and Norway's Nomos-Bank. RAO UES will continue to sell blocs of its stock in the hopes of raising $15 billion.
"Given the significant expenditure planned for new capacity in the coming years, (the generation company) will need the higher revenues from the liberalized market to cover the costs of new construction," says a Merrill Lynch statement. "Access to gas supplies also presents significant business risks."
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RAO UES is expected to be liberalized and split into separate generation, transmission and distribution companies. The power generation companies will be privately controlled. But, the transmission system will remain government-owned and tightly regulated while no single private owner could control more than 35 percent of generating capacity in any price zone. Nuclear plants there will also remain state-owned.
The difficulty in attracting investors to a nascent industry with highly subsidized prices is evident. If power producers were to recapture their costs and earn fair returns, prices would likely jump as much as 200 percent. Russia is not about to pull the plug on all state controls. It will move cautiously and try to walk a fine line between opening markets and not dislocating its people. Perhaps a first step, says Pan Eurasian Enterprises, is to increase the current 25 percent efficiency rates of the existing power plants.
"We expect that the new system for regulated power supply contracts will reduce significantly the regulatory risk for power generators, improve the transparency and timeliness of the rate-adjustment process, and make it easier to pass full costs through to end users, thereby improving the predictability of earnings and enhance their stability," adds Standard & Poor's credit analyst Eugene Korovin.
In the end, the analyst expects the new system to improve overall risk profiles. The potential problem, of course, is that the Russian's could get cold feet and delay the liberalization process or even revamp it. National elections are to be held there and the results of the presidential race in particular could alter current plans. As it stands now, President Putin favors the gradual transition and it appears that that this popular internal figure will remain active in Russian affairs for the foreseeable future.
The International Energy Agency (IEA) in Paris is upbeat on Russian electric reform, saying that the keys to success lie in the ability to keep its transmission system independent of its generation. It's about creating a competitive market and allowing alternative energy providers the opportunity to transport their power. The agency also says that regulators there must remain impartial, well-informed and well-trained.
"The IEA is heartened by Russia's progress to date in defining its electricity reform process and the Government's reaffirmed commitment in late 2004," says IEA's Executive Director Claude Mandil, at a public forum.
Investors require clear rules and open markets. As such, Russia's policymakers are affirming their commitment to liberalizing markets and providing a predictable regulatory structure. That task will be perpetual and daunting, requiring leaders there to keep their eye on the prize and to communicate the true market cost of generating power.
More information is available from Energy Central:
• Russian Power Opportunity, EnergyBiz, March/April 2005
• Russia Beckons - Electric Infrastructure Needs Investors, EnergyBiz, May/June 2007
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November 9, 2007
Ken Silverstein EnergyBiz Insider Editor-in-Chief
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