RS Market breakdown The Russian electric power industry: still in transition

The Russian electric power industry: still in transition


The Russian electric power industry today is a state monopoly that still remains a high risk investment. Analysts concur that there is just too much uncertainty. The government is hell-bent on micromanaging everything, totally negating all the achievements of the reform of RAO UES of Russia that completed in 2008. The sector is hardly made more attractive to potential investors by the continued lack of a new market model, increases in electricity rates being limited to 6% a year while natural gas prices are growing at 15% and last but not least the struggle for assets between the ex-deputy prime minister and now chair of the Management Board of Rosneft Igor Sechin and the current deputy chair of the cabinet Arkadiy Dvorkovich. In the 30-day period through mid-April, the Moscow Central Stock Exchange index, one of Russia’s key stock indices, had declined by 3%, while the MCSE ‘Electric Power’ index had plummeted 22% (this last index tracks the share prices of Russian electric power companies).

Let’s look at what is going on in each of the three key segments of the electric power sector: generation companies, grid companies and electric utilities.

The government is hell-bent on micromanaging everything, totally negating all the achievements of the reform of RAO UES of Russia that completed in 2008

Generation: waiting for a new market model

In 2010 the Russian authorities introduced a system of capacity supply agreements under which power generation companies could use high rate to recoup investments in construction. The amount of capacity put into operation through this system amounts to about 15% of the total demand for new capacity through 2030.

As a new model for the wholesale electricity and capacity market is being created a number of generation companies such as Inter RAO and Gazprom Energy Holding are lobbying the creation of a similar system but this time they want to use it to modernise existing capacity rather than build new generation facilities (capacity supply agreements version 2). The wear and tear of power equipment is extremely high, reaching 60-80% and the head of Gazprom Energy Holding Denis Fedorov believes that we may be facing chronic shortages of electric power as soon as 2019-2020 unless a way is found for power generation companies to modernise their equipment.

The wear and tear of power equipment is extremely high, reaching 60-80% and the head of Gazprom Energy Holding Denis Fedorov believes that we may be facing chronic shortages of electric power as soon as 2019-2020

In the meantime the Ministry for Energy of Russia, fearing a significant increase in the price of electricity, is leaning towards a different model. Under this different model electricity is to be purchased and sold in the wholesale market under bi-lateral contracts between consumers and specific power plants. The minimal period for such contracts will be one month, however, it is expected that most such contracts will be entered into for 10-20 years. The model also assumes that generation companies will include the costs of recouping their investments in equipment in the rates agreed in the contracts they enter into with consumers.

According to latest industry news the new electricity market model will only go into effect in Q1 2015, rather than in 2014 as was originally planned. Nevertheless, it’s fairly easy to see that foreign generation companies such as the German E.ON, Italian Enel and the Finnish Fortum demonstrate better efficiency under the same conditions. ‘Under the same tariff and regulatory conditions companies managed by foreign investors demonstrated much better performance and profitability than their Russian state-controlled counterparts <…> Slowly but surely we began to notice the hard work they’re doing to cut costs and seek out cheaper fuel suppliers <…> Foreign investors began to actively spend on new construction and put new generation capacity into operation just as many Russian power generation companies were trying to postpone launches of new capacity,’ notes Deutsche Bank Analyst Dmitry Bulgakov.

Russian grids, they are a-merging

The Russian national grid is comprised of high voltage long distance power transmission lines (220 KV and above) managed by Federal Grid Company (FGC) and distribution grids with lower voltage transmission lines managed by MRSK Holding. In November 2012 the Russian President Vladimir Putin signed a decree to merge the two companies. The merger is to be completed by late June.

On April 4th MRSK Holding was officially renamed Russian Grids. The company’s share capital is going to be increased by issuing 161,066 additional shares. The state acting through Russian Property must pay for the securities with the FGC shares it holds except for one. Once the process has been completed FGC will become a subsidiary of Russian Grids while the state will hold a stake of between 74% and 86%, according to various estimates) in the increased share capital of Russian Grids.

Russian authorities believe that the merger will result in more efficient management of the two companies and Russia’s entire power grid. It’s the exact same argument only reversed 180 degrees that was put forward when grid companies were spun off from RAO UES.


Analysts are less optimistic in their estimates. The strengthening of the role played by the state in Russian Grids is obvious, however the fate of the two companies’ investment programmes is far less clear. The goals of the new company are also rather vague. Experts believe that the national grid can potentially be a good investment because return is practically guaranteed, seeing how the national grid is a monopoly in Russia. However, the probability that the government will decide to privatise the managing company Russian Grids any time soon is practically zero. Experts tend to believe that even under the best circumstances privatisation will only happen in 5 to 6 years.

In the opinion of most experts one of the most desirable and most likely options for the development of the new company would be the privatisation in 2013 of one or several of MRSK Holding’s subsidiaries, announced by the government. In early February of this year the head of the Board of Directors of the holding Georgy Boos was quoted as saying that candidates for privatisation might include such companies as Lenenergo, Yantarenergo, Central and Volga MRSK as well as Tumenenergo. Analysits believe that MRSK Centre and MRSK Volga may also be added to this list. However, even though on many levels these are all very attractive assets, they are not without problems. For example none of them have a single clearly defined strategy for cutting costs and deciding on investment programmes. And yet, even despite these caveats, investors regard these companies as the most attractive candidates for privatisation as they can generate sustained cash flow by setting power transmission rates.

We can only hope that the announced privatisation is not too far away and that it will bring into the power grid sector any new efficient investors, who will be serious about cutting costs and increasing the value of their business.

Electric utilities: a rough patch

In November 2011 the then prime minister of Russia Vladimir Putin tasked the Ministry for Economic Development, the Ministry for Energy and the Federal Tariffs Service with developing, ASAP, a draft government resolution imposing restrictions on the profitability of electric utilities. In the opinion of the prime minister it was necessary because the appetites of electric utilities were going through the roof: their profit margin was 3-4 times the margin level set by regulatory authorities, which was causing a significant increase in the electricity prices paid by end consumers.

The emergency amendments made to the rules of the retail electricity markets restricted the ability of electric utilities to make money from providing services other than supplying electricity (compensation for switching to another supplier, reselling of electricity and other), which had an especially negative impact on guaranteed suppliers – regional electric utilities obliged to sell electricity to any customer who wants to buy from them. ‘Putin said a cap should be put on the profit of electric utilities because they were getting too fat and because of them electricity in Russia was too expensive. A resolution was rushed through without much thought or consideration… The result is that the majority of utilities are now on the verge of breaking even… in other words the margin they’re allowed to charge barely covers their operating costs,’ notes Rye, Man & Gor Securities analyst Dmitry Doronin.

In an attempt to rectify the situation the Ministry for Energy joined forces with other agencies and organisations regulating the sector to develop a new model for the so called ‘benchmark sales’, which should somewhat increase the revenue of electric utilities. At the moment it’s unclear when this new model will be ready and how well thought-out it’s going to be this time around, in the meantime in just about a year and a half investors have lost practically all interest in electric utilities. ‘Because of a poorly thought-out government resolution an entire sector has been condemned to wallow in the dumps for over a year and as an investment option has become a complete no-no.’ Mr Doronin sums up.

Because of a poorly thought-out government resolution an entire sector has been condemned to wallow in the dumps for over a year and as an investment option has become a complete no-no

Electric utilities also have other problems in addition to state restrictions on profitability. The increase in the amount of unpaid bills in the retail market of electricity and capacity caused 9 electric utilities to lose the status of guaranteed suppliers: Novgorodoblenergo, Tulaеnergosbyt, Kolenergosbyt, Bryanskenergosbyt, Ivenergosbyt, Kurskregionenergosbyt, Omskenergosbyt, Orelenergosbyt and Penzaenergosbyt. The future of several more companies remains unclear.

Soon after, the then MRSK Holding, several of whose subsidiaries were provisionally acting as guaranteed suppliers instead of the electric utilities that had lost this statues, suggested that said subsidiaries be made guaranteed suppliers without any biddings which independent electric utilities would have had to have participated in as well. The Ministry for Energy has not yet decided on a final position regarding this issue, however, experts believe that if the Ministry for Energy decides to go ahead with this option it will result in ‘monopoly squared. ‘In a situation where everyone agrees that we need more competition through making sure any consumer can switch suppliers, expanding the monopoly of suppliers by granting this status to grid companies would spell the end for a retail market of electricity. It was the high degree of monopoly that guaranteed suppliers enjoyed that kept consumers from switching suppliers and if the status of a guaranteed supplier is given to a grid company, switching suppliers will be totally out of the question,’ believes the chair of the Management Board of the Non-Profit Partnership of Guaranteed Suppliers and Electric Utilities Natalia Nevmerzhitskaya.

Larisa Makeeva, Elena Kudryavtseva
RIA Novosti
Exclusively for Russian Survey RS