Privatized, But Not Yet Liberalized

MTWorkers from electricity industry repair firm Energosetservis replacing insulators on a tower in the Moscow region city of Noginsk. Industry experts say about 70 percent of electrical equipment in the country should be replaced.
KASHIRA, Moscow Region -- The jewel in the crown of the Unified Energy System network, OGK-1, will be auctioned off Thursday as part of the culmination of a decade-long sector reform that will see the electricity monopoly officially cease to exist on July 1.

The opening of the strategic sector to foreign investors is unprecedented and is perhaps a sign of desperation. The country's booming economy has fostered greater demand for electricity from a sector starved of government investment over the past two decades and in dire need of money for new power stations and the modernization of existing facilities.

German, Italian and Finnish electricity firms have all stepped in to purchase significant assets, but the most active buyer has been state-controlled Gazprom, which has scooped up a controlling stake in the four largest generating assets to go on the block so far.

The scope of Gazprom's involvement has drawn criticism from foreign experts, but those foreign companies that have managed to get their hands on assets have sung the praises of the reform -- and of its architect, UES chief Anatoly Chubais -- and are expecting significant profits.

Reaping a decent return on their investment, however, will only become a reality if the country's electricity market is fully liberalized, something that is supposed to happen by 2011. The hope is that the state will stick to its promise to allow the liberalization to go ahead. But there are few guarantees from a government that has demonstrated its willingness to step in to regulate prices and has few qualms about state ownership of major assets.

"The Russian power market is extremely attractive and we see a lot of opportunities for us here," said Dominique Fache, Enel's country manager for Russia and the CIS.

Enel, Italy's biggest electricity producer, became the first foreign company to purchase a significant chunk of UES, buying power generator OGK-5 at the beginning of the asset spinoff last June.

"Now, for the continued success of the reform it is critical to invest in infrastructure, innovation and IT, and to ensure the stability and relevance of rules governing the energy market," Fache said.

Finland's Fortum paid $2 billion for a controlling stake in TGK-10, a record for a regional generating unit, and secured a significant interest in TGK-1. The company's vice president, Tapio Kuula, has expressed some concern about the safety of the company's Russian investments, however.

Igor Tabakov / MT
"After UES ceases to exist, it is crucial that political circles maintain adherence to the schedule for the development of the electricity market," Kuula said. "Since the investment in the electricity-generation sector is long-term, we do need guarantees of returns on our investment."

Guarantees of such returns depend on market liberalization.

Currently, just 20 percent of all electricity produced in the country is sold at deregulated prices. This figure, however, is slated to reach 100 percent by 2011.

The markets do not seem to have much faith in the sector's profitability. The RTS index of electricity stocks has lost 23.6 percent of its value

Meanwhile, the Elektroenergia Index on the RTS has dropped 23.6 percent, and most companies in the sector have seen their share prices fall significantly in that period.

Analysts said Gazprom's activities in buying up electricity assets had played a role in spooking investors.

"Shares in the companies formed out of UES have been falling as investors are confused and don't understand why the Russian government has gotten actively involved in the market through Gazprom, even though it has accepted an obligation not to," said Derek Weaving, head of utilities sector research at Renaissance Capital.

Igor Tabakov / MT
New laws to govern the electricity sector adopted in 2003 said that, while the government would hold on to electricity distribution assets, it would no longer be a player in the markets for generation and sales.

Gazprom's plans for the four electricity-generating assets it has already bought clearly go against the spirit, if not the letter, of the 2003 law. The gas-producing giant plans to merge those assets with two producers snapped up by major coal producer SUEK later this year. Gazprom will hold a stake of 50 percent plus one share in the resulting entity.

"The core of the reform is to create a competitive market, Weaving said, "and we face a big danger of not getting it."

Dmitry Bulgakov, a utilities analyst at Deutsche Bank, agrees.

"The question is whether the government will at least keep its promise on the liberalization," Bulgakov said. "The hopes for a free market are the only reason foreigners are buying into the sector now."

Bulgakov is doubtful that the government will be able to keep its hands off.

"The liberalization will put upward pressure on prices," Bulgakov said. "And the government can intervene vigorously at any point in the process in an attempt to battle soaring inflation numbers."

Federal Energy Agency head Dmitry Akhanov admits that the coherence and consistency of the government's activities will be the main factor determining how successful the market liberalization will be.

Chubais said there was an instrument to help make sure the state sticks to the plan, if not a particularly comforting one.

"It is written down in the official documents -- if the government swerves from the plan, force majeur is declared, the investors are freed from their investment obligations and from the development programs for the companies they have bought," Chubais said on the sidelines of a Moscow conference for electricity market reform Wednesday.

So far, the government seems to be the winner in the reform program, having managed to attract investment to the sector while retaining partial control and the right to step in to regulate in "extraordinary" circumstances.

Igor Tabakov / MT
Nikolai Korobkov, the general director of the Energosetservis, the state-owned company that provides maintenance for electricity distribution grids, said his company had also suffered from the market privatization.

"We have a number of obligations as a state-controlled entity, but at the same time we now have a whole bunch of competitors whose hands are untied, so they can be more flexible in terms of the prices they charge for their services, and so on," Korobkov said.

The numbers of those opposed to the reform are deep, including many industry veterans whose opposition springs from a deep understanding of the sector, a vested interested in maintaining the status quo or a combination of the two.

Vladimir Sukhov, 71 and now retired, worked for 38 years -- the final 11 as general director -- at the thermal power station in Kashira, a town in the Moscow region. The station was the first built in the Soviet Union, opened under Soviet leader Vladimir Lenin in 1922, as part of a massive program to bring electricity to the whole country.

Today the Kashira station is part of OGK-1, an asset that UES hopes will turn out to be worth as much as $7 billion when it is sold this Thursday.

"I don't believe in the UES reform," Sukhov said. "The government is consolidating aircraft and ship production but fragmenting one of the country's most strategic industries -- electricity production, which is of dramatically high importance in country as big as Russia."

"Instead, we have handed control to unreliable private investors," he added.

He says the problem is that the government has not committed sufficient resources to building additional generating capacity to keep up with climbing demand.

At the Kashira station, he said, the equipment is on average 30 years old and the average worker's age is over 40, as low salaries and the lack of professional training have taken their toll.

"The system deteriorated in the 1990s, as the idea appeared that working as an electrician or a plumber meant you were no one, Sukhov said. "It was simply not fashionable."

Industry analysts said the opportunity to address the problems earlier was missed.

"We proposed the reform as early as 1994," said Renaissance Capital's Weaving, who was working for KPMG at the same time it was acting as a consultant for the government. "But no one was listening to us."

"In 2001, Chubais came up with a program that had the main principles we had suggested a decade earlier -- creating a competitive generation market and preventing the creation of vertically integrated companies," Weaving said.

As it has turned out, the critics say, the wait has not made the sector any readier for the changes to come. They warn of the chaos likely in a country they say is too large for its electricity sector to be privatized, of the sector's inability to attract investment on its own, of skyrocketing electricity prices and of the possibility that Gazprom could pressure the industry -- the majority of which still burns gas to produce electricity -- to operate on its terms.

But there are still optimists, who say the situation was much worse not so long ago.

"We used to be paid in women's underwear, cognac or goods like woolen boots instead of money in the 1990s, as enterprises had no cash to pay for electricity, so they paid with what they produced," said Korobkov, of Energosetservis.

"We didn't receive our salaries for months and didn't know what would happen tomorrow," he said. "Today we at least get real money. And that is actually all the Russian electricity sector needs."

UES Generating Assets


Power stations: Perm, Verkhny Tagil, Kashira, Nizhnevartovsk, Urengoi, Iriklinsk

Major shareholders: UES (91.7 percent)

Installed capacity: 9,531 MW

Market capitalization: $5.3 billion

Power stations: Surgut, Pskov, Stavropol, Serov, Troitsk

Major shareholders: Gazprom (52.4 percent)

Installed capacity: 8,695 MW

Market capitalization: $4.3 billion

Power stations: Kostroma, Pechora, Gusinoozersk, Yasnogorsk, Suvorov, Yuzhnouralsk

Major shareholders: Norilsk Nickel (64.9 percent)

Installed capacity: 8,497 MW

Market capitalization: $5.7 billion

Power stations: Sharypovo, Shatura, Smolensk, Yaiva, Surgut

Major shareholders: E.On (76.1 percent), UES (22.5 percent)

Installed capacity: 8,630 MW

Market capitalization: $7.6 billion

Power stations: Konakovo, Nevinnomyssk, Sredneuralsk, Reftinsky

Major shareholders: Enel (60 percent)

Installed capacity: 8,700 MW

Market capitalization: $3.9 billion

Power stations: Ryazan, Novocherkassk, Cherepovets, Kirishi, Krasnoyarsk, Novomichurinsk

Major shareholders: Gazprom (51.7 percent)

Installed capacity: 9,052 MW

Market capitalization: $2.4 billion

Location: St. Petersburg, Leningrad and Murmansk regions, republic of Karelia

Major shareholders: Gazprom (37.8 percent), Fortum (25.7 percent)

Installed capacity:
Electric - 6,200 MW
Heat - 14,800 Gcal/h

Market capitalization: $5.4 billion

Location: Arkhangelsk, Vologda, Kostroma, Nizhny Novgorod, Tver and

Yaroslavl regions

Major shareholders: RWE (51 percent agreed on, to be acquired)

Installed capacity:
Electric - 2,582.5 MW
Heat - 12,471 Gcal/h

Market capitalization: $1.1 billion
TGK-3 (Mosenergo)

Location: Moscow and Moscow region

Major shareholders: Gazprom (53 percent), Moscow city government (26 percent)

Installed capacity:
Electric - 11,000 MW
Heat - 34,200 Gcal/h

Market capitalization: $7.9 billion

Location: Belgorod, Bryansk, Voronezh, Kaluga, Kursk, Lipetsk, Oryol, Ryazan, Smolensk, Tambov and Tula regions

Major shareholders: Onexim Group (32 percent)

Installed capacity:
Electricity - 3,347.8 MW
Heat - 17,653 Gcal/h

Market capitalization: $1.5 billion

Location: Kirov region, republics of Udmurtia, Chuvashia and Marii-El

Major shareholders: Integrated Energy Systems (46.1 percent)

Installed capacity:
Electricity - 2,467 MW
Heat - 9,040 Gcal/h

Market capitalization: $984.2 million

Location: Nizhny Novgorod, Vladimir, Ivanovo and Penza regions and the republic of Mordovia.

Installed capacity:
Electricity - 3,112.5 MW
Heat - 10,688.8 Gcal/h

Major shareholders: Integrated Energy Systems (34 percent), Prosperity Capital Management (18.9 percent)

Market capitalization: $1.3 billion
TGK-7 (Volzhskaya)

Location: Samara, Ulyanovsk, Saratov and Orenburg regions.

Installed capacity:
Electricity - 6,879.7 MW
Heat - 30,687.2 Gcal/h

Major shareholders: Joint venture between Integrated Energy Systems and the New Russian Generation Fund (82.2 percent)

Market capitalization: $2.7 billion

Location: Astrakhan, Volgograd, Rostov, Krasnodar, Stavropol regions and the republic of Dagestan

Major shareholders: LUKoil (82.3 percent, so far has paid for 30 percent)

Installed capacity:
Electricity - 3,600 MW
Heat - 13,366 Gcal/h

Market capitalization: $1.9 billion

Location: Perm and Sverdlovsk regions, republic of Komi

Major shareholders: Integrated Energy Systems (76 percent)

Installed capacity:
Electricity - 3,280 MW
Heat - 16,952 Gcal/h

Market capitalization: $1.7 billion

Location: Chelyabinsk and Tyumen regions, Khanty-Mansiisk and

Yamal-Nenets autonomous regions

Major shareholders: Fortum (76.5 percent)

Installed capacity:
Electric - 2,773 MW
Heat - 12,512 Gcal/h

Market capitalization: $1.8 billion

Location: Omsk and Tomsk regions.

Major shareholders: UES (50.46 percent)

Installed capacity:
Electricity - 2,026 MW
Heat - 8,241 Gcal/h

Market capitalization: $728.2 million
TGK-12 (Kuzbassenergo)

Location: Kemerovo and Altai regions

Major shareholders: SUEK (43.5 percent), UES (42.6 percent)

Installed capacity:
Electricity - 4,375.2 MW
Heat - 8,744.5 Gcal/h

Market capitalization: $1.5 billion
TGK-13 (Yeniseiskaya)

Location: Krasnoyarsk region and republic of Khakasia

Major shareholders: UES (56.5 percent), SUEK (35 percent)

Installed capacity:
Electricity - 2,548 MW
Heat - 7,717 Gcal/h

Market capitalization: $1.5 billion

Location: Zabaikalsky region, republic of Buryatia

Major shareholders: UES (49.66 percent), Norilsk Nickel (27.69 percent)

Installed capacity:
Electricity - 653 MW
Heat - 2,707.6 Gcal/h

Market capitalization: $233.4 million