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. Last Updated: 07/27/2016

It Will Take Time to Transform UES

One of Russia's key structural reforms -- the restructuring of national power grid Unified Energy Systems -- has been progressing slowly.

The energy sector that UES head Anatoly Chubais tackled in 1998 had changed little from the vertically integrated structure left after the fall of the Soviet Union. The inefficient monopoly lacked competition in the retail and wholesale markets and ran on funds generated by low, government-regulated electricity tariffs.

Over the next two years, UES is to be dramatically transformed both on the federal and regional levels.

The restructuring of the power industry, approved by the government in July 2001, is aimed at liberalizing electricity markets by 2004 and attracting strategic investors. UES is to restructure all of its subsidiaries, including 72 regional energos and more than 30 wholesale power plants.

Under the restructuring program, by March 2004 the company is to be broken up into a national transmission company, 10 wholesale generation companies and a holding company to manage stakes in the regional generation and distribution companies that are to emerge from the transformation of regional energos. UES shareholders are to receive stakes in these 12 companies on a pro rata basis.

The government, experts, market participants and investors have expressed concerns over the speed of power-sector reform and have indicated that the reform process is unlikely to be completed within the previously announced time frame.

"Structural reforms at UES and regional energos are progressing very slowly -- the creation of the wholesale generation companies has not yet been approved by the government; UES's plans are being resisted by minority and strategic investors in regional energos; and the transfer of the regulatory function from the regional to the federal level has not been adopted," Brunswick UBS Warburg wrote in its "UES Trend Watch" issued last week.

A new electricity law -- yet to be adopted -- is planned as the most important legislative base for implementing the reform. It aims to set the framework for structural reforms in the sector and introduce a new pricing mechanism on the electricity market. It envisages changes in the regulation of monopoly areas (transmission and distribution) and the transfer of the regulatory function from the regional to the federal level, as well as the liberalization of competitive areas (generation and supply).

According to the initial time frame of the reforms, this law was to have been passed by the State Duma in December 2001. The draft law met opposition even before being submitted to the Duma, and the government is still discussing it. The presidential administration's legal department has expressed concerns about the law's key provisions, including the transformation of regulatory functions and certain structural changes.

Kaha Kiknavelidze, an energy analyst at Troika Dialog, said that "UES planned a very aggressive reform in a very short time, so such a delay is expected.

"The whole reform is aimed to attract investment. Investors are not interested in the industry as long as revenues in the energy sector are negative due to low tariffs," Kiknavelidze said. The government is showing that it is not yet ready to increase electricity rates, he added.

The creation of a competitive electricity market is expected to finally bring domestic electricity tariffs to economically justified levels and boost earnings.

The regulation of noncompetitive areas is to undergo significant transformation with the introduction of a return-on-equity formula, which should increase the attractiveness of these businesses for private shareholders.

Furthermore, consolidation by business activity should result in the emergence of companies large enough to be attractive to investors. Finally, both local and foreign strategic investors are expected to become interested in the sector when the government sells its stakes in the newly created generation companies.