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. Last Updated: 07/27/2016

Italy's ENEL Eyes Piece of UES Power

Anatoly Chubais' long-simmering idea to bring in foreign companies to manage Russia's power assets is finally gaining shape.

Unified Energy Systems, the power monopoly Chubais heads, this month confirmed its plans to hand over management of the Northwest power station near St. Petersburg to a consortium of Western companies, naming Germany's E.ON and Finland's Fortum as strong candidates.

"It is a matter of principle for Chubais," said an industry insider who asked not to be named. "He does not want to go down in history as a man who handed all the nation's assets to the oligarchs."

Chubais engineered the infamous loans-for-shares privatizations of the mid-1990s, in which large swaths of state assets were snapped up by well-connected businessmen for a fraction of their true value. If the liberalization of the power sector, planned to stretch over the next five years, goes the same way, his public image would be tarnished even further.

The country's electric grid was not sold off in the first round of privatizations, as one of the country's natural monopolies, but remained in the government's hands for safe keeping.

But as part of President Vladimir Putin's reform initiative, the government is loosening its grip. A raft of bills passed by the Duma this spring gave the green light to break UES up over five years into generating companies, which will be privatized, and a national grid network, which will remain under state control.

Italy's ENEL was one of the first foreign firms to gets its foot in the door of the domestic power industry in July when it agreed to set a joint venture with Russian partner ESN, the group that orchestrated the sell-off of oil firm KomiTEK to LUKoil, and it now manages Kolenergo, in the Murmansk region, under contract with UES.

ENEL says its experience at home with energy sector liberalization makes it well suited to play a role in UES reform.

"We were in the same situation five years ago," Ricardo del Bravo, vice president with Enel, said by telephone from the Italian power utility's headquarters in Rome.

"[At home], we have cut costs and improved both technically and economically," del Bravo said.

In many ways, he is right. Italy's power industry story mirrors Russia's. Like UES, ENEL was built to achieve the government's goal of delivering electricity to the farthest flung corners of its map.

Until the 1960s, the Italian power sector included a large number of small firms eager to serve metropolitan areas but not willing to extend their grids to the provinces, leaving parts of the country in the dark. The government stepped in to nationalize all power assets and piled them into one state-owned company -- ENEL-- in 1962.

Within four decades, the power grid covered all of Italian territory but the state monopoly was charging consumers exorbitant prices to compensate for the financial burden posed by its glaring inefficiencies and behemoth structure.

Faced with the European Union's 1996 directive to liberalize the power market, the Italian government in 1999 ordered ENEL to spin off 50 percent of its assets as a way to inject competition into the sector.

ENEL, in which the Italian government holds a 68 percent stake, went public in November 1999, attracting capital of $16.5 billion.

Following its 1996 ruling that kick-started deregulation, the EU has since given countries a deadline of 2007 to do so. As a result, the majority of EU members have the next four years to figure out how to restructure what remains of their state monopolies, much as UES is doing.

The UES reform plan calls for overhauling the power industry by spinning off UES's generation and distribution arms, but it keeps the transmission grid and dispatch center under state control.

ENEL plans to participate in a tender for one of the 10 wholesale generating companies, known as gencos, that currently make up Unified Energy Systems when the umbrella UES structure is dismantled over the next few years. Four of the highly prized gencos will incorporate hydroelectric stations and the remaining six will be built around thermal power plants.

ENEL hopes to win a management contract for one of the thermal gencos, like the Northwest station, for which it will have to go head to head with its German and Finnish counterparts.

Should ENEL get hold of one of the gencos, it will control 5 percent to 7 percent of Russia's power production.

But whether ENEL can bring value to the Russian market is an open question. Although it is one of the Europe's top power companies, in a league with Fortum, E.On and France's EDF, it is by far not the most efficient.

In terms of market capitalization, ENEL was the largest of Europe's power generating companies as of 2002 with a value of $34.6 billion, according to the Financial Times' list of the world's top 500 firms.

ENEL's cost of production runs at 40 euros per megawatt hour, whereas Spain's Endesa produces the same amount of energy for half the cost.

Only its high power tariffs -- the highest in Western Europe -- keep the company's finances above board.

"For the moment, ENEL is a relatively inefficient generating company," said Harold Hutchinson, utilities analyst with Commerzbank in London. "In other words, it is not very efficient relative to other players in Southern Europe," he said.

"ENEL is a story of a big future restructuring, but today it is itself facing the same task [as UES]," Hutchinson said, pointing to both firms' drive for efficiency.

Flush with cash from its own genco sales in the late 1990s, ENEL tried to establish presence in telecommunications and water supply industries, but that diversification effort failed, and ENEL decided to focus on what it knows best -- power generation -- and went on a shopping spree, snapping up a handful of utilities assets across Europe from Spain to Hungary to Romania until it finally set its sights on Russia.

ENEL chief executive Paolo Scaroni unveiled a four-year plan in March to refocus the utility on its core business, terminate oil dependency and boost profits by 8 percent a year.

"Our strategy is to be one of the biggest companies in terms of renewables -- solar, wind, hydroelectric power -- and to expand geographically outside our home market where we face a 50 percent cap," del Bravo said.

It is not without detractors.

"ENEL has not done anything itself," said Laura Tait, a director with Prospex Research, a London-based electricity sector consulting firm. "It was forced to change by the Italian energy law."

But, she conceded, ENEL has made huge steps forward.

"It was virtually impossible to speak to ENEL several years ago," Tait said.

"They've improved significantly on the investor relations side."