UES Restructuring Could Revolutionize Energy Sector

Despite the infamous voucher privatization that took place in Russia during the 1990s, large swaths of the economy still remain in the hands of the state, with the government retaining complete or partial ownership of behemoth enterprises such as Russian Railways, Rosneft, LUKoil and Gazprom. It’s all the more ironic, then, that Anatoly Chubais, the architect of Russia’s earlier privatization, is head of the country’s monopoly electrical utility, Unified Energy System of Russia (UES), eight years after his original appointment. The Russian government still holds 52.6 percent of the company’s share capital through the Federal Agency for Federal Property Management.

UES is the largest power utility in the Russian Federation, outputting 69.4 percent of the country’s general electricity and accounting for 72.4 percent of its installed capacity. It also owns 96.1 percent of Russia’s high-voltage grids and 77 percent of its distribution network.

As a holding company, UES also owns controlling stakes of between 49 percent to 100 percent in 73 regional, vertically integrated energy companies and 44 federal power plants (of which eight are under construction), 100 percent in the Federal Grid Company and 100 percent in the System Operator-Centralized Dispatching Administration.

Reform of the electricity sector is badly needed. Although many Western experts believe that Russia’s decline started with the collapse of the Soviet Union and was greatly exacerbated by the economic policies of the so-called Washington Consensus, electricity, like the oil sector, was, in fact, already in considerable trouble in the 1980s when signs of stagnation appeared as generating capacity was renewed slower than power consumption increased.

So Russia’s investment in infrastructure, like the United States and the United Kingdom, has often been lacking not just over years, but decades. Chubais has repeatedly made very public statements in recent years that the whole system, which received virtually no investment after the Soviet Union collapsed, was working at the limit of its capacity and needed immediate cash to avoid a collapse. Spectacular proof came last winter, when major parts of Moscow experienced an outage for several hours. A cold spell, even by Russian standards, hit the country last winter and put a serious strain on the country’s power grid, while rising energy consumption created a generating-capacity shortfall. This autumn Chubais courted controversy when he warned that, if the temperatures dropped to below minus-25 degrees Celsius for more than three days, blackouts would ensue.

In October he said that the company would consider reducing electricity exports during the coming winter to cover the domestic energy shortfall. “An extremely difficult situation is currently developing in Russia with the shortfall in power capacity,” Chubais said. “Given this situation, we are forced to take measures to make maximum use of existing capacity during the autumn-winter [consumption] peak.” In an interesting move, Ukraine’s energy ministry proposed to help Russia cover its power shortage with its power plants’ spare capacity in exchange for Russian natural gas.

At the same time, Russia’s strategy is to export electricity to neighboring countries, and UES has close ties with, for example, Kazakhstan, the Kyrgyz Republic and Armenia.

But, despite the need for reform, progress has been slow. The electricity sector has been undergoing major change since early 2002, but it has been held back by competing vested interests at federal and regional levels that have different ideas about how reform should proceed. Previous plans have, therefore, been only partially fulfilled and planned legislation only partially implemented. One result of this was a fall in UES’s share price and market capitalization, which Chubais’ many opponents in Russia used to attack the company chief.

Russian Prime Minister Mikhail Fradkov is also on record as saying that “the power industry is hampering the country’s economic development. We cannot continue to keep silent over this. The government must help Chubais resolve [the sector’s] problems.”

Against this background, the Russian government announced a 200 billion ruble package (5 billion euros) in June 2006 for the sector involving a major restructuring of UES, which will now be broken up into generating companies to be listed on domestic and foreign stock exchanges, and into the state-controlled grid and distribution companies. The philosophy behind this move is largely derived from Western approaches aimed at increasing private investment and the deregulation and liberalization of the market and prices. UES aims to reform its assets structure and the structure of the energy sector by separating the main competitive businesses of generation and supply from transmission and distribution, which are non-competitive. The hope is that market conditions in the competitive businesses will finally increase efficiency and the value of UES’ assets.

The Russian government estimates that some $78 billion will be invested in the utility sector during the next five years and, in June 2006, Chubais said that Russia would welcome the massive foreign investment the company needs to modernize its infrastructure.

UES argues that reorganizing the company would be the logical completion of the sector’s restructuring and lead to a new, de-monopolized industry. Competition is expected to develop among the new, stand-alone electricity players that are expected to arise, while UES itself could cease to exist as a state-owned monopoly whose assets will be transformed into several state-owned and private companies.

The first stage is scheduled to last from the end of 2006 to the second half or the end of 2007, with one wholesale generating company and one territorial company due to spin off from UES, since they can already function on a stand-alone basis and implement long-term investment projects. But, even here, the government will hold at least a 25 percent stake in these companies, plus one golden share.

An extraordinary shareholders’ general meeting was held December 6, 2006 to approve these plans, with general shareholders’ meetings scheduled in 2007 to approve the decisions on the reorganization of the two companies.

The second stage is planned for 2007 to 2008, when UES, in its present form, will cease to exist after being split into multiple companies to produce the target structure of the industry, which will then comprise the Federal Grid Company, the System Operator, the Wholesale Generation Companies, the Territorial Generation Companies, and Interregional Distribution Companies.

UES could, therefore, cease to exist as a corporate entity, although the company says its brand could be transferred to another corporate entity or “cancelled,” although this has yet to be settled. Numerous questions still remain regarding the reorganisation of UES, the sector as a whole, and price liberalisation. And though it is easy to criticise the slow pace of reform in Russia’s electricity sector, the reform in California, not to mention blackouts in New England and, just recently, in Europe not only show how dependent modern society is on power, but also that getting it right is by no means easy.

By Ian Pryde

Published in Trendlline Russia, a series of sponsored supplements on the Russian economy commissioned by RIA-Novosti and published with the print editions of The Daily Telegraph (UK) and The Washington Post (USA) in November-December 2006.

Appeared in The Washington Post as a supplement entitled ‘UES Restructuring Could Revolutionize Energy Sector’ and at http://www.washingtonpost.com/wp-adv/specialsale/spotlight2006/articles_v4/restructuring.html

Appeared in The Daily Telegraph as a supplement entitled ‘Sparks begin to fly: the first stage of the break-up of the state monopoly of electricity will soon be underway’

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