(This section is best read in conjunction with our RAO UES page)

The Russian power sector is undergoing rapid unbundling and reform, while facing into a potential supply crisis as Russia's economy (expanding at over 5% p.a. since 2001) outgrows an ageing infrastructure in need of upgrading, and where historical state involvement has stifled upgrading and investment. In 2006 President Putin approved legislation ushering in a series of privatizations and further liberalization of what has been a heavily protected market. The government aims to attract some $87 billion to the sector between 2006 and 2010, introducing market driven reforms and pricing structures. Up until 2006 most energy in Russia had been sold at heavily subsidized prices. Similarly, most of Russia's electricity generating sations run on natural gas supplied to them by the state-backed "national champions" (Gazprom or Rosneft) at subsidized prices.

The unbundling of former energy companies into 14 TGCs and 7 WGCs has facilitated a clear distinction between state-owned (Nuclear & Hydro-electric) assets, and generating units geared towards reform and eventual full privatization (TGCs, vertically integrated territorially based generation companies running heat and power plants generating thermal and electric power, & WGCs, wholesale generation companies with power plants specializing in electric power) 4 TGCs and 4 WGCs were admitted to the stock exchange in 2006. In November ’06 WGC-5, in which RAO UES previously held an 87.67% stake, floated 14% of its stock, raising $459 million on the RTS and MICEX. In this respect IPOs are seen as a vital mecahanism for attracting much needed investment to the sector.

(source: RAO UES)

RAO UES, United Energy Systems, chaired by former Prime Minister and reformer Anatoly Borisovich Chubais, is ostensibly a state holding company that owns controlling stakes (49%-100%) in 73 regional vertically integrated energy companies and 44 Federal power plants (of which 8 are under construction). It owns 100% in OAO "FGC" ( OAO "Federal Grid Company") and 100% in OAO "SO-CDA" (OAO "System Operator - Centralized Dispatching Administration"), the former of which will oversee an eventually liberalized wholesale and retail electricity market.

ENERGY & EMISSIONS: RAO UES alone is responsible for 2% of the Earth's carbon emmissions. At present, Russia, as a signatory of the Kyoto Protocol governing the trading of emissions quotas, is in a postion to release billions of dollars of emission quota onto the market. Gazprom Bank, a wholly owned banking subsidiary of Gazprom, and Dresdner Kleinwort have created a joint venture to invest in projects generating corresponding certificates within the mechanism envisaged by the Kyoto Protocol and will convert carbon dioxide loans into securities for sale on the secondary market. The company, Carbon Trade & Finance SICAR S.A. has been set up on a parity basis and registered in Luxembourg.

Merrill Lynch has also secured a foothold in the Russian carbon trading and emissions reductions market through taking a minority stake and providing debt financing for the Russian Carbon Fund, a Copenhagen-based company, in a deal understood to be worth about $200m. The money will be used to get emissions reductions projects off the ground in a move that gives Merrill access to a carbon trading market analysts estimate could be worth up to €15bn ($19.7bn). According to data on its website, RCF could generate revenues from selling "carbon credits" of more than €2bn in the four years from 2008.

Significantly, the joint venture and Merrill's eagerness to enter the market clealy flags a more rapid signing off of carbon emissions trading legislation by the government than had been anticipated by Chubais at RAO UES.

REFORM: Unsurprisingly, Chubais has lead the way in promoting and in some cases demanding power sector reform, as his predictions of an impending energy crisis should Russia experience a cold snap such as that of January 2006 are meant to further promote his reform agenda. A series of IPOs have been planned involving major power and energy units which involved roadshows to attract international investors, and from which the state hopes to generate funds to re-invest in ageing infrastructure.

(Source: RAO UES)

A combined WGC-3/Mosenergo(TGC-3) share issue will take place in March 2007. Gazprom will buy the Mosenergo shares in a deal welcomed by Chubais, while Troika bank reported that WGC-3’s offering will be privately taken up by Interros for $1.5 billion. Mosenergo is by far the biggest TGC, controlling a 5 percent share of Russia’s installed electric capacity and supplying 65 percent of electricity in the Moscow region. State control is maintained through the Federal Grid Company (See RAO UES), the Trading Systems Administrator (for power trading) and a Heating System Operator. Business New Europe analysts also expect TGC-5’s May 2007 IPO to involve a strategic investor (reputedly Viktor Vekselberg’s Integrated Energy Systems). The TGC-1 IPO is scheduled for July 2007 and WGC-4 for later in the year.

Wholesale power generation firm OGK-5 plans to launch a global depository receipt (GDRs) programme for up to 20 percent of its shares by June 2007. OGK-5 (Wholesale Generating Company No. 5) is the first spin-off of Unified Energy System. It sold a 14.4 percent stake in an additional share issue in October 2006, the first offering in Russia's power sector reform, which raised the free float of its shares to 25 percent. UES has approved a sale of 25.03 percent in OGK-5 to a strategic investor at an open auction in mid-June, which will cut its stake in the company to 50 percent from the current 75.03 percent.

Genco's share prices have risen by 36% on average January through Feb '07, well ahead of the RTS (6%) and UES (15%),  though achieved on very low volumes, casting doubt on the sustainability of growth. Other significant potential downsides have emerged. In February the government strongly indicated that Fortum, which holds a blocking stake in TGK 1, would be prevented from taking control of the company, a move which could have a negative effect on potential investment throughout the Russian electric utilities sector.

Secondly UES has attached strings to strategic OGK and TGK purchases, requiring potential strategic investors to coordinate all key development issues with UES (or its successor after unbundling). Finally, Gazprom and SUEK, Russia's biggest coal producer, announced the formation of a joint venture, with Gazprom holding the controlling interest. This will effectively control the supply of coal, earmarked for domestic power production while gas is exported, to a newly privatized and expanding utilities sector.

Aton Capital analysis also points out that the current average market price for gas-fired OGKs/TGKs ($548/kW) is close to the price of new entry ($750/kW), suggesting new entrants might prefer greenfield or standalone projects rather than buying into existing infra-structure.

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According to government decree No. 529 of 31 August 31 2006, the guaranteed market opening in 2007 will be only 5% and between 5% and 15% per year subsequently. The government is proposing another 15% opening in July 2007 and 15-20% per year going forward. The idea is to synchronize the liberalization of the gas and electricity markets, though greater liberalization and higher gas tariffs will also lead to higher average electricity prices.

Overall, average electricity prices in 2007 will rise not by 12%, as forecasted by the Federal Tariff Service, but by some 17.8% (according to Ministry of Economic Development and Trade). The average price of electricity is forecast to increase by 21.1% (the previous tariff rise was set at 9%), in 2009 by 12.6% (the previous tariff rise was set at 8%) and in 2010 by 7.9%.

Wholesale electricity prices have nearly tripled in dollar terms since 2000 and are likely to rise an additional 69% through 2011, according to Renaissance Capital estimates. It is likely prices wil be caracterised by strong demand-led spikes as Chubais continues to seek investors into the sector, thought to include Enel SpA, Fortum Oyj, E.On AG. UES is targeting construction of 21.3 gigawatts of new capacity by the end of 2010.

Russian Utilities:  Hydro Windfalls  (Troika Dialog Research, March 2, 2004) -- Adobe Acrobat file