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Session Summary. Utilities: What’s Left to Be Done in Order to Get the Promised Market Model?

February 5, 2010

Seppo Remes began by observing the targets of UES’ reform and providing a comment on the current status.

  • Separation of competitive and monopolistic (regulated) segments of the utilities sector – completed.
  • Market liberalization (the electricity generation segment) – proceeding and close to completion.
  • Privatization of generation assets – mostly completed.
  • Restructuring of UES in the form of a breakup – completed.

Mr Remes claimed that Russia is on average far ahead of the EU in terms of the structure and development level of the electricity market and on par with the Nordic countries. The EU countries are only on their way to implementing the mechanisms for structuring the electricity market.

The speaker noted a few points that must be developed to ensure sustainable development of the sector.

  • Approval of the long-term capacity market model and ensuring that a “real” market is in place.
  • Transition to the RAB system in both the electricity distribution (which is on the way) and heat businesses.
  • Continuation of the privatization process, in terms of both gencos and potentially discos.

Denis Fedorov said that his company is more satisfied with the process and results of the 2010 capacity auction compared with those for 2009, although not fully content in absolute terms. When it comes to the methodology, the notion of standard benchmark capex is acceptable, in his company’s view, since this mechanism incentivizes companies to minimize the costs of new capacity construction. However, a few issues remain. In particular, it is currently unclear what the prices for old capacity will be in 2015; the WACC methodology is still not approved by the regulator; and his company feels uncomfortable with the notion of “terminal value” in the capacity price calculation, as its introduction would lengthen the payback period beyond 15 years. The speaker emphasized the importance of the long-term capacity market, since it will provide the necessary signals to market participants (e.g. in case consumers consider constructing their own in-house generating capacity) and secure the sustainability of the electricity market. The current plan is to have a government resolution regarding the capacity market issued by April 1; a delay would be problematic.

Dominique Fache noted that electricity tariffs in Russia are currently four times lower on average than in Western countries, although Russia is roughly four times more energy-intensive. The speaker noted that around 40% of generation assets in Russia should be replaced – there is an excess of obsolete capacity and it should be decommissioned. Another problem in the sector is the increase in non-payments for electricity. Mr Fache also expressed the idea of possible future consolidation in the sector, assuming that only large genco players will remain operating on the generation market in Russia in the end.

Mikhail Slobodin noted that the heat subsector is one of the most inefficient sectors in Russia due to the high losses in heating networks and the decaying asset base inherited from the Soviet period. The law on energy saving and efficiency improvements, signed in November 2009, is a breakthrough. It implies the transition of heat production and transportation to long-term tariffs with a return on investment methodology (RAB in effect) starting from January 1, 2012. A very important issue now is subordinate legislation, i.e. regulatory and quality parameters. The system will enable long-term relations (three to five years), provide incentives for producers to cut costs and enable them to start an investment process. There has to be a balance: the market pays an adequate price for the product, but sets requirements in terms of the quality of the product. Transition to a RAB system for the heat subsector will inevitably lead to improvements in the quality of heat deliveries longer term, although in the short term consumers may not feel these improvements, as they will take time. Mr Slobodin also claimed that market rules should be developed continually. This would increase transparency in the sector and enable market participants to create long-term strategies. He does not believe that there will be construction of in-house generating capacity in Russia on a large scale.

Pavel Strunilin presented a rather pessimistic comment on the electricity market from the standpoint of consumers – there is no market and no competition, it is a seller’s market, and the current market structure is a kind of veiled regulation system. Mr Strunilin noted the advantages for investors as a result of the market rules being discussed, as they would in effect provide a practically risk-free investment, in his view, i.e. if the capacity price is set in accordance with the proposed market model. However, when the economy reaches a limit in terms of an acceptable electricity price level, the current favoring of gencos by the regulator may reverse in favor of customers in the future. Mr Strunilin expressed the idea that under such market conditions, relatively large industrial customers are incentivized to install their own in-house generating capacities.

George Rizhinashvili disclosed that RusHydro is developing a 15-year strategy that should be presented at the BoD meeting in mid-April. The current strategy will be complemented with a long-term technical upgrade program for existing assets, the determination of new capacity construction projects, and inclusion of the issue of long-term financing of projects with a lifespan of more than 15 years. Some of the projects may be excluded from the strategy. He noted that the company is in talks with foreign design and engineering companies, which should contribute to the efficiency of RusHydro’s new projects. The recovery of Sayano-Shushensk GES continues at a sustainable pace (thanks in part to well-timed government support) and the works are generally on schedule. Mr Rizhinashvili also noted that his company will increase the volume of debt financing, thereby improving its capital structure and thus reducing its WACC. Conducting new share issues is inefficient, in his view. The view of minority shareholders is important to the management, he added.

Nikolay Shvets agreed that some 50% of the asset base must be replaced in Russia’s electricity sector. Losses in the power distribution network total around 12% today, while the aim is to reduce this figure to the target level of 5-6%. Seventeen regions have already been transferred to RAB and the remaining 52 are waiting for this to occur (some from July 1, 2010, and others from January 1, 2011). The main priority for his company is to establish a new strategy until 2030, which could be ready by mid-2010. Its main focus will be how to operate/manage the electricity distribution sector in an efficient manner. From January 1, 2011, the legal ban on reduction of the state’s stakes in MRSKs below controlling should cease to be effective. As a result, attracting strategic investors should then become possible (taking an MRSK under management or entering the share capital, if a principal decision on such a possibility is made by the state). Attracting a leading company on the global market as a partner is one potential option, and another is to have MRSKs transfer to a single share. These are just potential alternatives, and currently the possible future model for the sector has yet to be determined. The relevant work is ongoing, and it is up to the government to decide.

Andrey Shishkin said that an energy market exists, but it should now be fine-tuned accurately. The electricity market price should correspond with the ability of customers to pay that price, but at the same time, the price should also be a driver for investors to invest. It is important that the capex (per MW) is not exaggerated and that the right technical solutions are used when new capacity is constructed. Cost-saving in the sector is another very important area, he indicated. Most notably, the speaker stated that there is a will to launch the long-term capacity market and it should be functioning from 2011.


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