By Christopher Owen and Oxana Gorshkolepova

Reform in the electric power sector in Russia has been a major work in progress for years.  Under the most recent plan, RAO UES of Russia should itself be phased out at the end of 2006.  But, according to the internal materials of RAO UES of Russia, this is now unlikely to happen earlier than 2008.

This article looks at the progress to date and what we can expect in the short and medium term.

Despite some delays in the implementation of certain elements of the future market model and a complex coordination process between the government and UES, power reform seems to be almost halfway there. The transition market model is scheduled to run through 2008.  From the year 2009 onwards a free competitive market is expected to be in place.

Background

UES is an enormous electric utility. The company is a holding company that owns controlling stakes in 73 regionally vertically-integrated utilities in Russia.  It owns 72.4% of the installed generating capacity in the country, 96.1% of the high-voltage grid, and 77% of the distribution network.  It owns 100% of the Federal Grid Company and 100% of the System Operator, which operates the grid.  The Russian government has been moving for some time toward privatizing UES.

The basic principles for reform of the Russian electricity market were legislated during 2001 to 2003.  In July 2001, these principles were defined in a “Decree on Restructuring the Electric Power Industry of the Russian Federation.” In mid-2003, a series of laws came into force, including the “Law on the Electric Power Industry.” In connection with this decree and these laws, several regulations were adopted, in particular the “Rules of the Wholesale Electric Power Market (Capacity) During the Transitional Period.” Rules on the operation of the electric power retail market should be adopted shortly.

The electricity market reforms envisage restructuring formerly vertically-integrated companies that combined all industry functions, by splitting them into a separate monopoly sector — electric power transmission and operational dispatcher control — and a competitive sector — electric power generation, sales, repairs and related services.

The end goal of power reform is a fully competitive wholesale market.  However, a prerequisite for such a market to develop is the full de-monopolization of the electric power sector.

Electric power sale-purchases during the transitional period are to be made through two sectors: the free sector, launched on November 1, 2003, and the regulated sector. Within the regulated sector, there is also a trade in differential between the actual and requested capacity of electric power production or consumption.

Wholesale and Retail Markets

To be eligible to engage in electric power sale and purchase transactions, the administrator of the trading system — called “ATS” — must give a participant the status of a wholesale market participant, followed by subsequent registration with ATS.  In addition, a participant must execute a standard agreement with ATS for access to the wholesale market trading system.

The functioning of the wholesale market depends on freedom for market participants to choose counterparties and the prices at which they want to buy or sell, and to enter into bilateral agreements for the sale and purchase of electric power.

For additional information, please refer to the table below.

Functions of the Sector’s Key Institutions

1.   The Federal Grid Company administers the unified national electric power grid.

2.   The System Operator (“SO”):

• is responsible for operating the grid,
• provides technical grid connection of generating equipment held by any legal entity or individuals pursuant to their ownership or other rights, and
• offers electric power transmission services.

Note: The reform proposals call for more than 75% of the Federal Grid Company and the SO to remain state owned.

3.   ATS organizes electric power sale-purchases in the wholesale market.  For example:

• ATS, together with the SO, enters into an agreement with a new participant in the wholesale market regarding the terms and conditions of access to the trading system of that market, and
• ATS registers electric power sale-purchase agreements between the supplier and consumer.

Participants in the wholesale market are free to determine the price for electricity based on a so-called equilibrium price, which is a function of supply and demand and is arrived at either by comparing the bids of electric power providers with a selection process done by ATS, or the parties can fix the contract price on their own by means of a two-party agreement.

The retail market is more strictly regulated. To ensure stable power supply conditions and to prevent price escalations, the state introduced regulated bilateral agreements, in which capacity and price-related terms are set directly by the State.

To date, more than 30 regional generation companies — called “AO-Energos” — have been privatized.  All seven wholesale generation companies envisaged in the reform proposals have been established, and the majority of 14 territorial generation companies envisaged have completed their state registration.  By 2008, UES is intended to be phased out.  Following the end of the transitional period, the majority of shares in the wholesale and territorial generation companies will be privately owned.

According to information available on the web-site of UES, the shares of the new companies will be proportionally distributed among the shareholders of the respective AO-Energos.

For political reasons, the state has been taking very gradual steps to exit the retail market.  A transitional retail market, where part of the electric power supplied will be at competitive prices, is scheduled for 2006.  However, the state will keep control over prices for individual consumers even when the transitional retail market is in operation.

An arbitration tribunal has been established within ATS.  This is a permanent arbitration tribunal that considers economic disputes arising out of civil contracts in the electric power industry, provided the parties have agreed to submit to its authority. The tribunal provides the parties to a dispute with the following advantages: shorter periods for consideration of their disputes as compared with other arbitration courts, a simplified arbitration hearing procedure, the right of the party to select an arbitrator to hear a dispute and enhanced confidentiality.

Investments

In September 2005, the Ministry for Industry and Energy submitted to the Russian government a draft of a planned “Decree on Investment Guarantee Mechanisms for the Construction of Generation Facilities.” The aim is to ensure that investors will be reimbursed for an amount equivalent to the difference between the market electric power price and the payback price for a fixed payback period. The draft is currently under consideration within the Russian government.

Under the terms of the draft, an investor will be selected through a tender to be held by the System Operator with the participation of representatives of the local authorities.  Preferred projects will be those using state-of-the-art technologies for generating facility construction.  According to the information available, the draft proposes to limit the aggregate capacity of the facilities built under the investment guarantee mechanism to 5,000 megawatts.  The mechanism contemplated in the draft is planned as a transitional stage of reforming the power sector.  It is a provisional measure providing for the construction of new generation facilities in certain regions with power deficits.

There is still a lack of investment into the Russian electric power sector in general. There are several underlying reasons, but the majority of large industrial consumers would expect to be served directly by generating companies, and distribution companies limit their focus to the retail market.  Generation activities look more attractive to potential investors.