Oct 25, 2005 -- Datamonitor

 

Following the fall of the Soviet Union, the Russian economy slumped and the demand for electricity and gas plummeted. While demand has revived during the economic recovery that began in the late 1990s, the years of neglect have affected the infrastructure of the Russian power industry to the point that without private investment, a lack of capacity may place a cap on further economic growth.

The Russian power market is dominated by former monopoly RAO UES (Unified Energy System), which in 2004 accounted for 72% of the installed capacity, 69% of power production and 71% of end-user sales. The Federal Network Company (FSK), owner of the high-voltage grid, is also a RAO UES subsidiary.

RAO UES operates as a holding company, with the majority of its generation assets being in the form of equity ownership of federal power stations and of regional electricity companies. Only nuclear power stations (owned by the Ministry of Nuclear Energy) and a small number of regional electricity companies are not majority or wholly-owned by RAO UES.

RAO UES is 52.7% owned by the Russian state, with a further 10.3% owned by the state-controlled gas monopoly Gazprom. However under the industry restructuring and liberalization plans to 2008, the state will concentrate its ownership in the high-voltage grid (increasing its share to 100%), while non-nuclear generating assets on the one hand and regional distribution companies on the other will eventually be privatized. This industry restructuring is intended to attract much-needed private investment to the power sector, where much of the physical infrastructure is nearing the end of its useful life and requires significant investment.

Some areas of the country, principally in Siberia and the Far East, are still not connected to the national grid due to their isolated position, and the Far Eastern part of the grid is not connected to the rest of the system.

Almost half of the country's nuclear reactors are within 5-10 years of completing their useful life and will need to be replaced. By 2020 Russia is planning to double its nuclear output in order to decrease its dependence on natural gas. Hydro power is also a priority, with RAO UES earmarking $14 billion for new plants in Siberia and the Far East, which are currently energy-deficient.

Best laid plans

Russia's plan for power sector restructuring was adopted in 1998 and covers the ten-year period to 2008. By that time, the current vertically integrated structure should be unbundled into the regulated network business on the one hand, and competitive generating and supply businesses on the other. RAO UES will be broken up into generation, transmission, and distribution and supply companies.

Currently, the Federal Energy Commission (FEC) is mostly engaged in tariff-setting, as the liberalized segment is very limited in both scale and scope. It is too early to tell if it will have become a vigorous enforcer of competition rules by 2008, but it is unlikely that it will have too much room for independent action.

Moreover, the planned reform of RAO UES will focus the company on running the national grid rather than generation and supply, reducing the scope for conflict of interest. With RAO UES taking a much more modest role within the wholesale market, Datamonitor expects a reasonably equitable balancing and data transfer regime to emerge by 2008.

Gazprom in control

The Russian gas market is dominated by one player- Gazprom, in which the state is the controlling shareholder. At present, the state is in the process of increasing its stake to 51% through an additional share issue. Gazprom controls all of Russia's gas transmission and most gas distribution, as well as the bulk of gas reserves and 86% of total production.

Russia is the world's biggest gas exporter and gas exports contribute 25% of the Russian budget. Not surprisingly, Gazprom's export monopoly is being carefully guarded by the government. Furthermore, several new gas export projects are underway or being planned, including the North European Pipeline under the Baltic Sea, and a planned increase in LNG exports.

That said, reform has also started in the gas sector. Gazprom is undergoing the process of organizational and financial unbundling into production, transportation, distribution and supply, and non-core activities. Whereas the immediate objectives of this are greater financial transparency and efficiency, in the long run the unbundling process will enable a relatively quick introduction of deeper market reform.

The liberalized segment of the gas market- while relatively small - is gradually growing. In 2004 there were 33 independent shippers of gas on the Russian market.

Foreign investment opportunities exist mostly on the upstream side. Several production sharing agreements (PSA) under which a foreign company receives a concession to develop a gas field, in return for a fixed proportion of its output, have been in effect since the late 1990s. However this has so far been confined to Sakhalin Island in the Far East. Furthermore, PSA conditions are being tightened and few further concessions are likely to be available in the near future.

In 2004, Gazprom was responsible for 86% of Russia's wholesale gas. By 2008, this may decline to about 75% as independent producers increase their output.

Currently, Gazprom and its subsidiaries represent 70% of distribution volumes in the mass market and the bulk of large user sales volumes. By 2008, the company is likely to cede some market share at the top end of the market but consolidate its grip on distribution.

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