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Russia: YeES Deputy Head Speaks of Electricity Sector Problems

CEP20021204000096 Moscow Rossiyskaya Gazeta in Russian 03 Dec 02 P 5

[Interview with Sergey Dubinin, deputy chairman of Unified Energy System of Russia Russian Joint-Stock Company, by Vladimir Fedorov under "Energy" rubric; place, date not given: "No Place for Investment Hiatus"]

[FBIS Translated Text]
The state of the energy sector today is such that in a few years' time Russia could encounter the need to buy electricity abroad.  This likelihood exists because the growth rate in industry may exceed the dynamics of the commissioning of energy capacities.

   There is one way out:  To construct new generating capacities, but for this it is necessary to attract large-scale investments.  This is what Sergey Dubinin, deputy chairman of the YeES Rossii [Unified Energy System of Russia] RAO [Russian Joint-Stock Company], believes.

   [Fedorov]  Sergey Konstantinovich, Russia now supplies energy not only to itself but also to certain neighbors.  According to [YeES Rossii CEO] Anatoliy Chubays, an increase in electricity exports abroad is, in turn, not too much of a prospect.  So does the Russian economy need new generating capacities now, if there is sufficient energy anyway?

   [Dubinin]  Let us, nonetheless, endeavor to investigate the situation in greater detail and then draw a conclusion.  First, whether or not anyone wishes to acknowledge this, there is a real problem of worn-out fixed capital in the energy sector.  Here are data from an independent technical audit.  Precisely 54 percent of the basic equipment in the energy joint-stock company is worn out, while equipment with a total capacity of 31 million kw has exhausted its normative operating life:  To put it more simply, it is operating with reduced reliability.

   During the next two years a further 23 million kw of heat and electric power station capacities will reach the end of their operating life.  In all, almost 47 million kw of generating capacities will reach the end of their stock operating life in 2007.

   [Fedorov]  But, after all, these capacities can be repaired, can they not?

   [Dubinin]  All the figures I have cited take account of the maintenance and repair of energy facilities.  But at a certain moment it becomes simply economically unprofitable to maintain old capacities.  This is roughly the same thing as driving an old car for a very long time:  One fine day the cost of repairing it starts to exceed the difference between its value and the price of a new car, which, moreover, is also both technically more sophisticated and more economical.

   A similar situation has taken shape in the energy sector.  Technologically, we have lagged behind very seriously.  Existing power stations have an average performance coefficient of 30 percent.  In modern steam and gas plants, which now form the basis of heat and power generation in developed countries, the performance coefficient stands at 55-57 percent.  That is, there is a difference of almost one-third.  We have just one such plant -- at the Northwestern Heat and Electric Power Station.  Taking into account the expected growth in the cost of gas fuel, this figure could altogether become critical for the existence of thermal power stations.

   This is why it is necessary not just to maintain what we have today but also to construct new, more modern capacities to replace the old ones.  Naturally, this will require investment.

   [Fedorov]  Nevertheless, thanks to our own fuel stocks, we will always enjoy more favorable conditions than, say, West European countries.

   [Dubinin]  We are already encountering the problem of the increasing cost of gas in the country -- which is inevitable.  An attempt to profit from Russia's inexpensive resources is, in my view, a purely temporary solution.

   Of course, taking into account the conditions of extraction and transportation, oil and gas will be less expensive in our country than in countries which do not extract their own, but the difference will gradually boil down to the elementary cost of the transportation component.  At present oil and coal prices are regulated by the market, while gas prices are regulated by administrative means.  A quite dangerous situation is arising:  Given artificially cheap gas and old electricity generation capacities, today our electricity tariff helps our industry, as it were, to withstand competition.  But tomorrow, when gas becomes expensive while the available capacities remain as before -- that is, obsolete and burning 40 billion cubic meters of gas a year more than they might -- electricity will become expensive, which will deprive our industry of its competitive advantages.

   This is very dangerous, when you consider that we are now building an open economy.  Never before in Russia's history, incidentally, has the economy been so open -- not in Soviet times or even in czarist times.  Today we encounter international competition on a daily basis.  Starting with the range of goods on store counters and ending with the array of offers relating to a major purchase by tender, everything attests that we are already part of the world market.  Therefore the money invested now and subsequently in the energy sector will ensure the normal functioning of the entire economy.

   [Fedorov]  In your view, what funds should be used to finance the construction of energy installations?

   [Dubinin]  For the past 10 years 99 percent of the investment in the energy sector has been provided from the resources of the RAO YeES Rossii.  To date there has been virtually no outside investment -- that is, on the part of other companies, Russian or foreign.

   Admittedly, there are some exceptions, where outside investors also participate in funding the construction of facilities.  The construction, say, of quite a large steam and gas station in Bashkortostan.  Or Kamchatka, where the Mutnovskaya Geothermal Power Station was constructed with funds from the European Bank for Reconstruction and Development.  Its first unit was commissioned a year ago and the second in October this year.  But these, after all, are just isolated examples.  We now have approximately 6,000 megawatts of capacity at installations which are being completed, and, in addition, it would be desirable to construct a further 5,000 megawatts of capacity at a number of energy centers where a capacity imbalance is possible.  In my view, it will be impossible to realize these plans without attracting outside investment.

   [Fedorov]  Do you expect investors to arrive as reform of the energy sector is implemented?

   [Dubinin]  The aim of the reform is indeed to make the sector attractive to investors outside the RAO.  We believe that it is necessary to restructure the sector and to create a genuinely competitive market, whereby market parameters will determine the cost of the electricity generated, and this, in turn, will enable investors to make a real calculation of the effectiveness of investments.

   Nevertheless, there is another problem, peculiar to Russia.  From the experience of energy sector liberalization in all European countries and the United States, we can see that immediately after the introduction of a competitive market there is usually a fall in the tariff and a certain hiatus in investment, because investors want to know at what level income from investment will stabilize in the future.

   If liberalization has been preceded by a period during which significant power-generation capacity was commissioned, as was the case in Britain, for example, such a hiatus is almost natural and may not be frightening.  In our country, unfortunately, the situation is different:  We are now going into the market, as I have already said, with a very large amount of capacity that is nearing the end of its service life.  And if demand continues to grow pretty dynamically in these conditions, we will inevitably encounter a situation in which all facilities, including the least effective ones, will be in operation.  This could lead to a rise in tariffs.

   In order to prevent such a rise, this investment hiatus must be avoided.  There is a need to create a sort of bridge across the first few years of market operation, perhaps even involving the use of techniques of regulation not purely by the market but by the state.  The Economy Ministry, together with the RAO YeES Rossii, has proposed a formula for the creation of a fund for completing the construction of generating facilities and guaranteeing investments.  We propose giving investors certain guarantees against market instability in the transitional period.

   But we do not intend to guarantee the full tariff, which is necessary in order to cover costs, but the difference between it and the tariff's market level in a competitive market.  Thus we are not giving investors a full guarantee; we are forcing them to work in the market, to compete.  At the recent symposium on investment in Russia in Boston, we tried to present this scheme to investors in general terms.

   [Fedorov]  Nevertheless, the project was subjected to furious criticism by presidential adviser Andrey Illarionov in the presence of foreign investors.  What, in your view, are this project's prospects, and how, in your view, will it influence foreign investment in the energy sector?

   [Dubinin]  After the forum Mr Illarionov said that he had spoken not as an adviser but as a private individual.  On the other hand, those investors who have been working in Russia for a long time know the value of statements made by Illarionov, who ventures to make very subjective judgments, based, to put it mildly, on a selective attitude to the facts and material to be analyzed.  Take, for example, the attempt to compare the changes in the market capitalization of the RAO YeES Rossii, in other words of a company currently outside the competitive market, with similar indicators for companies whose operations are determined principally by market rules.

   Moreover, data for the RAO YeES Rossii were cited for the period from the start of 1998 in US dollars, in other words before the August crisis, and were compared with the present day.  But the data for oil companies were only from after the crisis.  But even such a comparison, in my view, demonstrates the need for urgent reform of the energy sector.

   Illarionov called for the State Duma's consideration of electricity laws to be postponed indefinitely.  This would inevitably have prompted a fall in the value of RAO YeES Rossii shares, because of the renewed uncertainty about the prospect of reform.  This is evidently what he was trying to do.  Someone could have bought these shares very cheaply.  However, the reform schedule was reconfirmed.

   The market hardly reacted at all.  This demonstrates, in any case, what market players think about Illarionov's statements.  True, this applies to those investors who are already operating in one way or another in Russia and know our situation well.  As for potential investors, who are only thinking about the possibility of going into Russia, the speech undoubtedly produced a negative impression on them.  If a Russian state functionary of such a rank undertakes to tell investors where they should and should not invest their money, many will decide to keep away from such a country.

   Now both the government and industrialists will again have to expend energy on trying to persuade foreign capital to come to Russia.  Paradoxically enough, Mr Illarionov's speech makes the proposed program for guaranteeing investments in the energy sector even more topical.


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