THE BREAK-UP of Russia's power sector and the move towards a free market for electricity has reached the halfway mark as power monopoly United Energy Systems (UES) gets ready to auction off its generating assets in one of the last big privatizations on the slate.
By this summer, UES hopes to have created 24 super-regional generating companies (gencos) out of 72 existing regional power companies (energos). These will then be auctioned off to private investors.
"There has been a lot of movement and now the energos are already in the process of restructuring in preparation for the sell-off," says David Herne, a UES board member and the head of the restructuring committee that represents minority shareholders' interests to management. "Most of the action is under the surface," he says.
UES daughter companies account for 57% of Russian power sales, with nuclear power plants controlled by state company Rosenergoatom providing the remainder.
Russia launched a trial free market for power towards the end of last year in which energos can sell between 5% and 15% of their output to customers at unregulated prices. All price controls are due to be dropped by 2006. The complete break-up of UES and transformation to a free market is due to be finished by 2008.
Crucial stage
The utilities reform has entered a crucial stage. Over the next month the UES board of directors will decide on which generation assets, currently belonging to the energos, will go to make up the new gencos, 10 of which will sell directly to the wholesale market over a state-owned national grid. The other 14 will be regional gencos that largely supply their local markets.
"The list of 10 wholesale gencos – six if Russia is to meet growing demand and avoid blackouts after 2008. But at the moment, the company can can scrape together only about $1 billion a year for capital investment.
Under UES's 5+5 strategy (covering the five years since the start of reforms and five years to go) the 10 wholesale gencos will account for about a third of Russian generating capacity. But the company was struggling to finalize a list at the end of last year.
"There is still a lot of horse trading to do, but we are not expecting any drastic changes to the list now," says Hartman Jacob, a utilities analyst with Renaissance Capital. "It means that whatever changes come there will still be a high level of regional consolidation, which is good as it will avoid the fractionalization of the sector."
Russian strategic investors have been snapping up UES shares, driving the stock's price up from a 52-week low of $0.10 to a September high of $0.35 before it fell back to around $0.28 following jitters caused by the Kremlin's attack on the Yukos oil company. At the same time, the company's free float has fallen from over 40% to about 15% and the buying is still going on as UES shares are likely to be the pre-eminent currency in the genco auctions this summer.
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Controlling stakes
"The oligarchs have bought controlling stakes in energos in the hope of controlling gencos that supply their companies, but there are also Russian strategic investors who think that power is a good stand-alone business from which they can generate profits," says Jacob.
MDM Group, which owns leading commercial bank MDM Bank, is one of the investors that think they can make money from selling electricity. It has emerged as the biggest domestic strategic investor in the power sector. Many of the other household names, such as oil company LUKoil, nickel producer Interros and aluminium holding company Basic Element, are also significant shareholders.
"I used to worry about the industrial groups coming in, but now I am less concerned as there are so many of them. There is no way they are all going to agree on what to do and so they will keep each other honest as none of the oligarchs will let the others get away with cheating," says Still, UES was pleased with the results and expects both the number of participants and the volumes to increase quickly.
"Prices at the competitive electricity market turned out to be lower than at the regulated market," said Vyacheslav Sinyugin, deputy head of UES. "The competitive electricity market operated more efficiently than the regulated market. The five-15 market is not really a prototype of the free market, but this is the first step that will allow [market participants] to begin bargaining."
Price uncertainty remains
The free market still has to pass a key test. Following the years of hyperinflation, energos' fixed costs have been deflated to nothing and their prices do not include the cost of capital, which will only be included once the investment programme to renew ageing power plants begins. Critics fear that prices on a free wholesale market will increase.
Vladimir Khlebnikov, general director of wholesale power market operator Forem, said in October that he expected prices on the wholesale market eventually to come in at 20% to 30% above the current regulated level.
"No-one knows what will happen to the price of power and every expert seems to
have their own prediction," says Herne. "There will be tariff changes in early 2004 that should increase the demand, but we are all waiting to see what happens."
The trial market is being watched closely as investors prepare for the genco auctions, due this summer. By December, UES had still not settled on the key question of how to structure the process by which ownership in UES shares would be transformed into ownership of the new gencos.
At the time of writing the most likely option is a simultaneous proportional exchange, auction and repurchase. Under this, all shareholders will be offered the right to exchange a fraction of their UES shares for shares in the wholesale gencos on a pro-rata basis; UES shareholders and outsiders can use cash to bid for the wholesale gencos; and UES shareholders can put up their shares for auction, with UES using this cash to settle the repurchases.