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No-one outside the railways ministry understands how money is spent on the rail network |
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Despite a decade of economic turmoil Russians still have a standard-of-living safety net. They are clothed, few of them starve and everyone has a heated apartment. Without reform this won’t last. Infrastructure built in the Soviet era is still propping up the economy, but Russia is living on borrowed time.
The infrastructure is slowly decaying. There has been virtually no investment in the fuel and energy sector or the rail network since 1991. The levels of production of gas, oil and electricity have all fallen over the past decade, although the production collapse does seem to have bottomed out. Unless there is massive investments in infrastructure it will begin to break down. And it could start happening within the next five years.
The government has woken up to the need to get on with restructuring Russia’s natural monopolies, and the Kremlin realizes that the amount of funding needed is so huge that it will have to come from outside. The government also sees that unless the natural monopolies of gas, power and the railways are broken up, Russia will be unable to attract the necessary investment.
For example, national power company, United Energy Systems (UES), is one of the least efficient producers in the world, using 10 times more fuel per unit of GDP than producers of EU countries. The European Bank for Reconstruction&Development estimates that UES needs to spend some $5 billion a year over the next decade to maintain its production. In 1999, it spent a little under $1 billion, which was 10% less than in 1998.
Reforming the natural monopolies cuts to the heart of the problems with Russia’s economy. For the past decade the state has allowed companies to ignore their electricity and gas bills, handing an implicit subsidy to deadwood industries that clutter the economy and squander valuable resources. Making these sectors profitable and efficient is one of the simplest ways of forcing reform on the economy as a whole.
It won’t be easy. The natural monopolies have long been the venue for a political fight club. During the Yeltsin era, Russia’s young reformers would earn kudos by trading blows and bloody noses with the likes of state-owned gas monopolist Gazprom. Because of their importance to the economy, these companies wield enormous political power in their own right, and the railways are still run by a ministry. Gazprom for one has been called “a state within the state”.
Since the end of the summer the Kremlin has been on a campaign to cut the natural monopolies down to size. The fact that it is attempting the task at all is encouraging – the debate under Yeltsin was all about unpaid tax bills. Restructuring something like Gazprom was unthinkable 18 months ago. Now the management is fighting a rearguard action as it tries to stave off change.
But there is much to do. President Vladimir Putin may have been able to slap down the regional governors and curb the oligarchs, but now he has picked on someone his own size. It remains to be seen if the Kremlin will get far enough, fast enough.
The most progress has been made at national power company, United Energy Systems (UES), under the leadership of former privatization tsar Anatoly Chubais.
In a speech in October, Chubais estimated that demand for power would exceed supply by 2005 if no investments were made. The money will have to come from abroad. But that means making UES attractive to investors.
“A critical juncture will be 2005,” Chubais told the US-Russian Investment Symposium in Boston in October. “Unless the trend changes, we will find ourselves in a situation where Russia will have to become an energy importer. We declare that what we need is western investment in our company on a grand scale.”
Chubais started the ball rolling in April by releasing the first of what became a stream of restructuring plans. UES is a monopolist in that it controls both generation and distribution. The two needed to be separated and generators to be sold off to create some competition.
However, Chubais’s plan was met with derision from minority shareholders in UES, which by itself accounts for 90% of capitalization of the Russian stock market and is far and away the most traded share on the RTS (Russian Trading System).
Investors want to see generators sold off, but not until tariffs, which are a fraction of world levels, are increased. If generators are sold first and tariffs raised later, UES shareholders are afraid they will miss out on any rise in value of their shares.
A second problem is that if generators are sold with low tariffs still in place, the prospective buyers are likely to be confined to local industry and municipalities for the at-cost power they can supply: hardly conducive to raising investment or making the sector more efficient.
| Anatoly Chubais | ||||||
In October the government finally lost its patience with Chubais’s fluffed attempts to propose acceptable changes and handed the responsibility for drawing up a plan to the economic development and trade ministry, headed by German Gref.
But a month before Gref was due to pass sentence on the sector at a December 14 cabinet meeting, UES announced that it was setting up a new super-regional energy company in the Volga river valley. Chubais hoped that his revamp would be a model of the reform of the whole power sector and, more important, put the ball back in his court.
The new Mid-Volga Interregional Management Company (MVIP) is supposed to streamline operations in the region and improve collection rates. Based in Samara and owned by UES, the new company will bundle together seven regional power companies, establish a wholesale supplier, and buy a luxurious office building in Moscow. Minority investors are up in arms for the second time. They were again excluded from discussions.
UES is pushing for the creation of 15 inter-regional companies that will compete on a competitive market, along with another 30 smaller regional companies that may compete on the same market. The company won’t comment on this point and the mechanism and underlying principles of this market remain unclear.
Although inter-regional holding companies are not a bad idea, rushing through the first one only a month before the government presents its plan smacks of power politics more than power reform.
Chubais called on his allies to help him take back the initiative. The governor general of the Volga federal district – one of seven districts Putin set up at the start of the year – is Sergei Kiriyenko, a Chubais ally. UES is believed to have sponsored Kiriyenko’s party, the Union of Right Forces, in the December 1999 Duma elections.
At the same time Chubais was also wooing the regional governors, offering them a stake in the new inter-regional companies in exchange for cancelling debt, promising they could “participate in the restructuring process”. Winning the support of governors brings Chubais some useful political support, but bringing in the governors is a really bad idea. Most are in the pockets of local industry and will actively block reforms if it means they have to pay more for energy.
At the time of writing, it looked as if a flawed plan was going to be introduced. And the government is expecting the worst. One of the reasons why the 2001 budget included a zero deficit and tight spending limits was to save money that will be used to invest in infrastructure: next year UES plans to invest between $3 billion and $4 billion from its own resources on infrastructure. The government realizes that it will take time to convince investors that they are serious, so it is preparing to weather the storm until then.
Things are not perfect at UES, but at least they are moving forward. Reforms to gas behemoth Gazprom are going more slowly, but here too the government is showing resolve.
The state owns about 38% of Gazprom and took control of the board at the annual general meeting this summer. By October, the management was starting to feel the heat as the Kremlin zeroed in on the company.
First the management was forced into agreeing to raise the number of foreign shareholders to the 20% cap set in law – by the end of 2000 the number of foreign shareholders was supposed to be raised from the current 11.5% to 20% through special auctions.
Secondly the management is having to answer an increasing number of embarrassing questions about asset transfers. Over the past two years a private company called Iteria, registered in the US, has come from nowhere to be one of the biggest players in the Russian gas market. It is widely believed that it is owned by Gazprom’s senior management, although the company denies this.
Analysts have been quick to crow about “the beginning of the end” of the management’s hegemony. In particular they point to the increase in foreign ownership as a gate in Gazprom’s “ring fence” around domestically traded shares – a set of rules that effectively preclude foreigners from buying local shares in Gazprom – which is one of western investors’ biggest gripes with the Russian equity market.
But the management could not have conceded less. The government frankly admits that it doesn’t have a clue how Gazprom’s money is organized. Before the Kremlin can even begin to think about reform, it needs to work out what sort of an entity Gazprom is.
Arkady Dvorkovich, advisor to Gref, says: “The primary task of the government is to introduce transparency into the company. We still don’t know what the real financial situation is within the company nor what their investment programme is.”
Although the Gref plan calls for Gazprom to be broken up in a similar fashion to UES – the production of gas is to be split from the distribution, and competition introduced among producers – the reform effort this autumn began with little more than chipping away at the management’s empire. Control over export pipelines was hived off and given to a new body headed by liberal deputy prime minister Viktor Khristenko, which is a start.
As with UES, Gazprom’s domestic tariffs are a fraction of international prices and need to be increased; something that Gazprom is also pressing for. The average Russian price of gas is between one-seventh and one-tenth that in western Europe.
But unlike UES, Gazprom has significant exports. It supplies a third of all Germany’s gas needs, and following an agreement signed with the EU this autumn it will export even more in the future.
Because it makes such good money from exports, Gazprom has ignored reforms at home, content to trade free gas to the regions for political favours in the Duma, making it a formidable political player. UES says that it no longer has unpaid bills and the all-important proportion of those bills paid in cash is up to 73%. By comparison, half of Gazprom’s bills have gone unpaid for the past few years and much of what is paid is still in barter.
At least the government has some sort of plan for both UES and Gazprom. It hasn’t even got to this stage with the railways ministry.
The October deadline for presenting a strategy was missed because of a heated dispute between railways minister Nikolai Aksyonenko and the ministry of economic development and trade, headed by German Gref, over how to proceed.
In a country that stretches across 11 time zones, railways are essential for businesses and individuals. As with the other two natural monopolies, the way Russia’s railway business is organised stifles competition. Commercial freight is used to subsidize passenger traffic for political reasons and the two need to be separated. Tariffs are too low and need to be increased. And the different aspects of the rail system – buildings, repair shops, procurement, etc – need to be split up into entities as, again, no-one but the railways ministry understands how the money is spent.
Aksyonenko has different ideas. He wants to privatize the whole system, turning it into a Gazprom of trains with himself at the head. The October meeting was cancelled as Aksyonenko’s presented a plan to increase – rather than lower – the level of monopoly wielded by the railways, with the power to set tariffs given to the railways ministry.
After a week of behind the scenes wrangling, Putin had to step in and, encouragingly, came down on Gref’s side, saying the MinEcon now had the authority to draw up a new plan by April 1 2001.
Nevertheless Gref has a real fight on his hands. Over the past year the ministry has been reorganizing the system on its own, merging the various aspects of railways together into bigger and bigger holdings.
“We quickly realize that once these things had been brought together we would never be able to get them apart again,” says the MinEcon’s Dvorkovich.
Although reforms are progressing well in such areas as tax and customs, Russia was only six months into the process by December. As the reforms go on the fights are going to get tough. It is still not clear if they can do enough, fast enough.
