1

Speech by Mr. Y. Udaltsov,

member of the Management Board of RAO «UES of Russia»,

at the seminar

«Central and Eastern Europe:

A source of Future Growth for Utilities?»

 

 

 

Reform: the next steps

London, June 30, 2004

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Company

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RAO “UES of Russia” Today: Operating Highlights

Source: RAO “UES of Russia”, IEA

 

The World’s Ten Largest Electricity Companies (2003)

>156RussiaRAO UES

Capacity (GW)Home-baseCompany

42South AfricaESKOM

43GermanyRWE

45ItalyENEL

49FranceSUEZ

54GermanyE.ON

59JapanTEPCO

121FranceEDF

151ChinaSPCC

42USAAEP

Key Facts

Except for nuclear capacity and several large independent generators,

UES controls the electricity industry in Russia

72% of Russia’s installed generation capacity

69% of Russia’s electricity output32% of Russia’s heat production

96% of Russia’s power transmission lines

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52%

RAO UES Holding – current ownership structure

Minority Shareholders

Other Minority Shareholders

Russian Federation

RAO “UES of Russia”

48%

System Operator

44 federal power plants, including

8 plants under construction

Federal Grid Company

100%

Sales

Generation

Dispatching Services

72 Regional Power Companies

100%

T&D Grids

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RAO “UES of Russia” Today: Key Financial Data

2003 (Forecast Data): Revenue – around $19,6 bn

2002:Revenue – $15,83 bn

US$ m 9 months ended 30 Sept 2001

9 months ended 30 Sept 2002

9 months ended 30 Sept 2003

Revenue 8,474 10,328 13,720

Net Profit 909 669 543

EBITDA 1,070 1,494 2,720

EBITDA Margin 12.6% 14.5% 19.8%

Operational Margin 1.2% 0.6% 8.9%

Net Margin 10.7% 6.5% 4%

Fixed Assets 24,201 25,834 29,293

Shareholder Equity 14,404 16,730 19,733

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100%

150%

200%

250%

300%

350%

400%

450%

03.09

.2002

03.11

.2002

03.01

.2003

03.03

.2003

03.05

.2003

03.07

.2003

03.09

.2003

03.11

.2003

03.01

.2004

03.03

.2004

03.05

.2004

EESR equities Russian Trade System index

Growth of the market capitalisation of RAO «UES of Russia» (RTS data)

In the recent two years the stocks of RAO «UES of Russia» were largely outperforming the Russian securities market as a whole

30.06

.2004

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Reform

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RAO UES role in the legal base creation of the power sector reform

Fundamental bills governing the electricity industry restructuring process

were enacted into law in April 2003Laws

Directive of the Russian Federation Government No 865-r "Plan of activities aimed at the restructuring of the electricity industry in 2003-2005" was signed on 27.06.03

The "Energy Strategy of Russia for the period up to 2020” (Directive of the Russian Federation Government No. 1234-r) was adopted on 28.08.03

Directive of the Russian Federation Government No 1254-r "Composition of the generation companies of the wholesale electricity market" was signed 01.09.03

Regulation of the Russian Federation Government No 643 ”Rules of the transitional wholesale electricity market" was signed on 24.10.03

Directive of the Russian Federation Government No 1939-r "On the participation of the state in the establishment of interregional transmission companies" was signed on 29.12.03

Governmental acts

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Operation of the competitive sector of the wholesale electricity market (5-15%). Preparation for the opening of the electricity markets

Growth of the weekly trading volumes in the competitive sector of the wholesale market (million kWh)

03.11.2003 - 30.06.2004

The first trading session was held on November 1, 2003 The share of the sector has exceeded 7% of the wholesale market of the European

Russia and Urals The price levels of the competitive sector are less then the tariffs of the regulated

sector for 4.6% The number of the market participants continues to grow

158 million kWh 14 market entities

882 million kWh 84 market entities

weeks

0

200

400

600

800

1000

1200

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33

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Restructuring of AO-energos

Restructuring of the regional utilities involves their unbundling with spinning off separate lines of business

By June 1, 2004, the Board of Directors of RAO UES approved 51 restructuring project out of 70 restructuring projects of AO-energos requiring approval

43 utilities launched their restructuring projects

Implementation schedule of the utilities restructuring process

2Q2004

1

3Q2004

1 5

6

11 17

1734

4Q2004 2Q20051Q2005

42*

3

3Q2005

Total (cumulative)

Current quarter

* - JSC “Pskovenergo” is to be restructured not by “basic variant”

39

5

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State owned companies (State owns more than 50% + 1 share):

FGC SO

Hydro generation-

based WGCs

Holding of guaranteed suppliers, isolated

AO-energos

Isolated AO-energos

Guarantee suppliers

IDC

Private companies (State owns less than 50% of shares):

Reforming of RAO “UES of Russia”

Industry ownership structure by 2008

About 20 TGCs

Thermal generation-

based WGCs

FGC – Federal Grid Company (the Unified National Electricity Grid)IDC – Interregional Distribution Company SO – System OperatorWGC – Wholesale Generation CompanyTGC – Territorial Generation Company

SupplyRepair

business

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Establishment of new industry players

Consolidation of assets

comprising the Unified National Electricity Grid

(UNEG) 

Operational and dispatch control

structure

56 regional dispatching units (RDUs), established as branches of the System Operator, were launched by 01.05.04. The units are responsible for the regional operational control in 62 utilities

By the end of 2004, restructuring of operational control function in 7 more AO-energos is expected to be completed, including the utilities independent from RAO UES

On 29.12.03 the RF Government approved Directive No 1939-r "On the participation of the state in the establishment of interregional transmission companies" (stake of the Russian Federation in their capital is set at 85%, the stake of the Federal Grid Company is set at 15%)

By 01.05.04, 49 branches (out of 53) were set up, based on the assets of transmission networks belonging to the Unified National Electricity Grid

RAO UES signed an order directing commencement of the handover of the UNEG assets owned by AO-energos to interregional transmission companies (ITCs)

IDCs

Interregional distribution companies (IDCs) are scheduled to be set up as wholly-owned subsidiaries of RAO UES. Contributions into their share capital will be made by shares of the distribution companies spun off in the course of reorganisation of AO-energos owned by RAO UES

On April 23, 2004 the Board of Directors of RAO UES approved the configuration of the IDCs and principles of their management during the transitional restructuring period

IDCs are scheduled to be incorporated in 3Q04

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Raising the efficiency of the current operations through cost-cutting and tariff-limiting measures

Cost management programs of RAO UES for the period of 2001-2003: the savings exceeded RUR45 billion

Setting tariff growth caps for 2004-2006

by each electricity system and for

RAO “UES of Russia” as a whole

Cost management

programs

RAO UES tariff policy initiatives

Government Directive

No 1754-r dated 01.12.03

New approach to cost management implemented

at the utilities level

20%

11%

8%8.5%

7.5%6%

9.5%

7.5%5%

10%

15%

20%

2005 2006 2007

gas

Inflation rate

electricity

Decisions adopted at a meeting of the Russian Federation Government on 27.05.04 which discussed the 3-year natural monopolies tariffs revision program

represented a quantum leap in the tariff-setting system

Tariff growth caps:

Instead of cutting costs based on projected costs (“cost plus” basis) – avoiding growth of costs above the inflation and tariff levels (“inflation minus” basis)

Tighter control measures of the utilities' costs have been implemented

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Investments guarantee mechanism

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Project objectives

To engage investors in construction of new generating capacities to cover pending capacity deficiency, their commissioning being planned for 2006

In the immediate 5 years the energy market will be in a formative stage and won’t provide for engagement of investors without applying special mechanisms!

The task is to offer a special mechanism of attracting guaranteed investments during transition period (5 years)

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What do we expect from the use of the mechanism

Expectations – electrical energy generation during certain time intervals to cover energy deficiencies

Minimum cost of the mechanism’s implementation for market community Cost signals for investor and market providing economic efficiency

Effective Effective peak capacitpeak capacities ies are neededare needed

Objects for attraction of investments:

increase of rated capacity through construction of new electric power plants or new auxiliary blocs on operating electric power plants

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Investor’s interests

We take into consideration the interests of foreign and Russian investors

Investors want guarantees as to the reimbursement of committed facilities and rate of return:

Long-term agreement with reliable and credit-worthy counterparty, ensuring backing of committed

facilities and rate of return

Legislative consolidation of legitimacy of such agreement

Escaping the risk, connected with a rate of foreign exchange (contract value should be in Euro)

Guaranteed fuel supplies with due account for the investor’s generating capacities utilisation

Integration into a future model of electric energy market (power)

State guarantees for all cases of default of a treaty: changes of legislation, non-fulfillment of

obligations by the counterparty, etc.

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Ways to secure investor’s interests and correct cost signals

Two-stage mechanism of payment for investor’s services:

Reimbursement of committed facilities and rate of return – through payment of services related to provision of technological reserve of generating capacities (demand charge analogue) – through tariff of SO

Payment for produced electric energy – through payment for electric energy cost (energy tariff analogue)

Why such mechanism of payment?It is the most effective because:

Provides correct cost signals to investors and market

Maintains capacity in a state of readiness at any time specified by SO at minimum prices

Provides for generation of electric energy only when it is profitable for investor and market

Allows escaping guarantees to the investor in terms of annual load of generating capacities

It smoothly incorporates into competitive market of power and electric energy

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Financial consequences of the mechanism implementation

Attraction of investments into construction of 4 100 МW, with guarantee period (pay-off period) being 10 years

Cost of construction of 1 МW of power

($/МW)

Rate of return

Cost of mechanism

New tariff of SO

(today 0.88 copecs/КWh)

Increase of average tariff for end users

1 000 000 

30% 5.72 copecs/КWh 6.6 copecs/КWh 9.1%

900 000 

15% 3.22 copecs/КWh 4.1 copecs/КWh 5.1%

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Thank you for your attention