Electrical Energy Price Surge in Russia

25.10.2010 — Analysis

Prices for electrical energy are leapfrogging in Russian regions. In 2009, they demonstrated one quarter increase, setting up some kind of a record. In 2010, the federal authorities placed a fifteen percent cap on tariffs for the population. They estimate that the increase will not exceed 10% next year. Year 2013 will be the last time when the government can apply its levers. Starting from 2014, Russians will have to buy electrical energy at market prices. The opinion of the experts interviewed by the "RusBusinessNews" columnists was unanimous: prices will soar.

Steadily increasing tariffs for electrical energy have become a customary event in Russia like growing prices for bread and sausage. Energy producers have always had the same explanation – growing fuel costs, though back in the early 2000s Andrei Illarionov, a well-known Russian economist and former advisor to the RF President, tried to debunk the myth about tight coupling between fuel costs and end-user prices. "Administrative boosting of tariffs is nothing but a smoothly running system of reallocation of huge financial resources from the non-monopoly sector of economy to its monopoly sector ", was his conclusion.

The reforms in the power industry forced up by the United Energy System of Russia resulted in partial denationalization of the industry. The government retained the grid system, and private investors gained control of power generation (exclusive of nuclear power plants and hydro power plants) and sales. In 2003, the wholesale electricity market (OREM) came into being. The market was meant to facilitate a gradual withdrawal from controlled sale prices. If in 2009 half of the wholesale energy (capacity) was sold at the tariffs set by the government, starting from July 1st in 2010 the controlled sales accounted only for 20%. Starting from January 2011, the kilowatt-hour price will be determined solely by demand and supply (the so-called 100% deregulation of market). 

The logic is simple: the competition forces generating companies to lower costs and to sell the product at prices that are more favorable for consumers. The latter include retail companies and business organizations. Entrepreneurs can buy energy both from retailers and directly on the wholesale market, which is affordable only to large companies. Tariffs for population will remain under control of the government until 2014. Besides, for the next three years, the plans provide for retaining of cross-subsidies when part of energy costs payable by population is covered by industrial companies. 

However, the existing model of the wholesale market offers just a subtle glimpse of competition. As it was told to "RusBusinessNews" by Vyacheslav Geide, head of the Directorate for Energy Supply at the Sverdlovsk Energy & Gas Company, consumers hardly ever are involved in pricing. Generating companies rule the roost on the market.

Starting from the second half of 2010, 20% of the capacity is sold at controlled tariffs. The other part goes through the so-called competitive capacity selection (COM). The idea is to stimulate producers struggling for consumers to reduce the posted price. The sources that are excessively expensive will have to draw away. However, the organizers of tenders, without further ado, included all the existing capacities in the selection of the current year. The consumer pays for a megawatt at the average COM price, and financial flows are distributed in such a way that each generating company could receive its tariff. 

Experts tagged this system a parody. In their opinion, generating companies will dominate the market until the disastrous deficit of capacities is refilled. In the opinion of Igor Yushkov, an analyst of the National Energy Security Fund, Russia failed to create competitive environment by relying on foreign experience in energy sector reforms. Therefore, the reforms resulted in escalating tariffs. He is confident that true competition can take place only at the production and demand ratio equal to 3 to 1. Besides, the generation cost must be approximately similar.

In foreign countries, the industry restructuring brought different results. The experiment in Argentine is seen as successful. Due to elimination of tariff control and large-scale "energy privatization", within 7 years the Latin American country was able to reduce energy prices by 40%, attract sizeable foreign investment and add 10 billion US dollars to the federal budget. The reforms started with restructuring and privatization of Segba, Ayee and Hidronor, largest vertically integrated companies. As a result, 40 independent producers came to the market. They were forbidden to exceed 10% of generating capacities and to have controlling interest in energy transmission companies. 

Russia again took the wrong turning. Experts say that the competitive and monopoly energy sectors have not split up so far. Large companies (Gazprom, Inter RAO and others) acquire not only generating facilities and retail companies, but also shares of grid, repair and construction companies. In addition, they take advantage of arrangements that allow them to rent grid companies through a number of affiliated organizations. "It is clear that major energy players will get a grip of shares of the Inter-Regional Grid Company whose privatization is announced by the government. Instead of one natural monopolist, after the reforms Russia came up with numerous unnatural monopolists who are not willing to bear the investor’s burden", Igor Yushkov notes. 

It is true that investment in the Russian energy sector has markedly increased in the last few years. Reports submitted by major market players are «packed» with built and repaired megawatts and kilowatts. However, owners of energy assets prefer to hush up the fact that they include their investment costs in tariffs. In the meantime, their Western colleagues "fight off" their capital investment by cutting down their own costs. 

"By 2020, only one third of new production facilities will be involved in competitive bids and will receive a "market price". On the one hand, it provides the possibility to prevent excessive growth of prices under marginal pricing. On the other hand, lack of transparency in investment programs based on "arrangements with business community" rather than on a well-though approach is fraught with overpayment for excessive and expensive projects. It challenges economic feasibility of prices and, eventually, damages the image of competition in the sector", said Fedor Veselov, head of the laboratory at the Energy Research Institute at the Russian Academy of Sciences.

By the way, Dominique Fache, General Director of Enel for Russia and CIS, in his interview to mass media stated that generating companies are not interested in regulators’ "multiple supervision" over compliance with requirements of investment programs.

Starting from 2014, the kilowatt-hour price for population will also be determined by the market. Experts hesitate to give any forecast concerning tariff growth. Today the population of Russia pays 7.3 US cents for one kilowatt-hour. Several years ago the tariff was equal to 4.9 cents. Curiously enough that at the same time Inter RAO was selling electricity to China at the price of 1.8 cents for a kilowatt-hour. After the Russian company offered to double tariffs, export to Celestial China was discontinued. In 2009, supplies resumed; however, that time the price was 1.3 cents for one kilowatt-hour. The expenses on construction of foreign power transmission lines and transit losses were disburdened upon citizens of the Russian Far East.

Restructuring, privatization and deregulation have not solved any of the global problems facing the Russian energy industry. In opinion of Fedor Veselov, the reforms failed to establish long-term equilibrium between reliability, price and innovative development of the industry. Key risks remained at the same level. The only visible outcome was another change-over in nomenclature political groups.

Marina Sirina, Vladimir Terletsky