Electricity sector between a rock and a hard place: Year in Review

Electrical Yard file photo

MOSCOW. Jan 9 (Interfax) – Russia’s electricity sector in 2012 became a kind of blanket that was pulled in opposite directions by two opposing forces, which were personified by the government’s former and current tsars of the sector, Igor Sechin and Arkady Dvorkovich. They pulled on two, very large, corners – RusHydro and the combination of Federal Grid Company (FGC) and IDGC Holding.

While the government’s toolbox was familiar and unchanged, consisting of resolutions, orders and directives, the former deputy prime minister’s was more innovative. First of all, Sechin chairs the board of directors of state holding Rosneftegaz, which by presidential decree is allowed to buy up assets in the energy sector, including the electricity sector. Secondly, he is the executive secretary of the presidential commission for the fuel and energy sector, the decisions of which are binding for all executive government agencies.

Naturally, both Dvorkovich and Sechin fought to improve the condition of companies that suffered from the crisis and the pre-election freeze on prices. But, as they say, when you chop wood the chips are going to fly. On one hand, the sector is still plagued by a tangle of unresolved, perennial problems, and on the other the share prices of power companies tumbled 16% over the year while the Russian stock market grew 6%.

Two brooms

Having bid farewell to the former leadership of the sector, which set tough targets for power companies in the run-up to the elections, analysts expected the new overseers to turn toward investors and tackle festering problems. Investors saw Arkady Dvorkovich, the new deputy prime minister in charge of the energy sector, as a liberal, and expected that Alexander Novak, who came to head the Energy Ministry from the Finance Ministry, where he was responsible for financing of key investment projects, to set a course toward updating the sector amid modest price
growth. Mikhail Kurbatov, a young senior executive at IDGC Holding with years of experience and some degree of authority in the sector, was appointed a deputy to Novak.

On the other hand, analysts expected Igor Sechin, the former deputy prime minister in charge of the sector, to retain his influence. After becoming president of state-controlled oil major Rosneft (RTS: ROSN), he also become chairman of Rosneftegaz, the state company that holds a 75.2% stake in Rosneft and 10.7% of shares in Gazprom.

In May-June, just after the confirmation of the new government, President Vladimir Putin issued a decree allowing Rosneftegaz, which was sitting on several years of dividends from Rosneft and Gazprom, to use its cash to recapitalize companies in the energy sector. Putin also formed and became head of the Kremlin fuel and energy sector, appointing Sechin as its executive secretary. It is perhaps with the creation of this commission that the rivalry between the former and current authorities began – it took some effort for the government to restrict the powers of the commission’s executive secretary. Initially, this post essentially gave Sechin the right to give orders to members of the government and even hold certain “preliminary meetings” with them, as well as with governors and the heads of “organizations.” However, taking into account the government’s criticism, in the end Putin preferred to just not detail the role of the executive secretary at all. True, without formal rights, Sechin can decide himself what the commission will do and its decisions are binding. However, it has largely lost its point, since Putin as president already has powers in this area.

Nonetheless, the energy sector believed that the absence of a mandate for the executive secretary “changes nothing” and that Sechin would de facto still retain his “initial powers.” Sechin himself said that he had been delegated “technical work aimed at the collection, analysis and processing of instructions for the president.” And apparently it was from the technical point of view that a little later Sechin asked Deputy Prime Minister Vladislav Surkov to inform him of any actions by the Cabinet concerning the energy sector.

Dvorkovich vs. Sechin – 1:1?

It was clear that recapitalization with Rosneftegaz’s resources would apply to power companies, because the state holding’s 132 billion rubles was not enough for the oil or gas sectors. But this cash would be plenty to plug the holes in the investment programs of power companies. Sechin agreed. Sources told Interfax that the plan for recapitalization of power companies by Rosneftegaz was developed by former deputy energy minister Andrei Shishkin, who was appointed vice president in charge of electricity at Rosneft in June.

Rosneftegaz decided that the first company it should help would be RusHydro, which according to preliminary estimates was 85 billion rubles short for its three-year investment program (the amount of the planned capital injection later changed). The government agreed that RusHydro, which suffered financial from the clamp down on electricity prices and had acquired control of the troubled RAO Energy Systems of the East (RAO ES Vostoka), was in need of recapitalization. The fight over RusHydro essentially broke down into two rounds: Rosneftegaz acquiring a stake in RusHydro and the fate of a 40% stake in Siberian hydropower company Irkutskenergo currently held by state-controlled Inter RAO. The controlling stake in the regional power company is held by units of Eurosibenergo (ESE), which in turn is controlled by billionaire Oleg

Deripaska’s En+ Group.

The plans proposed by Sechin changed but consistently called for the acquisition of a stake in RusHydro and the transfer of the Irkutskenergo stake to it, either directly or through Rosneftegaz, with the possibility of it remaining on the latter’s books. Dvorkovich also proposed more than one option of financial aid with Rosneftegaz’s cash, but categorically opposed the idea of Rosneftegaz acquiring a stake in RusHydro. The government also believed that the generating company should get the Irkutskenergo stake in order to subsequently contribute it to ESE and create just about the world’s biggest hydropower company, to which RusHydro would also contribute a number of dams in Siberia and its stake in ESE-controlled Krasnoyarsk HPP (RTS: KRSG).

A source close to one of the parties to the deal told Interfax in September that negotiations on RusHydro acquiring a stake in ESE were close to completion and are going according to the government’s schedule – the asset swap could be completed by the second quarter of 2013.

“Here, it seems to me, we need to consider whether this work (scheme) is partial subsidization of metallurgical enterprises at the expense of RusHydro, whether this will benefit RusHydro itself, for when assets are removed capitalization falls,” Sechin said concerning this plan. ESE head Yevgeny Fyodorov made assurances that the shareholder agreement would protect the interests of RusHydro.

The Kremlin administration, which favored RusHydro being recapitalized by Rosneftegaz, took Sechin’s side. The decision by the presidential energy commission on the transfer of the Irkutskenergo stake to the state holding also favored Sechin. This is what Putin decided, although in 2011, while prime minister, he himself approved the sale of this stake directly to RusHydro.

In any case, in the fall the government’s position was finalized and took on the form of drafts and, subsequently signed directives for corporate procedures at both the power company and the state holding – Rosneftegaz was to pay the federal treasury 50.2 billion rubles, which the government would use to pay for new RusHydro shares and also contribute a number of assets as payment for new shares.

The first round of the battle over RusHydro ended on December 5, when Rosneftegaz, without acquiring a stake in RusHydro, shared its wealth to finance the hydropower giant and transferred 50 billion rubles to the federal budget.

Meanwhile, all the necessary procedures for a new share issue by RusHydro, from internal corporate decision to the relevant presidential decree, were completed by this time. The company was ready to place new shares equivalent to a third of its charter capital in return for cash and assets, including 40% stakes in Irkutskenergo and Irkutsk Electricity Grid Company, which is also controlled by ESE.

And then suddenly the bell rang for the start of the round two. The chairman of the board of the hydropower company, Gazprombank (RTS: GZPR) senior vice president Vladimir Tatsy sent board members a draft decision proposing a vote to reverse the earlier decisions to issue shares and to begin the new share issue again.

Dvorkovich had to personally attend the board meeting and make sure the new share issue and its price were approved. This helped – in late December the company began the share placement after all. But the dispute took its toll and five of the 13 directors on the board stepped down: Tatsy, Inter RAO head Boris Kovalchuk, Grigory Kurtser of Rosneft, LLC United Investments deputy general director Mikhail Shelkov, a veteran of the Rosoboronexport group, and VTB (RTS: VTBR) senior vice president Sergei Shishin.

RusHydro says it can still function, despite the mutiny on its board of directors. Under the company’s charter, at least half of the board members, or seven directors, are needed for a quorum. However, there has already been an instance when at a recent meeting the board was unable to make a decision on interested-party transactions.

Despite all the formal procedures for RusHydro’s share issue, Interfax source believe that Irkutskenergo will still go to Rosneftegaz. “This has nothing to do with the economy and I think the score will be 1:1,” a source close to one of the parties said.

Russian grids: How to untangle without getting tangled

The other ‘corner’ being pulled by Sechin and Dvorkovich is Federal Grid Company (FGC) (RTS: FEES) and IDGC Holding, the holding company for regional distribution grid companies. From the outside, it seemed that if Rosneftegaz was interested in these assets it was more as a pleasant bonus or last brick in the construction of an energy giant. Therefore, the rivalry for these two state-controlled companies was not as interesting on its own as the transformations that they underwent.

At the beginning of 2012 they were to major, independent companies, one responsible for backbone power transmission and the other for delivering it to end users. Related businesses, different competencies and one rate for two that had to be shared. Amid measures to hold down electricity prices, this became an acute problem, as the growth of tariffs for grids had to be squeezed but the government was unable to decide on who would see a big rate cut and who would suffer an even bigger one. The situation got so heated that journalists were once treated to the spectacle of a squabble between the head of the two companies over who should bear the brunt of the rate cuts.

Not long before its dismissal, the former government, in which Sechin still oversaw the electricity sector, decided to make FGC the chief executive body of IDGC Holding. Of course, the market has periodically speculated about a possible merger of the two grids ever since they were split up, but this decision still came as a surprise. The problem with tariffs was resolved a few days later, but the problem remained of what to do with this huge and unwieldy structure of two companies.

Who was first to come up with an answer did not come as a surprise. National Grid Company, a subsidiary of Rosneftegaz, could be a platform for the gradual consolidation of FGC and IDGC Holding, Sechin proposed. But such a plan would require up to 400 billion rubles for buyout offers to minority shareholders and repayment of debts, and would essentially be privatization requiring changes in legislation, as both companies are on Russia’s strategic list, the new government countered. As an alternative, the Cabinet proposed merging IDGC Holding and FGC and consolidating the companies’ shares without taking into account the subsidiaries of the holding. Or the state’s stake in IDGC Holding could be folded into FGC.

Ultimately, however, the authorities overplayed their plans, deciding to create a unified management company for the power grid sector. At the end of November, Putin signed a decree to change the name of IDGC Holding to OJSC Russian Grids and fold the government stake in FGC into this company. The creation of Russian Grids is supposed to be completed by July 2013. The Energy Ministry explained the choice of creating a management company for the country’s grids based on IDGC Holding by the fact that this company is already a holding and it makes sense to integrate operating company FGC into it by making turning it into a subsidiary. Such a restructuring has the most economic benefit and requires the least costs, the ministry reckoned.

It is still unclear who will head Russian Grids. The chief candidate for the post is the current head of FGC, Oleg Budargin, who has been with the company for the past three years. Prior to this, he worked primarily in government, including as mayor of Norilsk, where his deputy for financial and economic issues was Alexander Novak. Budargin’s rival is thought to be IDGC Holding executive director Andrei Murov, the son of Federal Guard Service director Yevgeny Murov.

Despite all the changes and transformations, IDGC Holding has remained constant on at least one issue. It is still cherishing the hope of finding an investor for several of its subsidiaries, though now only after the completion of the corporate process with Russian Grids. Perhaps these hopes are not groundless, as Korea’s KOWEPO cast its eye on North Caucasus IDGC (RTS: MRKK) in 2012 and wants to manage the company.

Not by Rosneftegaz alone

Still, not the whole electricity sector spent the year between two fires, while some were less damaged by the flames.

Inter RAO was a mainstay of consensus and solidarity between the two bitter rivals. “And also Rosneftegaz wants Inter RAO” – “That’s not possiblea(euro) Although wait a second, would Rosneftegaz like Inter RAO?” – this is approximately how the sluggish dialog over the state electricity holding between Sechin and Dvorkovich looked. It ended with a letter from Dvorkovich to Putin saying that all direct and indirect government stakes in Inter RAO would be consolidated on the books of Rosneftegaz by 2016. The letter was a report on the implementation of the presidential decree on Rosneftegaz’s involvement in the privatization of energy companies.

One of Inter RAO’s shareholders happens to be RusHydro, through which the government owns 5% of the company. So if Rosneftegaz ends up with the Irkutskenergo stake after all, why not get it from the state holding by trading the stake in Inter RAO, first taking it under management. This is the scheme that the Energy Ministry and Economic Development Ministry proposed to Dvorkovich. But whether or not Rosneftegaz buys RusHydro’s stake in Inter RAO, the other government stakes will still give it control of the company.

Other power companies largely looked on from the sidelines and continued with business as usual. Gazprom Energoholding (GEH) professed for most of the year that it wanted to complete a merger with IES Holding, and only in the fall admitted that it had given up on the idea of consolidation. It said at the time that it was still negotiating with the Renova Group on the purchase of a number of power assets, but it was unclear which assets in particular and with whom the negotiations were being held, since IES said it was not discussing any assets with


On the whole, GEH’s subsidiaries, like all other generating companies, continued to pursue their investment programs. However, OGK-2, which had consistently shown growing financial results, saw a slump in profits and faced a shortage of cash for its projects after taking over OGK-6. Now the company is placing new shares to finance investment and one of its projects – construction of 420 MW of capacity at Cherepovetskaya GRES power plant – will be co-financed by Mosenergo. Towards the end of the year, GEH operations director Denis Bashuk became head of OGK-2, replacing Alexei Mityushov, who led the company into the merger with OGK-6.

Enel OGK-5 (RTS: OGKE), for whom 2012 was the first year when two new combined cycle gas turbine units were fully operations, is also continuing its “growth and investment.” Russia remains a strategic market for Enel, which has invested about EUR4.5 billion in the country and plans to make further investments aimed at modernizing existing facilities, improving productivity and protecting the environment, Enel OGK-5 chief executive Enrico Viale told Interfax.

The head of E.On Russia (RTS: OGKD), Maxim Shirokov said his company’s “absolute priority” for 2013 is to build a third generating unit at Berezovskaya GRES. This is the company’s last mandatory investment project, but it does not intend to stop there. E.On Russia recently started working on a new development strategy in the area of generation.

Private company Eurosibenergo (ESE), which is not encumbered by investment obligations, also has quite ambitious plans for capital expenditures. “In 2013 the investment program will increase by about 30% to 20 billion rubles. The growth is due primarily to the start of the project to modernize the Avtozavodskaya combined heat-and-power plant in Nizhny Novgorod – this is the key project for next year,” ESE chief executive Yevgeny Fyodorov said.

The CEO of Siberian Generating Company (SGC), Sergei Mironosetsky said 2012 was a good year. “At the very least, it gave hope for changes in regulation of the sector, in approaches to the formation of the market in principle and ultimately for resolving the current problems that we as energy producers see,” Mironosetsky said.

Looking to a new model and solutions to old problems

Russia’s electricity sector does in fact have a few chronic problems. Year after year the government takes steps towards tackling them and everyone hopes that next year they will finally be solved.

“I would identify two main problems. The first is the formation of a new model for the wholesale and retail markets. The second is a thermal energy market that is synchronized with the new electricity model,” ESE’s Fyodorov said.

“We’re concerned that the problems of the heating component of the electricity sector has not received the attention it deserves,” Fortum first deputy CEO Sergei Chizhnov said.

“There should be guaranteed return of investment in modernization and repair of existing power plants,” Enel OGK-5’s Viale said.

“I’m also hoping for a solution to another key industry issue, which is the problem of nonpayments – both in the regions of the North Caucasus and in general on the wholesale electricity and capacity market,” E.On Russia’s Shirokov said.

These problems have been partially addressed. The main rules and regulations for the law on heating, including on pricing, have been signed; resolutions have been passed on the operation of retail power markets; and a modernization program to 2020 has been approved. The government also plans to review or adjust the current model for the wholesale power market in 2013, but experience suggests that this process will take more than one year.

The director of the Energy Consumers Association, Dmitry Govorov said there has been some progress in that “they have begun to ask our opinion more and more often. But unfortunately the rule of taking it into consideration when making decisions has not yet taken hold.” Looking forward, it is important “to moderate the appetites of grid companies” and reduce cross subsidies, he said. These problems are also hardly new.

A positive trend that could bear fruit over the next year is the “clear line” the government has taken in regard to dividend payments by companies in which it is a shareholders – now they will have to share at least a quarter of their net profit with shareholders, Gazprombank analyst Dmitry Kotlyarov said. “Another perceptible trend is the emergence of competition among gas suppliers, which has already enabled a number of companies to get substantial discounts, which is of course a positive development,” he said.

Dmitry Bulgakov of Deutsche Bank believes that the effect of new capacity launched at the end of 2012 will have an important impact in 2013.

But still the main issue and intrigue of the coming year will be Rosneftegaz’s presence and degree of involvement in the electricity sector. Already in 2012 investors saw the state holding companies meddling as the end of the plan for privatizing electricity assets and its replacement with a quasi-privatization through the state company, Metropol’s Konstantin Reily said. Against this backdrop, the shares of the whole sector fell in a growing market, with those of RusHydro, FGC and Inter RAO plunging 22-27%.