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Risk of Underinvestment

Sergey Pikin, Director of Energy Development Fund.

By looking at the state of Russian power industry, one may say that there are good news and not so good news. The first news is that we managed to the set up a healthy investment process: the power plants are being built, the grids and substations are coming on line. The electric energy is bought and sold. At the same time, the quality of the process leaves room for improvement - the rules regulating the energy sector have not been finalized by the government.

All the problems we are dealing with are stemming form the fact that the energy reform was not completed, which makes regulatory efforts constantly run in circles. They put the regulation in place for one thing, and they start on another, than it turns out that the earlier regulation is not aligned with the plans for some future regulation, and so we arrive at some kind of institutional deadlock. The consequence of this is that as soon as the the investors start to lose confidence in guarantee of return of their investments, the market ceases to be able to reproduce these investments, and the system finds itself thrown back 10 years.

The system is not sustainable. It allows for mitigation of the infrastructure development issues, but fails to address the challenges of long-term development of the industry. This is the source of the massive misalignment and market regulation problems. In my view, the entire power industry of Russia is currently trapped in this institutional deadlock.

What is more, all financing from the foreign investors, just as the Russian for that matter, is tied to the contracts with guaranteed profitability - the Capacity Supply Agreements - which reduce the market risks to a minimum.

Some companies, like Enel OGK-5, have already completed the mandatory investment program they signed up for as part of the initial asset purchase deal.  Others, like E. ON Russia and Fortum, are nearing completion of their projects. Certainly, the progress may be significantly behind the schedules, but for the most part the delays are not attributable to the actions of the investors, but rather the performance of the contractors.

It's encouraging that our foreign investors are willing to continue to put their money in energy beyond this program, but the issue of return on investments remains.

So far each of the companies I mentioned have invested billions of euros, and on top of that they are running non-mandatory expenses - upgrading the worn out and inefficient assets to keep them from crumbling into scrap metal. But then again, in view of the lack of a clear government policy beyond the guaranteed investment horizon (2017), I doubt we will be receiving any substantial capital infusions from the foreign companies, let alone the Russian companies.

The situation with tariffs is very similar. On one hand, the tariffs have increased dramatically over the past 10 years, but is this growth limit caused by greed of the energy companies? It is rather a matter of inefficiency in the sector. The tariffs are driven by the production costs. The higher the inefficiency of the industry, the higher the costs, and the higher the tariffs. The costs are also growing due to the fuel price, since the main fuel is gas (70% of the fuel mix). As the gas price grows, so does the price of electricity. Moreover, the costs are climbing due to the bloated investment programs of both grid and generating companies. So, the issue is not about the tariffs as such, but rather the quality of these tariffs. For certain categories of consumers, the tariffs are not of significant importance. Particularly, this refers to the companies with low share of energy in the costs or revenues. Whereas for other categories of consumers with high energy share in costs (large industrial companies), the price of energy is a matter of competitiveness on the foreign markets. The attitude towards the energy price is determined by the consumers' operating environment: the higher the competition, the more important the energy price trend.

Therefore, the tariff issue is very subjective and case-specific. I believe, without such an abrupt tariff increase, the energy efficiency program is inviable in principle.  The consumers will not conserve an energy resource unless they are affected by its price, and therefore, the consumers who became sensitive to the energy price several years ago have already implemented, are implementing and will continue to implement the energy efficiency improvements. Those who are not affected will never bother with energy efficiency, not even on pain of penalties. Else, they may confine their efforts to paper formalities. The energy price is high indeed, but it reflects a general inefficiency of the energy system and has nothing to do with the consumers' readiness to pay for this inefficiency. If a consumer finds the energy price too high, it begins to take actions to reduce its energy dependency - by building own generation, taking measures to reduce the energy costs, finding better purchase options.

We are unlikely to see a decline in energy price in this decade, rather the opposite. The task for the government and the industry now is to bring the efficiency of Russian energy sector to the world level. Only then will we be able to speak of success in modernization of the power industry. In my opinion it is achievable only in the next decade.

An important issue to consider in developing the energy modernization policy is the optimal balance of fuel and energy distribution in the country. What is better - to transport across the country billions of cubic meters of gas and millions of tons of coal via railway or bring the power generation closer to the primary energy sources? Should we build an expensive centralized power supply system for local territories or try to achieve their energy independence by developing distributed generation, perhaps, using renewable energy sources?

The market will not solve the issue of efficient long term energy distribution, it is unable to provide proper price signals for the development. Especially today that the Russian energy system is divided in two price zones. Therefore, it is necessary to establish a common market space and then, within this market space, find the optimal energy balance.

The idea of delivering cheap energy, particularly from Siberia, to the central part of Russia has been around for a long time, since the soviet times. Thus, the core of Russian hydroelectric power is found in Siberia, where even now the regional power grid is starting to have excess energy. Meanwhile, the region has huge reserves of coal, which can also be used more efficiently. I think this problem should be overcome by the Siberia-Ural-Center energy bridge project, which was presented at the 3rd Siberian Energy Forum in Krasonyarsk late November. According to the project, developed by Krasnoyarsk Territory Development Corporation, the overall length of the bridge would be more than 3.5 thousand km. Its engineering design may be launched in 2013 to be released for construction in 2017.

According to the authors of the project, the Russian power industry with physical wear of assets of 60-70% does not meet the requirements of national security and is expensive. A transfer of power via the energy bridge to the European part of Russia not only would save about 1 trillion rubles (among other things, by not building additional capacity), but also free up additional export volumes of gas (203 BCM of gas worth 2.4 trillion rubles) and enable the use of additional coal, which is currently not in demand (632 million tons worth 474 billion rubles).

Industry experts also point out that, in addition to the direct effect of lowering the prices due to cheap Siberian electricity and improving competitiveness of Russian industry, the project can solve more complex problems. For example, the power flows between systems that lie in different time zones can spread the peak loads in time and enhance the grid dispatching reliability. Cost of the project is comprised of two parts. The cost of building high voltage power lines will be 175 billion rubles and the cost of new generation facilities in Siberia 450 billion rubles (in prices of 2012). The share of state and private investments will be 23% and 77%, respectively. It is expected that the investment in energy bridge will come from private investors interested in implementation of the project, including large generating and distribution companies. Recently, similar ideas were incorporated in the government's plans. As the head of state Vladimir Putin said in September 2012 at the APEC summit, the energy facilities developed in the Far East will be connected by infrastructure to the European part of Russia to facilitate the transfer of necessary raw materials and energy from one part of the country to another and enable access to both European markets and Asia-Pacific markets.

The Nezavisimaya Gazeta, 11.12.2012