Electricity investors: When will they come to Russia?

With United Energy Systems (UES) and Russia’s entire electricity sector on the road towards restructuring, questions are being asked about whether foreign investors will exhibit strong interest in Russian power as they have in Russian oil.

As always, foreign investors will be seeking enticing financial returns and political guarantees that true reform in the sector is underway. Given uncertainty in the structural reforms and investor fear about corporate governance in Russia, however, direct investors are likely to be extremely cautious and to refrain from serious commitments to the power sector until 2003.

UES is attempting to improve the investment climate, at least in terms of potential financial returns. Specifically, UES expects that electricity tariffs should be at about US$0.035-0.050 by 2004, meaning that tariffs would — finally — cover costs and include a profit for electricity companies. According to Alexey Minaev, senior utility analyst at Rye, Man, Gor (RMG), until electricity tariffs supercede costs and necessary reform bills are passed in the Duma, foreigners will stay in the sidelines in 2002, with 2003 being the year that “foreigners may start coming to this market.”

Troika Dialog’s senior utility analyst Kaha Kiknavelidze, concurs. It is unlikely that observers will see “actual large-scale investments, at least in the coming 1-2 years,” he says.

Most companies in the Russian electricity sector welcome foreign investment. Unsurprisingly, the hope of receiving cash is the major attraction. According to Minaev: “UES strongly supports the coming of foreign investors into the power sector. For [CEO Anatoly] Chubais this would be ideal, as it would solve the problem of ageing assets. Most energos are controlled by UES and will likely follow UES.”

In addition to cash, however, energos would also like to gain from foreign expertise. Mikhail Seleznev, senior utilities analyst at United Financial Group (UFG), believes that energos could gain expertise “in metering, disconnection procedures, and commercial losses countermeasures.”

Yet, the actions taken by energo managers will continue to keep foreign investors on guard. Cash is what is important for energos. Issues of corporate governance are not high on many energo managements’ priorities. According to Seleznev, foreign investors are “looking for control, but as it appears right now, the Russian government is not very willing to yield control. Management’s lack of openness is a major stumbling block for investors. According to Seleznev, this lack of openness is “why foreigners are looking for control – if you have control openness is not an issue any more.”

Minaev also point out a typical problem with Russian utilities. “The interests of shareholders may differ — for example, if a shareholder is a utilities customer at the same time.”

Clearly, management openness depends on company management, which is elected by shareholders. As such, investors should look closely at the

management, ownership, and shareholder structure of Russian power companies.

Another serious question to consider, however, is that of how regional governments would react to foreign investors. Given Russia’s political structure, local governors can wield inordinate influence on political and economic affairs of their regions. Succinctly put, RMG’s Minaev explains, “Russia is a big country and governors vary significantly in their political views.” Specifically, he said, some politicians like Moscow’s Mayor Yuri Luzhkov would resist attempts by any other party to control Mosenergo, whereas “in the regions with democratic governments, [the] situation may be opposite.”

Importantly, in most cases regional governments are not shareholders in energos or individual power stations and cannot fully thwart foreign investment. Yet the issue of raising tariffs would be a problem. According to Kiknavelidze, “foreign companies want higher tariffs, which would be met by regional governors’ opposition.”

Minaev agrees that there would be strong opposition if “newcomers began boosting tariffs,” but he sees such a move as “unlikely because there will be competition and licensing, which won’t allow arbitrary tariff growth.”

Already, some foreign electricity companies have attempted to invest in Russia. As Minaev noted, “EdF, the France-based electricity utility, reportedly joined a project on the construction of a power station in Moscow.” But negotiations between UES and foreign companies took place before the 1998 ruble crisis, which brought discussions to a jarring halt.

While it is difficult to ascertain exactly what companies would come in to Russia when reforms are more evident, those experienced in emerging markets are the likely prospects. Minaev believes that those with CIS experience such as “AES, Iberdrola, and RWE AG” are the most likely candidates. Troika’s Kiknavelidze mentioned companies such as “AES, EdF, Preussen Elektra and Fortum” as potentially interested. “AES seems to be the most aggressive and willing to take business risks, while EdF seems to be trying to negotiate government guarantees for specific projects.”

Some potential investors might have difficulties even in the early stages of exploring investments in Russia, though. According to Seleznev, “AES is most willing to come, but also most disliked by UES. They clashed over electricity supplies to Turkey from Georgia.” Undeniably, he said companies with close relationships to UES, such as “EdF and E.ON (one of the principal shareholders in Lenenergo)” might have an easier time getting a foot in the door.

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