Russia holds the world’s largest natural gas reserves, the second largest coal reserves, and the eighth largest oil reserves. Russia is also the world’s largest exporter of natural gas, the second largest oil exporter and the third largest energy consumer. Its economy is heavily dependent on oil and natural gas exports and tends to rise or fall with the price of oil. The energy stabilisation fund introduced in 2004 to manage windfall oil receipts was worth $158 billion by end-2007, or about 12 % of the country’s nominal GDP. In 2007, Russia’s real GDP grew by approximately 8.1 %, surpassing average growth rates in all other G8 countries, and marking the country’s seventh consecutive year of economic expansion.The fuel sector accounts for about 20.5 % of GDP, and the oil and gas sector alone generates more than 60 % of Russia’s export revenues.

The government sees electricity sector reform as a crucial component of reducing domestic natural gas consumption, and thereby increasing export earnings. To liberalise its energy market and to raise capital for its extensive rebuild programme ($115 billion by 2010) the Russian government has introduced major reforms to the power sector by auctioning off to private investors large chunks of its generation and transmission and distribution capacity. The auction took place during 2007-8 and at the end of it in July last year RAO UES, the monopoly shareholder in the entire power system excluding nuclear plants, had been dismantled and its remnants absorbed into the federal grid company FGC. Hydro generation and the four largest independent generators have remained outside the sale, while the entire nuclear industry remains under direct government control through Rosatom, but all the fossil fuelled plants have been reorganised into 20 separated electricity and heat generation companies (six wholesale generating companies and 14 local or “territorial” companies) and controlling interest in their stock sold to private investors. In what some see as a return to virtual state control much of this stock has been bought up by other Russian companies – heavily state influenced concerns such as SUEK, the Siberian mining company, or by energy industry tsars such as Viktor Vekselberg, the owner of Norilsk and IES – but four large European utilities, Enel, E.ON, RWE and Fortum have bought controlling interests in several of the new energos and at present these represent the best hope of substantial foreign investment. The possibility of large concerns re-monopolising the industry is nonetheless real. SUEK and Gazprom for example have reportedly made plans to pool their electricity assets into a single holding company worth up to $18 billion. Russia’s Federal Anti-monopoly Service exists to prevent this process getting out of control and has been active. In 2008 it allowed IES to buy control of TGK-6 and TGK-7 but demanded that it sell power stations amounting to at least 741 MW within the year.

The first step, liberalisation of the electricity industry, has successfully got under way and the reform seems to be headed in the right direction, that is, achievement of a competitive and efficient electricity sector. However, significant investments were and are still needed to achieve this state and future investors have the same need to be convinced of the political will for reform, the consistency of the regulation and an adequate return on capital as necessary conditions for making private investments. There are some signs that the first and third of these are weakening, and that the whole rebuild process will take considerably longer than at first anticipated.

From the first it was never going to be easy, despite a government promise to deregulate electricity prices by 2011 and upbeat messages to the target investors, such as that from Anatoly Chubais, head of UES, who in June 2007 presented the investment case to The International Economic Forum of the Americas under the heading ‘The Russian electric power industry is superpromising for investors’. In June 2006 Yelena Obukhova of Antanta Capital sounded a typical note of caution by warning in an investors’ note that ‘generating companies could become a lucrative investment if the sector were properly regulated along market lines. Whatever happens, investors should be aware that their money will be tied up for at least five years.’

In June 2007 Standard and Poors rated the sector as a ‘weak’ business prospect, predicting 5% sustained growth but pointing up risks associated with a transitional economic environment, and an uncertain political and regulatory regime. But having observed the need for investment and the relatively low share offer price (as reckoned by cost per kW of generation) it called the market “an increasingly attractive investment opportunity for Western European utilities”. Investors agreed, enthusiastically at first, less so later, but the sell-off was, with one or two minor exceptions, completed as planned in July 2008. Since then the value of all UES divestments has fallen considerably and on 24 March this year Standard & Poors downgraded the credit rating of Mosenergo, the largest of the new generation companies, in a move that may signal a period of general difficulty in raising credit for ambitious generation enterprises.

The system post-liberalisation

Russia’s economic recovery contributed to an increase in total electricity consumption from 715 billion kWh in 1998 to 980 billion kWh in 2007. Fossil fuelled power (oil, natural gas, and coal-fired) accounts for about 63 % of electricity generation, followed by hydropower (21%) and nuclear (16%), according to the EIA (US DoE Energy Information Administation). According to state data, these plants produced 913 billion kWh in 2007.

Russia’s power sector has a total generation capacity of 217 GW and includes over 440 thermal and hydropower plants, 77 of which are coal-fired, and 31 nuclear reactors. Some capacity in the far-eastern part of the country is not connected to the power grid.

Post-liberalisation the state retains ownership of the system operator and transmission controller, the FGC (Federal Grid Company) through its stake of 75% or more, and maintains its total ownership of the nuclear sector through the existing state agency Rosatom and its mining, fuel handling, construction and operating arms. The Interregional Distribution Company and the Hydro OGK remain in the government’s control by virtue of its minimum 52% ownership of each, a similar position to that of the supply companies in which it always retains a minimum 51% stake.

The rest was largely sold to private investors and corporations, although the state has some small residual shareholdings. After the sale, stakes between 51 and 60% in each of the six wholesale gencos, the OGKs (also known as WGCs or OGCs), had been autioned off as had 75-85% of the 14 regional or ‘territorial’ gencos, the TGKs (aka TGCs), while the independent local Energos, amounting to about 30% of total generating capacity, remained in private ownership.

Nuclear power

The Russian government has stated that it intends to expand the role of nuclear and hydropower generation in the future to allow for greater export of fossil fuels. Russia has an installed nuclear capacity of 22 GW, distributed across 31 operational nuclear reactors at 10 locations, all west of the Ural Mountains. However, Russia’s nuclear power facilities are ageing. About half of its reactors are of the RBMK design employed in Ukraine’s ill-fated Chernobyl plant. The working life of a reactor is considered to be 30 years: nine of Russia’s plants are between 28 and 32 years old, and six are between 23 and 27 years old. Before the current economic crisis hit, investment in the nuclear sector was expected to double to around $1 bn during 2009. Gazprom has also expressed interest in building nuclear plant. But perhaps most promising is the Siemens-Rosatom joint venture (see p 35) which aims to become one of the world’s principle suppliers across the entire range of nuclear power activity.

Transmission and distribution

There are seven separate regional power systems in the Russian electricity sector: Northwest, Centre, Middle Volga, North Caucasus, Urals, Siberia, and Far East. The Far East region is the only one not connected to an integrated power system. Until 2007/8 UES, which is 52 % owned by the government (Gazprom has a 10% stake), owned 96 % of the T&D system, the central dispatch unit, and the federal wholesale electricity market (FOREM). The grid comprises almost 2 million miles of power lines, 93 000 miles of which are high-voltage cables over 220 kV. The former UES structure passed to the NGC in July 2008.

There are currently two efforts underway to integrate the Russian and Western European electricity grids. UES has been participating in the Baltrel programme, designed to create an energy ring of power companies in the Baltic states. Also, the Union for the Co-ordination of Transmission of Electricity (UCTE), of which 20 European countries are members, has entered into discussions with its Russian counterparts over the technological and operational aspects of interconnecting their systems.

European investment

By early 2008 three EU-based companies – Enel (Italy), E.ON (Germany) and Fortum (Finland) – had between them bought up 33% of the shares issued in the privatised Russian power sector, with Enel owning 60% of OGK-5 shares, E.ON 76% of OGK-4 and Fortum 76% of TGK-10. This meant that European investors had control at that time of approximately 10% of Russia’s installed capacity

Enel was the first major utility from outside Russia to invest, and its build programme is the most advanced (see page 30). It has been managing the Northwest Thermal Power Plant jointly with Russian company ESN since 2004. However, foreign investment was initially kept back by legal restrictions. At the beginning of the liberalisation process Russian law did not allow foreign companies to own more than 50% of local generating companies, which had to be kept in state control. Since this rule did not apply to wholesale generating companies, Enel was able to buy a blocking stake in OGK-5 during its IPO, and in due course to increase its investment to a controlling stake of 56%.

E.ON has also earned a good reputation in Russia. In 2007 it signed an agreement with the government of Siberia’s Tyumen Region to build a gas turbine power plant with a capacity of 3000 MW in Tyumen. Investment in the project would exceed $1 billion. The German energy giant also announced its intention to buy, and then bought, major stakes in OGK-1, OGK-4 and TGK-3. In July last year E.ON began building two 400 MW turbines at Surgutskaya, a power station in Russia’s oil heartland, which when completed would make it at 5.6 GW the largest gas fired power station and second largest fossil fuelled plant in the world (see page 32). The construction is part of a 150 billion rouble ($3.29 billion) investment programme that E.ON plans to carry out at OGK-4 by the end of 2011.

In February last year OGK-1 and TNK-BP signed a Shareholders Agreement to implement together an investment project under a new joint venture Nvgres Holding Ltd, for the construction of a new power unit at Nizhnevartovskaya TPP. OGK-1 will contribute 100% of the shares of Nizhevartovskaya GRES ZAO, which owns two existing power units, Nizhnevartovskaya TPP, with combined installed capacity of 1600 MW. TNK-BP will contribute approximately US$320m. The agreement also provides an option for TNK-BP to increase its stake to 50% less one share after the construction of the new power unit is completed in 2010.

To Fortum the investment equation still looks an attractive one. Russia has promised to deregulate electricity prices within the next two years, suggesting that decent dividends are in prospect for suppliers, and on the strength of that Fortum has committed to an extensive investment programme at TGK-10 which will increase its generation capacity by approximately 70% to 5.3 GW by 2013 at a cost of r 2.2 billion. And in October last year it promised to incease its planned investment in Russia by more than 10 %.