RUSSIAN ELECTRICITY SECTOR PRIVATIZATION BEGINS

C O N F I D E N T I A L MOSCOW 012261

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SENSITIVE
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STATE FOR EUR/RUS; EB/ESC
DOE FOR HARBERT
DOC FOR 4231/IEP/EUR/JBROUGHER
NSC FOR GRAHAM AND MCKIBBEN

E.O. 12958: DECL: 11/01/2016
TAGS: ECON EIND ENRG PREL RS
SUBJECT: RUSSIAN ELECTRICITY SECTOR PRIVATIZATION BEGINS
WITH SUCESSFUL STOCK OFFERING


Classified By: Econ M/C Quanrud by reason 1.4 (b) and (d).


1. (C) Summary. Russian electricity monopoly, RAO UES, on
October 31 sold 14.4 percent of daughter company WGK-5 for
$459 million, marking the first of the restructured power
generating companies to be successfully privatized.
Speculation that Gazprom would acquire the entire offering
proved to be unfounded. No one strategic investor received
more than one percent of WGK-5 in the public offering,
according to UES CEO Anatoliy Chubays. UES tells us foreign
bidders are welcomed for the 25 percent stake sale of WGK-5
to be held in 2007, but it is clear that Gazprom or Rusal
would dearly like to get their hands on this strategic
morsel. On other reform news, the spot market for wholesale
electricity is expected to grow from 20 percent in 2006 to 40
percent by 2008. End summary.

WGK-5 PRIVATIZATION BEGINS
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2. (U) The electricity monopoly, RAO UES, on October 31
raised $459 million through a successful public offering for
a 14.4 percent stake in Wholesale Generating Company 5
(WGK-5),the first of its 20 restructured power generating
companies set to be privatized. This is the first stage of
UES' three part privatization program that will spin off all

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of UES' thermal power generating capacity. The issuance
reduces UES' stake in WGK-5 from 87.7 percent to 75 percent.
According to business newspaper Vedomosti, Gazprombank, the
Finnish energy concern Fortum, the EBRD, independent gas
producer Novatek, Vnesheconombank, and Nomos-Bank took the
largest stakes in the offering. Step two of WGK-5's
privatization will occur in mid-2007 when UES sells a 25 plus
one percent lot to a strategic investor. Finally, UES will
divest itself of its remaining shares in the last stage when
it proportionately distributes the shares among UES' minority
shareholders.


3. (SBU) In an October 24 meeting with econboff, UES Deputy
Head of Strategy Alexey Kachay said a competitive bidding
system would be employed to choose a strategic investor in
stage two of WGK-5's privatization and that foreign investors
would be welcomed. Responding to emboff concerns that the
proposed strategic sectors law on foreign investment could
complicate foreign bids, he said the WGK is not considered a
monopoly and, in any case, the sale would not reach the 50
percent limit stipulated in the law.


4. (C) The government earlier this year approved additional
public offerings for WGK-3 and WGK-4 in 2007. (Comment: The
power shortages last winter and the blackout in Moscow last
May probably helped persuade the Kremlin to speed up
investment into the power sector's aging infrastructure. End
comment.) UES plans to raise more than $12 billion in
2007-08 by issuing shares for all of its restructured
companies, according to the press.

GAZPROM'S POWER GRAB
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5. (U) According to the press, the demand for the issuance
was eight times greater than the amount offered, resulting in
a price at the high end of nine cents per share. Speculation
in recent days centered on Gazprom's interest in acquiring
the whole 14.5 percent. One article this week surmised that
the Gazprom news was a ploy to drum up interest in the
offering. After the tender, UES CEO Anatoliy Chubays
responded to concerns over Gazprom's acquisitions by
reassuring the public that no one strategic investor would
receive more than one percent of WGK-5 in this public
offering.


6. (U) In addition, on October 27, RAO UES' board of
directors approved Gazprom's acquisition of Mosenergo's
additional share issuance for $2.1 billion, which would
increase the gas monopoly's stake in the Moscow utility to a
controlling 52.4 percent.

GROWING SPOT MARKET
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7. (U) According to UES, all major generation companies on
January 1, 2006 became participants of the federal wholesale
market. The unregulated wholesale electricity market will

increase gradually as regulated one to three-year contracts
expire and wholesale customers start turning to the spot
market. In addition, all future power generating capacity
coming on-line will only sell to the spot market. In 2006, so
far, 20 percent of the electricity consumed was traded
(including retrades) at competitive spot market prices. UES
plans to increase this share to 40 percent by 2008. The
Federal Tariff Service continues to regulate prices for
retail consumers and is set to increase prices by at least 10
percent in 2007.


8. (C) Comment: WGK-5's successful public offering should
inject much needed investment into its power plants (Note:
WGK-5 operates heating and power plants in the Moscow, Yekat
and Rostov regions). The success will also encourage UES in
its plans to issue additional shares for its other WGKs and
RGKs (the Regional Generating Companies) in the 2007-08
period. UES's ability to keep Gazprom at bay in its power
plant buying spree was a positive development, but the next
stage of privatization in mid-2007 will be more decisive when
UES sells a 25 percent stake in WGK-5 to a single strategic

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investor. Russia's industrialists, like Gazprom and RUSAL,
are positioning themselves to acquire controlling stakes in
these strategic assets. It remains to be seen if UES
assurances to keep the process transparent and competitive
can keep the potential mix of political and commercial
interests at bay in determining the final ownership of these
power generating companies. End comment.
BURNS