RUSSIA: GAZPROM'S REACH INTO POWER SECTOR

C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 003817

SIPDIS

SIPDIS

DEPT FOR EUR/RUS,EEB/ESC
DOE FOR HARBERT/EKIMOFF
DOC FOR 4231/IEP/EUR/JBROUGHER
NSC FOR MCKIBBON

E.O. 12958: DECL: 08/03/2017
TAGS: ECON EIND ENRG PREL RS
SUBJECT: RUSSIA: GAZPROM'S REACH INTO POWER SECTOR
THREATENS REFORM

REF: A. MOSCOW 01198

B. MOSCOW 02728

Classified By: Acting Econ M/C Kathleen Doherty. Reasons 1.4 (b/d).


1. (C) SUMMARY. In a July 27 board of directors meeting,
electricity monopoly, RAO UES, approved the terms of an asset
swap deal giving state-controlled gas monopoly, Gazprom,
control over Wholesale Generating Company 2 (WGC-2) and WGC-6
in exchange for Gazprom's UES shares. Power sector reform
seemed to be on track this spring with the transfer of UES's
daughter companies to these strategic investors proceeding as
planned. However, this latest deal giving Gazprom control
over WGC-2 and WGC-6 and the proposed Gazprom/SUEK joint
venture could potentially derail UES CEO Chubays' power
sector reform by giving the sector's main fuel suppliers
control over much of the country's power generation capacity.
END SUMMARY.
.

2. (SBU) Gazprom, metals conglomerate Norilsk Nickel, and
coal company SUEK are the three largest minority shareholders
in RAO UES with 10.5 percent, 3.5 percent, and 1 percent,
respectively. As part of UES's planned breakup, its minority
shareholders are scheduled to receive proportional stakes in
UES's constituent daughter companies, according to their

SIPDIS
current share holdings in the electricity monopoly, when the
holding company ceases operations in July 2008. However, the
UES board of directors on July 27 decided to allow Gazprom,

SIPDIS
SUEK, and Norilsk Nickel to swap out their diluted stakes in
these daughter companies for controlling stakes in specific
companies. In particular, Gazprom will receive 55 percent of
WGC-2 and 52 percent in WGC-6 for its claim on UES daughter
companies. SUEK will receive 13 percent in Territorial
Generating Company 12 (TGC-12) and 15 percent in TGC-13 for
its diluted stakes, raising its current share in the two TGCs
to 56 and 47 percent, respectively. Norilsk Nickel will add
to its current 73 percent stake in WGC-3 in exchange for its
diluted shares.
.
REFORM SEEMED ON TRACK
--------------
.

3. (SBU) As UES CEO Chubays has repeated many times over the
past few years, the main objective of UES's planned breakup
has been to introduce competition into the wholesale power
market by selling UES's newly created daughter companies, the
five WGCs and 14 TGCs, to a number of strategic investors,
who would then compete in power generation (reftel A). The
transfer of UES's daughter companies to these strategic
investors started to accelerate this spring with Norilsk
Nickel acquiring a 38 percent in WGC-3 in a March private
share offering. Subsequently, Norilsk bought out shares from
minority shareholders and now holds 72 percent of WGC-3. In
June, Italy's Enel purchased a blocking stake in WGC-5; the
deal touted by Chubays as an example of the reform's
progress. Afterwards, Enel announced plans to acquire a
majority stake in WGC-5 (reftel B).
.
UES REFORM AT RISK

SIPDIS
--------------
.

4. (C) However, industry analysts are expressing concerns
that this latest deal giving Gazprom control over WGC-2 and
WGC-6 could potentially derail Chubays' power sector reform.
As the power sector's primary fuel supplier and a major
player on the wholesale electricity market, Gazprom could
exert undue influence on wholesale electricity pricing.
Gazprom already controls more than 50 percent of Russia's
largest power company, TGC-3 or Mosenergo, Moscow's
electricity provider. In addition to power plants in other
regions, WGC-2 includes the Troitskaya and Surgutskaya GRES
(State District Power Station),which power the oil and gas
regions of West Siberia. WGC-6 includes the Kirishskaya
GRES, which is UES's largest thermal power plant in the St.
Petersburg region.
.

5. (C) In addition, the proposed Gazprom/SUEK joint venture
would compound the problem of fuel supply companies entering
the power generation sector by including a major coal
producer. 59.1 percent of Russia's thermal power plants
(i.e., excluding hydroelectric and nuclear) rely on gas,
compared to 40.9 on coal. According to Vedomosti, a Federal
Anti-Monopoly Service (FAS) analysis indicates that the deal

MOSCOW 00003817 002 OF 002


would give the Gazprom/SUEK joint venture 45 percent of the
thermal power generation capacity in the European and Urals
region of Russia, and 42 percent of Siberia's power
generation capacity.
.
COMMENT
--------------
.

6. (C) The latest news that the Gazprom/SUEK deal has been
delayed until the end of the year may be a sign that
back-room lobbying is intensifying. Anti-Monopoly Service
head Artemyev has been a strong opponent of the proposed
Gazprom/SUEK joint venture, but has also admitted that his
agency could not stop the deal if the government wants it to
proceed. The structuring of UES's wholesale power market and
some FAS restrictions placed on Gazprom's activities in the
power sector might be able to stave off some of the most
anti-competitive advantages that Gazprom-controlled power
plants would enjoy. However, a Gazprom/SUEK joint venture
would almost certainly end any hope of salvaging Chubays'
power sector reform. END COMMENT.
RUSSELL