ELECTRICITY SECTOR REFORM: STILL ON HOLD

C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 001520 SIPDIS STATE FOR EUR/RUS, EEB/IFD DOC FOR 4231/MAC/EUR/JBROUGHER NSC FOR MCFAUL E.O. 12958: DECL: 06/08/2019 TAGS: ECON EINV EIND ENRG RS SUBJECT: ELECTRICITY SECTOR REFORM: STILL ON HOLD REF: 08 MOSCOW 3062 Classified By: ECON Minister-Counselor Eric T. Schultz for reasons 1.4 (b, d) -------------- Summary -------------- ¶1. (C) The strains of the economic crisis are increasing pressure on the GOR to slow down electricity sector reform. Consumers are concerned about the speed of price reform and generating companies (gencos) are reluctant to modernize generating capacity. The GOR's signals about its intentions are mixed, yet it continues to exhort gencos to fulfill their investment obligations. Its influence over the sector may be waning, however, with most gencos significantly reducing capital expenditures in the face of collapsing industrial demand. Thus, as genco owners squeeze maximum returns from their decaying assets and delay infrastructure investment, the risk of disruptive blackouts is increasing. End summary. -------------- Mixed Messages on Pricing -------------- ¶2. (SBU) After a 15-20 percent hike in tariffs in January 2009, popular pressure has increased to delay the pace of electricity price reform. Electricity prices in Russia comprise two components: an increasing band of liberalized (free market) prices and GOR-approved tariffs. Currently, liberalized prices represent 25-30 percent of the whole price. By 2011, the GOR had promised to liberalize all prices. ¶3. (SBU) But, while Economic Development Minister Nabiullina has been vocal in supporting delays in price restructuring, the Energy Ministry appears to have held the line. The band of liberalized prices will increase to 50 percent in July 2009 as planned. The crisis is actually an ideal time to liberalize prices, since low demand has resulted in a substantial drop in liberalized prices. As for delaying the January 2010 15-20 percent tariff increase, t TC7Q(iQQ~Y of the GOR's intent to follow through with price liberalization and fearing that powerful industrial interests are lobbying hard to keep electricity prices artificially low, power sector investors are hesitant to complete their commitments. Onexim Group CEO Dmitry Razumov told us that Onexim, which has a majority stake in TGK-4 generating company, would not be investing any further in the sector. Onexim no longer had any faith that the GOR would 
stick to its price restructuring program, despite Onexim President Mikhail Prokhorov's recent public statement that he was "betting on the future" of the power sector at the opening of a new generating station. ¶5. (SBU) For months, the GOR also has waffled on whether it will allow gencos to renegotiate the investment obligations they undertook at the time of RAO UES' privatization last July. While Prime Minister Putin recently seconded Energy Minister Shmatko's call on gencos to fulfill their investment obligations, few seem to be complying. With tight credit markets and demand from the industrial sector collapsing -- industrial production dropped 16.9 percent year-on-year in April --, the costs of increasing capacity are continuing to grow exponentially (reftel). ¶6. (C) Igor Goncharev, a sector analyst at UBS, told us that the GOR's levers to enforce the investment contracts were weak. He explained that many contracts between the gencos and distribution companies were never signed by GOR representatives. Furthermore, the severe penalties often touted in the press were far less draconian than reported. Goncharev concluded that since gencos cannot "openly disrespect the GOR", they have just quietly cut their capex programs and ignored it. ¶7. (C According to Goncharev, gencos have cut capital expenditures by as much as 40 percent already, a result of MOSCOW 00001520 002 OF 002 the difficulties they are having raising financing and a lack of cash, However, while Goncharev said many gencos do have financial constraints, others are only pretending. David Herne (U.S. citizen protect),President of Halcyon Investments, also told us that a number of gencos are "doing very well". They are earning money in the current environment by squeezing the remaining productivity out of their assets, taking advantage of low input prices, and putting off upgrading. ¶8. (C) Mikhail Slobodin, President of Integrated Energy Systems (IES),which owns a number of gencos, painted a less upbeat financial picture. While cagey about IES' current revenue stream, he said that Russia's industrial production would not recover for another five to ten years. Consequently, IES had put off major investments for the foreseeable future; it would maintain and repair only as needed. Slobodin acknowledged that since the system was so ancient (much of it over 50 years old),the costs of lost efficiency were high, but still cheaper than borrowing in current markets. -------------- Sector Can't Wait Forever -------------- ¶9. (SBU) Analysts have stated that 50 percent of the sector's infrastructure needs to be replaced by 2013. Furthermore, analysts at Renaissance Capital and elsewhere concluded long ago that had robust growth continued, Russia's generating capacity would have been exceeded in just a few years. These same analysts are concerned that with a strong recovery, capacity could be exceeded as early as next year, leading to spiraling prices and blackouts. Moreover, these analyses do not account for the effects of an unexpected loss of capacity due to accidental failure of the generation, transmission, or distribution parts of the infrastructure. -------------- Comment -------------- ¶10. (C) Russia's delicate electricity infrastructure is aging rapidly and fraught with potential disaster. "Duct tape" may hold the grid and the rest of it together for another few years, but, regardless of how strong a recovery Russia experiences, the sector cannot run indefinitely without further GOR or private investment. Fulfilling this need, after all, was the entire point of privatizing RAO UES. BEYRLE