Russian Federation: Russia Prepares to Reform its Electricity Sector

Last Updated: 15 April 2003

By Jay Cuclis, Doug Glass, Doug Glass, Natalya Morozova and Donna Bobbish

After years of delay, Russia is prepared to adopt new laws reforming its electricity sector, allowing foreign investors to participate in the Russian power market. A number of Western companies have shown great interest in participating in the largest electricity privatization in the world.

The Government's package of reform legislation largely was adopted by the Federal Assembly (Russia's Upper House of Parliament) on March 12, 2003. The new laws, once signed by President Putin, will clear the way for the Government to break up the existing power monopoly, RAO UES of Russia and its numerous subsidiary and dependent companies (Energos), into competing power generating and/or power trading companies and a single, Government-controlled, power transmission monopoly. Although the Government has expressed dissatisfaction because its original proposals were not adopted in full and the final versions lack clarity and are contradictory, President Putin is said to support the drafts and is expected to sign them shortly.

According to the new laws, by January 1, 2005, the reorganization of RAO UES of Russia and its subsidiary companies must be substantially complete. From that date, the transmission of electricity will be unbundled from generation and sales activities. Owning and operating both power generation and transmission facilities will be prohibited. Also, a Wholesale Power Market (the WPM) will be established not earlier than July 1, 2005. By that date, the Government will decide when each region of Russia is ready to adopt a deregulated power market. Some experimental trading in power can take place during a transition period, but the Government will determine how much, in what regions, and how long the transition periods will last.

Establishing a United National Power Grid

The new laws provide for rules that will establish the United National Power Grid (UNPG), which will be a complex of power networks and network facilities owned by State-controlled entities.

Two new Governmental companies will be established: the Federal Grid Company (FGC) responsible for managing transmission and having some power transmission networks and facilities within the UNPG; and the System Operator Company (SOC) responsible for dispatch functions. Both companies, along with power producers and consumers, will become the participants in the WPM. Some power facilities such as nuclear power stations will remain federal property.

FGC and SOC will handle the main coordinating operations within the UNPG. FGC will be required to enter into agreements with private owners of power facilities regulating the use of such facilities. FGC will also enter into agreements on transmission of power with participants in the WPM. The FGC will offer power transmission services for participants in the WPM and other smaller owners of power facilities connected to the UNPG, and will be prohibited from the sale or purchase of electric power.

The Government will manage and control dispatching operations through SOC. SOC will enter into agreements on dispatching of power with virtually all persons operating in the electricity sector. SOC and its affiliated companies also will be prohibited from activities related to the generation, sale or purchase of electric power.

Establishing a Wholesale Power Market

The WPM will be designed to guarantee open access to private producers and buyers of power and to establish deregulated prices for electrical power, subject to legislative and Governmental regulation. Private competitors, created from RAO UES of Russia's major subsidiary companies, will become participants in the WPM. The Trade System Administrator, a non-commercial organization consisting of WPM participants, will be responsible for facilitating wholesale market operations and the pricing regime. Tariffs for heat as well as tariffs for electric power in certain limited cases and tariffs for services will be regulated by the Government.

Regional authorities also will have rights to control guaranteed supplies; that is, supplies to the housing and public utilities sector. The owner of the relevant network must provide non-discriminatory access to customers and suppliers.

Some Issues for Investors

In the retail electric power market, the State will regulate the margin imposed by guarantors of power supply sales.

At issue is the rate at which tariffs will be allowed to rise to enable the profitability of investments in Russia's electricity sector. Current estimates are that power prices must at least double (not a politically attractive result) to allow generators to cover their costs, including the costs of needed system upgrades.

As has been the case with electricity sector restructuring and regulatory reforms in other countries, a big question for investors is the way in which Russia's electricity sector reforms will be implemented, and how long it will take to move some of the local Energos into private hands. Also of concern to investors will be whether the market framework established by the Government will be sufficient to create a truly competitive market for power, and whether Government control of prices will result in cross-subsidies, leading to market inefficiencies.

This material is not intended to create, and does not create, an attorney-client relationship between you and Vinson & Elkins L.L.P., and you should not act or rely on any of this information. As legal advice must be tailored to the specific circumstances of each case, nothing provided herein should be used as a substitute for advice of competent counsel. These materials do not constitute legal advice, do not necessarily reflect the opinions of Vinson & Elkins L.L.P. or any of its attorneys or clients, and are not guaranteed to be correct, complete, or up-to-date. Vinson & Elkins L.L.P. assumes no liability for the use or interpretation of information contained herein. This publication is provided "AS IS" WITHOUT WARRANTY OF ANY KIND, EITHER EXPRESSED OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, OR NON-INFRINGEMENT. Unless otherwise indicated, V&E attorneys listed are: not Certified by the Texas Board of Legal Specialization. None of the attorneys listed on this website is certified as an "expert" or "specialist" pursuant to any authority governing the practice of law in New York.

Vinson & Elkins is a registered limited liability partnership. Principal office-Houston.

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