Inside Russia

Inside Russia

May 20, 2009

Darrell Delamaide

Russia, the biggest country in the World by area and the fourth-biggest by installed electricity generating capacity, is nearing a significant milestone. By next year -- unless the global recession continues to dampen demand -- it should again reach the level of electricity consumption it had in 1990, all of 20 years ago.

The collapse of the Soviet Union and the transition from Communism hit the entire Russian economy. In a sense, the subsequent decline in demand was a good thing, because years of inadequate investment had left the Russian power industry with aging and inefficient plants. But as the economy has grown in recent years, and particularly as it surged on the back of skyrocketing prices for oil and gas, the lack of investment in power has become a hindrance. Russia has the world's largest reserves of natural gas and eighth-largest oil reserves.

"They have a problem meeting internal demand," said Luca Cesari, managing director of Accenture's utilities industry group.

Providing electricity is a particular challenge in Russia because it sprawls across 11 time zones and is divided geographically by the Ural mountain range and the Siberian tundra. The transmission system is divided into three regions -- European, Urals and Siberia -- but the connection between time zones remains fragile.

A power blackout in Moscow in May 2005 that affected as many as two million people brought home the fragile state of the electricity system. It then prompted the government to start in earnest with plans to liberalize the highly centralized and government-controlled system. Investment became imperative. "They had no choice," said Accenture's Cesari. "The system would deteriorate."

The liberalization program started to bear fruit last year with the privatization of several wholesale generating plants: OGKs in Russian, and territorial plants, or TGKs. The sale of the plants drew foreign companies such as Germany's E.ON, Italy's Enel and Eni, and Finland's Fortum as investors, as well as domestic energy giant Gazprom.

The stakes come with some strings attached, as the acquiring companies must commit to certain levels of investment -- up to four trillion rubles, or about $150 billion. The government targets for investment through 2020 call for $500 billion to be spent, with about one-third coming in the OGKs and TGKs.

Falling Demand

However, the government has not yet determined how it will monitor whether these investments are made. Gazprom has already indicated that it will scale back its planned investments after the decline in natural gas prices. Dubai World sovereign wealth fund in September pulled out of its planned $5 billion acquisition of OGK-1.

The fact that electricity rates for residential customers are still set at artificially low levels means there will be pressure on profit margins until these, too, are liberalized. And as the global economy lurched downward in recent months, domestic industry urged the Kremlin to delay the planned liberalization -- increase -- in industry tariffs.

Such a postponement in lifting the caps on rates could provide a disincentive to both foreign and domestic investors, said Semyon Schetinin, a senior executive in Accenture's utility group based in Moscow. But, by the same token, the economic downturn has led to reduced consumption, so that the load on the system this year has not been high. According to Accenture's analysis, consumption and generation this year may decline by 1 percent after increasing by 2 percent last year.

However, in March, the Market Council, which monitors the electricity industry, said that demand had fallen off more than expected in the first two months of the year, declining 7.7 percent year on year in January, and 4.8 percent in February. The sharp decline in consumption has put downward pressure on unregulated prices, the council said, and some power plant operators may register losses. Opinions were divided as to whether the downturn would prompt the government to scale back the investment requirements.

In addition to its oil and gas resources, Russia also has massive coal reserves, the second-largest in the world. Currently, about 70 percent of Russian electricity is generated in coal- and gas-fired plants -- 2-to-1 in favor of gas -- with the remainder coming from nuclear and hydroelectric, about evenly divided.

The country would like to increase the portion of power coming from nuclear, but the government is also keen on maintaining tight control of this sector. Nonetheless, because it would like to get the technology for third- and fourth-generation reactors, authorities are in talks with France and other nuclear operators and may be willing to give up some of this control. Eventually, the portion of electricity generated by coal and gas should be nearer 60 percent, analysts believe.

Many of the coal plants are so old that they will have to be dismantled, and the choice of whether to replace them with gas or coal is made more on an economic basis than with any consideration about carbon emissions, Schetinin said.

This pragmatism extends to alternative energy sources as well. Unlike the Chinese, who have made a strong commitment to developing renewable and other alternative energies, Russia has not made it a priority, said Schetinin. "It comes down to economic ability. If there is a business case for wind-based or solar-based generation, using comparable parameters as for hydrocarbons, then obviously they will do it."

The government would like to invest not only to improve the quality of both generation and transmission assets but also to make them smarter and more productive. "Not all of the planned investment is for increasing capacity," Schetinin said.

The precipitous drop in oil prices and the worldwide financial and economic crisis may slow down Russia's ambitious plans for renewing its electricity infrastructure. But the stage has been set for foreign participation in the investment to power the burgeoning Russian economy once it shakes off the effects of recession.