Rao Unified Energy System Of Russia Business Information, Profile, and History

Company Perspectives:

The Russian joint stock power and electrification company RAO UES of Russia was established by Russian Federation Presidential Decree No. 923 of August 15, 1992 as a sector-wide holding company with extensive functions in ensuring a reliable supply of electricity and heat energy to the various sectors of the economy and the general public, the centralised management of the Unified Energy System of Russia, and the implementation of investment programmes in the electric power sector. RAO UES of Russia is the most important component of Russia's power generation and supply industry and operates in structural terms as a company, a holding company and a group.

History of Rao Unified Energy System Of Russia

RAO Unified Energy System of Russia (UES) is one of the two largest companies in Russia. The electrical company controls the output of more than 70 percent of Russia's electricity, providing power to domestic households, industry, agriculture, and transportation through its nationwide system of transmission lines and power plants. Structured as a holding company, UES oversees the 440 power stations that comprise Russia's Unified Energy System, including thermal, nuclear, and hydroelectric power plants with a total capacity of 197,000 megawatts. The system produces over 600 billion kilowatt-hours of power a year. UES's holdings give it control over nearly all aspects of Russia's power generation and transmission. On the federal level, the company owns more than three million kilometers of electric power lines, giving it control over all the high-voltage lines in Russia's transmission grid. UES also operates the central dispatching system that coordinates its far-flung network. On the regional level, the company controls most local power generation through holdings that average 51 percent in 73 regional power utilities, known as "energos." Finally, the company also operates 34 independent electric stations that supply power directly to the national wholesale market.

The state owns 52 percent of UES and asserts its control over the company through several representatives on the board of directors. Foreign investors hold a third of the company. Thus, as is the case with many large Russian companies, management and staffing decisions at UES often have political significance. UES's history illustrates the conflicts that have marked the birth of capitalism in Russia, including the struggle between Soviet-era traditionalists and reform-minded capitalists, and the attempt on the part of the state to rein in powerful oligarchs.

Building an Electricity Infrastructure in the Soviet Era

A group commissioned by Vladimir Lenin worked out the first comprehensive plan for the electrification of the Soviet Union. The plan developed by GOELRO, the State Commission for the Electrification of Russia, was adopted by the Eighth Congress of Soviets in December 1920. It outlined plans to rebuild the prewar electric system and build 30 new regional power plants, paying special attention to the nation's hydropower resources. Electrification was expected to be a key factor in the development of heavy industry in the Soviet Union.

Driven by the force of a centrally planned economic system, the electrification of Russia proceeded quickly. Electric power output grew from 0.8 billion kilowatts per hour (kwh) in 1922 to 48.3 billion kwh in 1940. A few years later several power plants in the Central Siberian Area connected their stations to form an integrated power grid. The Bratsk and Krasnoyarsk hydroelectric plants became part of the grid in the 1970s.

European Russia also recognized the advantages of an interconnected power system. In 1956 a transmission line was constructed between the Volga Hydroelectric Power Plant and Moscow. Generating capacity continued to expand. Power output in 1960 was 292.3 billion kwh, and a decade later output reached 741 billion kwh. Soviet plans for economic development stressed the potential benefits of a centrally coordinated, nationally connected power system. East European states were also drawn into the Soviet system in a network dubbed the Peace power grid.

The Privatization Process of the Early 1990s

After the Soviet Union dissolved in 1991, the United Power System was privatized in a whirlwind process along with scores of other state entities. RAO UES was set up by decree of the president and put together largely from the staff of the former Ministry of Fuel and Power. The initial plan put forth by Economic Minister Yegor Gaidar called for the creation of a state monopoly to control the entire power grid, while power producers would be converted into joint stock companies. However, the viewpoint of the Ministry of Fuel and Power prevailed, and a more centralized, vertically integrated system was created.

In the new arrangement, high-voltage grids became the property of RAO UES, while low-voltage grids remained under control of local power producers. As a result, local energy barons retained a monopoly in their areas, despite the existence of a nationwide system. The price of power was regulated at three levels: the government set rates for the general population and for agriculture, a Federal Energy Commission was created to regulate wholesale rates, and regional energy commissions established rates for local industry. Price was based not on supply and demand, but on the cost of production. Consequently, there was no incentive to close inefficient plants; a plant that produced power more cheaply would see all potential profit eaten up by lower rates. In addition, management at many regional power companies fell short of the dispassionate business ideal as an uncertain capitalism was grafted onto the ingrained Soviet way of doing things. Power was supplied to traditional customers regardless of ability to pay, and artificially high prices were often lowered for industries who had preferred standing with the utility. To make matters worse, barter was a common method of payment amid an economy plagued by insolvency.

In spite of business irregularities, UES became a popular investment. The company sometimes accounted for more than 90 percent of daily trading volume on the MICEX exchange. The perception that the company was undervalued made it an attractive prospect. Talks were underway about the creation of an East-West energy bridge reaching from Smolensk through Belarus and Poland to Germany. Feasibility studies were completed in 1994 and 1995 and the first power was sent to Europe in October 2000.

In the mid-1990s, the entire power industry became bogged down in a situation of widespread mutual indebtedness. The metallurgical, chemical, and machinery sectors were defaulting widely on power bills. In 1995 the government prohibited UES from cutting off power to certain strategic defense installations, causing arrears at the company to soar. UES consequently had trouble paying the natural gas company RAO Gazprom for fuel deliveries, and Gazprom cut fuel supply to some plants in Russia's central regions. The Federal Energy Commission stepped into the fray when it indexed electricity rates to 80 percent of wholesale producer price inflation from late 1995 through mid-1996. At the end of 1995, results were mixed. UES reported a profit of over $20 million. But 60 percent of energy sales were not paid for that year. Power output had also fallen by 25 percent since 1992. That decline, however, was less than the nationwide decline in industrial production.

The company's difficulties continued into 1996. Consumer debt increased from Ru 43 to Ru 79 trillion. Regional power plants continued to have trouble paying for fuel, and power outages ensued during the harsh winters. Another area of concern was capital investment, which stood at 42 percent of its 1991 level. Although several new turbines and transmission lines were brought on line in 1996, the overall system lagged behind in efficiency and technological advancement.

Reformers Taking Power: 1997-99

The Unified Power System, privatized during an unstable and confusing transition period, was clearly in need of restructuring. The first steps toward reform were taken in 1997 when the state began to exert the influence of its controlling stake. That spring President Boris Yeltsin appointed his deputy prime ministers Anatoly Chubais, who had been in charge of the original privatization process, and Boris Nemtsov to develop a strategy to introduce competition into natural monopolies. Nemtsov and Chubais acted on the basis of the Law on Natural Monopoly, which had been passed in 1995 to provide a legislative framework for regulation. In the short term, the reformers saw a need to reduce energy tariffs. They hoped that, in a chain reaction, industries would be able to pay lower tariffs, UES could pay Gazprom for fuel, and both companies could pay taxes to the government. In the long run, Nemtsov suggested spinning off UES's power generation assets, leaving it in charge of transmission only, and encouraging competition by allowing third party access to the transmission grid.

In April 1997 Yeltsin set out provisions for reform in the edict "On Reforming the Natural Monopolies." Soon a Nemtsov-supported reformer, the 29-year-old bank manager Boris Brevnov, replaced longtime company head Anatoly Dyakov as CEO. Dyakov remained on as chairman of the board of directors. Brevnov set about implementing a reform agenda. He brought in a younger staff, retained Price Waterhouse as auditors, and consolidated 130 accounts in various banks that had ties to management into a single account. Company expenditures became more transparent to the state and the percentage of cash payments nearly doubled by year's end.

Brevnov's opponents accused him of exploiting company luxuries for personal purposes and pointed out that conditions at regional power stations continued to deteriorate. Regional managers were particularly opposed to Brevnov's plan for price reform. He wanted to give big industrial customers the right to buy electricity from the cheapest provider, so that the competition would drive industrial rates down and bring domestic rates up to replace lost revenues. Lowering artificially high rates, in Brevnov's view, would rein in the barter payment system and allow for better bookkeeping and a more realistic pricing system. Regional utilities, however, did not want to lose their captive customers, while local governors opposed the imposition of higher rates on their citizens.

The conflict culminated in a showdown in January 1998. The board of directors fired Brevnov and restored Dyakov as acting CEO. The state refused to allow its wishes to be flouted, voided the board's decision, and locked Dyakov out of his office. Dyakov contended that Brevnov was a dilettante who lacked the old guard's involvement in the electricity sector. Finally, in April, Brevnov resigned as CEO and Dyakov was forced out as chairman, to be replaced by Viktor Kudryavy. The economist-reformer Chubais, who had recently been removed as deputy prime minister, was eventually chosen to be the new CEO. Critics pointed out that the whole fiasco did little to improve the company's image in the eyes of investors.

More than one urgent problem faced the new manager. Consumer debt increased from Ru 79 trillion to Ru 102 trillion in 1997, despite a reported pretax profit of Ru 30.9 million. Capital investment also decreased slightly from the previous year. Meanwhile, Russia's harsh climate made the question of power supply particularly urgent. Power outages plagued residents every winter, especially in the Far East. Agreements with Gazprom and LUKOIL managed to make fuel reserves 22 percent higher before the 1997-98 winter than the previous year, but the agreements were never substantial enough to avoid an annual winter-preparations crisis. In response, Chubais issued an August 1999 ultimatum that gas and oil companies must supply needed fuel to UES regardless of payment, or face higher export duties. Higher duties were eventually imposed by the state, bringing in extra revenue that was earmarked to help UES buy fuel.

Chubais shared many of his predecessor's views on long-term reform, including the desire to reduce the cost of energy for industry while raising charges to domestic consumers. The position won him the enmity of regional political leaders. Some federal government insiders also disliked certain aspects of his reform-minded independence. Assailed from many sides, Chubais nevertheless strengthened his position at the June 1999 annual meeting. The company charter was altered so that a 75 percent vote was required to remove him from his post. There was, however, a check to Chubais's power: Presidential Chief of Staff Alexander Voloshin took on duties as chairman of the board, so that the Kremlin could block any particularly objectionable actions.

The Debate Over Restructuring: 1999-2001

With stable leadership at the head of UES, the pieces were in place for the final debate over what form restructuring would take. A driving force in the push for reform was the drastic need for capital investment in the electricity infrastructure. It was estimated that UES could provide only a quarter of the needed funds. Chubais looked abroad for support, requesting that a 25 percent cap on foreign investment in the company be removed. The limit had blocked foreign investment for several years, since foreigners already held 33 percent of UES at the time the limit was imposed. At the same time, a superficial rule change would not be enough to bring in the needed funds. Foreigners were unlikely to pour money into UES until it was restructured to allow for competition and profitability.

To that end, in December 1999 the board charged Chubais with creating a draft for restructuring by March 2000. Chubais made it clear that he wanted to break up the state monopoly and separate production of electricity from transmission at both the local and federal level. Critics, prominent among them Fuel and Power Minister Viktor Kalyuzhny, contended that such a move would strip UES of all but the transmission grid and put power plants in the hands of foreign investors. Nevertheless, Chubais's plan received initial approval from the board of directors, acting as an arm of the Kremlin, in April 2000. As shareholders worried that they would soon be left with the shell of a company, UES stock fell during the course of an 18-month debate over restructuring.

At the same time, UES had to face the usual problems of consumer debt and fuel shortages. The state took a strong hand in combating these issues. In August President Vladimir Putin threatened Gazprom with personnel changes if the gas company did not comply with UES's fuel requirements. Gazprom agreed to negotiate fuel deliveries quarterly, even though the company would rather supply gas to foreign companies with cash to pay for it. In an effort to address nonpayment, the state set new rules declaring that all legal entities must pay for fuel in advance. Manufacturers were wasting fuel, according to the administration, because they did not have to pay a realistic price for it.

UES announced in November that regional utilities had 85 to 90 percent of the coal and fuel oil needed for the 2000-2001 winter. Stocks in the Far East, however, were much smaller. Resultant power outages in the area served by the Dalenergo utility were so severe that not only industry, but apartment houses, hospitals, and kindergartens were affected. Residents of Vladivostok blocked the major highways of the city, demanding the resignation of the governor and the management of Dalenergo. Chubais, quoted by the ITAR/TASS news agency, blamed the dire situation on the "craziness, stupidity and narrow-mindedness of local bosses." He sent a commission to the area, which arranged for delivery of coal sufficient to reduce blackouts to a few hours a day.

The debate over restructuring also took a more combative turn that winter. Presidential advisors began to criticize Chubais's plan, saying it would leave the state with no control over electricity and the shareholders with no company. Regional governors, longtime opponents of Chubais's policies, appealed to Putin, who established a commission headed by Tomsk Province Governor Viktor Kress to formulate an alternative plan for restructuring. Kress supported vertically integrated regional companies, as opposed to Chubais's plan for separation of production and transmission.

Chubais also drew criticism for several initiatives that stretched UES's sphere of operations. In an attempt to capitalize on opportunities for profit, he supported the formation of a Russian-Kazakh-American coal and electricity company, UralTEK, in the Ural Mountains area, and also pushed for the creation of a combined company that would bring together an aluminum plant and a hydroelectric station in Sayan. Another source of hard cash was electricity exports, which could take advantage of the fact that UES's rates were lower than the European average. In February 2001 Chubais signed an agreement with Ukrainian Fuel and Energy Minister Sergei Yermilov, establishing the ground rules for bringing the energy grids of the two countries into a parallel system. The two grids were connected in late 2001.

Assailed from many sides, Chubais nevertheless managed to retain his position at the April 2001 shareholders meeting. However, he lost a measure of authority to the board of directors, two-thirds of whom were state representatives. In a repeal of a rule passed two years earlier, it was determined that only a simple majority, rather than a 75 percent vote, was required to remove the CEO. The board of directors gained more decision-making power in financial matters, and Chubais was required to present management's plans to the board every quarter.

In May a compromise restructuring plan was finally approved. It provided that UES would spin off two wholly owned subsidiaries, a federal grid company and a central dispatching system. Regional plants would remain vertically integrated but would spin off their transmission networks into separate subsidiaries. By 2006, UES was to be dissolved completely, replaced by the federal grid company and a separate holding company to manage the state's shares in regional power companies. The state would supervise most aspects of the reform process.

Although the agreed-upon plan did not accomplish Chubais's hoped-for liquidation of assets, he nevertheless welcomed it as a common sense approach. Chubais's chief opponent, economics advisor Andrei Illarionov, also gave his stamp of approval to the plan. Analysts predicted that the general accord would win back the confidence of investors. Chubais expressed a desire to continue as executive and lead UES through the reform process.

Principal Subsidiaries: 72 regional joint stock power companies ("energos"), including OAO Tyumenenergo; OAO Orenburgenergo; OAO Mosenergo (51%); OAO Kirovenergo (64%); OAO Permenergo (64%); OAO Saratovenergo (64%); OAO Dalenergo (49%); OAO Pskovenergo (49%); OAO Astrkhanenergo (49%); 36 power stations, including OAO Ryazan FFPS; OAO Kama HPS; OAO Krasnoyarsk FFPS 2; OAO Volga Hydro Power Station (86%); OAO V.I. Lenin Hydro Power Station (87%); OAO Pechora FFPS (51%); OAO Pskov FFPS (50%); one dispatching company, OAO Central Dispatch Department of the Unified Energy System of the Russian Federation; 57 research and development institutes; 73 power industry construction and maintenance companies.

Principal Competitors: OAO Gazprom; OAO Lukoil; Electricité de France.

Chronology

• Key Dates:
• 1920: GOELRO presents plan for electrification of Russia.
• 1956: Transmission line connects Volga power plant to Moscow.
• 1992: Unified Energy System of Russia (UES) is privatized by presidential decree.
• 1995: Consumer nonpayments cause arrears to soar.
• 1998: Anatoly Chubais becomes CEO.
• 2001: Plan is adopted for restructuring of UES.