with Elena Kolocok, General Director, Strategic Energy Development Fund Foresight
Ms. Kolocok and Mr. Abramov, you have both been analyzing the five year results of the reforms of the Russian power sector, in which you stated that the current situation is suboptimal. Even more so, it was said that investors are leaving the industry today. What exactly went wrong?
The key issue is that after 10 years of reform we do not have a true market for power but a system that one would refer to as ‘manual control’ of the industry. While nominally the market is almost 100% liberalized around 70% of revenues are actually regulated in one way or another like price caps or special tariffs for generators. The activity of the regulator not just hearts returns for investors who paid up to $800 per kW of installed capacity but distorts market signals. For instance recently the Federal Anti-Monopoly Service proposed a methodology for checking generator’s market bids. If followed this methodology will distort power plant merit order – around 1 bn of natural gas and 0,2 mn tons of heating oil will be wasted p.a.
Attempts to control wholesale prices however did not prevent retail prices growth rates to exceed government targets. While introducing controls in the liberalized market it allowed regulated grid tariffs to more than double. Energy intensive industrials began to actively build their own power sources as they now pay more per KWh than their foreign competitors.
As private investors are leaving state ownership in generation may exceed 85% in 2 years (up from 75%) – several new acquisitions are currently rumored. There are pockets of opportunities however – retail power prices are high and we see opportunities in retail and in the heat market that start attracting private capital.
How are the current investments in the sector justifiable then?
That’s a good question. Investments and modernization are in fact two big problems. But not in the sense you would expect – it’s too much investments this time.
In one of our projects we found that up to 85% of the investment of a gridco could be avoided. We build excess generating capacity. Why does this happen?
The regulator has set special mechanisms for guaranteeing capital return for power plants and RAB regulation for grid. But it’s not the investor who really makes decisions on what to build but the regulator (somewhat similar to renewables in Europe). This approach worked in the 30th during industrialization, maybe for China during double digit growth but not in modern Russia.
And this is being done with no clear strategy in mind. The “modernization of the power sector till 2020” program calls for around $300 Bn investments in 8 years. The NASA moon program cost was around 150 bn in today’s dollars. What does the sector plan to achieve for twice the cost of getting to the moon? No clear goals.
No regulator has resources to do investment planning for the whole industry especially with no strategy. So we have now billions of dollars to invest – but that is dumb money and dumb money makes smart people make dumb decisions.
The new Ministry of Energy is determined to change this situation. If it fails power prices will reach levels at which the centralized grid will lose its market share to distributed generation and other new technologies resulting in true competition and modernization.