with Mikhail Andronov, President, RUSENERGOSBYT
The electricity market in Russia has undergone severe changes in recent years. Today, a number of ongoing issues –such as price formation, transparency and cross-subsidies– have been identified. How optimistic are you about the current shape of the market in Russia and where do you see need for change?
One can distinguish the Russian energy market in two parts: the wholesale and the retail market. When the entire Russian economy was reformed roughly ten years ago, Soviet law was still dictating the Russian energy market. Today, the wholesale market has been liberalized and several assets are now owned by private companies –both domestic and foreign. We now have an exchange –the ATS– as well as the non-commercial partnership (NP) Market Council that acts as a regulatory body.
It is very important to have a regulatory body in place where representatives of the Ministry of Energy, the Federal Tariff Service, the Anti-Monopoly Service, generation companies, supply companies and customers can be present. Through elaborate discussions, they play an important role in finding points of equilibrium between their often contradicting conflicts of interest.
In the retail market, however, the governing rules are still those of the Soviet regime. Liberalizing this part of the energy industry is the last task to be completed. One could ask why this liberalization has come this late and find answers in a few of the aforementioned ‘ongoing issues.’
One such aspect is that of cross-subsidizing. In Russia, the low incomes of our domestic clients often do not allow for economically reasonable pricing. While cross-subsidizing is therefore more than necessary, the current system we have in place is unfair. A pensioner with a small flat needs extra money from the government to pay his electricity bill. But the fact that these subsidies remain linked to the amount of kilowatts per hour used unfortunately also implies that a wealthier person –with a larger home and greater electricity usage– will receive more subsidies.
Russia needs a so-called ‘social norm of consumption,’ where usage is subsidized up to a certain amount. Any additional usage then comes at a normal commercial tariff. The discussions to implement such system are now ongoing. For example, the government could start reinforcing agreements between regional guaranteeing suppliers and local pension funds, for them to provide the supplier with information on pensioners in the regions which can then be used to achieve more favorable tariff formation.
A second ongoing issue relates to insolvency on the customer side. As in any country, Russia has its problems with bad payers. There are a few ways to address this problem however, such as smart metering systems. Smart metering allows for better control of consumption as well as the possibility to limit consumption if customers do not pay in time. If needed, systems can be switched on and off remotely without the need for any additional employees. Our partner and shareholder Enel has vast experience in this area. In its domestic market in Italy, Enel’s investments into smart metering systems have seen a return on investment of four years.
Smart metering goes beyond payment support alone and can also help to identify consumption patterns and needs in Russia. As we move from a Soviet system towards a modern market system, we as a retailer see the increasing need to know and understand the real needs of the Russian customers. The idea is that in the long-run, under the final retail market model, the customer should be free to choose between suppliers and tariffs.
The third problem in Russia is that –historically– our country has been able to reap the benefits of low electricity prices. This story is over now. This year for example, our prices were already higher than those in the USA. If they continue to grow at the 10 to 15 percent rates from previous years they will also exceed those in Europe soon. It is a trend that questions the future competitiveness of Russia in the world market and has led to the so-called new era of energy efficiency.
How does this era of energy efficiency affect retailers in this market? Do you need to change your business model to accommodate this drive towards efficiency which –effectively– implies a reduction in your volumes and turnover?
Energy supply companies do not always have the best reputation. Everyone knows the role of generation companies, transportation companies, and so forth, but many do not see the relevance of the retailer. For them, we are trading entities that merely buy and sell electricity. What is the value and role of electricity retailers worldwide?
The wholesale electricity market carries an inherent risk, as there is no certitude about the expected levels of consumption on the consumer side. The task of supply companies therefore exists in reducing this risk and ensuring timely and reliable deliveries. Understanding such data requires complex models of forecasting, which customers prefer to have done by companies such as ours. At present, the risk in the Russian retail market is still reasonable. And even though our markets are now largely liberalized, we continue to have mechanisms in place to control our electricity tariffs.
However, without risk it is impossible to develop an effective system and develop the energy industry in Russia. In the future we therefore need to open the market for risk while maintain a certain level of government control. This gives clients the opportunity to work on long-term contracts and receive more beneficial payment conditions. Such market carries both risk and opportunity, and would inherently become more open.
I have to say that I am rather optimistic about the future of retail companies in Russia. Certainly, our model will need to change from a ‘billing and money-collecting entity’ to a ‘risk controlling, customer-oriented trading company.’ This switch will not be easy, but I do believe we are ready to embark on this journey.
In the case of Rusenergosbyt, we have the advantage of being supported by two strong shareholders: The privately-owned Russian ESN Group and the globally active Italian company Enel. Enel Traders has roughly 200 million clients and was ranked as one of the top three traders in Europe last year. In our view, we should now make that last step towards a real open market in Russia. The energy industry will require a lot of investment and we need to ensure that this can happen in an efficient manner.
Rusenergosbyt, in turn, has been a company that grown in this changing market for the past ten years. How would you describe the company’s positioning today?
We now operate in more than 50 regions of the Russian Federation and are pleased to be celebrating the company’s tenth birthday in December 2012. Today, we have clients and regional representatives in each main industrial region of the country. Our biggest client is the Russian Railways, but we also work with large companies such as Lukoil, Gazpromneft, Sibur, GAZ Group and Severstal for instance. While we have mainly focused on these large accounts during our first years, we are now increasingly looking at serving mid-sized clients –such as Magnit Retail Chain– as well. Today, we already have more than 250,000 clients.
In the case of Magnit, electricity consumption for each superstore or hypermarket is not that significant, but the anticipated growth path of the company is particularly strong. This provides us with some promising prospects too. As we have access to the power network at a federal level, we are quite uniquely positioned to service such companies as they expand throughout the Russian territory.
You seem to be well aware of your customers’ expansion plans. Is this something you study for every customer?
We are more than happy to take on any client on board and our door is always open. Naturally, it is preferable to service customers that showcase strong growth prospects. The better we understand how much electricity our customers will likely need in the future, the more cards we can bring to the table in our discussion and negotiation with the generation companies. An example as such is discounts on future connections to the network.
A client such as GAZ Group for example, is part of the empire of Mr. Oleg Deripaska, which also has its own energy supply company. Nonetheless, this customer remains very cost-minded and organizes open tenders. As soon as we can offer better price conditions, we are able to win the tendering process. More and more customers start to understand that ‘in order to have shoes, they should not necessarily become shoemakers. It can in fact be cheaper for them to buy the shoes in a store instead.
We have seen a similar evolution in the electricity market in Russia, where several customers were trying to set up their own energy supply companies ten years ago. At an initial stage –when the price was still unpredictable and margins sometimes unreasonable– this still made good business sense. Today, however, as the market has clearer rules and as open tenders are frequently organized; it can easily be cheaper and more transparent to sign contracts with a professional entity. Our customers have now also grown up and have come to understand this model. Rusenergosbyt has a BB- financial rating from Fitch and is backed up by transparent shareholders.
You mentioned large customers in the early years of the company story. Surely, a young company can be grateful to work with large entities such as Russian Railways, but what gave Rusenergosbyt the edge to do so?
The underlying idea and argument has always been the drive towards saving money for our customers. When we first started, nearly all of this customer’s electricity was being supplied by a regional guaranteeing supplier. We soon understood that we could supply energy cheaper and supported our statements with a detailed economic analysis. This was not an easy process, as the nature of their electricity consumption is very hard to predict and forecast. Their consumptions constantly changes, for instance as the trains move or as the temperature changes. To support such complex forecasting models we do not only use mathematical but also statistical methods. Using historical data, we work with probabilities to increase the accuracy of our calculations.
Has this been the most complex contract to date?
Our energy story began with Kolenergo –the energy system of the Murman region– which was managed by the ESN Group and consisted of various heat, coal, fuel and hydro plants, as well as grid and transportation systems. ESN Group rescued this company from bankruptcy and reformed its structure severely.
Later on –in 2006– Enel also came on board, which was the result of a joint-venture to build an energy block for a power and heat plant in St. Petersburg together, with the first-time installation of a Siemens turbine. This was the first case of cooperation between a Russian and foreign company and highly important for both Rusenergosbyt and Enel. Following this project, we suggested Enel to take an interest in the retail market, upon which they acquired 49.5 percent of Rusenergosbyt.
You mentioned before that Enel has some great technical experience too, in the area of smart metering for instance. Beyond the knowledge exchange, did this transaction also imply greater financial stability for Rusenergosbyt?
This was definitely the case. For our clients owned by foreign corporations, it has been particularly important to see the support of one of Europe’s biggest energy producers. Beyond expertise, people and experience, Enel also brings its corporate culture to the table. As Enel is a public company, we are for instance being encouraged to engage in more transparent and timely bookkeeping.
Rusenergosbyt’s historical revenue growth shows a convex shape. While growth rates were very high the first years, 2011 resulted in a more moderate increase of 8 percent. What growth rates do you deem realistic for the company’s future and how do you also see the company expanding geographically?
A first priority is to pay increasing attention to mid-sized customers. As soon as the market will be liberalized for small customers, we will also move in there too. For this reason, we are increasingly establishing ourselves in the different regions of the Russian Federation.
It is worth noting that –in line with our strategy– in 2012 the main growth in revenues was achieved by our regional representatives, rather than our head office in Moscow. To be successful in this market, it is essential to be local.
In this regard, how do you see Rusenergosbyt in 2017, when you can celebrate the company’s 15th anniversary?
We will see a more mature market where customers can receive a wider range of services from energy supply companies. I foresee many financial instruments including futures, forwards, and an exchange that will allow market participants to hedge risk.
Russia has vast experience in the energy industry which serves the entire Russian economy. In the future, we will see an industry that becomes much more