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Interview

with Yuri Lipatov, Chairman, State Duma Committee for Energy

30.06.2009 / Energyboardroom

The Ministry of Energy and Ministry of Economic Development play an important role on the Russian energy strategy. What is the part of the Duma’s Energy Committee different from theirs?

I would like to start with a bit of history. This is my third term in the State Duma; I was elected for the first time in December 1999, when the Committee was called Committee for Energy, Transport and Communication. I was deputy Chairman of the Committee and it was then that I was destined to prepare and pass one of the most notorious laws in post-Soviet times – the law “On reforming the electric power sector”. I say notorious because energy is the basic sector for the development of any country. When it came to reforming it in Russia through partial privatization and, allegedly, dismantling of the entire state power company, it was regarded as negative development: “They’re destroying the power system, so they must be destroying the country”, as the opponents of the reform were saying.

As for the Committee, it has accomplished its mission over the last eight years. The basic laws for the power sector have been approved although it may sound paradoxical: as early as 1922, Lenin announced the GOELRO (State Commission for Electrification of Russia – Translator’s Note) plan which paved the way for the largest and most interesting power system in the world, with synchronized functioning in 6 time zones. Nevertheless, the sector had no legislation. Its operation was coordinated through State Decrees and the first legal basis appeared as late as 2003. Over the eight years that followed, the Committee approved the laws “On communication”, “On railway transport” and a few other laws that regulate the work of other sectors.

The fuel and energy complex of Russia is the vital force of the country and relates directly to the strategic task of selling hydrocarbons to neighboring countries, and receiving foreign currency influx in return. Back in 2005-2006 we begаn discussing the necessary restructuring of the Ministry of Industry and Energy, as the functions of industry and energy should be separated. Correspondingly, the relations of legislation and state power had to change as well. When the fifth State Duma was elected in December 2007, a new energy committee and transport committee were formed. After the last presidential elections, when the new Government was formed, the Ministry of Industry and Energy was divided, as a solution to organize cooperation between the Ministry of Energy and the Energy Committee.

Strategically, the main task of the Committee is to provide a modern legal basis for the efficient work of the whole fuel and energy sector; I mean the coal, oil and gas sector, and, of course, the most important component – electricity as a derivative of oil, gas and coal. 70% of power generating plants is thermal, powered with coal, gas and fuel oil. Therefore we try to analyze the current problems of the sector and organize meetings where our Committee considers not only legislative but also technical and economic issues, to have an understanding of the current imperfections in the legislation. Main documents are formed through sublaws. But the interests of the different related Ministries are intertwined and it should be taken into account in the legislation. This requires thorough legal preparation and, unfortunately, it can delay the process of approval. In such cases we try to support the process so that the sublaws are passed directly by the Government. There are no conflicts between the parties as it is my personal believe that any task can be solved peacefully depending on how you assert yourself in a certain situation. I always try and find common ground with all the representatives of the Ministries and other authorities.

What legislative issues still need to be resolved as a priority following the radical reform of the electricity sector? Where is the potential to develop the legislation?

Firstly, a law is not a dogma. I treat any law as a living organism. Any law lives its life, and life poses ever-changing tasks, and one’s viewpoint also changes.

The reform of the electric power sector is the best example of improving legislation; the whole sector was divided according to the provisions of the law: power generation was privatized; nuclear energy was partly privatized, while hydro energy remained more than 50% state-owned; Duma’s Deputies insisted that nuclear and hydro energy remain state-owned due to their potential dangerousness. Thermal power generation is mainly privatized and natural monopolies – the System Operator, Federal Grid Company and Interregional Grid Company are state–owned.

The main philosophy of the reform WAS that the energy tariffs used to be fixed over the whole territory of the former USSR for private and industrial consumers. But, in the last decade of the 20th century, when the first joint stock companies appeared, each regional power system was self-financed and it turned out that tariffs were different in each single region. People were against it because it violated their constitutional rights. Due to the decline of production and the economic problems, both industry and people were sustained by virtually two monopolies – RAO UES of Russia and Gazprom. It was less difficult for Gazprom to survive and thrive as gas is a commodity that is sold for a price, but the electric power sector was financially depleted. When Anatoly Chubais came to head RAO UES of Russia, the situation was catastrophic: no money and almost no investments over 10 years, outdated facilities and networks.

So, the first liberalization of the power market was driven by the need for investments rather than a philosophic idea…

Of course, it was a financial idea in the first place. It was clear that there is no future without power generation, and the issue that Chubais had to deal with was: how to handle the sector without money? And so the decision to liberalize the electric power sector was made. Had anyone before him done anything similar in history? He, who came from the Government to head the power system, realized that no one was paying for electricity, and decided to cut the power supply off from the strategic military sites. It was a scandal but in this way it became clear that a solution was necessary to ensure that money was paid for the consumed power. The law was drafted based on the experience that the ‘couriers’ of RAO UES were gathering and analyzing all over the world, in Latin America as well. Approaches differ in all countries, and the current Russian power legislation is the symbiosis of the best practices in the world.

Symbiosis is not always good, especially in the case of Russia…

We’ve tried to make a ‘best of”. We were so willing to grasp the philosophy of the process, as our main task was to draw assets for construction of new power generation facilities. In October 2005 all the thermal power plants and state district power stations were regrouped to form TGKs (territorial power generation companies – Translator’s Note) and OGKs (wholesale power generation companies – Translator’s Note). Each OGK was created with a set of assets from different parts of the country so that each OGK would be equal in terms of its capacity and power generation, to create fair competition between them. After that, these companies were put on sale and attracted foreign investors such as Enel, Fortune, E.On. It is important to note that the investors were buying these companies with encumbrance: it was clearly stated that the new owners were to construct new power generation facilities on certain territories in the framework of the General scheme of allocating power generation facilities till 2020, approved by the Government in February 2008.

Does it look like many investors are unable to fulfill their commitments?

We are coming to the heart of the matter In order to invest in construction of new generation sites, the owner needs to understand if it will be possible to return the investments and over what term. Does the double-rated tariff solve this problem?

The capacity market was introduced in Russia on July 1, 2008, and it follows this principle: all the generated capacity should be paid, including non-consumed capacity. Total power output should cover the maximum possible consumption that is called peak consumption. Peak consumption occurs in emergency situations such as daily peak loads and monthly peak loads. For example, the monthly peak in Russia occurs in winter: in 2009, it occurred on January 8. A power plant needs to be constantly on stand-by in order to produce the peak capacity over one day during the whole year, and that requires fuel to burn and there are subsequent losses, and the plant needs to get paid for the electricity generated to be able to compensate for those losses, but, where is this financial compensation taken from on the market? The entire capacity is formally divided in wholesale market prices of kilowatt-hour and capacity prices.

The matter is that the capacity market was adapted for constant economic progress and an increase of consumption. But we know that consumption fell drastically in the end of 2008 and in the first quarter of 2009, especially at energy-consuming enterprises. Capacity suppliers began to compensate for the lack of capacity consumption at the expense of private consumers and increased the tariffs in many regions. That is why the Government is now developing a set of measures to return to fair pricing.

Can the market correct the situation itself?

The legislation is needed to define the rules of the game. We are currently developing sublaws and we are quite confident that we will solve the situation. Personally, I don’t think that further market liberalization is dangerous. The Government should fix the legislation. There are some offers to postpone liberalization for a couple of years but my opinion is that it is not reasonable: we will lose the tempo and we have no right to make the investors suspect that the reform would be suspended, with all its consequences. I would like to remind you that from July 1, 2009 the share of energy traded on the basis of a free and non-regulated price is to be increased to 50%, and it will reach 100% on January 1, 2011, according to the law, with one exception: the law covers all enterprises and organizations except private consumers who will continue to pay on a tariff basis. But private consumers represent only 11-13% out of the total energy consumption.

The major industrial companies won’t be very happy with that, as one of their competitive advantages is cheap energy…

I used to be the director of an electrical engineering plant, and I assure you that the percentage of energy price in the production costs of the machine-building sector is far from essential. I’ve had many occasions to speak in public in front of my former colleagues, and they did not manage to prove that energy prices are suffocating them. Each product has a price. Here we can remember a good universal saying: those who don’t feed their army feed the enemy’s army. Those who do not want to realize that power generation is a very special industry that conditions further development of the state – a flourishing state or a dying state –will live in a dying state.

Legislation can help route companies in the path towards being more competitive even with higher electricity prices…

The State Duma is drafting the law “On energy efficiency”. It states the responsibility for energy efficiency of buildings and constructions, and defines the standards of power consumption. It follows the idea that there will be certain preferences for efficient power consumers; those who want to engage in power efficiency will get state support and all others will be forced to. A system of incentives has been developed for that.

Energy efficiency takes a lot of investment…

Not as much as you think!

Mr. Lipatov, as you know, ours is an international audience. As Russia and its power system is still in the midst of transition, should we be concerned about the outcome for companies once the sector’s liberalization is over?

We hope that the philosophy of the law will, at the end of the day, form competitive pricing, which in turn will allow reducing costs and introducing lower prices. On the one hand, everything should support the development of power generation and the investor should have a clear picture of when he gets his ROI. Contracts with fixed terms of ROI will be made with some investors. A state Decree is to be published around July 1, 2009 with all the corresponding conditions that regulate the relations of the state and the energy sector. This document is being developed in the Market Council for it to be mutually acceptable for all parties.

We, as state representatives, should use our power to ensure smooth improving of the legislative machine in case of problems. Once again, I emphasize that we are here to make the market work as clearly and naturally as possible. This is the art of human thought!

Thank you, Mr. Lipatov, for sharing your thoughts with us!

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