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Inter RAO rises from the ashes of UES

Russia's electricity-trading monopoly is making inroads into the power generation sector, raising doubts about the government's pledge to privatise the industry, writes Isabel Gorst

INTER RAO plans to spend $5.5bn on foreign acquisitions, turning itself into a national electricity champion. The company was founded as a subsidiary of Unified Energy Systems (UES), Russia's former electricity monopoly, to handle imports and exports, and oversee Russian-controlled power plants in the Commonwealth of Independent states (CIS). After UES was dismantled, in July 2008, Inter RAO came under the control of the state-owned nuclear power company, Rosatom, and over the past year, despite a sharp downturn in electricity prices caused by the economic crisis, it has developed an ambitious expansion strategy – investing in Russian power plants and seeking electricity assets abroad.

Inter RAO officials told June's annual shareholders meeting that the company had $5.5bn to finance foreign acquisitions and would transform itself into a national electricity champion. Igor Sechin, Russia's deputy prime minister and Inter RAO's chairman, mentioned Latin America, the Middle East and southern Europe as possible targets for acquisitions. "Inter RAO will continue its dynamic development and become a national company," he said.

Analysts interpreted Sechin's January appointment as a sign that the state plans to expand its presence in the electricity industry. Sechin, a close ally of prime minister Vladimir Putin, is known as Russia's energy tsar. As chairman of state-controlled oil firm Rosneft, he has overseen its transformation into a national champion.

In 2003, when the government devised its plan to break up UES into six separate power groups it said it would transfer the Russian power generation business to private ownership and surrender its monopoly over international electricity trade. Packets of shares in the new companies were offered at auctions and the remainder were floated on the Russian stock exchange. For market reformers, power-sector restructuring was a welcome contrast to the Kremlin's nationalisation of large parts of the oil and gas industry, and the limitations placed on foreign investment in strategic sectors.

Russian and foreign investors leapt at the opportunity to participate in one of the world's fastest-growing electricity markets. The government, meanwhile, said it would steadily deregulate heavily subsidised electricity prices. At the time, international capital was in plentiful supply and Russian natural-resources firms were earning windfall export revenues as world oil and commodity prices soared. The power plant auctions raised $40bn and committed winning bidders to invest large sums in new power plants to prevent electricity shortages.

Plunged into recession

But the global financial crisis has changed the investment landscape, plunging Russia into its first economic recession in almost 10 years and driving down domestic energy demand. Before the crisis, UES said Russian electricity consumption, an indicator of economic health, would rise by 4-5% a year until 2012. Instead, demand has fallen by about 9% in the past year, as the energy-intensive steel and car-manufacturing industries idled plants.

"We invested in a different country," says Mikhail Slobodin, president of Integrated Energy Systems, an investment company. "The market model was created for growth."

Meanwhile, non-payment, a problem UES almost eradicated by refusing to supply indebted electricity customers, is creeping back, particularly in poor areas of Russia, where the government will hesitate to sanction supply cuts. Sechin claimed the Russian electricity industry was generally coping with the economic downturn, but urged power-plant owners to continue with their investment programmes. "Crises come and crises go, but we have to work every day," he said.

But high borrowing costs have forced many investors to rethink projects that were supposed to add about 6.4 gigawatts (GW) to Russia's generating capacity by 2010. An 18% depreciation of the Russian rouble against the dollar since the onset of the economic crisis has increased the cost of imported equipment, adding to the difficulties in financing projects. Italian energy company Enel, which invested $4bn last year to gain control of OGK-5, one of the six companies spun off from UES, said it could not forecast future investments unless the government introduced regulations guaranteeing profitability.

The European Bank for Reconstruction and Development (EBRD), which has invested €1.3bn ($1.8bn) in 11 Russian power projects since 2001, remains committed to the sector. The bank, which this year lent OGK-5 €120m to help fund the installation of energy-efficient equipment, expects to disburse at least two more loans to the industry this year. "Even if electricity demand is down, sooner or later it will go up," says Riccardo Puliti, the EBRD director in charge of energy and natural resources. "The government must ensure investments go ahead, but it must also be flexible and allow [electricity] companies to be sustainable," he says, adding that he hopes "common sense" will prevail.

There is a risk that if the recession drags on, electricity-privatisation deals could begin to unravel, which would likely trigger acrimonious disputes. Last year, Russian energy company Sintez filed a lawsuit against RWE for $1.41bn in damages after the German firm pulled out of a plan to invest in TGK-2, the biggest heat and power generation company in northwestern Russia.

Derek Weaving, an electricity analyst at Renaissance Capital, says large European utilities – including Enel, E.On and Finland's Fortum – that have bought Russian power plants understand that the power sector is a long-term business and will probably stay the course. But privately held Russian natural resources companies are struggling to service large debts and might rethink their electricity strategies.

Although it is unlikely that the government will try to reverse electricity privatisations altogether, there is a risk that the greater involvement of state-controlled companies will place the private sector at a competitive disadvantage – they can take advantage of their privileged access to government funds to buy low-priced assets.

Meanwhile, Yevgeny Dod, chief executive of Inter RAO, said the company was not "fixated" on its target to increase capacity to 30 GW and could grow by three times that amount. Inter RAO took over management rights at OGK-1 from state-owned RusHydro last month. This may presage a full take-over attempt. The company now controls 14 GW of generating capacity in Russia – about 6% of the national total.

Inter RAO recently joined a $1bn investment pool with VTB, the Russian state-owned bank, and Kuwait's Alghanim & Sons to invest in electricity projects in Russia, the CIS and Arab countries. It is also bidding in partnership with Rosatom for a contract to build a nuclear power plant in Turkey (PE 5/09 p31).

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