Railway and Electricity Restructuring in Russia: On the Road to … Where?

1. Railway and Electricity Restructuring in Russia:On the Road to … Where? Russell Pittman Antitrust Division, U.S. Department of Justice, and New Economic School, Moscow SEVENTH ANNUAL CONFERENCE OF THE CYCLE “LEONTIEF READINGS”: Economic Theory and History 1st Section Session: “Economic reforms: ideas and results. Are the Natural Monopolies Reformed?” Leontief Centre, St. Petersburg, 5-6 October 2007 The views expressed are not those of the U.S. Department of Justice.

2. Background: Breaking Up Bell • U.S. telecoms sector in 1950s and 1960s: Third Party Access • U.S. v. AT&T: TPA not effective; replace with Vertical Separation

3. Similar issues in all infrastructure sectors • “Grid” may remain a “natural monopoly”, but “upstream” supply may be potentially competitive. • Telecoms: “local loop” vs. “value added services”: long distance, mobile, internet • Electricity: transmission/distribution vs. generation • Natural gas: pipelines vs. exploration/production • Railways: track vs. trains • Water: pipelines vs. production/purification

4. Primary policy issue: TPA vs. VS • Third Party Access • Advantage: Maintain economies of vertical integration, don’t break up going concern • Disadvantage: Incentives to discriminate against non-integrated competitors • Vertical Separation • Advantage: No incentive to discriminate • Disadvantage: Lose economies of vertical integration, break up going concern

5. Another important policy issue: Are the gains from restructuring worth the costs? • Economies of scale “upstream”: two monopolies instead of one? • New challenges for (new) regulators • Access pricing: too many targets for one instrument? • Incentives for investment in the grid

6. Are there alternatives? Sure. • Competition among vertically integrated “regional monopolists” • Mexican railways • Tsarist railways • Vertically integrated monopolists with government regulation: Back to the future?

7. Mexican railways

8. Tsarist railways

9. JSC Russian Railways • Current structure: TPA, but where are the TPs? • No legislation for permits (until recently) • “Common carrier” requirement – unique • Very high access charges – also unique • Regulatory reform and the “daughter companies” • Transcontainer • Refservice • Russkaya Troika • New Cargo Company • Future: timber and lumber, autos?

10. JSC Russian Railways (continued) • Long-term goal: Vertical separation? • G.O. Gref, I. Levitin, I.Y. Artemyev: The only way • V.I. Yakunin: Never • A. Belova: Did we say “competition”? We meant “competitiveness”. • Alternatives? Government’s reform plan included consideration of Mexican-style plan.

11. Restructuring option maintaining vertical integration

12. Looking Forward • Where do we stand? • Strong, vertically integrated monopolist • Weak regulators will try to protect entrants from discrimination • Growing, but weak, intermodal competition • Looks like monopoly power • V.I. Yakunin: “During the third reform stage, which we have just entered, we would like to have all the necessary legal, economic and technological conditions in place in order to assure competitiveness. And after that we will evaluate and make a decision regarding the possible emergence of alternative railway carriers to OAO RZD.”

13. Unified Energy System of Russia • Current structure: in the process of Vertical Separation • The plan: • 6 interregional gencos (OGKs) and 14 territorial gencos (TGKs) • Separate nuclear and hydro gencos • Separate Federal Grid Company, regional distribution companies • Wholesale prices gradually liberalized; goal of 100% by 2011

14. But will the liberalized wholesale markets be “competitive”? • Special features of electricity sector • Inelastic demand (poor price signals) • Inelastic supply as capacity utilization rises • Baseload vs. peakload technologies • Non-storability of product • Thus: system vulnerable to manipulation • California experience: market structure that looks “competitive” may not be • Ceilings on wholesale market share: CA vs. RU

15. Liberalized wholesale markets: continued • Additional special features of Russian electricity sector • Limited inter-regional transmission capacities • Subsidized coal transport – unlikely to survive RZhD tariff liberalization • Winter peak • Importance of CHP plants • International Energy Agency, Russian Electricity Reform: Emerging Challenges and Opportunities

16. Russian “dispatching areas”

17. Limited inter-regional transmission capacities

18. Example: Volga region

21. Ultimately: Contradictions • Need for massive resources for investments in generation, distribution • Plan to rely on private sector • But reluctance to allow prices to increase • P.К. Katyshev (CEMI RAS), Е.Yu. Maruhkevich (NES), S.Ya. Chernavsky (CEMI RAS), О.А. Eismont (NES),“Influence of Natural Monopolies’ Tariffs on Russian Economy”, HSE conference April 2007 • Alexander Abolmasov and Denis Kolodin, “Market Power and Power Markets: Structural Problems of Russian Wholesale Electricity Market”, EERC 2002 • V. Khristenko: Wholesale prices completely deregulated by 2011, but retail prices regulated “for at least 10 more years”

22. Contradictions (continued) • All of this INDEPENDENT of concerns about monopoly power in generation • A. Chubais: “I have ambivalent feelings about this. As CEO of the company, I have to attract investors and create favorable conditions for investment to come into the sector. But as an independent analyst of the energy sector, I feel some concerns about monopolism in the power sector.”