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Speech by Mr. Y. Udaltsov, member of the Management Board of RAO «UES of Russia»,

Speech by Mr. Y. Udaltsov, member of the Management Board of RAO «UES of Russia», at the seminar «Central and Eastern Europe: A source of Future Growth for Utilities?». Reform: the next steps. London, June 30, 2004. Company. Key Facts Except for nuclear capacity

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Speech by Mr. Y. Udaltsov, member of the Management Board of RAO «UES of Russia»,

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  1. Speech by Mr. Y. Udaltsov, member of the Management Board of RAO «UES of Russia», at the seminar «Central and Eastern Europe: A source of Future Growth for Utilities?» Reform: the next steps London, June 30, 2004

  2. Company

  3. Key Facts • Except for nuclear capacity • and several large independent generators, • UES controls the electricity industry in Russia • 72% of Russia’s installed generation capacity • 69% of Russia’s electricity output • 32% of Russia’s heat production • 96% of Russia’s power transmission lines RAO “UES of Russia” Today: Operating Highlights The World’s Ten Largest Electricity Companies (2003) Company Home-base Capacity (GW) RAO UES Russia >156 SPCC China 151 EDF France 121 TEPCO Japan 59 E.ON Germany 54 SUEZ France 49 ENEL Italy 45 RWE Germany 43 USA 42 AEP ESKOM South Africa 42 Source: RAO “UES of Russia”,IEA

  4. RAO UES Holding – current ownership structure Other Minority Shareholders Russian Federation Minority Shareholders 52% 48% RAO “UES of Russia” 100% 100% Federal Grid Company System Operator 44 federal power plants, including 8 plants under construction 72 Regional Power Companies Generation T&D Grids Sales Dispatching Services

  5. Shareholder Equity 14,404 16,730 19,733 RAO “UES of Russia” Today: Key Financial Data US$ m 9 months ended 30 Sept 2001 9 months ended 30 Sept 2002 9 months ended 30 Sept 2003 Revenue 8,474 10,328 13,720 Net Profit 909 669 543 EBITDA 1,070 1,494 2,720 EBITDA Margin 12.6% 14.5% 19.8% Operational Margin 1.2% 0.6% 8.9% Net Margin 10.7% 6.5% 4% Fixed Assets 24,201 25,834 29,293 2002:Revenue – $15,83 bn 2003 (Forecast Data): Revenue – around $19,6 bn

  6. Growth of the market capitalisation of RAO «UES of Russia» (RTS data) In the recent two years the stocks of RAO «UES of Russia» were largely outperforming the Russian securities market as a whole 450% 400% 350% 300% 250% 200% 150% 100% 03.01.2004 03.03.2003 03.09.2002 03.11.2002 03.05.2003 03.07.2003 03.09.2003 03.11.2003 03.03.2004 03.05.2004 30.06.2004 03.01.2003 Russian Trade System index EESR equities

  7. Reform

  8. RAO UES role in the legal base creation of thepower sector reform • Fundamental bills governing the electricity industry restructuring process were enacted into law in April 2003 Laws Governmental acts • Directive of the Russian Federation Government No 865-r "Plan of activities aimed at the restructuring of the electricity industry in 2003-2005" was signed on 27.06.03 • The "Energy Strategy of Russia for the period up to 2020” (Directive of the Russian Federation Government No. 1234-r) was adopted on 28.08.03 • Directive of the Russian Federation Government No 1254-r "Compositionof the generation companies of the wholesale electricity market" was signed 01.09.03 • Regulation of the Russian Federation Government No 643 ”Rules of the transitional wholesale electricity market" was signed on 24.10.03 • Directive of the Russian Federation Government No 1939-r "On the participation of the state in the establishment of interregional transmission companies" was signed on 29.12.03

  9. Operation of the competitive sector of the wholesale electricity market (5-15%). Preparation for the opening of the electricity markets • The first trading session was held on November 1, 2003 • The share of the sector has exceeded 7% of the wholesale market of the European Russia and Urals • The price levels of the competitive sector are less then the tariffs of the regulated sector for 4.6% • The number of the market participants continues to grow Growth of the weekly trading volumes in the competitive sector of the wholesale market (million kWh)03.11.2003 - 30.06.2004 • 882million kWh • 84 market entities 1200 • 158 million kWh • 14 market entities 1000 800 600 400 200 0 33 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 weeks

  10. Restructuring of AO-energos • Restructuring of the regional utilities involves their unbundling with spinning off separate lines of business • By June 1, 2004, the Board of Directors of RAO UES approved 51 restructuring project out of 70 restructuring projects of AO-energos requiring approval 43 utilities launched their restructuring projects Implementation schedule of the utilities restructuring process 42* 39 34 17 6 Total (cumulative) 1 Current quarter 3 5 5 11 17 1 2Q2004 3Q2004 4Q2004 1Q2005 2Q2005 3Q2005 * - JSC “Pskovenergo” is to be restructured not by “basic variant”

  11. Reforming of RAO “UES of Russia” Industry ownership structure by 2008 State owned companies(State owns more than 50% +1 share): Private companies(State owns less than 50% of shares): FGC IDC SO Holding of guaranteed suppliers, isolated AO-energos Hydro generation-based WGCs Thermal generation-based WGCs About 20 TGCs Supply Repair business Guarantee suppliers Isolated AO-energos FGC – Federal Grid Company (the Unified National Electricity Grid) IDC – Interregional Distribution Company SO – System Operator WGC – Wholesale Generation Company TGC – Territorial Generation Company

  12. Establishment of new industry players • Interregional distribution companies (IDCs) are scheduled to be set up as wholly-owned subsidiaries of RAO UES. Contributions into their share capital will be made by shares of the distribution companies spun off in the course of reorganisation of AO-energos owned by RAO UES • On April 23, 2004 the Board of Directors of RAO UES approved the configuration of the IDCs and principles of their management during the transitional restructuring period • IDCs are scheduled to be incorporated in 3Q04 IDCs • On 29.12.03 the RF Government approved Directive No 1939-r "On the participation of the state in the establishment of interregional transmission companies" (stake of the Russian Federation in their capital is set at 85%, the stake of the Federal Grid Company is set at 15%) • By 01.05.04, 49 branches (out of 53) were set up, based on the assets of transmission networks belonging to the Unified National Electricity Grid • RAO UES signed an order directing commencement of the handover of the UNEG assets owned by AO-energos to interregional transmission companies (ITCs) Consolidation of assets comprising the Unified National Electricity Grid (UNEG) • 56 regional dispatching units (RDUs), established as branches of the System Operator, were launched by 01.05.04. The units are responsible for the regional operational control in 62 utilities • By the end of 2004, restructuring of operational control function in 7 more AO-energos is expected to be completed, including the utilities independent from RAO UES Operational and dispatch control structure

  13. 20% 20% 15% 11% 9.5% 10% 8% 7.5% 8.5% 6% 7.5% 5% 2005 2006 2007 Raising the efficiency of the current operations through cost-cutting and tariff-limiting measures Cost management programs RAO UES tariff policy initiatives Government DirectiveNo 1754-r dated 01.12.03 New approach to cost management implemented at the utilities level • Instead of cutting costs based on projected costs (“cost plus” basis) – avoiding growth of costs above the inflation and tariff levels (“inflation minus” basis) • Tighter control measures of the utilities' costs have been implemented Setting tariff growth caps for 2004-2006 by each electricity system and for RAO “UES of Russia” as a whole Cost management programs of RAO UES for the period of 2001-2003: the savings exceeded RUR45 billion Decisions adopted at a meeting of the Russian Federation Government on 27.05.04 which discussed the 3-year natural monopolies tariffs revision program represented a quantum leap in the tariff-setting system Tariff growth caps: gas electricity Inflation rate

  14. Investments guarantee mechanism

  15. To engage investors in construction of new generating capacitiesto cover pending capacity deficiency, their commissioning being planned for 2006 In the immediate 5 years the energy market will be in a formative stage and won’t provide for engagement of investors withoutapplying special mechanisms! The task is to offer aspecial mechanism of attracting guaranteed investments during transition period(5 years) Project objectives

  16. Expectations – electricalenergy generation during certain time intervalsto cover energy deficiencies Minimum cost of the mechanism’s implementation formarket community Cost signals for investor and market providing economic efficiency Effective peak capacities are needed What do we expect from the use of the mechanism • Objects for attraction of investments: • increase of rated capacity through construction of new electric power plants or newauxiliaryblocs on operating electric power plants

  17. We take into consideration the interestsof foreign and Russian investors Investors want guarantees as to the reimbursement of committed facilities and rate of return: Long-term agreement with reliable and credit-worthy counterparty, ensuringbacking ofcommitted facilities and rate of return Legislative consolidation of legitimacy of such agreement Escapingthe risk, connected with a rate of foreign exchange(contract value should be in Euro) Guaranteed fuel supplies with due account for the investor’s generating capacities utilisation Integration into a future model of electric energy market (power) State guarantees for all cases of default of a treaty: changes of legislation, non-fulfillment of obligationsby the counterparty, etc. Investor’s interests

  18. Two-stage mechanism of payment for investor’s services: Reimbursement of committed facilities and rate of return – through payment of servicesrelated to provision of technological reserve of generating capacities (demand charge analogue) – through tariff of SO Payment for produced electric energy – through payment for electric energy cost (energy tariff analogue) Why such mechanism of payment? It is the most effective because: Provides correct cost signals to investors and market Maintains capacity in a state of readiness at any time specified by SO at minimum prices Provides for generation of electric energy only when it is profitable for investor and market Allows escaping guarantees to the investor in terms of annual load of generating capacities It smoothly incorporates into competitive market of power and electric energy Ways to secure investor’s interests and correct cost signals

  19. Cost of construction of 1 МWof power ($/МW) Rate of return Cost of mechanism New tariff ofSO (today 0.88 copecs/КWh) Increase of average tariff for end users 1 000 000 30% 5.72 copecs/КWh 6.6 copecs/КWh 9.1% 900 000 15% 3.22 copecs/КWh 4.1 copecs/КWh 5.1% Financial consequences of the mechanism implementation Attraction of investments into construction of 4 100 МW, with guarantee period (pay-off period) being 10 years

  20. Thank you for your attention

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