COMMENT: Russia struggles with electricity tariff reform

By bne IntelliNews October 5, 2011

Sergei Bubnov of Renaissance Asset Managers -

Bad news for Russia's utility sector after the government got its calculations wrong for the second time this year. On January 1, Russia's utility sector switched from the crude "cost-plus" calculation to set electricity prices, to a "regulatory asset base", or RAB, for power distributed by network companies. But now politics has thrown the whole RAB policy into question.

Before you nod off, it is worth reading on a little as while the power sector is notoriously boring, getting the price for power right is one of the biggest challenges for Russia's government and will determine the pace of economic growth for decades to come. The battle that has broken out to increase the tariffs for power is, well, maybe not exciting, but at least very important to Russia's near-term future.

And the government has already fluffed it. The generation part of Russia's power sector has already been broken up in an extremely successful privatisation, which must count amongst the biggest sell-offs in the world's history. However, the network and distribution part (wittily dubbed the "discos") that actually connects houses and factories to the grid over the "last mile" has not been reformed and can't be sold until a formula to determine how much they can charge for their services is decided on.

Everyone hates the cost-plus formula, as all it does is drive up costs without actually bringing greater efficiency. So the switch to tariffs linked to the value of assets should have been a big improvement, as the discos would have an incentive to invest in their companies and make them more valuable.

The government spent the second half of 2010 negotiating with these companies before finally settling on a formula that was launched on January 1 this year; under the new system, tariffs should have increased by 15-20%. Trouble is, no one had explained to the Kremlin just how much prices were going to rise - and in an election year too.

When the plan in all its glory was finally shown to Prime Minister Vladimir Putin in February, he was caught by surprise and said the tariff hikes were "too much." Everyone started back peddling quickly. The government had already got egg on its face at about the same time from a hike to social taxes that everyone now agrees was too high and has hurt consumer spending this year. The Federal Tariff Agency is responsible for calculating tariffs, but maybe the PM didn't get the memo, as it refused to take responsibility for the actual level of the tariffs.

Power politics

Russia's power industry is badly in need of more capital that it can earn from higher tariffs. Over the last two decades it has been starved of investment funds as the government held down tariffs as part of its drive to bring down inflation. That aim was achieved at the start of 2008 when inflation fell to single digits for the first time in modern history.

The state has since turned its attention to creating cash for investment and switched to the RAB system ahead of a new round of privatisation in which the regional distribution grids,grouped under MRSK Holding, will be sold off. These discos have remained in majority government ownership on the grounds that as there can be no competition in distribution, they must therefore always be regulated.

MRSK Holding was included on the list of major state-owned companies earmarked for sale in March of this year: the proposal was that the government's stake would be cut from 53.69% to 50% plus one share. However, when the final list was approved by the government in early August, the privatisation plans for MRSK were made subject to confirmation.

The tariff regime is a crucial prerequisite to the privatisation of the discos, but as autumn closes in on Moscow the government has backtracked on RAB and suspended the new tariffs, allowing power tariffs to rise at the slower pace of about 6% so far this year and grid companies' tariffs will be hiked to 11% from July 1 next year.

Now the whole RAB policy is in question. The government has already said that the RAB programme needs to be revised, but there is no clarity on how this should be done.

Under the RAB system, assets are valued and the tariffs are then set for five years, after which the assets' value is assessed again. As most of the assets were valued before the 2008 crisis struck, there is clearly room to reassess them (downward) and so the tariffs will almost certainly fall.

The government is expected to make its recommendations by the end of this year and actual changes to be effected in the regions in the second half of 2012.

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