Energy Subsidies: Lessons Learned in Assessing their Impact - UNEP

Energy Subsidies in Russia: The Case of District Heating
Some Russian experts disagree, arguing that the economic price of power supply should
reflect the over-capacity that has characterised the industry for many years. Raising prices
immediately to long-run marginal cost levels would be inappropriate, as it would overremunerate
the owners of generation assets and leave the generation companies with large
retained earnings and cash surpluses. Nevertheless, efficient prices would be expected to rise
over time towards long-run marginal costs as demand picks up and the need for large-scale
investments grows. They also argue that, under current arrangements, generation capacity is
not dispatched in least-cost merit order, resulting in an economically irrational use of
generation assets and higher wholesale power costs. The plants with the lowest marginal
operating costs – hydro and nuclear facilities – are usually dispatched only after centralised
fossil-fuel and local co-generation plants. Operating and capital costs are also thought to be
much lower in Russia than in industrialised countries because the cost of labour and materials
is a lot lower.
Cross-subsidies in the electricity sector remain a major problem. Residential electricity prices
have recently increased significantly relative to industrial prices in many Russian regions,
implying that cross-subsidies have been reduced. In most cases, however, industrial prices
remain higher even though supply costs are much lower.
Planned regulatory reforms to make the wholesale market work more efficiently and the
introduction of competition in electricity supply to encourage improvements in productivity
could contribute to lower costs and, therefore, help to reduce subsidies. In the context of
industry restructuring, the Ministry of Economic Development initially planned to raise
electricity tariffs on average by 15 to 18% per year from 2002 to 2004. In fact, prices were
increased by 27% in 2002 and are due to rise by a further 30% in 2003. These increases are
nonetheless much lower than those sought by RAO UES.
5.2 District Heat Subsidies
District heat plays an exceptionally large role in the energy sector in Russia. It meets over a
third of final energy needs of industry and close to half those of the commercial and
household sectors. The value of heat sales was about $20 billion in 2002, compared to around
$27 billion for both domestic and export sales of natural gas. Close to 50% of primary energy
consumption in Russia is used directly and indirectly for heat generation, transmission and
distribution.
District-heat supplies are heavily subsidised. Total budget allocations for heat currently
amount to an estimated $3.5 billion to $4.0 billion per year, of which about $2 billion are
subsidies $3.5 billion to $4.0 billion per year, of which about $2 billion are subsidies in the
form of payments to heat suppliers and low-income families and the Government also offers
interest-free loans to supply fuel to district-heating companies in remote locations. Prices
vary across the country, ranging from $6 to $75 per Gcal.
The Government decided in 2001 to raise heat prices quickly to 100% of costs for most
residential customers and retain subsidies only for poor households whose housing and
associated costs exceed 22% of income. At the beginning of 2002, a smoother transition to
full cost pricing was agreed in the face of public resistance and political opposition.
The district-heat industry is characterised by poor metering of supplies and consumption, and
inadequate monitoring of fuel inputs to heat-generation plants. There is enormous uncertainty
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