European Infrastructure Finance Yearbook - Investing In Bonds ...

UTILITIES
26 ■ NOVEMBER 2007
supply risk) and obtaining control of municipally
owned electricity and heat distribution networks
(to provide a base of stable, network earnings and
improve operations). However, the potential
degree of diversification is limited by the legal
prohibition of simultaneous ownership of
“monopoly” (transmission, electricity distribution,
and dispatching) and “competitive”
(generation and supply) assets within one market
price zone. The two power market zones are
Europe and the Urals, and Siberia. This law
prohibits the vertically integrated generation and
distribution structures typical of European
power utilities.
Diversification, the potential synergies, and
hedging opportunities should support the interest
of gencos and their strategic minority investors to
invest in supply companies, all of which UES
plans to sell in 2007-2008. A combination of
wholesale generation and supply should reduce
overall business risk through diversification of the
customer base and higher customer loyalty. This is
likely to result in lower competitive pressure and
reduced customer attrition, as well as higher
margins in retail electricity sales. At the same
time, on their own, electricity supply operations
have the highest business risk in the electricity
value chain.
A Whole New Wholesale System
In September 2006, Russia introduced new rules
for its electricity market that are a big step
toward full deregulation of wholesale power. In
place of the old regulated pool system, where
generators sold power at cost-based rates and
received regulated payments for fixed capacity
costs, the new market is based on bilateral
regulated contracts between generators and
wholesale customers, which initially covered 95%
of planned generation volumes. Generators sell
any volumes not covered by regulated contracts,
and customers sell any surplus power from
regulated purchases on the deregulated spot
market. Actual supply/demand dynamics
determine the deregulated market’s share.
The government intends to deregulate the
market and reduce volumes sold under regulated
contracts. In April 2007, it approved a new
deregulation plan that would fully evolve from
2007 to 2010 (see chart 3). This is well ahead of
previous plans that had a seven- to 20-year
time frame.
STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK
The contracts have “take-or-pay” terms (that is,
buyers will make payments to the electricity
wholesaler for the contract electricity volume
regardless of their actual power demand). Since
2008, the contracts will also have an automatic
adjustment for passing fuel costs on to customers
and an annual adjustment to regulated rates for
other increasing costs through an inflationbased
formula.
In the new market model, a generator also
recovers fixed costs through regulated bilateral
contracts. The government plans to deregulate
capacity payments in line with the spot market by
reducing the portion of generation capacity
covered by regulated payments. Wholesale market
participants will have to procure capacity
covering their peak demand, minus capacity paid
through regulated contracts from generators
through a market-based mechanism. The first
auction is likely in 2007 for capacity to be
delivered in 2008 and 2012.
Exposure to spot price volatility will grow in line
with market deregulation
Seasonal, daily, and intraday power-demand
variations make spot electricity prices highly
volatile (see chart 4 on next page). While gencos’
current exposure to the spot price is limited
because only 10% of the wholesale market has
been opened, this exposure will increase in line
with wholesale market deregulation and will
reach 100% by 2011.
Spot-price deregulation for generators in
European Russia and in the Ural region has been
positive to date (see chart 5 on next page).
Chart 3
Russian Wholesale Market
Deregulation Schedule