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#20 - JRL 7061
Wall Street Journal
February 13, 2003
End of Russia Power Monopoly Will Be Test for Putin Reforms

MOSCOW -- One of Russia's most ambitious economic reforms should finally get the go-ahead this week with the launch of a plan to dismantle the world's largest power company and create a free market in electricity.

After two years of acrimonious debate, lawmakers are expected to pass bills Friday paving the way for the breakup of Russian electricity monopoly RAO Unified Energy System. This will also eventually lead to the lifting of rigid state controls on electricity prices, more than a decade after Moscow freed prices for most other goods.

Russian President Vladimir Putin has cautiously backed the reform, despite fears it might lead to blackouts and soaring utility bills. Mindful of elections this year and next, ministers say prices for some households will remain subsidized for many years to come -- a concession some economists say undermines the whole point of the reform.

Energy restructuring is being seen as a crucial test of Mr. Putin's reformist credentials. His government has made bold strides in cutting taxes, establishing land ownership rights and improving investor protections. But so far, little has been done to break up the state-run gas, electricity and railway monopolies that still dominate Russia's economy.

As a result, western power companies aren't flocking to invest in Russian electricity. German utility company E.On AG and Finnish energy group Fortum Oy both have stakes in Lenergo, a UES subsidiary in St. Petersburg renowned for its shareholder-friendly management team. But they are the exceptions: Most find the prospects too uncertain -- and state regulation still too heavy-handed -- to invest.

While much of the oil industry is now in private hands and driven by market forces, the rest of the energy sector remains stuck in the Soviet past. UES, which is 52%-owned by the state, and OAO Gazprom, the natural-gas company, are overstaffed and inefficient, their tariffs set by the government at artificially low rates. That has left both companies starved of investment.

Most of Russia's power plants, commissioned in the 1960s and '70s, are obsolete, and the government says more than half will have to be replaced in the next 10 years, at a cost of more than $60 billion (55.90 billion). Meanwhile, the productivity of UES's 665,000 workers is as little as one-tenth that at power companies in other emerging markets, according to one survey by a Moscow brokerage firm.

Anatoly Chubais, chief executive of UES and a former senior aide to President Boris Yeltsin, has been the driving force behind plans to split the power giant into a state-controlled firm responsible for transmitting electricity and 10 privately owned, competing companies that will generate power and trade it on a new wholesale market.

"The market model will improve efficiency and create the conditions for private investment in the sector," said Vyacheslav Sinyugin, UES's deputy CEO. "Countries like Britain have shown that electricity privatization can work, and that the best cure for inefficiency is competition."

Meanwhile, attempts at liberalization have so far been stymied by domestic opposition. Critics fear the reform will lead to nationwide power shortages in a country where winter temperatures drop to minus 30 degrees Celsius. After giving preliminary approval to the laws last October, lawmakers repeatedly put off a second reading, fearing a popular backlash at this December's elections.

"In 1992, at the start of radical reforms, the government said prices would double or triple, and instead they rose by 2,600%," said Grigory Yavlinsky, head of the liberal Yabloko party and a fierce opponent of the restructuring. "We can expect the same result from these proposals."

Mr. Chubais was the mastermind of Russia's controversial privatizations of the 1990s, under which valuable state property was often sold to insiders at giveaway prices. There were fears, particularly among minority shareholders in UES, that the planned revamp is a smoke screen for an asset grab.

Those concerns grew late last year when companies linked to rich industrialists, known in Russia as oligarchs, began buying up shares in UES. Minority shareholders worried that the businessmen -- whose industries are big electricity consumers -- would gain control of UES's valuable generation assets and leave them with nothing.

UES's management denies claims it is secretly selling the company's crown jewels. "UES is a public company," says Mr. Sinyugin. "All transactions involving sales of assets have to be discussed and approved by the board of directors. There's no place for any backroom deals."

To address such concerns, the government has moved to take greater control of the reform process. Ministers will now have the ultimate say over when the wholesale electricity market will be deregulated. Then, for three years after liberalization, generating companies will have to deliver as much as 35% of their output under long-term contracts to guaranteeing suppliers, who then resell it to the residential sector and state organizations. The government has also said it will continue to subsidize electricity prices for the poor until 2008 at least.

But some analysts say that undermines the plan. "The purpose of the reform essentially is to change ownership, and in itself that's a good thing," says Fedor Tregubenko, utilities analyst at Brunswick UBS Warburg. "But the fundamental problem in the sector is price regulation, and at least for the next few years, the reform doesn't solve this."

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