In 1998, the electric power stations of UES (excluding those owned by Irkutskenergo and Tatenergo) generated a total of 603.8 billion kWh or 99.3% of the 1997 level. The Holding Company's share of Russia’s total electric power generation was 74.3%. 1998 production of heat energy by the Holding Company amounted to 506.1 million Gcal or 97.5% of the 1997 level. The Holding Company's share of Russia’s total heat power production was 89.6%. During 1998, the system maintained a stable operating regime in compliance with established norms and standards.

       The Holding Company's subsidiaries and associated companies are major suppliers of electric and heat power to the Federal wholesale market and to consumers. UES seeks to ensure regular electric power supply to Russian consumers at economically justified prices.
        UES sells power on the consumer market using the following three types of trading mechanisms:

• Centralized sales of electric power by “energosbyt” companies (which control metering, billing and collections) and subdivisions of these energosbyt companies
• Decentralized sales of electric power by electric grid companies.
• Mixed types of sales (primarily to major consumers by the “energos” through their “energosbyt” sales units; while the electric grid companies limit their sales to households and minor consumers, feeding from their own grids).

        Out of 72 regional energos (excluding the newly established Taimyrenergo) 32 energy systems conduct centralized sales (44%); 24 energy systems, decentralized sales (33%); 16 energy systems (23%), mixed types of sales.
        The Holding Company's strategic objective is to improve its marketing and sales activities so as to collect full payment for energy supplied to consumers. In 1998, UES initiated reforms in its marketing and sales functions seeking to:

• Grant more authority to energy sales “energosbyt” outlets;
• Design marketing policies focused on clients’ needs and working with consumers on an individual basis
• Introduction of a new employee remuneration system for energy sales outlets that links compensation with financial results
• Establish procedures for exchanging information on the most efficient ways to organize sales using the best companies as models

        In 1998, the Holding Company's regional energos sold 544.7 billion kWh of electric power and 465.9 million Gcal of heatpower to consumers in their regions.

    Industrial consumers account for 46.0% of the consumer market for electric energy. The second largest consumer is housing and public utilities (11.0%). Transportation and communication facilities constitute 9.0% of the market. Industrial consumers are also major thermal power consumers. They account for 29.0% of that market. The difference in heat consumption levels between households and public utilities on the one hand and industrial consumers on the other hand is negligible - 23.1% and 18.6%.
        In 1998, regulatory authorities restricted increases in energy tariffs, while at the same time prices of products produced by UES suppliers continued to rise. As a result, the rate of tariff growth charged to industrial consumers throughout Russia was significantly lower than that of the producer price index for industrial products.
        Between 1990 and 1998 the price of electric energy rose 11.7 thousand times, while the prices of industrial goods produced using that energy rose 17.6 thousand times. In 1998, the practice of cross-subsidies continued - considerable exemptions were granted to the entire population regardless of their income as well as to agricultural consumers. These costs were offset by unduly high tariffs charged to industrial consumers and the railway transportation sector.

        Russia’s average industrial tariff in 1998 exceeded residential tariff by 120% and agricultural tariff by 50%.
        The tariff burden is even heavier on the electric railway transportation sector which, across the country, pays 15% more for electric energy than even industrial consumers. The Russian Federation Government passed a number of decrees aimed first, at phasing out the current practice of indiscriminately subsidizing selected consumers of electric energy and second, at increasing rates charged for electric power to reflect actual costs. These measures somewhat eased the tariff burden in 1998 on industrial consumers and helped to normalize price-setting for sales to individual households.
        Cost-based methods of tariff setting in the regions also add to the existing irrational tariff structure. This approach creates false investment incentives, causing enterprise to invest in expensive alternative sources of electricity. Industrial consumers continue to build low-capacity, inefficient electric generators, which over the long term will lead to increasing energy costs for Russian consumers.

Average tariff structure in Russia - 1998 (%) ^*

        In 1998, efforts were taken to further develop the Federal Wholesale Electricity Market (FOREM) so as to reduce the cost of electricity and heat by developing competition among various economic entities. Thirty-five major electric power stations, 9 energy supply companies and Altaikoks supplied electric power to Russia's Federal Wholesale Electricty Market. The FOREM operates using transmission lines from 220 to 1150 kV.

        A certain amount of electric power was sold on the FOREM through the Independent Financial Operator (IFO) under special contracts.
        In 1998, government regulation of the FOREM was carried out by Russia’s Federal Energy Commission (FEC). FEC regulations set caps for tariffs that can be charged by energy suppliers to the wholesale market. But these rates may be lowered without further FEC approval.
        The market operator - the Central Dispatch Unit (CDU - a 100% subsidiary of UES) - chose suppliers to FOREM on a competitive basis and gave preference to facilities that operated in the most cost-effective manner.
        These policies, combined with improved market performance because of greater competition, made it possible to lower wholesale tariff rates by 5% three times in succession. But because of the financial and economic crisis of August 17, 1998, energy producers began to incur higher costs and thus there were no further reductions in electric energy tariffs. The objective of tariff regulation policies applied to the FOREM in 1998 was to lower costs and tariffs by offering a choice of suppliers on a competitive basis. This so-called tariff menu was further developed into a two-tier system of tariffs with separate rates for capacity and power consumed, and one-tier tariffs with rates differing by zones of daily load capacities.
        This system enabled consumers to choose the most flexible payment arrangement for energy consumed, and eventually to design their own schedule for the most efficient electric power consumption. During 1998, new rules were drafted for the operation of the FOREM. These rules provided for clearer regulation of the relationship among wholesale market participants. Russia’s Federal Energy Commission approved a number of documents of a regulatory and methodological nature aimed at improving the performance of the FOREM.
        The development of market relations in the sphere of electric power generation and supply, requires the establishment of regulations governing the design, construction and operation of the main grid facilities of UES. Such regulations should comprise a single regulatory document - the Russian Federation Grid Code - which shall be approved by FEC and the Russian Ministry of Fuel and Energy. The provisions set forth in the Grid Code must be binding upon all FOREM participants.

        Technological and commercial dispatch control within UES is performed by a multilevel hierarchical system which includes the following:

• The Central Dispatch Unit (CDU) of UES
• Seven regional unified dispatch boards of united energy systems of the Central, Northwestern, Mid-Volga, North Caucasian, Urals, Siberian and Far Eastern zones
• Central dispatch points of energy systems
• Dispatch management points of power stations and electric grid facilities
• Mobile operational and support team

        Centralized dispatch control and efficient use of energy resources ensures higher cost-effectiveness and reliability of electric power supply to consumers throughout Russia. The UES centralized and automated dispatch system—whose grid spreads over the vast territory of a country covering seven time zones—is unique in the international electric energy industry. Evidence of its high efficiency is seen in the fact that in the last 50 years Russia has experienced no global systemic failures leading to long disruptions in energy supply to large cities, such as those that have occurred in Europe and America.
        This unique automatic safety system has no analogies anywhere else in the world and consists of several sub-systems with the following functions:

• Automatic prevention of stability losses
• Automatic elimination of asynchronous conditions
• Automatic restrictions of frequency drops
• Automatic restriction of voltage drops
• Automatic relief of equipment overload

        The quality of electric power is maintained by automatic equipment operating in standard conditions, and dispatch management is performed through an automatic system based on state-of-the-art computer hardware, information transfer and mapping. Regular electric power supply to consumers in a market environment calls for radically different standards for information gathering, processing and transfer systems. The earliest possible development of computer systems remains a top priority for dispatch control and communication.
        The plan is to improve industrial communication systems by a phased transition to a primary digital communications network. In the initial phases, integrated digital networks, integrated services digital networks, and intelligent networks will be installed. A satellite communication line based on the most advanced Flexi DAMA-2 technology will be used to establish a digital network. This technology has a good record of safety and cost-effectiveness.