The most important decisions on reforming the Russian power industry and on restructuring RAO "UES of Russia" were made in 2001. On 11 July the Russian Government issued Resolution No. 526 approving the Priority Directions of Reforms in the Power Industry, and on 3 August, further to that Resolution, the Russian Government issued Resolution No. 1040-r approving the Plan of Measures for the first stage of reforms. These documents define the goals and objectives and the main principles of the reform, describe the key steps that need to be taken in the preparation for the creation of a competitive electricity market; the organisation of the work of the electricity market and its participants; electricity price formation; ensuring a reliable operation of the industry during the transition period.

More than 70% of all generation, and practically all transmission and distribution, are done by the entities in the Holding RAO "UES of Russia". The key participants in the future market will be formed from these entities. Thus, RAO "UES of Russia" will play a key role in reforming the sector.

RAO "UES of Russia" was actively involved in the preparation of the Government Resolution № 526. In 2001 a lot of work was done to explain to the State authorities, the Company's shareholders and to the general public the position of RAO "UES of Russia" on the reform of the sector.

RAO "UES of Russia" set up the following project groups "Federal Transmission Company"; "Generating Companies"; "Trading System Administrator"; "System Operator"; "Science and Projects Complex"; "Organisation of the Wholesale and Retail Trade". Each of them was headed by one of the vice chairmen of the Management Board of RAO "UES of Russia". These groups drafted regulations on the corresponding market subjects, including detailed calculations and substantiation. They also developed a model for the functioning of the participants and infrastructure during the transition period and during the operation of a fully competitive electricity market. The work of these project groups proved to be a success.

In August 2001 the Reform Committee under the Board of Directors of RAO "UES of Russia" was established. It comprises representatives of minority shareholders, potential investors, the federal government and RAO "UES of Russia". Now all issues, which are in any way related to the reform of the sector, are to be submitted for consideration by the Reform Committee.

Pursuant to the Russian Government Resolution No. 1040-r, the Company participates in the discussion and development of the legal framework for the reforms in the power sector, including:

• developing the legal foundation for technological and economic relations in the sector, defining the legal status of new entities, the measures of state control over the sector, the structure and operation of the wholesale and retail power markets (the Law of the Russian Federation "On the power industry");
• making amendments to the Civil Code of the Russian Federation in respect of the development of contractual relations (in addition to power supply agreements) and the right to terminate the supply of power to a consumer in case of non-payment;
• working out a more precise definition of power sector activities to be classified as "naturally monopolistic": electrical and thermal energy transmission scheduling and dispatch (the Law of the Russian Federation "On Natural Monopolies);
• defining the principles for the provision of equal access to transmission and distribution networks and other market infrastructure facilities (the Law of the Russian Federation "On Competition and Restriction of Monopolistic Activities in Commodity Markets").

The formation of prices for electrical and thermal energy is still a topical issue. RAO "UES of Russia" has prepared amendments to the Law of the Russian Federation "On State Regulation of Tariffs for Electrical and Thermal Energy", providing for the improvement of the pricing mechanisms and for tariff regulation in the period of transition to the competitive market. It is now planned to submit proposals for phasing out the practice of cross-subsidies in the power industry and for regulation of activities of distribution companies and suppliers of last resort.

RAO "UES of Russia" is now also directly involved in the development of the principles and rules governing the operation of the competitive wholesale electricity market, both the commercial and technological.

In November 2001 RAO "UES of Russia" became one of the co-founders of the non-commercial partnership "Trading System Administrator of the UES Wholesale Electricity Market". The Company will have 50% of votes in the supervisory board of this partnership.

RAO "UES of Russia" is now establishing the Federal Transmission Company (OAO "UES FTC") and the UES System Operator (OAO "UES SO"). OAO "UES FTC" will receive the transmission assets from the Company. For the future it is planned that FTC will control the Unified National Power Grid (UNG) that will also include trunk transmission lines belonging to regional energos. The criteria for transferring power lines to UNG have been approved by RF Government Resolution No. 881 of 21 December 2001.

OAO "UES CDA" that will dispatch the power systems will be created on the basis of the Central Dispatch Administration of RAO "UES of Russia" (CDA) and the regional (integrated) dispatch administrations (IDA). A vertically integrated dispatch control system from the federal level down to the regional ones will be built.

Wholesale Generating Companies (WGC) - the main suppliers of electricity to the wholesale market will be created on the basis of federal power stations and some large power stations owned by regional energos. They will be composed on the principle of equal starting conditions for doing business. In order to exclude the possibility of the emergence of local monopolies in the field of power generation, each generation company will consist of several power stations located in different areas of the country. In 2001 we prepared and submitted to the Ministry of Economic Development and Trade of the Russian Federation the criteria and principles for the establishment of generating companies. These should be ratified by a Resolution of the Government of the Russian Federation. The list of federal power stations included in WGC must be ratifed by the Government as well. The mentioned market participants will be created in the form of subsidiaries 100% owned by RAO "UES of Russia".

In 2004 the restructuring of RAO "UES of Russia" will be complete. In the next year it is planned to increase the state share in the FTC and the SO and to reduce the share of the state in generating companies. This can be done through the attraction of private investments.

One of the major aspects of the reforms in the power industry is the transformation of regional energos. Pursuant to the Russian Government Resolution No.1072-r and the decision of the Board of Directors of RAO "UES of Russia" dated 27 July 2000, the Management Board of the Company has started to implement the preparatory stage of transformation of regional energos. The following measures have already been taken:

• inventory and state registration of ownership rights to immovable property, the rights to land plots of RAO "UES of Russia" and regional energos. Inventory was taken of 235 thousand property items (more than 7 thousand transmission assets), including construction in progress;
• technological examination of companies operating in the power sector;
• establishing a system of separate cost accounting for various types of activities at subsidiaries and dependent companies, separation of non-core types of activities and withdrawal of SDCs from such activities;
• financial sanation, implementation of cost control programmes, inventory and restructuring of debts owed by and to the companies of the Holding; a transition to a simplified standard model of a business plan that takes into account the efficiency of individual types of activities (in the future: types of separate businesses).
• the personnel audit, re-training of the staff, preparation of a personnel reserve.

The projects for the transformation of regional energos were launched in the autumn of 2001. The principles of transactions involving assets and the procedures for making decisions related to the reform of SDCs were considered by the Reform Committee and approved by the Board of Directors of RAO "UES of Russia" on 28 September 2001. The Projects Committee began to accept and consider reform projects in November 2001.

The Board of Directors of RAO "UES of Russia" approved the basic draft plan for the re-organisation of regional energos through the creation of joint stock companies on their basis. The shares in these newly created companies will be distributed in proportion to the existing shareholding in the relevant regional energo. RAO "UES of Russia" believes that each reform project must be prepared with due regard to the interests of all the parties involved.