Investment Phase of the UES Development

The large-scale construction of generation facilities will be financed with own capital of the energy companies, proceeds from the offerings new WGC and TGC shares to private investors, the use of project finance mechanisms, direct private investments, and debt financing. The RAO UES Investment Programme provides that the construction of power units will also be financed with funds provided by private investors under the investment guarantee mechanism.

The principal source of investments in the power grids and dispatching facilities will be charges for the transmission and dispatching services, payments for new user connections, debt finance and the proceeds from the new share offerings of OAO "UES FGC" and OAO "UES SO-CDA" to the state, and from the sale of the shares in thermal generation companies (WGCs and TGCs) owned by RAO "UES of Russia" to private investors.

Sources of Finance for Investment Programmes of the Generation Companies of RAO "UES of Russia", billions of RUB

Sources of Finance for Investment Programmes of Grid Companies and OAO "UES SO-CDA", billions of RUB

Additional Share Issues of Generation Companies

One of the sources of finance for generation companies' investment projects are additional share issues by WGCs and TGCs to private investors.

In 2006, the Board of Directors of RAO "UES of Russia" took decisions in principle aimed at attracting private investment through issuance of additional shares in thermal generation companies.

The Board of Directors at its meetings of 23 June, 30 August and 29 September 2006 approved the list of thermal generation companies which may place additional shares to private investors. The list includes the following thermal generation companies: WGC-1, WGC-2, WGC-3, WGC-4, WGC-5, WGC-6, TGC-1, TGC-3, TGC-4, TGC-5, TGC-7, TGC-8, TGC-9, TGC-10, TGC-12, and TGC-13.

It may be decided in 2007 on whether it is advisable for TGC-2, TGC-6, TGC-11, and TGC-14 to issue new shares.

The proceeds that the WGCs and TGCs may receive from their share offerings in 2006-2008 are estimated at over RUB400 billion.

The bulk of funds from the companies' new share issues is anticipated in 2007-2008. In order to ensure that their investment programmes are properly financed in 2007-2008, the generation companies will have to rely strongly on other sources of finance available to them, i.e. own capital and debt funds.

In November 2006, OAO "WGC-5" placed its new shares on the stock market. The investors were offered 5.1 billion shares in WGC-5, or 14.4 percent of the company's increased authorized capital. The investors' appetite for the shares significantly exceeded the number of shares on offer, tenfold at the lower bound of the price range and eightfold at the upper bound. The bidders were both Russian and international institutional and strategic investors. WGC-5 raised USD459 million in its IPO.

The issuance of new shares by WGC-5 is the first experience in Russia's electric power industry in attracting large-scale private investment in electricity generation companies. The company will use the offering proceeds to build new power capacity in the areas of Russia which suffer from energy shortages and to revamp the existing power plants of WGC-5.

In March 2007, OAO "WGC-3" completed the first placement of shares to a strategic investor. The highest price, USD3.084 billion, for the 18 billion ordinary shares (37.9 percent of the WGC-3 increased authorized capital) was offered by Norilsk Nickel Group.

In May 2007, OAO "TGC-5" was the first among the territorial generation companies to issue its new shares to a private strategic investor. The company issued 329.734 billion ordinary shares, which makes 26.8 percent of its increased capital, and raised over USD450 million.

The offerings by the three generation companies alone-WGC-3, WGC-5 and TGC-5-raised USD4 billion in funds for the electricity industry. This amount is much bigger than the aggregate public expenditure in the electricity sector over the past decades.

The funds raised by WGC-3, WGC-5 and TGC-5 will be used to implement investment projects-construction of new and modernization of the existing generation capacity.

Investment Guarantee Mechanism

In light of the need to ensure investments in the electricity industry during the transitional period, the Russian Federation Government, by its Resolution No. 738 of 7 December 2005, approved the use of the investment guarantee mechanism (IGM) as an instrument to stimulate investments during the transitional period which provides additional guarantees and incentives to investors. Such a mechanism is intended as a measure to safeguard investors from most market risks.

Under the IGM, investors are guaranteed a certain return on their investments in the construction of new capacity in Russia by setting a special fee for the services aimed at the creation of the long-term technological reserve of capacity (similar to the capacity fee) under a long-term agreement with OAO "UES SO-CDA".

The mechanism applies only to investments in the creation of new generation capacity, i.e. investments aimed at addressing capacity shortages in certain regions of Russia. The IGM is not intended to attract investments for projects to modernize the existing generation facilities which do not result in the expansion of their installed capacity.

The Russian Federation Ministry of Industry and Energy has prepared an order to hold a tender to procure the construction of a thermal power plant of up to 1,200 MW near the Tarko-Sale Substation in the Tyumen Region. Also, an order is pending approval from the ministries and government agencies of Russia regarding the siting of generation facilities at the Urengoyskaya TPP in the Tyumen Region and Serovskaya TPP in the Sverdlovsk Region. The investment programme also includes IGM projects on the sites of the Shchekinskaya TPP (Tula Region), Petrovskaya TPP (Moscow Region), and the TPP in the neighbourhood of the city of Syktyvkar. RAO "UES of Russia" and OAO "UES SO-CDA" are considering a list of pumped storage power plants (PSPPs) and coal-fired TPPs with an aggregate installed capacity of 25 thousand MW, whose construction may be feasible only within the framework of the IGM.

To implement their investment programmes, the electricity infrastructure companies needed government support in the form of capital contributions to OAO "UES FGC", OAO "UES SO-CDA", OAO "HydroWGC". The amount of such contributions is determined in accordance with Federal Laws No. 35-FZ On the Electric Power Industry and No. 36-FZ On Specific Features of Functioning of Electric Power Industry During the Transitional Period, which provide that the state must hold at least 75 percent plus one share in OAO "UES FGC" and OAO "UES SO-CDA", and at least 50 percent in OAO "HydroWGC". Another factor determining the amount of capital contributions is the amount provided the companies' investment programmes.

RAO "UES of Russia" submitted to the Russian Federation Ministry of Industry and Energy a proposal that the Russian Federation acquire shares in OAO "UES FGC", OAO "UES SO-CDA", OAO "HydroWGC" in 2007-2010: RUB91.78 billion worth of shares in OAO "UES FGC", RUB5.22 billion worth of shares in OAO "UES SO-CDA", and RUB23.0 billion worth of shares in OAO "HydroWGC".

On 20 March 2007, OAO "UES FGC" completed its additional share issue. The RUB80 billion share issue was registered with the securities regulator on 21 March 2006. The shares were issued by private placement to RAO "UES of Russia" and the Russian Federation.

In return for the additional shares in FGC, RAO "UES of Russia" transferred its shares in the transmission (trunk grid) companies, network facilities relating to the Unified National Energy Grid (UNEG), and cash. The Russian Federation paid RUB22.48 billion in cash for the additional shares in FGC in accordance with the Federal Law On the Federal Budget for Year 2007.

As a result of the share issue, the Russian Federation, through the Federal Agency for Federal Property Management, now holds a 12.44 percent of OAO "UES FGC", and the stake held by RAO "UES of Russia" declined to 87.56 percent.

It is planned that the deficit of the Investment Programmes of OAO "UES FGC" and OAO "HydroWGC" will be eliminated after the sale of the shares in 5 thermal WGCs and 13 TGCs (i.e. all companies except for WGC-5 and TGC-5, which will have been spun off from RAO "UES of Russia" by that time within the first reorganization phase) owned by the state during the final phase of RAO UES reorganization.

Greenhouse Emissions Trading System

One of the sources of investment in the electricity industry is the use of the joint implementation (JI) mechanism provided by Article 6 of the Kyoto Protocol to the UN Framework Convention on Climate Change. An investment project being implemented as a JI project is intended to generate greenhouse gas reductions which may be sold to an interested buyer.

In 2006, the RAO UES Investment Programme was reviewed to determine whether certain projects could be implemented as JI projects. The potential greenhouse gas reductions are estimated at 25.6 million tonnes of CO_2, which may bring over EUR180 million in funds from carbon reduction projects.

In order for energy companies to meet the eligibility requirements and benefit from the Kyoto Protocol mechanisms, the companies are required to estimate their greenhouse emissions and make the appropriate register of emissions. For an investment project to be structured as a JI project, special project documentation must be produced in the PIN and PDD format and verified by an independent entity accredited by the UN, and receive the relevant approvals on the national and international levels.

RAO "UES of Russia" has put in place the necessary infrastructure and methodology which will facilitate carbon reduction finance in investment projects. The work is coordinated by a dedicated wholly-owned subsidiary of RAO "UES of Russia", Energy Carbon Fund. Standards have been produced for the preparation of JI projects and detailed assessment of greenhouse gas emissions at RAO UES entities. Preparations are well underway to implement the Kyoto Protocol mechanisms: greenhouse to date emissions inventories have been prepared for 125 energy facilities.

The Energy Carbon Fund, together with the RAO UES energy companies, has started drafting documentation for the first priority projects in the PIN and PDD formats, and is in the process of negotiations with the potential ERU buyers. Currently, documentation is being prepared for 20 investment projects.

Payment for Connection of New Users to Power Grids

One of the sources of finance for the investment projects in the power grids, especially in the distribution networks, is the fee charged to new consumers for grid connection. In 2004-2006, the legal framework was created for charging the connection fee to new consumers. In order to regulate the technical connection process, the Russian Federation Government adopted Resolution No. 861, dated 27 December 2004, approving the Rules for Technical Connection of Energy Consuming Devices (Energy Units) of Legal and Natural Persons to Power Grids. Pursuant the Connection Rules, the Federal Tariffs Service of Russia approved its Methodological Guidance for Determining the Amount of the Fee for Connection to Power Grids. 2006 saw continued work to improve the legal framework for technical connections, and on 27 March 2007 some amendments were made to the Resolution which provided that the connection fee must necessarily include an investment component.

It is expected that, in 2006-2010, the connection fee receipts will make over RUB252 billion. These receipts will be used to finance the investment programmes in distribution and transmission grids.

"2006 saw the establishment of HydroWGC, Europe's largest company producing electricity using renewable energy sources. We launched the construction of the Boguchanskaya HPP with the design capacity of 3,000 MW. This project is the largest one in Russia's electricity industry over the past decade" Vyacheslav Sinyugin, Member of the Management Board, and Managing Director of RAO "UES of Russia"; Chairman of the Management Board, OAO "HydroWGC"