Regulatory environment and macroeconomic indicators

FACTORS AFFECTING PRICING IN ELECTRICITY INDUSTRY

With electricity and heat tariffs regulated by the state, pricing in the energy industry is primarily affected by the changes in fuel prices, inflation and investments financed with energy companies' own sources of funds.

The Programme for changing the level of regulated prices (tariffs) in the electricity industry approved by the Russian Government was in effect in 2004-2006. This Programme envisaged raising the electricity prices (tariffs) within the inflation rate. This Programme was successfully accomplished, helping ensure a predictable dynamic of electricity prices during the period of energy companies' restructuring and reduce risks for consumers in the first years of the electricity reform.

However, the economic growth seen in Russia has led to the exhaustion of available reserves of generation capacity and shortage of grid resources, especially in the rapidly developing regions. The operation of the energy system during the period of abnormally low temperatures in the winter of 2005/2006 demonstrated the potential issues in energy supply due to capacity shortages.

In order to address these issues, RAO "UES of Russia" produced an investment programme which envisaged a substantial increase in investments in the generation and grid sector. The principal parameters of this Programme were approved by the Russian Government and served as one of the drivers for changing the tariff policy in the electricity industry.

Another important factor was the policy pursued by the Government aimed at gradual levelling-off the terms of sale of natural gas on the domestic and international markets. The decision taken by the Russian Government on 30 November 2006 provided for an increase in the domestic gas prices by 15 percent in 2007 (2006: 11 percent) with the further growth by up to 25-27 percent annually in 2008-2010. The coal prices grew by 11.6 percent.

These factors were incorporated in the forecast of Russia's social and economic development in 2007-2009, which led to the need to change the tariff policy: the regulated retail electricity prices were set to grow by 11 percent in 2007 instead of the previous forecast of 7.5 percent. The increase in the regulated retail tariffs was higher than the inflation forecast for 2007 (5 percent). However, at end-2007, the actual inflation rate was as high as 11.9 percent, outpacing the increase in the regulated electricity tariffs.

The average retail electricity prices (including the regulated tariffs and retail prices taking into account the translation of unregulated prices on the wholesale market) were projected at 12-13 percent in 2007. The actual retail electricity prices grew on average by 14.5 percent in 2007.

The dynamic of unregulated prices was strongly affected by the unscheduled repairs carried out at nuclear power plants in the first price area and the low water level in the Siberian rivers in Q3 2007, which led to an increase in the share of thermal power plants in the generation mix compared to that of nuclear and hydropower plants in the second price area, which produce cheaper electricity.

INDUSTRIAL PRICES VS ELECTRICITY PRICES*