Article published
in Rossiyskaya Gazeta on 23 January
in response to the charges made by Andrey Illarionov in the same publication
REFORM NEEDS CONTENT, NOT JUGGLING OF FIGURES
The electricity monopoly Unified Energy System of Russia [UES] has defended itself
against charges made by Russian President Vladimir Putin's economic aide, Andrey
Illarionov, in an article published in the government newspaper Rossiyskaya Gazeta. In a
letter published in the same newspaper, UES said that Illarionov's statements on its
performance, and pricing and investment policies were tendentious, based on misleading
comparisons and ignored the particular conditions and difficulties facing the electricity
sector in Russia. In particular, the company said Illarionov had failed to take account of
the level of depreciation on UES's fixed assets, and had thus both exaggerated its losses,
and underestimated its need for investment. The company argued that the tariffs charged
were both fair and geared to meeting these investment needs. The following is an excerpt
from the article published in Rossiyskaya Gazeta on 23 January. Subheadings have been
inserted editorially:
On 14-15 January, Rossiyskaya Gazeta published an article by Andrey Illarionov, adviser to
Russian President [Vladimir Putin], entitled "The substance of reform is more
important than its pace". The editorial board has now received a letter from Unified
Energy System of Russia [UES], which we are publishing.
"Andrey Illarionov's article The substance of reform is more important than its
pace" published in Rossiyskaya Gazeta on 14-15 January 2003 contains a whole series
of factual distortions and inaccurate information and conclusions about the work of UES
and the electricity sector as a whole.
Performance
Mr Illarionov effectively casts doubt on UES's official accounts, which have been
confirmed by the company's board of directors (most of the members of which are
representatives of the state, including the head of the Russian presidential staff and a
deputy prime minister, ministers, and deputy ministers of the Russian government) and the
auditors and have been repeatedly submitted to various state power bodies.
For example, Mr Illarionov claims that the volume of UES's output has shrunk by 2 per cent
over the last five years. Meanwhile, in 2002 the holding company produced 1.6 per cent
more electricity than in 1997.
In an analogous way, the statement that UES's work efficiency has fallen by 14 per cent
over the last five years does not correspond to reality either. In reality, in 2002 output
per worker in the holding company was 7.2 per cent up on 1997.
Mr Illarionov states that UES has the worst corporate management parameters of all Russian
blue-chip companies. This assessment reflects his preferences of taste rather than
reality. According to information from the Russian Institute of Corporate Law and
Management, UES is in third place among Russia's leading public companies in terms of its
quality of corporate management. Moreover, first and second places are occupied by
companies that cannot be compared with UES in terms of their ownership structure, the
structure of their joint-stock capital, or number of employees.
Mr Illarionov also claims that there is unjustifiably inflated wage growth at UES
enterprises. In fact, wage trends at the holding company's enterprises over the last ten
years have not only fallen behind general Russian trends, but also the rate of inflation!
Aside from this, as we know, the size of electricity workers' wages is set by authorized
executive power bodies, the regional energy commissions (REKs), which set the electricity
tariffs, which include the joint-stock electricity companies' wage funds.
The facts Mr Illarionov cites on the growth in the number of UES employees do not
correspond to reality. Staffing levels have not risen but fallen from 664,000 people in
1997 to 629,000 in 2002 (according to operational information).
Mr Illarionov says losses on UES grids have grown from 10 per cent to 12 per cent over the
last five years. At the same time, he remains silent about what class of grids this has
happened on and why losses are growing. In fact, in high-voltage (trunk) grids, losses are
not growing but falling (they currently come to around 3.5 per cent on grids of 330
kilovolts and higher). The losses mainly take place in the distribution grids. The main
reasons are wear and tear on equipment, which has reached 70 per cent, and the flaws in
Russian legislation concerning the scrapping of non-ferrous metals, which are creating
extensive opportunities for mass embezzlement.
Mr Illarionov draws very tendentious conclusions when analysing the company's export
activity. The volume of electricity exports has indeed fallen from 19.7bn kilowatt-hours
in 1997 (not the 22 bn claimed by Mr Illarionov) to 17.9bn kilowatt-hours in 2002. This is
chiefly linked to the fact that UES has ceased the unpaid export of electricity, primarily
to countries of the CIS. Whereas in 1997 electricity payment collections rates came to 15
per cent of transfers, in 2002 they came to 100 per cent. The average price of export
supplies has indeed fallen because of the situation that has emerged on foreign markets as
a result of their liberalization.
Mr Illarionov's claim that "the export price to Kazakhstan is lower than prices on
Russia's FOREM [Federal wholesale market for electricity and generating capacity]"
does not match reality either. The average price of export to Kazakhstan is 1.46 cents
while the tariff on FOREM is 1.055 cents per kilowatt-hour.
Tariffs
Mr Illarionov's main attention is devoted to the question of tariffs for electricity in
Russia, which he considers "overblown in relation to the size of our GDP and our
income levels." In arguing this thesis, the author compares the price of electricity
for industrial consumers in the United States and Germany (4.1 cents per kilowatt-hour)
and in Russia (2.1 cents per kilowatt-hour). As we know, industrial tariffs in Russia are
indeed exaggerated because of cross subsidies to tariffs for the individual customers.
According to operational information, the overall amount of cross subsidies in UES alone
came to over R40bn in 2002. Eliminating cross subsidies would allow a significant
reduction in tariffs for major industrial consumers down to 1-1.4 cents.
If we compare prices for the individual customers, in Russia they average less than 2
cents per kilowatt-hour while in the United States they reach 15.5 cents and in Germany 16
cents. At the same time, according to State Statistics Committee data, electricity
spending does not exceed 1-2 per cent of the incomes of the Russian population and the
proportion of spending on municipal services as a whole reaches up to 5 per cent (while
the statistically average family spends up to 5 per cent of their budget on alcoholic
drinks and tobacco).
Mr Illarionov also tries to ground his conclusion on tariffs in Russia being overblown on
the fact that according to his calculations, the share of Russia's GDP spent on
electricity is 2.5-3 times higher than in the United States and other developed countries.
In fact, calculated as the correlation of the cost of the electricity released to
consumers and gross domestic product, the share of Russian GDP spent on electricity in
1995 came to 5.0 per cent, in 1997 - 5.4 per cent, in 2000 - 3.1 per cent, and in 2001 -
3.3 per cent. This is comparable with the proportion of GDP spent on electricity in such
countries as Sweden and Finland, which have similar climatic conditions to Russia. We must
also take into account the fact that energy costs to manufacture a single item are
significantly higher than European parameters in the Russian economy because of the lack
of energy-saving technologies.
To confirm his thesis about high electricity tariffs in Russia, Mr Illarionov compares
tariffs in the Republics of Kalmykia and Sakha (Yakutia) and in Arkhangelsk, Kamchatka,
and Sakhalin Regions with prices in France, Finland, Norway, and New Zealand. This
comparison is wrong and tendentious. Most of the aforementioned Russian regions'
electricity systems are isolated. A large part of the fuel prices are made up by transport
costs. Kalmykia has no electricity production facility of its own and there is a high
level of cross subsidization. The cost of electricity on Sakhalin or in Chukotka
Autonomous Area is rightly to be compared not with European states with their own
generating capacities and working in harshly competitive conditions but, for example, with
Alaska, where it is very high.
Mr Illarionov goes on to claim that in Russia internal prices for fuel oil come to 20-25
per cent of world prices, for gas - 15-20 per cent, for oil -20-30 per cent, and for
electricity - 40-50 per cent of the level of prices in developed countries. Mr Illarionov
consequently once again concludes that Russian electricity prices are overblown. As we
know, the internal price for oil in Russia is a transfer price. As we also know, the price
of fuel oil on the internal Russian market depends on the tasks to supply fuel to the
internal market set by the Russian Energy Ministry and the export duty on fuel oil. The
gas price is also regulated by the state. Moreover, oil and gas companies do not derive
the bulk of their profit from selling crude on the internal market but from export
supplies. As we know, Gazprom's activity on the internal market is loss-making and the
price on the oil companies' end product - gasoline - has now practically come level with
prices in the United States, something Mr Illarionov passes over in silence.
Investment
In his Rossiyskaya Gazeta article, Mr Illarionov once again tries to justify his thesis
that investments in generating capacities are unnecessary because the country has
"surplus capacity". He does not, however, mention the fact that because of the
shortage of investment, wear and tear of UES production capacities now exceeds 50 per
cent. Including:
-30 per cent (power transformers) to 70 per cent (electric motors) of items of
electro-technical apparatus have outlived their usefulness;
- Of the 249 150-1,200-megawatt reactor units, 80 per cent have an accrued operating time
of over half the class's life;
- The wear and tear of the electricity grids' fixed assets comes to over 40 per cent while
substation equipment has a wear and tear of over 60 per cent.
Aside from this, because of the shortage of investment, the holding companies' enterprises
are using equipment that is not only physically worn out but also obsolete and
ineffective. Meanwhile, replacing the currently used gas turbines with an efficiency of
30-35 per cent with modern steam and gas devices with efficiencies of 56-60 per cent would
allow a saving of around 40bn cubic meters of gas a year from the 140bn cubic metres a
year currently consumed by UES enterprises. Moreover, most of the surplus capacities Mr
Illarionov refers to are so-called closed-off capacities. Making full use of them would
require significant investment in developing the electricity grids. It is precisely in
order to attract investment that the electricity industry needs to be reformed. Otherwise
the wear and tear of fixed assets will lead to an avalanche-like exiting of capacities
over 2005-2010 and a corresponding rise in tariffs.
Mr Illarionov also reproaches the UES management for the fact that investment in the
holding company in 2002 has fallen in comparison with 1997 while investment in the
Rosenergoatom concern has grown. As we know, the investment programmes of UES and
Rosenergoatom and the priorities for developing the electricity industry, including
questions of radioactive safety, are set by the Russian Federation government. Aside from
this, the effectiveness of investments has grown substantially over the last five years
after the eradication of barter operations, promissory notes, and offsetting schemes in
the electricity industry and the transition to money forms of settlement. Thus, the amount
of money being channelled into investment in the electricity industry has grown from
R2.268bn in 1998 to R20.328bn in 2002 (according to operational information). Moreover,
capital construction debts have shrunk from R3.200bn in 1998 to R700m in 2002 (according
to operational information). This is allowed a renewal of the starting up of new
facilities and the construction of previously "mothballed" ones...
Mr Illarionov once again cites a range of arguments in favour of retaining vertically
integrated companies in Russia. He claims electricity prices are lower in countries where
vertically integrated companies have been preserved during the course of reforms than in
countries where they have been split up. In reality, electricity prices and the form of
integration in the sector are not directly linked and depend on the structure of
generation, its geographic location, the equipment used, the fuel balance, and the fuel
price. After numerous discussions of this question, the vast majority of experts have
recognized that retaining vertical integration in Russia would inevitably lead to an
imbalance of tariffs and unequal conditions for the development of the economy and social
sphere in various Russian regions.
Among other complaints about the government option for reforming the electricity industry,
Mr Illarionov does not like the fact that in the first stage, the Federal Network Company
been set up as a 100 per cent subsidiary enterprise of UES. His main counterargument is
that this allegedly does not ensure non-discriminatory access to grids. Meanwhile, it is
universally known that establishing the Federal Network Company as a 100 per cent
subsidiary of UES is a temporary measure for the transition stage intended to facilitate
the process of adapting the company for independent operation. This has been done
primarily in order to maintain the reliability of the energy supply. In the next stage of
reform, the Federal Network Company's joint-stock capital will be distributed between the
proprietors of UES in proportion to their stakes. In the future, if the draft law "On
the electricity industry" is passed, the state's stake will be increased to 75 per
cent plus one voting share.
The legislation will thus ensure non-discriminatory access to Federal Network Company
grids and state control over its activity in electricity transmission services.
In conclusion, we would note that Mr Illarionov's effective charging of the UES management
with artificially creating a fuel shortage in Maritime Territory in winter 2000-2001
altogether goes beyond the boundaries of substantive analysis. We would only remind people
that the region's electricity crises stopped after the Russian president accepted the
resignation of the head of Maritime Territory and the newly elected governor introduced
electricity tariffs that were in line with the actual production costs.
UES is a transparent company that is open for discussions on current issues and prospects
for developing the electricity industry. We are always ready to provide the public with
objective information that reflects the real state of affairs in the electricity complex.
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