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RAO UES of Russia: Investment Phase of the Reform

A. B. Chubais

Chairman of the Management Board RAO UES of Russia

10th Annual Investor Conference"Russia: Looking into the Future"

June 20, 2006Moscow

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1. Investment Phase of the Reform: Essence, Concept, Volumes and Mechanisms …………………………. 3-9

2. Structural Transformations …………………………………………………… 10-12

3. Market Liberalization ……………………………………………………………. 13-14

4. Conclusions ……………………………………………………………………….. 15

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Investment Phase of the Reform: Essence

Power Industry Reform: Investment Phase(2006–2008)

Completionof structural

transformations

Liberalizationof electricity

markets

Attraction of large-scale long-term investment

in the Russian electricity industry

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Investment: Concept and Volumes

Restructuring Concept

Investment annually required for the electricity industry:

about $7 billion in 2006, about $20 billion a year from 2008

Investment Deployment Concept

Budget financing

Private investment

Industry'scompetitive sectors (primarily, thermal generation)

Industry'snatural monopolysectors

Large-scale investment needs to be attracted,not after the completion of the reform, but during its final phase! !

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Investment in the Russian Electricity Industry:Demand

Source: RAO UESR estimates; material for the June 7, 2006 session of the Russian Government

2006–2010:

Electricity industry's demand for investment: about 2.3 trillion rubles (over $85 billion), including generation demand: about 1.28 trillion rubles (over $47 billion)

2006-2010

9

21.8

38

0

10

20

30

40

2001-2005 2011-2015

GW

Commissioning of generation capacity in Russia:actual and demand

1.6

2.5

3.9

6.67.2

0

2

4

6

8

2006 2007 2008 2009 2010

GW

Capacity commissioning

dynamics, 2006–2010

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Investment in Competitive Sectors:Major Mechanisms

Thermal generation is primary investment target

2/3 of Russia's total power generation

Additional issue of shares in Wholesale Generation Companies (WGCs) and Territorial Generation

Companies (TGCs)

Investment Guarantee Mechanism

Direct private investment

in local projects

Private placement

Public placement

Projectfinancing

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Potential Candidates for the First Placements of Additional Shares

Company Share held by RAO UES of Russia

before additional issue

Smallest possible share to be held by RAO UES of Russia

after additional issue

Largest possible additional issue

(percentage of current authorized capital)

WGC-3 59.72% 25% + 1 share 138.7%

WGC-4 89.6%* 50% + 1 share 79.2%

WGC-5 87.7% 75% + 1 share 16.8%

Mosenergo 50.9% 25% + 1 share 103.5%

TGC-9 50.03% 25% + 1 share 99.9%

* - Upon completion of company formation (Q3 2006)

Fundamental principles for defining the exact volumes, time limits, and sequence of each additional issue are:

• Investors' actual demand for additionally issued shares• Market trends: maximize placement price • Provision of funds for companies' investment projects in specified volumes and within the required time limits

!Figures shown in columns 3 and 4 define the limits of each additional issue.

None of these figures are an end in itself.

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Investment in Competitive SectorsInvestment Guarantee Mechanism

Essence:

to compensate the investor for the difference between the electricity price formed in the marketand the price necessary for the investment project payback

Total generation capacity to be constructed using the Mechanism

in 2006–2010:

about 5,000 MW

The first projects will be implemented in the following energy systems: Tyumenskaya, Tulskaya, Sverdlovskaya, Kuzbasskaya, Tomskaya

Investment Guarantee Mechanismapproved by a Government Resolution in December 2005

2006: the first bids to attract investment through the Mechanism

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Special purposeinvestments Loans

VAT refundand othersources

Additional issue of shares inFederal Grid Company, System

Operator, and Hydro WGCto be transferred to the

Government*

Federal Grid Companyof Unified Energy System

(FGC UES)

System Operator –Centralized Dispatching

Administration (SO – CDA)Hydro WGC

* Funds from the FederalBudget required topurchase sharesin 2007–2009: 160 billion rubles

* Funds from the FederalBudget required topurchase sharesin 2007–2009: 5.02 billion rubles

* Funds from the FederalBudget required topurchase sharesin 2007–2009: 39 billion rubles

Investment in Natural Monopoly Sectors:Major Mechanisms

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Structural Transformations and Market Formation:Main Results as of mid-2006

Electricity Industry Reform (2001–2006)

Structural Transformations Market Formation

• 7 out of 7 WGCs, 13 out of 14 TGCs, 4 out of 4 Interregional Distribution Grid Companies (IDGCs) established

• Federal Grid Company and System Operator established and in operation

• Unbundling by activity type completed in 57 out of 72 regional energy companies

• Shares in 83 new generation, grid, sales, service and management companies placed in the Russian stock market (including shares in WGC-3, WGC-5, and TGC-3)

• Free Trade Sector of the Wholesale Electricity Market established and in operation (annual trade volume is about $3.5 billion)

• Competitive balancing electricity market in operation

• All large generation companies brought to the wholesale market (as from January 1, 2006)

• New model formed for the wholesale electricity and capacity markets (the model is based on a bilateral contract system and competitive markets)

• New rules developed for the functioning of retail electricity markets

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Structural Transformations: in the Short Term (from August 1, 2006)

Structural Transformations

Preparatory works for share placement inthe first WGCs and TGCs

First Reorganization:pro rata distribution of shares

General Meeting of Shareholders ofRAO UES of Russia (November 2006)

Board of Directors of RAO UES of Russia(June 23, 2006)

• Selection of 1-3 generation companieswith pro rata distribution of shares(candidates: WGC-3, WGC-5, TGC-5)

• Decision on the additional issue and placement of shares in 3–5 Thermal WGCs and TGCs in the stock market

Board of Directors of RAO UES of Russia (July–September)

• Approval of specific characteristics of the additional issue and placement of shares in WGCs and TGCs based on the list approved on June 23, 2006

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Structural Transformations: in the Medium Term (2007–2008)

Share placement in the rest of TGCs and WGCs

Structural Transformations

Second Reorganization:pro rata distribution of shares

General Meeting of Shareholders ofRAO UES of Russia (2008)

Board of Directors of RAO UES of Russia (2007–2008)

•Unbundling of RAO UES of Russia• Pro rata distribution of company`s assetsamong shareholders• Transfer of functions to the Government and to the power infrastructuralentities

• Decisions on the additional issue andplacement of shares in WGCs and TGCs

Possible additional decisions:

Sale of minority shareholdings inthermal generation companies

Direct equity in project finance investments inthermal power plants SPVs

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Market Liberalization: in the Short Term (from August 1, 2006)

Launch of short-term RBCs(with a term until the end of 2006)

Market Structure (from August 1, 2006)

Regulated Bilateral Contracts (RBCs)

Competitive Markets

The 2007 State Budget should fund the termination of

cross-subsidies

• Status of the Supplier of Last Resort• Translation of the Wholesale Market price to retail consumers in the case of deviations from contractual volumes

Day-Ahead Market (spot)

Balancing Market

New rules in the Retail Market

!!

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Modifying and Supplementing Market Structure

Transition to the long-term RBCs(with a term of 3 years)

Capacity Market

Ancillary Services Market

Retail Market• All new generation to be commissioned into the free market (spot or Free Bilateral Contracts). • Synchronization of liberalization processes in

the wholesale and retail markets• Termination of cross-subsidies

Competitive market through auctions held by SO

• Transition from tariff-based capacity sales to competitive capacity trade at auctions held by SO• Transition from one-year auctions to long-term auctions

• Gradual market liberalization: within a range from 5% to 15% a year(5% from January 1, 2007)• Voluntary exit from RBCs and entry into Free Bilateral Contracts, spot market

Market Liberalization: in the Medium Term (2007–2008)

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Investment Phase of the Reform: Impact on Investors – Impact on the Electricity Industry

Financial stability in afree market

environment

Predictable payback and financial profitability of

investment projects

Growth in capitalization of energy companies and

their appeal as an investment destination

Implementation of large-scale investment projects,

satisfaction of growing demand for electricity

Investors Power Companies

ROI guaranteesFavorable conditions to

attract investmentInvestment Phase

of theReform