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Evgeny Fedorov on the issues of the energy market

The Russian energy market is going through a tumultuous time. One of last years key questions was who will get the state-owned stake (40%) in Irkutskenergo, the countrys largest power and coal company. Those concerned about this question included EuroSibEnergo, which comprises all energy assets of Oleg Deripaska, as the company owns a 50% stake in Irkutskenergo. The state-owned stake in Irkutskenergo attracted the interest of Igor Sechin, the Chairman of the Board of Directors of Rosneftegaz. RusHydro is also competing for it. The government has not yet decided who it will sell the shares of Irkutskenergo to. Evgeny Fedorov believes that they should be acquired by RusHydro.

Meanwhile, the participants of the energy market, including EuroSibEnergo, are actively involved in dividing other assets. According to Mr. Fedorov, EuroSibEnergo has made considerable investments in heat distribution networks all over the country and is still interested in acquiring heat generating facilities owned by Viktor Vekselberg and IDGC of Siberia, which operates all interregional electricity grids in Siberia.

Quite a number of investors are deterred by the lack of clear-cut regulations on the heat market governing pricing, conditions for the recovery of investments (this mechanism exists in the electricity market) etc. However, EuroSibEnergo is not discouraged by this. Evgeny Fedorov believes that now it is a good time to make investments: in Russia, there are numerous heat distribution networks built back in the Soviet times, they have not been modernized, although potentially this is a very profitable business with a short payback period. In his interview to Vedomosti, Evgeny Fedorov has told about the competitors, the role of the government in market regulation and the distribution of assets, and about investing outside Russia.

After the government has started interfering in the energy market, attempting to keep the prices down, it has faced criticism from all sides. However, power companies in Central Russia have been more actively involved in the discussion with the regulators. Is it because Siberian companies face less difficulties or because these difficulties are easier to resolve on the regional level?

The Siberian energy market does have certain special characteristics: here, over 30% of consumers are energy-intensive enterprises, for whom electricity prices are a vital factor. This is a far cry from the central region, where the only thing that matters to power generating companies is how to achieve a price rise. By contrast, we have to build the relationship with consumers very carefully. So it is not that our approach is less active; rather, it is more cautious: we normally try to negotiate locally, taking into account the economics of our key consumers. I understand the possible skepticism towards US Rusal, which, along with EuroSibEnergo, forms part of En+; but it is not the only thing that matters. Apart from aluminum smelters, in Siberia there are also timber processing plants, producers of ferroalloys, etc.; electricity costs account for 25-40% of their cost structure. The Krasnoyarsk Territory and the Irkutsk Region between them have electric boiler stations with a total capacity of 500 MW, whose operations depend crucially on electricity prices.

Power companies have complained time and again that the regulations on the electricity market are too complicated, and there are no regulations on the heat market at all. Does this hinder investments in heat distribution networks? Does this pose any obstacles to EuroSibEnergo as an investor?

In fact, the government has recently started tackling the issues of heat more actively. A special group has been formed under the Government Fuel and Energy Commission; it will deal with the issues related to heat supply. Its agenda is clear and reasonable. And if its plans are implemented, there is hope that by the end of the first quarter of this year all the key issues will be sorted out. We have only two or three years left to resolve the issues of heat distribution without causing considerable harm to the industry; the government is aware of this. But even apart from this, EuroSibEnergo is interested in heat distribution facilities. We have already acquired heat distribution networks in Sayanogorsk and leased the networks in Miass. We also hope to conclude an agreement on the long-term lease of heat distribution networks in Nizhny Novgorod in the near future. Besides, we are searching actively in the Moscow region; we have already conducted an audit in several districts.

Are you entering into a long-term lease with a view to subsequently acquiring the assets?

Not necessarily. The conditions of this kind of lease or concession are quite acceptable for us. 15 years are quite enough for implementing investment projects; they will be able to generate profit within this time frame. I do not think that currently any investor in Russia is willing to make investment for a period exceeding 15 years.

How much is EuroSibEnergo willing to invest in these projects?

We are ready to invest in all networks clearly facing the issue of a lack of financing. I will not name a specific number, but I can tell you that it amounts to billions of rubles. We have already identified about 20 projects with a five-year payback period in one district alone [in the Moscow Region] and we are clearly ready to invest in them.

Are you the only active investor in heat distribution networks or are we to expect growing competition for these assets?

I do not think there will be strong competition; there is enough work for everyone. The amount of projects is simply enormous. The facilities were built as far back as 15 years ago. If now they form part of a properly functioning commercial enterprise, no-one will even wait for an annual business plan: anyone in their right mind would switch over from boiler stations using fuel oil to gas-fired ones, given that this will pay off within one heating season.

Why then are heat distribution companies in Moscow doing nothing?

Because these are mostly municipal enterprises; they are facing the issue of arrears, they are unable to raise finance, and at the same time it is impossible to include these investments in the tariff structure.

What about heat generating assets? Have you resumed negotiations over the power plants owned by IES-Holding after Viktor Vekselberg officially announced that negotiations on the merger of assets with Gazprom Energoholding had been broken off?

We are interested in some of the power plants forming part of TGC-6 and TGC-9. But we have not yet discussed this with IES.

EuroSibEnergo has repeatedly declared its readiness to acquire IDGC of Siberia. The government has expressed an opinion that, when deciding which of the distribution grid companies should be privatized, one should definitely exclude strategic companies and troubled companies from the list of candidates. As the issue of the last mile remains unresolved, IDGC of Siberia is precisely one of the troubled companies.

It is a strange approach: a company is not troubled, it is not strategic, so lets sell something which functions properly anyway. I think that eventually the Ministry of Energy will realize that it is necessary to find a competent investment consultant who would determine what should be sold, what the consequences of this sale will be, what obligations the investor should assume, who is competing for the asset

Are there other potential buyers for IDGC of Siberia, apart from EuroSibEnergo?

Yes, there are. For instance, there are foreign grid companies that I will not name, which are more than willing to own a stake in Russian grid assets.

EuroSibEnergo owns a 50.19% in Irkutskenergo, the companys main asset. What will happen to the remaining 40% of Irkutskenergos shares? When will they be sold? Have you tried to influence the destiny of this stake in any way?

Officially, this stake is owned by Inter RAO, and we have not yet tried to do anything about it. But our opinion remains unchanged: we believe that from the point of view of the strategy it be reasonable for EuroSibEnergo and RusHydro to swap hydropower assets, with the latter company acquiring this 40% stake in Irkutskenergo (this transaction was approved by the government in 2011; under the terms of the transaction, Inter RAO was to sell the stake to RusHydro with a view to swapping assets with EuroSibEnergo.

Vedomosti). As far as we understand, in this sense Rosneftegaz is not the final destination for Irkustkenergos shares, whereas it would certainly be better for the company to have a long-term strategic shareholder right from the start.

What kind of transaction in hydropower assets can EuroSibEnergo conduct at present?

We would like to have a strategic partner, a shareholder of Irkutskenergo. We believe that RusHydro would be a logical choice. This would give us quite a number of advantages. For instance, together we could operate the Angara-Yenisei cascade of HPPs much more efficiently.

The government has resumed the discussion of yet another project of the century: the construction of grids between the first and second price zones of the wholesale market aimed at integrating the power systems of European Russia and Siberia. This will entail massive budget expenditure. Besides, for Siberia this might result in a sharp rise in electricity prices. Do you participate in discussing this scheme?

Yes, we do, and our stance is as follows: this idea is irrelevant and will certainly remain so for the next 15 years at least. The energy bridge sounds ambitious, profitable, impressive. But given the expected launch of new capacities under power supply agreements, the first price zone including the Urals and Central Russia will not need the power we generate, while the second zone in Siberia will not need the power generated by them. After all, the central part of the country and the Urals, except for certain individual regions, is unlikely to face a power shortage until 2025: the facilities built by power companies under power supply agreements are enough to meet the demand. Siberia also has a fairly balanced power system. Besides, if the electricity link is constructed, electricity prices in this region might indeed be several times higher than they are now. Cheap electricity is one of the few advantages the Siberian economy still has. Without it, the very existence of the Siberian economy will be jeopardized: the population is sparse here, thus the demand for goods and services is low, while the ports are 5,000 kilometers away All right, we have aluminum smelters accounting for about 25 percent of electricity consumption in Siberia. Suppose we will double the price for them; so what will we achieve? We will end up in the same situation as in Krasnoturyinsk.

What mechanism for encouraging investments in the Russian power industry do you think is the most efficient?

It can be any kind of mechanism; the main point is that the rules governing its use should be transparent and that it should be discussed publicly, and not behind the scenes. I think it will be something along the lines of power supply agreements: although at present this mechanism is widely criticized by large consumers, nothing more efficient has been suggested yet.

Could you explain how you manage to retain the long-term agreements between UC Rusal and EuroSibEnergo, under which the electricity price was linked to the aluminum price on the LME, after new regulations on the electricity market were adopted last year? After all, under these rules, consumers have to pay twice as much for capacity. Did some companies within the group have to make concessions?

No, we have merely made amendments to the agreements; under these agreements, we used to sell both electricity and capacity, whereas now we only sell electricity. As for capacity, UC Rusal buys it in the market.

But this is merely a short-term solution to the problem.

Yes, this is an adjustment to the current market conditions, which are not very logical. It might seem absurd, but, essentially, we are prohibited from conducting direct sale and purchase transactions. The cause of this problem lies in the fact that there are two commodities in the market, not one: electricity and capacity. Until we abandon this model in favor of trading in a single commodity, distortions are inevitable. The problems that our company faced last year are a clear illustration of the issues that will arise in the future. In the course of competitive capacity selection for 2013, when the list is made of the most efficient power plants payment for the capacity of which is guaranteed, one of our power plants failed to pass the selection procedure. This happened because the cost of its capacity was higher than that of its competitors. But the cost of electricity generation was considerably lower, which means that the price consumers would ultimately have to pay would also be lower 1.5 times lower! In other words, the price signal was distorted and turned into its opposite. If there was no division into two commodities and consumers paid a single fee for electricity and capacity taken together, this situation would not have arisen.

Why then were these issues not discussed publicly?

Because there is the opinion of the System Operator, which stated that selection was made strictly in compliance with the methodology. The Operator admitted, though, that sometimes failures occur in the model; but it was already too late, so it will only be possible to rectify the situation starting from the next period of regulation, while for 2013 we need a special resolution. But in actual fact it is not only this particular problem that needs to be resolved what we really need is to change the entire methodology; otherwise one blunder will be followed by another next year, and we will end up with a one-year time lag again. And this will happen all the time, while we keep fiddling with the rules.

Was your point of view supported by the new management of the Ministry of Energy?

Well, the Ministrys task is somewhat more complicated than merely supporting generating companies: apart from them, there are grids, consumers, distribution companies. But I am convinced that the Ministry of Energy is committed to resolving the issues.

Last year, EuroSibEnergo started cooperating with China Yangtze Power: together, the two companies started building 3 GW power plants in Russia. It is said that the main energy consumers include only Russian companies, despite the growing Chinese energy market close by. Are you negotiating on imports into China? What poses an obstacle to the negotiations?

There are no obstacles. If you mean doubts as to whether electricity will be exported from Russia to China in about 15 years, we have no doubts about this. I am absolutely certain that it will. We need some time to develop cooperation of this kind. Clearly, 3 GW is a laughably small figure for China; it probably equals to grid losses in some of the smaller provinces. There it is possible to find a buyer even for 10 GW power plants. We are sure that, strategically, this cooperation will develop further. But first we want to trial it with these 3 GW stations. As we build them, we will gain experience in collaboration and will get a clear idea of the interests of the parties.

In March 2012, Inter RAO signed an agreement which is valid until 2037 and enables exporting up to 4 bln kWh per year to China. Do you consider Inter RAO as your competitor in the Asian market?

In China, Russia does not face a risk of tough competition. The capacity the Chinese launch within a single year amounts to half of that of Russias entire power system so why should we be afraid of competitors? All in all, if an electricity link is to be built, it should be constructed not between the Urals and Siberia, but between Siberia and China. This is what our joint projects with Yangtze Power are aimed at.

Irkutskenergo used to operate the power system of Mongolia, and EuroSibEnergo has expressed hopes that the company will start working there again. Have you made any progress in this direction?

Mongolia is really a very interesting and promising area, but its power system is developing very slowly and inconsistently. While the Chinese intend to resolve the issues of energy shortage within the next three five-year periods, Mongolia has to solve the problems related to power supply now; otherwise they will continue to greatly hinder its economic growth for many years to come. The electricity shortage in Mongolia is really severe, but the country has no answer to the key question of who will build the generating capacities and what rules are to be followed when building them.

Are there any other candidates apart from you?

I think there are quite a number of them. The main issue is the transparency of the rules.

You have said once that, while working in Irkutsk, you have grown quite fond of the city; but before that, you did not use to show much enthusiasm about it In fact, I have a reserved attitude towards the cities where I work. There are certain things I like in Irkutsk, and there are things I like in Moscow. What I like about Irkutsk is the life balance: everything is close by, there are no traffic jams, it takes a mere five minutes to get to the office and an hour and a half to a place where you can go skiing; the nature here is beautiful. I set out for my office at 7.55, and at 8.00 Im already there; I read through various documents, sign all sorts of papers; at 8.30 I have a meeting. I finish work late, though, between 21.00 and 22.00. On Saturdays, I spend about four hours at the office, and on Sundays I dont go there.

Was it easy for you to transfer from UC Rusal to EuroSibEnergo in 2010?

I did not hesitate; besides, the special atmosphere I have mentioned (see the sidebar) can be found in any company within En+ Group. It all happened rather quickly: I was told: I believe you should transfer; I went home, discussed the situation with my wife after all, a transfer from Moscow from Irkutsk is a serious matter, I simply had to discuss it. So we discussed it, and I agreed.

So, theoretically, when told I believe you should transfer, you might refuse? Frankly, I have no idea. I have never tried to. And if you were told again that you should transfer, would you agree?

I want to continue working for a company of En+ or Basel, it is important for me. The only thing that matters is the business tasks and whether or not they are interesting for me. At 34, it would be strange to think that this or that point in ones career is final.

Some people stay with a company for decades as they find it difficult to leave.

I believe that working for the same company for more than five or seven years at the maximum is a totally wrong thing to do.

So, does this mean that you will continue working for EuroSibEnergo for two or three years more?

(Smiling.) Even three or four years.

*** A brief biography. Evgeny Fedorov was born in 1978 in Obninsk. He graduated from the Bauman Moscow State Technical University in 2001, and subsequently completed postgraduate studies at Moscow Power Engineering Institute. In 2004, he headed the Power Engineering Department at UC Rusal, an aluminum company. In 2006, he supervised the implementation of a joint project of RUSAL and RusHydro, Boguchanskoye Energy and Metals Complex. In 2008, he headed the Energy Division and later the Engineering and Construction Division of UC Rusal. In 2010, Evgeny Fedorov was appointed CEO of EuroSibEnergo and Irkutskenergo. A dynasty of power engineers. Evgeny and Denis Fedorov started their career at the same time; now the brothers head two largest Russian power companies. Denis Fedorov became the head of Gazprom Energoholding in 2009, while Evgeny has been the head of EuroSibEnergo and Irkutskenergo since 2010. Evgeny and Denis Fedorov come from a dynasty of power engineers; their father, Vladimir Alekseyevich, is a Doctor of Engineering; since 1997, he has been managing a research company in Kaluga which conducts R&D in the sphere of power engineering. Often it is at their fathers house that the brothers meet, says Denis Fedorov: We regularly come to Kaluga, sometimes together, sometimes separately; there we get some rest, we catch up on our sleep and feed ourselves up.

The spirit of Rusal. Evgeny Fedorov states that he has always worked only for the companies of Oleg Deripaska: In 2002 I joined UC Rusal; therefore I might probably have a somewhat biased opinion of the corporation, but it seems to me that Rusal really has a special spirit that attracts people. This is really the largest private corporation. And people feel very comfortable in this company because its ultimate goals are clearly formulated and easy to understand. There are no nuanced like we are supposedly seeking to achieve business efficiency, but there are also some other interests, so we abandon our goals in their favor, the way it often happens in state-owned corporations. I think that the very purpose of state-owned companies is not quite clear: on the one hand, there is an ultimate beneficiary, but on the other hand, this beneficiary is in fact a group of people who all have different interests and attitudes to life. By contrast, in our company, everyone has a clear view of what they are working towards and what results they are expected to deliver. So I can hardly imagine transferring to a different company.

EuroSibEnergo is a power company owned by En+ Group. Financial results (2011): the revenue totaled RUB 99.248 bln, net income totaled RUB 13.854 bln. EuroSibEnergo is Russias largest private power company and one of the worlds leaders in hydropower generation. It was established through mergers and acquisitions of power generating, engineering and coal assets starting from 2001. EuroSibEnergo operates 18 power plants with a total installed capacity of 19.5 GW, as well as heat generating assets whose capacity totals 17,485 Gcal/h. The companys major HPPs located on the Angara and Yenisei Rivers (the Krasnoyarskaya, Bratskaya, Ust-Ilimskaya and Irkutskaya HPPs) have a total capacity of over 15 GW. EuroSibEnergos principal asset, Irkutskenergo, is Russias largest power and coal company.

Ksenia Dokukina, Vedomosti

January 18, 2013
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