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Financial Times: Russian power reform

EXTRACT:as the Kremlin’s treatment of Yukos, Royal Dutch Shell and BP demonstrate, investors’ money to rebuild Russia is often welcomed, only for the rules to change later on.

Published: May 31 2007 03:00 | Last updated: May 31 2007 03:00

Russia’s recent economic and geopolitical resurgence belies some serious weaknesses at home. One is the country’s ageing electricity system. In his recent address to the Duma, President Vladimir Putin said that, up to 2020, the sector would need new investment of $460bn – equivalent to 34 per cent of Russia’s current, commodity-charged gross domestic product.

That means tapping the capital markets, which is why the long-stalled restructuring of the power sector has finally kicked off. Unified Energy System, the state-controlled monolith, is being broken up into generation, supply and wires units, with stakes being sold to investors.

The valuations fetched in the initial auctions of UES’s components demonstrated investors’ faith in the project, as does UES’s 2007 price/earnings multiple of 43 times, which was about double the level of 12 months ago. Justifying such optimism largely depends on what happens with domestic electricity prices.

Russian households’ monthly power bills are perhaps less than $15, which is a quarter of what goes to alcohol and cigarettes, according to Renaissance Capital. The broker reckons tariffs will need to double between now and 2011 if investors are to earn an adequate return on the capital being funnelled into the sector.

The good news is that many Russians clearly have the capacity to absorb higher prices. No politician likes to raise prices for basic goods such as power, but the prospect of the lights going out in the early years of a new presidency could help them overcome that. There are two big reasons to be cautious, however.

First, Russia is not the only big emerging economy embarking on a massive overhaul of its power sector, so cost inflation and delays are real risks. Second, as the Kremlin’s treatment of Yukos, Royal Dutch Shell and BP demonstrate, investors’ money to rebuild Russia is often welcomed, only for the rules to change later on.

Copyright The Financial Times Limited 2007

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