Last month (February) the Lower House of the Russian parliament gave the final approval to a package of bills to fully privatize and liberalize Russia’s monopolistic electricity sector. The passage of the key bill in the package means the legislation now goes to the upper house, the Federation Council, where it is expected to face less debate than in the lower house.

Like many liberalizations around the world, there is never unanimous agreement that it is the right thing to do, especially with a sector producing a commodity that is seen as essential. The move to break up the majority government-owned Unified Energy Systems (UES), caused heated debate in the Duma with legislators pointing to the failures of previous privatizations. One Communist legislator noted: “We are fed up with the results of privatization in industry and other spheres of the economy. There is no doubt that privatization of generating facilities will lead to the same results.” Romanov was referring to industries which have seen tycoons amass huge assets for far less than their probable market value.

Other critics pointed out that the law gives way to privatization but does not secure sector transparency. No doubt Romanov and other critics know the pitfalls of doing business in Russia better than I, but whether the critics have a case or not is not the point. The question is: without privatization, how does Russia raise the money needed to rehabilitate its ageing power plant and meet increasing demand? Certainly the need is urgent.

Installed capacity stands at just over 200 000 MW, although only about 170 000 MW is actually available. It is estimated that some 50 per cent of the country’s power assets have passed their intended lifespan. By 2010, about 110 000 MW of generating capacity will have reached retirement age (see PEi, January 2003, page 15).

In fully liberalizing its electricity sector, the Russian government will face all the problems that other countries have faced: adjusting tariffs to reflect the cost of generation and ensure investors can get a reasonable return on investment; pricing assets realistically to attract buyers while maximising its own return.

One of the most thorny issues will be increasing electricity prices – while maintaining public support. Under the plan, the amount by which electricity prices can rise during the reform process will be capped. Russia will likely follow the example of other countries that have subsidised tariffs, and raise tariffs in two or three steps over a period of a few years. This will reduce social impact and subsequently meet with less opposition.

The size of the task facing Russia should not be underestimated. The Russian electricity sector is the largest in the world. Its power grids span 9000 km east to west through six time zones. Yet certain parts of the bill have met with controversy. Most notably, the reforms have removed a fixed date for the start of a free wholesale market but stipulate that it will be no earlier than June 1, 2005, the date originally planned. Further, the wholesale market will now be introduced region-by-region, as opposed to nationwide.

With the size of the Russian market and the poor state of its electricity sector, it makes sense to be not only realistic about the time it will take but also to allow some flexibility in the start date for the wholesale market. Global experience has shown that setting specific start dates often proves to be an exercise in futility. How often have we seen smaller, more developed markets fail to meet target dates? A regional approach is probably also a sensible idea. This will probably be not too dissimilar to what is being done in China.

With Russia it is more than just a case of carefully planned electricity sector reform; the whole banking system needs to be reformed. The sooner this happens, the better – for Russia and the whole European power sector. Russia needs an estimated $70 billion to rehabilitate and upgrade, generation, transmission and distribution facilities.

At the same time, European players need Russia. With the indecision in Eastern Europe and the degree of consolidation that has already taken place in Western Europe; opportunities for strategic, reasonably priced investments are becoming increasingly difficult to find.

Nevertheless, foreign investors will remain cautious about investing in Russia. The rewards may be great but the risks are high. And with the current problems facing global power players, moving into risky markets cannot be high on anyone’s agenda. Certainly the march into Russia will come, but the frontline soldiers will be in no hurry.