The structural defects of the utilities sector...

1. WestMerchant-CISME Conference on Corporate GovernanceUtilitiesA case studyMiles SaltielHead of Equity Research—European Emerging MarketsWest Merchant BankLondon Business School30th June 1998

2. The structural defects of the utilities sector... ...begin with a flawed industrial structure

3. ...and continue with... … regulatory failure

4. Incoherent regulatory objectives • Protection of consumers tainted by political weakness • Heavy industry • Households—both price and collection • Protection of suppliers tainted by conflict • Coal (employment vs economy vs pollution) • Nuclear (high tech emblem vs safety) • Gas (economy vs depletion vs transfer pricing) • No anti-cartel tradition to challenge monopolistic re-integration Enables a classic “regulatory capture”

5. Overseas Investors Russian Gov’t Local Gov’ts Russian Investors Mgt & employees Other Investors 11.3% 5.5% 30.7% 52.5% 60% 100% 100% Irkutsk-energo Tat- energo UES RNPC <49% 49-100% 100% 100% 19.7MW 7 Energos2 Stations L’grad Nuc Station 8 nuclear stations 42 Energos 9 Energos 20.2MW 45.6MW 18.4MW One hundred percent of nine energos, representing nine percent of capacity 100% 49% 51-87% 21MW Controlling stakes in 42 energos, representing 22% of capacity Grid 14 Energos 10 stations Minority stakes in 21 energos, representing a further 22% of capacity Other wholly-owned assets representing 16% of capacity 24.4MW 24.8MW 100% 100% 100% De facto control of some eighty percent of generating capacity 7 Leased stations 12 stations 4 branches 17.7MW 2.7MW 12.2MW UES dominates an unliberalised structure

6. Twelve percent dilutionthreatened at Mosenergo In the absence of satisfactory governance—rent-seeking • The former UES management declined to consider rebalancing its portfolio • Instead it sought to dilute outside holders of Energos • The plan was to force duff assets on them at inflated prices denominated in new stock Similar plans once beset the entire sector

7. Plus capacity hoarding Rent-seeking—2 Utilisation Wholly owned energos 54% Minority owned energos 48% Majority owned energos 45% Independent energos 43% Other power plant assets 41% Wholly owned p plant subsids 40% Part owned power plant subsids 39% Leased-out power plants 36% Average for system 45% Compare UK 57% • Divergence of interest between prefs & ords exploited by managements • The local energos retain anti-investor statutes, also resisting control by UES • The Duma has sought to maintain protection of the Rodina by introducing restrictions on overseas ownership “A bunch of bald guys fighting about a comb”

8. Regulators protect consumers Mutually conflictingregulation Incestuous ownership Owners seek returns Efficiency maximising management, subject to law Rent-seeking management ...and the actual the model To recap:

9. The consequences • Overcapacity prevails, tariffs remain unbalanced, energy supplies mis-priced • Management remains more concerned about control and/or independence than operational efficiency • Energy retains its part in an unintended hodge-podge of social policies • Utility bills remain uncollected, taxes and wages unpaid, the economy enmired in barter The public interest has been seen off

10. One: develop three models to liberalise energy markets European Russia Independent, not-for-profit grid Reorganisation of UES’ capacity into competitive companies Hydro (to be used for stabilisation) & tranmission subject to regulation Siberia—Competitive integrated hydro-based utilities Far East—Integrated monopoly, subject to regulation Two: improve control over subsids But n.b. potential conflict with objectives for competition Three: Facilitate investment But do we really believe in new investment in capacity? The Chubais proposals Liberalise a sclerotic structure

11. He may not be Superman Conclusion • Corporate governance has undoubtedly failed the utility sector—and Russia • It is, however, only part of the story • Regulatory inadequacies and flawed industrial structure play at least as great a part • Both find their roots in political weakness but Chubais’ proposals look the best hope of reform