The Importance of Antitrust Regulation for the Creation of Competitive Relations in the Russian Power Industry.

Pirozhenko Alexander

Federal Antimonopoly Service

Italy, Rome June 1, 2006

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«The key to success in creating competitive power market (…) in Russia is to create strong, well-financed, well-informed, trained and independent regulator capable of providing access to grids and other monopolies’ products and services on fair and reasonable terms for all market participants»

Claude Mandil, ex-Executive Director of International Energy Agency (IEA)

Quote

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1. Antipasti: Conditions for competition development on Russian power markets

2. Il primo piatto: The role of FAS in power industry restructuring

3. Il secondo piatto: Risks of price manipulation in the wholesale power market

4. I dolchi: Control over price manipulation: the Russian approach

1. Conditions for competition development on Russian power markets

Antipasti:

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The most important conditions for the creation of competitive energy markets

On the wholesale level:- Sufficient number of independent producers- Separation of competitive activities from monopolistic ones- Non-discriminatory access to services provided by natural

monopolies- Control over price manipulation- Developed power grid

On the retail level:- Option for consumers to choose a power supplier- Wholesale power cost differentiation should be reflected in retail

market’s prices:- Wholesale price translation- Hourly record translation

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Configuration of generation companies (1)

Pursuant to the Russian Federation Government Resolutions, generation companies comprise assets of the RAO UESR Holding: 6 thermal WGCs on extraterritorial basis 1 Hydro-WGC on the basis of hydroelectric power plants 14 TGCs on territorial basis

There are 5 companies independent from RAO “UES of Russia” in the wholesale market: Concern “Rosenergoatom” “Irkutskenergo” “Novosibirskenergo” “Bashkirenergo” “Tatenergo”

It is assumed that in the process of restructuring the State will withdraw from the equity capital of thermal WGCs and all TGCs

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Generation companies are created with maximum limitation of their market power.

Each WGC and TGC could have the least influence over wholesale power market prices.

The configuration of generation companies was independently evaluated by FAS and was approved for arrangement of conditions for the development of actual competition in the wholesale market.

CR-3 index for the two Russian price areas within the wholesale market:

Europe+Ural Siberia

Configuration of generation companies’ (2)

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WGC-6 - 2,85

Hydro WGC - 14,59

TGC-11 - 4,56

TGC-12 - 11,63

TGC-13 - 5,7

TGC-14 - 1,37

Irkutskenergo - 29,41

WGC-3 - 3,49

WGC-4 - 3,28

Uzhno-Kuzbasskaya

TPP - 1,7

Zapadni-Sibirskaya TPP -

2,8

Krasnoyarskaya HPP - 13,68

Novosibirskenergo - 6,84

Holding RAO “UES of Russia” - 45,57%Independent producers - 54,43%

The second price zone (Siberia)

Market concentration (installed capacity of generation companies)

The first price zone (Europe + Ural)

Holding RAO “UES of Russia” - 72,55%Concern «Rosenergoatom» - 15,42%Independent AO-energos - 12,03%

TGC-6-2,08

TGC-5-1,68

TGC-8 -2,35

Rosenergoatom-15,42

TGC-7-4,63

TGC-9-3,15

TGC-10-1,74

TGC-4-2,21

Tatenergo-3,45

Bashkirenergo-8,58

WGC-1-6,37

WGC-2-5,83

WGC-3-4,67

WGC-4-4,8

WGC-5-5,83

WGC-6-5,2

Hydro WGC-9,19

TGC-1-4,09

TGC-2-1,61TGC-3-7,11

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6,116,04

3,37

6,01

1,76

3,523,65

1,42

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1,941,51,4

3,992,49

8,53

2,43

8,68

21,92

2,923,38

0

5

10

15

20

25

WGC-1

WGC-2

WGC-3

WGC-4

WGC-5

WGC-6

TGC-1

TGC-2

TGC-3

TGC-4

TGC-5

TGC-6

TGC-7

TGC-8

TGC-9

TGC-10

Hydro WGC

Rosenergoatom

Tatenergo

Bashkirenergo

Supposing the reform was completed in 2005?Share assessment between generation companies in Europe and Urals(index shows the output volume).

Holding RAO “UES of Russia”Independentproducers

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3,183,99

2,774,99

13,1

7,69

2,44

31,22

5,18

24,44

0

5

10

15

20

25

30

35

WGC-3

WGC-4

WGC-6

TGC-11

TGC-12

TGC-13

TGC-14

Hydro WGC

Novosibirskenergo

Irkutskenergo

Holding RAO “UES of Russia”Independent producers

Supposing the reform was completed in 2005?Share assessment between generation companies in Siberia(index shows the output volume).

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Market concentration in Russia

Market concentration in the second price zone is higher than that in the first price zone. But it doesn’t mean that leading companies – HydroWGC and Irkutskenergo – have considerable market power, because the largest contribution to the amount of energy produced by these companies is made by hydroelectric power plants, which have limited opportunities to influence market prices.

But the results of the investigation carried out by the Federal Antimonopoly Service of Russia in order to evaluate the situation with Kuzbassenergo restructuring showed that TGC-12, which was established on the basis of Kuzbassenergo assets, has considerable market power and thus may influence market prices in Siberia. For this reason, the decision was taken to exclude two Kuzbassenergo’s power plants from the configuration of TGC-12. These power plants are to be sold in the auction by mid-2007.

Considerable market share of the Concern “Rosenergoatom” is not proportional to its market power. The company has limited opportunities to influence prices.

According to the wholesale market rules, producers make zero price bids for the minimum amount of the technological production (cogeneration, safe working conditions for nuclear power plants, restrictions on water content for HEPPs)

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Market power of energy producers is determined by:

1. Market share (including potential one, i.e. installed capacity share)

However, market boundaries are flexible; they may change depending on the following factors: current balance between supply and demand, presence of system restrictions

2. Correlation between producer’s supply volume and the “remaining supply” of other producers

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Unbundling

The Russian legislation specifies the necessity to separate competitive activities from natural monopoly ones before April 1, 2006

This requirement of the legislation is the strictest in the world: all energy companies, irrespective of their size, must separate their activities

Different legal entities should perform different activity types, but during the transition period some of them may be affiliated

Energy companies that fail to undergo unbundling by activity type are subject to compulsory reorganization

By the end of 2006 unbundling will be practically completed (by now more than 35% of companies have separated their activities)

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Non-discriminatory access to services provided by energy monopolies

In 2004 the Russian Federation Government approved the rules for non-discriminatory access to services provided by:

- grid companies- Trading System Administrator - System Operator

and:The rules for the connection to power grids

2. The role of FAS in power industry restructuring

Il primo piatto:

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Powers of FAS in the power industry

1. Antimonopoly control in accordance with the antitrust legislation

2. Antimonopoly control in accordance with the special regulations imposed by the Federal Law “On the Electric Power Industry”, which controls:

the level of economic concentration in the power market power market prices

3. FAS is the authority commissioned by the government to control: Trading System Administrator Observance of the rules for the non-discriminatory access to the infrastructure Observance of the standards of information disclosure by both wholesale and retail

market participants Observance of the requirements imposed by the legislation concerning unbundling

of energy companies by activity type

Besides, FAS plays a very important role in defining the strategy and tactics of the restructuring of the Russian power sector

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Tasks of FAS in the wholesale power market

1. To avoid price manipulation by means of: Abuse of dominant position

by power suppliers Vertical integration (including restrictions on fuel supplies) Horizontal integration (affiliation of generation companies, which

are capable of influencing prices) Agreements and agreed decisions (between producers;

between producers and infrastructure organizations: the System Operator, Trading System Administrator, grid companies)

2. To provide free and non-discriminatory access of producers and consumers to wholesale market

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problem consequence FAS solutions

Horizontal integration

Risks of market power abuse grow – companies may manipulate prices

To limit acquisition of control over those WGCs or TGCs that are located in one area (if they have an opportunity to influence prices together) by a group of people

Vertical integration «fuel supplier – generation company»

Shake-out of competitive generation companies by manipulating fuel supplies – rise in prices for electric power

To limit acquisition of control over WGCs or TGCs by fuel companies that have a dominant position in fuel supplies to power plants

How to reduce risks of horizontal and vertical integration in the power industry

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Tasks of FAS in the retail power market

To ensure competition using: Separation of competitive activities from natural monopoly ones Creation of conditions that encourage local supply companies to

enter the wholesale market Fair competitive selection of guaranteeing suppliers Control over non-discriminatory access to grids (by consumers and

independent supply companies) Creation of conditions that encourage consumers to use their right

to choose a supplier

It will take from 3 to 5 years to create the fully competitive retail power market in Russia

3. Risks of price manipulation in the wholesale power market

Il secondo piatto:

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The Russian market today: absence of price risks

0

50

100

150

200

250

November December January February March April May June July August September October

mln. kWh

350

400

450

500

550

600

Volume of direct contracts Free trade sector volume

Free trade sector price Regulated sector price

5068 5284 51095794 4382 4311 4948 5179

543,50

530,39

547,80555,68 557,96 556,51

548,48

551,36 556,34551,82

5078 56185415 6060

506,73 505,93

The market organized in this way, i.e. the state regulated price is a natural price cap, can’t give right market signals. In 2006 the market model will undergo changes encouraging the creation of actual competition; price risks will also appear in the market.

Regulated price (tariff)

Market price

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Special features of the power

market

Inelastic demand

Continuous (inseparable) process of production and consumption

Technical and technological limitations (production, transmission)

Peculiarity of the power market from a regulatory point of view:

not having a commonly understood dominant position (market share of more than 35%), in certain moments a producer may manipulate market price (abuse his position in the market)

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Price,RUB.

Volume, MW

Manipulation of power market price without having a considerable market share

The demand (vertical line) won’t be met without the volume produced by the generator №5. None of other generators will be able to substitute the volume of power offered by this generator.

This means that this generator may increase the price specified in its bid and set a new price (horizontal dashed line).

The volumes produced by other generators can be substituted by competitors.

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3

4

5

6

7

Х

х5 Y

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Opportunities for price manipulation:

1. Do not depend directly on the market share of generation companies.

2. Each TGC or WGC may potentially have these opportunities.

3. May arise in different periods of time depending on the balance between power supply and demand or restrictions imposed on grids, which in turn depend on: weather conditions,

preplanned or unplanned maintenance schedules for network and generation equipment,

fuel prices, and many other factors.

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CAISO (California ) 2000-2001: 640%

Daily base & peak load index APX July 2001

0

50

100

150

200

250

300

350

400

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31

Eu

ro/M

Wh

Base load Peak load

May-99

Dec-99

May-00

Dec-00

Jun-01

Dec-01

Apr-02

Month

0

50

100

150

200

250

300

350

400Actual Load

Average Cost per MWh

APX (The Netherlands ) 2001: 1200%

Price volatility in power markets

Russia is not ready for such price movements: a significant price increase may "bury" further

liberalization

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Means to reduce risks of price manipulation

1. Developed derivatives market (derivatives for electric power and capacity) - smoothing of price volatility

2. Timely and transparent development of network infrastructure in favor of market interests

3. Information transparency and efficiency of the information delivery

4. Sufficient number of independent power suppliers

5. Presence of a professional, transparent, independent and objective state regulator

6. Effective antimonopoly control based on: precautionary measures taken by the organizer of trade (TSA)

tough sanctions imposed by the State

4. Control over price manipulation: the Russian approach

I dolchi:

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Price manipulation: how to fight?

In order to reduce risks of abrupt price movements and to avoid price manipulation, most foreign power markets implement a monitoring system with individual measures and sanctions, which are different from those implemented in other markets

Russia will also have a monitoring system, which will help to avoid unfair behavior in the power market

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The Russian approach (1)

1. The Russian wholesale market monitoring and controlling system will be based on the evaluation of generation companies’ behavior in the wholesale market, when they are filing applications for their participation in the day ahead market and in the balancing market.

2. The temporary dominant position of generators will be defined. This refers to those generators, which may increase prices for electric power using the inelastic demand and the current network topology.

3. Trading System Administrator will control market behavior of such generators.

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The Russian approach (2)

1. If a leading generator increases (reduces) the price previously fixed in its price bid, TSA will correct this bid.

2. The price specified in the price bids previously made by the generator and accepted in the market during the period when this generator didn’t have a dominant position, will serve as the criterion of “competitiveness” of the bid.

3. Final evaluation of dominant producers’ behavior, which led to the price increase (reduction), will be made by the Federal Antimonopoly Service of Russia.

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The scheme of control

Market participants

Supervision in accordance with the Rules and regulations

(ex-ante control)

Supervision in accordance with the Rules and the antitrust legislation

(ex-post control)

Supervision in accordance with the Rules

Federal Antimonopoly Service

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Prospects of the control system

Availability of the control system with tough sanctions for violations is a condition that is necessary and obligatory for competitive market formation

In the future the system will be improved, thus being able to resist such complex violations as confederacy, joint strategy of price behavior etc.

Before the liquidation of RAO “UES of Russia”, the company will have a corporate system of responsibilities and liabilities imposed on Directors General of generation companies (TGCs and WGCs). They will bear responsibility for non-competitive behavior in the wholesale power market. This system is now being developed jointly by RAO UES and FAS.

Generation companies will be obliged to take notice of the system of responsibilities when choosing their market behavior, because this system doesn’t allow them to abuse their behavior in the market.

Grazie! Il conto per favore…

© Federal Antimonopoly Service