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The restructuring of the electricity sector is at last under way
Russia in 2003 embarked on the restructuring of its electricity sector. The reform is to introduce competition into electricity production and supply, leaving dispatch, transmission and distribution as regulated natural monopolies with non-discriminatory third-party access to the networks. This builds on recent experience in OECD and other countries. The ultimate aim of the reform is to ensure that supply continues to meet growing demand by creating conditions that will encourage both investment in new capacity and greater efficiency of both production and consumption. This will mean allowing prices to rise to fully cost-reflective levels, ending cross subsidies and allowing markets to operate where possible. Broadly speaking, Russia’s electricity reform strategy reflects an approach to utility restructuring similar to that implemented in many other countries over the last decade or two. Its core elements include:
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breaking up the vertically integrated monopoly of production, transmission and distribution, and separating the potentially contestable activities from those that have a substantial element of natural monopoly;
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introducing competition into those activities where it is feasible, such as generation and supply; and
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setting regulated tariffs for transmission and distribution, which are natural monopolies, in such a way as to encourage efficiency and not merely cover costs.
This overall strategy is embodied in a detailed reform programme that comprises two basic pillars: a legislative framework composed of six laws adopted in March–April 2003 and a plan for the restructuring of UES itself, known as the ‘5+5’ plan (referring to the five years to the market transition and the five years after). The legislation is concerned with the fundamental rules that will govern both liberalised markets and the remaining state-controlled monopolies in the reformed sector, while ‘5+5’ is concerned primarily with asset restructuring. The legislation and the ‘5+5’ plan are closely linked, since the restructuring of UES is essential for the creation of a more competitive market structure during the transition and is, indeed, required by the unbundling provisions of the legislation.
There is a serious risk that the reform will be distorted during the implementation phase
The overall approach embodied in the reform is promising and the reform plan is thorough and well thought out. However, there remains a serious risk that its aims could be subverted by special-interest lobbying during the lengthy implementation phase. Such lobbying has been evident since the reform process was launched in 2001 and shows no sign of abating. The government’s challenge will be to ensure that the reform is implemented in a manner consistent with its overall goal of combining effective competition and effective regulation. The risk that special-interest lobbies will work to distort the reform as it is implemented is all the greater in view of the fact that the asset restructuring and the creation of the liberalised sector’s architecture are proceeding in parallel. Both are necessary elements of the reform, but conducting them simultaneously complicates the process. The value of assets to be allocated as UES is broken up will depend in many cases on the institutions and rules that are eventually created to govern the market. Participants in asset-control contests thus have powerful incentives to lobby for specific outcomes with respect to questions of regulatory reform and market design.
The state must commit itself to a genuinely competitive market…
If the reform is to achieve its major aims, the marketised segments of the sector must be characterised by real competition based on economically meaningful prices. There are two dangers here. The first is that private-sector interests will secure strategic holdings that allow them to exercise market power or even local monopoly power. The second is that the state itself will use the assets it retains, combined with the considerable regulatory powers at its disposal, to ‘manage’ the market. Even after the wholesale market is liberalised, the state will retain considerable capacity to hold down electricity prices, if it so chooses, and it could do so in ways that unduly distort the signals the market is sending and deter the very investment that the reform is meant to attract.
…While establishing a regulatory framework that is transparent, stable and credible
At the same time, a stable legal and regulatory framework, with predictable policies, will be needed to attract investment over the long term. However, it will be difficult, within the structures currently envisaged, for the government credibly to commit to the stability of the arrangements being put in place. Investors will be reluctant to enter the market if they believe the authorities will intervene in heavy handed fashion to hold down prices. Indeed, they are likely to be wary of entering any market in which regulatory authority, control of the infrastructure and the largest share of generating capacity are all concentrated in the hands of the state. An early and credible commitment by the state to withdraw from the generation business after the transition is over would be a reassuring signal to investors. A further important signal would be to clarify the rule regarding price caps, making it clear that they are to be set at very high levels and only to be imposed in very exceptional circumstances. More generally, the creation of a strong, independent regulatory authority, with a clear mandate and clear rules, would greatly reduce the need for the authorities to send such signals of their commitment to refrain from heavy-handed intervention in the market. The absence from the entire scheme of plans for such a regulator must cause concern. In the absence of strong, independent regulatory authority with a clear mandate, it will be difficult to convince investors that the legal and regulatory framework now being put in place will be stable. Investors may fear that, once they are committed, they could be subject to ex post exploitation as a result of later revision of that framework.
The government’s commitment to the reform must be clear and consistent if it is to be credible
The evolution of the reform during 2003 and the first half of 2004 well illustrated the potential pitfalls ahead. The contest over whether and how to privatise power sector assets led to repeated delays and much public conflict. While some delay need not be fatal to the reform process, the government’s evident vacillation with respect to key elements of the reform and its repeated failure to approve restructuring arrangements by the promised deadlines helped to undermine confidence in the reform as a whole and, in particular, in the government’s commitment to the arrangements set out in the electricity reform legislation and the restructuring plan approved by the government in 2003. If investors and other market participants conclude that the government is no longer really committed to the reform, then opposition to it is likely to grow and confidence to wane, making it less likely that the power sector will attract the badly needed investment that is one of the chief aims of the reform.
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The full edition of the OECD Economic Survey for the Russian Federation is available from:
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SourceOECD for subscribing institutions and many libraries
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Government officials with OLISnet accounts
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Return to the OECD Economic Survey - Russian Federation 2004 homepage
A printer-friendly Policy Brief (pdf format) may also be downloaded. The Policy Brief contains the OECD assessment and recommendations, but does not include all of the charts available from the above pages
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Economic Policy Reforms: Going for Growth 2008
