Transcript No Slide Title

WestMerchant-CISME Conference on Corporate Governance
Utilities
A case study
Miles Saltiel
Head of Equity Research—European Emerging Markets
West Merchant Bank
London Business School
30th June 1998
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533
The structural defects of the utilities sector...
Typical
Underlying structure Many independent
companies
Russia
Single holding company
plus subsids
Power generation
Several national or
regional
companies
Local companies
including leased assets
from holding co
Power transmission
—“Grid”
US: No single
owner
UK: Separate
company
Independently
owned local
companies
Owned by holding
company
Power distribution
Local companies,
generally owned by
holding company
...begin with a flawed industrial structure
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533
...and continue with...
Typical
Russia
Wholesale terms
Contract and/or
spot market
Prices regulated by fiat
Retail terms
Rebalancing plus
regulation by ROR
(US), or RPI-X (UK)
No rebalancing.
Prices regulated by fiat
Strategic thrust of
industry
Some local
reintegration, plus
international
diversification
Local reintegration
Regulatory structure Transparent; anticartel plus national
and local pricesetting
Opaque; sponsoring
and other ministries,
plus national and local
price-setting
… regulatory failure
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533
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”
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533
UES dominates an unliberalised structure
Russian
Investors
11.3%
Mgt &
employees
5.5%
Overseas
Investors
Russian
Gov’t
30.7%
52.5%
Local Gov’ts
Other
Investors
60%
100%
UES
<49%
49-100%
7 Energos
2 Stations
20.2MW
100%
Grid
100%
42 Energos
12 stations
17.7MW
RNPC
100%
9 Energos
45.6MW
18.4MW
49%
51-87%
14 Energos
10 stations
24.4MW
24.8MW
100%
4 branches
2.7MW
100%
100%
7 Leased
stations
12.2MW
100%
Irkutskenergo
Tatenergo
19.7MW
L’grad Nuc
Station
8 nuclear
stations
One hundred percent
of nine
energos,
Controlling
stakes
in 42 energos,
Minority
stakes in
representing
nine
representing
Other
wholly-owned
assets
21
energos,
representing
percent
22% of capacity
representing
a further
of control
capacityof some
De22%
facto
16% of capacity
21MW
eighty percent of generating
capacity
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533
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
100%
90%
80%
70%
60%
Twelve percent dilution threatened
at
50%
Mosenergo
40%
30%
20%
10%
0%
Before Dilution
UES
Moscow
After Dilution
Others
Similar plans once
beset the entire sector
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533
Rent-seeking—2

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
Plus capacity hoarding
Wholly owned energos
Minority owned energos
Majority owned energos
Independent energos
Other power plant assets
Wholly owned p plant subsids
Part owned power plant subsids
Leased-out power plants
Average for system
Compare UK
Utilisation
54%
48%
45%
43%
41%
40%
39%
36%
45%
57%
“A bunch of bald guys fighting
about a comb”
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533
To recap: the model
Owners seek
returns
Regulators
protect
consumers
Efficiency
maximising
management,
subject to law
...and the actual
Incestuous
ownership
Mutually
conflicting
regulation
Rent-seeking
management
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533
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
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533
The Chubais proposals
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?
Liberalise a sclerotic structure
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533
Conclusion

Corporate governance has undoubtedly failed the
utility sector—and Russia
He
may
not
be
Regulatory inadequacies and flawed industrial



It is, however, only part of the story
structure play at least as great a part
Both find their roots in political weakness
Superman
but Chubais’ proposals look the best
hope of reform
West Merchant Bank Limited 33-36 Gracechurch Street London EC3V 0AX Tel (0171) 220 8765 Fax (0171) 220 8533