Putin Retakes the Commanding Heights “Communism is Soviet power plus electrification” Lenin

Nothing symbolizes Russia’s economic problems better than its creaky electricity network.  Russia’s electricity generation and transmission capacity was already stretched to its limits during the Soviet period. Most equipment dates back to the electrification drive of the 1930s. Electricity supply is unreliable. Few customers pay enough to cover costs. There is no real regulatory framework.

With the collapse of the USSR, the state-owned Unified Energy System (UES) succeeded the Ministry of Electricity. Prior to 2003, there was virtually no domestic investment in the electricity system. Electricity remained a political football. Regional and municipal governments sold electricity below costs or gave it away free to households. Providers covered their costs, if they were lucky. There were no funds in national or regional budgets for investment in electricity infrastructure.

Russian reformers, headed by UES chairman Anatoly Chubais, saw the electricity system’s salvation in privatization and competition. They peddled promises of market liberalization, deregulation and government assurances to bring in Western investment.

From 2003 to 2008, the government broke up UES and drew in billions of dollars in foreign investment to modernize the industry and create a competitive market for power. The Russian state sold generating and transmission assets to Russian private companies and to European energy giants, such as E.ON,  Enel SpA and Fortum Oyj. The primary concern of investors was whether the Russian government would really allow rate increases to pay off the investment, but these deals were not negotiated in a back room. E.ON’s six billion dollar investment in the Urals and Siberian electricity generating company OGK-4 was signed in the presence of Vladimir Putin and Angela Merkel.  

I can imagine the shock of E.ON and other Western investors to learn that on July 7   Russia announced its intention to de facto re-nationalize the electricity market. Russia’s natural gas giant Gazprom and “privately-held” IES Holding agreed to combine their electricity assets. The new company will supply 70 percent of Russia’s electricity.

The majority shareholder of Gazprom is the Russian government. The Kremlin-friendly billionaire Viktor Vekselberg owns IES. In addition to Gazprom and IES, InterRAO, a state-controlled electricity trader created during privatization, has also been buying power assets to bring more of the industry under state control.

In the announcement of the Gazprom-IES deal, Veksleberg stated that the new company could save billions because “it can buy natural gas cheap from Gazprom.” In other words, over seventy percent of Russian electricity will be produced by a monopoly that uses subsidized natural gas to produce at much lower costs than competitors.

So much for increased competition  and deregulation of Russia’s electricity market. This announcement should send Western investors scrambling for the exit.

As in oil and gas, Putin has recaptured the “commanding heights” of Russian electricity for the Russian state. This is not good news for the Russian economy. It is another slap in the face for Western investors.