Transcript of the beginning of the meeting:

Dmitry Medvedev: I would like to say a few words before we get started.

First, I would like to discuss the modernisation of the national power industry, the main item on our current agenda, and the main projects and measures up to 2020. The sector has been modernised and reorganised over the past few years. And, of course, this is of great significance for the development of the national economy. Of course, various reforms and measures, due to be discussed by us today, are targetted towards a single goal: that of further modernising and upgrading this most important sector of the economy and to elevate it to a more advanced and sophisticated technological level. What the country needs today is a safe and effective power supply network, one that will fully meet the needs of the economy. This is about specific volumes, rates and prices, as well as the living standards of millions of our country’s citizens. We all know that electricity means light, heat and the uninterrupted operation of the housing and municipal utilities, transport and social sectors. In short, it encompasses everything, including the most important social facilities like schools and hospitals.

Demand for electricity is increasing across the world. Analysts predict that energy consumption will increase by almost a quarter by 2020, and we must make sure that there will be no power shortages. That is the most important thing. Secondly, and no less important given the current circumstances in the country, the existing costly and lengthy procedure for connecting various facilities to the power grids has to be made more affordable and less time-consuming. The modernisation of the industry should enhance generation adequacy and the performance factor of power stations and reduce the wear and tear of their basic facilities. It should, of course, also decrease losses in electricity grids that are incredibly large in this country. We have started moving in this direction. During the past year, we put into service 6 GW of new generating capacity. This is a good figure – in fact, this is the highest level since 1985.

The launch of the fourth power unit of the Kalininskaya nuclear power plant was a big event for power engineers. We will launch a similar amount of new, modernised generating capacity during this year. In the first half of the year, we have put into service new generating capacity at the Krasnodar, Krasnoyarsk and Kirishi thermal power stations. These are major facilities and we will continue launching more capacity.

We must overcome the current gap; we need new technology and the latest equipment at all stages – from electricity production to transportation and distribution. We badly need a new grid infrastructure and a modern system for managing the country’s united energy grid that suits modern market conditions in Russia. Last but not the least, we need effective mechanisms of government regulation and control in this sphere.

The investment plans of energy companies to 2020 run into the trillions of roubles. These are huge sums. We must attract a considerable part of this investment from external sources. We must create a system that encourages investors to put money into the Russian power industry and introduce modern innovative energy technology. We need to upgrade the energy industry in order to enhance its efficiency. This is one of our headaches. I’d like to draw the attention of all parties – energy companies as well as federal and regional executive authorities. We cannot afford an increase in electricity prices like we have seen in the last five years. We need to think of other mechanisms.

There is one more question that I’d like to mention in this public, first part of the Government meeting. It is linked with the build-up of our defences. It involves hundreds of thousands of young people. I’m referring to measures that are designed to raise the prestige and appeal of conscription.

It plays an important role in improving the Armed Forces. As you know, the length of service was reduced to one year on January 1, 2008. Moreover, conscripts should be freed from performing irrelevant functions and should concentrate on mastering their military specialty. The conditions of service are changing and the performance of conscripts is improving. Now specialised organisations are responsible for the upkeep of military townships and cleaning their territory. Public organisations and parents are expanding oversight over conscription.

The draft prepared by the Defence Ministry directly concerns future generations of conscripts. It provides for grants to conscripts for studies at educational and scientific organisations, including foreign institutions. They will also receive preference in applying for government civil service. Let me remind you that benefits for enrolment in universities and an opportunity to prepare for entrance exams at the expense of the state are already envisaged in the draft law on education that has been submitted to the State Duma. I hope it will open new opportunities for the education of those who have honestly fulfilled their military duty.

There are a number of other issues, including our agreements with Tajikistan on the use of our military base and on cooperation in countering drug trafficking – this is also a very important part of our work.

And, finally, there is one more formal subject that I’d like to pay attention to – I’m referring to the government healthcare commission. Obviously, health is a key indicator of quality of life. Here a great deal depends on coordinated actions of the executive branch and the entire system of executive power in the country at all levels and also on how effectively the regions are working in the sphere of healthcare. The relevant commission will be established and these issues will be within its competence. During the preliminary discussion of this issue, I decided that it will be headed by the Prime Minister, so I will deal personally with this issue, considering its importance. I hope that new, specific programmes will be drafted as a result of these efforts and we will reach new indicators that will determine the health of our people in the next few years.

Let’s start our discussion. I’d like to give the floor on the first item to Energy Minister Alexander Novak. Go ahead, please.

Alexander Novak: Mr Medvedev, ladies and gentlemen. Reliable and effective performance of the power industry is the foundation of the steady development of our economy and an indispensable condition for ensuring comfortable living conditions for our people.

Slide two shows the main characteristics and technical condition of the industry’s facilities. The installed power capacity of the national United Power Grid totalled 218 GW in the beginning of this year.

In 2011, Russia produced 1.4 trillion kWh of electricity, up 1.1% from 2010. As can be seen from our analysis, the industry’s fixed assets are extremely worn out. Much of the equipment is completely worn out (marked red on the slide) and should be replaced within the next 20 years. Please note that 74% of thermal power plants were commissioned over 30 years ago, and 22% were commissioned more than 50 years ago. More than half of power supply equipment is over 30 years old. This reduces the efficiency of the system and the reliability of customer service. Slide Three shows that we have ten times more power outages than European countries.

The situation is similar when it comes to equipment efficiency. Specific fuel consumption in Russia is more than 20% higher than in developed countries, and power distribution losses are also 1.5-2 times higher than in other countries. The Ministry was asked to develop a Russian power industry modernisation programme to 2020. The programme was drafted by leading industry institutions along with energy companies and leading power and heavy engineering enterprises (Slide Four). We carried out a technological analysis of the industry and assessed the technical condition of power generation and grid equipment and then drafted the programme.

We have identified key programme benchmarks (next slide) which include increasing the efficiency of power plants, reducing specific fuel consumption by 10%, down to 300 grams of fuel per one kWh, reducing grid losses to 4% in the unified national power grid and from 9% to 6.5% in the power distribution complex. The main goals of the programme include decommissioning obsolete power generation units, building new ones and streamlining the location of grid facilities. The programme is synched with the current arrangements for the programme for the development of the UES of Russia and regional development based on changes in network topology and streamlined loads.

Slide Six shows the volume of construction under the programme broken down by the structure of power generating plants. The programme provides for the commissioning of 76 GW of new capacity and dismantling 26.4 GW worth of old plants. More than 150 substations in main grids and 8,500 substations in distribution networks will be commissioned and over 300,000 km of transmission lines will be built or renovated. The rates of commissioning of generating capacity, of building distribution networks and high-voltage substations will be increased by over 30% on average. The rates of expanding the Unified National Power Grid (UNPG) and building medium-voltage substations should be even higher. We based our calculations of increases in energy consumption, which amounted to about 2% a year, on the master plan for the layout of electric power generation plants to 2030.

Please note that the consumption growth rate should be further adjusted in accordance with the updated forecast by the Ministry of Economic Development, and we will include these figures in our calculations.

The next slide shows how the modernisation programme will impact the replacement of worn-out equipment. The charts show the wear and tear of each type of equipment under the modernisation programme and without it.

Slide Eight. The cost of upgrading and creating new generating capacity is estimated at 6.8 trillion roubles to 2020, with a net increase in installed capacity amounting to 50 GW. We will build more new plants than upgrade existing ones. The list of new plants was drafted in accordance with basic industry documents. Deeper modernisation is achieved through increased decommissioning of obsolete equipment and commissioning new capacities based on combined-cycle gas turbine methods with extensive use of district heat supply effects. The equipment subject to decommissioning should be specified in urban heat supply schemes.

The cost of upgrading and building the power grid complex is estimated at 4.6 trillion roubles (Slide Nine). Once implemented, the programme for building and modernising the distribution grid will reduce the number of worn-out grids to 50% from the current 67%, and the number of worn-out main grids from 57% to 30%, thus reducing the gap between Russia and developed countries in half. Extensive innovations in the grid complex should help overcome new challenges with regard to creating a modern grid topology and the phased-in transition to building a smart grid in Russia based on the active-adaptive grid. Thus, the total funding under the programme will amount to 1.4 trillion roubles (Slide Ten).

Please note that the amount of investment is in line with the energy companies’ approved investment plans until 2014. Of course, the all-important question comes up: who will fund the renovation and modernisation of fixed assets in the power sector? Slide Eleven shows that the existing pricing system does not provide incentives for carrying out construction or modernisation. Using the modernisation of the coal and gas plants as an example, it can be clearly seen that the current price secures a return on existing plants but does not pay back for investments in upgrades or new construction. If domestic and export gas prices were similar, new construction would be competitive with existing plants due to fuel economy, but the price of electricity would be almost twice as high. Fuel prices would have to be increased by 30% and coal prices by 50%. Of course, in the absence of proper incentives and tools, the increase in prices does not guarantee that investments will flow into the sector.

We believe that such scenarios are unrealistic, so the question remains: where do we find sources of funding? Before we get there, I would like to start by showing Slide Twelve, where you can see how things stand with new construction and the modernisation of the power industry. In 2007, we started building power plants using investments received from privatised generation companies of RAO UES of Russia. In 2010, the mechanism for investing in the sector using a capacity supply agreement (CSA) was legally formalised. These agreements set forth fixed rates of return and provided that payments were to be made separately from market mechanisms. The chart shows that the CSA mechanism has significantly increased the number of newly commissioned capacities. The capacity will increase by 36.4 GW from 2007 to 2017, but the mechanism will stop working in 2017. As of 2012, the share of CSA in the amount of supplied power is only about 6%, or 18% in terms of cost of the total capacity payment, which, in turn, raises questions and causes justified criticism on behalf of consumers.

In view of the above (Slide Thirteen), one way to ensure the inflow of investment is to extend the CSA mechanism (dubbed by investors the CSA bar). However, such approach involves the use of state control mechanisms and ensures to a high degree the implementation of the outlined construction plans. However, there is a risk of making unnecessary decisions on building new capacities and ensuing unjustified price increases which will hurt consumers. Alternatively, there are market-based instruments for investors. They, too, have their shortcomings, since they make possible additional revenue from existing generators and create a risk of price increases in certain regions with limited power supply. Therefore, the Energy Ministry along with concerned agencies, energy companies, consumers and experts worked on both. In December, after the public discussion is over, we will report on further development of the electric power and capacity market. This will make it possible to create a new legal framework by the middle of 2013 so that changes can be made as early as 2014.

Of course, we see significant potential for improving the industry’s efficiency in terms of investment and operating costs. According to various estimates, it amounts to about 40% in developed countries. Our solutions, which will go into the minutes of this meeting, include measures to create incentives to encourage investment in the industry, adopt balanced regulatory decisions and improve the industry’s efficiency. To prevent unjustified price increases and maintain balance between reliability and price, we believe it is necessary, first, to adopt a new market model that incentivises upgrading energy facilities and obtaining investment for modernisation; develop a plan to eliminate cross-subsidies for different groups of heat consumers and payments for thermal energy and electric power. Third, we need to approve long-term regulations for grid organisations that will encourage the upgrading of power grids. Fourth, we need to develop proposals for using standard capital expenditures in relation to benchmark figures for electric power plants, including facilities using renewable energy sources.

The draft resolution also includes instructions to ensure the increased effectiveness of industry at all stages – from design to energy facility operation.

The project has been duly agreed upon with the relevant federal executive agencies and has been discussed with experts and industry stakeholders. I ask you to support the project. That's the end of the report.

Dmitry Medvedev: All right, thank you. Any comments on the report? Mr Dvorkovich, how are we going to finance the project?

Arkady Dvorkovich (Deputy Prime Minister): The funds required to modernise the electric power industry will mostly be provided by investors. Therefore, the key objective is to create a favourable investment environment.   

With regard to budget financing of commercially unattractive projects related to the development of the Far East and other distant regions, funds have been partially allocated for this purpose from the budget for the medium term.

Partly, we suggest using Rosneftegaz's extra earnings – as was mentioned during the previous government meeting. They can be used for the further capitalisation of Vnesheconombank’s subsidiary company in the Far East, as well as major energy companies like RusHydro that implement projects there and in Eastern Siberia.

With regard to creating favourable conditions for investors, there are two primary aspects. First is long-term tariff regulation, which creates a predictable operational environment for several years ahead. Second is the elimination of cross-subsidies, which was mentioned by the Minister of Energy. This should be done in relation to three components – electricity, heat, and in-between electricity and heat.

This requires detailed work in each region, as there is no universal solution for the country as a whole. The Ministry of Energy and the Ministry of Regional Development are working on this matter. With regard to electricity, work is scheduled for completion this year. Heat and in-between heat and electricity projects will end by the middle of next year. This is a priority and must be done for the new industry model to become fully functional in 2014. Thank you.

Dmitry Medvedev: All right. Are there any other comments and proposals on the protocol resolution and further activities?

Mr Ishayev, please.

Viktor Ishayev (Minister for the Development of the Far East): Thank you. Mr Medvedev, I suggest that these programmes should include the development of the power grid, since we have a single energy system – neither technological nor economic. Considering that we have many time zones, we could transfer power and receive cheap electricity when some regions are not working.        

In the Far East, almost 70% of the power generation facilities are dedicated energy systems. Regarding cross-financing, heat, and electricity, the priority in the northern and Far Eastern regions is generating heat, while electricity is a by-product. Therefore, even with excess electricity and power generation, there can still be a lack of heat. This issue cannot be resolved with hydropower plants, and neither can electric power be transformed into heat, as it would be too expensive.

Another problem is that the issue of small energy generating facilities has not been addressed. Today, there is cross-financing in some regions, including Yakutia, the Khabarovsk Territory, and the Magadan Region. The extremely expensive power produced by diesel generators, which costs up to 30 roubles per 1 kW, is shifted to large energy generating facilities, creating a burden on the economy.

Naturally, development under these conditions would be extremely difficult, and we need to consider... The tariffs should be set and economically justified. As for the payment sources of these tariffs, we need to see where and from what... Otherwise, we will never streamline this field. The power grid should be developed in an expedited fashion. Thank you.

Dmitry Medvedev: Thank you. Are there any other comments? No? Thank you.

I think everyone understands the complexity of the tasks and the validity of the comments on the power grid, the small generating facilities, and other instruments that we will have to use... But in any event, the situation must change. Therefore, the resolution needs to be finalised in due course and adopted. Agreed? Thank you.

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