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ATON - Federal Grid Company (FSK), Regulation, Outlook for 2012, Jan 16, 2012.

Regulation

General Framework

Unlike MRSKs, FSK's tariffs are set by the Federal Tariff Service (FTS), not local regulators (RECs). FTS decides on the transmission company's tariffs individually for each region.

(To view the full document, please click on the link below:

http://reports.aiidatapro.com/brokers/AtonEN/16012012_FSK_Lower_Risk_than_MRSKs_but_Triggers_are_Lacking.pdf)

Regarding its core activity - electricity transmission - FSK has a two-part tariff consisting of a grid maintenance rate (RUB/MW per month), which is charged per MW of connected capacity, and a rate for electricity loss compensation (RUB/MWh), which is charged per MWh of normative technological loss of electricity in the transmission grid.

The grid maintenance rate was uniform across all regions until 2011, when FTS set a lower rate for the North Caucasus regions vs the rest of Russia. Tariffs for the compensation of losses vary greatly across regions.

RAB Regulation in Place

Before 2010, FSK was regulated under the cost-plus approach, which envisaged annual tariff setting. From 1 Jan 2010, FSK introduced the RAB regulatory method, the same approach that was applied to regional branches of MRSKs. For details on RAB methodology, please see our 16 Dec 2009 report Electricity Distribution: Pricing in RAB.

Initial RAB parameters raise concerns

The regulator initially set the base regulatory rate of return at 11% and the rates of return on initial RAB at only 3.9-6.5% for 2010-12. The base regulatory rate of return was lowered from 11% to 10% effective from 2013 by an FTS decision in Sep 2010. FTS set regulatory controllable operating expenses for 2010 at a 14% discount to actual controllable expenses in 2009.

Amendments to FSK Tariffs in Dec 2010 and Apr 2011

The initial RAB parameters for FSK implied a quite high tariff growth CAGR of 35% for 2010-12. FTS has revised tariffs for FSK twice since that time. First, they prolonged the long-term regulatory period from three to five years in Dec 2010. Second, as part of the government's tightening measures for 2011, FTS re-calculated FSK's tariffs effective from Apr 2011, primarily by applying a tariff-smoothing mechanism. Interestingly, the tariff revision in Apr 2011 envisaged a tariff CAGR of 26% in 2011- 14, which is 2 ppts above the tariff CAGR of 24% established prior to that revision.

Connection Fees

Connection fees do not have a meaningful impact on FSK's cash flows as compared to some MRSKs (such as MOESK and Lenenergo).

Outlook for 2012: Further Tightening Expected

In Sep 2011 the government approved the socio-economic forecast for 2012-14 prepared by the Ministry of Economic Development. In its report, MED cut its earlier estimate for end-user electricity price growth in 2012 by 4.5-5.5 ppts to only 6.5- 7.5%. MED expects average tariffs for electricity grids (both distribution and transmission) to rise by only 6% this year (that is, by 11% from July 2012).

This forecast has already been used as a basis for many official documents from the FTS, Minenergo and other authorities, so we believe it will be implemented by regulators in 2012 (and perhaps beyond). We view this as a clear signal of continued regulatory tightening in the utilities sector in general and the grid segment in particular.

Amendments Proposed to Regulation

According to various materials released by FTS, the following measures might be implemented in order to curb tariff growth for FSK:

1) Change in the timing of the annual tariff review from 1 Jan to 1 July. This means that in 1H12 transmission tariffs will remain at the 2011 level. The next tariff hike would be postponed to 1 July 2012. The respective decision has already been taken, according to an official press release from FTS in Dec 2011.

2) Amendments to the accounting method for invested capital (RAB value). Currently, investments are accounted for in RAB value by financing while the FTS wants to change this approach to actual capacity commissioning.

3) Changes to investment programmes. The regulators stressed the need for revisions to the investment programmes of grids. They noted the problems with capex execution, identifying cases where companies are building assets which are barely used. To deal with this issue, FTS plans to amend the RAB methodology in order to adjust tariffs on the basis of actually utilised capacity.

4) Prolongation of the long-term regulatory period. The five year long-term regulatory period for FSK might be reset to start from 1 July 2012 and to end on 1 July 2017, effectively extending the current long-term regulatory period to 7.5 years (i.e. from 1 Jan 2010 to 1 July 2017).

During an investor meeting hosted by Aton in Dec 2011, FTS said that FSK's tariff hike from 1 July 2012 would range from 10-15%, significantly down from the currently established rate of 26%.

Importantly, according to FTS, the long-term RAB parameters for FSK (such as initial RAB values and regulatory rates of return) should remain intact.

Methodology changes related to RAB tariff revision (to be introduced by a special government decree effective from 1 July 2012) and the recalculated distribution tariffs should be announced by 1 Apr 2012.

more: (http://reports.aiidatapro.com/brokers/AtonEN/16012012_FSK_Lower_Risk_than_MRSKs_but_Triggers_are_Lacking.pdf)

***

Copyright: Aton OOO (LLC), All rights reserved.

For further Information please contact: Aton OOO (LLC),

27 Pokrovka str., bld.6, 105062 Moscow, Russia

phone: (495) 777-66-77, (495) 228-38-99

aton-line@aton-line.ru, http://www.aton.ru
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Publication:Russian Banks and Brokers Reports
Date:Jan 16, 2012
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