Modernization of the District Heating Sector Will Not Be Possible Without State Investment

In his interview with, Ivan Grachev, Chairman of the State Duma Energy Committee, Doctor of Economics, talks about legislative plans in the energy sector for the autumn session.

Mr. Grachev, please tell us about the Committee’s legislative initiatives in the energy sector for the upcoming autumn session. What is the outlook for these legislative proposals? 

We are not planning anything revolutionary in terms of legislation for this session. However, the Committee intends to continue considering a number of bills that are already being worked on. 

Specifically, the parliament will discuss the Crimean power supply issue. In this respect, certain amendments to the current legislation will be required, since the local energy sector used to be based on a different model, which is more similar to the Chinese system. It is necessary to bring it into alignment, and we are already carefully doing this. It is clear that we’ll have to build new power generation facilities in Crimea. If we want it done fast, we’ll have to attract private investors. But they want the government to guarantee that electricity prices won’t drop and will remain at the current level. Meanwhile, the price in Crimea is RUB 3 per kWh, which is a good price by Russian standards (electricity prices per kWh range from RUB 2 to 4.5 in Russian cities – Ed.) Therefore, this complex issue can be resolved only by legislative measures. 

Besides, we will also have to sort out the situation with the district heating system. We have already made the first steps in this direction. I believe that unified heat supply organizations (UHSO) need to be established. These should be controlled by municipal authorities. 

We’ll certainly have sessions on power grids. In this respect, a fundamental decision has been made to gradually move towards centralization. Nevertheless, certain problems are still unresolved. One of them is what to do with territorial grid organizations (TGO). The relevant draft bills are currently being refined. 

We will also continue to improve the energy efficiency legislation. A small step along these lines has been made to widen the scope of the laws and take a more diversified approach to energy facilities. There is, however, a certain gap with regards to benefits. The legislation fails to provide for any benefits for those who use energy efficient technologies. Meanwhile, if we really want to get people interested, there need to be certain preferences. 

Also, we are going to refine the draft legislation on improving bill collection, which was approved by the State Duma in the first reading, and work on a number of social and other legislative proposals. 

Thermal power sector is the priority 
In your opinion, what fundamental changes are currently imminent in the power and thermal power sectors? 
We have to admit that the energy sector reform was fundamentally wrong. Its main idea – market liberalization and domination of free market principles – is utopian. It is even more obvious in the thermal power sector. 

There are hardly any cities or towns in Russia with competing thermal power companies. Most cities have one district heating plant only, sometimes two. Therefore, there can be no competition at all. The majority of countries, such as Norway or Finland, for example, admitted this long time ago. There are no operating liberal models in the thermal power sector; this is why there have to be quotas and price regulation. It’s common knowledge that quotas are usually introduced through legislation. Enforcement of these regulations in the regions should be controlled by municipal authorities, especially since all issues related to heat supply are handled by them in most cities anyway. 

Incidentally, in mid-June this year, the International Energy Agency (IEA) released Russia 2014 – Energy Policies Beyond IEA Countries, an in-depth review of Russian energy policies. The IEA also regards heat supply as the most troubled sector of the Russian energy industry and recommends that its modernization should not be put off. Do you agree? 
What do you think about this study? It is an interesting report. The section focused on oil and gas production and exports as well as prices for these energy resources is clear and intelligible. The objectives defined in this review are quite correct, including those related to the development of hard-to-recover reserves. 

I agree with the IEA’s idea that district heating is the most troubled industry. However, our approach to solving the problems is different from the one proposed by the agency. The IEA believes that this industry needs liberalization, while I beg to differ on this point. Ideally, heating should be linked to power supply. There are no significant private investments in the heating sector, and the required funds are unlikely to be invested in the future, so we can safely say that the system will only be modernized inasmuch as the state is prepared to fund this process. This requires effective federal programs, which are missing. The country’s district heating systems are badly worn out. According to my estimates, their renovation will require RUB 9–10 trillion. It will take 100 years to collect these funds from residents (according to the formula). 

We have to clearly and honestly admit that we won’t be able to modernize the sector unless the government invests in it. Public funds can be combined with private investment. In this case, though, the government should provide investors with return of investment guarantees. 

Social rates postponed 
Introduction of the so-called social electricity consumption rates in Russia was postponed for nearly two years, from July 1, 2014 to July 1, 2016 at the latest. You were among those who supported this decision. Why is this delay necessary? What is expected to happen during this period? 
As regards the idea to introduce social electricity consumption rates, I believe they should be cancelled. The expected advantages of this measure include growth of prices for electricity consumed in excess of the fixed rate, as well as energy savings. However, this would produce a zero economic effect, while causing a lot of trouble for people. 

No one benefits from growth of electricity prices; they are already higher than in some other countries. As for energy savings, the effect is also questionable. People will have to install electricity meters, which is rather expensive. Moreover, they will have to go somewhere to register them, etc. Besides, we need to rely on actual facts here. During the years before the reform, electricity prices increased 12-fold in dollar terms, but this didn’t affect energy efficiency in any way. So, it appears that there is a lot of fuss and trouble, while the effect is questionable. 

Several Russian regions introduced the social consumption rates as an experiment. Yet none of the interviewed experts were able to provide any real facts proving that the method had any beneficial effect. Therefore, the country won’t benefit from this proposal in any way. 

Consequences of sanctions 
What consequences of the sanctions imposed by the EU and USA can be expected for Russian energy companies? 
The sanctions of the European Union and the USA mostly don’t apply to the Russian energy sector because Europe is heavily dependent on our energy resources. For example, its dependence on Russian oil and gas is about 30 percent. 

The sanctions will probably adversely affect the financial sector, by partially cutting back on loans. The impact, however, will hardly be significant since Russia has USD 100 billion of available funds annually, due to oil and other raw materials. These funds are quite sufficient to finance a lot of investment projects. It is a matter of economic policy and cash flow management. 

What will be the effect of the Russian energy companies’ shifting their focus to the Asia-Pacific Region, India and other developing markets following the sanctions? 
In my opinion, Russia should continue to diversify its oil and gas supply to global markets. The bulk of its energy resource exports go to Europe, from deposits in Western Siberia. Gas will be supplied to China under long-term contracts from Kovyktinskoye and Chayandinskoye fields in Eastern Siberia. 

There are some other promising markets for us. For example, after the Fukushima accident, Japan’s annual gas demand roughly totals 70 billion cubic meters. The country is ready to pay about USD 500–600 for liquefied natural gas. But Sakhalin does not have enough gas yet to cover extra exports, while laying a pipeline from Vladivostok to Japan will be rather difficult. South Korea is willing to buy our gas as well. One of the most promising markets for Russia is India. The Ministry of Energy has even established a whole unit focusing on a project to build a pipeline from India to Russia. 

Do you feel that the sanctions somehow compromised the image and reputation of the Russian nuclear industry? What is the outlook for this sector? 
We have good reasons to believe that other countries’ confidence in Russian nuclear technologies was not shaken but rather increased. For instance, Japan turns to us for technology advice after the Fukushima disaster. Our international contracts in the nuclear sector currently total about USD 60 billion. There are more orders than Russia can fulfill. 

Crimea and Ukraine 
Is it possible that power supply will be cut off in Crimea this winter, and what will Russia do if it happens? 
Crimea will definitely have electricity this winter. The region has received enough temporary devices to ensure it. In addition, it has sufficient reserves of diesel fuel. Basically, Ukraine has no grounds for power cuts. This is a lucrative business for the country. Crimea is its last reliable source of money. So, the risk that the new Russian region’s power supply will be cut off for the entire winter is rather low. Besides, Russia is prepared to supply electricity to the republic using “a temporary model” if necessary. 

How do you assess the outlook for the upcoming trilateral talks on gas issues between Russia, the EU, and Ukraine? 
I suppose that no particular results will be achieved at the trilateral meeting. It is our fault, in part. Everyone understands that debts have to be paid. Nevertheless, our negotiators and those of Europe are unwilling to openly admit that Ukraine can’t afford it. A country that is fighting a war and has a destroyed economy and a whole lot of social problems has no money to pay its bills, and these are not gas bills only. Assuming that the IMF tranches include funds to pay gas debts is utopian. The International Monetary Fund’s next tranche of USD 1.4 billion will also be spent on waging the war and paying the interest. 

Therefore, I believe that Russia will have to agree with Europe on who and how will pay these old debts for Ukraine. The country currently needs about USD 10 billion to settle its gas debts and make other payments. It’s not like Europe is willing to give the money with no strings attached. Although Germany can do this, it won’t just grant a loan but will need Ukraine’s pipelines. 

German companies are ready to invest USD 5–7 billion in modernization of Ukraine’s gas transmission system through buying a stake in it. This will cover one third of the debts to Russia. Apart from this, we have to take into account the benefits from the trilateral consortium, which would be guaranteed to receive further profits from transmission of Russian gas. 

By the way, what can the announced reform of Ukraine’s gas transmission system management lead to? 
The USA’s buying a 49 percent stake in Ukraine’s gas transmission system will be the worst option for all countries. It is only beneficial for the US: if Americans buy it, risks will increase. The USA will then get a stop valve between Russia and Europe. If an agreement can be reached after all and a trilateral consortium (between Ukraine, Russia and Europe) is established, this would mean the end of the problems. 

So, it is still probable that Ukraine will be stealing our gas in winter, isn’t it? 
Ukraine will end up stealing European gas from its own gas transmission system. Even Günther Oettinger, former European Commissioner for Energy, started talking about this openly. Today, we supply gas only to Europe. The supply to Ukraine is cut off; the country has sufficient gas reserves in its underground gas storage facilities, about 16 billion cubic meters, which will last till winter. That’s when Ukraine will have run out of gas. This time Russia prepared for this situation better, taking into account its previous experience. The country agreed with Europe on the presence of its observers at the border and appropriate control over the volume of gas being transmitted. But Ukraine will steal anyway; it won’t have any other choice. 

What will happen if Russia stops supplying gas via Ukraine? 
Ukraine’s losses from this will total about USD 4 billion. This is a substantial amount for the country taking into account its current economic situation. On top of that, it will be likely that Ukraine won’t get any gas in winter at all. There will be no reverse supply in this case because Europe won’t have any extra gas. 

Russia will have to negotiate with Germany on expansion of the Nord Stream gas pipeline’s capacity; in particular, on full utilization of the Baltic Sea Pipeline Link (OPAL). We are also launching the Belorussian transit route, which isn’t fully utilized yet. As soon as in 2015, gas supply will start via the South Stream as well.

30-09-2014 21:15