Main Principles of Electricity and Capacity Market Functioning

The Importance of the Electricity Industry and the Interrelation of Markets within the Fuel and

Energy Complex

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The Importance of the Electricity Industry in the Russian Economy

0,5% – 1,5%* construction, engineering, agriculture; coke, oil products and nuclear materials production

2,0% – 2,6%* transport and communications; gas, water and steam production and distribution; mining operations

4,9% – 6,1%* chemical industry, metallurgy

17,8%* electricity industry

* Electricity cost in the final product

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Planned Electricity Consumption

Reduction of electricity consumption results from economic slowdown in Russia. 2009 electricity consumption equals that of 2006

Europe and UralsPlanned electricity consumption is the entire planned volume of customer purchase determined as a result of

competitive day-ahead bid selection

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1 300

1 500

1 700

1 900

2 100

2 300

2 500

J F M A M J J A S O N D

Th

ou

san

d

MW

h

Planned electricity consumption 2010

Planned electricity consumption 2009

Planned electricity consumption 2008

Planned electricity consumption 2007

Planned Electricity Consumption

Reduction of electricity consumption results from the economic slowdown in Russia. 2009 electricity consumption equals that of 2006

SiberiaPlanned electricity consumption is the entire planned volume of customer purchase determined as a result of

competitive day-ahead bid selection

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350

400

450

500

550

600

650

700

750

J F M A M J J A S O N D

Thou

sand

MW

h

Planned electricity consumption 2009

Planned electricity consumption 2008

Planned electricity consumption 2007

Markets of the Fuel and Energy Complex

By 2011, all electricity shall be sold at non-regulated prices, except for electricity sold to the

population (at regulated tariffs until 2014)From July 1 till December 31 2009, 50 % of

electricity from the FTS balance and consumption volume for 2007 shall be sold at non-regulated

prices

Increasing marginal gas prices in order to ensure equal profitability of domestic and external markets by 2011 (domestic market gas price = gas price on the European market less logistics and export duties)

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Synchronous Liberalization of Electricity and Gas Markets

From 1.01.07 From 1.01.08 From 1.01.09 From 1.07.09 From 1.01.10 From 1.07.10 From 1.01.11

15%40%

53%66%

79%92%

European market price

100%

From 1.01.07

From 1.07.07

From 1.01.08

From 1.07.08

From 1.01.09

From 1.07.09

From 1.01.10

From 1.07.10

From 1.01.11

25%30%

50%60%

80%

15 %10 %5 %

Supplies at non-regulated prices

100%

ELECTRICITY ELECTRICITY

GAS

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The Electricity and Capacity Market Model

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Market Model: a Two-level System

Retail MarketRetail MarketWholesale Market Wholesale Market

Suppliers: generating companies of the wholesale market, electricity importers

Suppliers: energy supply companies and suppliers of last resort, generating companies of the retail market

Buyers: retail customers, partial participants

Electricity and capacity may be sold both separately or as a single product

(electricity inclusive of capacity)

Buyers: large consumers (total connected capacity of at least 20 MVA and at least 2 MVA in each delivery point cluster), including partial participants (over 85% of planned consumption purchased on the retail market), energy supply companies and suppliers of last resort, electricity exporters

Electricity and capacity are sold separatelyEach participant may act both as a seller

and a buyer

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Wholesale Market Model: Entities and Infrastructure

Generation

7 WGCs, 14 TGCs7 WGCs, 14 TGCs

RusHydro, OJSCRusHydro, OJSC

Kontsern Energoatom, OJSC

Kontsern Energoatom, OJSC

Consumers and retail companies

Suppliers of last resort

Suppliers of last resort

Energy supply companies

Energy supply companies

Consumers – market entities

Consumers – market entities

Other generating companies

Other generating companies

Market entities

Technological

System OperatorDistribution companies

System OperatorDistribution companies

Market infrastructure

CommercialNP “Market Council”

TSA, OJSCCFS, CJSC

NP “Market Council”

TSA, OJSCCFS, CJSC

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Wholesale Market Model: Regulation

STATESTATE NON-STATENON-STATE

Tariff (FTS of Russia)

Tariff (FTS of Russia)

Antimonopoly (FAMS of Russia)

Antimonopoly (FAMS of Russia)

WECM rules(NP “Market Council”)

WECM rules(NP “Market Council”)

Connection Agreement (NP “Market Council”)

Connection Agreement (NP “Market Council”)

RegulatoryRegulatory Contract relationsContract relations

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Wholesale Market Areas

■ ■ PRICE AREAS

(areas with a liberalized wholesale market) –

European Russia and Urals + Siberia

■ ISOLATED REGIONS

■ NON-PRICE AREAS

(areas with a regulated wholesale market) –Kaliningrad and

Arkhangelsk Regions, Komi Republic, the Far East

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Wholesale Market Model: Sectors

Capacity MarketCapacity MarketElectricity MarketElectricity Market

Regulated Contracts (RCs)Electricity and/or capacity sale and purchase contracts between suppliers and buyers where the prices are set according to electricity and/or capacity tariffs set by the FTS

Non-regulated Bilateral Contracts (NRBCs)

Electricity sale and purchase contracts between suppliers and buyers where the terms and conditions, including prices, are agreed upon by the parties

Day-Ahead Market (DAM)System of relations within price areas of the wholesale electricity market between wholesale market participants and FGC UES, which involves supply/consumption of electricity in volumes determined

based on the results of competitive selection of day-ahead price bids

Balancing Market (BM)Sector for the trade of deviations from planned volumes of electricity supply determined as a result of competitive selection of price bids for system balancing and (or) determined by actual generation/consumption of electricity based on metering data

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Wholesale Market Model: Sectors

Electricity MarketElectricity MarketCapacity MarketCapacity Market

Regulated Contracts (RCs), including: Capacity contracts for generating equipment of nuclear and hydro power plants (CBCs)

Sale and Purchase and Agency ContractsSales of excessive electricity or capacity by the buyer or purchase of deficient electricity or capacity by the supplier

under agency or sale and purchase contracts Non-regulated Electricity and Capacity Sale and Purchase Contracts (NRECCs), including:Stock-Exchange NRECCs

Non-regulated sale and purchase electricity and capacity contracts concluded during trading on the exchange organized according to Russian Federation legislation on commodity exchanges and exchange trade, by a commodity exchange, the rules for exchange trade of which contain a procedure for conclusion of non-regulated electricity and capacity sale and purchase contracts through trading on the exchange and determination of prices in such contracts, and other terms for arranging stock-exchange auctions that correspond to the requirements of the Agreement on connection to the trading system of the wholesale market

Over-the-Counter NRECCsNon-regulated electricity and capacity sale and purchase contracts concluded in accordance with the Agreement on connection to the trading system of the wholesale market or concluded for volumes of generating equipment capacity not included in the forecast balance for 2007

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Wholesale Market Performance (Price Areas)

Electricity Market Turnover, 2009

Sector Sales volume, mln MWh

Sector share,

RCs 527,94 46,9%

DAM 457,91 40,7%

NRBCs 85,00 7,6%

BM 54,20 4,8%

Total 1125,05 100%

SectorSales

volume, mln MWh

Sector share, %

RCs 1 371,96 63,5%

CBCs 155,65 7,2%

OTC NRECCs 216,75 10,0%

Stock-exchange NRECCs

121 5,6%

Agency or sale/purchase 296,17 13,7%

Total 2 161,53 100%

Capacity Market Turnover, 2009

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Pricing on the Wholesale Electricity and Capacity Market

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Regulated Contracts

Formation of the buyer’s regulated contracts package

Supplier Supplier’s tariffContract volume

Contract cost

Customer’s consumption

Customer’s tariff

Generator 1 100 150 15 000

Generator 2 200 60 12 000

Generator 3 300 40 12 000

Total under RCs: 25039 000

RC package tariff: 156 250 156

Terms of the regulated contracts (prices, volumes, counterparts binding) are defined by the Federal Tariff Service (the FTS of Russia) and the commercial operator (TSA, OJSC) so that the average price of regulated contracts does not exceed the electricity tariff set by the FTS for the relevant region

The share of regulated contracts in the electricity generation/consumption balance approved by the FTS for 2007 is gradually decreasing; by 2011 RCs shall cease to exist

Terms of the regulated contracts (prices, volumes, counterparts binding) are defined by the Federal Tariff Service (the FTS of Russia) and the commercial operator (TSA, OJSC) so that the average price of regulated contracts does not exceed the electricity tariff set by the FTS for the relevant region

The share of regulated contracts in the electricity generation/consumption balance approved by the FTS for 2007 is gradually decreasing; by 2011 RCs shall cease to exist

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Operation of the Competitive Sector of the Wholesale Electricity Market

DAM(competitive selection)

Trading day (X-1) Operation day (X)

Payment upon delivery

Bids Trading results (prices, volumes)

Supply

BidsConsumption

Payment

Payments

Customers

Trading results (prices, volumes)

Day X-7

UC(unit

commitment)

BidsUC results

Balancing market Collection

of metering data

Payment upon

delivery

Suppliers

Price bid auction

Reserve formation

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Unit Commitment Procedure

Units (non-block sections), the state of which in the UC optimization

calculation is always predetermined

“Regime” generators Forced modesState

determined based on bids

On state is fixed before the optimization

calculation in order to ensure system reliability

On state is fixed before the optimization calculation on other

grounds (e.g., generation of thermal power, equipment

condition)

On/off statedetermined based on

results of the optimization calculation

On/off stateis fixed before the optimization

calculation

• NPPs• HPPs• TPPs: units (non-block sections),

IC of at least 150 MWh

Based on indicative price bids (for start-ups and electricity generation) of suppliers for all units and “regime” generating units System Operator conducts a Unit Commitment

Procedure (UCP) according to electricity generation cost minimization criteria

Units (non-block sections) of TPPs, the state of which may be determined based on the results of the

UC optimization calculation

Generating Equipment at the WECM

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Day-Ahead Market

The Day-Ahead Market (DAM) is based on a competitive selection (auction) conducted by TSA (OJSC) of price bids of suppliers and buyers with

delivery on the day following the day of the auction

Electricity losses and system constraints are considered during competitive selection

Based on DAM results the following are determinedfor each node of the computed model for every hour of the next day:● Planned hourly consumption● Planned hourly generation● Equilibrium electricity prices

At the DAM marginal pricing is used – the price is determined based on the most expensive electricity supply bid satisfied

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DAM: Marginal Pricing

Price

VolumeEquilibrium volume

Equilibrium price

Supply(suppliers’ bids)

Demand(buyers’ bids)

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DAM: Preventing Manipulation

To reduce the risk of price manipulation, the participants are incited to bid competitively – the lowest price bids are satisfied first

Administrative measures aimed at manipulation prevention

State•Corporate procedures for naturally monopolistic entities where the controlling stake belongs to the State•Introducing price regulation for specific market entities•Introducing bidding constraints•Mandatory separation of dominating market entities

Infrastructure organizations •Deprivation of WECM entity status •Terminating admission to the trading system•Applying BM imbalance distribution coefficients for metering and billing violations•Reducing the value of the generating equipment availability factor•Applying penalties

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DAM: Price Volatility

0

150

300

450

600

750

янв фев мар апр май июн июл авг сен окт

On March 29, 2009, against the background of demand reduction, a flow increase over the controlled connection between the Europe and Siberia price areas towards Siberia was observed. A price reduction in the price bids of suppliers was also observed. As a result the auctions accepted the lowest price bids.

Equilibrium electricity price index dynamics in Siberia (January – October 2009), rub/MWh

On June 3, 2009, in Siberia a sharp decline of the equilibrium price index, owing to a decrease of electricity demand, was observed. As a result the low price bids of generating companies were the closing bids. Nonzero prices were established in Omsk and Altai, but in the rest of Siberia, the price was approaching minimum.

On September 13, 2009, impacted by the decrease of electricity consumption due to the absence of an electricity purchase bid from a large customer, the equilibrium price index in Siberia decreased.

The DAM prices are characterized by:

• Cyclical fluctuations (daily, weekly, annual)

• Price fluctuations caused by unforecastable changes in the demand or supply side

• High volatility

The participant risks:

• Lower competition as a result of a monopolistic power of a consumer or the generator in some regions

• Lower system reliability as a result of planning difficulties

The DAM prices are characterized by:

• Cyclical fluctuations (daily, weekly, annual)

• Price fluctuations caused by unforecastable changes in the demand or supply side

• High volatility

The participant risks:

• Lower competition as a result of a monopolistic power of a consumer or the generator in some regions

• Lower system reliability as a result of planning difficulties

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Non-regulated Bilateral Contracts

Non-regulated Bilateral Contracts for Electricity Sale and Purchase (NRBCs) are concluded between the supplier and the buyer under the terms and

conditions agreed by the parties

The NRBCs allow the participants:● to carry out long-term business planning● to fix the electricity purchase/sale prices● to hedge the risks of performing obligations under regulated contracts● to determine the terms and procedure of payments for electricity

Non-regulated contracts allow the participants to reduce financial risks resulting from high volatility of electricity prices on the day-ahead market

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Balancing Market

The Balancing Market (BM) is designed to cover the deviations of the actual electricity generation and consumption from those planned

At the BM trading is conducted by the System Operator as a competitive selection of the suppliers' bids in conditions of short-term planning of generation and consumption (3 hours ahead) and real-time

At the Balancing Market marginal pricing is used with account of losses and system constraints

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Balancing Market: Competitive Selection

VolumeDAM planned consumption

Consumption growth

DAM price

BM indicator

Price

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Capacity Market

Competitive Capacity Selection (CCS) for operation the following year:● Is performed by System Operator on the basis of generators’ bids● The bid price is set no higher than the FTS tariff

Capacity sales at the tariffs of Regulated Contracts:The share – according to the electricity market liberalization process

Non-regulated Bilateral Electricity and Capacity Contracts (NRECCs)

Stock-exchangeThe participants sell/buy standard electricity and capacity contracts

at the exchange

The remaining capacity is sold by the generators at the CCS bid price

Over-the-counter

For new generation

To replace the RCs

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Capacity Market: Mechanisms of Determining the Purchase Price

The payment for capacity is conducted as follows

The capacity purchase price as a result of the CCS is determined as follows

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Capacity Market: Non-regulated Contracts

Non-regulated Electricity and Capacity Sale and Purchase Contracts (NRECCs) assume simultaneous supply of electricity and capacity

NRECCs are traded on certified stock-exchanges (currently, the MEEX) in the form of contracts standardized by terms, types and volumes of electricity and capacity .

In organized NRECC trade, marginal pricing is used. Over-the-counter NRECCs are concluded between suppliers and consumers under the terms agreed upon by the parties.

Under agency and sale-and-purchase contracts the following is sold:● excess energy resulting from purchase under RCs (including CBCs), sold at the weighted

average RC price● excess energy resulting from purchase under non-regulated contracts, sold at the price equal to

the weighted average price of the bids for all selected capacity

Trade in capacity agency and sale-and-purchase contracts is performed through CFS (CJSC) (a subsidiary of Market Council and TSA)

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Capacity Market: CSCs

Capacity Supply Contracts (CSCs): an obligation of the generator to introduce new capacity with specified characteristics within a set period with guaranteed payment for the commissioned capacity for a specified

period

New system of capacity supply contracts has been designed.These contracts:● provide supply of capacity via generating facilities ● are included in investment programs of generating companies● provide payment for such capacity, in general, within 7 years of the facility commissioning date

These contracts provide, among other things,  the mechanism of control over fulfillment of the investment programs, and the responsibility of the parties for failure

to fulfill their obligations

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Capacity Market: Transition to the Target Model

Payment for all existing capacity

•No competition between suppliers •No motivation to decrease the costs•The customer pays for excess capacity

Separate pricing for two related products

•Marginal revenue from the electricity market does not reduce the cost of the supplier’s capacity – overstating the aggregate cost for the customer

No long-term relations

•No long-term conditions for investments•No long-term signals for the customer

Competition between suppliers for payment of capacity – partial payment for capacity

•Motivation to reduce costs•Only the capacity needed in the system is paid for – move away from excess capacity•Accurate price signals reflecting sufficiency (deficiency) of capacity in the regions

Interrelation of the capacity and electricity markets

•Motivation to reduce aggregate electricity and capacity costs

Long-term relations

• Long-term guarantee of payment for capacity in the future (after its commissioning)

• Possibility of bilateral relations • Long-term regional price signals for industrial growth

Transition ModelTransition Model Long-term Capacity MarketLong-term Capacity Market

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Retail Electricity Market

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Retail Market: Main Principles of Operation

Electricity and capacity purchased by suppliers of last resort and retail companies at the wholesale market are sold to end customers

Each supplier of last resort (SLR) operates in its special area of operation. One area – one SLR

The supplier of last resort concludes a contract with each customer according to the contract form approved by the government

The SLR translates the non-regulated wholesale market prices to retail customers: ● Sells the volumes purchased under the RCs at a regulated tariff to retail ● Sells the volumes purchased at non-regulated prices to the end customers also at non-

regulated prices

The population buys electricity from the SLR only at regulated prices

An energy supply company has the right to conclude a contract with a customer under any terms and conditions, as well as to refuse to conclude a contract

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Retail Market: Wholesale Market Price Translation

Supply under regulated contracts (tariffs)

Liberalized portion

Population Customers on the retail market

Wholesale market regulated price

Wholesale market non-regulated price

Wholesale Market

Retail Market

Supplier of last resort Energy supply company

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Retail Market: Pricing

2009 Retail Price Structure

_____* regulated prices

The main factor influencing the price for the end customer is the cost of electricity and capacity purchased at the wholesale market

Changes of electricity and capacity cost purchased on the wholesale market may be due to: •Price changes under the influence of supply and demand•Change of regulated tariffs•Change of the share of liberalized volumes•Change of electricity and/or capacity consumption volumes

The main factor influencing the price for the end customer is the cost of electricity and capacity purchased at the wholesale market

Changes of electricity and capacity cost purchased on the wholesale market may be due to: •Price changes under the influence of supply and demand•Change of regulated tariffs•Change of the share of liberalized volumes•Change of electricity and/or capacity consumption volumes

Electricity and capacity

on the WECM; 55%

Regional generation;

6%

Regional grids*27%

FGC*5%

Infrastructure(SO, TSA)*

3%

Sales margin*

4%

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Information Disclosure

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Information Disclosure

Government Order #24 of 21.01.2004 established information disclosure standards

For all entities of the electricity market ● Financial (accounting) reporting● Tariffs

For network organizations● Contract terms and conditions ● Return on investment (for RAB)● Asset flow● Capital investment● Network losses and grid state● Number of applications for technological connection

For System Operator● Contract terms and conditions● Market simulation model● Electricity quality and electricity supply reliability● Dispatcher orders and reasons for deviation from the planned schedule● Generation and consumption plans (day, month, 1 year, 5 years)● Repair, hydroregime and system constraints forecasts and schedules

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Information Disclosure

Government Order #24 of 21.01.2004 established information disclosure standards

For generating companies● Hazardous emissions● Hydrologic system use mode and its state (for HPPs)

For the commercial operator● List of wholesale market entities● Terms and conditions of the connection agreement and of participation in wholesale market

trading● Membership fee for market participants● Aggregated wholesale market operation results (without detailing transactions of specific

participants)● List of system generators● Reports on the results of control over System operator actions

Information disclosure:● via mass-media● via web-sites of disclosing organizations● at the request of a market participant

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DERIVATIVES MARKET

DERIVATIVES MARKET IN POWER SECTOR

INSTRUMENTS

«MEEX» has built up a work group from energy companies representatives, Russian and foreign brokers, «RTS» clearing center professionals, that analyzed foreign experience of electric power trades, technology of commodity assets trading in Russian exchanges.

Contract specification is developed. Month futures contract is selected, based on the average price of electric power index in Center and Ural hubs of the Price zone 1 and Kuzbass hub of the Price zone 2 during certain delivery hours (base-load hours and peak hours).

The trading technology is similar to the EEX exchange technology that makes the trading mechanism multipurpose for the Russian and foreign participants.

MEEX TRADE ORGANIZER.

REGISTRATION OF DEALS, DEVELOPMENT OF TRADE REGULATIONS

CLEARING CENTER

GUARANTEE OF TRANSACTION FULFILLMENT.

FINANCIAL SETTLEMENT OF CONTRACTS

DEPOSITARY OF PARTICIPANTS’ CASH ASSETS.

MONEY TRANSFERS ACCORDING TO TRADE RESULTS

BR

OK

ER

client

client

client

client

client

client

TRADE ORGANIZATIONTRADE ORGANIZATION

PRICE FORMATIONPRICE FORMATION

A METHOD OF PRICE FORMATION – CONTINIOUS TWO WAY AUCTIONSUBMISSION OF ORDERS TO THE EXCHANGE SYSTEM.

•ANONIMOUS ORDERSMARKET PRICE.FIXED PRICE.

•ADDRESS LIMIT ORDERS:FIXED PRICE.

TRADING HOURS 10:30-23:50 (MOSCOW TIME)CLEARING – SYSTEM OF THE PARTIES’ OBLIGATIONS DEFINITION

UNDER TRANSACTIONS:•CLEARING TIME: 14-00, 18-45.•VARIATION MARGIN RECALCULATION.•SETTLEMENT PRICE DETERMINATION (TWICE A DAY).

Thank you for your attention!

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