Since PJSC ROSSETI does not perform any direct operating activities and only carries out corporate management of its subsidiaries and dependent companies (SDCs), the industry-specific risks described below are primarily associated with the Company’s SDCs.
Tariff risks
The core activities of the Company’s SDCs, the provision of electricity distribution and transmission services and network connection services, are subject to regulation by the government. Taking account of these special features of PJSC ROSSETI’s operations, the industry-specific risks of the Company include tariff risks.
The government’s tariff regulation policy is based on the need to curb inflation and provides for a change in grid organizations’ regulated tariffs in 2016–2018 for the index lower than actual inflation, which leads to the risk that regulatory authorities may impose a pool of tariffs that would not make it possible to collect economically feasible revenues.
The risk that regulatory authorities may set tariffs lower than an economically feasible level arises out of the following factors:
- it is necessary to return the accumulated negative smoothing of minimum regulated revenue;
- in the course of approving tariffs, it is not possible for the regulator to exceed the ceiling value of cross-subsidies frozen at the 2013 level with a reduction in the cross-subsidy rate for the VN1 voltage level while industrial electricity consumption is on the decline;
- grid organizations pay more for electricity network losses as a result of an outstripping growth in prices in the wholesale electricity market;
- network connection services are subject to existing and new preferential terms while connection costs are on the rise;
- economically feasible expenses incurred by grid companies are not taken into account in full in the course of approving tariffs.
Another tariff risk is that the actual indicators of electricity and capacity consumption are different from the indicators taken into account in the course of making tariff and balancing decisions, including as a result of changes in consumption patterns.
These tariff risks result in a shortfall in tariff revenues received by SDCs from the regulated activities.
Risk management related to tariff regulation is carried out in the following areas:
- effective interaction with executive authorities of constituent entities of the Russian Federation in government regulation of tariffs in course of designing economically feasible tariffs;
- interaction with federal executive authorities (the Federal Antimonopoly Service, the Ministry of Energy, the Ministry of Economic Development, etc.) as related to systematically improving the principles of tariff regulation;
- appeals filed against regional regulators’ decisions by applying the pre-trial resolution of disagreements and by having resort to court proceedings.
As part of its tariff risk management measures, PJSC ROSSETI prepared and submitted to federal executive authorities amendments to the Pricing Fundamentals, aimed at defining the list of objective criteria for exceeding the ceiling value of cross-subsidies or at revising the ceiling value. The Company also cooperates with federal executive authorities in introducing into legal regulations the fair distribution of cross-subsidies among all customers, the abolishment of the smoothing mechanism of minimum regulated revenue, and the practical application of regulatory agreements with regional tariff regulators to hold territorial grid organizations’ lost income resulting from interrupted electricity consumption at a fixed level and define a mechanism for settling such lost income.
In addition, to minimize these risk factors, the Company and SDCs pursue a balanced policy on improving the efficiency of investing and operating activities, aimed at reducing costs and optimally planning the structure of the financing sources.
Risk associated with the decreased volume of electricity distribution services.
The risk associated with the decreased volume of electricity distribution services is due to the following factors:
1) Overall decline in electricity demand
The principal reason is Russia’s contracting investment activity and adverse changes in market conditions, chiefly in the hydrocarbons and metals markets. Statistics show the continuing decline in industrial production in the Russian Federation.
2) External electricity supply optimized by customers decreasing electricity consumption from Russia’s United Power System (Unified National (All-Russian) Electric Grid) and making increasingly wide use of in-house generation facilities.
The negative factors affecting Russia’s socioeconomic activities were a fall in real household income, a higher level of inflation, a rise in production costs, etc.
The facts described above increase the risk that electricity demand and the volume of electricity distribution services provided by SDCs may decrease.
In order to minimize this risk, the Company and SDCs carry out measures to enhance the reliability of the predicted volume of electricity distribution services for pricing and business planning purposes.
Risks associated with the provision of network connection services for electricity consumers, specifically a risk of a shortfall in a requesting entity’s volume of connected capacity in network connection requests.
In order to reduce this risk, the Company works to monitor the maximum capacity requested in network connection requests and cause SDCs of PJSC ROSSETI to assume the appropriate scope of obligations under network connection contracts.
Network connection services involve a risk that financing sources may be insufficient for measures to perform contracts. A potential factor contributing to this risk is amendments to Russian laws specifying that the investment component for covering the construction costs of electric grid facilities will be changed for network connection fees for power-receiving equipment rated below 150 kW. To minimize the risk, the Company forms the appropriate scope of obligations under network connection contracts, develops project documents, and submits to regulatory authorities the necessary documents to justify the economic feasibility of network connection fee rates. Approaches to organizing the business process related to the performance of electricity network connection services are improved.
Given that the number of network connection requests is not consistent with the capability to grant them, there are risks that network connections may fail to be provided, which may eventually adversely affect revenues because of the loss of potential customers, that antimonopoly laws may be violated as related to electricity distribution and network connection services, and that litigation may be initiated by requesting entities.
With coordination and control on the part of PJSC ROSSETI, SDCs take measures to improve the efficiency of the process of processing customers’ network connection requests, including by means of using information technology and template solutions in improving the business process. Simultaneously, the process of providing network connection services is explained to customers, including by using the Customer Relations Portal on the Company’s website and customer service centers and call centers of PJSC ROSSETI’s SDCs.
There is also a risk of lost profits resulting from the failure to perform network connection contracts. The principal risk factor is the nonfulfillment by requesting entities of their obligations, including from their abandonment of network connections. This leads to the nonutilization of new equipment and to lost profits from electricity distribution services. In order to mitigate this risk, SDCs file claims against requesting entities for damages in relation to abandoned network connections and for damages payable to superior grid organizations if network connection contracts are entered into in favor of ultimate requesting entities. Obligations under network connection contracts, together with the implications of their nonperformance (penalties, extended deadlines of network connections), are explained to requesting entities.
Risk associated with the failure if customers to pay for provided electricity distribution services (contested and uncontested overdue receivables).
This risk arises from imperfect operation mechanisms of the retail electricity market and from the insufficiency of existing mechanisms for encouraging customers to make timely payments for electricity distribution services and also results from macroeconomic factors.
This entails disagreements between electric grid companies and retail companies over the volume of consumed electricity and capacity. This leads to overdue receivables related to electricity distribution services provided by SDCs, impairing the liquidity and financial stability of the Company’s SDCs.
The Company and SDCs take measures to eliminate the causes of disagreements with customers, reduce contested overdue receivables for their services provided, cooperate with federal governmental authorities in preparing amendments to the rules for the operation of the retail market, form judicial practice, and set positive precedents. In addition, the Company’s SDCs implement the Long-Term Development Programs for Electricity Metering Systems in the Retail Electricity Market in Distribution Grids of PJSC ROSSETI’s SDCs approved by their boards of directors.
A significant factor influencing the level of payment for provided electricity distribution services is an imbalance in the existing incentives for the fulfillment of obligations in the wholesale and retail electricity markets. The risk of losing the Wholesale Electricity (Capacity) Market entity status due to failure to comply with extremely tight payment schedules motivates customers (mainly, suppliers of last resort) to give priority to the obligations to pay for electricity purchased in the Wholesale Electricity (Capacity) Market while paying for electricity distribution services on a secondary basis.
With the aim of minimizing the risk of nonpayments, the Company implements the Program for Improving the Efficiency of Measures to Reduce Receivables for Electricity Distribution Services.
Federal Law No. 307-FZ of November 3, 2015, “On Amendments to Specific Legislative Acts of the Russian Federation in Connection with the Enhancement of the Payment Discipline of Energy Resource Users,” effective from December 5, 2015, is expected to become an effective mechanism to reduce the risk of nonpayments.
Since the Company does not perform any direct operating activities and its core business is corporate management of SDCs, there are no risks associated with possible changes in any prices of raw materials and services used by the Company or associated with possible changes in any prices of the Company’s products and/or services, which risks may affect the Company’s activities and the performance of its securities-related obligations.
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