BMI View : A severe economic contraction will destroy demand for electricity in Russia and weigh heavily on investment and profitability in the utilities sector in 2015. A combination of a weakened currency and rising inflation will suffocate consumer demand , while tight credit conditions in reaction to this inflationary pressure will restrict funding for projects in the power sector.
The outlook for domestic and foreign utilities operating in the Russian power market in 2015 is bleak and the operating environment will remain challenging. Our Country Risk team forecast the economy will contract by 5.2% in 2015 as a combination of a weakened currency and rising inflation will suffocate consumer demand. At the same time, tight credit conditions in reaction to this inflationary pressure will severely restrict business activity across all areas of the economy.
This means there is limited upside to our outlook for the Russian economy - and by extension the power market and electricity demand growth. Domestic electricity demand remains highly correlated with industrial output in Russia and, as such, we forecast electricity generation will contract 2.3% in 2015. In addition to weaker demand, tightening credit conditions are a direct risk to domestic utilities. A series of downgrades to Russia's credit rating (and the ratings of some Russian utilities themselves) over late 2014/early 2015 - to just above 'junk status' will further raise borrowing costs for domestic utilities. This risks starving the power sector of much-needed funding for new, more efficient generation capacity.
This will present significant challenges for domestic utilities such as Inter Rao, RusHydro, Gazprom and Rossetti, as well as foreign firms like E.ON and Fortum, which have domestic subsidiaries. We do not expect an exodus of foreign owned power companies, but we do expect them to repatriate any profits rather than reinvest in assets during this period of volatility.
Key Trends And Developments
Russia froze tariff growth on state-regulated services including gas and electricity in 2014 - in an effort to ease pressure on household budgets and help lower inflation. We expect weak domestic growth and a freeze on electricity and gas tariff growth to further depress the outlook for Russian power generators such as Inter Rao, Gazprom and Finland's Fortum.
German utility E.ON's Russian earnings have been hit hard by rouble volatility in recent quarters, and we note that the utility announced plans in November 2014 to break itself in two and spin off its fossil fuel-focused operations into a new company called Uniper in 2016. The Russian subsidiary will be part of Uniper - a business that we believe could become a bad bank for some of E.ON's more unattractive assets.
We maintain that Russian energy policy is orientating eastwards towards China in the wake of deteriorating relations with Europe. This will feed through into the power sector, where we have already seen projects mooted that would deliver export electricity flows to the Chinese market - presumably with backing from Chinese investors.
Russian plans to expand its nuclear fleet suffered another setback in February 2015 when it emerged that all four planned units at the Leningrad II nuclear power plant project in western Russia are likely to be delayed by one year, according to project head Yuri Galanchuk (World Nuclear News). The reason for the delay appears to be a change in the management structure of the project - with Leningrad Nuclear Power Plant (LNNP) set to take complete control of construction.
Tougher power market condition could lead to consolidation in the Russian government-owned utilities space - with Inter Rao Capital, the subsidiary of Inter Rao, buying 20.56% of the share capital of Mosenergobyt on April 20 2015. Under the deal, Inter RAO increased its stake in Mosenergosbyt to 71.48% in a move that could ultimately lead to a delisting of Mosenergosbyt, which focuses on the purchase and distribution of electricity in the Moscow region.