Alexander Kovalev: ‘We see prospects for increasing the share of major players in energy market’

Mining accounts for 2% of electricity consumption in the country

According to data for the first 5 months of 2022, consumption in the domestic energy system increased by 485,0 billion kWh, (+2,5% YoY).

We tend to justify such results by inertial effect, favourable temperature conditions, and an increase in the activity of cryptocurrency miners. Regarding the latter factor, there are more and more reasons to strengthen legislative regulation, since, according to the deputy head of the ministry of industry and trade, Vasily Shpak, mining already accounts for about 2% of electricity consumption in the country. In May, the dynamics of growth in the Far Eastern Federal District became particularly noticeable, which was associated with an increase in electricity exports to China.

The events of February caused the desire of foreign investors to leave the Russian market, and therefore M&A activity in the industry has increased markedly. In particular, Enel (Enel Russia) and Fortum (a stake in TGC-1, Unipro and WPP of the former FRV) announced their desire to sell their assets. The main contenders for renewable energy assets, in our opinion, are Rosatom, Novatek and Lukoil, and for other generation — Inter RAO, Gazprom Energoholding, T Plus and SUEK. It is worth noting that M&A transactions will lead to an increase in concentration in the electricity market, which fits into the general trend of consolidation observed in recent months. In particular, the issues of the reform of the consolidation of local grid operators (TSOs) and the transition to uniform tariffs in the regional context are still not put on pause. In this regard, we see prospects for further increasing the share of major players in the market, and this applies to both the grid complex and generation. In the case of the latter, consolidation and acquisitions seem to be almost the only way to further growth in the conditions of the likely rejection of Russian electricity by the EU countries.

Long-term export prospects

On May 14, Inter RAO stopped supplying electricity to Finland, which has been the largest importer in recent years. The Finland-Lithuania-Latvia group accounted for about 61% of all exports, which, in addition, were among the most profitable in the structure of domestic electricity exports. For example, in 2021, the average price per 1 MWh sent to Finland, Lithuania and Latvia was $71,4, $61,1 and $61,5, respectively. At the same time, the weighted average price for the entire volume of exports in January-December 2021 was $58,0. An attempt to replace these volumes with supplies to China, which more than doubled in the first five months of this year (1,78 billion kW versus 0,88 billion kW a year earlier), is unlikely to be fully justified. By the end of the year, we expect a decrease in exports in the region of 25% YoY to 16,7 billion kW.

Long-term export prospects look a little better. In particular, talks have intensified about the construction of the Russia-Kazakhstan-Kyrgyzstan energy bridge, which could potentially provide an opportunity to supply up to 18 billion kWh a year to Kyrgyzstan, despite that Inter RAO has lost demand of about 14 billion kWh. However, the construction will require significant investments, primarily from Rosseti, and the load on their investment programme is already high due to inflation and problems with the supply of foreign components. In such circumstances, we believe that the implementation of the project is possible on the horizon for more than 5 years. Increasing the supply of electricity to China is associated with similar difficulties, since it will require not only strengthening the grid infrastructure connecting the Siberian Federal District and the Far Eastern Federal District, but also additional capacity in the Far East. Flood-proof hydroelectric power plants planned for construction in the Amur basin can be used for these purposes, but the prospect here is also medium-term at best.

In the conditions of sanctions, the sector is facing acute issues of resource provision for the implementation of investment and repair programmes. The head of Rosseti, Andrey Ryumin, estimated the share of foreign equipment and materials in the company's procurement programme at 10%, which will allow the company to “wait out” the adaptation period due to old stocks with further reorientation to domestic analogues and parallel imports. Nevertheless, a number of companies (Siemens, ABB, General Electric) supplied equipment critical for the industry, and supply disruptions will affect not only the grid complex, but also generation. At the SPIEF, Nikolay Shulginov said that the ministry is “thinking about what to do with the COMMOD," and now it is logical to assume a delay in the initial dates of commissioning, which may affect financial results and dividends already by the end of this year.

Profitability of the industry — 7,3%

Special attention should be paid to the prospects of the CDA RES programme, which look quite vague in the current realities. Nikolay Shulginov said that the work on the development of the industry is now “put on pause”, but at the same time, the ministry has not abandoned it at all. According to our assessment, the terms of commissioning under the CDA RES 1.0 programme can be postponed for 1-2 years in the conditions of transition to new owners, and the amount of financing of the CDA RES 2.0 will be significantly reduced.

Among the risks for the industry and its representatives, a possible reform of the system of surcharges to the price of electricity is now seen due to the increased burden on the domestic industry. In particular, the System Operator of the Unified Power System has already developed a new model of Capacity Price Auction, which will reduce the minimum reserve in the power system by 14 GW. This will reduce the volumes of modernisation programmes for electric power facilities, the construction of which is paid for by consumers. We do not rule out further steps in this direction, including limited indexing of tariffs, as well as changing the payment scheme for reserve capacity. In any of these scenarios, the industry's revenues will be under additional pressure.

At the beginning of the crisis, industry regulators recommended that electric power companies refuse to pay dividends in favour of implementing investment programmes, but in fact, many companies in the sector entered the dividend season with good dividends and high dividend yield. Record dividends were paid by the flagship of the sector, Inter RAO — 0,2366 rubles with a yield of 7,3% on the closing date of the register. The leaders in DY are the Gazprom Energoholding groups — Mosenergo (DY 10,6%), OGK-2 (DY 14,5%) and TGK-1 (DY 12,0%). As a result, companies with foreign shareholders — Unipro and Enel Russia — refused to pay dividends in the summer, and the average yield in the industry amounted to 7,3%, which is comparable to previous years.

Payment of dividends retained the interest of investors

In the electric grid complex, the situation has changed little: Lenenergo-ap, Rosseti Centre and Rosseti Centre and Volga region have become the best in terms of profitability. The holding itself refused to pay dividends at the end of 2021, which was generally expected and, in our opinion, has already been taken into account in prices (shares are traded near non-dividend levels, and the RSTI rate itself has already fallen 3 times from the highs of December 2020). Traditionally, the dividend “feature” of the FGC UES has not officially announced the cancellation of dividends for 2021, but at the end of May, there was news that the government recommended the company to refuse payments to shareholders. The investment programme of the FGC UES contains projects to increase the capacity of the energy infrastructure for the Baikal–Amur Mainline and the Trans-Siberian Railway, which have become especially relevant in the context of the reorientation of the economy to the East, and we assume that profits will be directed to investment programmes in the future.

The average dividend yield in the industry is at the level of 5% due to that about half of the subsidiaries of Rosseti will not pay dividends this season. The payment of dividends in the sector could maintain investor interest, and high-yield stocks performed significantly better than the market.

In the electric power sector, we are optimistic about the stocks of Inter RAO, one of the largest companies in the sector. The issuer's long-term strategy involves the expansion of generating capacities and sales through its own projects and the purchase of ready-made assets. The current crisis, of course, will adversely affect the sector in the medium term, but at the same time, presents an opportunity to increase the base f operations through profitable acquisitions, especially since the company has extensive financial resources on the balance sheet for this.

The common stocks of Rosseti, which is practically a monopolist in the grids, are now trading at multi-year lows, after falling 3 times from the highs of December 2020, and may be of interest to long-term investors. The company cancelled dividends for the previous year, but the securities are already at non-dividend levels, and this factor, like many other crisis risks, can be said to have been taken into account in the price. Just as in the case of Inter RAO, the holding can expand its market share by acquiring local grid assets. In fact, energy consumption is still much better than we expected, showing an increase of 3,7% YoY in May in the IPS/UPS and 2,4% YoY in the first 5 months of 2022.