IFC’s Global Experience in Power Distribution London March 12-13, 2012 Russian Power

The World Bank Group IBRD International Bank for Reconstruction and Development IDA International Development Association IFC International Finance Corporation MIGA Multilateral Investment and Guarantee Agency Est. 1945Est. 1960Est. 1956Est Role To promote institutional, legal and regulatory reform To promote private sector development – portfolio end 2011: $42.8 billion in 127 countries To reduce political investment risk Clients Governments of member countries with per capita income between $1,025 and $6,055 Governments of poorest countries with per capita income of less than $1,025 Private companies in member countries – 1,737 currently in portfolio Foreign investors in member countries Products Technical Assistance Loans Policy Advice Technical Assistance Interest Free Loans Policy Advice Equity/Loans - $12.2 billion committed in 2011 Risk Management Advisory Services Mobilized: $6.5 billion Political Risk Insurance 2

IFC is a Leading Investor in Emerging Markets Power 200+ power investments in 57 countries  Generation – Financed 26,000+ MW across wide range of technologies  Transmission – Selected investments in transmission assets  Distribution - Current power portfolio reaches over 20 million customers around the world Typically play a leading role in financing early private investments in markets under reform Have not been able to do so in Russia, despite early engagement on reform - and financing Mosenergo We hope the distribution sector will soon offer an opportunity to contribute 3 Cumulative Commitments since 1967 Total Commitments = US$ 7.8 billion

IFC’s Experience in Distribution 4 Some lessons distilled from that experience, follow

Why are Distribution Systems Privatized? Govs may have set tariffs set below costs generating mounting subsidies Billing and Collections: often weak; high arrears; culture of non-payment Poor Customer Service Staffing – high number of staff, bureaucratic internal organization Operational Issues – High technical losses and poor maintenance as a result of sustained lack of proper funding Private investors are expected to reduce losses, cut costs, improve service 5 Some combination of these issues triggers privatisation or concessioning of distribution

What the Distribution margin needs to cover 6

Cost of Capital This calculation is generally done at the beginning of the regulatory period (3 years or more) Multi Year Tariff Regulation

What can go wrong…. Dilution of the Distribution Margin 8

Power Purchase Cost and Asset Valuation 9

Failure to allow full pass through of generation cost Regulatory risk is key – and the rules always change All of the power sector’s policy mistakes tend to show up here Often because the distributor not allowed to pass on full generation costs An agreed level of losses included in costs- but may discover it is too low Losses above that – valued at wholesale market price or at the import price? Formula to fund smoothing of fluctuations in generation cost - beware Devaluation will hit impact capital and maintenance costs Inflation will impact staff and other overhead costs Agreement that generation costs can be passed through to the consumer, can in practice, soon lead to a dispute which could bankrupt the distribution Co. 10

Devaluation and no indexation Below cost tariffs policy – subsidies Loss-making Billing and Collections – High arrears, culture of non-payment Lack of Customer Service – No customer focus, lack of service and communication with customers Staffing – high number of staff, bureaucratic internal organization Institutional Set Up – Under the tutelage of one Ministry Operational Issues – High technical losses and poor maintenance as a result of sustained lack of proper funding 11

Between 1992 and 1998, forty six electricity distribution companies were privatized worldwide... …raising nearly $28 billion in sales proceeds 12 Privatization of distribution: boomed in the1990s Since 2000, distribution companies were privatized in Armenia, Macedonia, Ukraine, Bulgaria, Slovakia, Uganda, Cameroon, Turkey, Pakistan and India

Valuation: Enterprise Value per customer 13

Did Privatization Work? Total Losses (%)

Turnaround of Privatised Distribtion Cos can be quick 15 Controllable costs cut quite quickly

Power Distribution: Main risks for investors 16

South American Regulatory Models 17

Romania - with a World Bank Guarantee of Gov. Obligations WACC: 12% for first regulatory period (FRP) of 3 years; 10% for second Efficiency Factor: 1% for FRP. For second: 80% of actual over FRP New investments agreed with Regulator & included in RAB at the start Loss reduction linked to new capital investments plan. Starting at 13% Quality Standards: Apply only from 2 nd period. Tougher in 3 rd RAB is indexed to inflation at the end of each regulatory period Pass through of power purchase costs based on quarterly average Investors see reliable, long term cash flow which they can borrow against 18 Government’s obligations under the concessions guaranteed by World Bank

Distribution: Reducing Regulatory & Market Risks Maximize “choice” at the distribution level through competition in generation Adjust and rebalance tariffs prior to privatisation: tariffs will always be “political” Establish a transition tariff formula for an initial period – at least 4 years Establish detailed methodology with efficiency incentives – avoid auditing costs Avoid regulatory discretion by agreeing a market based return – e.g. a utility index Avoid regulatory discretion by assuming model capital structure e.g. D/E of 60:40 Include a formula to adjust tariffs monthly for inflation and devaluation Establish a long concession period – 30 years? Must specify what would happen if terminated – how assets are to be transferred Establish clear and measurable quality standards the concessionaire must meet Obtain technical audit of distribution losses - agree realistic loss reduction targets Obtain regulatory approval for investment program for first regulatory period Indicate the upper limit of the efficiency factor “X” for 2 regulatory periods Obtain an audit for starting “accounts receivable” and what % of that is “bad debt” 19

Trust is All – Prices paid for Distribution Cos. (US$/customer) 20