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Analysis & Opinion
11.06.08 Caught Unprepared
By Graham Stack

The flood of investment in expanding Russia’s power generation capacity has taken most people by surprise – including the power engineering companies who will be involved in achieving it.

"No one anticipated the success of the UES spin offs in raising investment funds," said Alfa Bank’s Alexander Kornilov, "and so the power generation machinery sector was caught unprepared for the huge surge in demand."
St. Petersburg-based Power Machines, a conglomerate of several large power engineering plants which took shape in 2004, possesses 60 percent of the Russian market, so it is taking a lion's share of the capex. But according to Kornilov, Power Machines is facing a "severe shortage of qualified personnel and manpower."

It was only in 2007, as the sell-off of the state’s stakes in power generation companies begun, that the scale of the forthcoming investment boom became clear. In February of 2007, Power Machines announced that its sales revenue could jump to $1.5 billion in 2010 from $680 million in 2006, as the result of a one billion-dollar investment in 2010.
This abrupt change in fortune turned the loss-making Power Machines into a hot property with strategic importance. Both electricity utility RAO UES and financial-industrial group Interros announced that they would sell their stakes to a strategic investor, promptly unleashing a bidding war between metal oligarchs Oleg Deripaska and Alexei Mordashov, which resulted in the latter consolidating a 55 percent stake in the company for close to one billion dollars.

With a strategic investor in the driver’s seat, new management, and an additional share issue having raised $275 million, Power Machines’ plans to more than double the generation capacity of the machinery produced looked more realistic.

But it was still striving to catch up, with new demand exceeding current output fivefold. Moreover, construction of new generation capacity is on an extremely tight schedule: mandatory investment programs stipulate 280 turbines to be built by 2011.

This bottleneck does not just relate to turbine producers. A whole range of further engineering services, construction materials, and construction work industries are coming up short and it’s not just due to a lack of capacity. Russian produced-technology still lags far behind its Western counterparts.

Luckily for Power Machines, but unfortunately for Russia’s electricity generators, foreign giants such as Siemens and Alstom are also operating at full capacity. "The world's largest producers of generating equipment, such as General Electric, Alstom, Siemens and Mitsubishi, are just as overloaded as Russian Power Machines, leaving no room for an increase in their production," said Kornilov.

The Freedonia market report predicts global electric transmission and distribution equipment demand to rise by 4.4 percent annually through 2011, and the International Energy Agency forecasts at least around 140 billion euro per year to be invested in power generation until 2030.

As a result, Russian power generators have to line up to place orders. Mosenergo reportedly paid a $54 million booking fee for a $500 million equipment order from a foreign producer, according to the Russia Today television channel.
The surprise guests at the feast have thus been no-name Chinese producers. OGK-2 invited Harbin Power Equipment to be an equipment supplier for the Troitsk HPP, and at the end of April, it announced that it was inviting a project developer from China to take part in the construction of new generating units at the plant.

These steps awakened alarmist fears of a myriad of cheap Chinese power station components and companies flooding the market. However, according to Alfa's Kornilov, Chinese manufacturers still lack the quality to make real inroads.

How to kick-start engineering

The upshot is that Anatoly Chubais, the godfather of the 1990’s economic reform, the scourge of industrialists and the idol of free-marketeers, has succeeded where the government’s interventionist silovik faction has little to show: by kick-starting a revival of the ailing machine-building sector. Much of the Kremlin’s economic policy during Putin’s second term was focused on reorganizing the machine-building sector – including “deprivatizing” where necessary.
The culmination of this policy was the establishment of the Russian Technologies state corporation in December of 2007, dedicated to supporting and developing machine-building, and exercising direct control over more than 300 companies, headed by Putin’s old friend Sergei Chemezov.

Chemezov argues – with some justification - that turning the sprawling machine--building sector around is the key to achieving economic diversification. “In any country, and especially in ours, machine-building is the key sector of industry," Chemezov told Nezavisimaya Gazeta in an interview on May 28th.

And this is what Chubais has achieved with the rags-to-riches tale of power equipment producers – without a ruble of state support and without infringing on property rights or creating opaque structures as the siloviki are prone to do.
On the same day that headlines boasted the maiden flight of Russia's new regional jet, the Sukhoi Superjet 110, a product of the state-owned holding United Aircraft-building Corporation, Chubais opened the first Russian-produced, combined-cycle power unit in Komsomolsk, the work of private companies and private investment, claiming “a breakthrough for the country's heavy-machinery sector.”

One company had dual cause to celebrate: Yaroslav-based turbine producer NPO Saturn built the engines for the Superjet, and also the turbines for the Komsomolsk power plant. The case of NPO Saturn also illustrates the very different approaches between the “industrialists” Chubais and Chemezov.

In his speech opening the power plant, Chubais congratulated Russia's power engineering managers, but warned them that they had to stay internationally competitive to keep winning tenders. “I'm for Siemens as well, and I'm for General Electric. If you fail to produce the ten new units, I'll strangle you with my own hands," he warned them playfully, as quoted by the Interfax news agency.

On the other hand, Chemezov’s threats toward NPO Saturn are far less playful: Russian Technologies holds a 37 percent stake in the company, and is pushing for the company to be merged into a state-controlled conglomerate, effectively renationalizing it. The company’s director, Yury Lastochkin, bitterly resists it.

Deputy Industry Minister Denis Manturov, a Chemezov ally, has publicly called Lastochkin’s position “destructive,” adding in a Kommersant interview: “I advise Lastochkin to read what is set down black on white in the presidential decree about who is to do what and when,” and stating that Russian Technologies would ultimately require full control over Saturn.

Lastochkin responded in the Vedomosti daily that “to hand over the assets that we have been developing and structuring for over ten years to complete nobodies would be beyond a laughing matter.” Asked if he feared pressure from the law-enforcement agencies forcing a management sell-out, he said he hoped the state was clever enough to realize that any such “games and experiments” would have a disastrous effect on such a finely-tuned, technological enterprise.

Which of these two battling paradigms--Chubais versus Chemezov, the unbundling of RAO UES versus the snowballing of Russian Technologies, competition and private investment versus state control--wins over, is one of the first things that the new President Dmitry Medvedev will have to decide.
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