Fortum in Russia Tapio Kuula Senior Vice President Fortum Corporation Capital Markets Day Stockholm, 4 June 2007
Disclaimer This presentation does not constitute an invitation to underwrite, subscribe for, or otherwise acquire or dispose of any Fortum shares. Past performance is no guide to future performance, and persons needing advice should consult an independent financial adviser. 2
Contents Fortum in Russia Russian power market reform development The way forward 3
Fortum in Russia Russian power market reform development The way forward 4
Fortum's current ownership in Russia TGC-1 Electricity production capacity 6,248 MW (of which hydro about 50%) Production volume (2006) electricity ~24 TWh heat ~26 TWh Over 25% stake in Territorial Generating Company No.1 (TGC-1) ~1/3 stake in other companies spun off companies Lenenergo (distribution) StP Sales Company StP Main Power Circuit (transmission) < 1% stake in Wholesale Generating Company No.5 (WGC-5) WGC-5 Electricity production capacity 8,660 MW Annual generation (2006) electricity ~40 TWh Four power stations in economically attractive regions Konak 2,400 MW Nevinn. 1,290 MW Reftins. 3,800 MW Sredne. 1,170 MW Fortum's investment EUR ~300 million, current market capitalisation EUR ~1.2 billion 5
Fortum s service activities in Russia Hydro power plant modernisations Vuoksi, Volkhov, Svir Power plant audits TGC-9 O&M services Performance Center Energy sector reform has initiated major interest in Fortum's service expertise Fortum is the preferred supplier of Owner s Engineering/Construction Manager services for hydropower plant modernisations A number of such projects in contract negotiation phase Our newly established Performance Center in St Petersburg gives Fortum a unique position to meet the increasing demand for power plant performance improvements and Operation & Maintenance services 6
Long experience of successful co-operation with Russia / USSR 1950 1960 1970 1980 1990 2000 Construction of hydro power plants in Kola area Loviisa NPP construction Construction of North-West CHP in St Petersburg Electricity import Lenenergo shareholding Distribution Co St Petersburg Sales Co Main Power Circuits TGC-1 Nuclear fuel import Automation & information system deliveries to thermal power plants Permanent presence in Moscow/St Petersburg Safety improvements for nuclear power plants MoU on JI with RAO UES WGC-5 7
Fortum in Russia Russian power market reform development The way forward 8
Substantial need for new capacity is the main challenge in Russia 1,800 1,600 1,400 1,200 1,000 Russian power demand forecast TWh (bln kwh) Demand growth 500+ TWh before year 2020 1,710 1,520 1,420 Power generation investment is expected to total 90 billion by 2011: nuclear 40 billion (10,000 MW) thermal 40 billion (42,000 MW) and hydro 10 billion (4,800 MW) In addition grid and transmission investment expected to amount to 40 billion 2000 2005 2010 2015 2020 9
Development of Russian power industry similar to the Nordic market Unbundling of businesses by type of activity Competitive businesses: Natural monopolies: Generation Sales Transmission Distribution Market liberalisation in competitive businesses Pricing model reform from tariff regulation to competitive pricing 10
Russian power industry reform has progressed well Key steps in the reform Time "Power industry law" approved 2003 Establishment of Russian power exchange (ATS) 2001 Launch of the free-trade sector of the wholesale market in European & Urals 2003 in Siberia 2005 Launch of balancing power segment 2006 Launch of new wholesale market model 2006 Restructuring of regional energos (P&H companies) almost complete Formation of new companies almost complete Capacity market 2007 Competitive market of ancillary services 2007 Financial derivatives market 2008 Full liberalisation of the power market 2011 11
Reform Key events taken place in 2006-2007 Structural reform Restructuring is almost completed Unbundling of energos; creation of TGCs and WGCs New configuration of Interregional Distribution Companies (11 instead of initial four, + Far East) Strategy for sales companies disposal Reorganisation of RAO UES' asset ownership started Additional share issues implemented in WGC-5, WGC-3, TGC-3, TGC-5 Procedures approved to spin off WGC-5 and TGC-5 Market liberalisation New wholesale market model launched Power market liberalisation schedule decided (100% by 2011) Decisions on gas prices and supply taken 12
Planned wholesale market model in Russia Long-term Day-ahead Intra-day Energy market - to cover marginal production costs Bilateral energy agreements free prices & volumes Day ahead market power plant wise bidding to form hourly planned production for next day Balancing market 'market' for deviations between actual and planned volumes Capacity market - to ensure availability of capacity in long and short term and provide stable source of income for GenCos Capacity auction capacity tariff formed on bid-basis Bilateral capacity agreements free prices & volumes Main differences to the Nordic market model Power market and electricity price split into two components: energy and capacity Nodal energy pricing about 8,000 nodes where prices differ due to losses and transmission bottlenecks Centralized dispatching No separate after-spot bids Financial market not yet designed; however, regulated bilateral agreements serve as financial instruments 13
Demand and supply now reflected to prices Liberalised energy price in Russia * Pace of liberalization RUB/MWh 1000 900 800 700 600 500 400 300 200 100 0 2006 2007 *) Daily average for European and Urals part of Russia. In addition to energy price a separate capacity payment. EUR/MWh 25 20 15 10 5 0 TWh/a 1400 1200 1000 800 600 400 200 0 regulated volume liberal volume 2007 2008 2009 2010 2011 Implicit price cap was removed along with the launch of new wholesale market model in September 2006 Russian government approved future liberalization volumes on April 7, 2007 Until 2011 electricity to households will be sold at regulated prices 14
Gas price is an important factor affecting electricity price Nuclear 16% (156 TWh) Hydro 18% (175 TWh) Russian power generation 991 TWh in 2006 1 Oil 2% Gas 46% (455 TWh) Price EUR/MWh 60 50 40 30 20 10 Electricity price and typical marginal costs for gas-fired power plant 2 Electricity price CO2 cost Gas cost Other <1% Coal 18% (178 TWh) 0 Russia Nordic Germany Price of gas is the key factor affecting the electricity price in Russia since almost half of power is produced with gas-fired power generation. Gas price is regulated and is currently very low. Long term gas contracts available for the first time in power sector 1) Source: RAO UES, MinPromEnergo 2) Annual average market prices for 2006 (for Russia liberal energy price). In Russia there is a separate capacity payment in addition to energy price. 15
Reform Planned key events for 2007-2008 Structural reform Completion of the Structural reform RAO UES to release ownership from generation assets Share placements and sales of stakes in WGCs and TGCs Completion of the first spin-offs of RAO UES Distribution of RAO UES assets to its shareholders Selling off maintenance and repairing companies Selling off sales companies Market liberalisation Launch of Capacity Market Launch of Ancillary Services Market Launch of Financial Derivatives Market 16
Share issues and sales of stakes RAO UES to release ownership in generation companies (WGCs and TGCs) Share issues to raise capital into companies for investments current owners have pre-emptive right RAO UES not participating i.e. is diluting may include 'strategic stakes', e.g. WGC-3 in March 2007 Sales of RAO UES /state s stakes in the companies e.g., sale of >25% stake in WGC-5 planned in June 2007 to raise capital for FGC and HydroWGC Distribution of RAO UES' stakes in the companies on pro rata basis to RAO UES' shareholders holding companies as vehicles state's stakes in TGCs and thermal WGC s temporarily to FGC and HydroWGC, but to be sold WGCs WGC 1 WGC 2 WGC 3 WGC 4 WGC 5 WGC 6 TGCs TGC 1 TGC 2 TGC 3 TGC 4 TGC 5 TGC 6 TGC 7 TGC 8 TGC 9 TGC 10 TGC 11 TGC 12 TGC 13 TGC 14 2006 Q4 Nov Dec Indicative time schedule Q1 Q2 Jan Feb Mar Apr May 2007 2008 Q3 Q4 Q1 Jun July Aug Sep Oct Nov Dec Jan Q1-> Q1-> Q1-> 17
Ownership structure after the completion of restructuring of RAO UES 100% >75% >75% State >50% (52%) 2) During transition period HydroWGC and FGC will own State's shares in WGCs and TGCs, and sell them to finance their investments Nuclear FGC <25%* System Operator <25%* Hydro- WGC <50%* 6 WGC 14 TGC 100%** Other shareholders 100%** Other 1) (48%) 2) State will not have ownership in TGCs and WGCs after completion of RAO UES reorganisation RAO UES minority owners will get pro rata based shareholdings in TGC's and WGC's FGC = Federal Grid Company WGC = Wholesale Generation Company TGC = Territorial Generating Company * Minority Shareholders RAO UES ** Minority shareholders RAO UES, WGC/TGC, private investors 1) Far East Generation companies and other assets owned by RAO UES + other capacity (standalone) 2) presents State's and minority shareholders shares of RAO UES assets only 18
Planned capacity market System Operator determines capacity to be auctioned based on peak demand estimate and reserve margin requirement Different capacity requirement by region and for flexible and inflexible capacity Generators bid in the auction. If bid accepted generator can choose to be a tariff or a free supplier (liberal energy market and free bilateral capacity agreements) after the auction. Consumer can in order to cover his peak demand and reserve ratio either make free agreements or receive the average capacity payment of those staying with them Capacity auctions for 5 years ahead for a 10-year period + annual corrective auctions (if more capacity needed) 2007 Long-term auction for 2012-21 Corrective auctions 2008 2009 2010 2011 2012 2013 Separate auctions for each year in the transition period 2008-2011 for the liberalised part of the volume Capacity auctions: for 2008 to take place in Sep 2007, for 2012 (10-year period) in Dec 2007, for 2009-2011 after Dec 2007 19
Gas price liberalization to secure supply for domestic use EUR/MWh 50 40 30 20 10 0 Planned gas price development 1 Germany The Netherlands Russia ~ transmission, export duty 2006 2007 2008 2009 2010 2011 Security of gas supply for power sector in the long term is a key question guiding future investments Gas production from existing fields is decreasing Supply-demand tightness is increasing Independent suppliers expected to take major part of production growth Gas price liberalisation till 2011 is planned as a remedy to secure gas supply for domestic use. Regulation on Independent gas producers access to Gazprom's gas pipelines is under discussion 1) Russia, gas price development as in government plans 30 Nov 2006; The Netherlands, TTF spot + futures; Germany, Bunde-Oude spot + futures 20
Fortum view - Market based solutions in focus when developing the market further Functioning wholesale market with free price formation is the most important factor in securing needed investments and reform success Today there is an excellent platform but some additional actions could take the market towards further liberalization Ensure transparency and simplicity of market rules Ensure a regulatory body that can continue power market development after RAO UES Launch of capacity trading and financial derivatives market to provide credible long term price signal and risk management instruments Investments into transmission to enhance competition Ensure security and equal access to fuel supply Ensure that demand and supply flexibility is fully reflected to market prices Continue liberalization of retail market 21
Fortum in Russia Russian power market reform development The way forward 22
Share issue in TGC-1 Fortum prepared for participation TGC-1 has decided on a share issue in July 2007 which aims at increasing the share capital by about EUR 930 million Fortum s target is to maintain its current, slightly over 25% stake in the company Fortum is thus preparing acquisition of the corresponding amount of new shares Fortum is currently the second largest shareholder of the company The planned use of the new capital in TGC-1 is financing the company s investment program to increase electricity production capacity by 50% or over 3,000 MW by 2015 23
Lenenergo continuing as a distribution company Fortum owns about one third of the electricity distribution company Lenenergo in St Petersburg According to the latest reform plans for interregional distribution companies, Lenenergo will be left in its current form City of St Petersburg has informed its interest in obtaining a minority stake of 25+% in Lenenergo. Discussions started on possible share issue in Lenenergo for the benefit of the City as part of City's contribution would be the grid assets owned by the City 24
New opportunities along with the restructuring - Generation in Fortum's primary focus in Russia Thermal capacity is the main generation type in each area in Russia Gas primary energy in thermal generation TGCs regional, with power and heat generation nuclear hydro thermal coal oil gas WGCs large scale power generation, with big generation units and only limited heat generation located in several areas (ensuring market formation and competition) capacities 8,500-9,000 MW power generation volumes 30-50 TWh/a new investment programs 1,900-3,100 MW, bringing power generation volumes to a level of 50-70 TWh/a TWh 60 50 40 30 20 10 0 Power generation each TGC except Mosenergo each WGC Fortum 25
Fortum has more than 10 years experience from liberalised power markets Well-functioning Nordic power market Nordic Competition Authorities 7/2003 "Deregulation of the Nordic electricity sector has been largely successful." Swedish governmental commission 1/2005 "Price formation in Nord Pool is credible" Damsgaard & Green 9/2005 "Market liberalisation has been beneficial to the national economy and has brought efficiency to the industry." Damsgaard/ECON 9/2006 "The current high prices reflect the hydrological situation. Current pricing gives right market signals. Don t mess with a well-functioning market model!" EUR/MWh 80 70 60 50 40 30 20 10 0 Futures 30 May 2007 Source: Nord Pool 1995-97 -99-01 -03-05 -07-09 -11 Generation others Dong Energy E.ON Leading Nordic power company Vattenfall Fortum Statkraft Distribution Fortum others Vattenfall E.ON Dong Energy Hafslund Retail Fortum Vattenfall others E.ON Dong Energy Hafslund 2006 26
Fortum as a strategic investor brings not only capital but also experience to the industry A functioning liberalised power market needs market rules but also capable actors Over 10 years experience from liberalised power markets trading, risk management Excellence both in management and overall performance of generation companies Benchmark operation of different production forms (nuclear, hydro, CHP, condensing) efficiency with proper environmental approach Global experience in O&M operations Long track record in cooperation with Russia 100 95 90 85 80 75 70 Energy availability in gas fired power plants Germany Fortum USA 1996 1998 2000 2002 2004 Sources: Fortum, VGB/Germany, NERC/USA 27
Stable investment environment key for a foreign strategic investor Political commitment to the reform and its timetable Stable and predictable regulation Equal treatment of both domestic and foreign actors Transparent and free price formation in the wholesale power market - no mechanisms that distort the market Market based capacity investments should be encouraged Constant efficiency improvements to be encouraged 28
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