2014-03-24 12:06:54 - Recently published research from Business Monitor International, "Russia Power Report Q2 2014", is now available at Fast Market Research
A slowdown in household consumption and the Kremlin's failure to sufficiently address structural impediments to investment are likely to continue to weigh on the Russian power sector - based on the fact that power demand remains highly correlated with economic development and industrial production. While the Russian power market is huge in terms of its sheer scale, we maintain our view that it will only register subdued growth over our forecast period as macroeconomic headwinds, a difficult political environment and weak institutional capacity continue to discourage foreign investment. As such, with much of the country's aging capacity having been built in the 1960s and 1970s, we expect most of the investment that is channelled into the power sector to be
targeted at modernising and substituting aging and inefficient thermal and nuclear capacity, and improving the inadequate transmission infrastructure.
Our relatively subdued outlook for the Russian power market continues to be underpinned by our downbeat forecasts for Russian economic growth this quarter. In line with our already bearish view on the Russian economy, real GDP growth continued to slow in 2013 - coming in at a modest 1.3%. While a breakdown of the Q413 result was not available at the time of writing, BMI's Country Risk team expects fixed investment to have continued to drag on growth in the fourth quarter - much like it did over the preceding nine months.
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At the same time, the main driver of growth over the past decade - household consumption - continues to weaken. We have said previously, that we believe such a slowdown is structural rather than cyclical and, as a consequence, unless structural reforms are implemented, economic growth is likely to remain subdued over our forecast period to 2023.
Indeed, despite the Russian authorities taking steps to actively encourage investment, the Kremlin continues to fail to address supply-side impediments. To this end, while the Central Bank of Russia has demonstrated it has the resolve to rein in inflation so it can cut rates in H114 and ease liquidity conditions, while at the same time the government has tolerated a weaker rouble to boost export competitiveness, there does not appear to have been any real effort to address structural issues such as corruption, grossly inefficient bureaucracy, inadequate property rights and questionable autonomy of the judiciary. As such, we maintain a gloomy outlook for fixed investment over 2014-2015 and reiterate that, unless structural reforms are implemented to address these issues, investment will continue to make modest contributions to GDP growth for the foreseeable future.
At the same time, private consumption, which had been the main driver of growth over the past few years, exhibited signs of a gradual and steady deceleration in 2013, and BMI's Country Risk team expects this trend to continue for the foreseeable future. This slowdown continues to be a symptom of household consumption coming under pressure on three main fronts: With income growth slowing as oil prices are unable to sustain the rise in incomes recorded over the last decade, credit growth also diminishing as banks start ramping-up loan loss provisioning and inflation set to remain elevated due to structural rouble weakness,Critically, this slowdown will serve to constrain real GDP growth at 1.9% in 2014 and 2.2% in 2015. This in turn will affect power demand, which is high correlated with economic development and industrial production. As such we expect power generation to grow by a modest annual average of 1.3% to the end of our forecasts period in 2023. Consumption will average a similarly muted at around 1.4% annually.
Although Russia's current 'Energy Strategy 2030' outlines plans for the expansion of the nuclear and nonhydropower renewable industries, we remain cautious based on delays to the construction of nuclear installations and the slow development of the renewables segment. As such, although the outlook for renewables is improving, with Russia successfully closing its first renewables auction in 2013, we maintain the view that the country's heavy reliance on thermal energy sources, particularly gas, will continue into the next decade.
Among the key trends and developments observed in the market, we also highlight that:
* With oil revenues falling, state-run companies rather than the government will likely have to support any capital expenditure and investment in new capacity, as the Kremlin attempts to improve its balance sheet. However, complicating matters, we note that in September 2013 the Russian government proposed freezing electricity tariff growth - in an effort to tame inflation and enable the Central Bank to cut rates. This is a move that will weigh heavily on state-owned utilities' profits and revenues. These companies may be caught in the position of having to pick up any slack in power sector investment (as an extension of the state), even at a time when the tariff growth freeze is affecting their profitability.
* To this end, Economy Minister Alexei Ulyukayev was quoted in September 2013 as saying that gas and electricity rates, which are normally raised in July, would not be raised until July 2015 - and then only at the level of inflation in 2014. Taking things a step further, Prime Minister Dmitry Medvedev is also reported to have told ministers to draw up a new economic development plan for 2014-2016 that would incorporate a scenario whereby tariffs are maintained at 2013 levels - a directive that is reportedly 'being considered'.
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