In the coming months, the IEA will publish Russia 2014, an in-depth energy policy review of the Russian Federation. This article about electricity reform, a critical aspect of the country's energy policy, appears in the latest issue of IEA Energy: The Journal of the International Energy Agency.

Russia is undertaking one of the most ambitious electricity reform programmes in history. The country has already made impressive progress by international standards, and the project offers the potential to transform the sector into a key driver of longer-term economic growth and prosperity.

Among other gains, Russia has realised an unbundling and privatisation of generation infrastructure; an investment obligation mechanism targeting new investment; a wholesale spot market for European Russia, the Urals and Siberia; and incentive-based economic regulation. It has also made progress on more cost-reflective retail pricing while creating or strengthening critical market and regulatory institutions.

But Russian electricity reform is entering a critical phase where IEA experience suggests that government commitment may be tested and the risk of undue compromises jeopardising successful implementation may increase. So the Agency recently updated its 2005 study that advised Russian policy makers.

Russian Electricity Reform 2013 Update draws on the experience of IEA member countries and the views of key Russian stakeholders to examine the main challenges affecting the development of competitive wholesale and retail markets including market structure, market design, pricing, investment and related regulation.

Harnessing competition and innovation

The IEA has found that diversity of ownership is the best way to achieve a competitive wholesale market structure. Although Russia’s very successful 2008 privatisation brought several new entrants, the government still has considerable scope to diversify ownership and wholesale competition through further divestment as well as virtual power auctions or similar mechanisms to sell rights to the output of publicly owned generators. It can also strengthen market integration. The new report notes the crucial role of effective competition supervision, especially during the current initial phase of rationalisation.

Russia’s competitive wholesale spot market is one of the most successful components of the reform implemented to date. Russian Electricity Reform 2013 Update emphasises the importance of establishing transparent and competitive wholesale markets that create strong incentives for efficient and innovative investment responses, including renovation, refurbishment and retirements, while also removing undue legal and regulatory barriers.

IEA experience suggests that a well-functioning energy-only market will provide Russia with an effective electricity wholesale market model in the longer term. But that requires a competitive wholesale market structure; cost-reflective pricing and efficient price formation; a transparent and efficient financial market; and access to accurate and timely information, including medium-term demand projections.

Competitive retail markets are in an early phase of development in Russia, which is generally reflected in a highly fragmented and concentrated retail market structure. Russian policy makers have taken some positive steps towards establishing the market rules and regulations needed to develop competitive and innovative retail markets. But much depends on how effectively these rules and regulations are translated into commercial incentives and practical processes that support efficient, competitive and innovative market operation and development.

Russian Electricity Reform 2013 Update proposes an integrated approach, calling for effective market processes and practices for contracting, billing, switching and settlement; and building customer awareness and active engagement. It notes the need for close monitoring and supervision of retail markets to identify and eliminate barriers to new entry.

Price reform is essential for success

In the decade since it passed the main legislative backbone for electricity reform, Russia has also made considerable progress in rebalancing tariffs, but here too there is more to do, especially for regulated residential consumers.

Unwinding the remaining cross-subsidies and moving to cost-reflective pricing are needed to realise the full benefits of electricity reform.

The IEA proposes that on the demand side, price increases be linked to growth in user capacity to pay while direct government payments to regulated users replace user-funded subsidies. At the same time, the government needs to keep pursuing supply-side reforms to help reduce the level of cost-reflective prices, especially in relation to network services.