THE RUSSIAN FEDERATION WANTS U.S. UTILITIES AND businesses to know investments are welcome and that processes soon will ensure the safety of American ventures there.

Nevertheless, it appears to favor traditional, American-style utility regulation, setting rates of return and limiting profits.

The Federal Energy Commission of the Russian Federation wants to create competition wherever possible, according to Andrey F. Zadernyuk, the first chairman of the year-old commission. The energy sector, formerly a state monopoly, is slowly privatizing, said Zadernyuk, whose organization is akin to the Federal Energy Regulatory Commission. This process has created joint stock companies and set up regional energy commissions, similar to state public service commissions in the U.S.

Zadernyuk, in an interview at the U.S. Energy Association in Washington, D.C., explained that the Russian Federation is looking for a model to follow as it introduces competition. Zadernyuk visited California in early 1998 but was disappointed that he was too early to see competitive markets in action due to the delay of restructuring there.

Zadernyuk pointed to the USEA/USAID partnership program that joins Russians (and members from other countries) with U.S. utilities to gain experience in their methods of utility regulation and business operations. In fact, it was because of Zadernyuk's experiences with the Illinois Commerce Commission and subsequent knowledge of regulation that he was appointed chairman of the Russian FEC. Through these relationships, he was able to organize seminars with commission staff and introduce concepts such as rate design and conflict resolution.

Old-Fashioned Rate Regulation

The reality of what is occurring in the Russian Federation is complicated. Zadernyuk acknowledges economic decline, but noted that in 1997 early signs of a growth spurt arrived. He believes a rational energy rate policy is important to Russia's development. He said his FEC is taking all measures to reduce energy rates. For example, it cut electric wholesale rates by 5 percent on Jan. 1 and another 5 percent on April 1. On Jan. 1, it cut rates for transportation of export oil 5 percent.

When asked how the FEC will determine "optimum rates," Zadernyuk replied that the "optimum price is a slippery concept in the absence of competition." His commission will be creating procedures to set prices.

Zadernyuk said the rate must be economically justified, the price must be such that the costs of production will be recovered while allowing a reasonable rate of return, and that excessive profits at the expense of ratepayers must be excluded. He added that the optimum price is a balancing act between customers and producers, and yet should not frighten away investors.

Zadernyuk said the method for setting rate of return is still unresolved. While a majority of regulatory bodies sets a percentage figure, the rate of return that is set often is in the negative figures. It is an arbitrary process. Only now is Russia moving to a cost-of-service-based approach that uses asset valuations.

Complete with Federal/State Conflicts

Natalia Fonaryova, chairman of the Anti-Monopoly Committee of the Russian Federation, said that it will handle the immense size of Russia by establishing regional bodies that regulate on a local basis. But the key point is that a federal system of regulation as found in the U.S. is in place, she stressed. Fonaryova explained that the American experience is valuable because Russia also has two levels of government and is learning more about federal/state jurisdictional issues. She stressed that her committee is fighting unsanctioned activities at the local levels, and in one year had overturned 1,500 decrees by local governments that acted as obstacles to an effective government.

Zadernyuk explained the FEC appeals process, noting that FEC decisions are binding for the list of industries that are considered natural monopolies. Those decisions only can be appealed to the courts. For local conflicts, the FEC acts as arbiter, and uses pre-trial procedures to resolve problems. But he explained that now Russia is doing in one month what it took other nations 10 years to do.

Zadernyuk said that an enormous opportunity exists in oil refinery upgrading and refitting. Present refining techniques in Russia only allow 52 percent purity but western technologies allow up to 98 percent. Major profit also can be made in the electric sector because they are at the mercy of outdated technologies; for example, only now are combined-cycle technologies starting to be used.

The Russian Federation welcomes U.S. investment to upgrade facilities, Zadernyuk said. Although risk is part of the equation, there likely will be benefits to the U.S. companies that invest first, especially as relationships are built and the vast areas of opportunity open up, he added.

Lori A. Burkhart is contributing legal editor to Public Utilities Fortnightly.

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