Long-Term Development Strategy

Market Overview

Macroeconomic Environment

The social and economic conditions in Russia in the reporting year were the main factor that constrained the increase of electricity consumption and, as a result, the volume services provided by Federal Grid Company.

Industrial output in Russia dropped by 3.4% for the full year 2015 (in 2014, Russia reported growth by 1.7%). Output in the energy-intensive sectors, such as metallurgy and manufacture of machines and equipment, declined by 6.5 and 11.1%, respectively¹.

According to the System Operator of UES², electricity consumption across the unified energy system (UES) of Russia reduced by 0.55% year-on-year in 2015, to 1,008.3 billion kWh. Export to the neighbouring countries increased by 25% but it accounts for a small share in electricity consumption in UES of Russia (less than 2%). The average annual growth of electricity consumption in UES of Russia is estimated at 100.81% in 2016–2022.

Electricity Consumption in UES of Russia in 2015 and Forecast for 2016–2022, billion kWh

Moderate GDP growth rates in Russia in the coming years and electricity consumption developments are important factors that affect the volumes of electricity consumption and electricity transmission services. Electricity consumption in the manufacture of the most energy-intensive goods has been declining over the past years due to modernisation of production technologies and implementation of energy saving programmes. A steady increase of electricity consumption was reported only in the oil industry.

These factors mitigate the effect of changes in the geography of demand for electricity and distribution of loads. They also help to use the available spare capacity in the grid, and postpone expensive enhancement projects.

Industry Market

Changes in Electricity Consumption Per Unit of Certain Types of Goods Manufactured in 2014 Relative to 1995

^{Source: Rosstat, “Russian Statistical Yearbook, 2015”}

Federal Grid Company transmits electricity via backbone grids and provides technological connection to the grid. Electricity transmission via backbone grids is a natural monopoly. Besides PJSC Federal Grid Company of the United Energy System, certain transmission services and technological connection to the Unified National Electric Grid (UNEG) are provided by JSC Grid Company (Republic of Tatarstan), JSC Bashkir Grid Company (Republic of Bashkortostan), JSC Regional Electric Grids (REG) (Novosibirsk oblast) and JSC Irkutsk Electric Grid Company (Irkutsk oblast) (within grids that they own).

The Russian market of electricity transmission services is affected primarily by macroeconomic factors that characterise the overall economic situation in the country. The volume of services in the backbone electric grid depends on the capacity which is sold to the customers of electricity transmission services, and on the capacity of power receivers connected to the grid.

In 2015, the paid capacity amounted to 87.9 GW, down by 3 GW relative to the previous year. This change is caused not so much by the lower consumption as by the transition to the principle of measuring services at their average arithmetic capacity when these services are sold to direct customers. Optimisation of consumption modes by the customers and their possible use of distributed sources of generation also constrain the increase of the volume of Federal Grid Company’s services.

The volume of technological connection (of customers and generation facilities) in physical terms did not change substantially over the past few years. These changes largely depend on the demand for capacity which is required for the customers’ and electricity producers’ investment projects. The substantial increase of service in physical terms in 2015 was driven by the completion of several large projects of technological connection at the generating stations of State Nuclear Corporation ROSATOM.

Capacity Paid For by Customers of Transmission Services Provided by Federal Grid Company, GW

Technological Connection Services in Physical Terms*, MW

Based on the estimated electricity consumption and electricity exports and imports, and with regard of factors behind the lower electricity consumption growth rates (energy saving in the first place), the Company does not anticipate any significant increase in the volume of services paid for by the customers. The volume of services will increase in the coming years because UES of Russia will be expanded within the IPS South and IPS East (integration of the western and central energy regions of the Republic of Sakha (Yakutia).

Depreciation of the national currency and growing inflation rates increase the uncertainty of investment expectations and might delay implementation of investment projects run by electricity consumers and producers. New projects of technological connection will be smaller as a result.

Development Strategy

Federal Grid Company’s mission is to ensure reliable operation and development of UNEG that will be adequate to economic growth, and demonstrate high economic efficiency and cost minimisation. Our strategy should ensure steady commitment to this mission, respond to technological and economic challenges and promote the solution of problems that are caused by the current situation in the backbone electric grids and the capacity which is available for meeting the demand.

Challenges

Given the overall economic situation in the coming years, we anticipate the continued restrictive policy of tariff regulation and the transition to the setting of tariffs based on the “inflation minus” principle. One of the main incentives in the Company’s operations in this environment is the reduction of operating and investment costs. However, this reduction should not adversely affect reliability and entail higher costs in the future.

While pursuing its cost reduction policy, the Company should carefully select investment projects for upgrade and development of its electrical grid network.

The stagnating volume of services and restrictive tariff policy, even on the back of cost reduction, results in risks of restraining earnings increase for shareholders.

Innovative development of Federal Grid Company should focus on the selection of the most relevant projects with the best prospects. The priority areas are identified in the Innovative Development Programme for PJSC FGC UES for 2016–2020. They include the design of substations with a high level of automated management of technological processes (“digital substation”), digital design, energy efficiency, and reliability and asset management.

The grid remains underutilised in comparison to foreign peers. The utilisation ratio is the result of structural changes in electricity consumption and reflects principles of UNEG Planning that have been established over decades, and methods that ensure reliability.

Long-Term Development Programme

The Company’s strategy is outlined in the Long-Term Development Programme of Federal Grid Company which is approved by the Board of Directors (Minutes No. 243 dated 19 December 2014). The Programme is coordinated with the relevant federal executive authorities and supported by the Expert Council at the Government of the Russian Federation.

The Long-Term Programme is consistent with the targets and provisions of the Development Strategy for the Russian Electric Grid Complex, as approved by Resolution No. 511-r of the Government of the Russian Federation, dated 3 April 2013, and Methodological Guidelines on the Drafting of Long-Term Development Programmes approved by the RF Ministry of Economic Development in 2014¹.

In 2015, the Company drew up an updated Long-Term Development Programme which factors in a weaker operating environment in the coming years due to external factors and changes of macroeconomic parameters in late 2014 and early 2015. The new Long-Term Programme includes adjusted goals, objectives and implementation actions. The long-term goals and objectives were adjusted in such a way that they would meet the electrical grid users’ needs and shareholder expectations to the utmost possible extent, and would be feasible and achievable. The updated Long- Term Development Programme has a stronger focus on cost saving. This is reflected in the initiatives to reduce operating costs (they are more ambitious than those envisioned by the Government directives), and in a more cautious approach to the planning of electric grid development and earnings metrics.

Guided by the Strategy of the Electric Grid Complex Development of the Russian Federation, Federal Grid Company focuses on the following strategic goals in its operations until 2030:

• To ensure service reliability and quality
  
• To maintain financial sustainability and independence and ensure an increase in the Company value
  
• To develop UNEG with regard of technical and economic optimisation of the backbone grids
  
• To meet customers’ demand for the Company’s services with regard of their region-specific features of demand and higher effectiveness of capacity utilisation
  
• To consolidate, under Federal Grid Company’s management, all electric grid facilities that are part of UNEG
  and are consistent with the criteria for including the facilities in UNEG.

Question for S. Danilov - Temporary Acting Director for Strategic Development and Head of Strategic Development Department

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WHATE ARE THE MAIN OUTCOMES IN THE FIRST YEAR OF IMPLEMENTATION OF FEDERAL GRID COMPANY’S LONG-TERM DEVELOPMENT PROGRAMME?

“The drafting and implementation of the Long-Term Development Programme resulted in a new level of planning in Federal Grid Company. It also produced a new set of well-thought-out strategic goals in taking management decisions and communicating them within the Company and to external stakeholders. Since 2015, all key processes (such as investment planning, business planning and regulation of operational areas) are consistent with the strategic goals that are outlined in the Long-Term Development Programme.

Key performance indicators are now also consistent with the strategic goals outlined in the Long-Term Development Programme. They were met and exceeded in 2014, as was proven by the Programme implementation audit that was held for the first time in 2015.

As for the efficiency of actions with deadlines in 2015, I can say that the Company has fully implemented its import substitution initiatives, both in organisational terms and in the development and use of domestically manufactured products / technologies. Plans to reduce operating and investment costs and increase labour productivity have been overachieved. Electricity losses were reduced in 2015 by almost 49.4 million KWh due to measures that were part of the programme for reducing electricity losses. The Company considerably reduced duration of transmission interruptions. It drew up many rules and regulations, and organised communication for addressing important issues, such as improvement of schemes for financing of the fee for technological connection, optimisation of load on the energy grid, and financing of projects of national significance.

I would like to note that experience of operating in accordance with a long-term programme document is in itself a key outcome in the first year of implementation of the Long-Term Development Programme. We were able to assess the viability of our forecasts and feasibility of goals. While updating our Programme, we received feedback from a broad range of experts within the Company, in the ministries and in the Open Government, and we intend to use all new information for improvement of our long-term planning.”

Actions that are part of the Long-Term Development Programme are targeted at implementation of strategic goals and objectives. The base case scenario underlying Federal Grid Company’s financial model is based on the meeting of key performance indicators including a 30% reduction in operating and investment costs against 2012 already by 2017. These targets are more ambitious than those set in the Development Strategy for the Russian Electric Grid Complex. Yet, the Company aims to achieve these higher targets because it needs to complete a long-term investment programme and maintain a sustainable financial position.

Reliability and quality of services to customers

Maintenance of financial stability and independence

Development of UNEG with regard of technical and economic optimisation of backbone grids

Meeting of customers’ demand for services

Strategy in the Context of Sustainable Development

Traditionally, sustainable development is based on the ambition to meet the needs of the existing generation without threatening the needs of future generations. This can only be done if all stakeholders’ positions are taken into account, with continuous communication with these stakeholders and integration of these practices in all of the Company’s business processes.

Owing to its specific role in the energy sector, economy and social development, Federal Grid Company expands and complements the traditional concept of sustainability in its operations.

As a monopoly operator of UNEG, The Company ensures electricity transmission via backbone electric grids and is responsible for providing a reliable power supply for consumers across the Russian Federation.

The Company’s responsibility for the efficient administration and development of UNEG is not only to ensure a safe, reliable and uninterrupted electricity supply but also to provide nondiscriminatory access to its grid services that should be provided in a transparent, honest (corruption-free) and innovations-based manner. This is why one of the Company’s most important tasks in terms of philosophy and values of corporate social responsibility and sustainable development is to continuously seek the balance between public and economic interests in Federal Grid’s work.

Federal Grid Company, as one of the largest electric power companies in Russia, is responsible for the condition of UNEG, the lynchpin of the national grid system and a vital public infrastructure. Having assessed existing problems and prospective threats, the Company developed and began implementing a Long-Term Development Programme aimed, among other things, at the renovation, modernisation and innovative development of UNEG. The success of this programme largely depends on constructive cooperation between the Company and a broad range of stakeholders. These include suppliers, contractors, project and R&D think tanks, and distribution electric grid companies, IDGCs, customers, generators, infrastructure regulators, labour unions, government authorities, public and environmental organisations and the expert community.

Regular, open communication with stakeholders plays an important role, as it allows us to better understand their expectations and to use a targetoriented approach for shaping the corporate social responsibility agenda. The communication channels we use for the dialogue include congress and exhibition arrangements, multilateral discussions, raising awareness through mass media.

Stakeholder Engagement

Stakeholders	Understanding of Social Responsibility	Progress in 2015
The State and general public	Ensuring the reliable and uninterrupted power supply Implementation of priority public sector projects Transparency and efficiency of operations, meeting with the needs of the economy	Meeting obligations under the investment programme Meetings with the heads of regions Signing several cooperation agreements with the regional authorities (Krasnodar krai, Republic of Tatarstan) Implementing import substitution programme
Customers	Openness and flexibility in consumer relations Support of Russian machine manufacturing industry in order to implement import substitution processes	Creating and arranging meetings of the Consumer Council Signing cooperation agreements (with RZD)
Shareholders and investors	Transparency of business processes Growth in shareholder value	Holding General Meeting of Shareholders Arranging meetings of Federal Grid Company’s senior executives with analysts from investment banks and funds, and rating agencies Holding consultation meetings with minority shareholders – individuals Participation in investment activities, such as forums, conferences and meetings with investors
Employees	Creating decent working conditions Providing opportunities for professional and personal growth	Taking measures for attracting and retaining young specialists Implementing a Corporate Housing Programme Sports and fitness events Doors Open Days for employees’ children Conducting professional skills competitions and ensuring professional training, including within the “Knowledge Days”
Suppliers and Contractors	Creating transparent competitive environment Using a market-based pricing model	Signing agreements with Russian and foreign manufacturers Supporting domestic suppliers in access to foreign markets
Local Communities and Environmental Team	Reducing negative impact on the environment	Implementing environmental safety policy Cooperation with the World Wildlife Fund (WWF) on conservation of oriental storks and prevention of bird death on power lines Participation in Earth Day
Science and Education	Promoting industry-specific science and education Personnel training and ensuring generational continuity Applying innovative technologies that reduce environmental impact	Cooperating with scientific organisations and placing orders for R&D R&D and technical partnership with SIGRE Russian National Committee Organising guest lectures and on-the-job training for students Organising students construction teams Participating in events for young people, such as forums, conferences and seminars Cooperating with the Russian Geographic Society (celebrations of the 70th anniversary of victory in the Great Patriotic War)1 Cooperating with the Russian Chess Federation
Mass Media	Transparency of business processes Ensuring information accessibility of the Company’s activities	Holding media events (briefings, press-points, and others) Distributing press releases on a timely basis Handling requests from mass media