Risks related to our operations

One of the risk factors is imperfect retail mechanisms resulting in controversies between grid and supply companies regarding energy and capacity consumption used for tariff calculation. As a result, there appears debatable and overdue debt for the Company’s transmission services ending in the decreased liquidity and financial stability of the Company. The Company takes measures to eliminate causes of conflicts with consumers, to decrease debatable and overdue debt, to cooperate with federal authorities preparing changes into retail market rules, on court practice and creating positive precedents. Besides, the Company implements programs on perspective metering development adopted by the Board of Directors.

Large industrial consumers subsidize other consumers, including residents, and this is also a significant risk factor. Several large industrial consumers connected to UNES networks pay for the transmission services according to the transmission tariffs in cases when grid facilities are rented by the Company under the last mile contracts between us and FSK. In 2010-2013, due to the lack of last-mile legislation, several large industrial consumers migrated to direct contracts with FSK via judicial decisions. According to item 5, article 8 of Federal Law #35-FZ dd. 26.03.2003 on Energy sector till 01.01.2014 UNES is entitled to rent grid facilities to regional grid companies upon approval of the federal executive authorities. Russian Government Decree #1173 dd. 27.12. approved the Rules regarding the transfer of UNES grids into rent by regional grid companies. Since the beginning of 2011 the transfer of UNES facilities into rent is approved according to a resolution adopted by regional executive bodies. According to the decree the transfer is approved if direct contracts between FSK and consumers are cancelled and if a written letter from the regional head is forwarded. In 2012 the Ministry of Energy approved Decree #403 dd. 24.08.2012 under which IDGC of Urals and FSK concluded UNES facilities rental contracts (last mile contracts) for 2013. Transmission of energy using UNES facilities rented by the Company under last mile contracts is included by federal and regional regulators in planned transmission volume for 2013. Since 2014, according to Federal Law #308-FZ dd. 06.11.2013, lastmile mechanism is retained only in a number of regions (for instance, the Chelyabinsk region). Consumers connected to UNES networks pay for the transmission services according to privileged HH1 tariff including crosssubsidizing. There is also a possibility to prolong last-mile contracts on the Chelyabinsk region till 2017. Consumers situated in other regions on our service area have moved to direct contracts with FSK.

One of the regulatory risks is a risk of decreased demand for connection and transmission in comparison to planned volumes used by regulators during tariff approval procedures. To reduce the risk the Company continues to monitor applications and form a forecast of productive supply, connection demand based on the applications as well as submit increased number of applications related to individual connection fee to regulators. At the same time due to a large amount of applications for connection the Company is not always able to fully satisfy the demand, this can negatively influence the revenues due to the loss of potential consumers as well as violation of anti-monopoly legislation in terms of transmission and connection. To resolve the problem the Company improves the procedure of connection application processing. We also explain our consumers the peculiarities of connection process, including dissemination of information on the services and creation of client centers.

Due to regulatory documents adopted at the end of 2012 simplifying the procedure related to the withdrawal of last resort provider status from energy supply companies the Company encountered new risks related to the necessity to assume authorities and liabilities of last resort providers from energy supply companies. During 2013 several subsidiaries of Russian Grids took over the functions of providers of last resort. There were some contests on the assignment of provider of last resort status but grid companies are not entitled to participate in the contests under the present legislation. To minimize the risks the Company interacts with federal and regional authorities, mass media, wholesale market infrastructure organizations, law enforcement bodies as well as companies with withdrawn provider-of-last-resort status on the functions of last-resort provider and debt settlements. Besides, we form legislative initiatives on the optimization of substitution procedures.

The Company operates on a wide territory with various climatic conditions. There is a possibility of emergencies due to natural disasters that may lead to systematic failures in grid efficiency and shortages. Operating and technological risks influencing supply reliability are related mainly to high depreciation of facilities, failures in exploitation and operating modes of equipment, failures to execute repair plans in full. Besides, exploitation and technological risks may include incidents of natural and technogenic character, decreased efficiency of our asset management system, transition to constrained emergency modes as well as factors related to equipment exploitation (limit deviation from technical requirements, personnel mistakes, etc.). In case the risks occur, we can encounter both economic and reputation consequences. Besides, these risk factors influence losses increasing our expenses on energy purchase to compensate losses. To decrease the risks we take measures aimed at the increase of supply reliability and prevention of technological violation risks (line widening and clearing, facilities reconstruction, expansion of reserve power centers, enlargement of the fleet of automotive and special-purpose vehicles for accident recovery work, switchgear and telematics update, etc.).

The Company actively invests to update and expand its infrastructure, encountering a risk related to the efficiency decrease and capex depreciation during the execution of investment programs, innovative development and R&D programs. Growing investment programs demand considerable financial resources, both internal and external, raised under conditions satisfying RAB parameters. Even if the Company has enough financial resources to finance its investment program, the Company may violate planned terms for capex and delay the commissioning of the facilities from its investment program, including failures to discharge or untimely discharge liabilities of contractors and suppliers. Government Decree #159 dd. 27.02.2013 stipulates the exclusion of facilities from the Company’s investment program that are not covered by regional development programs. Here we can encounter a risk related to increased incomplete construction due to the exclusion of such facilities. To decrease the investment risk the Company prepares its investment program taking into account the following efficiency criteria: increased availability of network infrastructure, decreased depreciation and update of grid facilities, high utilization of commissioned capacities. Integration of the investment program with regional development plans is a compulsory condition for the preparation of the investment program. Besides, the Company monitors investment programs and financing and analyzes reasons that led to deviation from the plan. The Company implements investment project management. We take measures aimed at the increase of project implementation quality and investment efficiency, decrease of construction unit cost, high utilization of commissioned facilities, development and implementation of comparative analysis system dealing with unit cost of construction-assembly works and materials, arrangement of innovative activities management system, automated investment management system.

Frequent changes of the Russian legislation (keeping in mind state regulation of the sector), wide range of regulatory requirements and limitations are risk factors related to failures to observe legislation and other regulatory documents, requirements of regulators and supervisors as well as local documents of the Company determining internal policy, rules and procedures. The Company’s operations are regulated and controlled by various institutions (Federal Antimonopoly Service, Federal Tariff Service, Federal Tax Service, Ministry of Energy, etc.). Besides, being a state-owned company, IDGC of Urals, OAO executes a range of instructions from the President and Government. In this respect the risk factors are of high importance. IDGC of Urals, being a monopolist, is subject to risk related to violations of antimonopoly legislation (connection services, disclosure of information on the services and tender activities, etc.). To decrease the risk we monitor prompt processing of applications and appeals from consumers, we also regulate and control timely disclosure of information according to the Russian legislation.

The Company owns, rents or has a right for unlimited use of the majority of land plots with grid infrastructure on them. Nevertheless, some land plots have no proper registration. Besides, the legislation stipulates the term for re-registration of a right for unlimited use of property or rent till 01.01.2015. To minimize the risk the Company implements a program dealing with re-registration of right for unlimited use.

Another risk factor may occur when the Company is acknowledged a violator of antimonopoly legislation. The most risky operation is connection of applicants’ equipment to the network. Appeals of applicants to regional anti-monopoly authorities and initiation of proceedings may be caused by violation of consumers’ rights. Particularly, refusals to connect, failures to observe statutory terms for connection and other factors may result in it. Another disturbing factor is that the legislation provides the anti-monopoly authorities with a right to give a broad interpretation of commodity market limits. Thus, validated complaint may cause a turnover-based fine calculated from overall revenues. To reduce the risks we improve and simplify our business processes on connection as well as implement new forms of consumer relations (for instance, online servicing).