Market Risk Management at Russian Power Companies

KPMG IN RUSSIA AND THE CIS Market Risk Management at Russian Power Companies An analytical study kpmg.ru Management Consulting

Contents Preface 4 Key findings 5 Profile of respondents 6 Key financial indicators 8 Risk exposure 9 The importance of the risk management function 12 The risk management function 16 Forecasting, quantitative assessment and reporting 20 Hedging methods 24 Trading 30 Future Plans 32 Conclusion 33 2011 Закрытое акционерное общество «КПМГ». Все права защищены.

Foreword Dear Readers, KPMG in Russia and the CIS is pleased to present this study of market risk management at Russian power companies. The purpose of the study was to obtain information on the state of risk management at Russian power companies, including the organisation of risk management processes and methods, quantitative risk assessment, the exchange-traded instruments used and future plans for market risk management. To this end, we surveyed more than 200 Russian power companies in 2011. To collect the information, we asked management and key employees responsible for market risk management to complete a questionnaire. The survey was carried out jointly with the Moscow Energy Exchange. In light of the reforms to the Russian power sector and the movement towards tariff deregulation, the use of exchange-traded instruments making it possible to manage price of electricity and to accurately forecast future cash fl ows from electricity trading, whatever the fl uctuations in the price of electricity, is become more and more important for companies. The experience of foreign countries shows that setting up energy exchanges enables companies to improve fi nancial risk management. We would like to express our gratitude to everyone who contributed to the success of this survey. Best wishes, Andrew Korn 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 3

Preface ЭThe Russian power industry is set to undergo a major overhaul meaning that power companies will need to attract signifi cant investment. The key factors in attracting private investors and lending institutions to the sector are stability of the regulatory and legal framework, realistic industry forecasting and prudent market risk management. The purpose of this survey is to assess the state of market risk management at Russian power companies, including aspects such as risk management processes and methods in the short and long term, market and fi nancial forecasting, and the organisation and practical aspects of trading and hedging. In July-October 2011, KPMG and the Moscow Energy Exchange the biggest energy exchange in the CIS surveyed 204 major power companies generating, transmitting and distributing electricity in Russia and abroad. These included large Russian companies and subsidiaries of the biggest western energy corporations. The respondents included CEOs, CFOs and heads of Risk Management. We asked them to complete a questionnaire with 41 multiple-choice questions, each with an «Other» option for them to give their own answers. For some of the questions they were allowed to give more than one answer. When the results were tallied, each of the companies surveyed was given the same weighting. In analysing the responses, we aggregated all the information received as well as individual comments from some of the respondents. We hope that you will fi nd this report interesting and that it will help you to achieve your long-term goals. Please do not hesitate to contact us if you have any questions or would like to take part in a more detailed discussion. 4 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

Key findings In their risk management, the companies focus mainly on their fi nancial performance for the period rather than shareholder or balance sheet value. The biggest infl uence on the companies activities may come from the risk of regulatory change. Price risks, the risk of constraints in demand for electricity and electricity transmission, and investment and tax risks also have a signifi cant infl u- ence. Most Russian companies recognise the importance of risk management, but either do not have a risk management strategy written down or do not have one at all. The majority of the companies either do not use hedging as a method of risk management or do formalise this process. As it stands, risk management at Russian power companies is at a basic level and centres on meeting external requirements. The respondents get most of their market data forecasts from regulators, and make almost no use of professional market models. The most popular quantitative risk assessment methods are scenario analysis and Value at Risk (VaR). The majority of the companies either do not produce regular quantitative risk assessment reports or include them in their annual budget planning and control processes. Among those where management is provided with regular risk reports, the most popular period is the quarter, which goes against international practice and means that signifi cant market changes cannot be identifi ed in time. Trading and risk management automation is not common Russia: just 4 of the companies have introduced, or plan to introduce, an ETRM system, and around the same number have their own system. The market for derivative contracts on the price of electricity, which facilitates effective price risk management, is still in its infancy in Russia. Just 40 or so electricity producers and consumers, plus a few fi nancial organisations, are involved. Going by the development history of the derivatives markets in the USA and Northern, Western and Central Europe, we can expect a sharp rise in trading in the next 3-5 years, from volumes making up a few percent of electricity consumption in Russia to volumes exceeding annual consumption. The main risk management objectives for Russian power companies in the next two years are to develop a strategy and set up a risk management system. 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 5

Profile of respondents Most of the companies surveyed are subsidiaries of a group. As in the Russian power industry as a whole, the majority of the companies belong to the generation and sales sector. The overwhelming majority operate solely in Russia; just 8% do business abroad. Almost half of the companies surveyed have annual revenue of less than 10 billion RUB, a consequence of the fact that most operate in the sales sector. More than 80% of the respondents have annual revenue of 100 billion RUB or less. Which of the categories listed below does your company belong to? 9% Parent company in a group of companies 39% Subsidiary in a group of companies 52% Other Which of the business areas listed below does your company work in? 70% 60% 50% 40% 30% 20% 10% 0% 67% 42% 25% 8% Generation Transmission Sales Other Answers in the Other category included mining and financial services. 6 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

Does your company operate outside Russia? 8% Yes No 92% What was your company s revenue? 13% less than 10 billion RUB 10 50 billion RUB 26% 44% 51 100 billion RUB more than 100 billion RUB 17% 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 7

Key financial indicators Before studying the impact of market risks on the companies operating and fi nancial activities, we need to determine their fi nancial performance measures. In their risk management, the companies focus mainly on their fi nancial performance for the period/fi nancial year: more than 70% selected free cash fl ow and net profi t as manageable fi nancial indicators. Only a third manage or plan to manage company value (market and balance sheet). For which of your company s financial indicators below would you like to manage the risk of change? 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 71% 79% 33% 38% Net profit Free cash flow Balance sheet value of the company Market value of the company 8 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

Risk exposure The global financial crisis showed that Russian companies are highly exposed to market risks. According to the CEOs, CFOs and heads of Risk Management, the biggest influence on their companies activities may come from the risk of regulatory change; 83% of the respondents chose this option. KPMG s study «Power Sector Development in Europe Lenders Perspectives 2011» showed that the main concern for banks lending to investment projects in the power industry is retroactive legislation that undermines companies economic assumptions. All the respondents whose business relates to power transmission picked the option «The risk of transmission demand constraints». Price risks (the risks of changes in the price of electricity and fuel), the risk of power demand constraints, and investment and tax risks also have a significant influence; all were chosen by more than 30% of the respondents. The graph below shows average daily baseload electricity prices. In addition to the high hourly volatility, there are also weekly and seasonal fluctuations. The graph also shows individual price spikes departing by 40-50% from the monthly average. Index of average daily baseload prices at the Centre (MSNX-ECB), Ural (MSNX-EUB), Western Siberia (MSNX-SEB) and Eastern Siberia (MSNX-SWB) hubs 1600 1400 1200 1000 800 600 400 200 0 02.01.2008 01.01.2009 01.01.2010 01.01.2011 MSNX-ECB MSNX-EUB MSNX-SEB MSNX-SWB Source: Moscow Energy Exchange 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 9

It is worth noting that despite the strong link between demand for electricity/heating and the weather, the respondents did not see the climate risk as important. The companies surveyed said they were not concerned about the departure of the foreign investors who came to the industry during the fi rst wave of privatisation (i.e., primarily, large European energy companies such as E.ON, Enel, Fortum, etc.). Which of the risks listed below have an effect on your company s operations? The risk of regulatory change 83% 13% 4% The risk of price changes in the power and capacity markets 71% 21% 8% The risk of power demand constraints 61% 30% 9% The risk of investment project deadlines not being met 48% 24% 29% The operating and technology risk 43% 24% 33% The tax risk 41% 50% 9% The risk of price changes in fuel markets 39% 17% 43% The risk of an increase of expenses of investment projects 38% 33% 29% The risk of loss of assets 33% 33% 33% The risk of errors in mathematical models 29% 38% 33% The liquidity risk 29% 48% 24% The risk of fuel supply constraints The risk of an increase in the cost of borrowing 23% 23% 23% 50% 55% 27% The risk of not being able to attract borrowed funds 23% 36% 41% The environmental risk 19% 24% 57% The risk of transmission demand constraints 14% 23% 64% The climate risk 10% 43% 48% The currency risk 5% 14% 81% The general infl ation risk 5% 52% 43% The risk of outfl ow of foreign capital 100% Signifi cant effect Insignificant effect No effect 10 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

Among the risks classed as signifi cant by the respondents, those managed by the most companies include investment risks (the risks of deadlines not being met and of project costs increasing), the tax risk, the risk of price changes in the power and capacity markets, the risk of loss of assets, the operating and technology risk, and the liquidity and fi nancing risks. Which of the risks listed below does your company manage? The California energy crisis The operating and technology risk The risk of errors in mathematical models The risk of price changes in the coal market The risk of outflow of foreign capital The risk of gas supply constraints The liquidity risk The climate risk The risk of an increase in the cost of borrowing The risk of fuel oil supply constraints The environmental risk The tax risk The general inflation risk The general inflation risk The foreign currency risk The risk of coal supply constraints The risk of investment project deadlines not being met The risk of not being able to attract borrowed funds The risk of power demand constraints The risk of price changes in the fuel oil market The risk of price changes in the power and capacity markets The risk of loss of assets The risk of transmission demand constraints The risk of an increase of expenses of investment projects The risk of regulatory change 58% 58% 58% 54% 54% 54% 50% 46% 42% 42% 33% 33% 29% 29% 21% 17% 17% 13% 13% 13% 13% 8% 8% 4% In 1996-1998, California became one of the first US states to start deregulation (reducing government regulation) of the energy industry. The generation companies were separated from the distribution companies and the California Power Exchange was created. Under the legislation, all wholesale electricity trading had to go through the exchange, with the result that wholesale electricity prices became subject to market forces. At the same time, retail electricity prices were either capped or clearly fixed from the outset. Bilateral agreements between generation and sales companies were not permitted. As a result of manipulations by certain participants in the wholesale electricity market (Enron, etc.), plus the insufficient load capacity of the power lines, wholesale prices for electricity buying bought by the sales companies increased by 8-20 times in certain periods. This forced the sales companies to purchase electricity on the wholesale market at a price several times higher than maximum permitted retail price. The crisis bankrupted two of California s biggest electricity companies the Pacific Gas and Electric Company and Southern California Edison. Source: Federal Energy Regulation Commission (USA) 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 11

The importance of the risk management function Russian energy companies recognise the importance of risk management. The vast majority of our respondents consider risk management either an important (46%) or a signifi cant (50%) function of the overall corporate governance. A well-organised and streamlined risk management system makes it possible to improve forecasting and control of company operations, and to reduce the impact of price changes in the markets and increase shareholder value. How would you rate the importance of the risk management function for your company? 4% Important 46% Significant 50% Insignificant In today s market conditions, risk management is becoming a key element in the corporate management system. Good risk management requires management to develop a strategy for achieving company-wide goals. At most leading companies, the risk management strategy is set down in a risk management policy. The survey revealed that just 22% of the respondents have a risk management strategy approved by management and set out in a separate document, and most of those are major players in the market. In other words, although Russian companies recognise the importance of risk management, most either do not have a risk management strategy written down or do not have one at all. Does your company have a written risk management strategy? Yes 22% No 78% 12 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

At most of the companies that do have a risk management strategy (i.e., 37% of the total number of respondents), it has been developed by top management the Board of Directors and the Management Board. At 8% of the companies, the strategy has been approved by the Risk Committee, and at 13% it has been approved by the Finance Department. Which of the units listed below is responsible for approving the risk management strategy at your company? The Management Boardе 29% The Board of Directors 25% The Finance Department 13% The Risk Committee 8% We do not currently have a risk strategy 63% 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 13

Hedging is one of the most popular methods at leading companies for market risk management in the short and medium term (up to a year), facilitating the achievement of strategic and operational goals such as: Implementing the annual budget through stabilising cash fl ows and increasing their predictability implementing the annual budget is a priority for Russian power companies, and a carefully designed hedging programme makes it possible to reduce signifi cantly the deviations between actual and target values for budget items, as long as the target values correspond to market forecasts when the budget is prepared Guaranteeing a certain price range for the company s products through stabilising production and fi nancial costs controlling the increase in electricity tariffs is a priority for the Russian government Ensuring debt payments through fi xing the size of payments using foreign exchange derivatives and interest rate derivatives and stabilising operating cash fl ows according to leading rating agencies, the effectiveness of the market risk management system is one of the key criteria in assessing a company s reliability, and having such a system may help to boost a company s credit rating and narrow its credit spread. Generating additional profi t through taking advantage of temporary price changes and their deep industry knowledge major companies in the sector have signifi - cantly deeper knowledge of the relevant markets and can use this for short-term variations in their hedging programme within the limits of the volume of production or consumption of the commodities in question The hedging process affects basic aspects of the company s activity and therefore should be clearly formalised. More often than not, the hedging schedule is set out in a separate document or in the general risk management policy. Our survey showed that most Russian companies either do not use hedging as a method of risk management or do not have a written hedging schedule. Does your company have a written risk hedging policy? Yes 17% 4% No, but we are developing one 79% No 14 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

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The risk management function As it stands, risk management at Russian power companies is in its infancy and centres on meeting external requirements. At large American and European energy fi rms, the risk management structure usually includes clearly defi ned areas of responsibility and is integrated into the overall management system. At the companies surveyed that do have a management function, it is centralised. 39% do not have a risk management function at all. Where is the risk management function at your company? 6% Centralized at the respondent 33% 33% Divided between the respondent and the parent company Centralised at the parent company 11% 17% We do not currently have a risk management function N/A 16 Market Risk Management at Russian Power Companies

A third of the respondents said that their Management Board played a role in risk management, and the fi gure for the Board of Directors was similar. However, just 8% said that a Risk Committee was involved. In large western companies, the participation of all these units in the risk management process (sometimes the functions are performed by an Audit Committee or a Strategy Committee) is an essential condition of the effectiveness of the company s activities in this area. With regard to the functional divisions (Finance, Procurement, Sales), the Finance Department plays a key role. In western companies among functional divisions fi nal responsibility for fi nancial risk management, which includes market risk management, is born by corporate treasury. In which of the structural divisions listed below is the risk management function performed at your company? The Management Board The Board of Directors The Finance Department The Sales Department The Procurement Department The Treasury The Audit Committee 33% 29% 29% 25% 21% 17% 17% The Risk Committee The Risk Management Department 8% 8% The Internal Control Committee The Strategy Department 4% 4% Other 33% We do not have a risk management function 42% 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 17

At a quarter of the companies, management of all types of risk is centralised. This is normal. At 30% of the companies, risk management is performed separately for each group of risks (e.g. price, interest and technology), and at 45% it is performed separately for each type of risk. How are different types of risk managed at your company? Centralised for all types of risk 25% Separately for each group of risks 45% Separately for each type of risk 30% At western companies, risk management at a strategic and operational level is organised by the Risk Committee, with the Board of Directors retaining overall responsibility for the effectiveness of the process and the right to make decisions on major transactions. 71% of the Russian companies we surveyed said that they did not have a risk committee. Moreover, this was a feature of both small and large firms (including majority of those with annual revenue exceeding 100 billion RUB). If the Risk Committee is part of the company s management structure, it tends to be made up of senior management. None of the companies surveyed had independent experts on their Risk Committee. Which of the following are on the Risk Committee at your company? Senior managers 22% The company s owners 4% Independent experts 0% We do not have a Risk Committee 74% 18 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

The risk management structure at E.ON Supervisory Board Auditor s Report Risk Committee Management Board Internal Audit Committee Reports on Financial Management, including Liquidity Commodity and Credit Risk Reports Quarterly Risk Reports Process Efficiency Reports Corporate Sector Control and Transparency Division Planning and Control Division Finansial Risks Market Risks External/Regulatory Risks Operational Risks Income and Expenses Reports; Medium- Term Plans Strategic Risks Other Risks Local Risk Management, Monitoring and Reporting Divisions The Risk Committee, which consists of representatives of the company s divisions and departments, is responsible for ensuring that the risk strategy for commodity and credit risks defined by the Board of Management is implemented, complied with, and further developed. The Energy Trading unit is responsible for all aspects of the company s power, gas and oil trading activities, which are conducted according to its trading limits and market risk management procedures. In some cases, the unit may take advantage of favourable changes in market prices and risk positions. Source: The offi cial website of E.ON (Germany) 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companiesх 19

Forecasting, quantitative assessment and reporting Forecasting of the market and companies fi nancial results is a guarantor of the industry s stable development. The main sources of market data forecasts for the respondents are the forecasts of regulators and the market models developed by them. What forecast market data sources does your company use for quantitative risk assessment? Our own model 83% Forecasts of regulators 83% Third-party models 9% Independent providers of price forecast reports 0% As well as long-term forecasts by national regulators, large western companies often use market models developed by professional analysts. You can t manage what you can t measure. This is why quantitative risk assessment is a key element in any effective risk management system. The most popular quantitative risk assessment method is scenario analysis, which is used by more than half of the companies. In second place comes Value at Risk (VaR) an estimate of the maximum possible loss in the value of the company for a given probability. This method came to the energy business from companies in the fi nancial sector trading in the fi nancial and commodity markets. However, because of the relative illiquidity of the companies fi xed assets and the impossibility of storing electricity, VaR is not the best way of refl ecting the companies market risks. Even so, half of the companies either prefer this method or use it as much as they do others. 20 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

On the whole, large companies typically use 2-4 risk assessment methods and smaller companies no more than one. Despite the importance of the problem of default, none of the companies use the Credit Value at Risk (CVaR) method. 29% of the respondents do not perform quantitative risk assessment at all. The leading quantitative market risk assessment methods at western power companies are Gross Margin at Risk in conjunction with the Real Options method in stochastic modelling. Currently, only a few companies in Russia use these methods, but many players in the market are starting to show interest in them. What quantitative risk assessment approaches does your company use? Scenario analysis 58% Value at Risk 29% Stress testing 13% Gross Margin at Risk 13% Cash Flow at Risk 4% Expert assessment 4% Real Options 4% Credit Value at Risk 0% We do not use quantitative risk assessment 29% 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 21

Russian companies typically produce risk reports as part of their annual budgeting process, as well as when undertaking major transactions and when management requires. The period most commonly used for quantitative risk assessment reports is the quarter. Just 6-19% of the companies provide management (the CEO or CFO) with weekly risk reports. At western companies, on the other hand, such reports tend to be provided every week or month, and trading divisions at western power companies provide them on a daily basis. Such processes are typically optimised using ERP and CTRM systems and specialised risk management software. This result can be put down to the lack of a streamlined risk management process at Russian power companies. How often does your company produce risk assessment reports? Board of Directors 4% 13% 33% 50% Risk Committee 8% 17% 75% CEO 13% 21% 25% 42% CFO 4% 8% 13% 25% 50% Weekly Monthly Quarterly Other We do not produce risk assessment reports. 22 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

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Hedging methods Hedging is a popular and effective method of market risk management in the power industry. In Russia, the derivatives market for non-fi nancial assets is just beginning to develop. The main trading fl oor for electricity price instruments in Russia is the Moscow Energy Exchange, while for interest-rate and foreign exchange instruments it is the RTS exchange. The most popular instrument for managing the risk of price changes in the power and capacity markets, used frequently by 33% of the companies, is the conclusion of long-term fi xed-price agreements. Futures contracts constitute the second-most popular category. Option contracts are practically not used. Which instruments for managing the risk of price change in the power and capacity markets provided by Russian and foreign financial institutions does your company use? Futures contracts 20% 20% 60% Option contracts 5% 95% Long term fixed price agreements 33% 19% 48% Used frequently Used rarely Not used 24 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

KPMG s study «Power Sector Development in Europe Lenders Perspectives 2011» showed that for banks fi nancing major power projects the «ideal structure» in terms of the project s economic viability includes a long-term (20-25 year long) Power Purchase Agreement (PPA) backed by the government and a stable regulatory environment. However, it is getting ever harder to enter into such agreements, and PPAs covering the majority of the electricity output for at least 10 years are become more popular and acceptable to the banks. Non-deliverable and deliverable fi nancial instruments are equally popular with Russian power companies: 27-30% of the respondents make active use of them, and half plan to start using them in the near future. Which power and capacity market derivatives does your company use or plan to use? Non-deliverable financial instruments in the power and capacity markets 27% 50% 23% Deliverable financial instruments in the power and capacity markets 30% 43% 26% Used frequently Not used, but planned Not used and not planned 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 25

45% of the respondents consider a month the optimum horizon for exchange-traded electricity price contracts. As the contract horizon increases, interest in it falls: 35% of the respondents are interested in contracts where the horizon is a quarter, and just 20% where the horizon is a year. What horizon for exchange-traded electricity price contracts is your company most interested in? Month 20% 45% Quarter 35% Year 26 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

The only instrument for managing the risk of change in price changes in the fuel markets that Russian power companies use is long-term fi xed price agreements; this option was marked by a third of the respondents. Exchange-based methods of managing fuel purchase prices (futures, options and swaps) are not used in Russia, and the derivatives market for fuel prices is undeveloped. At the same time, western companies make active use of both exchangetraded and over-the-counter instruments for fuel (gas, fuel oil, coal) prices. Which instruments for managing the risk of price change in the fuel markets provided by Russian and foreign financial institutions does your company use? Long term fixed price agreements 30% 5% 65% Options contracts 100% Futures contracts 100% Swap contracts 100% Used frequently Used rarely Not used The issue of down payments is very relevant for Russian power companies, but only around half of the respondents said they were ready to make such payments (e.g. option premiums or the initial margin on futures contracts). Is your company ready to pledge collateral for derivatives? Yes 39% No 48% It is difficult to say 13% 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 27

Roughly half the companies are not ready to pay more than 10% of the face value of the contract as a down payment, and none is ready to pay more than 20%. What preliminary deposit is your company prepared to make when entering into financial instrument transactions (as a percentage of the proposed transaction volume)? 9% 0% 38% 1 10% 43% 11 20% 10% It is difficult to say Collateral is an important issue for a quarter of the companies, and more than half consider it signifi cant. How significant for your company is or will be the problem of cash shortfalls caused by the need to pledge collateral? Important 20% 20% Significant Insignificant 60% 28 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

At present, none of the companies use bank guarantees for fi nancial instrument trading (for electricity or fuel prices, foreign exchange or interest rates), but 21% plan to start doing so as an alternative to pledging collateral. Does your company use bank guarantees for derivatives trading as an as an alternative to pledging collateral? No, but we plan to 26% 21% No; our own resources are sufficient 5% 48% Not; we use other financing arrangements Other An analysis of the diffi culties faced by companies needing to trade in derivatives shows that the main problem is insuffi cient market liquidity. A third of the respondents noted the lack of a developed legislative framework. In addition, the companies surveyed also noted possible claims from tax authorities and the lack of risk management experts. What is stopping your company from using exchange-traded and over-the-counter derivatives? Insufficient market liquidity 68% The lack of a developed legislative framework 42% The high risk of claims from the tax authorities 16% The lack of risk management specialists in the company 16% The lack of derivatives trading specialists in the company 5% Other 26% 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 29

Trading Trading accounts for much of the incoming and outgoing cash fl ows of generation and sales companies. Most Russian power companies have trading divisions, or plan to create ones, but a third of the respondents said they had not yet decided or did not operate in the wholesale power and capacity market. Does your company have or plan to set up a separate trading division? Yes; we have a separate trading division 36% 50% Yes; we plan to set up a separate trading division No; using a broker is more convenient 5% 5% 4% No; using a broker is cheaper No; we don t need to or have not yet decided In American and European power companies, trading is usually allocated a separate division. Moreover, the trading divisions of large companies do not just sell electricity produced by the generating assets of their parent companies but also participate in speculative trading on the spot markets (where special terms apply) and derivatives markets in order to increase their profi t. Examples of such companies include EDF, RWE and E.ON. It is worth noting that Russian oil and gas companies such as Gazprom, LUKOIL and Gazprom Neft have gone down the road of creating separate trading divisions in the last ten years. The average annual trade volume for the trading divisions of these companies is several times higher than the export volume of their Russian parent companies, a testament to their participation in the market as a speculative player. 30 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

At power companies in North America and Western Europe, trading is fully automated using Energy Trading and Risk Management (ETRM)-type systems. Typically, these can be used to track trading in all commodities purchased and sold by the company. Such systems also help to monitor trading, logistic, risk management and transaction accounting processes and give users more options than ERP systems used in this area. Trading automation is not common in Russia: only a few companies have introduced, or plan to introduce, an ETRM system, and around the same number have their own system. 71% have no plans to optimise trading business processes in the near future. What Energy Trading and Risk Management (ETRM)-type system does your company have? Our own system 17% 8% We plan to introduce an ETRM system 71% 4% An ETRM system from a professional developer We do not have such systems Analysis of other key sectors of the Russian economy shows that trading is already automated in practically all the trading divisions of Russian oil and gas companies in Western Europe, while Russian and Ukrainian metals and mining companies are beginning to use automation. E.ON Energy Trading, торговое подразделение энергетической компании E.ON, базируется в Дюссельдорфе и насчитывает более 1000 человек более чем из 50 стран мира. Данное подразделение ответственно за поставочные и расчётные торговые операции на спотовых и форвардных оптовых рынках электроэнергии, угля, газа, нефти, фрахта и сертификатов на эмиссии более чем в 40 странах мира. Группа E.ON рассматривает своё торговое подразделение в качестве центра прибыли для компании. E.ON Energy Trading зарабатывал в 2009-2010 годах более 10% прибыли всей группы (по показателю adjusted EBIT). Источник: Годовой отчёт E.ON за 2010 год 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 31

Future plans The 2008 crisis led many companies to think seriously about risk management and to start implement projects in this fi eld that they had previously put off or suspended. Today, Russian companies are only at the start of this process, so their main focus is on developing a risk management strategy (42%) and setting up or optimising high-level risk management systems (58%). Individual fi rms plan to automate the company-wide risk management process or management of trading and trading risks. It is worth noting that just 17% of the respondents do not plan to develop the risk management function in the next two years. What risk management projects does your company plan to implement in the next two years? Setting up / optimizing the risk management function 58% Developing a risk management strategy 42% Introducing an ETRM system 8% Other 4% We have got no such plans. 17% 32 Market Risk Management at Russian Power Companies 2012 ZAO KPMG. All rights reserved.

Conclusion Our survey shows that market risk management at Russian power companies is still in its infancy: business processes and policies in terms of risk management are insuffi ciently formalised, and the business processes of market forecasting, quantitative risk assessment, trading and reporting are not automated. On the other hand, the respondents acknowledge that they are highly exposed to market risks and recognise the importance of risk management. Given these factors, and the development history of the risk management function in American and European power companies, we expect that in the near future companies will start setting up market risk management functions along the lines of the best practice models at large western power companies. 2012 ZAO KPMG. All rights reserved. Market Risk Management at Russian Power Companies 33

Contacts KPMG Moscow Energy Exchange Andrew Korn Head of Power & Utilities Partner, KPMG in Russia and the CIS T: + 7 (495) 937 44 77 F: + 7 (495) 937 44 99 E: andrewkorn@kpmg.ru Sergey Trofimenko General Director T: +7 (495) 228 80 91 M: +7 (985) 762 54 77 E: trof@mosenex.ru Roman Malyuga Head of Commodity and Energy Operations Management Director T: +7 (495) 937 44 77 F: +7 (495) 937 44 99 E: rmalyuga@kpmg.ru www.mosenex.ru Arkady Petrosyan Commodity and Energy Operations Management Senior Manager T: +7 (495) 937 44 77 F: +7 (495) 937 44 99 E: sselin@kpmg.ru Sergey Selin Commodity and Energy Operations Management Manager T: +7 (495) 937 44 77 F: +7 (495) 937 44 99 E: sselin@kpmg.ru www.kpmg.ru The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 2012 ZAO KPMG, a company incorporated under the Laws of the Russian Federation, a subsidiary of KPMG Europe LLP, and a member fi rm of the KPMG network of independent member fi rms affi liated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in Russia. The KPMG name and logo and cutting through complexity are registered trademarks or trademarks of KPMG International.