SEneC_Cross_Subsidization_EN_V3

THE CROSS-SUBSIDIZATION
IN THE ELECTRIC POWER
INDUSTRY: THE OUTCOME
OF A 15 YEAR HASSLE
Energy Centre
Moscow School of Management SKOLKOVO
March 2013
The cross-subsidization of electric power consumers remains one of the
most pressing issues in the industry. It has a great deal of ins and outs
and it is difficult to measure it precisely. Its biggest part is concealed in
the non-transparent unified tariffs of the distribution system. It results in a
significant increase in electricity prices for large consumers and is highly
ineffective as a means of protecting the poor.
The continued existence of this mechanism threatens the efficiency of the
power industry and economics in Russia. Solving the issue of the cross-
subsidization is a difficult and intricate task and requires decisive steps to
be undertaken by the authorities and industry associations. One of the first
steps, along with the introduction of social norms of power consumption,
should become a principle increase of transparency of the unified tariffs
for transferring the power over the distribution system.

Igor RYAPIN
Senior Analyst of the Electric Power Section
SKOLKOVO Energy Centre
Igor_Ryapin@skolkovo.ru
AUTHOR

March 2013
Moscow School of Management SKOLKOVO Energy Centre 1
The Cross-Subsidization in the Electric Power Industry: the Outcome of a 15 Year Hassle
CONTENT
SUMMARY 2
INTRODUCTION 7
MECHANISMS OF THE CROSS-SUBSIDIZATION 9
CROSS-SUBSIDIZATION VOLUMES 13
REGULATED CONTRACTS IN THE WHOLESALE ELECTRIC POWER AND CAPACITY MARKET 15
”LAST MILE” RENTAL 16
REDISTRIBUTION OF GRR WITHIN TARIFFS FOR THE NETWORK UPKEEP 18
CROSS-SUBSIDIZATION IN THE TARIFF FOR POWER TRANSMISSION LOSSES 23
THE ONE-PART AND TWO-PART HIGH VOLTAGE TARIFFS 26
CROSS-SUBSIDIZATION IMPACT 27
SUBSIDIZING AND SUBSIDIZED GROUPS OF CONSUMERS 27
CROSS-SUBSIDIZATION IMPACT ON LARGE CONSUMERS 28
CROSS-SUBSIDIZATION IMPACT ON THE MACROECONOMICS 31
CROSS-SUBSIDIZATION IMPACT ON HOUSEHOLDS 32
CONCLUSION 35

Moscow School of Management SKOLKOVO Energy Centre
March 2013 The Cross-Subsidization in the Electric Power Industry: the Outcome of a 15 Year Hassle
2
The cross-subsidization of consumers used in the electric
power industry means the redistribution of the payments
for electricity between different groups of consumers, when
certain consumers pay for a part of the cost for electricity used
by other customers. The practice started during the period
of the economic reforms as an element of social protection,
when the part of the price paid for electricity was transferred
from the population to industrial consumers.
The Russian government has been struggling with the cross-
subsidies for 15 years at least, but it still loses the fight.
In 2012, the government started the active discussion on
the introduction of the social norms of power consumption
for the population as a measure for eliminating the cross-
subsidization practice. These initiatives allow us to hope that
even if the cross-subsidization would not be finally defeated,
then, at least, it would be brought under control.
The main bulk of the cross-subsidization in the electric power
industry is included now in the tariffs for the transmission
of electricity over the distribution network. Regulated
agreements used on the wholesale power and capacity market,
which are the sole means for the provision of reduced price on
electricity for the population provided for by the legislation,
account for a small part of the cross-subsidization. The
increase in the cross-subsidization used in the payments for
the transmission of electricity occurs significantly due to the
non-transparent process of establishing unified tariffs for the
transmission of electricity over the distribution system.
The tariff burden included into the electricity distribution
tariffs is redistributed among the groups of power consumers
both as the part of the charge for the maintenance of the
distribution networks and as the part of the fee for the
compensation of power loss in the networks. Also, there is
a widely known problem of “last mile” rental, which provides
additional revenues for electricity distribution network
companies under the conditions of the cost containment
administered for subsidized consumer groups. And, finally,
the cross-subsidization is exercised through some other
distortions of network tariffs.
According to our estimates, in 2011, the total amount of
the overpayment by subsidizing consumer groups equalled
to 323.9 bln rubles exclusive of VAT (382.2 bln rubles with
VAT), which is one and a half times more than the estimates
given by the Federal Tariff Service of Russia (204.8 bln rubles
SUMMARY

March 2013
exclusive of VAT or 241.7 bln rubles with VAT).
This amount is composed of the following components (all
figures are exclusive of VAT):
• 60 bln rubles – regulated agreements in the wholesale
power and capacity market;
• 58.6 bln rubles – “the last mile” rental;
• 172.2 bln rubles - redistribution of GRR (gross revenue
requirement) included in the tariff for the network
maintenance;
• 31.2 bln rubles - redistribution of the loss compensation
payments included in the tariff for power loss during
transmission;
• 1.9 bln rubles - overestimation of the high voltage two-
part tariff as compared to the one-part tariff.
In total, the cross-subsidies made by means of the distribution
network tariffs account for 263.9 bln rubles or more than 80%
of the cross-subsidization.
Subsidizing groups of consumers consist of customers
connected to high and primary medium voltage lines, while
subsidized ones are comprised of the population and other
consumers connected to low and secondary medium voltage
lines.
The cross-subsidies lead to a significant increase in the
electricity bills of subsidizing groups of consumers. Thus,
the consumers connected to “the last mile” facilities have
to pay for electricity transmission services 3.6 times more
than they would pay using the tariffs for backbone networks.
The electricity consumers connected to the high voltage
distribution networks pay for electricity transmission services
2.3 times more on the average than they would have to pay
if there was no cross-subsidization.
One of the outcomes of the distorted network tariffs is that
the charges for the transmission of electricity imposed on
Russian industrial consumers have been considerably higher
than that in the USA – the American industry paid by 41% less

4
for electricity in 2011, than the Russian one had to. Moreover,
by the end of 2011, the average price of electricity for Russian
industrial consumers was higher than the average prices
for same in the United States. While the largest electricity
consumers – those, which are connected to “the last mile”
facilities in Russia, have to pay for the electricity transmission
and distribution on average 3 times more, and as compared
with certain countries – even up to 7 times more than similar
European enterprises connected to the backbone transmission
network.
This, in particular, explains the intention of large consumers
to develop their own power generation. The rapid development
of distributed generation taking place in Russia lately was
analyzed in the review called “The Development of Distributed
Generation” published by the SKOLKOVO Energy Centre as of
3 August 2012, which can be found at: http://energy.skolkovo.
ru/products/139/.
Inflated bills for electricity, which industrial consumers have
to pay, impact the country’s macroeconomic indicators. The
loss of the industrial growth in Russia occurring due to the
cross-subsidization is estimated at 3.6%, which is comparable
with the annual growth rate of industrial production in the
country. The losses of Russia’s GDP, respectively, amount to
0.8% or 451.5 bln rubles.
The main, but not the only, group of consumers, which benefits
from the cross-subsidization, is the population – it receives
just over 63% of the total subsidized amounts (205 bln rubles
exclusive of VAT). This amount approximately equals to
the sum, which the population paid for electricity in 2011,
which means that the tariffs for households are understated
by almost twofold.
At the same time, the electricity bills averaged about 1.3% of
the total household expenses, which was almost a quarter less
than a share of household spending on alcoholic beverages
(1.7%).
A significant shortcoming of the existing form of the cross-
subsidization is the fact that it is distributed in proportion to
specific power consumption by households. Since the power
consumption increases with the income growth, wealthier
households receive the most part of the subsidization as
compared to poorer ones. In 2011, on the average, the monthly
subsidization of the well-off household totaled to almost

March 2013
500 rubles, while the least well-off ones received only 226
rubles per month. As a result, the subsidization of electricity
consumed in 2011 by 30% of the least well-off households
took less money, than it was provided for in the regulated
contracts used in the wholesale power and capacity market.
Besides households, the subsidies in the form of reduced
electricity costs are allocated to the consumers belonging to
the tariff group called “other consumes,” who are connected to
low voltage lines (22 bln rubles exclusive of VAT) and those,
who consume electricity from secondary medium voltage
lines (25.9 bln rubles exclusive of VAT). And, last, but not least,
significant amounts overpaid by large consumers “dissolve”
in the total business revenues of the distribution network
companies, so that exact beneficiaries of these overpayments
cannot be identified.
The cross-subsidization has also an adverse effect on
distribution network companies. Legal proceedings
commenced by the consumers connected to “the last mile”
facilities lead to the risks of losing a significant amount of
sales and, therefore, revenues. Inflated prices for the electricity
transmission services imposed on industrial consumers
stimulate them to actively develop their own generation
facilities and try to reduce the consumption of electricity
from a centralized network, which also threatens the financial
stability of the distribution network companies. This, of
course, affects the market capitalization and the ability of
the distribution network companies to raise loan funds.
The ideal solution of the cross-subsidization problem would
be its complete abandonment, setting of the tariffs at an
economically feasible level (here, we mean setting the tariffs
in full compliance with the Russian Federal Tariff Service
instructions) and the transition to targeted subsidies for the
needy. It seems, however, that today it involves considerable
difficulties, including social and political ones. The introduction
of the social norm for energy consumption and setting it at an
adequate level, which would limit the size of subsidy allocated
to the well-to-do, would decrease the volume of the cross-
subsidization and, therefore, it would be a good start for the
process of the cross-subsidization abandonment.
Nevertheless, according to our research, for the time being,
the tariffs set for the electricity distribution considerably
differ from the rates calculated in accordance with the Russian
Federal Tariff Service instructions. It also occurs due to the

6
non-transparent process of establishing unified tariffs. The
structure of unified tariffs and the parameters taken into
account during their computation by regional regulating
authorities are not disclosed and the consumers have virtually
no opportunity to check the validity of the tariffs set forth by
regional regulators and challenge them.
In this situation, even the introduction of the social norm
of power consumption, which provides entering additional
parameters to be established by regional regulators, could
become just another source of distorting the tariff situation
in the region, rather than help to reduce the volumes of the
cross-subsidies.
Guaranteeing transparency of unified tariffs, and, in particular,
publication of the parameters taken into account during
the calculation and setting of the tariffs, which are made
by the executive authorities of the RF constituents, is an
important element of the solution to the problem of the cross-
subsidization and the improvement of the tariff regulation
quality in general. This would allow for the establishment
of public control over setting of unified tariffs for the
transmission of electricity through distribution networks, as
well as provide the control over the included amount of the
cross-subsidization.
The reserve for the extensive growth of tariffs for electricity
transmission has been already exhausted. It is necessary to
increase the efficiency of the distribution network companies,
to introduce explicit criteria for the selection of investment
projects and to enhance the efficiency of investment programs
on the whole. And finally, it is necessary to establish control
over the activities of the regional network companies.
The cross-subsidization is a complex issue and its abandonment
would require the commitment of the authorities and the
consent of all interested parties that it should be eliminated.
However, it is no longer possible to discard this problem and
leave everything as it is.

March 2013
The cross-subsidization of electricity consumers is one of the
oldest and well-known problems in the Russian power industry.
It means that the part of the cost for consumed electricity is
transferred from one group of consumers to another. Usually,
it is declared that the main objective of the cross-subsidization
is a reduction of the expenses paid by the population for
electricity.
It is believed that there was no cross-subsidization in electricity
tariffs in the Soviet Union – the population paid for electricity
much more than the industrial consumers used to. After the
beginning of the economic reforms in Russia, the government
began to restrain the growth of the tariffs on electricity for
the population at the expense of the more rapid increase of
the tariffs for industrial consumers. This was done in order to
decrease the financial burden on the population during the
transitional period and to maintain the social stability.
As a result, the households started to pay less for electricity
than industrial consumers did. If, for instance, in 1985, the
electricity tariff for households (without electric stoves) equaled
to 4 kopecks for a kWh and for industrial consumers it was
1.5 kopecks for a kWh (the electricity cost for the population
was 2.67 times higher than for the industry), then, in 2010, in
accordance with the Energy Balances Forecasting Agency data1
,
the average cost of electrical power for the urban population
amounted to 172.4 kop/kWh and for the industry – 197.9 kop/
kWh (the population paid for electricity by 13% less than the
industrial users).
At the same time it is obvious that due to the cumulative
expenditures associated with electric power supply, its cost
for households should be higher. Households consume low
voltage electricity, which requires a large number of network
facilities (transformers and distribution points), besides, while
electricity voltage lowers and the amount of network facilities
grow, so electric power losses increase. Industrial companies,
as a rule, consume high voltage electricity and the cumulative
expenditures for maintaining these grid facilities and electric
power losses are lower. In addition, the costs associated with
accounting of consumed electricity and the administration of
client accounts per unit of consumed electricity are higher for
households, than same for industrial consumers.
1 The analysis of prices, tariffs and the development of competitive relations
in the electricity retail markets of the Russian Federation in 2009-2010
INTRODUCTION
In 1985, the population
paid for electricity
2.67 times more, than
industrial consumers.
In 2010, it paid by 13%
cheaper in comparison
to the costs paid by the
industry

8
The Russian government repeatedly showed its concern in
eliminating the cross-subsidization. For instance, Resolution
# 1231 of the RF Government as of September 26, 1997
set forth the “Schedule for Bringing the Electricity Tariffs
for Households in Compliance with the Actual Cost of Its
Production, Transmission and Distribution,” contemplating the
elimination of the cross-subsidization by the middle of 2000.
It was stipulated in the Guidelines for the Reformation of the
Electrical Power Industry of the Russian Federation approved
by RF Government Resolution # 526 as of July 11, 2011, that
one of the main issues, which solution would lead to the success
of the power industry reform, is “a phased elimination of the
cross-subsidization of the regions and groups of electricity
consumers.”
The Concept of Socio-Economic Development of the Russian
Federation for the period up to 2020 (approved by Resolution
# 1662-p of the RF Government as of November 17, 2008)
specified that “for the period up to 2014, it is planned to bring
the electricity tariffs used for households in compliance with
the market rates in order to eliminate the cross-subsidization
between households and other power consumers, and increase
the targeted protection of low-income groups of the population.”
Last but not least, Resolution # 442 of the RF Government as of
May 4, 2012, specified that, “no later than 1 January 2013, the
Ministry of Economic Development, the Federal Tariff Service,
the Ministry of Energy, the Federal Antimonopoly Service
and the Ministry of Finance should develop and submit to
the RF Government draft regulations aimed at solving the
issues concerning the cross-subsidization in the retail power
markets.”
It also should be noted that Federal Law # 35-FZ on Electrical
Power Industry as of March 26, 2003, stipulates that “when
establishing preferential prices (tariffs), provided for by the
Russian legislation, on electrical power (capacity) for a certain
group consumers, it is not allowed to increase prices (tariffs)
for other consumers (Subclause 5 of Article 23)”.
However, despite numerous instructions and even legislative
acts prohibiting the cross-subsidization, the problem has
not yet been solved. Nonetheless, now, there is an active
discussion on the ways of its solution, and it seems that this
time the Russian government really intends to take the cross-
subsidization under control and eliminate it in the electric
power sector.

March 2013
During the reformation process of the electric power industry,
the mechanisms of the cross-subsidization were undergoing
significant changes.
Initially, when the final tariffs of vertically integrated
electricity suppliers were formed, the cross-subsidization was
carried out by determining different end tariffs for different
consumer groups.
The establishment of the federal wholesale electricity (electric
capacity) market open to a number of large consumers on
a par with the vertically integrated suppliers, motivated
these consumers to part with those suppliers and start
buying electricity on the wholesale market, which price did
not include the cross-subsidization amounts. The vertically
integrated companies (called AO-Energo) tried to prevent large
consumers from entering the federal wholesale electricity
market, which, in some cases, lead to conflicts.
The reforms in the electric power sector, the unbundling
of AO-Energoes by types of activities, and the transition to
the regulation of certain components of the final price for
electrical power provision required changes in the cross-
subsidization mechanism. Its inclusion in the sales markup of
a guaranteeing supplier was complicated by the liberalization
of the relations in the electrical power industry, the facilitation
of the wholesale electricity (capacity) market entry, as well as
by the emerged competition in the retail electricity markets,
when a buyer, which did not meet the requirements imposed
on the wholesale market entity (or a buyer, which did not
want to go directly to the wholesale electricity market for
some reason), could replace a guaranteeing supplier with an
independent power retail supplier.
As the result, the sales increment of the suppliers contain
a relatively small proportion of the cross-subsidization money,
and it is not even directly included in the allowance for network
companies purchasing electricity for the compensation of the
losses.
MECHANISMS
OF THE CROSS-
SUBSIDIZATION

10
Cost at the Electricity
and Capacities Market
Federal Grid
Company Tariff
Distribution Network
Companies Tariff
Guaranteeing Supplier
Sales Increment
Regulated
Agreements
Interterritorial Subsidies
(Not discussed here)
Last Mile Rental
GRR Redistribution
in Maintenance Tariff
Redistribution of
Revenues in Power
Loss Tariff
Cross-Subsidization
between One-and
Two-Part Tariffs
for High Voltage
Overpricing of the cost
of Electricity purchased
by the distribution
companies for Power
Loss Compensation
(Not discussed here)
Types of the cross-subsidization
Source: Moscow School of Management SKOLKOVO Energy Centre
Figure 1. Constituents of the final cost of electricity and the types of the cross-subsidization
elements included in it
Partially, the cross-subsidization mechanization is included
into the mechanism of the wholesale electricity and electrical
capacities market, which is done by the conclusion of the
regulated contracts between the electricity suppliers and
guaranteeing suppliers (starting from 2011, the regulated
contracts are concluded only on electricity volumes for
household consumption), which prices and volumes are set
forth by the Russian Federal Tariff Service.
However, the most part of the cross-subsidization was forced
out from the competitive sectors into the monopolistic one, i.e.
the tariffs for the electricity distribution over the distribution
networks. This is a considerable part of the electricity price for
the end user and the cross-subsidization is one of the factors,
which contributes to the growth of its share in the final price
of electricity for large consumers. The control of the tariffs
for the electricity transmission over the distribution networks
get more complicated due to the fact that they are set by the
authorized executive bodies of the constituent territories of
Russian Federation and the transparency of the established
tariffs leaves much to be desired. Moreover, consumers have to
pay in accordance with the unified tariff set for the electricity
distribution services and which is used for all the distribution
network companies located in the constituent territory of
the Russian Federation (a total number of such companies
varies from 2,500 to 3000 for the whole Russian Federation,
The reform of the
electric industry and
the introduction of
competition in the
retail markets have
led to squeezing the
cross-subsidies into the
monopoly tariffs for
electricity transmission

March 2013
according to expert opinion), while the structure of the set
unified tariffs and the parameters taken into consideration
during their computation remain undisclosed.
The growth of the tariffs for electricity transmission over the
distribution networks exacerbated the problem associated with
some large customers de facto connected to the supergrid (the
United National (All-Russia) Electric Grid Network run by the
Federal Grid Company), but which historically were serviced
by AO-Energo companies, which, in their turn, after their split
remained serviced by the distribution network companies.
These consumers sought to evade the distribution network
companies’ services turning to the Federal Grid Company,
which tariffs for the provision of the services appeared to be
significantly lower.
Such a replacement of the service provider, however, breaches
the tariff balances since the leaving consumers stop paying
their share of the cross-subsidized amounts. In a number of
cases, the conflicts were resolved only after lengthy trials.
In order to bring the situation under control, the specific
amendments to the legislation concerning the electric power
industry had to be introduced in 2007 – the concept of “the
last mile” rental. It means that the organization managing
the Unified National Electric Grid leases to the distribution
network company the electric network facilities (transformers,
the last span of power transmission lines, switchgear), where
large consumers are connected.
In addition to this, such facilities are placed, as usual,
at substations, which are continued to be served by the
organization managing the Federal Electric Grid. It results
in the situation when a large consumer is connected to the
network facilities, which are leased to a distribution network
company and it has to enter into a contract for the provision of
electrical transmission services with this distribution network
company. But, in reality, the distribution network companies
have nothing in common with these network facilities and, as
a rule, do not operate them. It is worth noting that, initially,
it was intended to use this mechanism up to 1 January 2011,
but later it was extended up to 1 January 2014.
However, according to our study, “the last mile” rental is
not the main means of the cross-subsidization application,
although it is one of the best known one.

12
The main amount of the cross-subsidization is included in
the tariffs for the provision of the services for electricity
transmission over the distribution networks, which is then
realized by the redistribution of the tariff revenues among
the voltage levels and groups of consumers.
The equality in the tariffs for low voltage electricity
transmission for households and other consumers does not
mean that there is no cross-subsidization in the region
The Russian legislation provides for the establishment of
separate electricity transmission tariffs for the tariff group
called “the population and customers similar to it.” It could
be assumed that the cross-subsidization is put into practice
by setting lower tariffs for this group of consumers and the
even distribution of profit gaps of the distribution network
companies among other groups of consumers. However, our
calculations show that the cross-subsidization covers not only
households and consumers similar to them, but also it includes
some other consumers using low and secondary medium
voltage electricity. Moreover, the establishment of the tariff
for electricity transmission services for households in a region
at the same level as for other low voltage consumers does
not mean that there is no cross-subsidization in that region.
The cross-subsidization is present in all the regions and it is
included both in the tariffs for the network maintenance and in
the tariffs for the compensation of power transmission losses.
Besides these methods of the cross-subsidization, we have
also found a very specific method used in some regions – the
redistribution of the tariff revenues between one-part and
two-part tariffs for electricity transmission for high voltage
consumers. This means that the tariffs, which, in theory, should
be the same (if load factors are accounted for), are actually set
at different levels, given the fact that some consumers don’t
have the right for choosing the tariff options when making
payments to the distribution network companies.
The equality in the
tariffs for low voltage
for households and other
consumers does not
mean that there is no
cross-subsidization in the
region

March 2013
Within the framework of this study are the unified tariffs
for electricity transmission over the distribution networks
belonging to 59 distribution network companies. Due to
the specifics of the electric power industry, the analysis did
not include the regions of the Russian Federation, where
transmission services are provided by the subsidiaries of
the Interregional Distribution Grid Company of the North
Caucasus, Far-Eastern Distribution Company, the Kaliningrad
and Tomsk regions. Also, we made a separate analysis of
the situation with the Moscow United Power Grid Company
providing services for Moscow and Moscow region and
Lenenergo – for St. Petersburg and the Leningrad region. Thus,
61 instances of setting the tariffs for electricity transmission
services on the territory, which aggregate consumption of
electricity makes more than 92% of Russia’s overall electric
power consumption and 88% of all household electricity
consumption.
For calculating the cross-subsidization volumes, we used
the data from the Russian Ministry of Energy, Federal Tariff
Service, the Trading System Administrator of the Wholesale
Energy Market, Automated Data System “Power and capacity
markets” of the Market Council, the executive authorities of
the Russian Federation, the distribution network companies,
and guaranteeing suppliers. All the calculations of the research
are shown exclusive of VAT, unless otherwise specified.
The total volume of the cross-subsidization types in the
electrical power industry in 2011, according to our calculations,
amounted to 323.9 bln rubles (382.2 bln rubles inclusive of
VAT). This is one and a half time more than the volumes
published by the Russian Federal Tariff Service – 204.8 bln
rubles (241.7 bln rubles inclusive of VAT).
Out of the above amounts, the cross-subsidization volume
added up to the network tariffs (excluding “the last mile”
overpayments) in 2011, amounted to 205.3 bln rubles
exclusive of VAT or 63.4% of all the cross-subsidies – these
are volumes related to different forms of distorting tariffs for
the electricity transmission over the distribution networks.
CROSS-
SUBSIDIZATION
VOLUMES
The total volume of the
cross-subsidization in 2011
amounted to 323.9 bln
rubles (w/o VAT), which is
one and a half times more
than the estimates given
by the Russian Federal
Tariff Service

14
350
300
250
200
150
100
50
0
bln rubles
”The last mile”
tariff
Redistribution of
GRR in the tariff
for the network
maintenance
Redistribution
of revenues for
compensation of
power transmission
losses
Overrated two-part
HV tariff in relation
to the one-part tariff
Regulated contracts
in the electricity
and capacity
wholesale market
58,6
172,2
31,2
1,9
60,0
Figure 2. Volumes of the different cross-subsidization types in 2011, bln rubles exclusive of VAT
According to the preliminary estimates, the volume of the
cross-subsidization did not change significantly in 2012 as
compared to 2011. It can be stated that the main achievement of
the last year was halting the growth of the cross-subsidization
volumes. In many ways, however it can be explained by the
postponement of the tariff change to the middle of the year,
which was why the average annual tariffs in 2012 changed
just a little compared to 2011.

March 2013
Regulated contracts in the wholesale market are used for
the sale of both electrical power and capacity. The electricity
volumes, which were sold in the wholesale electric power
and capacity market via the regulated contracts, amounted to
144 bln kWh, which is about 13.5% of the all the electricity
volumes sold at that market in 2011.The average cost
of the electricity sold under the regulated contracts was
527.53 rubles/th kWh, which was by 38.3% lower than the
average price for electricity in the open market (day-ahead
and balancing power markets), which amounted to 981.35
rubles/th kWh.
The volume of electric capacity sold under the regulated
contracts in 2011, according to Market Council, amounted to
481.66 th MW (24.5% of the total amount of power sold in the
wholesale market), while the average price of the capacities
sold to households under the regulated contracts amounted to
130.86 th rubles per MW, which was by 16.7% lower than the
average price of electric capacities in the wholesale market
(157.1 th rubles/MW).
The total amount of the cross-subsidization made through
the regulated contracts for electricity and capacity, therefore,
was about 60 bln rubles. The use of the regulated contracts in
the wholesale electricity and capacity market is the only way
of ensuring preferential tariffs for the population, originally
established in the legislation related to electric power.
Electrical power, th rubles/kWh Capacity, th rubles/MW
800
700
900
600
500
400
300
200
100
0
160
140
180
120
100
80
60
40
20
0
RC RCWM
w/o RC
WM
w/o RC
Figure 3. Free and regulated prices for electric power and capacity in the wholesale market in 2011
Source: information from Market Council, Moscow School of Management SKOLKOVO Energy Centre
REGULATED CONTRACTS
IN THE WHOLESALE
ELECTRIC POWER AND
CAPACITY MARKET

16
As was mentioned above, the rental of “the last mile” was
introduced as a temporary mechanism for ensuring the
tariff balance in the distribution networks until solving the
issue of the cross-subsidization. At the same time, in order
to determine the amount of the overpayments made by the
consumers connected to such facilities, it is necessary to
compare the tariffs for the electricity transmission over the
Federal Grid Company networks (here, the calculations imply
the lowest voltage level – 220 kV) and the tariffs for electricity
transmission over the distribution networks (high voltage,
110 kV). As can be seen, the Federal Grid Company tariffs
are much lower than the tariffs of the distribution network
companies, and this difference varies significantly from region
to region.
In 2011, the minimal overrun (1.32 times) of the distribution
network companies’ high voltage tariff as compared to the
Federal Grid Company one was in St. Petersburg, while the
maximum overrun of the distribution network tariff (11 times)
over FGC one was observed in the Republic of Tyva. On the
average, the distribution network high voltage tariff exceeded
3.6 times the FGC tariff in the surveyed regions (a conventional
one-part tariff was used for comparison, which was computed
from two-part tariffs using a uniform coefficient for power
metering).
12
10
8
6
4
2
0
times
Figure 4. The exceedances of the conventional one-part high voltage tariff of the distribution
networks over the conventional one-part 220 kV tariff of the federal grid, times
Note: Each point corresponds to a certain region, the regions are arranged along the horizontal axis
in ascending order of the tariff ratios.
”LAST MILE” RENTAL

March 2013
The volume of electricity supplied to the consumers of “the
last mile,” according to the Interregional Distribution Grid
Holding Company, totaled to 103.7 bln kWh (17% of the total
net supply of the distribution network companies).
It follows from the calculations that “last mile” consumers
overpaid 58.6 bln rubles in 2011. This amount was determined
as the difference of the tariffs for electric power transmission
over the federal grid network (220kV) and the weighted
average tariff for high voltage electricity transmission over
the distribution networks in the regions, where “the last mile”
facilities are located, multiplied by the volume of the useful
output received by “last mile” consumers (according to the
Interregional Distribution Grid Holding Company).
Table 1.
The difference of the Federal Grid Company and distribution network tariffs,
the overpayment made by “the last mile” consumers in 2009 – 2011
2009 2010 2011
Conventional average one-part tariff of the Federal Grid Company for
power transmission, RUR/th kWh
124.6 168.5 212.9
Conventional average one-part tariff of the distribution network
companies for high voltage power transmission (the regions with “the last
mile” users), RUR/th kWh
495.5 631.4 777.7
Difference between the average one-part tariffs, RUR/ th kWh 370.9 462.9 564.8
Volumes supplied to “the last mile” consumers, bln kWh 140.6 113.7 103.7
Amounts overpaid by “the last mile” consumers, bln RUR 52.2 52.6 58.6
It is important to stress that the amounts supplied to “the last
mile” consumers have steadily declined over the past three
years: the distribution network companies have lost more than
a quarter of useful output delivered to such consumers. At the
same time, the overpaid amounts have grown, which means
that the entire shortfall of the revenues has been shifted to
the remaining consumers. Moreover, in 2011, there was the
change in the types of leaving consumers: if, for instance, in
2010, only four subsidiaries of the Interregional Distribution
Grid Holding Company lost their “last mile” consumers, in
2011, there were already nine (out of all 12 subsidiaries of the
Interregional Distribution Grid Holding Company, studied by

18
the Energy Centre) companies which lost such consumers.
At the same time the average volumes supplied to the lost
consumers also decreased, which means, that not only the
largest and most significant consumers started to leave, but
also those, whose levels of power consumption were not so
high. The increased burden put on remaining consumers
connected to “the last mile” facilities will only contribute to
their further outflow, despite the efforts of the distribution
network companies and the authorities to curtail this process.
The largest cross-subsidization amounts flow through the
redistribution of the gross revenue requirement (GRR) of
the distribution network companies, which is made between
different voltage levels within the structure of the tariff for
network maintenance.
To explain the nature of this mechanism, the process
of establishing the tariffs for the services for electricity
transmission over the distribution network should be put
in question. As was said, the consumers pay the unified
tariffs for the transmission of electricity via the distribution
networks, which combine the required gross proceeds of all
the distribution network companies operating in the region.
At the same time, regardless of the methods (whether they are
based on expenses reasonably incurred, price indexation, or
return on invested capital) used for the establishment of the
amount of the required gross proceeds, the unified tariffs are
set in accordance with the Guidelines for the Establishment of
Regulated Tariffs and Prices for Electrical (Thermal) Energy in
the Retail (Consumer) Market approved by Resolution №20-
e/2 of the Russian Federal Tariff Service as of 06.08.2004.
The process of setting the tariffs for electricity transmission
services through the distribution networks consists of two
major parts:
(1) Determination of the required gross proceeds for all the
distribution network companies operating in the region, and
the total sum of the required gross proceeds of these companies
(for this purpose different methods of GRR determination
could be used for different companies operating in the same
subdivision of the Russian Federation);
REDISTRIBUTION OF
THE GROSS REVENUE
REQUIREMENT IN THE
STRUCTURE OF THE TARIFFS
FOR THE NETWORK UPKEEP
The non-transparent
nature of unified tariffs for
via the distribution
networks contributes
to almost uncontrolled
growth of the cross-
subsidization and
numerous violations in
the tariff making process

March 2013
(2) Distribution of the GRR total in accordance with voltage
levels and consumer groups, and the establishment of the
tariffs (rates for network management), based on the planned
volumes of the customer contract demand for certain voltage
levels for the corresponding customer group (which is done
in accordance with Resolution №20-e/2).
DNC
TNO
Total GRR of
Network
Companies
Unified
HV Tariff
Unified
MV1 Tariff
Unified
MV2 Tariff
Unified
LV Tariff
Unified
Household Tariff
TNO
TNO
Figure 5. Establishment of the tariffs for electricity transmission over the distribution network
In accordance with the FTS method mentioned above, the
required gross proceeds are distributed in proportion to the
amount of conventional units at the appropriate voltage level,
and the tariff is set as the quotient resulting from dividing
the part of GRR referred to the appropriate voltage level and
on the planned volumes of customer demand.
Then, the consumers receive electricity from that distribution
company, which they are connected to, however, depending
on what tariff scheme is approved in the region, they make
payments for the electricity transmission services to different
companies.
The mostly widespread scheme is when payments go “up to
the pool,” which means that consumers pay for electricity
transmission services to the company holding all payments
(usually it is a distribution network company, which is

20
a subsidiary of the Interregional Distribution Grid Holding
Company). Then, this company pays to the territorial
distribution network companies for electricity transmitted
over their lines in accordance with the approved individual
inter-network tariffs. These tariffs serve for passing the
required amounts of revenues to TNOs (territorial network
organizations), and they much differ from the tariffs approved
for customers..
DNC
“the Pool” Holder
(HV – MV1)
TNO
(MV1- MV2)
TNO
(MV2 - LV)
HV Consumer
MV2 Consumer
LV Consumer
Electricity
Unified payments at the corresponding voltage level
Settlements between network organizations acc. to individual tariffs
Figure 6. Payment settlement used under the unified tariff structure (payments going to “the pool”)
In our analysis we used the summary data on the amounts
of conventional units by the voltage levels provided by the
Russian Ministry of Energy, as well as the total volumes for
each voltage level of power supplied to end-users of all the
regions studied.
Based on the above data, we have calculated “theoretical”
ratios between the rates for different voltage levels, which
are the correlations satisfying the requirements of the
FTS regulations. After that, we computed the “theoretical”
average tariffs for electricity transmission, suggesting
that the consolidated revenues of the distribution network
companies should remain the same as they were in the

March 2013
approved tariffs. It would be noted that in this study we did
not assess the validity of the consolidated required gross
revenue amounts of the distribution network companies.
Table 2.
Assessment of the cross-subsidization levels in the tariff for the upkeep of the power networks in 2011
HV MV1 MV2
LV
Other
House-
holds
Share of network facilities (conventional
units) 0.22 0.17 0.38 0.24
Share of effective load supplied to end-users
0.58 0.05 0.14 0.23
Correlation of the “theoretical” tariffs for the
network upkeep 1.00 2.21 6.36 7.05
Hours of capacity utilization by consumers
(assumed for the calculations) 7500 6000 6000 4250
Correlation of the “theoretical” one-part
tariffs 1.00 1.95 4.68 5.71
”Theoretical” one-part tariff in 2011, RUR/
MWh w/o VAT 390.76 761.01 1827.5 2230.55
Actual average one-part tariff in 2011, RUR/
MWh w/o VAT 859.54 1300.75 1606.57 2130.75 991.31
Ratio of the “theoretical” one-part tariff to
the actual tariff 0.455 0.585 1.138 1.047 2.250
Consolidated volume of the effective load
supply in 2011, bln kWh 334.3 28.7 103.4 43.5 117.0
Overpayment (+)/ underpayment (-) by con-
sumers due to the redistribution of the tariff
load, bln RUR w/o VAT
156.72 15.50 -22.85 -4.34 -145.02
The difference between the “theoretical” and actual tariffs is
a deviation caused by the cross-subsidization inherent in the
very nature of the tariffs.

22
We compared the average tariffs approved in all the examined
regions, which were weighted by the volumes of effective load
supplied at the appropriate voltage level. For the convenience
of the calculations, the amounts of the obtained “theoretical”
tariffs for the network upkeep were converted into the
“theoretical” one-part tariffs using the average number of
capacity utilization and the actual approved tariffs used for
the compensation of power losses during transmission.
According to our estimates, in 2011, the cross-subsidization
included in the tariffs for the upkeep of the networks
amounted to 172.2 bln rubles, which implies that this type
of the cross-subsidization amounts to more than a half of the
total overpayments made by subsidizing consumers. This
amount of the required gross proceeds actually indicates that
the provisions of the FTS regulations are commonly violated
by the regional regulating bodies, when they set the tariffs
for electricity transmission over the distribution networks.
It is important to note once again that the structure of the
unified tariff is not disclosed by the regional authorities. Due
to a large number of the local distribution network companies
situated in the regions (in some federal constituent territories,
there could be over a hundred ones), it is practically impossible
to verify how exactly the tariffs for electricity transmission
were calculated, what parameters were used during their
establishment and what amounts of the cross-subsidization
were implied.
As a result, the setting of the tariffs for electricity transmission
over the distribution networks becomes practically
uncontrolled, provided that the regional regulators “meet” the
limit of the tariff growing. Subject to control is the growth of
the average tariffs for all consumers (excluding the accounting
for the dynamics of the tariffs at the different voltage levels)
and the tariff growth for households which is controlled
separately

March 2013
The assessment of the cross-subsidization in the tariff for
power transmission loss was made in accordance with
Regulation №20-e/2 of the FTS and the information from the
distribution network companies on actual power transmission
losses at different voltage levels and the average price paid by
the network distribution companies for electricity purchased
for the compensation of power transmission losses.
The essence of the method for the calculation of the unified
tariff for the compensation of power losses is that power
losses occurring at the respective voltage level and the part
of power losses in the higher voltage network, which occurs
during the transformation of electricity voltage into the levels,
which are analyzed. This means that, in accordance with this
method, the consumers connected to high voltage lines have
to pay 3.5 % of power losses occurring during due to their
consumption in high voltage lines. While consumers using
low voltage electricity have to compensate 27.8% of power
losses occurring in the lines of all the voltage levels.
HV: losses 3.5% (-3.5 kWh)
MV1: losses 5.3% (-5.1 kWh)
MV2: losses 8.3% (-7.6 kWh)
LV: losses 13.8% (-11.6 kWh)
100 kWh
96.5 kWh
91.4 kWh
83.8 kWh
72.2 kWhLV Consumer
Supplier
Figure 7. Power losses in the electric networks
Settlements for power losses are determined by multiplying
the amount of lost power and the tariff of the guaranteeing
supplier set for the electricity to be purchased by the
distribution company for the compensation of power
transmission losses.
CROSS-SUBSIDIZATION IN
THE TARIFF FOR POWER
TRANSMISSION LOSSES

24
The cost of this electricity does not depend on the voltage
level, where these losses have occurred.
Thus, the high voltage tariff for power transmission losses
should equal the cost of losses, occurring in high voltage
lines, divided by the consolidated volume of the supplied
electricity and the volumes of power transformed into lower
voltage levels. And, for instance, for low voltage electricity,
the tariff for power transmission losses should be equal to
the ratio of the cost of electricity losses (occurring both in
low voltage lines and lines of higher voltage in the amounts
corresponding to the electricity volumes, which have been
transformed into low voltage network) and the electricity
supplied to the consumers connected to low voltage lines.
Based on the data on the amount of power losses occurring
at the corresponding voltage levels and the amount of the
effective electricity supply according to voltage levels, we
determined what ratios between the amounts of the tariff
for power transmission losses at different voltage levels
correspond to the provisions of the regulations (“theoretical”
ratio). The calculations showed that the tariff rate for power
transmission losses at high voltage levels should be 3.17 times
less than the tariff rate at the first medium voltage, 5.26 times
less, than at the second medium voltage, and 11.09 times less,
than at low voltage level. In fact, in 2011, the average tariff
for compensation of power losses at the low voltage level
exceeded 3.4 times the tariff set for high voltage.
In order to estimate the amount of the cross-subsidization
included in the tariff for power losses compensation, we
calculated “theoretical” tariffs, satisfying the mentioned
ratios and made allowances for the average price of electricity
purchased by the distribution network companies from the
guaranteeing suppliers for the compensation of power losses.
The comparison of the “theoretical” and actual tariffs for
power losses showed that the amount of overpayments made
by the consumers connected to high and first medium voltage
totaled 31.2 bln rubles in 2011. This part of overpaid amounts
leads to the overall increase in the proceeds of the distribution
network companies (i. e., the proceeds of the distribution
network companies were somewhat over excessive, which
was probably due to the need to compensate unaccounted
power losses and other deviations from the regulations for
the tariff establishment).

March 2013
Table 3.
Assessment of the cross-subsidization in the tariff for compensation of electricity losses in 2011
HV MV1 MV2 LV
Planned power losses, % 3.20% 6.40% 5.80% 14.00%
Ratio of the “theoretical” tariff for power losses at the
given voltage level to the tariff on the high voltage,
times
1.00 3.17 5.26 11.09
“Theoretical” tariff for power losses,
RUR/ th kWh w/o VAT 54.34 172.34 258.88 602.35
Average actual tariff for power losses, RUR/ th kWh
w/o VAT 143.84 215.32 257.1 489.78
Effective load supplied in 2011, bln kWh 334.3 28.7 103.4 160.5
Consumer overpayments (+) / underpayments (-) due to
the redistribution of the tariff load, bln RUR w/o VAT 29.92 1.23 -3.00 -18.07
The analysis does not contain the assessment of the cross-
subsidization for households, as the difference between the
tariffs for households and other low voltage consumers
was taken into account in full in the analysis of the cross-
subsidization included in the tariffs for the network upkeep.
The volume of the cross-subsidization in the tariff for power
losses also suggests numerous violations of the FTS guidelines
occurring during the tariff setting. Again, it must be mentioned
that the unpublished parameters taken into consideration by
the regional authorities during the calculation of the tariffs
(amounts to be paid for power losses, planned volumes of
power losses, planned volumes of electricity supply) do not
allow interested parties to verify the validity of the set tariffs.

26
We have found out one more type of the cross-subsidization,
which, despite its relatively minor amount (1.9 bln rubles)
is quite interesting. This is the overestimation of the two-
part tariff as compared to the one-part tariff for high voltage
electricity.
According to the FTS provisions, the one-part and two-part
tariffs for the same voltage level, provided the included during
the calculation load factor ratio, should be equal. However,
“the last mile” consumers, among other things, do not have
the possibility to choose the one-part tariff for payment
settlements and, apparently, the regional regulators use it for
additional balancing of the tariff revenues of the distribution
network companies.
There are regions, where the two-part tariff is set at a higher
level than the one-part tariff, even if you take into consideration
the maximum theoretical number of hours of the capacity
utilization by the consumer of 8760 hours per year. This is
not a common occurrence – in 2011, such instances were
found only in 9 regions, but this practice gains popularity:
in 2009, there were no regions with such a form of the cross-
subsidization, while, in 2010, it was observed in 3 regions.
As a result, in 2011, the customers of the Leningrad region,
in order to make the high voltage two-part tariff and one-
pat tariff equal, would have had to consume the electricity
during 15 months per a year or nearly 30 hours per day for
12 months at the contracted capacity levels and provided
a steady consumption schedule.
THE ONE-PART AND TWO-
PART HIGH VOLTAGE TARIFFS
In 2011 alone, in order
to achieve the parity of
the two-part and one part
tariffs, a high voltage
consumer located in the
Leningrad region should
have steadily consumed
the requested amount
of electricity during
15 month per year or
30 hours per day during
12 months

March 2013
The volume of the cross-subsidization described above is
the aggregate total of all overpayments performed by the
subsidizing consumers. A particular interest, however, draws
the way how these overpayments are distributed among the
consumer groups. Moreover, our research showed that, in the
contrary to the widespread belief, not only the population and
eligible consumers are subsidized.
The subsidizing group of consumers is the customers
connected to the high and first medium voltage lines.
The high voltage consumers take the main burden –
188.5 bln rubles exclusive of VAT. This sum also consists
of the overpayment included in the tariff for the upkeep of
the networks and in the tariff for transmission losses both
related to high voltage lines, as well as the cross-subsidization
between the one-part and two-part high voltage tariffs.
Also, this sum includes the overpayments of the consumers
connected to “the last mile” facilities, which amount to 58.6
bln rubles. Thus, the total aggregate amount of the burden
imposed on the high voltage consumers totals 247.1 bln
rubles exclusive of VAT.
The consumers, connected to the first medium voltage lines,
overpaid 16.7 bln rubles owing to the cross-subsidies included
in the tariffs for network upkeep and transmission losses.
The main subsidized group of consumers is the population.
Just a little over 63% (205 bln rubles exclusive of VAT) of the
total amount of cross-subsidization, which were determined
during our research, is allocated to households.
This cross-subsidization amount consists of 60 bln rubles
obtained by means of regulated contracts in the wholesale
power and capacity market and 145 bln rubles – via the
redistribution of the required gross proceeds in the tariff for
the network upkeep.
As for the regulated contracts, it is difficult to identify a single
group of subsidizing consumers. It can be assumed that it
is evenly divided on all the consumers of the wholesale
electricity market. In this connection, we assume that the
entire amount of the cross-subsidization performed by means
of the regulated contracts is allocated to households (as the
volumes of electricity consumed by households included in
the FTS estimate are not made public, it is impossible to
compare these volumes with the actual data).
CROSS-
SUBSIDIZATION
IMPACT
SUBSIDIZING AND
SUBSIDIZED GROUPS
OF CONSUMERS
Just over 63% (205
bln rubles exclusive of
VAT) of the total cross-
subsidization amount
is redistributed to
households

28
The subsidized amount provided to households by the
redistribution of the GRR included in the tariff for the network
upkeeping is lower than the overpayments of the subsidizing
consumers within this type of the cross-subsidization, as in
some cases, the tariff for transmission services is lowered
not only for the consumer group called “the population and
consumers similar to it”, but for all the low voltage consumers
(including the “other consumers” group), and the same refers
to the consumers of the second medium voltage.
According to our estimates, in 2011, the subsidies to the
consumers connected to low voltage lines amounted to
22.4 bln rubles, and the subsidies to the consumers connected
to the second medium voltage totaled 25.9 bln rubles exclusive
of VAT. These amounts include the volumes of the subsidies
made by the redistribution of the required gross proceeds
included in the tariff for network upkeep (the part, which
refers to the stipulated groups of consumers) and in the tariff
for transmission losses (the entire volume).
It is important to note that not for all the types of overpayments
performed by the subsidizing groups, it is possible to
unambiguously identify the group of consumers, which
receive these overpayments. This, in particular, applies to the
overpayments of the consumers connected to “the last mile”
facilities because these sums increase the aggregate amount
of the distribution network companies’ revenues and they do
not represent a distinct type of the cross-subsidization.
The overall difference between the overpayments made by the
subsidizing consumers and the subsidies amounts, for which
the groups of the beneficiaries could be identified, totaled
70.6 bln rubles exclusive of VAT.
CROSS-SUBSIDIZATION
IMPACT ON LARGE
CONSUMERS

March 2013
59,96
247,14
16,73
204,98
22,41
25,85
70,59
0
50
100
150
200
250
300
350
Subsidizing groups Subsidized groups
Distribution network and
territorial network companies
MV2 consumers (small-scale
industry, shopping centers)
Other LV consumers
(small commercial and
administration buildings)
Households
MV1 (large consumers)
HV (industrial consumers)
Wholesale power and
capacity market
Figure 8. Distribution of the cross-subsidies acc. to the groups of consumers in 2011,
bln RUR (w/o VAT)
bln RUR
Table 4.
Total volume of the cross-subsidization in the electrical energy sector in 2011
and the amount of the subsidies attributed to households (w/o VAT))
Cross-subsidization mechanism Amounts overpaid by
subsidizers, bln RUR
Amounts attributed to
households, bln RUR
”The last mile” rental 58.6 -
GRR redistribution in the network upkeep tariff
172.2 145
Redistribution of expenses for compensation
of losses in the tariff for transmission losses
31.2 -
Overrating of the HV two-part tariff over the one-part
tariff 1.9 -
Amounts subsidized to consumers via
regulated contracts in wholesale power market 60 60
Amounts overpaid by consumers / amounts
subsidized to households, total 323.9 205
Difference between amounts overpaid by large con-
sumers and the volume of household subsidization,
bln RUR
118.9
Share of household subsidization in
the total amount overpaid by consumers, %
63.5%

30
The main group of electricity consumers which pay the
cross-subsidization burden is the large industrial enterprises.
Given the relatively small share of the household electricity
consumption in the total consumption of electricity in
Russia, it is assumed that this increase is relatively small.
Our estimates, however, show the opposite.
The consumers connected to “the last mile” facilities, for
instance, pay for the electricity transmission services 3.6times
more than they would pay for the tariffs set for the use of the
supergrid.
In 2011, the electricity consumers connected to the high
voltage distribution networks paid on the average 2.2 times
more for the upkeep of networks and 2.6 times more for the
compensation of the power transmission losses than they
would have paid if there had not been cross-subsidization
payments included in those tariffs. In terms of the one-part
tariff rate, it implies that the payments were 2.3 times bigger
than they would’ve been without the cross-subsidization.
In 2011, the consumers connected to the first medium voltage
lines paid on the average 1.7 times more for the upkeep of
the networks and 1.25 times more for transmission losses
than they would’ve paid if the tariffs did not have the cross-
subsidization levies included in them. In terms of the one-part
tariff rate, it means that they had to pay 1.6 times more than
they would without the cross-subsidization.
As is evident, the cross-subsidization leads to the fact that the
large electricity consumers pay for the power transmission
services several times more than they would have to pay if
there was no cross-subsidization included in the network
tariffs. This was the reason why the average prices for Russian
industrial power consumers in 2011, turned out to be higher
than those for US industrial consumers, while the payments
for the transmission services paid by US industrial consumers
were by 41% lower than the payments made by Russian
industrial consumers for the same.
More importantly, the largest electricity consumers in Russia
i.e. those, which are connected to “the last mile” facilities, pay
on the average 3 times, and as compared to certain countries,
7 times more for electricity transmission services, than similar
enterprises in Europe, connected to the supergrid.
In 2011, the consumers
connected to “the last
mile” facilities, paid 3.6
times more for the power
transmission services,
the consumers connected
to HV distribution lines
- 2.3 times more, those
connected to MV-1 lines
– 1.6 times more, than
they would have had to
pay without the cross-
subsidization

March 2013
0
1
2
3
4
5
6
7
8
Russia USA
US¢/kWh
Figure 9. The average ﬁnal cost of electric power and power transmission services
for US and Russian industrial consumers in 2011, US cents per kWh*
* Acc. to the annual average exchange rate
Source: EIA, Moscow School of Management SKOLKOVO Energy Centre
Network
component
1,73 US¢/kWh
Network
component
2,93 US¢/kWh
Final cost
7,21 US¢/kWh Final cost
6,82 US¢/kWh
5,4%
41%
Overcharged electrical bills paid by the subsidizers result in
a lower growth of the industrial production and, consequently,
leads to lower GDP growth. For the assessment of the impact
of the cross-subsidization on the industrial production, we
used the data from the Centre for Situation Analysis and
Forecast at the Central Economics and Mathematics Institute
of the Russian Academy of Sciences. Based on the 1995 – 2005
analytical data, the Centre defined the elasticity of physical
volume index related to electricity cost for Russia’s industry
(-0.10). We found out that in 2011 the cross-subsidization
included in the tariffs (including “the last mile’ rental)
amounted to 263.9 bln rubles.
In 2011, 363.03 bln kWh of the electric power was supplied
to consumers using high and first medium voltages, which
corresponds to 726.9 RUR/th kWh of overpaid amounts or
36.4% of the average final cost of electric power to large
industrial consumers (which is, according to the Ministry of
Energy, 1997.3 RUR/th kWh for industrial consumers with the
CROSS-SUBSIDIZATION
IMPACT ON THE
MACROECONOMICS
Due to the cross-
subsidization, Russia’s
industrial growth lags a
year behind

32
connected capacity of 750 and higher kilovolt-ampere). Thus,
the loss of the industrial production growth can be estimated
at 3.6% which is comparable to the annual growth rate of the
industrial production in Russia (2011 - 4.7%, 2012 – 2.6%).
This means that the cross-subsidization results in the loss
of one year of the country’s industrial production growth.
The GDP losses, respectively, are estimated at 0.8% or 451.5
rubles in 2011.
The cross-subsidization, however, means not only a significant
increase in the cost of electricity for large consumers. It is also
a significant reduction in household spending on electricity
bills. As was noted above, in 2011, the subsidies allocated
to households amounted to 205 bln rubles exclusive of VAT,
which makes 63.3% of all the amount of overpayments by the
subsidizers. The total amount of payments for electrical bills
paid by the population in 2011, residing in the regions that we
studied, was 210.1 bln rubles exclusive of VAT, according to
the Federal State Statistic Service and the Ministry of Energy.
This implies that the population paid for electricity just over
a half of the amount (50.6%) it would have had to pay if there
had not been the cross-subsidization in the country. In other
words, the 2011 electricity tariffs for the population were
reduced by almost a half.
That is not to say that the share of household spending
on electricity constitute a significant portion of its total
expenditures – according to the Federal State Statistic Service,
in 2011, the share of household spending on electricity
was 1.3% of its total consumer spending. It is almost by a
quarter less than the population’s expenses for the purchase
of alcoholic beverages, which accounted for 1.7% of the total
household consumption expenditure.
Moreover, the subsidies for the population, embedded in the
increased expenses of the industry spent on electricity, are
partially compensated by increasing the costs for industry
products, which are consumed by the same households.
CROSS-SUBSIDIZATION
IMPACT ON HOUSEHOLDS
Household expenditure
on electricity bills in 2011
amounted to 1.3% of total
consumer spending, which
is almost by a quarter less
than the amounts spent
by the population on
alcoholic beverages

March 2013
Food and so drinks; 29,5
Alcoholic beverages; 1,7
Smokables; 0,8
Clothing and footwear; 10,1
Housing services (w/o electricity); 10,1
Electricity; 1,3
Household items, appliances and housekeeping; 6,5 Health care; 3,5
Transportation; 15,9
Communication; 3,7
Leisure and
cultural activities; 6,8
Education; 1,2
Hotels, cafeterias
and restaurants; 3,2
Other goods and services; 5,7
Source: Federal State Statistic Service
Figure 10. Structure of household consumer spending in 2011, % of the total expenses
Low household expenses for electricity –is just one side of
the existing system of the cross-subsidization in the country.
Another important feature of the prevailing trend is that the
volume of the subsidies attributable to a household is directly
proportional to its electricity consumption.
Power consumption, in its turn, depends on a household well-
being – the richer the family, the bigger number of household
appliances can be purchased and, likewise, the wealthier is a
family, the bigger house it can afford, which requires more
electricity for its heating and lighting.
As a result, on the average, the least wealthy household (1st
decile) was subsidized 226 rubles for electricity spending
per month in 2011, the most well-to-do one (10th decile) was
averagely allocated 500 rubles from the cross-subsidization
per month for the same. That means that, on the average, the
richest household receives twice as much in subsidies than
the poorest one.

34
225,9
259,5 267,3
301,0
343,8
370,0 374,9
390,4
423,1
492,0
0
100
200
300
400
500
600
Figure 11. The average amount of the cross-subsidies per a household in 2011, RUR per month
RUR
poorer wealthierdecile groups
In overall, the least wealthy households (30%), which expenses
for electricity in 2011 equaled or exceeded 2% of the aggregate
household spending, received only 44.7 bln rubles (21.8%)
in subsidies out of 205 bln rubles, which the population did
not pay due to the cross-subsidization. This is about 14%
of the consolidated overpayments of the subsidizing group
of electricity consumers and less than the amount of the
subsidies allocated to the population via regulated contracts
concluded in the wholesale power and capacity market.
In 2011, the wealthiest
households received more
than twice as many cross-
subsidies than the least
wealthy ones

March 2013
The cross-subsidization makes significant distortions in the
tariffs for electricity transmission and the final prices of
electricity. The distorted network tariff provides incentives
for the development of negative trends in the power industry.
Legal proceedings with the consumers connected to “the last
mile” facilities lead the distribution network companies to the
loss clients and, therefore, revenues.
Inflated tariffs for electricity transmission for industrial
consumers make them to actively develop their own power
generation and strive to reduce the volumes of electricity
consumption from the centralized networks, which also
threatens the financial stability of the distribution network
companies. The inflated part of the network component in the
final electricity price “takes away” the revenues of generating
companies. All this, of course, affects the market capitalization
and the ability for loan making both for generating companies
and distribution network ones as well.
The tariffs for electricity sold to industrial consumers in
Russia are already higher than those in the US. For the largest
companies connected to the facilities of “the last mile”, the
tariffs are even higher than in the European countries. The
overpriced electricity costs for the industry are included in the
cost of output product resulting in the increased inflation in the
long run. Given this, the high price of electricity for industrial
enterprises leads to the loss of the growth in industrial output
and in the country’s economy as a whole. It can be stated that
the cross-subsidization has already resulted in the loss of one
year growth in Russia’s industrial production.
At the same time, the existing system of the cross-subsidization
of the population is extremely ineffective. First, the household
consumers receive only about 63% of the total volume of the
overpayments made by subsidizing consumer groups. Second,
the most well-to-do households receive more than twice as
many subsidies as the least wealthy ones.
In total, the amounts redistributed via the regulated contracts
on the wholesale power market would be enough to subsidize
the least wealthy 30% households.
The proposal on the introduction of social norm of electricity
consumption, which is being discussed currently, could help
to put under control the cross-subsidization and limit its
growth. The social norm, if adequate, will allow directing
the cross-subsidization for the protection of the poor and
reducing the undue burden on the subsidizers.
CONCLUSION

36
However, the open is the question – how the lost revenues
of electric industry companies will be reimbursed. Most
likely, after the introduction of the social norm of electricity
consumption, the cross-subsidization mechanism will remain
the same – the redistribution of the revenues inside the tariffs
for the electricity transmission services.
In this situation, it becomes especially important to establish
the transparency of setting tariffs for electricity distribution
via the distribution networks, as well as the control over
the expenses, including the control over the adequacy of
investment programs of distribution network companies.
Currently, neither the structure of the unified tariffs nor the
parameters taken into account during their establishment, as
well as the amount of cross-subsidization included in them,
are made public.
Given the large number of the distribution network companies,
which revenues are included in the unified tariffs, it is
practically unfeasible to control the fidelity of the performed
calculations and the validity of the tariffs for the transmission
of electricity over the distribution networks set forth by the
executive body of the Russian Federation constituent. It is
necessary to significantly increase the transparency of the
unified tariffs and invite interested parties to participate in the
process of calculation and setting of the tariffs for electricity
transmitted over the distribution networks.
Practice shows that it is impossible to cope with the cross-
subsidization without public control. After the introduction of
the social norm of electricity consumption and establishing
the transparency and accountability of the network tariffs, it
would be possible to take another step – replace the cross-
subsidization with targeted subsidies to the needy.
Solving the problem of the cross-subsidization of the
electricity consumers is a complex task that requires a
joint action of all electric power industry subjects and the
determination of the Russian government. Nowadays, the
cross-subsidization has reached such volumes that, if not
solved, it could threaten stable functioning of the electric
power industry and negatively affect the Russian economy

March 2013
All materials presented in this document are for informational
purposes only and are the private judgment of the authors
of the document and cannot be construed as an offer or
recommendation to do anything.
SKOLKOVO Management, a limited liability company and its
employees are not responsible for the use of the information
contained herein, for any direct or indirect damage occurred
due to the use of this information, as well as the reliability
of the information, obtained from external sources.
Any use of materials contained in the document is permitted
only with reference to the SKOLKOVO Energy Centre.

38
Energy Centre
Grigory VYGON Director
Ph. D. in Economics
energy@skolkovo.ru
Anton RUBTSOV Head of Strategy
and new business development
Anton_Rubtsov@skolkovo.ru
Sergey KLUBKOV Head of Operational efficiency
and Portfolio management
Ph. D. in Economics
Sergey_Klubkov@skolkovo.ru
Sergey EZHOV Chief Economist
Doctor of Science
Sergey_Ezhov@skolkovo.ru
Maria BELOVA Senior Analyst, Global Energy
Ph. D. in Economics
Maria_Belova@skolkovo.ru
Igor RYAPIN Senior Analyst, Electrical power
Igor_Ryapin@skolkovo.ru
Daria KOZLOVA Analyst, Strategy
and new business development
Daria_Kozlova@skolkovo.ru
http://energy.skolkovo.ru
phone.: +7 495 539 30 03
fax: +7 495 994 46 68
Build.100, Ul. Novaya, Skolkovo Village,
Odintsovsky District, Moskovskaya
Oblast, 143025, Russian Federation

The SKOLKOVO Energy Centre was founded in the Moscow
School of Management SKOLKOVO in July 2011. The mission
of the Centre is the establishment of a professional and
independent platform for discussing the issues concerning
the Russian fuel and energy complex and forming a balanced
government policy for its sustainable development.
The main areas of the Centre’s activities: the establishment of
a professional dialog between business and government aimed
at the development of a unified position in the sphere of the
fuel and energy complex, industry consulting, research and
analysis of the high priority issues in the Russian and global
energy sectors. The Centre’s employees are highly skilled and
reputable experts, who have vast prior experience of working
in oil and gas, consulting companies, and government bodies.
The Moscow School of Management SKOLKOVO is a joint
project launched by the Russian and international businesses,
who joined their efforts to create the next generation business
school from a scratch. The SKOLKOVO Business School, by
sharing practical knowledge, aims at educating future leaders,
intending to apply their expertise in the rapidly growing
industry markets. The Moscow School of Management is
noted for its leadership, entrepreneurship, focusing on
emerging markets, and its innovative approach to teaching
techniques.
The Moscow School of Management SKOLKOVO is
implemented on the principle of governmental and private
partnership within the framework of the high priority national
project “Education”. The Project is financed by private investors
and it does not involve the state budget funds. The Chairman
of the International Guardianship Board of the Moscow School
of Management SKOLKOVO is Dmitry Medvedev, Chairman
of the RF Government.

Energy Centre
http://energy.skolkovo.ru/en/
energy@skolkovo.ru
phone.: +7 495 539 30 03
fax: +7 495 994 46 68
Build.100, Ul. Novaya, Skolkovo Village,
Odintsovsky District, Moskovskaya Oblast,
143025, Russian Federation

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