MARKETING MATERIAL

RUSSIA EQUITY RESEARCH: UTILITIES

Mosenergo and TGK -1: technological superiority in two biggest Russian cities

Initiation of coverage 19 September 2011

Senior Analyst: Konstantin Reyli reyli_k@metropo l.ru Sales Moscow: +7 (495) 933 3303 Research Moscow: +7 (495) 933 3316 Junior Analyst: Svetlana Semenova [email protected] Sales & Trading London: +44 (207) 439 6881

We initiate coverage of Mosenergo and TGK-1 Bloomberg MSNG RX TGKA RX We initiate coverage of Mosenergo with a fair value of RUB 3.79 (USD Rating BUY BUY 0.124) per share, for 70% potential upside, and TGK-1 with a fair value of Fair value, USD 0.124 0.00084 RUB 0.026 (USD 0.00084) per share and 108 % potential upside. The Current price, USD 0.073 0.00040 companies were valued using a DCF approach with a WACC 13.3% and Upside potential, % 70% 108% 2% terminal growth rate. Both stocks are recommended as BUYs. Market cap, USD mn 2,897 1,560
Current market valuations exaggerate probability of EV, USD mn 2,912 2,370 Common shares 39,749 3,854,342 worst-case scenarios outstanding, mn 52 Week high, USD: 0.118 0.00079 Since the beginning of 2011, Mosenergo and TGK-1 have experienced deep corrections in their stock prices. Mosenergo has fallen by 31% YTD 52 Week low, USD: 0.057 0.00031 and TGK-1 has dropped 47% YTD, while the MICEX is down by just 10 % Free float % 15% 23% Average daily traded for the same period. In our view, the corrections were due to proposals 1.14 0.49 by the government to cap electricity prices for end customers in 2011 and volume, USD mn Share price performance

thereafter. In our view, the current prices offer the opportunity to take over the last: positions in both names at attractive levels. 1 month -7% -17%
We expect Mosenergo and TGK-1 to demonstrate 3 months -13% -31% strong EBITDA growth based on the addition of 12 months -31% -46% YTD -31% -47% more fuel efficient capacity Following the launch of new fuel efficient facilities operating under Profitability, % 2010 2011E 2012E capacity delivery contracts, we expect adjusted EBITDA to increase at a

CAGR of 12% for Mosenergo and 24% for TGK-1 over 2011-15. EBITDA Mosenergo margin should increase from 15% to 17% over the period for Mosenergo Operating margin 6% 7% 9% and from an estimated 18% in 2011 to 30% in 2015 for TGK-1. EBITDA margin 15% 15% 17% Net Income margin 7% 5% 7%
TGK-1 is the only TGK with significant hydro TGK-1 generation capacity Operating margin 17% 11% 13% Hydropower plants (HPPs) contribute approximately 3Gw of TGK-1’s EBITDA margin 16% 18% 20% 6Gw. Hydro plants demonstrate significantly higher margins than the Net Income margin 13% 7% 8% combined heat and power plants (CHPs) operated by most TGKs, given the la ck of fuel costs coupled with the marginal pricing method used in Multiples 2011E 2012E 2013E the electricity market. HPPs also generate most of their electricity in the

second quarter, and do not experience the seasonal variation associated Mosenergo with CHPs, which produce most electricity in the “heating season” of the EV/EBITDA 3.7 3.0 2.7 fourth and first quarters. P/E 10.8 7.6 6.9 EV/IC 240 236 229
Mosenergo leads the sector in efficiency TGK-1 Mosenergo leads the generation segment not only in terms of installed EV/EBITDA 6.0 4.7 3.6 capacity, but also in terms of margin due to the high level of fuel P/E 10.4 7.6 4.9 efficiency. Mosener go also offers the best exposure to Moscow and the EV/IC 346 323 326 Moscow region, which are characterized stable economic growth. The Source: Company data, IFC Metropol estimates launch of new, even more fuel efficient plants combines with these factors to ensure significant free cash flow.

FOR PROFESSIONAL INVESTORS ONLY This report must be read with the disclaimer, disclosure and analyst certifications on the last page

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Table of Contents

Share price drivers...... 3 Business drivers and competitive advantages...... 4 Business Risks ...... 5 TGK segment overview...... 6 The Russian electricity and heat markets...... 9 Mosenergo: a champion among TGKs...... 14 TGK-1: Adding hydro generation to the mix ...... 19 Appendix ...... 33

19 September 2011 3

Share price drivers

We initiate coverage of Mosenergo with a fair value of RUB 3.79 (USD 0.124) per share, which offers 70% potential upside and TGK-1 with a fair value of RUB 0.026 (USD 0.00084) per share and 108% potential upside. We recommend both stocks as BUYs. Market valuations exaggerate probability of worst-case scenarios, in our view

Since the beginning of 2011, Mosenergo and TGK-1 have experienced deep corrections in their stock prices. Mosenergo has fallen by 31% YTD while TGK-1 is down 47% YTD. In comparison, the MICEX is down by 10% for the same period. In our view, there are three main reasons for the correction. First, in February the government announced its intention to cap electricity price increases for end users by 15% this year. However, in our view, the measures proposed to limit price growth to 15% will have a greater negative impact on grid companies than generators like Mosenergo and TGK-1. Second, Prime Minister Vladimir Putin proposed holding tariff increases for natural monopolies equal to the inflation rate in 2012-14. In our view, the market views this scenario as a base case. However, we believe the regulators will allow tariffs to increase faster than inflation from 2013 as the government wants utility companies to invest significantly in modernizing depreciated assets. Third, a special team of experts that the government tasked with finding methods to limit electricity price increases suggested changes to the electricity market model, the industry’s managing principles and the policy for establishing tariffs. Were these changes to be implemented, the most efficient generation companies could suffer more than other generating companies. However, these measures remain only suggestions for the moment. Were the measures to be implemented, we believe the negative impact on Mosenergo and TGK-1 would be outweighed by the companies’ competitive advantages. While it is reasonable for the market to incorporate the risks associated with future free cash flows into valuations, we believe the market’s perception of these risks is exaggerated. In our view, corrections offer investors the chance to buy into Mosenergo and TGK-1 in 2011 at attractive levels. Rising gas prices in 2012 will push up electricity prices, boosting margins for efficient generators

The government has said that gas prices for domestic industrial users in 2012 could be increased by 15% from July 1, 2012 or by an average of 7.1% over the full year. Most generating plants in the regions where TGK-1 and Mosenergo operate are gas-fired, so gas prices are one of the principal drivers for free market electricity prices in these regions. The marginal pricing mechanism used in Russia means that the most efficient generators are paid the same price as less efficient generators. While moderate gas price increases have no impact on inefficient generators, efficient generators like Mosenergo and TGK-1 should benefit, as higher gas prices should bring higher electricity prices, resulting in higher company margins. Mosenergo and TGK-1 are Russia’s most liquid generating companies and should benefit the most from recovery in the sector

Mosenergo is listed on the RTS and MICEX and is the leading TGK in terms of liquidity, followed by TGK-1. High liquidity should cause Mosenergo and TGK-1 to benefit more than other names once investor perception of risk decreases.

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Business drivers and competitive advantages

Mosenergo and TGK-1 benefit from urban locations

Most of Mosenergo’s generating assets are located in Moscow, while a significant portion TGK-1’s generating capacity is in Saint-Petersburg. The significant wealth, size and strong growth prospects for these two cities ensure that demand will continue to rise. Mosenergo and TGK-1 have efficient generating facilities

Fuel rate is a major indicator of generation efficiency. Mosenergo is the leading TGK in terms of fuel rate, using just 252 grams of fuel to produce 1 KWh of electricity. TGK-1 is also significantly more efficient than most TGKs, using 277 grams of fuel per KWh produced. The sector average is 321 g/KWh. As Gazprom Energoholding subsidiaries, Mosenergo and TGK-1 benefit from relatively strong corporate governance

Gazprom Energoholding holds a 53.5% stake in Mosenergo and 51.8% in TGK-1. The company demonstrates many examples of best practices in the generation sector, offering a high level of transparency and investor-friendly IR departments. Mosenergo and TGK-1 both publish quarterly IFRS financial statements and in 2010 approved dividend policies that imply payout ratios between 5% and 35%. We expect the companies to start paying significant dividends once their major investment projects are completed in 2013. We expect Mosenergo to demonstrate an EBITDA CAGR of 14% over 2011-2015, while TGK-1 should see a 23% CAGR

We expect adjusted EBITDA to increase at a CAGR of 12% for Mosenergo and 24% for TGK-1 over 2011-2015, mainly due to the expected impact from new facilities. For Mosenergo, we forecast EBITDA to rise from RUB 24.2bn in 2011 to RUB 42.9bn in 2015. EBITDA margin should increase from 15% to 17% over the period. For TGK-1, EBITDA should increase from RUB 12bn in 2011 to RUB 35.5 in 2015, with EBITDA margin growing from an estimated 18% in 2011 to 30% in 2015. TGK-1 is the only TGK with significant hydro generation capacity

Hydropower plants (HPPs) contribute approximately 3Gw TGK-1’s 6.3Gw capacity. Hydropower plants demonstrate significantly higher margins than the combined heat and power plants (CHPs) operated by most TGKs, given the lack of fuel costs coupled with the marginal pricing method used in the electricity market. HPPs also generate most of their electricity in the second quarter, and do not demonstrate the same seasonality factor associated with CHPs, which produce most electricity in the “heating season” of the fourth and first quarters. TGK-1’s chronically unprofitable Murmanskaya CHP subsidiary could see net income this year

TGK-1 holds a 90% stake in Murmanskaya CHP. Our estimates suggest that the chronically unprofitable plant could generate a net profit of RUB 83mn this year, compared to a net loss of RUB 450mn in 2010. The potential to move into the black comes on the back of a 14% y-o-y increase in the heat tariff coupled with new government grants and flat fuel expenses y-o-y.

19 September 2011 5

Business Risks Possible changes to the current market model could be detrimental to efficient generating companies Russia’s current market model for electricity and capacity was put into full operation only at the beginning of 2011. However, following rapid increases in electricity prices for end consumers, the government has already begun to consider changes in order to limit price growth. The market regulator is currently considering a number of possible changes to the existing electricity and capacity model, which could be amended as early as 2013. One of the most important measures would be to combine separate payments for electricity and capacity into a single payment, with prices based on direct agreements between electricity generators and consumers rather than the current marginal pricing mechanism. Although there is uncertainty regarding possible changes to the electricity and capacity markets, we believe the elimination of marginal pricing is likely to have the greatest negative impact on those generating companies benefitting from the current system; i.e. efficient, high-margin generators like Mosenergo and TGK-1. Main risks to production forecast include uncertainty regarding sector shift to CHPs, increasing energy efficiency and switch to integrated generation by major industrial customers With our forecast based on the existing market model, we see three main risks to our estimated production figures. First, heat production in Russia is currently shifting from boiler facilities to CHPs that produce heat and electricity simultaneously. This transfer results in increased electricity output and should be beneficial to TGKs. However, the uncertainty regarding the extent of this trend presents an upside risk to our valuation. Second, a number of industrial users are beginning to generate their own power through their own generating facilities instead of in order to cut costs. This could have a negative effect on TGKs over the medium term and render our valuation overly optimistic. Third, significant electricity price growth and the Energy Efficiency Law introduced in 2009 are likely to increase the pace at which energy-efficient technology is implemented in Russia. This could have a negative impact on TGKs, which could make our valuation overly optimistic. Rising heat transmission tariffs may depress margins in Mosenergo’s heat segment A quarter of Mosenergo’s operating expenses are attributable to heat transmission charges paid to MTK, a company controlled by the regional government. Both MTK’s heat transmission tariff and Mosenergo’s heat generation tariff are set by the regional regulator. Maintaining heat grids requires significant CAPEX given high depreciation, which suggests the possibility that transmission costs will increase faster than generation tariffs. This would decrease margins for Mosenergo’s heat segment. TGK-1’s signs new lower margin contract with Rusal TGK-1 has signed a contract, valid through 2015, to provide electricity to UC Rusal, which operates aluminum smelters in the North-West region. According to company representatives, the smelters consume 3.4bn kWh per year, or about 10% of TGK-1’s electricity output. The contracts are reportedly linked to aluminum spot prices on the LME, and do not include capacity payments. This suggests that margins on electricity delivered to Rusal will be lower than in pre-contract mode. Based on guidance from TGK-1 regarding contract prices, we estimate that the company could lose approximately 2% of estimated pre-contract 2011 EBITBA. Despite this potential loss, bilateral contracts between HPPs and large industrial plants benefit the parties involved. Industrial plants receive inexpensive electricity and HPPs benefit from predictable prices and demand for their electricity, with less risk from changes in market regulation. Strategic shareholder Gazprom Energoholding is considering a merger with KES Holding. The deal structure is currently uncertain. Gazprom Energoholding, the majority shareholder in TGK-1 and Mosenergo, is currently negotiating with KES Holding, the owner of four other TGKs, regarding a merger. Such a deal would create Russia’s largest utilities company in terms of installed heat and electricity capacity. However, the merger could create additional risks related to valuation and swap ratios following the deal structuring and possible consolidation of subsidiaries.

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TGK segment overview

Most TGKs use combined heat and electricity power plants

Russia’s fourteen TGKs’ primary power generation facilities are combined heat and electricity power plants (CHPs), which can produce heat and electricity simultaneously, or only electricity. TGKs also include heat transmission grids, with CHPs typically located close to consumers so that less heat is lost. Producing heat and electricity simultaneously allows CHPs to be more efficient than boiler facilities. During the winter months, TGKs benefit from increased electricity sales while customers enjoy lower prices. Mosenergo leads the sector in installed capacity with TGK-1 in third place in 2010

In terms of installed capacity, Mosenergo leads the Russian generation sector with 11.9 GW of installed capacity at the end of 2010. TGK-1’s installed capacity of 6.3GW ranks third among the 14 generating companies, behind Mosenergo and TGK-7. Figure 1: TGK installed capacity and mean value, MW 14,000

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0 TGK-3 TGK-7 TGK-1 TGK-12 TGK-4 TGK-10 TGK-9 TGK-6 TGK-13 TGK-5 TGK-2 TGK-11 TGK-14 Source: Company data Mosenergo is also the obvious leader in terms of heat capacity with 34.8mn Gkal/h at the end of 2010. TGK-1 is in fourth place, with 14.4mn Gkal/h of heat capacity, behind Mosenergo, TGK-7 and TGK-9. Figure 2: TGK installed heat capacity and mean value, Gkal/h

35,000

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0 TGK-3 TGK-7 TGK-9 TGK-1 TGK-4 TGK-10 TGK-6 TGK-2 TGK-12 TGK-5 TGK-11 TGK-13 TGK-14 Source: Company data TGKs in Central Russia are gas fired while Siberian plants use coal

Depending on the location, TGKs may use gas or coal for electricity production. TGKs in Central Russia, such as Mosenergo and TGK-1, tend to use natural gas so their fuel costs are closely linked to the gas price. TGKs in Siberia tend to use thermal coal, which is a less efficient fuel source and for which prices are more volatile. Heating oil is used by all generation companies during peak demand periods, but is less cost-efficient than other types of fuel.

19 September 2011 7

Capacity utilization is the principal indicator of efficiency

The installed capacity utilization factor (ICUF) is the principal indicator of a generator’s efficiency, as its shows output relative to installed capacity. The higher the ICUF, the more efficiently a plant is producing electricity. ICUF is primarily influenced by the demand for electricity combined with the fuel rate. The fuel rate indicates how much fuel a generator needs to produce each KW of electricity, and depends primarily on the level of production technology being used. Modern, as opposed to highly depreciated, production facilities show lower fuel rates. Figure 3: TGK installed capacity utilization factors and mean value, % 80 70

60 50 40 30

20 10 0 TGK-10 TGK-3 TGK-12 TGK-13 TGK-9 TGK-11 TGK-1 TGK-5 TGK-14 TGK-6 TGK-7 TGK-2 TGK-4 Source: Company data Mosenergo is a leader in efficiency

Mosenergo demonstrates the lowest fuel rate in the sector, using 252 grams of fuel per KWh of electricity compared to the sector average of 321 g/KWh in 2010. The company occupies second place in terms of the capacity utilization factor, demonstrating a figure of 62% compared to 73% at TGK-10 in 2010. The sector average is 52%. Figure 4: TGK fuel rates and mean value, g/KWh

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200 TGK-3 TGK-5 TGK-7 TGK-6 TGK-1 TGK-9 TGK-10 TGK-13 TGK-4 TGK-2 TGK-11 TGK-12 TGK-14 Source: Company data Weather conditions, capacity replacement and demand influence production and consumption

Seasonal weather conditions have a strong impact on both the production and consumption of electricity in Russia. Obviously, demand for heat increases dramatically in winter and CHPs operate in the more efficient heating mode. Precipitation also affects water flow, which impacts the load factor for hydro-power plants (HPPs). Dispatchers load HPPs ahead of fuel-based generators because they are more efficient in terms of variable costs. This is a competitive advantage for TGK-1, which unlike other TGKs has significant hydroelectric assets. Electricity output is also affected by renovation work on generating assets and the construction of new generating units, which are often equipped with more advanced and fuel efficient technology As well as seasonal factors, electricity consumption can also be driven by increased demand from household and industrial users. Therefore, changes in electricity consumption tend to be closely linked to the business cycle.

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Electricity consumption is strongly correlated with GDP

Increasing business activity means that industrial users consume more electricity to boost production. Meanwhile, increasing household income means that consumers have more money to buy appliances and other devices that use electricity. Consequently, it is not surprising that there is a strong correlation between electricity consumption and GDP. We forecast GDP to grow by 5.3% on average over 2011-15. Figure 5: GDP and electricity consumption

Change in electricity consumption, y-o-y (rhs) Change in GDP, y-o-y (rhs) Elasticity of electricity consumption growth vs GDP growth (lhs) 12% 1.3 10.0% 10% 8.1% 7.3% 7.2% 7.7% 8% 6.4% 0.8 5.1% 5.6% 6% 4.7% 4.2% 4.4% 3.8% 4.0% 4.0% 4% 2.8% 2.4% 1.8% 2.3% 1.9% 0.3 1.4% 0.9% 2% 0.3% 0% -0.2 -2% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1Q 2011 -4% -6% -4.6% -0.7 -8% -7.8% -10% -1.2 Source: SO UES, Rosstat Mosenergo and TGK-1 led in electricity and heat output in 2010

Mosenergo was the leader among TGKs in terms of heat and electricity production in 2010, generating 65bn KWh of electricity and almost 70mn GKal of heat. TGK-1 took second place in electricity production, generating 27.1bn KWh of electricity. TGK-1 generated 28.8mn GKal of heat in 2010 and ranked fourth among TGKs. Figure 6: TGK electricity and heat production in 2010

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0 TGK-3 TGK-1 TGK-12 TGK-7 TGK-10 TGK-9 TGK-13 TGK-6 TGK-4 TGK-5 TGK-11 TGK-2 TGK-14 Source: Company data

19 September 2011 9

The Russian electricity and heat markets

TGK-owned plants are part of a unified energy system

There are two types of power stations in Russia. TGK’s own unified energy system power stations, which are managed by a centralized dispatcher and connected to the national electricity grid. These power stations must conform to specific technological requirements established by the regulator and they are generally obligated to sell electricity at prices set by the wholesale electricity and capacity market. Industrial power stations are owned by private businesses in order to meet their requirements for significant amounts of electricity. Industrial power stations are not connected to the national grid, and are not subject to the same regulations as the unified energy system power stations owned by TGKs. The Russian electricity market applies marginal pricing

The Russian electricity market is based on marginal pricing. In a marginal pricing environment, the market regulator estimates the next day’s electricity requirements in a given area and an auction is then held at which electricity generators state at what price they can produce electricity to meet the next day’s total demand. The regulator then selects electricity generators to provide the next day’s electricity; first purchasing electricity from the companies that offer the lowest prices. Once these companies’ supplies have been exhausted, the next cheapest supplier is chosen. This process continues until the full measure of demand has been met. The price paid to the last and most expensive generator tapped to meet the next day’s requirement is established as the price paid to all companies supplying electricity for the following day. More efficient generators that can produce electricity at a lower cost are paid the same price for their electricity as less efficient generators, and the difference between their price and the marginal price is profit. Therefore, the marginal pricing method obviously benefits efficient producers and encourages generators to upgrade their facilities to achieve maximum efficiency. Electricity generators are paid for both electricity and capacity

Russian generators are paid for electricity and capacity. Electricity payments are based on the generator’s variable costs and the amount of electricity produced by the company that is consumed. Capacity payments are based on the generator’s fixed costs and the volume of generation capacity provided per month. Capacity payments encourage companies to maintain sufficient capacity to supply electricity peak times

The level of electricity consumption depends on the time of day and the month of the year. There are peak times when significant generation capacity is necessary to meet demand. At non-peak times, much of this capacity is unused. Capacity payments are designed to cover the costs of maintaining facilities that provide the additional capacity necessary during peak periods. Capacity payments lower consumer prices for peak period electricity

Were electricity prices solely based on production costs, prices during peak periods would be very high. Separate payments for capacity cover some of the costs generators incur to produce electricity during peak periods, thus holding consumer prices to more reasonable levels during peak periods. Industrial and retail customers pay different prices

Prices for electricity and capacity differ for industrial and household consumers. Generators receive a percentage of their electricity and capacity payments for industrial consumers and a percentage for household consumers, as calculated by the regulator.

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Prices for household users are based on tariffs intended to cover costs

Household electricity and capacity prices are based on tariffs established annually for each individual power plant by the Federal Tariff Service. The methodology used to set electricity tariffs is mainly based on variable costs, such as the price of fuel in the case of the electricity tariff. If a plant’s costs over the year those estimated in setting the tariff, a generator can request compensation from the regulator. Generators are incentivized to build new facilities

Russia’s current electricity market model does not allow generation companies to achieve an attractive return on potential investments. Special agreements, called capacity delivery contracts (Russian abbreviation: DPM), are designed to encourage the construction of new facilities. Capacity delivery contracts often require a generator to build a generating facility in a particular location, within an established timeframe, and according to certain technological specifications. For its part, the regulator offers the company a guaranteed cash flow from the new facility in the form of capacity payments over a ten-year period. These capacity payments are established according to an approved methodology, and are designed to be high enough so that the combination of capacity payments and marginal profits from the electricity generated by the new plant will result in a specified internal rate of return (IRR). Generators sell electricity through direct agreements or on the spot market

There are three ways for Russian electricity generators to sell electricity to industrial customers. The first two are spot-markets: the day-ahead market and the balancing market. The third method involves signing direct agreements between generators and industrial customers. Free-market electricity prices are usually set via day-ahead auctions

In day-ahead auctions, the market regulator states how much electricity will be required the next day. Non-fuel generators, such as nuclear and hydro power plants (HPPs), state how much of this demand they will be able to meet. Generators operating fuel-efficient combined electricity and heat plants (CHPs), which simultaneously produce electricity and heat. Generators operating electricity-only plants then state the price for the volume of electricity they can provide for the next day. The least-expensive bid that satisfies the electricity demand is accepted by the regulator, and this bid becomes the next day’s marginal price for all generators supplying electricity on that day. Non-fuel generators such as HPPs and CHPs simultaneously producing heat and power do not provide price per volume bids, just the volume they can supply, because their variable cost will always be below the marginal price or they will have to produce heat. Figure 7: Pricing process on the day-ahead market

Source: Market Council

19 September 2011 11

The balancing market sets prices for unplanned deviations between supply and demand

The balancing market regulates supply and demand deviations from the plan outlined in the day-ahead market within a day and assumes real-time trading. Pricing principles are generally the same as for day-ahead market. Direct capacity agreement prices are not regulated

Occasionally generators sign contracts to supply power directly to major consumers. Prices under these agreements are negotiated between the supplier and the customer, and are not regulated. Instead, electricity prices in direct agreements are often linked to commodity prices and include floor and ceiling values. These contracts also usually contain some kind of capacity payment. Short- and long-term capacity auctions are held once a year

Generators sell capacity at capacity auctions (Russian abbreviation – KOM), which take place once a year. There two types of capacity auctions, short-term and long-term. Short-term capacity auctions are used to balance short-term supply and demand and are held one year before capacity will be needed. This gives generators enough time to bring mothballed facilities online to supply the required capacity. Long-term capacity auctions are held four years before the capacity will be required. This gives generators time to build new facilities to supply the electricity, and determine whether the construction of such facilities would offer a sufficient return on investment. Figure 8: Schedule for capacity auctions

Source: Market Council Capacity auctions use marginal pricing

The first capacity auction based on the current rules was held in November 2010. Like the electricity market, capacity auctions use a marginal pricing mechanism to set prices. The Russian wholesale electricity market is divided into 29 zones. Two of the 29 zones are described as “free price zones” and generators in these zones receive RUB 123,000 per Mw/month for capacity. The other 27 zones are called “price-cap zones”. In these zones, generators in European Russia receive RUB 118,125 per mw/month for capacity, while Siberian generators receive RUB 126,370 per mw/month.

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The most expensive generators are excluded from the auction system to help limit prices

In order to limit capacity prices, the market regulator excluded the most expensive 15% of generating facilities in Central Russia from that region’s free-price zone. Such facilities are called “expensive generators”. Figure 9: Capacity auction price setting within free price zones

Source: Market Council The most expensive 10% of generators in the Siberian cap-price zone and 15% in the European and Urals cap-price zone are described as operating in “forced mode”. These generating units tend to be highly inefficient, but their continued use maintains the stability of the overall system. Figure 10: Capacity auction price setting within price cap areas

Source: Market Council Pricing for expensive facilities encourages generators to decommission inefficient units over the medium term

Generators operating “forced mode” facilities may chose between one of two pricing options: either sell electricity on the free market without capacity payments or sell at tariffs both electricity and capacity. There is minimal difference in the bids made by “expensive generators” during capacity auctions in free price zones and the capacity payments that they receive as part of regulator-established tariffs. At the same time, all electricity produced by these generators is sold at the free market price.

19 September 2011 13

The share of the facilities of the two groups in the total share of facilities which are paid by the consumers at the capacity auction is close to 20% of total output. As a result, capacity auction perceived as a kind of new form of tariff regulation. Figure 11: Result of capacity auctions for 2011

KOM free prices

KOM with price cap

Forced mode

Expensive generators

Source: Moscow energy exchange The current market model may be changed in 2013 to direct contracts between generators and consumers

The existing electricity and capacity market model was fully in place at the beginning of 2011. However, 2012 is an election year, which has forced the government to find ways to limit the rapid growth in electricity prices for end users. The market regulator is currently considering a number of possible changes to the existing electricity and capacity model, which could be replaced as early as 2013. One of the most important possible changes is combining separate electricity and capacity payments into a single payment, with prices based on direct agreements between electricity generators and consumers rather than the current marginal pricing mechanism. We believe the elimination of marginal pricing is likely to have the greatest negative impact on the efficient, high margin generators, which benefit the most from the current system. Heat contributes 40-60% of total TGK revenue, but high costs make heat generation unprofitable

Heat production contributes between 40% and 60% of total revenue for TGKs. Tariffs for heat are set annually for each generator by regional energy commissions (REC). Household customers are the main consumers of heat. Regional governments therefore encourage RECs keep heat tariffs as low as possible in order to win the support of voters. Combined with the high cost of heat generation, artificially low tariffs generally make heat generation unprofitable for TGKs. TGKs subsidize the unprofitable heat business from electricity revenues

TGKs operating combined heat and electricity generating plants often use electricity segment revenues to cover heat segment losses. Some TGKs, including TGK-1, are attempting to solve the problem of “cross-subsidization” by transferring heat transmission segments into separate subsidiaries, in the hope that this will lead RECs to increase heat transmission tariffs to more realistic levels.

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Mosenergo: a champion among TGKs

Mosenergo has the greatest electricity and heat capacity in the sector

Mosenergo is the largest of Russia’s TGKs in terms of installed electricity and heat capacity. The company operated 15 power stations with 11.9Gw of installed electricity capacity and 34.9 th Gkal/h of installed heat capacity at the end of 2010. Ninety-eight percent of the generating facilities are gas-fired. Mosenergo is the major electricity supplier to Moscow and the surrounding region

Mosenergo’s assets are located in Moscow and the Moscow region. The company meets 67% of the demand in the area it serves, while 18% is provided by other producers and 15% transmitted from surrounding regions. Mosenergo’s main competitors are OGK-1, OGK-4 and RusHydro

Among Mosenergo’s main competitors are several regional power stations (GRES) in the Moscow region: the Kashirskaya GRES (1.9Gw), controlled by OGK-1, and the Shaturskaya GRES (1.4Gw), controlled by OGK-4. The Zagorskaya pumped-storage hydroelectric power station (1.2Gw), controlled by RusHydro, also makes a sizable contribution to Moscow’s electricity supply, by providing power during peak demand periods. We expect competition to increase over the medium term as companies invest in additional generating capacity and greater efficiency. Less-efficient MOEK is Mosenergo’s principal competitor in the heat segment

Mosenergo controls 70% of the heat market in Moscow and 43% of the market in the Moscow region. Mosenergo’s main competitor in this market is the Moscow Joint Energy Company (MOEK), which is controlled by the Moscow government. In contrast to the combined heat and power plants (CHPs) Mosenergo uses, MOEK mainly operates heat- only boiler facilities, which are less efficient than CHPs. Mosenergo’s investment program should increase installed capacity by 25%

Mosenergo is currently undertaking a significant investment program with approval of the regulator. The company’s installed capacity is due to increase by 25% with an additional 2.9Gw of new capacity bringing the total to 13.5Gw by the end of 2014. The installed capacity utilization factor of the new capacity is expected to reach 70%, compared to an average ICUF of 62% in 2010. Mosenergo already produced 12.4% of total output at the new facilities in 2010. Figure 12: Construction timetable, Mw

Power station 2007 2008 2009 2010 2011E 2012E 2013E 2014E

TEC-27 450 450 TEC-21 425 GTU-TEC 16 TEC-26 420 TEC-9 61.5 TEC-12 220 TEC-16 420 TEC-20 420 New facilities 450 1325 1341 1341 1761 1822,5 2462,5 2882,5 Total installed capacity 11,117 11,904 11,924 11,924 12,344 12,406 13,046 13,466 at the end of the year Source: Company data, IFC Metropol estimates

19 September 2011 15

Mosenergo’s production growth outpaced increasing demand in the region

In 2010, Mosenergo increased electricity production by 5.2% to 65 TWh, outpacing growth in electricity consumption in the region by 1.7ppts. This increase resulted from production growth at new facilities coupled with favorable weather conditions. Figure 13: Electricity production dynamics Electricity production, TWh Growth, %

66 6.0% 5.2% 65 4.0%

64 2.0% 0.9% 63 0.0% -1.1% 62 -2.0%

61 -3.9% -4.0%

60 -6.0% 2007 2008 2009 2010 Source: Company data, IFC Metropol estimates The heat segment saw strong results in 2010 due to the shift from boiler facilities to CHPs and the cold winter

Heat production rose by 6.8% in 2010 to 69.9 mn Gcal, exceeding heat consumption growth in the region of operations by 2.5ppts. Results were strong due to cold weather during the heating season and the shift in heat production from boiler facilities to Mosenergo’s more efficient CHPs. Figure 14: Heat production dynamics

Heat production, mn Gcal Growth, %

72 8.0% 6.8% 70 6.0% 4.8% 4.0% 68 2.0% 66 0.0% 64 -2.0% 62 -4.0% -4.8% 60 -6.6% -6.0% 58 -8.0% 2007 2008 2009 2010 Source: company data, IFC Metropol estimates Gazprom Energoholding holds a majority stake in Mosenergo and should support improved corporate governance practices

Gazprom Energoholding (GEH), Gazprom’s power utilities division, holds a 53.5% stake in Mosenergo, while the Moscow government holds a 26.4% stake. According to our estimates, the free float stands at 15%. We believe GEH maintains the best practices in the Russian TGK sector in terms of corporate governance. Both Mosenergo and TGK-1, another GEH subsidiary, publish quarterly IFRS financial statements and have investor-friendly IR departments. Gazprom Energoholding management’s also regularly holds meetings with the investment community.

16

Mosenergo and TGK-1 have an attractive dividend policy relative to the sector

In 2010, Mosenergo and TGK-1 approved dividend policies with an implied payout ratio of 5-35% following the formation of reserve funds, which represent 5% of the charter capital. We expect sizable dividends from the companies starting in 2014, when all major investment projects are due to be completed and the companies should see significant cash flow. Mosenergo is the most liquid TGK stock

Mosenergo leads the TGK sector in terms of liquidity. The company is included in the RTS Index with a weight of 0.28% and the RTS Power index with a weight of 3.85%. Mosenergo is also included in the MICEX Index with a weight of 0.3% and the MICEX Power Index with a weight of 4.65%. Heat transmission is Mosenergo’s Achilles' heel

TGKs usually control the majority of heat transmission grids within their areas of operation. The Moscow region is an exception. Mosenergo controls only a portion of the heat grid system, or 525km, due to the unusual reorganization of Moscow’s utilities system. The other 2,278km of heat transmission grids in the city are controlled by the Moscow Heat Transmission Company (MTK), which is indirectly controlled by the Moscow government. The Moscow government is also a major shareholder in MOEK. This link could mean that MOEK is given priority by dispatchers, with a negative impact on Mosenergo’s market share. In our view, the current situation has a negative affect on Mosenergo’s business. However, over the medium term the situation may become more favorable to the company. Mosenergo filed a successful complaint with the antimonopoly service regarding switching consumers from Mosenergo to MOEK. Since coming to office, Moscow Mayor Sergei Sobyanin has suggested several ways to resolve the situation, as has Gazprom Energoholding CEO Denis Fedorov. In our view, the issue is likely to be resolved in the near future, which could act as a positive trigger for Mosenergo’s stock price. Mosenergo sells only 12% of electricity by tariffs

Only 12% of Mosenergo’s total electricity output was sold to households at prices controlled by government tariffs in 1Q 11. As for capacity, tariffs were implemented for 19% of available capacity, with the remaining 81.2% sold through marginal pricing auctions and capacity supply agreements. Figure 15: Pricing segments for Mosenergo electricity total output in 1Q 11

3% 12% Day-ahead market

Regulated segment

Balancing market

85% Source: Company data, IFC Metropol estimates

19 September 2011 17

Since 2009, revenue per KWh the company produces has increased, both in terms of electricity and capacity. The main driver for the increase in revenue per KWh of electricity was the liberalization of the electricity market and marginal price growth. For capacity, capacity supply agreements had a significant impact on revenue per KWh growth, as did the completion of reform in the capacity market. Figure 16: Revenue per KWh of electricity and capacity

Capacity (RUB Mw/M) Electricity (RUB Mw/h) 1000 974 205,000 900

195,000 797 191,045 800 700 185,000 588 177,684 600 175,000 500 165,776 400 165,000 300 155,000 200 2009 2010 1Q 11 Source: Company data, IFC Metropol estimates The heat tariffs for the company for Moscow and Moscow region represent in the figure below and partially reflect the companies’ spending for fuel. Figure 17: Heat tariffs for Mosenergo, RUB/Gcal

Moscow Moscow region 1200

1079 1100

1000 918 900 859

800 748 760

700 650

600 2009 2010 2011 Source: Company data, IFC Metropol estimates Fuel costs have represented more than half of total costs since 2010. Transmission costs, which Mosenergo pays for the use of MTK’s heat grids, substantially outpaced the average growth in costs for the period and reached almost a quarter of the company’s total costs. However, the company has no control over these costs as the tariffs for the services are set by the regulator.

18

Nonetheless, the company has made efforts to cut other costs, reducing headcount costs from 8% of total costs in 2009 to 5% in 1H 11. Other controllable cost items have also declined. Figure 18: Mosenergo operating cost breakdown, %

Fuel Transport Depreciation Staff Others

100% 15% 14% 90% 18% 5% 80% 7% 8% 8% 9% 70% 11% 20% 60% 18% 16% 50%

40%

30% 54% 46% 51% 20%

10%

0% 2009 2010 1H 11 Source: Company data, IFC Metropol estimates

19 September 2011 19

TGK-1: Adding hydro generation to the mix

TGK-1 operates in Russia’s “Second Capital”

TGK-1 is third among Russian TGKs in terms of installed power generation capacity and fourth in terms of heat capacity. The company operated 56 power stations with 6.3 Gw of installed electricity capacity and 14.3 th Gcal/h of installed heat capacity at the end of 2010. The company operates primarily gas-fired facilities, with gas at 95% of the fuel balance. TGK-1 is the only TGK with significant hydro generation capacity

TGK-1 operates 41 hydro power plants (HPPs), which contribute approximately 3Gw to the company’s 6.3Gw capacity at the end of 2010. Hydro production differs from combined heat and power plants (CHPs) in several ways: • HPPs do not produce heat • water conditions influence output • HPPs do not require fuel to generate electricity, and thus their bids do not affect prices on the electricity spot market. Hydro facilities smooth seasonality factors

CHPs usually generate a significant portion of electricity during heating season, the first and fourth quarters when facilities produce heat and electricity simultaneously. HPPs produce more electricity in the second quarter and smooth revenue over the year. The regional electricity market is highly competitive

TGK-1’s generation assets are located in Saint-Petersburg and the Leningrad region (Nevsky unit), the Murmansk region (Kola unit) and the Republic of Karelia (Karelian unit). Main competitors include Nord-West CHP (0.9Gw), operated by Inter RAO, Kirishskaya GRES (2.1Gw) controlled by OGK-6, the Leningradskaya nuclear power plant (NPP) - 4Gw, and Kolskaya NPP (1.8Gw) controlled by Rosenergoatom. Figure 19: TGK-1 capacity breakdown in terms of installed capacity

31% Nevsky

Karelian

Kola 54% 15%

Source: company data, IFC Metropol estimates Rival investment projects should see TGK-1 lose market share

TGK-1’s investment program should add an additional 0.9Gw to installed capacity. However, other companies in the region also plan a number of investment projects. OGK-6 plans to modernize a generating unit at Kirishskaya GRES and add 0.5Gw of additional capacity. Rosenergoatom is building the Lenengradskaya NPP – 2 (1.2Gw) to partially replace facilities from Lenengradskaya NPP. RusHydro is also planning to complete the Leningradskaya pumped-storage hydro station (1.6Gw) by 2020. Despite the fact that some announced projects may be commissioned later then expected, we anticipate that TGK-1 will ultimately lose some market share in the region.

20

TGK-1 controls half of the heat market in Saint Petersburg and the Leningrad region

TGK-1 controls 55% of the Saint Petersburg heat market and 43% in the Leningrad region. TGK-1’s principal competitors in the segment are the boiler facilities operated by local governments. The combined generation technologies used by TGK-1 are more cost effective than the technology used by boiler facilities. Restructuring the heat segment should increase profitability

To increase efficiency in its heat business, TGK-1 is restructuring its heat transmission business and has created a joint company with a municipal enterprise. TGK-1 contributed heat transmission grids and received a 75% stake in the joint company, while the state company contributed distribution grids and boiler facilities and received a 25% stake. The target structure will operate 2.4 th km grids. TGK-1’s investment program targets a 16% increase in installed capacity by 2016

The regulator approved an investment program that will include construction of 2.1Gw of new capacity and decommission 0.4Gw. As a result, installed capacity should increase by 16% to reach 7.2 Gw at the end of 2015. The new capacity will be significantly more efficient in terms of fuel use and environmental impact. Figure 20: Construction timetable, Gw

Power station 2010 2011E 2012E 2013E 2014E 2015E

Pravoberegnaja CHP 450 Yujnaya CHP 450 Pervomajskaya CHP 180 180 Lesogorskaya HPP 30 30 30 Svetogorskaya HPP 30 30 30 Centralnaya CHP 220 100 New installed capacity 355 1,045 1,735 1,985 1,985 2,085 Total installed capacity 6,278 6,846 7,332 7,217 7,217 7,243 at the end of the year Source: Company data, IFC Metropol estimates TGK-1 output lagged regional consumption growth

In 2010, electricity output increased by 1.5% to 27.2 Twh, falling behind consumption growth in the region by 4.3ppts. The lag was based primarily on weak water conditions. The 7.4% drop in production by HPPs was offset by an 11% increase in production at CHPs. Figure 21: TGK-1 electricity production dynamics

Electricity production, TWh Growth, %

27.4 16.0% 15.1% 27.2 14.0% 12.0% 27.0 10.0% 26.8 8.0% 26.6 6.0%

26.4 4.0% 1.9% 2.0% 26.2 1.5% 0.0% 26.0 -1.5% -2.0% 25.8 -4.0% 2007 2008 2009 2010 Source: Company data, IFC Metropol estimates

19 September 2011 21

Heat production rose by 7.1% in 2010 to 28.8 mn Gcal, boosted by extremely cold temperatures. Figure 22: TGK-1 heat production dynamics

Heat production, mn Gcal Growth, % 29.5 20.0% 29 17.6% 18.0% 28.5 16.0% 28 14.0% 12.0% 27.5 10.0% 27 8.0% 26.5 7.1% 6.0% 26 4.0% 3.2% 25.5 2.0% 25 0.0% 0.0% 24.5 -2.0% 2007 2008 2009 2010 Source: Company data, IFC Metropol estimates TGK-1 exported about 4% of 2010 total HPP output to Norway and Finland based on one-year contracts with Fortum, a major Finnish utility company. As we can see from the figure below, export volumes are quite volatile and depend on price dynamics in the buyers’ markets. Dispatch schedules and limitations in transmission grids also impact exports. Figure 23: TGK-1 electricity export dynamics

Electricity output Export revenue 1,400 50.0% 44.8% 1,200 40.0%

1,000 30.0%

800 20.0%

600 10.0%

400 1.2% 0.0%

200 -10.0% -10.5% -12.9% 0 -20.0% 2007 2008 2009 2010 Source: Company data, IFC Metropol estimates TGK-1 enjoys strong corporate governance

Gazprom Energoholding (GEH), Gazprom’s power utilities division, holds a 51.8% stake in TGK-1, while Fortum Power and Heat only holds a 25.7% stake. We estimate the free float at 20%. As in the case with Mosenergo, TGK-1 publishes IFRS financial statements quarterly, has a strong IR department and a transparent dividend policy. Three of eleven members of the board represent Fortum. TGK-1 is extremely liquid compared to other TGKs

In terms of liquidity, TGK-1 remains behind Mosenergo but is significantly more liquid than other TGKs. Unlike Mosenergo, the company is not included in main indexes but is a component of the MICEX Power Index with a weight of 3.13%.

22

TGK-1 sells only 14% of electricity to households

TGK-1 sells electricity via more channels than most TGKs, and sells power for export. Following liberalization of the market, the target structure was achieved in early 2011. Only 14% of TGK-1’s total output was sold to households at prices set according to government tariffs in 1Q 11. Figure 24: Pricing segments for TGK-1 electricity total output in 1Q 11

2.1% 3.7% 8.2% Day-ahead market Regulated 13.5% segment Balancing market Export

72.5% Retail

Source: Company data, IFC Metropol estimates The current structure of the capacity market was fully in place by the start of 2011. More than a quarter of capacity is sold on the basis of regulated to retail customers and about 20% is sold as forced mode capacity, which also includes a special tariff setting process. DPMs are responsible for 3.5% of total capacity sales and significantly increased in 2011 as new generating capacity was commissioned. Forty-nine percent of capacity is allocated for competitive capacity auctions. Figure 25: Pricing segments for capacity in 1Q 11

26.6% Regulated segment

DPM

49.1% Forced mode 3.5%

KOM

20.7%

Source: Company data, IFC Metropol estimates

19 September 2011 23

As with Mosenergo, TGK-1’s revenue per KWh has increased both in terms of electricity and capacity since 2009. The main driver for the increase in revenue per KWh of electricity was the liberalization of the electricity market and marginal price growth. For capacity, direct agreements had a significant impact on revenue per KWh growth. Figure 26: Revenue for each unit of electricity and capacity produced has increased since 2009

Capacity (RUB Mw/M) Electricity (RUB Mw/h)

180,000 173,662 1000 936 900

155,000 800

717 700

130,000 600

510 109,349 500 105,000 400 92,773 300

80,000 200 2009 2010 1Q 11 Source: Company data, IFC Metropol estimates Heat tariffs for company plants are represented in the figure below and partially reflect fuel expenditures Figure 27: Heat tariffs, RUB/Gcal

Nevskiy branch Karelskiy branch Kolskiy branch 1000 927

900 850 852

777 800 750

700 646 602 600 523 500 473

400 2009 2010 2011 Source: Company data, IFC Metropol estimates

24

Fuel costs remain the main substantial expense despite the significant hydro capacity and are responsible for about a half of total operating costs. Electricity purchase expenses continue to be volatile, reflecting not only electricity purchases for TGK-1’s own needs and resale, but also for export operations depending on the factors described above. At the same time, the company has made significant cost-cutting efforts. Headcount expenses fell from 14% of costs in 2009 to 12% in 1H 11. Figure 28: Operating cost breakdown, %

Fuel Staff Electricity purchase Depreciation Others 100% 14% 90% 22% 20% 8% 80% 7% 8% 70% 14% 13% 18% 60% 12%

50% 14% 11%

40% 52% 43% 44% 30% 2009 2010 1H 11 Source: Company data, IFC Metropol estimates Chronically unprofitable, Murmanskaya CHP is a burden for TGK- 1…

TGK-1 holds a 90% stake in Murmanskaya CHP, which operates as a subsidiary of TGK-1. The subsidiary’s capacity is 12Mw, which is used as part of its heat production process and heat capacity is 1.1 th Gcal/h, or 8% of TGK-1’s aggregate heat capacity. The station has a 75% share of the Murmansk heat market. The plant was built in 1934 and uses heating oil for heat production. The policy in place for setting tariffs, combined with the age of the plants, makes profitable heat production a challenge. …but Murmanskaya CHP may see a profit in 2011

Murmanskaya CHP’s net loss increased from RUB 54mn in 2009 to RUB 450mn in 2010 following delays in the distribution of anticipated government grants. However, TGK-1 representatives do not expect heating oil prices to rise in 2011, while the heat tariff has risen by 14% y-o-y at the beginning of 2011. Moreover, the company received RUB 328bn in government grants as of July, and may receive about RUB 672mn in the second half of the year. As a result, TGK-1 guided Murmanskaya CHP’s estimated 2011 net income at RUB 83mn. The disposal of the subsidiary is a viable scenario, in our view

Gazprom Energoholding planned to decommission Murmanskaya CHP, but the system operator, the Russian electricity system technological regulator, refused the request. Decommissioning is not likely to take place for at least three years. In the meantime, TGK-1’s board gave approval to set up the Kolsk Heat Company as a Murmanskaya CHP subsidiary. This is expected to optimize the process for setting tariffs for the assets. TGK-1 signs supply contract with Rusal

UC Rusal, which operates three aluminum smelters in the North-West region, signed a contract with TGK-1 to supply power until 2015. The smelters consume 3.4 bn KWh per year, or about 10% of TGK-1’s output. The pricing has not been disclosed, but the contracts are linked to aluminum spot prices on the LME, have marginal floor and ceiling prices, and do not include capacity payments. TGK-1 will not receive capacity payments under the contracts

According to TGK-1 representatives, given favorable aluminum prices on the LME, contract prices for electricity exceed spot prices for electricity on the day-ahead market. In our model, we exclude payments for 280 Mw of capacity from respective HPPs and use our electricity price forecast for the day-ahead market.

19 September 2011 25

Despite a potential 2% loss in EBITDA from the contracts, the agreements are the lesser evil compared to the loss of a major customer

Based on the contract, TGK-1 could lose RUB 325mn, or 2% of 2011E EBITDA if TGK- 1’s HPPs sold electricity at pre-contract prices. However, the direct agreements with Rusal are beneficial for TGK-1, as it receives predictable prices and demand for its electricity, and decreases potential risks from changes in market regulation. RusHydro may cast an acquisitive eye on TGK-1 hydro assets

An additional risk for TGK-1 is the possibility that RusHydro may attempt to acquire its hydro assets. The hydro facilities were responsible for 45% of installed capacity and 48% of electricity output in 2010, and the value of hydro capacities constitutes a significant portion of the company’s market value. For heat generation in Russia, EV/Installed Capacity is USD 215 per kW and EV/generation is USD 47 per MWh, while the figures for RusHydro are USD 467 per kW and USD 147 per MWh respectively. We do not see the risk of acquisition as material at this stage.

26

Financial forecast and valuation Electricity price is based on the marginal producer and the price of fuel

As previously mentioned, the electricity market price is set by the marginal producer. Three principal variables impact the choice of marginal producer, including weather conditions, technical parameters and GDP dynamics. Natural factors, such as outside air temperature and water flow, are unpredictable. Technological factors include the replacement of less fuel-efficient generating units with more efficient capacity as well as eliminating electricity transmission bottlenecks. Change in demand on one hand is a function of production growth by industrial users and increased demand from household customers and, on the other hand, the implementation of energy-efficient technologies. Since the marginal producers in the free-flow zones, where Mosenergo and TGK-1 operate, are usually gas-fired plants and the market price for electricity is driven by domestic gas price. To forecast electricity prices we use forecast of Energy Forecasting Agency, adjusted for our forecast of fuel prices

The Energy Forecasting Agency forecasts Russian electricity prices in each electricity free-flow zone on an annual basis. These forecasts consider technological improvements and changes in demand and fuel prices. For our estimates we use the fuel price forecast by our oil&gas analysts and the government’s macro forecast, but for demand changes and technological improvements we rely on Energy Forecasting Agency figures for our forecast. Figure 29: Electricity prices and its growth forecast for Mosenergo and TGK-1

Mosenergo price, RUB/MWh TGK-1 price, RUB/MWh Mosenergo price' s growth TGK-1 price's growth 1,600 18.0% 1,438 1,400 1,341 16.0% 1,241 1,187 1,160 14.0% 1,200 1,043 1,029 12.0% 974 1,000 905 849 10.0% 800 8.0%

600 6.0%

400 4.0% 2011E 2012E 2013E 2014E 2015E Source: Energy Forecasting Agency, IFC Metropol estimates We adjust the electricity tariff for Mosenergo and TGK-1 to the domestic gas price growth to make the forecast on a per power station basis. To forecast changes in capacity prices we adjusted KOM prices and tariffs to inflation

We calculate three types of prices for capacity: marginal prices, tariff prices and capacity supply agreement prices. To forecast marginal prices and tariff prices we adjust approved levels for 2011 by anticipated inflation on a per power station basis for the whole forecasting period. The only exception is 2012 because of the government decision to cap electricity price growth in that year. We use sector methodology to calculate DPM-prices

To forecast capacity supply agreement prices we use the currently approved prices for the power units, and adjusted them in accordance with the methodology the regulator uses to forecast annual prices. For new power units that are due to be build according to capacity supply agreements we calculate the prices based on the regulator’s methodology, and company guidance in the case of TGK-1.

19 September 2011 27

Our heat tariff forecast is based on the Economy Ministry’s forecast and fuel growth rate

To calculate future heat tariffs we use the government macro forecast, which includes expected price growth for 2012-14. For 2015 onward, we adjust heat prices to our oil&gas team estimates for domestic gas price growth. Figure 30: Heat tariff growth forecast for Mosenergo and TGK-1

Mosenergo tariff, RUB Gcal TGK-1 tariff, RUB Gcal Mosenergo price' s growth TGK-1 price's growth 1,600 18.0% 1,419 1,400 1,314 16.0% 1,194 1,194 1,105 14.0% 1,200 1,091 996 1,005 12.0% 1,000 918 838 10.0% 800 8.0% 600 6.0% 400 4.0% 2011E 2012E 2013E 2014E 2015E Source: Energy Ministry, company data, IFC Metropol estimates We forecast flat electricity output for old generating units. The output of a generating unit depends on the demand for electricity, on the one side, and the variable cost of the generating unit on the other. As mentioned above, the demand for electricity from a generating unit is a function of a number of factors as well as the decision of a dispatcher which generating units to use and when to load. As the development of the electricity system inside a free flow zone is beyond the scope of our ability to estimate, we use load factor to forecast electricity production by each power station or each new generating unit. Despite the fact that demand for electricity is set to increase by a CAGR of 2.2% over 2012-20, we use the historical load factor for the last year for old power units to account for a rebound in electricity demand following the slump in 2009. For new generating units already commissioned we use historical figures, while new units to be commissioned in the scope of investment programs are assumed to demonstrate a 70% load factor. We use the average output for hydro power stations over the last two years for TGK-1. Three trends may change electricity consumption dynamics

Our forecast may differ from actual numbers due to three trends: • The transfer of heat production from boiler facilities to more efficient CHPs. This transfer causes electricity output to increase, because CHPs produce heat and electricity simultaneously during heating season. • A number of industrial users beginning to generate their own electricity in order to cut costs. This should decrease demand for electricity from generators connected to the national system, leading them to decrease electricity output. • Faster implementation of energy-efficient technology based on the law on energy efficiency and significant growth in electricity prices. This could also limit electricity output.

28

We only accounted for these trends conceptually, as we were not able to reliably estimate their effects on electricity output. Figure 31: Electricity production forecast for Mosenergo and TGK-1, bn KW/h

Mosenergo TGK-1 78 80 76 69 71 70 66 60 50 34 34 36 40 30 31 30 20 10 0 2011E 2012E 2013E 2014E 2015E Source: IFC Metropol estimates We forecast flat heat output for old generating units and the same load factors for new ones

The most import single factor that influences demand for heat is also one of the least predictable, the weather. The implementation of energy-efficient technology and the construction of new housing with improved insulation should decrease demand for heat, but to a relatively unpredictable extent. As we are not able to reliably estimate the impact of these factors, we account for them only conceptually and do not incorporate them into our model. We used the demand for heat in 2010 as the basis for estimating the affect of transferring heat production from boiler facilities to CHPs and the transfer of heat production from old facilities to new ones. As a result we can forecast revenue for Mosenergo and TGK-1. We estimate that Mosenergo revenue will grow at a CAGR of 11% over 2011-2015. We expect TGK-1’s revenue will increase at a CAGR of 12% over 2011-2015. Figure 32: Revenue forecast for Mosenergo and TGK-1, RUB bn

Mosenergo TGK-1 300 246 250 227 200 200 177 162 150 117 105 93 100 67 76 50

0 2011E 2012E 2013E 2014E 2015E Source: IFC Metropol estimates Gas price growth increases OPEX and revenue

Gas costs accounted for 50% of generators’ operating expenses in 1Q 11, and in our model we base our fuel cost forecast on gas price estimates from our oil and gas team. Gas price growth not only reduces a generator’s operating expenses, but also increases prices for electricity on the day-ahead market. While gas price increases have no impact on inefficient generators, efficient generators like Mosenergo and TGK-1 should benefit from rising margins.

19 September 2011 29

We assume a 7.1% increase in the gas price for domestic industrial users in 2012

Based on the opinion of our oil&gas team and the government macro forecast as well as discussions with utility company representatives, we use 7.1% average growth in gas prices in 2012 in our model. Thereafter, we use 15% growth for 2013-14, from the base scenario and after that we use the forecast from our oil&gas team. Figure 33: Gas price growth forecast

16% 15% 15% 15% 14% 12% 10% 10% 8% 8% 7% 6% 6% 4% 4% 4% 4% 2% 0%

2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Source: Energy Ministry, IFC Metropol estimates Transmission costs could erode Mosenergo’s profitability

Another significant OPEX item for Mosenergo is heat transmission costs, which accounted for 24% of total OPEX in 1Q 11. We adjusted the heat transmission tariff to estimated inflation growth +2p.p. after 2012, but we see the risk that actual growth will be more significant, due to the high depreciation of heat transmission grids. Figure 34: OPEX forecast for Mosenergo, RUB bn

Fuel Heat transportation Others 250

200 60 58 150 53 32 50 46 30 28 100 25 26 119 132 50 101 80 87

0 2011E 2012E 2013E 2014E 2015E Source: IFC Metropol estimates

30

Electricity purchases and headcount costs accounted for 22% of TGK-1 OPEX in 1Q 11

For TGK-1, electricity purchases accounted for 12% of total OPEX in 1Q 11, while payroll accounted for 10%. TGK-1 purchases electricity in order to fulfill its export contracts and in order to power its heat generating facilities. The electricity price depends on the average electricity price for the company. Payroll costs were adjusted for inflation, taking into account the company’s efforts to reduce headcount. Figure 35: OPEX breakdown forecast for TGK-1, RUB bn

Fuel Electricity purchase Staff Others 105

90 17 75 17 16 7 7 60 15 7 8 13 6 7 6 45 6 5 4 30 50 53 56 36 41 15

0 2011E 2012E 2013E 2014E 2015E Source: IFC Metropol estimates We use company guidance for CAPEX over 2011-14 and maintenance CAPEX thereafter

We use company estimates regarding CAPEX for 2011-14. We assume no significant investment projects related to new capacity construction after obligatory investment programs end in 2015. Thereafter, we forecast only CAPEX necessary to maintain facilities. Figure 36: CAPEX forecast for Mosenergo and TGK-1

Mosenergo TGK-1 20 18 19 17 17 18 16 16 16 14 14 12 10 9 10 8 8 6 4 2 0 2011E 2012E 2013E 2014E 2015E Source: Company data, IFC Metropol estimates

19 September 2011 31

We expected a 12% CAGR for Mosenergo EBITDA and 24% for TGK-1 over 2011-2015

We estimate that adjusted EBITDA will grow at a CAGR of 12% for Mosenergo and 24% for TGK-1 over 2011-2015. For Mosenergo, we forecast EBITDA to rise from RUB 24.2bn in 2011 to RUB 42.9bn in 2015 for an EBITDA margin of 15% to 17%. For TGK- 1, we expect EBITDA to increase from RUB 12bn in 2011 to RUB 35.5in 2015 for an EBITDA margin of 18% to 30%. Figure 37: EBITDA margin forecast

Mosenergo TGK-1 35%

30% 26% 29% 25% 20% 21% 20% 18% 17% 15% 17% 15% 16% 16% 10% 5%

0% 2011E 2012E 2013E 2014E 2015E Source: IFC Metropol estimates WACC calculation

We base our cost of equity calculations on a combination of the risk-free rate, the equity risk premium and a company-specific risk premium. We used the one-month average yield on 10-year US Treasury bonds of 2.1% as a base for our risk-free rate. We then added the one-month average yield difference between the US 10-year Treasury yield and the most liquid Russian bond, the 30-year Russian Eurobond, which is 2.0%, to account for Russia’s country risk. To estimate the standard equity risk premium, we used the historical 5% difference between the performance of stocks and bonds. We have applied an additional risk premium of 5.5% to the cost of equity for each company to account for the risks associated with uncertainty regarding future regulations and corporate events. WACC calculations are presented in the figure below Figure 38: WACC calculation

Mosenergo TGK-1

Cost of equity assumption Risk-free rate: 10-year US Treasury yield, 1m average 2.1% 2.1% Yield difference: 10-year US Treasury vs. Russia-30, 1m average 2.0% 2.0% Standard equity risk premium 5.0% 5.0% Company-specific risk premium 5.5% 5.5% Cost of equity 14.68% 14.68% Cost of debt (after tax) 8.0% 8.0% Capital structure % Equity 80.0% 80.0% % Debt 20.0% 20.0% WACC 13.34% 13.34% Source: IFC Metropol estimates

We have used a DCF valuation to account for ongoing changes in the Russian electricity market. We summarize our DCF model in the following tables. Despite strong profitability, the massive investment program results in negative cash flow until 2013 for TGK-1. We project free cash flow to be RUB 9.4bn in 2013E for Mosenergo and RUB 1bn in 2013E for TGK-1.

32

We assume a terminal growth rate of 2% and have used the Gordon Growth Model to estimate the companies’ terminal value. Terminal value accounted for 41% of Mosenergo’s valuation and 64% of TGK-1’s valuation. Figure 39: DCF Valuation for Mosenergo

2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Net Operating Profit 15,238 16,839 20,517 25,555 22,654 18,867 13,321 7,701 7,875 Income tax -3,048 -3,368 -4,103 -5,111 -4,531 -3,773 -2,664 -1,540 -1,575 NOPLAT 12,190 13,471 16,414 20,444 18,123 15,094 10,657 6,161 6,300 +AD&D 14,417 15,604 16,847 17,377 17,918 18,470 19,033 19,607 20,192 -CAPEX 16,949 17,797 18,644 7,955 8,114 8,277 8,442 8,611 8,783 -Ch. In WC 1,355 1,837 2,358 1,925 847 537 146 161 722 FCFF 8,303 9,442 12,259 27,941 27,079 24,750 21,101 16,995 16,988 DFCFF 7,326 7,350 8,419 16,930 14,476 11,673 8,781 6,239 5,502 WACC 13.34% Terminal growth rate 2.00% DCF 81,192 Terminal value 149,749 Discounted terminal value 54,976 EV 136,169 Net Debt 2011E -14,292 Equity 150,461 Shares outstanding, mn 39,749 Price 3.785 Source: IFC Metropol estimates Figure 40: DCF Valuation for TGK-1

2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Net Operating Profit 10,239 14,444 22,183 29,710 31,372 31,675 31,275 32,548 35,997 Income tax -2,048 -2,889 -4,437 -5,942 -6,274 -6,335 -6,255 -6,510 -7,199 NOPLAT 8,191 11,555 17,746 23,768 25,098 25,340 25,020 26,039 28,798 +AD&D 5,065 5,590 5,741 5,741 5,741 5,741 5,741 5,741 5,741 -CAPEX 16,469 13,605 10,319 8,809 9,074 9,255 9,440 9,629 9,822 -Ch. In WC 1,169 2,544 2,757 2,902 -1,372 354 18 438 1,080 FCFF -4,383 996 10,411 17,798 23,137 21,472 21,303 21,713 23,637 DFCFF -3,867 775 7,150 10,784 12,369 10,127 8,864 7,971 7,656 WACC 13.34% Terminal growth rate 2.00% DCF 54,174 Terminal value 208,366 Discounted terminal value 76,496 EV 130,670 Net Debt 2011E 31,550 Equity 99,262 Shares outstanding, mn 3,854,342 Price 0.026 Source: IFC Metropol estimates

19 September 2011 33

Appendix

Figure 41: Mosenergo Profit and Loss Statement, RUB mn

2010 2011E 2012E 2013E 2014E 2015E

Revenue 145,298 162,021 178,182 199,789 227,341 249,964 growth, y-o-y 29% 12% 10% 12% 14% 10% Electricity generation 78,862 89,388 99,192 113,929 134,034 148,557 Heat generation 62,307 68,194 74,263 80,872 88,070 95,908 Other 4,129 4,439 4,727 4,987 5,237 5,498 Operating expenses, excluding depreciation -124,227 -137,827 -148,527 -167,346 -189,977 -207,031 growth, y-o-y 25% 11% 8% 13% 14% 9% Fuel costs -70,372 -80,330 -86,813 -101,325 -119,337 -132,197 growth, y-o-y 29% 12% 10% 12% 14% 10% Heat transportation -23,469 -24,610 -26,434 -28,133 -29,801 -31,568 growth, y-o-y 28% 13% 11% 15% 18% 11% Other expenses -30,386 -32,887 -35,279 -37,888 -40,838 -43,266 growth, y-o-y 16% 8% 6% 5% 5% 5% EBITDA adjusted 21,071 24,194 29,655 32,443 37,364 42,932 growth, y-o-y 55% 15% 23% 9% 15% 15% EBITDA adjusted margin 15% 15% 17% 16% 16% 17% Depreciation 12,214 13,287 14,417 15,604 16,847 17,377 growth, y-o-y 4% 9% 9% 8% 8% 3% Operating expenses including depreciation -136,441 -151,114 -162,944 -182,950 -206,823 -224,409 growth, y-o-y 23% 11% 8% 12% 13% 9% Impairment release 0 0 0 0 0 0 Operating profit 8,857 10,906 15,238 16,839 20,517 25,555 growth, y-o-y 366% 23% 40% 11% 22% 25% Interest Income 2,428 208 208 208 208 208 Interest Expense -169 -400 -400 -400 -400 -400 Other 21 -120 0 0 0 0 Gain/Loss on disposal of financial investments 861 0 0 0 0 0 from subsidiaries Earnings before tax 0 0 0 0 0 0 Earnings before tax 11,998 10,595 15,046 16,647 20,325 25,363 growth, y-o-y 435% -12% 42% 11% 22% 25% Income tax -2,310 -2,119 -3,009 -3,329 -4,065 -5,073 Net income 9,688 8,476 12,037 13,318 16,260 20,291 growth, y-o-y 484% -13% 42% 11% 22% 25% to shareholders 9,688 8,476 12,037 13,318 16,260 20,291 minority interest 0 0 0 0 0 0 Net margin 7% 5% 7% 7% 7% 8% Source: Company data, IFC Metropol estimates

34

Figure 42: Mosenergo Balance Sheet, RUB mn

2010 2011E 2012E 2013E 2014E 2015E

Assets Non-current assets PP&E 180,559 183,373 185,905 188,098 189,895 180,473 Investments in associates and joint ventures 898 898 898 898 898 898 Prepayments to suppliers 15,195 15,195 15,195 15,195 15,195 15,195 Other non-current assets 15 2,150 1,583 927 927 927 Total non-current assets 197,147 202,096 204,061 205,598 207,395 197,973 Current assets Cash & cash equivalents 28,335 19,292 27,407 36,686 44,726 67,441 Trade & other recievables 21,132 23,587 25,963 29,158 33,244 36,591 Inventories 6,438 7,187 7,910 8,884 10,129 11,149 Other current assets 1,896 3,470 3,470 3,470 3,470 3,470 Total current assets 58,555 54,290 65,505 78,953 92,324 119,406 Total assets 255,702 254,237 268,018 283,668 302,902 325,635 Equity & liabilities Equity Share capital 166,124 166,124 166,124 166,124 166,124 166,124 Treasury shares -871 -871 -871 -871 -871 -871 Share premium 49,213 49,213 49,213 49,213 49,213 49,213 Revaluation and other reserves 86,639 86,639 86,639 86,639 86,639 86,639 Retained earnings -107,336 -98,860 -86,823 -73,505 -57,245 -36,955 Total equity 193,769 202,245 214,282 227,600 243,860 264,150 Minority interest 0 0 0 0 0 0 Total equity & minority interest 193,769 202,245 214,282 227,600 243,860 264,150 Liabilities LT liabilities Deferred income tax liabilities 24,758 24,758 24,758 24,758 24,758 24,758 LT Borrowings 11,770 1,962 1,962 1,962 1,962 1,962 Other LT Liabilities 1,356 1,356 1,356 1,356 1,356 1,356 Total LT liabilities 37,884 28,076 28,076 28,076 28,076 28,076 ST liabilities ST Borrowings 4,976 3,038 3,038 3,038 3,038 3,038 Accounts payable and accruals 15,683 17,488 19,232 21,565 24,538 26,980 Current income tax liabilities 812 812 812 812 812 812 Other taxes payable 2,389 2,389 2,389 2,389 2,389 2,389 Total ST liabilities 24,049 23,916 25,661 27,993 30,967 33,409 Total liabilities 61,933 51,992 53,736 56,069 59,042 61,484 Total equity, minority interest & liabilities 255,702 254,237 268,018 283,668 302,902 325,635 Source: Company data, IFC Metropol estimates

19 September 2011 35

Figure 43: Mosenergo Cash Flow Statement, RUB mn 2010 2011E 2012E 2013E 2014E 2015E Cash flows from operating activities Profit before tax 11,998 10,595 15,046 16,647 20,325 25,363 Adjustments for: Depreciation of property, plant and equipment 12,214 13,287 14,417 15,604 16,847 17,377 Interest expense, net -2,259 192 192 192 192 192 Other non-cash items -235 0 0 0 0 0 Change in WC: (Increase)/decrease in accounts receivables and 6,327 -2,455 -2,376 -3,195 -4,087 -3,347 prepayments(Increase)/decrease in other current assets 7 0 0 0 0 0 (Increase)/decrease in inventories -1,886 -749 -724 -974 -1,245 -1,020 (Increase)/decrease in other non-current assets -307 -2,135 567 656 0 0 Increase/(decrease) in accounts payable and accruals -1,622 1,805 1,744 2,332 2,974 2,442 Increase/(decrease) in other taxes payable 1,497 0 0 0 0 0 Increase/(decrease) in other non-current liabilities -8 0 0 0 0 0 Tax paid -2,282 -2,119 -3,009 -3,329 -4,065 -5,073 Net cash (used in)/from operating activities 23,444 18,422 25,858 27,933 30,941 35,935 Cash flow from investing activities Purchases of property, plant and equipment -6,663 -16,102 -16,949 -17,797 -18,644 -7,955 Other items 12,640 -192 -192 -192 -192 -192 Net cash used in investing activities 5,977 -16,293 -17,141 -17,988 -18,836 -8,147 Free cash flow 29,421 2,128 8,717 9,944 12,105 27,788 Cash flow from financing activities Increase/(decrease) in all borrowings 21,966 -11,746 0 0 0 0 Dividends paid -491 -424 -602 -666 -4,065 -5,073 Other items -23,829 0 0 0 0 0 Net cash (used in)/from financing activities -2,354 -12,170 -602 -666 -4,065 -5,073 Net (decrease)/increase in cash and cash equivalents 27,067 -10,042 8,115 9,278 8,040 22,715 Cash and cash equivalents at the beginning of the year 2,267 29,334 19,292 27,407 36,686 44,726 Cash and cash equivalents at year end 28,335 19,292 27,407 36,686 44,726 67,441 Source: Company data, IFC Metropol estimates Figure 44: TGK-1 Profit and Loss Statement, RUB mn 2010 2011E 2012E 2013E 2014E 2015E Revenue 54,104 67,409 76,922 93,328 106,341 119,131 growth, y-o-y 31% 25% 14% 21% 14% 12% Electricity 31,101 40,676 47,173 58,891 66,325 75,314 Heat 22,347 26,497 29,497 34,172 39,737 43,524 Other 656 236 251 265 278 292 Operating expenses, ex. depreciation -45,480 -55,451 -61,617 -73,295 -78,416 -83,679 growth, y-o-y 35% 22% 11% 19% 7% 7% Fuel -21,637 -36,424 -40,519 -49,734 -53,213 -56,226 growth, y-o-y 38% 68% 11% 23% 7% 6% Employee benefits -5,518 -5,932 -6,317 -6,665 -6,998 -7,348 growth, y-o-y 7% 8% 6% 5% 5% 5% Other expenses -18,325 -13,096 -14,781 -16,896 -18,206 -20,105 growth, y-o-y 44% -29% 13% 14% 8% 10% EBITDA adjusted 8,624 11,958 15,304 20,034 27,924 35,451 growth, y-o-y 11% 39% 28% 31% 39% 27% EBITDA adjusted margin 16% 18% 20% 21% 26% 30% Depreciation 3,383 4,273 5,065 5,590 5,741 5,741 growth, y-o-y 21% 26% 19% 10% 3% 0% Operating expenses incl. depreciation -48,863 -59,725 -66,682 -78,884 -84,158 -89,421 growth, y-o-y 34% 22% 12% 18% 7% 6% Impairment release 3,964 0 0 0 0 0 Operating profit 9,205 7,684 10,239 14,444 22,183 29,710 growth, y-o-y -11% -17% 33% 41% 54% 34% Interest Income 89 0 0 0 0 0 Interest Expense -211 -2,640 -3,200 -3,360 -3,040 -2,240 Other 0 436 436 436 436 436 Net financing costs -122 -2,204 -2,764 -2,924 -2,604 -1,804 Earnings before tax 9,083 5,481 7,476 11,521 19,579 27,906 growth, y-o-y -15% -40% 36% 54% 70% 43% Income tax -1,909 -1,096 -1,495 -2,304 -3,916 -5,581 Net income 7,174 4,385 5,981 9,216 15,663 22,325 growth, y-o-y -14% -39% 36% 54% 70% 43% to shareholders 7,203 4,414 6,010 9,245 15,692 22,354 minority interest -29 -29 -29 -29 -29 -29 Net margin 13% 7% 8% 10% 15% 19% Source: Company data, IFC Metropol estimate

36

Figure 45: TGK-1 Balance Sheet, RUB mn

2010 2011E 2012E 2013E 2014E 2015E

Assets Non-current assets Property, plant and equipment 99,020 111,007 122,411 130,427 135,005 138,073 Long-term investments 48 48 48 48 48 48 Deferred tax assets 592 592 592 592 592 592 Other non-current assets 592 592 592 592 592 592 Total non-current assets 100,252 112,239 123,643 131,659 136,237 139,305 Current assets Cash & cash equivalents 278 1,450 1,558 1,754 2,166 2,940 Trade & other recievables 10,763 14,639 16,325 20,021 22,686 25,484 Inventories 2,538 4,218 4,767 5,811 6,605 7,409 Other current assets 6 6 6 6 6 6 Total current assets 13,769 20,497 22,839 27,776 31,648 36,023 Total assets 114,021 132,736 146,483 159,435 167,885 175,328 Equity & liabilities Equity Share capital 38,543 38,543 38,543 38,543 38,543 38,543 Treasury shares 0 0 0 0 0 0 Share premium 22,914 22,914 22,914 22,914 22,914 22,914 Fair value reserve 0 0 0 0 0 0 Retained earnings 20,076 24,270 29,981 38,765 50,542 67,315 Total equity 75,446 79,640 85,351 94,135 105,912 122,685 Minority interest -142 -171 -200 -229 -258 -287 Total equity & minority interest 75,304 79,469 85,151 93,906 105,654 122,398 Liabilities LT liabilities Deferred tax liabilities 5,897 5,897 5,897 5,897 5,897 5,897 Long-term borrowings 16,294 25,403 30,792 32,332 29,252 21,554 Post-employment benefits obligations 892 892 892 892 892 892 Total LT liabilities 23,083 32,192 37,581 39,121 36,041 28,343 ST liabilities ST Borrowings 6,906 7,597 9,208 9,668 8,748 6,446 Accounts payable and accruals 7,711 12,887 14,388 17,021 18,159 19,294 Current income tax liabilities 445 445 445 445 445 445 Other taxes payable 572 572 572 572 572 572 Total ST liabilities 15,634 21,074 23,751 26,408 26,189 24,587 Total liabilities 38,717 53,267 61,332 65,529 62,231 52,930 Total equity, minority interest & liabilities 114,021 132,736 146,483 159,435 167,885 175,328 Source: Company data, IFC Metropol estimates

19 September 2011 37

Figure 46: TGK-1 Cash Flow Statement, RUB mn

2010 2011E 2012E 2013E 2014E 2015E

Cash flows from operating activities Profit before tax 9,082 5,481 7,476 11,521 19,579 27,906 Adjustments for: Depreciation of property, plant and equipment 3,383 4,273 5,065 5,590 5,741 5,741 Interest expense, net 122 2,204 2,764 2,924 2,604 1,804 Other non-cash items 90 0 0 0 0 0 Change in WC: (Increase)/decrease in accounts receivables and prepayments 155 -3,876 -1,686 -3,696 -2,664 -2,798 (Increase)/decrease in inventories -467 -1,680 -549 -1,045 -794 -803 (Increase)/decrease in other non-current assets 87 0 0 0 0 0 Increase/(decrease) in accounts payable and -1,799 5,176 1,501 2,633 1,138 1,136 accruals Increase/(decrease) in other taxes payable -54 0 0 0 0 0 Tax paid -429 -1,096 -1,495 -2,304 -3,916 -5,581 Net cash (used in)/from operating activities 4,189 7,841 9,876 12,262 18,647 25,164 Cash flow from investing activities Purchases of property, plant and equipment -13,373 -16,260 -16,469 -13,605 -10,319 -8,809 Other items 815 0 0 0 0 0 Net cash used in investing activities -12,558 -16,260 -16,469 -13,605 -10,319 -8,809 Free cash flow -8,369 -8,419 -6,593 -1,343 8,328 16,355 Cash flow from financing activities Increase/(decrease) in all borrowings 8,245 9,800 7,000 2,000 -4,000 -10,000 Dividends paid -168 -219 -299 -461 -3,916 -5,581 Other items 0 1 2 3 4 5 Net cash (used in)/from financing activities 8,077 9,581 6,701 1,539 -7,916 -15,581 Net (decrease)/increase in cash and cash equivalents -292 1,162 108 196 412 774 Cash and cash equivalents at the beginning of the year 580 288 1,450 1,558 1,754 2,166 Cash and cash equivalents at year end 278 1,450 1,558 1,754 2,166 2,940 Source: Company data, IFC Metropol estimates

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