JSC “TGC−1” ANNUAL REPORT 2007 Mission: CONTENTS

1. LETTER TO SHAREHOLDERS ...... 4 We are committed to becoming leaders of the energy market, being reliable partners for our investors, protecting shareholders’ 2. COMPANY OVERVIEW ...... 7 interests and meeting our customers’ highest expectations. 3. PERFORMANCE HIGHLIGHTS ...... 11 By adhering to global standards for transparency in business practices, an environmentally−responsible method of operating our 4. SIGNIFICANT EVENTS ...... 15 facilities and an innovative social policy, the Company should become 5. COMPANY RESULTS ...... 19 the standard−bearer for other players in Russia’s power−generating industry. 6. DEVELOPMENT OUTLOOK ...... 23

7. ENERGY INDUSTRY OVERVIEW ...... 27

8. BUSINESS ACTIVITY ...... 33

9. CORPORATE SOCIAL RESPONSIBILITY ...... 55

10. CORPORATE GOVERNANCE ...... 63

11. AUDIT COMMISSION REPORT ...... 73

12. PERFORMANCE AND FINANCIAL ANALYSIS ...... 77

13. SECURITIES ...... 87

14. INFORMATION FOR SHAREHOLDERS AND INVESTORS ...... 91

- IMPORTANT EVENTS AND THE ASSUMPTIONS USED IN PREPARING THE ANNUAL REPORT ...... 94

- SOCIAL CALENDAR ...... 97

- GLOSSARY ...... 102

- COMPANY FINANCIAL STATEMENTS ...... 106 JSC “TGC−1” ANNUAL REPORT 2007

3 1. LETTER TO SHAREHOLDERS Dear Shareholders, Dear Partners, Colleagues, The year 2007 has not only been a period of successful and effective operations at TGC-1, but also a signifi cant It is a great honour for me to address you on behalf of Fortum Power and Heat Oy, the second major shareholder of TGC-1. Dear Shareholders, benchmark for creating a strong foundation for future development of the power system. Last year we took part in the additional issue of TGC-1’s shares and If you asked me today to summarize the results of the previous year in one word, it would be “construction”. In May 2007, Murmanskaya CHPP became a subsidiary of TGC-1, thus fi nalizing the Company’s target managed to keep our stake at slightly over 25%. It is very important for us to And that relates not only to the commissioning of specifi c objects. The year 2007 will go down in TGC-1’s structure, as TGC-1 has truly become the largest power generation complex in the North-West Region participate in TGC-1 on an equity capital basis and to continue our partnership history as the year the Company started to establish a new, effi cient and up-to-date power infrastructure in of Russia. In June, the Chairman of the Board of RAO UES, Anatoly Chubais, and the Governor of with it. Fortum’s representatives are active members of the Company’s Board the region. Leningrad Oblast, Valery Serdyukov, signed an Agreement on Developing Leningrad Oblast Power of Directors and productively cooperate with its management, and we have System. A similar agreement was signed between RAO UES and the government of high esteem for the development of TGC-1’s corporate Construction of the new power unit at Pervomayskaya CHPP-14 has begun. Murmansk Oblast in November, and later in December, Anatoly Chubais and Valentina governance and its general performance. Contracts have been signed for the full replacement of hydroelectric units at Vuoksinskiye HEPP Cascade, Matvienko, the Governor of St. Petersburg, signed a Protocol for Increasing Investments The year 2007 enabled us to extend our cooperation the construction of the new power unit at Yuzhnaya CHPP-22, and project design of the new power unit at in the Development of the Power System of the Northern Capital, supplementing to the area of environmental protection. It is Severnaya CHPP-21. the Agreement that RAO UES and the government of St. Petersburg entered into important for every country in the world to protect the The fi rst stage of the reconstruction of HEPP-3 of Nivskiye HEPP Cascade, and construction of a steam in July 2006. Each of these documents is a guarantee from the regional authorities environment. Unfortunately, climate change is among boiler house at Pravoberezhnaya CHPP-5, a power boiler for Vasileostrovskaya CHPP-7, and a diesel of their interest in developing and modernizing power capacities. And this means that the most urgent issues on the global agenda and, power plant on Valaam Island have all been completed. the Investment Programme estimated at more than 150 billion rubles will be due to the fact that most greenhouse gases carried out. are emitted in the course of power generation The new turbine unit at Avtovskaya CHPP-15 has been commissioned. and utilisation, the power industry must As a fi ne tradition I should state that TGC-1’s management was able to play a vital role in the process of improving Over 50 km of heating grids have been laid, which is twice as much as during the two previous implement shareholder objectives for the previous year in terms of achieving environmental conditions. years of the Company’s operation. the desired production and fi nancial results. Corporate governance level The Board of Directors of TGC-1 approved remains high, which is proved, in particular, by the Company’s high ratings as The Company has reached agreements with the authorities of the Republic of Karelia and the Company’s environmental policy, Murmansk Oblast to expand Petrozavodskaya CHPP and construct Murmanskaya CHPP-2. issued by authorized rating agencies. According to Standard & Poor’s, TGC-1 and we agreed to cooperate with the holds fi rst place among Russian power companies in terms of its information In order to improve the new construction’s effi ciency, transparency and consistency, implementation of the Kyoto Protocol transparency rating, having increased its corporate governance rating the Company’s structure was signifi cantly altered in 2007 in order to optimize investment mechanisms in Russia. The massive up to 5+ (5.5 according to the Russian National Scale) in 2007. management processes. preparations made in 2007 allowed us to But the main event for TGC-1 in 2007 was surely the successful sale of sign the largest agreement in Russia on Indubitably, having issued additional TGC-1’s shares during the previous year was one of the the purchase of CO emission reduction additional shares. The price of TGC-1’s securities, considering net debts, 2 key factors that allowed us to realize our plans and created a favourable environment for the units (ERUs) in the beginning of 2008. amounted to $710 per 1 kW of installed electric capacity, which exceeds implementation of shareholder objectives. I would like to extend our deep appreciation to the The ERUs Fortum is buying from similar fi gures of other territorial generating companies that issued additional management of RAO UES for their support in the preparation and for handling the issue, as well as TGC-1 will be received by carrying out shares in the past. Thus, the Company not only received the funds required for to Fortum Power and Heat Oy for their confi dence, which resulted in keeping up the scope of their joint implementation projects, including implementation of the Investment Programme’s priority projects, but also got a participation in our Company’s equity capital. the reconstruction of the hydroelectric new strategic shareholder, the participation of which should positively infl uence power plants in Leningrad Oblast, the I would like to stress that the main volume of the additional shares was acquired by an institution the Company’s current operations and further development perspectives. The expansion and reconstruction of several representing the interests of Gazprom, which is as important as the fi nancial results of the shares fact that the new shares were acquired by an institution representing the interests CHPPs in Saint Petersburg, as well as the being purchased. Furthermore, preparation for the issue helped us assess the Company in a more of Gazprom is of crucial importance for the Company in terms of fuel supplies improvement of energy saving technologies in complex, consistent and objective manner, thus laying the basis for improvement in future production and the Company’s status in the region. However, it is not less important that the heating grids. Through applying the Kyoto effi ciencies. our international strategic shareholder Fortum Power and Heat Oy has kept its Protocol mechanisms, the Company will be blocking interest in TGC-1’s equity capital. I think that our best success to date is to have managed to maintain positive trends in our production able not only to raise additional fi nancing, but also to make environmental issues a part of its operations despite considerable changes in the Company’s management structure and equity capital as Dear colleagues, this is the last time that I address you as a representative Investment Programme. well as in the large increase of investment – from 3.5 up to 15 billion rubles. of the management of RAO UES. After the Holding’s reorganization is completed, which will be by mid 2008, power companies must be fully TGC-1 has a lot of work ahead due to the coming Electricity output in 2007 amounted to 26,063 million kWh, which is a 12.1% increase compared to 2006. prepared for independent operation in the new market-based power of a new majority shareholder, its separation The repair and maintenance programme has been implemented in the required scope, which enabled us industry. Nevertheless, I am sure that this expected full change of from RAO UES, and the implementation of a to pass autumn and winter peaks without serious equipment failures. A number of measures have been large Investment Programme. Nevertheless, taken to retain highly qualifi ed staff, especially workers, at the plants. operational environment will not become any kind of stress for our Company. TGC-1’s management has proven that the power system we are sure that the Company is well It is clear that not all power industry professionals can have the chance to witness new plants coming possesses suffi cient technical and managerial resources to maintain prepared to accomplish these objectives on line. And only few can be a part of events of the massive scale we undertake today. I am really stability during this crucial period of change in the industry. and will successfully achieve its targets happy for all of us, those who work and keep working with us during this important construction period. and goals in 2008. I invite you to share this confi dence with me. JSC “TGC−1” ANNUAL REPORT 2007 I warmly welcome our new shareholders, who support us at this very signifi cant moment for the region’s Thank you for the fruitful cooperation we had in 2007, and JSC “TGC−1” ANNUAL REPORT 2007 power system. I truly believe that we will retain our common understanding of our objectives as we reach for Wishing you prosperity and a blistering pace of development! let’s keep on working with the same positive attitude in the future! them.

Alexander Chikunov Chairman of the Board of Directors Tapio Kuula President Fortum Power and Heat Oy Valery Rodin General Director TGC-1 TGC-1 4 5 For notes and remarks

2. COMPANY OVERVIEW

Project: Institute «Teploelectroproject» (LO TEP) Avtovskaya CHPP-15. Saint Petersburg Joint Stock Company “Territorial Generating Company No. 1” is about 2.5% of the total electricity generated in Russia, with among the leading power companies of Russia and the largest 17 plants located within the Arctic Circle. That makes TGC-1 the electricity and heat producer in the North-West of Russia. largest electricity supplier in an area of more than 400 thousand square kilometres to a population of about 8 million people. JSC “TGC-1” was founded in March 2005 as part of Russian power sector reform. JSC “Lenenergo”, JSC “Kolenergo”, and TGC-1 operates in four constituents of the Russian Federation: JSC “Karelenergogeneratsiya” acted as founders of TGC-1. The St. Petersburg, Leningrad Oblast, Murmansk Oblast, and Company started its operations on 1 October 2005. the Republic of Karelia. TGC-1’s headquarters is located in St. Petersburg. Formation of the Company’s new integrated structure was completed through the exchange of newly issued shares for the The Company’s structure is represented by the Management unit shares of JSC “Murmanskaya CHPP” in 2007. and three regional branches: • Nevsky Branch (St. Petersburg and Leningrad Oblast) The major shareholders of TGC-1 are RAO UES (42.31%), • Karelsky Branch (the Republic of Karelia) Fortum Power and Heat Oy (25.69%), MMC Norilsk Nickel • Kolsky Branch (Murmansk Oblast). (5.60%) and Russian Energy Projects (17.67%). TGC-1’s total electric installed capacity is 6,278.4 MW, which Shares of TGC-1 are traded on the quotation lists “B” on the RTS makes it the third largest territorial generating company in Russia. and MICEX stock exchanges. Hydroelectric generating facilities account for 46% of TGC-1’s installed capacity, giving the Company substantial competitive The Company owns and operates 55 power plants producing benefi ts.

TGC-1’s branches and Murmanskaya CHPP performance fi gures

Specifi cations Nevsky Branch Kolsky Branch Karelsky Branch Murmanskaya CHPP Total

Installed capacity

Electricity, MW 3 ,436.8 1,915.8 913.8 12.0 6 ,278.4 Heat, GCal/h 12, 219.0 735.0 689.0 1,111.0 14,754.0

Power plants amount CHPP 11 1 1 1 14 HEPP 6 17 17 40 DPP 1 1

Most electricity produced by TGC-1 is sold on the wholesale TGC-1 is also a strategic supplier of heat in the regions of its electricity market in the Russian Federation. Owing to its operations. advantageous geographical position, TGC-1 has direct access TGC-1’s total heat installed capacity is 14,754 GCal/h. The to international energy markets. Three of the four regions where Company supplies heat to customers in St. Petersburg, Kirovsk TGC-1 has facilities border on the European Union, creating solid (Leningrad Oblast), Petrozavodsk, Murmansk and Apatity ground for transnational cooperation. TGC-1 exports electricity (Murmansk Oblast). TGC-1’s asset structure includes heat grids to Finland and Norway. Exports account for about 3.6% of the with the total length exceeding 940 km. JSC “TGC−1” ANNUAL REPORT 2007 Company’s total sales. The Company employs over 9,000 people.

9 For notes and remarks

3. PERFORMANCE HIGHLIGHTS

Architect N.A.Trotsky Central CHPP-2. Saint Petersburg In 2007, the Company experienced growth in key production and fi nancial performance indicators.

Key production fi gures

2006 2007.

Electricity generation, million kWh 23,242.4 26,063.5 Electricity useful output*, million kWh 23,527.1 28,212.4 Heat generation, thousand GCal 22,852.3 24,349.7 Heat useful output*, thousand GCal 22,190.0 23,509.9 *including purchased power

Over the past year, the total electricity output of Murmanskaya CHPP reached 37.1 million kWh, with 19 million kWh delivered to consumers. The heat output of Murmanskaya CHPP was 2,392.8 thousand GCal, with 2,171.9 thousand GCal delivered to customers.

Key fi nancial fi gures

2006 2007

Revenue, RUR million 20,502.7 26,194.6

Operating profi t, RUR million 325.3 851.0 Net profi t, RUR million 598.2 124.1 Total assets, RUR million 41,047.6 75,494.9 Equity, RUR million 29,955.7 62,456.9 Investments (excluding VAT), RUR million 3,598.5 12,350.6

At the end of 2007, TGC-1 reported revenues of 26,194.6 million rubles, 53.4% of which was from electricity sales and 42.4% from heat sales. Other sales and electricity exports accounted for 4.2% of the Company’s total revenues. TGC-1’s assets have increased by 1.8 times during the past year, reaching 75,494.9 million rubles. The Company’s equity capital has also increased as a result of the additional share issue in the amount of 32,400 million rubles. An increase in reserves of 29.9 million rubles allowed the Company to meet current regulations concerning the amount of reserves. In the past year, the amount spent by the Company on its programme of repairs reached 1,794 million rubles, matching the same value for 2006. JSC “TGC−1” ANNUAL REPORT 2007 TGC-1’s total investments for 2007 amounted to 12,350.6 million rubles (before value-added tax).

13 For notes and remarks

4. SIGNIFICANT EVENTS

Project: «Gidrokor» Ltd Diesel Power Plant at Valaam Island. The Republic of Karelia. January May

TGC-1’s shares started trading on the RTS and MICEX stock TGC-1’s General Director Valery Rodin and Power Machines’ exchanges. General Director Boris Vainzikher signed the contract for refurbishment of Vuoksinskiye HEPP Cascade.

TGC-1 received the highest corporate governance score among February Russian power industry companies from Standard & Poor’s The Federal Financial Market Service of the Russian Federation (CGS 5+). registered TGC-1’s bond issue. Formation of the Company’s new structure was completed through the exchange of shares from the additional issue of March shares of JSC “Murmanskaya CHPP”. TGC-1 became the owner of an 84.06% stake in the authorized capital of TGC-1 placed 4,000,000 seven-year bonds with a face value of Murmanskaya CHPP. 1,000 rubles each. The fi rst coupon rate was set at 7.75% per annum at a call for tenders held by MICEX. TGC-1’s shares started trading on the RTS stock exchange as “B” listed securities. The Company’s Board of Directors approved the establishment of Khibinskaya Heating Company, whose key goal is to lay a 17-kilometer heat pipeline from Apatitskaya CHPP to the June Kirovsk’s boiler facility. The Company’s stake was planned TGC-1 published the fi rst consolidated fi nancial results for 2006 to be 50% in the authorized capital of Khibinskaya Heating in accordance with the IFRS. Company. An Annual General Shareholder Meeting was held. The The FFMS of Russia registered an additional issue of the shareholders resolved to approve the Annual Report, annual Company’s ordinary shares to be exchanged for shares of fi nancial statements and pay dividends under the Company’s JSC “Murmanskaya CHPP”. ordinary shares on results of 2006 and on results of the 1st quarter 2007.

April The Chairman of RAO UES Anatoly Chubais and the Governor The 110th anniversary of the commissioning of the fi rst electric of Leningrad Oblast Valery Serdyukov signed a Cooperation power plant in Russia was celebrated at PP-2 of Central CHPP Agreement between RAO UES and Leningrad Oblast to of TGC-1. establish top-priority measures to ensure reliable electricity supply in the region. TGC-1’s investments in the projects under An Extraordinary General Shareholder Meeting was held to that Agreement will amount to about 6.5 billion rubles. endorse an increase in the Company’s authorized capital through the issue of additional ordinary shares for public subscription. The funds were aimed at fi nancing the Investment July Programme. The FFMS of Russia registered additional issue and Prospectus The establishment of Khibinskaya Heating Company was of ordinary shares of TGC-1, by means of public subscription, recorded in the Unifi ed State Register of Legal Entities. aimed at fi nancing of the Investment Programme. JSC “TGC−1” ANNUAL REPORT 2007

17 Valery Rodin, General Director of TGC-1, Sergey Katanandov, Extraordinary General Shareholder Meeting decided to approve Head of the Republic of Karelia, and Victor Maslyakov, Governor TGC-1’s reorganization in the form of JSC “TGC-1 Holding” 5. COMPANY RESULTS of Petrozavodsk signed an Agreement “On cooperation between accession to it. the Government of the Republic of Karelia, Administration of Petrozavodsk and TGC-1 for development of the heat supply November system of Petrozavodsk”. Within the framework of the Agreement the Company undertakes to invest over 7.5 billion rubles Standard & Poor`s awarded TGC-1 the highest rating of into development of the heat supply system of the Republic information transparency among all generating companies of Russia. of Karelia. The Governor of Murmansk Oblast Yury Yevdokimov and the Chairman of the Board of RAO UES Anatoly Chubais signed August an Agreement on Cooperation in Developmen