OREANDA-NEWS. Fitch Ratings expects amendments to capacity auctions, if successfully implemented, should improve Russian generators' earnings predictability, even if at possibly lower levels. Under the amendments, auctions will be held every four years instead of the current one year. The first auction under the new market model, however, will be split into two phases, one to be held in October 2015 for 2016 and the other in December 2015 for 2017-2019.

The new auction model would result in more predictable capacity prices for existing capacity units, which contribute between 15% and 30% of generators' total revenues. However, the surplus of capacities in the European pricing zone would continue to exert downward pressure on capacity prices for 2016, which are preliminarily set at RUB110,000/MW (-12.4% yoy). For the Siberian zone prices are set at a slightly more favourable RUB150,000/MW (4.2% yoy). Pressure may remain on 2017-2019 prices, which are expected to be indexed to inflation minus one percentage point. We assume the set levels will be adhered to, but revisions may occur due to future policy changes.

Among other key changes, capacity prices are expected to be set for two pricing zones, the European and Siberian parts of Russia, instead of 21 free-flow zones across the country, which in our view should improve competitiveness among generators. Thus under the new market model, generators with high capacity prices in their respective free-flow zones may not achieve the same prices in the larger pricing zone due to a larger number of competitors. An 'elastic demand' pricing mechanism has also been proposed to incentivise generators to decommission non-efficient capacities from operations, which would otherwise result in surplus weighing on auction prices on the market.

Capacity payments for existing power units are set via the auctions and are made to ensure plants remain operational (covering generators' fixed costs) and ready to produce electricity in periods of high demand. However, the commissioning of new power plants and the slowdown of Russia's economy have created excess capacity. As a result over 15GW of less efficient generation capacity, mostly in the European part of Russia, was surplus to requirements during last year's auction. Most of these plants have not received any capacity payments in 2015, in turn negatively hitting the respective generators' earnings.

Fitch expects financial deterioration at Russian thermal generators to be manageable at current ratings. Moreover, over the medium term the auction may accelerate the decommissioning of inefficient generation capacity, in turn improving the overall efficiency of the market where rated issuers are typically well-placed.

In the near future, the auction results are likely to reduce capacity revenue for the existing power units of several Russian generators operating in the European pricing zone, including Inter RAO (BBB-/Negative), RusHydro (BB+/Negative), OGK-2, Mosenergo (BB+/Stable), Enel OGK-5, E.On Russia, Fortum (TGK-10), etc. Nevertheless this pressure is likely to be offset by solid cash flow from capacity payments from newly commissioned units under the capacity supply agreement (CSA). Prices under CSAs are expected to increase in the medium-term due to rising interest rates and shortened payback period to 10 from 15 years. So far, CSAs have not been affected by policy revisions and represent a significant enhancement for issuers' credit profiles.