1

Progress of Cost Management Programs

at RAO Unified Energy System of Russia

2

Cost Management Programs (CMPs)

The expense growth rate is over the production growth rate for the following principal reasons:

• tariffs lag behind the price growth in industry;

• inefficient use of material, labor and financial resources.

Starting from the year 2000, we commenced developingand implementing cost management programs (CMPs) in Holding Subsidiary and Dependent Companies, i.e. JSC Energoes and JSC Power Plants:

• CMPs received an official status;

• Procedures for the development, approval and management of CMPs were worked out.

3Cost Structure at Holding Subsidiary and

Dependent Companies in 2000JSC Energoes: Cost StructureJSC Power Plants: Cost Structure

Fuel

54%

Labor

14%

Other expenses

8%

Repair and materials 24%

Fuel31%

Purchased energy22%

Repair and materials

16%

Labor14%

Other expenses10%

Subscribing fee7%

4Reducible Expenses in 2001

Fuel40%Repair and

materials21%

Labor18%

Other expenses17%

Losses3%

‘Non-profiles’1%

5In 2001, the Holding saved Rb 12.3 billion as compared with

expenses included into tariffs. That amounted to 4.1% of reducible expenses.

16%

4%3%

9%11%

57%

Fuel

Repair and materials

Other expenses

Energy losses

Labor

‘Non-profiles’

6Fuel - 2001

• Fuel accounted for 57% of cost reduction

• Large portion of fuel saving (37%) was due to modification of the fuel balance structure

In 2001, the Holding saved Rb 6.8 billion, i.e. 5.4% of overall expenses for fuel (Rb 126 billion)

9%

7%

4%

37%

Fuel - due tostructuring the balance

Fuel - due to cuttingunit costs

Claims, etc.

Due to prices(including tenders)

Fuel expenses saved (within overall cost reduction)

7

Repair and materials - 2001

• The Holding saved Rb 1.96 billion, i.e. 3.2% of expenses for repair (without reducing physical amounts of repair)

• Repair accounted for 17.6% of all reducible expenses • Amount of repair carried out on a self-support basis (57%) was inadmissible

8

358.8%

327.3%302.6%

251.7%

184.4%

100.0%

230.3%

167.4%

115.1%100.0%

0%

50%

100%

150%

200%

250%

300%

350%

400%

1997 1998 1999 2000 2001

Consumer price index, %

Rate of average wages growth, %.

Personnel at Holding Subsidiary and Dependent Companies - 2001

• In 2001, Holding subsidiary and dependent companies personnel dropped by 6700 employees while the output rose

• Electric energy output per employee increased: from 950,500 kWh/person in 2000 to 966,500 kWh/person in 2001

Rate of wages growth at Holding subsidiary and dependent companies is below the inflation rate

99.8

103.3

100.0 101.1100.5

100.8

101.6

100.0 98.398.6

97

99

101

103

105

107

1997г. 1998г. 1999г. 2000г. 2001г.

Number of personeel, %

Output per employee, %

Variation of output and personnel, %%

9‘Non-Profile’ Business - 2001

In 2001, Holding subsidiary and dependent companies spent Rb 3310 million supporting ‘non-profile’ facilities.

• Elimination of ‘non-profile’ activities saved Rb 370 million (in particular, 916,000 sq.m of housing premises were handed over to municipal authorities)

• Elimination of ‘non-profile’ activities proceeds at a low pace

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With due regard to experience gained in

cost reduction in 2001,

the Holding developed Cost Reduction Programs

for 2002

11In the first half-year of 2002, the Holding cut down reducible

expenses by Rb 6.3 billion, or by 3.7 %

24%

5%4%

9%

14%

44%

16%

4%3%

9%11%

57%

24%

5%4%

44%

14%

9%

Fuel

Repair and materials

Energy loss

Other

‘Non-profiles’

Labor costs

2001 First half-year of 2002

12

12%7%

6%

19%Fuel - balance structure

Fuel - claims, etc.

Fuel - unit cost

Due to prices (including tenders)

Fuel - First Half-Year of 2002

We saved Rb 2.8 billion, or 3,9% of expenses for fuel in the first half-year of 2002 (Rb 71.8 billion)

12%

7%

6%

19%

First half-year of 2002

Despite reduction of the saving share due to its balance structure (from 37% to 19%), it is still high

9%

7%

4%

37%

2001

Saving fuel expenses in the overall expenditure

13Repair and Materials - First Half-Year of 2002

• Rb 1.5 billion saved, i.e. 5.4% of expenses for repair and materials• The share of repair and materials within the overall cost reduction increased from 16% in 2001 to 23% in the first half-year of 2002• Tenders gave 16% of the overall cost reduction for repair and materials

Total tenders carried out: 653 tenders to pick up contractors for repair jobs858 tenders to pick up suppliers of materials and equipment

• Number of repair personnel at subsidiaries and dependent companies remains high

• The ratio of so-called ‘self-support’ jobs is still high (57%)

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Number of Personnel and Labor Expenses - First Half-Year of 2002

• Number of personnel in Holding subsidiary and dependent companies was cut down by 17,800 employees

• Labor expenses saved in the first half-year of 2002 amounted to Rb 200 million. Principal saving is expected in the second half-year of 2002 and in 2003

• The rate of personnel reduction is insufficient

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Non-Profile Activities - First Half-Year of 2002

• In the first half-year of 2002, Holding subsidiary and dependent companies spent Rb 1001 million supporting ‘non-profile’ facilities instead of Rb 1317 million accounted for in tariffs, i.e. respective cost reduction reached Rb 316 million

• Elimination of ‘non-profile’ facilities was boosted up, including the following:

- 531,000 sq.m of housing premises were handed over to municipal authorities; - participation in 230 ‘non-profile’ companies was stopped

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• engineering and technical measures in saving fuel, cutting down losses, reduction of environmental payments, etc.

• non-cost-efficient heat-generating equipment made to stand by as reserve

• recycling of materials

• acquisition of equipment by leasing

• review of personnel number standards

• saving upon fuel balance structure (self-illusion)

• personnel reduction programs have not reached the target

• elimination of ‘self-support’ jobs in repair proceeds at a very slow pace

• poor control of electric energy loss

• mechanisms encouraging cost reduction at specific worksites have not been used

Cost Analysis for 2001 - First Half-Year of 2002 revealed the following:

Positive experience: Negative experience:

17Assessment of Potential Cost Reduction in Holding Subsidiaries and Dependent Companies in 2003

Reducible expenses: Rb 325 billion

Assessment of limits for cost reduction:

Rb 14 - 15 billion per annum

Approximately 35% of expenses can be regarded as irreducible

Experience gained in CMP implementation by the best companies cutting down costs by 4-5% per annum in an open, sustainable and purposeful way

Overall production:

Rb 490-500 billion