Daily analyst comments

On December 31, Sakhalinenergo signed a coal supply agreement for 2007 on Sakhalinugol’s terms, since the supplier intended to suspend coal deliveries to Sakhalin GRES and South-Sakhalin TPP-1 on January 1, Interfax reported on January 12 quoting Sakhalinenergo’s press service. It was also reported that Sakhalinenergo views the terms of the new agreement as inexecutable obligations which it was forced to assume due to the threat of halted fuel supplies at the peak of the winter heating season.

Sakhalinenergo is one of the Far East’s isolated energy systems. The energy systems of this region can be divided into two large segments. The first one represents fully isolated energy systems with no possibilities to transmit electricity to Russia’s united energy system largely due to their geographical location. Such energy systems include Sakhalinenergo, Chukotskenergo, Magadanenergo and Kolymaenergo. At present, their restructuring blueprints are not under consideration in the absence of system links with other energy systems.

We believe it will be hard to negotiate lower coal prices. Coal companies are not known for their transparency and therefore they can easily attribute coal price hikes to a number of reasons and it will be no easy matter to challenge the appropriateness of these calculations. In addition, the coal-generation segment is becoming increasingly attractive now and demand for coal will rise due to a projected gas shortage. According to market laws, this will push up thermal coal prices. Therefore, in the future, fuel prices will continue to climb in other regions as well.

At present, market participants have a downbeat outlook on isolated energy systems. If generating companies WGCs and TGCs are valued on average at $350-400 per kW, market caps of isolated energy systems are estimated at $150 per kW. In addition, these companies have other assets on their balance sheets, such as power grids, sales and maintenance units, etc. We do not believe that in the near future, Sakhalinenergo could be an appealing target for portfolio investments. Magadanenergo shares look more appealing. The fair price of the latter is $0.14 per share, which implies 114% upside potential.