In early 2012, when the world economy growth rates slowed down and the European economy entered the stage of recession, the Russian economy showed stable performance indicators. However, in the beginning of the IV quarter of 2012 these indicators somewhat worsened. At the moment when GDP exceeded the pre-crisis maximum level, the Russian economy stepped on the path of the economic growth slow-down.

The first half of 2012 was favorable for the Russian economy. In the second half of 2012 the economic growth began to slow down and the inflation began to grow. Based on the results of 2012 Russia's GDP increased by 3.5 %, with the level of inflation of 6.6 %.

The crisis phenomena in the world economy reached Russia in 2012 having caused the slow-down of GDP, industry and investment activity growth. The former growth drivers, state support and consumer demand, do not work anymore, moreover, the weak consumption will become a key obstacle for the economy growth. According to forecasts of the Ministry of Economic Development the Russia's economy will grow by 3.6% in 2013.

The assessment of market perspectives of Russian electric energy companies fully depends on the development of the economy of the RF and reinvestment possibilities which are determining factors both for fundamental assessment of the value of companies and for capital inflow to the industry.

The Company sets a goal of increasing investment attractiveness due to technological and innovative renovation, reduction of depreciation of fixed assets, increase of reliability and efficiency of operation.

Achievement of these goals is connected with the resolving of the industry's system problems, in particular:

Necessary improvement of payment discipline

Over 90% of the Company's total accounts receivable as of the end of 2012 is presented by the indebtedness for electric energy transmission services.

In 2012 the volume of non-payment by selling companies to grid organizations and electric energy suppliers increased. Due to this fact, the Company faced the growth of overdue accounts receivable. Collection of overdue accounts receivable is carried out on the basis of the Regulation on Handling Accounts Receivable for electric energy transmission services on the balance of JSC IDGC of the North-West by creating the Plan-Schedule of Actions on a quarterly basis and taking the planned actions. The most common actions for collection of overdue accounts receivable are: filing claims to court, making restructuring agreements and offsetting counterclaims of the same kind.

The processes of handling accounts receivable are described in more detail in section 7 of the Annual Report.

Last mile issues

The significant risk factor is the mechanism of cross-subsidization by large industrial consumers of other categories of consumers, including the population. Many large industrial consumers connected directly to the UNEG networks pay for the Company's electric energy transmission services in the cases where the relevant facilities are leased out to the Company under "last mile" agreements made between JSC IDGC of the North-West and JSC FGC UES. In 2010-2013, due to the absence of legislation regulating "last mile" agreements, certain large industrial consumers switched to direct agreements with JSC FGC UES on the basis of court decisions.

In accordance with clause 5 of Article 8 of Federal Law No.35-FZ on Electric Energy Industry of March 26, 2003 an organization for management of the unified national (all-Russian) electric grid may, until January 01 2014, lease out electric grid facilities to territorial grid organizations with the consent of authorized federal executive bodies.

Resolution No. 1173 of the Russian Federation Government on Procedure for Approval of Leasing out Electric Grid Facilities Included in the Unified National (All-Russian) Electric Grid to Territorial Grid Organizations of December 27, 2010 approves the Rules of Approval by the Ministry of Energy of Russia of Leasing out Facilities Included in the UNEG to TGOs. The composition of the UNEG facilities leased out to TGOs from the beginning of 2011 is approved with regard to an opinion (consent) of authorized federal executive bodies of constituent entities of the Russian Federation.

However, pursuant to the above Resolution the leasing out of the UNEG facilities to TGOs shall be approved on the condition of termination of "direct" agreements for electric energy transmission made between JSC FGC UES and electric energy consumers and on the basis of a written request from the head of the relevant constituent entity of the Russian Federation.

In 2011 the Ministry of Energy of Russia approved Decree No. 374 of August 25, 2011, on the basis of which lease agreements for the UNEG facilities for 2012 were made between JSC IDGC of the North-West and JSC FGC UES. The transmission of electric energy using certain UNEG facilities leased by IDGC under "last mile" agreements is accounted by federal and regional governing authorities in the planned volumes of electric energy transmission services for 2012. However, despite this fact, a number of consumers (State Energy Enterprise VOKE, MUE Elektroset in Cherepovets, LLC Vologda Paper Manufacture) who had made agreements with JSC FGC UES refused from payment for JSC IDGC of the North-West services, which resulted, according to the Company's estimates, in reduction in electric energy transmission in the volume of 169 million kWh.

In 2012 the Ministry of Energy of Russia approved Decree No. 403 of August 24, 2012 on the basis of which lease agreements for the UNEG facilities ("last mile" agreements) for 2013 were made between JSC IDGC of the North-West and JSC FGC UES. However, the risk of a shortfall in income due to the consumers' switch to direct contract relations with JSC FGC UES in 2013 remains.

State tariff regulation

In 2012 the Company's tariffs were set in accordance with Resolution No. 1178 of the Government of December 29, 2011, according to which the maximum tariff increase was limited by the Forecast of Social and Economic Development of the RF. The Government set the level of maximum tariff increase for electric energy transmission services in 2012 at no more than 110%. The same maximum increase level was set for further years as well. The maximum increase level can be exceeded only by the amount of tariff funds allocated for realization of investment programs. This mechanism was used by the Archangelsk Region, the Republic of Karelia, the Pskov Region and the Republic of Komi.

In accordance with the Resolution of the Government Commission for Matters Relating to the Development of Electric Energy of July 30, 2012 the Company took actions for development of the mechanisms compensating a shortfall in income of the grid company resulting from termination of the "last mile" agreements. In the Ministry of Energy of Russia meetings were held in 2013 for pilot regions (in the territory of the Company's operation it is the Republic of Komi) with approval of such mechanisms and signing relevant protocols between regional representatives and grid companies. Pursuant to the decisions made by the Ministry of Energy of Russia relevant amendments are planned to be made in 2013 to the regulations which will allow for realization of mechanisms of compensation of a shortfall in income. Negotiations with consumers connected to the "last mile" facilities and the regional Administrations are planned and being conducted in 2013. In the territory of the Company's operation those are consumers of the Vologda Region and the Republic of Karelia. Based on results of such negotiations it is planned to sign relevant agreements on the schedule of termination of "last mile" agreements with realization of mechanisms of compensation of a shortfall in the Company's income.

Equipment Depreciation

The major part of electric grid facilities was built in 1960-70s in accordance with project solutions which do not meet modern requirements. A large number of facilities had been placed into operation during a relatively short period of time which resulted in the relevant large-scale ageing of the equipment park in the 1990s and constant growth of physical depreciation of fixed assets. The slow technical re-equipment and reconstruction of the grid complex did not allow stopping the growth of physical depreciation and resulted in the forced expenditure on repair of both physically and morally obsolete equipment. Only speed-up of technical re-equipment and reconstruction may help to stop the growth of physical depreciation of equipment.

In 2012 72% of the total investment volume was referred to technical re-equipment and reconstruction of the grid complex. In the nearest future the Company will continue investing funds into increasing electric supply of consumers, reducing depreciation of fixed assets, creating conditions for connection of new capacities and development of regions.

Electric Energy Market Layout