Russia Energy: Regressive new energy strategy hinders development of clean tech
- Energy Strategy 2035 is regressive and prioritises selling hydrocarbons to the world over new technology
- Stringent localisation requirements and unpredictable US$-based returns have discouraged investment in renewable energy
- We estimate that more rounded policies could attract over US$2bn of annual investments until 2030
Russia’s Energy Strategy 2035, adopted in April 2020, prioritises selling hydrocarbons to the world over embracing new technologies, such as renewable energy. Indeed, it regards anything that hinders Russia’s production (and export) of oil, gas and coal as threats.
The policy is not only at odds with President Putin's ambitions to lead the climate change response, it serves as another stumbling block for Russia's renewable investments, which have already been impeded by (among other things) two key problems: 1) requirements that 65-70% of the materials involved in the construction of renewable energy facilities should be made in Russia (aka localisation requirements) and 2) unpredictable risk-adjusted returns.
In this report, we also discuss why Russia might not meet its (very minimal) clean energy target, analyse the outlook for the country's electricity generation up until 2030 and look at the size of the opportunity for renewable sources of energy.
In the following tables, we also look at some of the major current solar and wind projects in Russia. So far, US$4.5bn (1.9GW) of solar projects and US$5.5bn (3.4GW) of wind projects have been selected through competitive auctions which is only a fraction of the total opportunity size of US$7.7bn (6.1GW) of solar and US$21.1bn (19.4GW) of wind energy.
Problem 1: Localisation requirements – too much, too soon
Russia's renewable equipment manufacturing industry is at a nascent stage. Mostly, the industry comprises joint ventures between foreign companies and Russian power companies and component manufacturers; this has helped reduce planned capital costs by more than 50% since 2015. Some of these joint ventures in wind power include:
Vestas Manufacturing RUS LLC (the technology partner for Finland's Fortum and state-owned Rusnano Wind Energy Development Fund);
WRS Towers LLC (a partnership between Spain's Windar Renovables, Rusnano and Russian steel-maker PJSC Severstal); and
Madrid-listed Siemens Gamesa Renewable Energy's JV with Siemens Gas Turbine Technologies (which is also a JV between Siemens and Russia's Power Machines).
Meanwhile, for solar photovoltaic (PV) technology, Hong Kong-listed Harbin Electric's subsidiary has set up Solar Systems LLC to produce PV panels in Russia, while local companies like Hevel Solar can produce more than 340MW of solar modules annually with up to 23.5% cell efficiency.
However, a major impediment to an expansion of renewable energy investment in Russia is the requirement that, in terms of the materials involved in the construction of facilities, 70% of solar and 65% of wind and small hydropower projects should be made in Russia. If an investor does not satisfy these localisation requirements, the final tariff (which is approved after the commercial operation date) can fall by up to 65% and 55% for solar and wind projects, respectively. As a result, project deliveries have been running behind schedule. As of 2018, only 59% of solar and 13% of wind capacities (selected through competitive auctions) had managed to come onstream.
The current renewable energy policy only runs until 2024. To attract more international renewable developers, Russia must first commit to the the long-term role of renewable energy in its overall fuel mix and relax the localisation requirements, but this is challenging without a clear decarbonisation agenda. Indeed, Energy Strategy 2035 is a testament to Russia's unwavering reliance on its hydrocarbon reserves, at the expense of the development of clean energy in the country.
Problem 2: 'Unpredictable' risk-adjusted returns
Based on the publicly available policy papers and projects installed so far, we observe that the tariffs offered by the Administrator of Trade System (ATS) aim to ensure a project internal rate of return (IRR) of 12% for a 15-year power purchase agreement (PPA). However, the tariffs are not indexed to the US dollar, which is a regular feature in many emerging markets to ensure a US$-based return to attract foreign investment in renewable energy. Without this, the returns for foreign investors on renewable energy plants could be lower in the event of the Russian ruble's depreciation against the US dollar, which is more likely in the context of lower-for-longer oil prices fuelled by the transformation of the global energy market towards cleaner sources and, more recently, the Covid-19 pandemic.
Low electricity prices in Russia (estimated at US¢8.1/kWh, US¢6.8/kWh excluding 20% VAT) further exacerbate the unattractive investment case. If allowed, higher feed-in tariffs (FiTs) would add to the inefficiency of Russia's power sector, which received subsidies on electricity worth US$13.7bn in 2019 (or 17% of total cost). If we assume the feed-in tariffs (FiTs) for renewable energy projects are equal to US¢6.8/kWh (thus allowing the power sector to run efficiently), the estimated US$-IRRs would range from 3.4-16.8% for solar and 12.7-19.9% for wind (assuming stable RUB:US$ parity and 2019's average capital costs of US$748/kW and US$974/kW for solar and wind projects, respectively ). The risk-adjusted returns, however, could be as low as negative to 7.0% if the ruble continues to depreciate 5% yoy against the US$ (as seen in the last 12 months).
To be able to offer more attractive returns, Russia could also bring its electricity prices in line with the EU average (currently 2.8x higher). The dilemma, however, is that energy is still considered a public good in Russia and any attempt to increase electricity prices will receive heavy criticism. Moreover, the increase in electricity prices will reduce the competitiveness of Russia’s industries, especially metals, which are energy-intensive and comprised 9.3% of the country’s exports in 2019 (or 2.4% of GDP).
Electricity outlook in Russia
Russia's energy demand set to increase c60% by 2030
We assume Russia's 2017 per-capita electricity consumption of 6,661kWh will grow in line with its GDP/capita growth (13-year, 2018-30 CAGR of 3.8%). As a result, the country's total consumption could stand at 1,557bn kWh in 2030, c60% higher than its 2017 consumption.
The share of renewable energy in total electricity production could only reach 1.1% by 2024
In 2017, 17% of Russia's electricity was produced from renewable resources, while solar and wind combined stood at a meagre 0.1%. By 2024, these renewables could reach a maximum 1.1% of the total electricity generation (according to the capacity targets stated in Order No. 1472-R). However, according to the renewable energy scenario (or REmap) published by the International Renewable Energy Agency (IRENA), the share of solar and wind combined could reach 3.4% by 2030, while the share of total renewable sources could reach 34%.
The size of the opportunity in Russia for renewable power capacity until 2030
It is estimated that the installed capacity for solar and wind energy stood at 818MW and 135MW, respectively. Based on the projects that have been selected through competitive auctions since 2013, solar capacity could reach 1,858MW by 2024 (higher than 1,520MW national target), while the wind capacity could reach 3,377MW (lower than 3,600MW national target). However, based on the generation targets laid out in IRENA's REmap, we estimate Russia's solar and wind capacities will have to increase to 6,066MW and 19,391GW (respectively) by 2030. This will require an estimated investment of US$3.4bn and US$17.4bn in solar and wind projects, respectively, between 2020 and 2030.
This is the second in a series of reports on the future of clean energy tech in emerging markets, which kicked off with a report on Vietnam.
- 1 Strategy Note/Global Turkey can't avoid conflict and can't afford war
- 2 Strategy Note/Kuwait Kuwait’s crown passes to 83-year-old successor amid fiscal challenges
- 3 Weekend Reading/Global Offshoring to accelerate post-Covid: Our new index shows the EMs set to benefit
- 4 Flash Report/Global Lebanon: H1 bank results throw a spotlight on an economy in freefall
- 5 Strategy Note/Global Emerging-Frontier Equity Monthly, September: EM Tech and FM outperform
This report is independent investment research as contemplated by COBS 12.2 of the FCA Handbook and is a research recommendation under COBS 12.4 of the FCA Handbook. Where it is not technically a res...