Green as camouflage for Kremlin's energy agenda

By bne IntelliNews March 18, 2008

Graham Stack in Berlin -

Far from flooding the carbon trading market with hot air, Russia is posing as an environmental purist and using the green issue to push the Kremlin's energy agenda.

After vacillating for months, Russia's decision to sign off on the Kyoto Protocol in January made the international agreement that is supposed to regulate international emissions of gases harmful to the environment a real document.

One of the quirks of the document was the chance it gave Russia to sell lots of "hot air:" because the 5% reduction target for 2008-2012 took 1990 as its baseline, before Russia's post-Soviet industrial collapse, it handed Russia 300m tonnes of carbon emission indulgences to dispose of. Environmentalists and traders were waiting anxiously to see what Russia intended to do with the Kyoto lottery win. Would Russia swamp the nascent carbon trading market with cheap hot air, allowing European companies to ramp up emissions with impunity and turning Kyoto on its head?

They needn't have worried - the opposite seems to be true. After years of bureaucratic foot-dragging, Russia's paper-pushers have finally drawn up the regulatory framework for joint implementation - the system whereby companies from signatory countries can harvest carbon credits for own consumption or for trading by investing in carbon-reduction "joint implementation" projects in other signatory states.

And the big surprise: far from letting the lottery win go to their heads, Russian officials have outed themselves as environmental purists.

Vsevolod Gavrilov, head of the natural resources department in the economy ministry, announced at a press conference on March 13 that his department will process joint implementation projects - of which 60 have already been drawn up by investors - according to a rejection-based approach. "The most correct approach is forbidding everything, but allowing certain things to go forward. The worst approach is to approve everything, but say certain things are forbidden," Gavrilov said. "We are working according to a principle of rejection - we have no interest in creating the largest carbon emissions market. Our goal is to promote norms of ecological responsibility."

Many potential foreign investors hoping for a slice of carbon credit action in Russia were dismayed at his words, although Gavrilov's statement was consistent with earlier assertions in January that, "the key goal is to attain ecological benefits both globally and locally here in Russia," rather than for Russia to earn big bucks.

Considering that the Russian government originally hemmed and hawed over signing up to Kyoto, leveraging a very strong bargaining position to secure EU consent to its WTO bid, is it really the case that Russian officials are now "greener than green" and intent on implementing the agreement for the sole good of the global environment? Or is Russian bureaucracy simply displaying its usual regulatory zeal? Or is there a more sophisticated Kremlin agenda for joint implementation, as for most everything else these days?

Trailing Ukraine in carbon readiness

The proposed stringency regarding project approval follows a long period of foot-dragging by government over establishing the procedures for joint implementation - meaning that for potential investors, time is running out. "The window of opportunity is closing now that with 2008 the commitment phase of the Kyoto protocol has already started," says Maria Kovalenko, carbon trading analyst at pointcarbon. "Projects have to be completed before 2012, the emissions reduction target date. Newcomers should consider carefully whether there is sufficient time left."

"Ukraine established its procedures in 2006, and they already have one project up and running," she says. Not surprisingly, pointcarbon's CIS office is located in Kyiv and not Moscow. The Ukraine project, the Podolsky cement factory, consists of a €140m investment to replace wet cement production with dry technology. Ireland-based CRH Finance is providing the investment and will acquire the resulting carbon credits.

Konvalenko explains the Russian time lag with the detailed work that the government has performed in establishing procedures for project approval - a testimony to Gavrilov's professed purism. The very real complexity of the process is all down to the concept of "additionality:" joint implementation projects have to prove that the emissions reduction would not take place without the incentive of carbon credits, to cut down on freeloaders' distorting the carbon credit market. Needless to say, the bureaucratic effort in ascertaining this additionality is immense. Joint implementation projects are both subject to approval at the national and UN level to guard against any softening of criteria leading to carbon credit inflation. Thus there is ample justification both for delays in establishing procedures and for future delays in approving projects. "Joint implementation is in itself a very slow process," says Kovalenko.

In Russia, the situation is made even more complex by the currently distorted incentives set by state-controlled prices for power and gas - controls that are about to be phased out. This means that rising domestic energy prices will anyway force companies to invest in improving energy efficiency, without any need for the additional incentive of selling carbon credits.

So the ministry, argues Astrid Moe of Norway's Fridtjof Nansen Institute, has a powerful argument for handling joint implementation strictly: to fence off "real" carbon reduction emissions from simple energy efficiency improvement stimulated by price rises. "I believe the Ministry of Economy wants to steer [joint implementation] into projects where new technology is needed and let the bulk of easy reductions be taken care of by price reforms, as well as emissions trading further on."

This is view is shared by Ingo Ramming, executive director of Carbon Trading and Finance, a joint venture established by Gazprombank and Dresdner Kleinwort. "This is a very important statement," argues Ramming, referring to Gavrilov, "coming against the background of controversies last year about projects in India and China where the additionality of projects was disputable. It seems the Russian authorities wanted to make quite sure about additionality. I would even say it was an important statement upholding the credibility of joint implementation in Russia.

This seems to back up eco-purist Gavrilov when he says, "unfortunately not all the investors are taking this opportunity the right way, some see it as a way to get a freebie without doing any work. We want to avoid these speculative projects."

Green as camouflage for energy agenda

However, Gavrilov not only surprised potential investors by the stringency of his department's approach and his green purism, he also surprised them by naming Russian oil major Surgutneftegaz as a shining example of how to implement carbon emission reductions - by capturing the associated gas for power generation instead of simply flaring it.

This relativises Gavrilov's ecological credentials: since 2007 it has been established Kremlin policy to clamp down on flaring. President Vladimir Putin even mentioned the issue in his last state of the nation speech in April of 2007. Government ministries have started drawing up regulatory measures to encourage a shift towards utilizing associated gas. The Kremlin's motivation is for cutting flaring is, however, not ecological, but to maximise Russia's energy clout. This raises the question of whether the tight bureaucratic supervision, combined with the small remaining window of opportunity for joint implementation projects, is not intended to channel Russia's carbon credit wealth towards strategic projects backed by the Kremlin.

The case of associated gas is one where Kremlin strategic goals and carbon emission goals coincide. However, a carbon-reducing classic - switching power generation from coal to gas - fundamentally contradicts Gazprom's ideas about how the Russian power sector should develop, and is thus likely to be a non-starter.

Gazprom is lobbying for exactly the opposite to happen: for an increase in the use of coal in Russia, to free up gas for more profitable exports. A planned rise in gas prices should stimulate this process. Gazprom has also just been given the go ahead to merge its considerable power generation assets with those of the SUEK coalmining concern, paving the way for increased use of coal domestically. According to Moe, this means that joint implementation projects envisaging a coal-to-gas switch for Russia are unlikely to win approval, however impeccable their environmental credentials. Russian regulatory authorities have the power to simply delay project approval until time runs out for implementation. So Gazprom's preferences are likely to shape policy regarding carbon credits as it does in most other policy spheres as well. And all the more so for that Gazprom is hatching big carbon plans itself.

Phillip Dewhurst, head of PR at Gazprom's London subsidiary Gazprom Marketing and Trading, a vehicle for global carbon credit trading, calls Russia "the Saudi Arabia of carbon." Gazprom M&T has already made its debut on the world's carbon trading market, acquiring carbon credits by investing in a Brazilian bioethanol plant and selling to Japanese company Marubeni. According to Gazprom M&T, however, these deals were just testing the water. Gazprom's ultimate aim is to set up a scheme systematically bundling carbon credits with its own natural gas sales, marketing the package as "carbon-neutral gas." In this way, Gazprom can leverage Kyoto to expand market share in Europe, in particular facilitating direct access to industrial customers, one of its long-term strategic goals.

And Gazprom is not going to be short of carbon credits. According to Anna Korppoo also of the Fridtjof Nansen Institute, 52% of proposed joint implementation projects and 60% of proposed emission reductions in Russia involve refurbishing gas pipelines to reduce leakage. This means that Gazprom, monopoly owner of Russia's gas pipelines, will be the driving force behind joint implementation in Russia. Korppoo notes that gas pipeline projects involve a minimum of foreign actors, some of which are anyway Russian companies registered overseas.

In general, Korppoo notes revealing details about proposed joint implementation projects in Russia compared to Ukraine: an extreme concentration of the Russian projects in few hands, with only 17 foreign actors spread between 38 projects, compared to 15 foreign partners for a total of 15 projects in Ukraine.

These figures also point to joint implementation in Russia being nationalized to further the Kremlin's strategic goals - with restrictive bureaucratic means being used to channel credits to national champions, while maximizing their value by restricting supply to the market as a whole.

Green fields for biofuel, blue skies for Sukhoi

It's hardly by chance that the same week Gavrilov outlined government policy on joint implementation, a trio of political heavyweights called on biofuel to become an important new string in Russia's energy bow. Russia currently has no bioethanol production, but the agriculture ministry estimates there are 20m hectares of idle arable land that could be brought back into use for biofuel production - supported by carbon credits.

No less than Vladimir Putin got the biofuel ball rolling. "Considering that the significance of biological fuel in the global energy sector is steadily growing, special attention will now be paid to countries that have enough arable land to ensure the necessary amounts. Certainly, Russia will occupy a special place among these countries. This is becoming no less important for us than the use of common national resources in the hydrocarbon sector," Putin said at a meeting with top officials of the State Duma on March 11, according to Interfax.

Duma speaker Boris Gryzlov was even more direct, saying: "we should capture this market, and then we will dictate our terms not only on the sale of gas and oil, but also of biofuel. This is a realistic opportunity for us."

The day after Putin's call for action, Prime Minister Viktor Zubkov, attending a timber industry conference, announced a state programme to be launched with the goal of achieving 2m tonnes of biofuel production per year, including construction of some 30 biofuel plants. The timing of his announcement in front of timber industry representatives might indicate future utilization of timber waste for bioethanol production, something done in Soviet times - and also chiming with Kremlin plans to increase added-value in the forestry industry,.

The Kremlin carbon agenda is not limited to energy. At least one of the Kremlin's pet high-tech projects is also lining up to gain from the carbon credit bonanza: Russia's flagship civil aviation project, the Sukhoi Superjet, a state of the art medium-range passenger plane yet to go to serial production, boasts significantly lower carbon emission values than its competitors - making it eligible for carbon credits under Kyoto. As Maria Konvalenko of pointcarbon points out, "in Russia a lot of business is very close to politics, and sometimes it is simply the same."

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