Russia is revving up to launch a four-decade-long, RUB480 trillion ($6.5 trillion) investment campaign to reduce carbon emissions by 60% before 2050 from 2019 levels, of which RUB89 trillion ($1.2 trillion) will come from public funds.
President Vladimir Putin offered an optimistic scenario of Russia’s attempts to reduce its CO2 emissions during his speech at the Russia Calling! Conference on 30 November.
The president said Russia could reach carbon neutrality even earlier than the 2060 target if all the goals in the plan are met on time. The country has “a whole set of tools for reducing the economy’s carbon intensity” and a comprehensive roadmap will be ready by March 1, 2022.
The president also promised Russia will develop renewables and hydrogen projects (including green hydrogen), and will benefit from the current large share of low-carbon generation in the mix.
“The country should also use the absorption potential of its forests, fighting forest fires more effectively and growing new forests,” said Putin, highlighting a big part of Russia’s plan to reduce its emissions.
Then on July 1 next year Russia will formally launch a massive climate initiative with the goal of reaching carbon neutrality by 2060. A new programme of energy efficiency will also be finalised by October 1, 2022.
After a slow start a string of environmental disasters in 2021 seems to have woken the Kremlin up to the dangers and encouraged it to grasp the nettle. As bne IntelliNews has reported, Russia’s permafrost is melting and could cause over a trillion dollars worth of damage to the Russian economy.
Russia has a relatively good starting point as, featured in the Cost of carbon in Russia, the collapse of the Soviet Union and the subsequent investment into modern equipment and technology have already seen emission levels fall dramatically over the last three decades. And on top of that, Russia is home to the largest forests in the world. But at the same time, it also hosts some of the most polluted places on the planet and any emissions by Russia are big emissions, as the country is so vast. Russia has a key role to play in the fight to avoid a global warming catastrophe.
The rate of temperature rise in Russia is now triple that of the global average. This summer was plagued by wildfires over territories the size of European countries.
In addition, warming weather led to a power unit belonging to Norilsk Nickel spilling over 20,000 tonnes of oil into Arctic rivers in the Pyasino region in June 2020, which was declared a federal emergency by the Kremlin and cost Norilsk $2bn in fines. Also in June 2020, a once-in-a-1,000 year snow melt flooded the TGK1 power station near Murmansk, putting two of its hydropower units out of action. A few months later, in October 2020, an unusual algae bloom off the coast of Kamchatka killed all sea life along several kilometres of coastline. And most recently Russian oil major Lukoil spilled 100 tonnes of oil in the Komi Peninsula, although very little of that got into the local rivers that flow into the Barents Sea.
Decarbonising Russia is going to be expensive. The effort, so far, has been led by Russia’s leading corporations after some found their shares excluded from Scandinavian pension funds for their poor environmental, social and governance (ESG) scores. For example, the world’s biggest nickel producer, Norilsk Nickel, spent over $2bn on cleaning up its act but complained that the money spent “adds nothing at all to the bottom line. It's pure cost.”
VTB issued a reports last week that looked at some of the cheaper and easier things Russia can do to reduce its emissions and estimated they can be reduced by a quarter for a price tag of RUB43 trillion (the equivalent of 1.3% of GDP per annum), and 50% of them for RUB86.6 trillion (2.7% of GDP per annum).
“In comparison, cutting 100% of emissions would require an astronomical RUB479.8 trillion by 2060 (or 15% of GDP),” VTB Capital (VTBC) analysts Vladimir Sklyar and Anastasia Tikhonova said in a report “ESG & Decarbonisation.”
“The cheapest ways to achieve these targets include tackling waste disposal, reducing emissions, decarbonising the power sector and undertaking forestry projects. These account for 59% of total emissions in Russia and can be decarbonised for RUB102.7 trillion ($1.4 trillion), we estimate. That broadly matches MinEconomy’s RUB88.8 trillion 60% CO2 reduction programme. Transport remains the most expensive sector to decarbonise, followed by cement and iron ore & steel,” the analysts said.
As these investments are pure cost they will come with price rises to close the gap. The most substantial price hike to foot the CO2 removal bill is required in the power (28% end-user price increase) and cement (40%) sectors, says VTBC. Decarbonising the oil & gas and metals & mining sectors would have a minimal effect on product pricing, the bank adds.
“Full decarbonisation requires annual capex at 5x annual EBITDA for transport, 2-3x for cement/chemicals, 1-1.5x for the power sector and waste, and less than 1x for oil & gas and M&M, keeping the dividend prospects in these sectors the highest in the economy, which is going through a green transformation,” VTBC said.
One of the key issues is what price the cost of carbon is set at, as this is the mechanism that has been adopted to price the cost of reduction and how to pass these costs on to consumers and government. A market for carbon has emerged in Europe and it currently values the cost of carbon at $50 per tonne, but governments are still setting prices arbitrarily, with the Scandinavians putting the cost at over €100 per tonne but poor countries like Ukraine estimating the figure at under $1.
At the start of the year Russia launched an experiment on the island of Sakhalin where it introduced market mechanisms for costing carbon that put the price at around $25 per tonne. Putin said in a speech this week that the Kremlin was ready to expand the experiment to other regions in Russia. But Russia has yet to launch the all important carbon trading system, where the price of carbon is the keystone.
“Our research indicates that Russia can halve its emissions using a carbon price of only $30/tonne. After the quick wins by 2030, the CO2 removal capex is set to rise as decarbonisation activities move away from methane and the power segments,” VTBC said.
During his speech at Russia Calling! Putin also said that he has ordered the Ministry of Finance and Central Bank of Russia (CBR) to work out tax credits, subsidies and guarantees for companies undertaking green projects also by March 1, 2022, when a register of climate projects will be finalised.
The cost of the programme means that MinFin and the CBR will play key roles, as the spending is bound to be inflationary at a time when Russia is already struggling to contain rising prices. “We think that 40-year decarbonisation could add as much as 12% to the real price increase (or a proportionate margin contraction),” the analysts at VTBC estimate.
Looking for cheap solutions
With its abundance of cheap fuels of all kinds and the wasteful habits of the Soviet era Russia is the third-biggest emitter of GHGs in history on a cumulative basis.
Russia’s officials are now looking for the cheapest ways they can find to decarbonise and adopting a “technology neutral” approach, where anything goes as long as it works.
Another factor going into the mix is some projects will actually make money, such as recycling projects or burning waste for fuel rather than dumping it in a methane-generating landfill, and these programmes can go ahead without the need for carbon pricing or a trading system.
“Russia is capable of delivering significant quick wins, even without decarbonisation capex rising significantly from present levels. Existing power sector investments planned until 2030 could lower the energy CO2 intensity 21% and waste management can be decarbonised with a negative cost, while oil & gas and coal companies can fit the CO2 reduction costs into their existing capex programmes (as regards methane emission reductions). Forestry projects also remain a competitive way of national decarbonisation,” VTBC said.
The Ministry of Economy’s plan so far is spread across a number of sectors, but is concentrated on improving energy efficiency and management, eliminating emissions through leakage, and undertaking various forestry projects. The most expensive heavy capex version of reducing emissions is going to be put off until later, after 2030.
“The cheapest decarbonisation options in Russia are still cutting methane emissions (in both oil & gas and coal mining), reducing the power sector’s footprint (through a greater share of renewables) and forestry projects. These three areas account for 59% of gross national emissions, on our estimates, with the full decarbonisation of these industries costing RUB102.7 trillion in capex,” VTBC said.
The oil, gas and power companies will bear the brunt of the costs in the first stage, but reducing their methane leakage will be negligible for the hydrocarbon producers.
The greatest effect on consumers from these investments is going to be the upward pressure on electricity prices. VTBC estimate that end-user electricity prices would need to rise 28% to accommodate sufficient decarbonisation funding for the sector (in a 100% scenario).
Later on, the mining and transport sectors are going to be the expensive ones. VTBC estimated that transport alone will consume a third of the entire RUB480 trillion that is going to be invested, or about RUB145 trillion, as the railways will have to replace its entire ICE fleet with electric vehicles.
However, costs will go up everywhere. With a focus on avoiding the capex-heavy solutions, the answer will be to improve energy efficiency and savings everywhere. That means things like new regulations for washing machines to force them to switch to more efficient motors, better waste management, retooling factories everywhere and investment into construction efficiency. And decarbonising households is one of the most expensive options for the economy and unlikely to start at the beginning, as those costs will fall on the public. “We do not anticipate any rapid decarbonisation of the average Russian household until 2060,” says the VTBC analysts.
A large share of these costs can be pushed on to the companies and VTBC estimates they will add some RUB7.4 trillion ($54bn) in annual additional payments for the goods and services. All this together will probably send prices up by about 12%.
“Our study shows that full decarbonisation would require a significant step-up in investment across the sectors (except for oil & gas). For some sectors, such as power, transport and chemicals, this step-up might translate into a two-three-fold increase in investments. However, we note that the existing CO2 reduction targets are milder and can generally be dealt with as part of Russian corporates’ announced investment programmes (except for the power sector),” says VTBC.
All this spending will also be a heavy burden on Russia’s investment case, as it will eat into free cash flows that are currently being paid out to dividends to shareholders; Russia currently has the highest dividend payout yields in the world – about twice those of the MSCI EM benchmark average.
As much of the capital expenditure will actually borne by companies and not the government, the amount of money they will have invest will also eat into their profits. VTBC estimates that in most sectors the current capex spending in most companies’ business plans is insufficient to cover the necessary investments to reduce emissions by the required amount. The extremes are in oil & gas, where the companies have plenty of money and the investments are relatively cheap, and the power sector, where the investments are huge and could wipe out the sector’s entire profits.
The government, of course, will also play an important role and has targeted boosting Russia’s renewable energy capacity and expanding its already extensive nuclear power production. Despite the legacy of Chernobyl, Russia’s nuclear technology is now considered to be world class and Russian nuclear exports are booming as a result.
The government also plans to significantly step up forestry projects and launch wide-scale carbon capturing, predominantly by oil & gas companies. Further down the line more of Russia’s hydrocarbon reserves will be re-tasked from a fuel for export to become the feedstock for a hydrogen production business. Although decarbonisation measures are planned in other sectors as well, the lion’s share of the activities will be concentrated on measures to keep Russia’s CO2 abatement curve relatively low.
“MinEconomy’s intensive decarbonisation strategy scenario envisages using the best and most efficient technologies, with measures to introduce, replicate and expand low and carbon-free technologies, encourage the use of secondary energy resources, change the tax, customs and budgetary policies, and develop green finance,” the VTBC analysts said.
“There are also measures to preserve and increase the absorptive capacity of forests and other ecosystems, and support technologies for capturing and utilising greenhouse gases [GHGs]. The strategy requires GHG emissions to be reported, rather than the requirement of the potential carbon pricing and trading quotas (the preliminary version envisaged it coming into operation after 2030, at RUB500-700/tCO2e),” VTBC concluded.
MinEconomy estimates that by 2050, this would make it possible to cut emissions 60% from the 2019 level and 80% from the 1990 level. The total investment for decarbonisation is estimated at 1% of GDP in 2022-30 and 1.5-2.0% in 2031-50. The additional growth in GDP due to this investment is expected to exceed the spent funds by 25%.