09.08.2008
Renewable Energy in Russia’s Future
№3 2008 July/September

President Dmitri Medvedev has begun to outline what could become
a serious Russian initiative to address the environmental impact of
profligate energy use and to encourage greater energy efficiency.
In a decree signed by the President on June 4, the government was
instructed to submit draft legislation to the Duma by October 1,
2008 which would provide incentives for introducing environmentally
friendly and energy efficient technologies. The order also calls
for allocating funds in the 2009-2011 federal budget for renewable
energy and providing subsidies for specific projects. These steps
may indicate that the elements of a broader domestic energy policy
extending beyond the oil and gas sector are now being put in place.
All this is occurring at the same time that Russia is making clear
its intention to play a larger role in the international effort to
address climate change and global warming.

Russia’s new policy direction – and particularly its nascent
interest in alternative energy – is important because Russia is
such a large energy exporter (number one in natural gas and number
two in oil), and is now the third largest emitter of CO2 from
fossil fuel (behind China and the United States. It is also
significant because President Medvedev has coupled his complaints
about the wastefulness of Russian industry and the lack of
environmentally sound technologies with the need to improve
Russia’s international competitiveness and develop technologies key
to the success of his “innovation strategy.” Over time, a more
diversified energy policy could also open up avenues for
entrepreneurial businesses in Russia as well as partnerships with
some of the fastest growing energy sectors in the United States and
Europe.

Russia has abundant oil, gas and coal productive capacity backed
up by enormous reserves, but it also has the potential to be a
giant in the area of renewable energy. Existing renewable
technologies for harnessing wind and solar power are available to
augment current energy supplies and could serve isolated
populations currently off the electricity grid, while biomass from
numerous forests and croplands around the country, numerous
watersheds in the eastern part of the country, tidal potential in
the White Sea and the Sea of Okhotsk, and geothermal fields in the
North Caucasus and in the Kamchatka Peninsula could be developed to
supplement current energy sources.

Yet in Russia in 2005, renewable energy sources accounted for
about 3.5 percent of the country’s total primary energy supply
(TPES), while globally renewable energy is the fastest growing
energy source today – some 13.5 percent of global energy supply.
(If hydro is excluded, renewable energy sources account today for
only 1.2 percent of Russia’s TPES, and by 2010 might account for
about 1.9 percent.)

Russia’s huge hydrocarbon (oil and gas) resources, low domestic
energy prices, weak economic incentives, and the lack of a
requisite legal structure to develop a renewable energy sector are
some of the reasons Russia has lagged behind in the development of
a renewable energy sector. At present, Russia does not fall within
the top 25 countries making investment in renewable energy
attractive and increasing the use of renewables – even though some
others in the top 25 are also energy rich (i.e. Norway and
Australia). Both in domestic debate and in international fora,
Russia’s potential is rarely discussed.

Why has interest in renewables lagged? The low level of state
support, a focus on other priorities – such as the urgent need to
upgrade existing infrastructure – and an almost complete lack of
public debate and understanding of the role renewables could play
are all important factors. With an economy based on abundant
reserves of oil and gas, not only is very little state budget money
allocated for the development of renewables, but there are few
incentives to invest in alternative sources of energy. The current
focus of economic policy is on investment in the “national
priority” projects, state corporations, and in major strategic
sectors. Companies may be hesitant to risk millions of dollars in
sectors or industries that the state appears to find less
attractive and they will want to wait for a more favorable
political and legal environment before undertaking costly projects.
The well-trodden path of innovation in the West – small startups
with innovative ideas that then become mainstream – is not easy to
transfer to any sector of the Russian economy.

RUSSIAN INCENTIVES TO DEVELOP RENEWABLE ENERGY

The incentives that could drive the development of renewable
energy in Russia are not as clear as they are for the U.S. – which
is trying to become less dependent on Middle Eastern oil – or for
Europe – which is trying to reduce reliance on Russian gas amidst
recent concerns about supply disruptions. Russia, as both a major
energy producer and exporter, has few incentives to develop
renewable energy sources. Given the difficulty of raising domestic
energy prices in Russia and a possible shortfall in gas and oil
production, expanded use of renewable energy sources at home could
save some expensive hydrocarbons. Using renewables could over time
free more oil and gas for export, but probably not enough to make
much of a difference.

A stimulus for growth in this sector globally has been growing
concerns over pollution levels and global warming. At present,
public consciousness in Russia on this issue remains lower than in
the West. However, given Russia’s close proximity to the glaciers
melting at the North Pole, as well as the extensive permafrost
covered regions of Siberia and the Far East, the impact of climate
change is likely to be great. Recent articles have highlighted the
threat from global warming to the environment, to small native
populations and to animal life in the Far East, as well as future
dislocations caused by melting of the permafrost. But given the
immediate social and economic problems facing the Russian
government, encouraging the use of renewables and energy-efficient
technologies to solve long-term problems does not rank high.
Renewables may have economic and environmental benefits, but they
are no panacea for tackling more acute problems, such as energy
inefficiency.

POTENTIAL MARKET FOR RUSSIA’S RENEWABLE ENERGY PRODUCTION

In 2003, some 10 million people not connected to the Russian
electricity grid relied on costly delivery of fossil fuels to
remote areas. In Russia’s largest entity, the Republic of Sakha,
for example, fuel and transportation accounted for around 75
percent of the cost of all municipal services in 2006. The annual
cost only of transporting fuel to the republic was estimated at 1.2
billion rubles (over $50 million) in 2007. These costs give a rough
indication of the potential market for renewable energy systems in
Russian regions like Sakha if greater investments were made, for
example, in off-grid electricity systems based on wind power.

The majority of the wind energy potential is found in Russia’s
far northern and eastern territories. Wind energy can be exploited
in Russia’s North West (i.e. Kaliningrad Region, Republic of
Karelia, and Arkhangelsk Region), the North Caucasus (i.e. the
Krasnodar Territory, the Rostov Region, Republic of Dagestan,
Republic of Kalmykia, and the Astrakhan Region), Siberia (i.e. the
Tyumen Region and the Novosibirsk Region,) and the Far East (i.e.
the Magadan Region, the Khabarovsk Territory, and the Sakhalin
Region). Some international cooperation on wind energy projects has
already begun. For example, Denmark helped Russia with the
construction of a wind power station in the Kaliningrad Region in
2002; Norway’s Troms Kraft in 2005 announced plans to build a wind
power station on the Solovetsky Island in the White Sea; the Czech
Republic’s Falcon Capital plans to build a wind farm in Kalmykia by
2010; Spain’s Iberdrola Renovables is planning a wind farm in the
Krasnodar Territory by 2011; and the Dutch company Windlife Energy
has plans to build a wind park in Murmansk Region. Russian HydroOGK
is also engaged in several wind power projects. For example, the
company plans to increase wind power capacity in Kalmykia from 1
megawatt in 2007 to 9 megawatts by 2010. The company has announced
a pilot investment program running to 2010 and sees opportunities
for domestic manufacturers of wind energy equipment.

Russia’s biomass resources include waste from forest industry,
agriculture, and other sources (municipal solid waste and sewage
waste). These resources can be used for the production of biogas,
butanol, ethanol, and other bio-fuel products. For example, driven
by domestic demand and export opportunities, the number of
producers of wood briquettes, pellets, and woodchips in Russia’s
North-West is estimated to have increased 10 times in the last five
years. Finland’s Wartsila Corporation has already delivered a
number of bio-energy boiler units for heat production to wood
processing companies in Russia, including a significant order for
the Irkutsk Region.

Russia’s agriculture industry has shown some interest in
supporting bio-fuel projects, many of which are supported by
regional authorities. In 2007, the Russian government
announced plans to invest 4.6 billion rubles (about $181
million) between 2008 and 2012 for increasing rapeseed
production to boost bio-diesel supply. In March 2008, then Prime
Minister Victor Zubkov announced that a new government program
would provide financial support for the construction of 30 new
bio-fuel plants, as well as for upgrading existing facilities. If
implemented, this could eventually increase bio-ethanol production
in Russia to 2 million tons per year. Construction plans for
bio-ethanol production plants have been announced in various
regions.

At present, these projects are often oriented toward export
because Russia’s current excise tax policy makes it more profitable
to export bio-fuel products than to sell them domestically.
According to estimates, the production cost of bio-ethanol in
Russia for transportation purposes is in the range of 25-35 cents
per liter, but an excise tax of 26 rubles (about $1.10) per liter
of bio-ethanol is added to the cost, making production of fuel
ethanol cost prohibitive for domestic use. Thus, Russia’s emerging
bio-fuel sector is primarily driven by the European Union’s growing
demand for bio-ethanol, rapeseed-based bio-diesel, and wood fuel,
rather than by domestic market conditions. Moreover, the country
does not yet have a unified standard for bio-diesel production. The
Russian National Bio-fuel Association organized its second
international forum on fuel bio-ethanol in April 2007 and a third
one in April 2008.

Solar potential is greatest in Southwest Russia, near the Black
Sea and the Caspian Sea, and in Southern Siberia, i.e. in the Altai
Republic. In 2006, former President Mikhail Gorbachev called upon
the leaders of the G8 to create a $50 billion Global Solar Fund
over 10 years to promote solar energy projects. No action appears
to have been taken to establish this fund. Nevertheless, private
initiatives to promote solar energy projects are moving ahead. For
example, the U.S.-based company Solar Night Industries, Inc. has
recently established an office in Moscow to further promote solar
energy research and technology commercialization. Nitol Solar,
Russia’s producer of silicon for solar panels, has recently
announced plans to list on the London Stock Exchange and expressed
interest in promoting the use of solar energy applications.

Russia’s substantial geothermal resources are located in
seismically active areas on the Kamchatka Peninsula, the Kuril
Islands, and in Sakhalin. Two functioning Mutnovsky geothermal
power stations in Kamchatka have already significantly increased
local electric power supply. In 2006, Iceland’s authorities
expressed interest in cooperating with Russia to build more
geothermal plants on Russian territory. In 2007, the top three
countries generating electricity from geothermal energy were United
States, Japan, and Iceland. Russia was not even in the top ten.

Russia is using about 20 percent of its economically viable
hydropower resources, with the extent of use varying from 48
percent in the European part of Russia, to 25 percent in Siberia,
to three percent in the Far East. (For comparison, the United
States, Canada, several countries in Western Europe, and Japan are
using from 50 to 90 percent of their resources.) Most of Russia’s
hydropower potential is in Central and Eastern Siberia and the Far
East. Russia ranks second after Brazil in terms of the level of
annual river runoff in the world. HydroOGK has an ambitious plan to
invest around $65 billion for renewable energy projects and plans
to double its installed capacity of electricity production by 2020.
HydroOGK has plans to build up to 20 mini-hydro power plants in the
North Caucasus by 2010.

Anticipating the adoption of renewable energy laws, Russian and
foreign investors are now beginning to explore investment
opportunities for hydropower. For example, Japan’s Mitsui and
Norway’s Statkraft are considering proposals to build a number of
hydropower plants in the North Caucasus. In addition, the federal
government is ready to financially assist HydroOGK with
construction of the Mezen Bay tidal power station on the White Sea,
which would supplement the existing Tugurskaya tidal power station
on the Sea of Okhotsk and the Kislogubskaya tidal power station on
the Barents Sea.

Several Russian investment companies, including Mikhail
Prokhorov’s Onexim Group, are seeking to implement hydrogen-fuel
projects. Interros and Norilsk Nickel have invested in the
U.S.-based Plug Power Inc. in 2006 to further promote hydrogen and
fuel cell technologies. The National Innovation Company “New Energy
Projects,” founded in 2005 and headed by Boris Kuzyk, promotes the
development of hydrogen technologies in Russia, some of which can
enhance solar or wind-powered generators. The company’s programs
emphasize the importance of developing a renewable energy sector in
Russia. Looking further ahead, Russian Minister of Industry and
Energy Victor Khristenko in the spring of 2007 announced plans to
use hydrogen-fueled buses at the 2014 Olympic Games in Sochi.
Holland’s European Technology and Investment Research Center
(ETIRC) is going to provide Sochi with conversion technologies for
gasoline and diesel oil buses to be powered by hydrogen. ETIRC also
has plans for hydrogen fuel projects in the Irkutsk Region, whose
administration signed an investment agreement with the Dutch
company in October 2007 to launch coal-to-fuel projects in the near
future.

WHAT IS TO BE DONE?

A favorable environment for the renewable energy market would
include four elements: a clear articulation of national goals by
Russia’s political leadership; passage of new legislation providing
a more solid legal framework, as well as subsidies and other
incentives for investing in renewable energy; greater public
interest and support at home; and partnerships between domestic
industry and international companies to kick-start a viable
market.

In general, growth in demand for renewable energy is highest in
countries that have made renewable energy development one of the
focal points of national energy policy. Including renewable energy
in national energy policy is an important first step toward
increasing the attractiveness of investment. So is establishing
quantifiable renewable energy targets that set a minimum percentage
of energy supply in a given country or region. Market players view
such goals as encouraging signals that investment in renewable
energy is welcome and will be rewarded. For example, Renova is
interested in participating in Russian wind and solar projects, but
is waiting for the introduction of state subsidies for electricity
generation from renewable sources.

In Russia, political signals matter greatly, but, increasingly,
so do economic ones. If the focus of political leadership continues
to be on gas and oil production and if the state budget continues
to rely heavily on tax revenues from these industries, there will
be few incentives to innovate and develop new resources on a
significant scale. In the future, however, as domestic gas prices
increase and the cost of renewable energy technologies falls, the
percentage share of renewables should grow. In addition, as
international companies began investing in renewables, it is likely
that more innovative Russian companies will follow. Some Russian
companies are now taking the first steps of investing in Western
technology firms. In 2006, Interros and Norilsk Nickel acquired a
35- percent stake in New York-based Plug Power Inc. In 2007, Renova
announced plans for wind, solar, and bio-energy projects in the
Italian market and this year increased its stake to 39 percent in
the Swiss technology company Oerlikon, a producer of equipment for
manufacturing solar cells. In early 2008, a subsidiary of the
Russian independent gas producer ITERA announced plans to invest in
construction of two bio-fuel plants in the U.S., as well as in
similar projects in Russia and the CIS.

Russian companies may now also attract foreign investment for
joint renewable energy projects in order to generate emission
reduction credits for subsequent sale on international markets. A
government commission under the auspices of the Economic
Development and Trade Ministry began accepting applications and
reviewing Joint Implementation (JI) projects in March 2008. In all
likelihood, Russian companies will not take full advantage of the
JI mechanism under the Kyoto Protocol to raise additional funding
for domestic energy efficiency projects if the approval and
issuance processes are too complicated and administratively
burdensome. So, too, the pace of technology transfers depends in
part on the emergence of favorable market conditions in Russia.

LEGISLATIVE INITIATIVES

A number of attempts to pass legislation aimed at developing
Russia’s renewable energy sector have already been made. A draft
bill on “State Policy for the Use of Non-Traditional, Renewable
Energy Sources,” introduced to the State Duma in April 1998 and
passed by the parliament in November 1999, was vetoed by President
Boris Yeltsin. The Putin Administration, preoccupied with other
issues, did not reintroduce the bill and it was removed from
further consideration in October 2003.

In January 2005, another draft bill, On Alternative Motor Fuels,
was introduced in the Duma, but in September 2007, it was put on
hold by the government, which said that the bill lacked clarity and
needed additional work. The bill included the provision of federal
subsidies for alternative fuels projects in Russia’s regions, and
called for the establishment of public-private partnerships for
undertaking large-scale investments in bio-fuels for
transportation.

Last spring, the Federation Council, supported by the
Agriculture Ministry, announced that a draft bill concerning Bases
of the Development of Bio-Energy in the Russian Federation would be
submitted to the State Duma in the near future. The draft bill
would lower the excise tax on fuel ethanol and offer tax breaks for
oil refineries to blend gasoline and diesel with ethanol.
In late November 2007, former President Vladimir Putin instructed
Agriculture Minister Alexei Gordeyev to create “conditions for
business to produce bio-fuel.” Some business leaders have gone
further, suggesting that the use of bio-ethanol and bio-diesel as
additives to motor fuels be mandated and Russia’s tax and customs
legislation changed. However, despite the country’s 20 million
hectares of unused arable land, critics have cited concerns about
the impact of grain-based bio-fuel production on Russian grain
market prices, as well as growing competition in the West among
producers of bio-fuel, as reasons to go slow.

The Industry and Energy Ministry has repeatedly spoken of the
need to expand the use of renewable energy sources. Working with
RAO UES, the ministry prepared a draft law, On Supporting Renewable
Energy Use, in early 2006. Late last year, a new federal law on
reforming RAO UES was passed, which could pave the way for federal
subsidies to utilities that use renewable energy sources to
generate electricity.

* * *

In the West, high energy prices have stimulated global
innovation in the development of solar, fuel cell, tidal,
geothermal, wind, biomass, and other technologies. Lacking similar
economic incentives to reduce dependence on fossil fuels, and with
little funding for pilot projects or investments in renewables, the
development of a robust renewable energy industry in Russia has
been slow.

It now appears that more attention is being given to the
potential for renewables and clean energy technologies. Former
President Vladimir Putin said at a January 2008 meeting of the
Security Council that “Russia now has the financial and economic
opportunities to promote the use of clean technology.” This speech
on Russia’s ecological security was followed by then First Deputy
Prime Minister Dmitry Medvedev’s call for Russia “to move quickly
to gain a foothold” in the market for clean and renewable energy
technologies.

Whether this happens will depend on creation of the conditions –
political, economic and legal – for the development of the
country’s renewable energy potential and then applying Russia’s
considerable scientific and technological resources to
accomplishing the task.