Workshop Review: Anatole Boute – Reform of the Russian Energy Sector

by Ornela Figurinaite and Michael G. Seyer

Anatole Boute is a lecturer of law at the University of Aberdeen and legal adviser to the International Finance Corporation (The World Bank Group). As a contributor to the projects conducted by the Russia Renewable Energy Program, Dr. Boute advises the IFC on the legal aspects surrounding the decarbonisation of energy supply. His work focuses on the potential to employ renewable energy sources for the production of electricity. Offering a lecture to students of the ENERPO program during the spring semester of 2013, Dr. Boute spoke in detail about his work. Structuring his presentation to include discussions of investment needs and required legal reforms within the Russian market structure, Dr. Boute concluded with his estimation that Russia, were it to take the necessary steps and overcome short-term financial obstacles, could become a “Green Giant” in terms of renewable energy utilization.

Electricity Sector’s Soviet Roots

During the introduction of his presentation, Dr. Boute suggests that, to understand the investment needs of the Russian electricity sector, one needs first to understand the history of its development. Currently, Russia is the fourth largest electricity market in the world and the largest market in terms of geography, facts that make it a key strategic sector for Russia. Its importance further stems from its strong ideological roots. The Soviets regarded electricity as a keystone for the prosperity of people; V. Lenin at the 8th All-Russia Convention of the Soviets, State Commission for the Electrification of Russia (GOELRO) in 1920, said that “Communism was equal to the Soviet power plus the electrification of the whole country” and the writings of K. Marx state that electricity is a way of spreading power to the people, stimulating the centralization of production, and helping spread wealth to the people.

Dr. Boute argues that even after the Soviet period, the importance of the electricity sector has not diminished. Russia takes particular care when pricing electricity and restricts the increase in costs as much as possible. Such efforts are also due mainly to ideological reasons – allowing prices to increase may create social unrest and the government may face criticism. Apart from ideological justifications, maintaining electricity tariffs below those of a free market economy creates a competitive advantage in many energy intensive industries, where electricity and heat are the main inputs. Consequently, the speaker argues, this creates a trade-off between sustaining low prices and stimulating investment. Providing investors with sufficient revenues to finance their capital-intensive projects is crucial for the development of the Russian electricity sector from its current state of stagnation.

High energy intensity was caused by the too slow decommissioning of old power plants and replacing them with new ones

Expanding the discussion, Dr. Boute outlines the plan of the State Commission for Electrification of Russia written in the 1920s when Russia was one of the pioneers of electrification process. Construction of large coal-fired power plants formed the basis of the plan – gas power plant technology had not been developed yet. In this document there was reference to waste, as well as to renewable energy. The main principle was to join the power plants in different parts of the country using an immense high voltage transmission network and in particular, to connect those regions which were rich in fossil fuels to those where most of consumption took place – industry rich regions. The idea was to exploit the significant day and seasonal variation in energy usage throughout Russia to optimize the efficiency of an integrated system. This document also stressed the use of regional resources and low quality fuel to power the plants, while higher quality fuels were intended for other purposes. Tracing the development of Russia’s electricity system to the present, the sector today is the result of the GOELRO plan and continues to be developed largely based upon the same principles.

Negligence and Lack of Funding

Following his discussion concerning the formation of the electrification program in Russia, Dr. Boute offers his evaluation of the problems the electricity sector was facing by the end of 1970s and continued to face throughout the 1980s and 1990s. During this later period, Russia saw a decline in investment which marked the beginning of the aging process of the entire electricity system. A monopolistic system prevailed because the investments otherwise would not have been financially viable. As a result, most of the power plants currently operating in Russia were built during the Soviet times, and have seen few upgrades, which in turn has resulted in inefficiencies. The Russian government began encouraging the use of coal in electricity production instead of gas which, although a cleaner fossil fuel, is intended mostly for export. The 1980s saw an attempt to modernize the industry, but failed due to the collapse of the Soviet Union and the poor condition of the state budget.

In 1990, Russia had a total installed capacity of approximately 213 GW and electricity production of 1073 TWh, which is significant when measured against current world standards. However, electricity consumption declined by 25% in the 1990s due to the collapse of the industrial sector following the dissolution of the Soviet Union. Yet, as argued by Boute, this was a blessing because before the collapse the Russian electricity sector had been under a huge strain. High energy intensity was caused by the too slow decommissioning of old power plants and replacing them with new ones, and by a lack of modernized infrastructure and technology due to the lack of adequate financial resources. However, from about 1998 until 2008 the Russian economy grew substantially and pushed electricity consumption to 1000 TWh – almost the same levels as pre-Soviet Union collapse, which again resulted in the loss of reserve margins. Hence the electricity system was exposed to the risks of blackouts, such as the one in 2005 in Moscow and accidents such as the collapse of the power plant Sayano– Shushenskaya in 2009. Furthermore, the pressure exerted on the system varies a lot depending on the region of Russia. Some regions are characterized by high demand, intense supply deficit, and limited network capacity to import power from other regions and therefore are at a higher risk of accident and outages. Moreover, some regions in southern Russia are entirely isolated from the centralized system and cases such as that of the Krasnodar region may pose serious concerns moving forward, especially in regards to the electricity supply for the Olympic Games in Sochi.

By 2008, Russia had installed capacity of about 224 GW. The current fuel mix for the production of electricity in Russia is approximately 68% thermal power (70% gas, 28% coal and of this 55% CHP), 21% hydro and 10% nuclear energy. The Russian electricity industry uses a very high percentage of Combined Heat and Power (CHP), which is an efficient way of producing electricity and heat because it captures heat from production and, through utilization of this output, avoids excessive waste. Dr. Boute concludes that Soviet electricity engineering was very advanced, but highlights that nothing since then has been done to build upon this practice. Therefore, these old installations are now operating inefficiently in terms of energy utilization. Within the energy mix, there is also a large share of hydro, 21%, which is considered to be a renewable energy. It is necessary to distinguish between large and small hydro power plants. This distinction is drawn at about 25 MW; up until 25 MGW, power plants are operating with small turbines and are considered to be purely renewable.

Forecasts for Russian Electricity Sector

Dr. Boute examines official government forecasts of Russia’s electricity sector for 2030; the government’s policies and objectives are outlined in the 2030 Energy Strategy as well as The General Scheme for Allocation of Electricity Production and Installation. These documents can be considered the new GOELRO and provide a strategic plan for the Russian electricity sector until 2030. The plan is to further develop hydro and coal-fired power plants in Siberia and to develop the network infrastructure to the European side of Russia in order to transport the electricity produced from hydro and coal to the parts of Russia where electricity consumption is higher. The document puts forward plans for coal and hydro power plants to be built in Siberia, gas plants in Ural regions, and nuclear power plants in the north. Important long-term price forecasts are outlined in the Concept of Longterm Social and Economic Development Plan of Russian Federation until 2020. The same document provides a target for renewable energy in Russia as 4.5% by 2020, which in Dr. Boute’s opinion, is very modest compared to Russia’s potential and to the European Union’s target of 20%.

…Europe has a moral responsibility in looking at what is happening with Russia’s electricity system. 

With the exception of the target for renewable energy, the goals of the forecast are, in Dr. Boute’s estimation, very ambitious. The government’s goal to have 324 GW installed capacity in 2030 means that Russia will have to build 220 GW in the next 20 years, which is the same as the total capacity in Russia today. Energy efficiency will be improved by about 40% by 2020. The fuel mix will move from gas to coal at least until 2020, in order to be able to supply enough gas to Europe, which is an issue until development of large gas fields on the Yamal Peninsula. Also in the 2030 forecast, it is planned to again increase the share of gas because of the relative importance of the domestic consumers to the Russian gas industry. The electricity sector is the biggest consumer of gas in Russia and therefore the success of both the electricity as well as gas sectors vis-à-vis one another is critical for mutual positive development. Of course these projects are very ambitious, but they are not binding. At the end of the day it is the private investor who is going to make the decision regarding whether or not to build this new capacity or to invest in renewable energy. The question is therefore, to what extent is Russia creating a regulatory environment that will attract these private investors?

Investment in Russian Electricity in the Best Interest of Many

Continuing the discussion, Dr. Boute next considers the importance of the development of the Russian electricity system for EU-Russian energy relations. The issue of developing coal to free up gas for export, mainly to the European Union, means that the additional emissions of CO2 generated in coal-fired power plants in Russia could be considered part of the carbon cost of Europe’s energy security. Hence Europe has a moral responsibility in looking at what is happening with Russia’s electricity system. Updating or replacing obsolete equipment today represents huge energy saving possibilities and of course is also important for Europe, because if these energy savings are generated, it could be exported to Europe. This, however, requires large capital investments. Russian authorities suggest 355-554 billion USD of investment needs, which is a huge market potential for investors. The modernization of the Russian electricity sector is important for Russian consumers because it is necessary to secure reliable electricity supply. If the practice of relying upon Soviet equipment is continued, consumers will ultimately have to pay for the energy inefficiency in the long run.

Following his conclusion that the modernization and decarbonization of the Russian energy mix is in the interest of both the Russian Federation and the European Union, Dr. Boute offers a brief glimpse into the deficiencies of the Soviet organization of the electricity market and the effects such shortcomings have on the ongoing modernization process. Throughout the Soviet period, the electricity sector was structured as a vertically integrated monopoly financed by the state budget and not bound to the principles of supply and demand. Perhaps the most damaging Soviet practice was the utilization of tariff structures and cross-subsidies, which, while designed to offset the costs of production and transmission and ultimately lower the end-cost for consumers, did not offset the costs for further investment into infrastructure and other modernization projects. According to Dr. Boute, this lack of investment into critical infrastructure and technology, which was a deficiency of the system throughout much of its history, was an inadequacy with consequences that continue to be detrimental to current modernization projects.

Russia’s Policy on Renewables

As a result, current efforts to liberalize the electricity market are oriented towards the attraction of private investments, both domestic and international, so as to modernize infrastructure, secure supply, and improve the efficiency of electricity production and transmission. To facilitate such a transition towards a competitive market, the Federal Electricity Law and the Wholesale Market Rules were established in 2003. The basic provisions outlined by this law were the following: free interaction between the market parties, economically justifiable prices, stability of investment conditions, security and reliability of supply, energy efficiency, non-discrimination, and transparency. Responsible for the implementation and regulation of this new framework are the Russian Ministry of Energy and Industry, the System Operator of the electricity sector, and the Federal Anti-Monopoly Service. Ultimately, such reforms have been implemented due to high-level interest on the part of the Russian government and industry to gradually transition not only towards a market based upon liberal principles but also to attract investments for the development of renewable resources as significant ingredients in the Russian energy mix.

…until the market allows for the introduction of RES into the overall energy mix of Russia at a cost comparable to the costs of traditional fuels, tariffs and premiums will be required to protect both consumers and industry from high end-user costs.

As expressed in both the 2030 Energy Strategy and the 2020 Concept of Long-term Social and Economic Development, the Russian government and industry leaders have confirmed their dedication to the Renewable Energy Standard (RES). Under this provision, electrical supply companies are tasked with the production of a certain percentage of their output through the harnessing of renewable energy resources. In the case of the Russian development strategy, this target percentage is currently held at 4.5% for the year 2020. Ultimately, these efforts to modernize energy infrastructure, increase supply in isolated and deficit regions, and address concerns re garding the disposal of agricultural waste. However, at this premature state in which renewable energy is more costly than traditional resources, heavy investments are required to, in the words of Dr. Boute, “level the playing field” to facilitate an increase in the level of renewable utilization.

In response to the challenges associated with attempts to include energy from non-renewable sources into the overall energy mix, such as price increases, and concerns regarding consumer access and trade arrangements, the Russian Federation has established a legal framework to encourage investments into an RES framework. In 2007, the Federal Electricity Law added a regulated premium to the wholesale electricity price and further amendments were made in 2011 that established long-term regulated capacity tariffs. These tariff structures and price premiums, designed to lower the cost of electricity for end-users, reflect serious concern on the part of the Russian government to risk the increase in costs associated with renewable resources. This concern is twofold. First, a low electricity price can be considered as a social right and Russian citizens appraise their government based on their efforts to keep costs low. Second, the competitiveness of Russian industries, as major consumers of electricity, is dependent upon low energy prices so as to allow energy-intensive enterprises to continue operating profitably. Therefore, until the market allows for the introduction of RES in to the overall energy mix of Russia at a cost comparable to the costs of traditional fuels, tariffs and premiums will be required to protect both consumers and industry from high end-user costs.

Concluding his presentation, Dr. Anatole Boute reasserts that such high costs can only be reduced if investments are made into the modernization of infrastructure and technologies are employed to harness renewable electricity sources. Russia, Dr. Boute illustrates, is rich in renewable resource potential. Taking the discussion further, Boute argues that it is in the interest of both the Russian Federation and the European Union to make dedicated investments into this sector. As Russia is the main energy supplier of the EU, its members should be motivated to assist in the modernization of the Russian energy sector so as to benefit from less expensive, increased, cleaner, and safer supplies. The benefit for Russia in this estimation is clear. As an economy based heavily on energy export, decreasing the costs for production and transmission and harnessing a wider spectrum of its resource base can only strengthen its economic development. Through investment and a common regulatory framework between Russia and the EU, Dr. Boute says that such positive developments in the Russian energy sector remain a genuine possibility.

Michael G. Seyer and Ornela Figurainte are MA candidates in the ENERPO program at the European University at St. Petersburg.

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