Europe wants to be carbon neutral by 2050, and is about to introduce a carbon import duty that is already forcing Russia’s biggest companies to speed up their efforts to go green.

As part of the EU’s Green Deal launched last year, the European Commission (EC) published its European Climate Law on March 4 that includes a “Carbon Border Adjustment Mechanism” – in effect a carbon import tax.

EC President Ursula von der Leyen said: “We are acting today to make the EU the world's first climate neutral continent by 2050. The Climate Law is the legal translation of our political commitment, and sets us irreversibly on the path to a more sustainable future. It is the heart of the European Green Deal. It offers predictability and transparency for European industry and investors. And it gives direction to our green growth strategy and guarantees that the transition will be gradual and fair.”

With the European Climate Law the Commission proposes a legally binding target of net zero greenhouse gas emissions by 2050. Currently the only country in the world that is carbon negative is Bhutan.

The spillover effects of the new law will be significant and Russia’s economy could be hit hard by the changes. Russian goods exported to Europe will have to pay an extra import duty if their factories are not clean and green. This is a serious change for Russia, as the EU accounted for 45% of its trade turnover in 2019, according to Rosstat – even more than Ukraine, which has 41.5% of its trade turnover with the EU, and also could be badly affected.

The clunkily-named carbon border adjustment mechanism is specifically designed to prevent “carbon leakage” where energy intensive EU companies simply dodge strict EU emission laws by moving production to other countries where the rules are not as strict, like Russia. The new rules are currently in the process of public consultations, but the final version should be adopted next summer.

“We believe this might have a fundamental effect on the competitiveness of Russian exporters and significant consequences for Russian utilities, leading in the long run to a premium for green energy producers,” said Vladimir Sklyar, a utilities analyst at VTB Capital (VTBC), in a note.

What will change is the cost of carbon used to make a widget imported into the EU will be charged as a tax. And the cost of carbon in the EU has more than doubled in the last year alone to €23.65 per tonne. Currently Russian exporters enjoy a competitive advantage thanks to the country’s cheap energy. Adding a carbon cost to Russian goods could completely destroy that price advantage and seriously impact Russia’s ability to export goods to the EU.

Russia has been slow to start greening its economy. Russian President Vladimir Putin said in November: “Humanity will end up in caves if it abandons hydrocarbons.” Russia then fluffed its National Climate Change Plan that sets the emission targets for companies after the limits were watered down thanks to intense lobbying by the biggest corporates.

It only ratified the Paris Accord in 2019, but gave itself easy to reach CO2 emission targets. Russia’s companies have been a bit more active and most large corporates have introduced environmental, social and governance (ESG) policies that include policies (and investments) to cut emissions after equity investors started selling shares of companies with bad ESG scores. Norway leads the pack and sparked a mini-revolution after its state-owned pension fund Norges banned investments into companies that were ignoring their environmental responsibilities.

Russia’s top miner Norilsk Nickel saw massive selling of its stock after the ban went into effect in 2018 and since then it has invested $2bn into reducing SO2 emissions (also bad for the environment and one of a bag of gases controlled by the Paris Accord) with plans to invest another $3bn in the coming years.

But part of the problem is that while companies can be punished for a bad ESG score, they are not being rewarded for having a good ESG score – there is no “green alpha”, or premium on the share prices for green companies.

In practical terms the EU’s carbon import tax will be applied to goods produced by companies that get their power from dirty power generators – and in Russia that is most of them.

It is still not clear exactly how the carbon duties will be applied, but analysts are expecting both a general country duty to be added to all traded goods and also company-specific duties for energy intensive industries.

And Russian companies are already reacting. For example, Russian major aluminium producer Rusal – the biggest single consumer of power in the country – is already switching from coal-burning power supplies to hydro in an effort to reduce its carbon footprint, reports VTBC, and is considering completely ditching its coal-fired power plants and coal mines.

The state is supporting the greenification of the economy and plans to lauch a “green certificate” scheme at the start of next year as the only legal way to claim the title of “green energy sourced” products that it hopes will be compatible with things like the EU legislation. Rusal’s parent company EN+ is way ahead of the state and has already launched the world’s first low-carbon aluminium trademark ALLOW to highlight its move to hydropower, and Phosagro told bne IntelliNews in a recent interview that it was also going to adopt a green certification system.

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Since 2015, the total installed capacity of Russian renewable sources has increased to 1,547MW and is expected to almost quadruple in the next four years to 4,792.8MW by 2024, according to Russia’s system operator.

Currently renewables only account for 0.1% of the total generating capacity vs hydro (17.6%), nuclear (19.3%), and the vast majority was still thermal (62.9%) as of the end of 2019, according to the ministry of energy.

Another problem is most of the existing generation capacity was built in Soviet times and it is getting old: but this issue is being addressed by the so-called DPM2 (power supply contracts) programme designed to modernise the power generation capacity that is already well underway. That has to be set against the high level of wastage as Russia is not an efficient consumer of power. Russia is one of the most energy-intensive large economies in the world, according to VTBC.

 

As bne IntelliNews reported, the cost of carbon in Russia is high and utilities account for just under half of all the country’s CO2 emissions. As the investment cycle in the power sector is coming to an end following the launch of reforms in 2007, the power sector has become very attractive to investors.

But with cash in their pocket and predictable revenues for several years to come thanks to Russia’s tariff policies, each power company has a different plan for what to do with its money and only the Italian owned Enel Russia has focused on going green as the main plank of its strategy going forward. The other companies are investing in new production, or paying more dividends as well as doing some green investments, but Enel radically transformed its generation profile by selling off its main coal-burning power plant in October.

“Taking into account the high energy intensity of the Russian economy and the importance of the EU as a trading partner for Russia, we believe [the carbon import duties] might have profound consequences for Russian industry in general, and electric generators specifically,” says Sklyar.

Sklyar speculates that Russia will be pushed into the position where companies have to pay a premia for green energy and utilities will have to give discounts for coal-fired capacity. The analyst also believes that Russian power companies could sign more bilateral electricity trade contracts as they look to source cleaner power. And finally, that all of Russia’s power companies will be forced to follow Enel’s lead and invest more intensively into renewable energy sources.

It is no surprise that the utility investing the most heavily into renewables is owned by Italians, as Europeans are a lot more conscious of the sea change in attitudes towards the environment that has taken place in the last year, personified by Greta Thunberg.

Despite Russia’s dominance in the nuclear power sector and Enel’s drive towards renewables, coal remains a very important fuel for power generation in Russia: from amongst the leading power generators just over half (54%) of Unipro’s power is generated by coal-burning power stations as a share of the revenues it generates, as is a fifth (21%) of OGK2’s power.

Change is coming, but it will be driven by market forces more than policy for the time being. Analysts are waiting to see what role renewables will play in the new 2030 strategy due soon from power major InerRAO that is expected to be a bellwether for the power sector. But despite the growing pressure to go green, things like ESG have not become part of the power sector’s DNA. It's going to be a slow process.

“We believe that Enel Russia’s strategic choice is a more optimal long-term pathway than that of InterRAO, which continues to show little interest in building renewable capacity and continues to consider the acquisition of coal-fired capacity, such as one of the Kaliningrad CHP units,” says Skylar.