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introduce a national strategy to deal with emissions and in January this year Deputy Prime Minister and ex-Minister of Energy Alexander Novak announced that a strategy to reduce GHG emissions will start this year.
A 2020 mini-government reshuffle and the promotion of Novak to Deputy Prime Minister was seen as a response to "green" challenges that Russia's energy sector will have to face in the international arena vis-a-vis the European Union and the administration of US President Joe Biden. Another veteran reformer, Anatoly Chubais, was entrusted with a role of "Climate Czar" and actually improving the ESG situation at home.
In a separate move, the Central Bank of Russia (CBR) announced in March that it intends to use ESG scores to calculate bank reserve ratios. A nationwide green certification system is also in the works amongst many other initiatives.
The government is taking up the baton, but so far the drive to introduce ESG ethics has been led by Russia’s leading corporates after big Scandinavian state- owned pension funds started banning investment into their equity because of poor ESG scores.
Utilities in the front line
Russia’s utility sector is particularly vulnerable to environmental concerns, and power generation makes up just under half of all Russia’s CO2 emissions. The Klieg lights are increasingly focused on the sector and knocking it into emissions-acceptable shape before all these issues become a real problem.
So far, the only Russia-based utility that has tackled the problem head on is Enel Russia, which last year sold its coal-fired Reftinskaya, which was responsible for about a third of its electricity output, and has started investing heavily into renewable energy. The bulk of the other utilities have made little progress in cleaning up their act.
And part of the proposals being suggested at the moment would force companies to disclose the share of their revenues that come coal-fired power
generation; currently none of the utilities report how much they earn from power generated from burning coal, except Enel, which now reports zero.
In Scandinavia investors have introduced a 5% threshold for utilities, above which they are not allowed to invest. According to investment bank estimates, few Russian utilities would clear this hurdle and several of the bigger utilities companies, such as OGK2, RusHydro and Unipor, earn at least a quarter of their revenues from coal-fired power plants. If the 5% threshold were introduced in Russia then these companies would see a lot of investors leave.
“For Russian utilities, we believe the dangers of carbon-pricing cash outflows are irrelevant at present; however, it might well become a provisional charge that must be reflected under IFRS rules,” VTBC analysts Vladimir Sklyar and Anastasia Tikhonova said in a recent report. “Over the last 12 months, we have witnessed
a growing number of calls for climate- related disclosure to become a mandatory part of public companies’ reporting and auditing. The support for such needs comes from the most significant asset managers and key regulators.”
The problem that analysts are trying to work out is what the cost of carbon will be. The most prominent of the proposals currently on the table reflect the possible expenses on carbon purchases, be they at the prevailing CO2 price or those required to reach Paris Agreement targets. And the uncertainty of these prices is large.
“We estimate such costs could eliminate 9-100% of Russian utilities’ EBITDA, leading to a 35% dividend payment reduction, depending on the CO2
price benchmark used,” VTBC says. “Our conclusion is that such external costs must be considered when making investment decisions, given the 30- to 50-year lifespan of capital-intensive projects in the sector. So far, we have seen such care from Enel, recently joined by Unipro, both of which are guided by their international controlling shareholders' green strategies. State- affiliated utilities broadly remain aloof to the risks of climate-related expenses in the future,” Sklyar and Tikhonova said.
Russia and Paris
A recent Bloomberg article claimed that Russia is “getting left behind in the global dash for clean energy”, but the country is not doing that badly in terms of reducing emissions, as bne IntelliNews reported in the feature “The cost of carbon.” Moscow signed off on the Paris accords in 2019 and is well on track to hit its emissions reduction targets.
Admittedly it set itself a low bar as it chose to bring its carbon levels down from its 1990 Soviet-era levels rather than the Paris Accord norm of 2005 levels.
A 30% reduction from the 1990 level would allow Russia to produce 1,678mn tonnes of CO2 per year, which is only slightly less than the 1,765 mtCO2/yr it was producing in 2017. However, if 2005 is set as the benchmark year then Russia would have to reduce its CO2 emissions by a third from their current levels, or by a hefty 550 mtCO2/yr.
Still, it has already made massive reductions, but these have come not from any environmentally friendly policies, but simply because energy and construction companies have been investing in new, more efficient, equipment that reduces emissions as a side product to boosting profits. For example, carbon emissions form the power sector have fallen by 29% between 1970 and 2017, while those from construction are now a whopping 56% lower in the same period. Going forward, the challenge will be bigger, as between 2005 and 2017 the only sector to see emissions fall was the power industry, while all other sectors saw emissions start to rise again by between 3% and 21% as Russia Inc. began to grow strongly in the boom years of the noughties.
Next step up
Russia’s power sector has just come to the end of another investment cycle and as capex needs fall most utilities have built up war chests and are generating lots of free cash. The power sector is well equipped to make some big changes if called on. All the companies are looking for new ways to grow.
“Despite delivering a robust combined 13.3% [free cash] yield, utilcos remain
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