Entering Russia's Power Sector

Any international proposal for reducing carbon emissions will require active Russian participation. Russia is the fourth largest emitter of carbon in the world. Its resource base of natural gas is unmatched by any other country, and its energy sector and industry are significant consumers of fossil fuels, and thus major emitters of carbon. For most of this decade, Russian emissions are likely to remain below their 1990 levels, due to the havoc created by the economic crisis within the Russian industrial sector. While the administration of Russian President Vladimir Putin is making strides to revitalize the economy, it will take time to restructure and rebuild. This may provide Russia with a unique opportunity to benefit from emissions trading.

The United States, Japan, Canada, and Australia have advocated the establishment of "flexibility mechanisms" within any international agreement to reduce carbon emissions. These mechanisms include those that allow entities with high abatement costs to purchase carbon emissions reduction credits from entities with low abatement costs. Credits could be generated, for example, if a high-cost country (or a firm within a high-cost country) invests in a project that will reduce emissions in a low-cost country. The flexibility mechanisms, like joint implementation and emissions trading, could create substantial new markets and investment opportunities.

As one of the world's largest greenhouse gas (GHG) emitters, Russia offers numerous opportunities for cost-effective reductions and straightforward emissions trading. This is because the costs of carbon emissions reductions in Russia – a country with an antiquated and energy-inefficient industrial base –are likely to be significantly lower than in economies already using more efficient fossil fuel-burning technology, such as Japan or the United States. The financial benefits of carbon trading for Russia's cash-strapped economy could be, according to one estimate, as high as $25 billion in the period 2008-2012.

Establishing an internationally sanctioned carbon trading regime within Russia will be a daunting challenge. The economic and institutional chaos that has enveloped the country since the devolution of Soviet authority has made it difficult to construct a broad Russian response to climate change and, more specifically, to establish a reliable and well-functioning greenhouse gas emissions reduction regime. The problem is not that the Russians are not interested in carbon reductions or credit trading; rather it is that the cost of the first trade – that is, the cost of establishing the institutional foundation, the rules, regulations, and human capitalis – is very high.

This reality has led many observers to focus on certain large and reasonably well-organized sectors, rather than on Russia's economy as whole. One of the most obvious candidates has been the energy sector, which accounts for the lion's share of Russia's carbon emissions and is the country's principal economic dynamo. Among Russia's energy producers, the electric power sector arguably offers the greatest potential for emissions reductions. According to various estimates, it presently emits approximately 515-550 million tons of CO2, or 30-35 percent of Russia's annual CO2 emissions.

As the country's largest single emitter of carbon and one of its most influential industries, the electric power sector will be integral to any domestic or international emissions abatement system. Detailed understanding of Russia's electricity industry – its physical structure, its markets, its investment climate, and the regulatory regime that oversees it – is therefore crucial to any serious plan aiming to draw Russia into global carbon emissions markets.

The first section of this paper reviews the physical, corporate, and regulatory structures of the electricity sector, describes the evolution of this sector during the first decade of Russia's stormy economic transition, and identifies the factors that will affect both its future growth and its carbon emissions. Part II discusses the opportunities for carbon emissions reductions. Part III identifies the obstacles that stand in the way of involving the Russian power sector in carbon trading. Part IV is a case study examining the Russian Far East, one of Russia''s seven "electricity zones," to illustrate the problems and opportunities that apply, to a greater or lesser degree, throughout Russia, as well as factors unique to the region.