In our final installment examining the issues surrounding the creation of a Russian biofuels market, we examine the “green shoots” of a nascent industry-domestic production for export and domestic interest in development of an industry.

The Russian National Biofuels Association, which monitors biofuel developments in the country, held the IV International Conference “Fuel Bioethanol 2009″ in mid-April 2009 in Moscow.  Aleksey Ablayev, president of the Association, noted on the sidelines of the conference that there is still strong opposition to the creation of a grain-based ethanol market in the country and that much of the discussion today has shifted to cellulosic biofuel.  Projects in this area do exist, though funding difficulties in particular have affected their ongoing pace  in various parts of Russia.

The most recent and ambitious biofuel initiative was launched by OJSC Biotechnologies Corporation, which is controlled by the state corporation Russian Technologies (Rostekh).  Having acquired the Tulun Hydrolytic Plant in Irkutsk (Eastern Siberia), the corporation last September produced and tested experimental butanol as a fuel additive in cars.  No information has been provided on the total cost of the butanol as compared to the cost of gasoline sold locally, nor is it clear whether the chosen method of producing butanol is cost efficient.

Titan, an Omsk Group of Companies, reportedly completed the construction of a grain-based ethanol plant in Omsk. This export-oriented project was launched in 2006, with an initial plan to build a production capacity of 150,000 metric tons of ethanol per year.  (A Czech company, Alta, was chosen as an equipment supplier for the plant.)

Funding Difficulties Slow Biofuel Projects 

A  plan to produce about 30,000 tons of butanol at the Tulun plant (in addition to other products) reportedly had difficulty last year obtaining the funds needed for the purchase and installation of equipment.  Biotechnologies Corporation also announced plans to set up butanol production at other sites, including at existing hydrolytic plants, by 2017.  The corporation’s long-term plan is to attract about $1.5 billion for its biofuel initiative.  If implemented as planned, this initiative would produce about 2 million tons of butanol annually.  The corporation reportedly has asked the authorities for subsidies, including reductions in future profit and property taxes during the initial investment period.

Bioethanol Ltd, a daughter company of the agricultural firm “Vinogradov,” launched a project in 2007 to construct a bioethanol plant in the Lipetsk Special Economic Zone, but halted construction in 2008, reportedly due to funding difficulties.  The initial plan was to produce wheat and/or corn-based ethanol as a biofuel additive.  The Moscow Oblast-based engineering company NPK Ekologia announced in April 2009 that it had an order to do the planning for a project with a production capacity of 250,000 tons of bioethanol per year in Tambov Oblast (in the Western part of Russia), and another order for a project with a capacity of 200,000 tons in Stavropol in Southern Russia.  The country’s financial crisis may put a hold on these projects as well.

Non-Food Based Biofuels

Several Russian companies have expressed interest in biodiesel.  For example, in May 2008, the Konti Group of Companies said that it was interested in producing rapeseed-based diesel in Ivanovo Oblast.  The plan was to construct a plant with an annual production capacity of up to 200,000 tons of biofuel.   In June 2008, the Masloprodukt Group of Companies signed a memorandum of cooperation with the National Reserve Bank (NRB), with the goal of increasing production of sunflower-seed oil at an existing plant in Voronezh Oblast.  The Masloprodukt-Bio initiative envisioned an annual production capacity of 100,000 tons of biodiesel and 10,000 tons of raw glycerin.

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In this, our second post on the issues surrounding a biofuels industry in Russia, we examine the attempts by the Russian political class to overcome the various policy barriers we outlined in our last installment.

For several years, the Russian political leadership has given rhetorical support to the idea of developing the domestic biofuel sector, but this has not followed that rhetoric with the new laws required to jump-start growth. While cabinet members made promising announcements on renewable energy and parliamentarians submitted drafts of biofuel laws, few results ensued.

The Agriculture Ministry under Aleksey Gordeev was a strong advocate of biofuel legislation.  In 2007, the Ministry made projections for biodiesel demand in Russia linked to the growth in rapeseed production and listed twelve cities as sites for future biofuel production.  Several Russian regions, including Tatarstan, announced pilot biofuel projects and called attention to the need for legislation that would open the door to biofuel businesses.  In late November 2007, President Vladimir Putin told Gordeev that business conditions to produce biofuel in Russia needed to be created.

In February 2008, the federal government approved the technical requirements for gasoline and diesel that allow the use of bioethanol as an additive for up to five percent.  (Russian law does not mandate the use of biofuel as an additive.)

In early March 2008, Chairman of the State Duma Boris Gryzlov said at a meeting with President Vladimir Putin and Duma faction leaders that 20 million hectares [about 49.4 million acres] of agricultural land were not currently being used, and that almost half of this land “could be used to produce biofuel, such as biodiesel and bioethanol.”  Following Gryzlov’s speech, the President called on the government to make use of the country’s comparative advantage in arable land.

The following day, Prime Minister Viktor Zubkov (currently first Deputy Prime Minister) announced that there was a proposal to finance the construction of 30 new bioethanol plants to eventually increase the country’s ethanol production to 2 million tons per year.  (By early 2009, production of industrial-grade and food-grade ethanol stood at about 0.6 million tons[1])  Mr. Zubkov did not anounce a time period for completing this program.  It is not clear whether such a federal biofuel funding program exists today or if it was ever been approved by the Cabinet.

Nikolai Ryzhkov, Chairman of the Federation Council Committee on Natural Monopolies, wrote in a December 2008 article that his Committee would “pay special attention to expanding the range of alternative energy sources.”  He praised the first results of experimental production, including the use of wood-based butanol produced at a biotechnology plant in the city of Tulun (Irkutsk Oblast).  The legislator also emphasized the urgent need “to prepare the legislative base for a biofuel industry.”

Despite such high-level support for biofuel initiatives, efforts to pass legislation based on a draft bill “About Alternative Motor Fuels” (#130858-4) introduced in January 2005 did not succeed.  The Government put the bill on hold on the grounds that it did not clearly address, among other issues, issues of jurisdiction and responsibilities of regional and/or federal authorities.  Subsequently, the Duma Energy Committee called upon the authors of the 2005 bill to amend the text in line with previous criticism by the State Duma’s Legal Department.

State Duma deputies and Federation Council members with the backing of the Ministry of Agriculture prepared another draft bill, “About the Bases for the Development of Bioenergy in the Russian Federation.”   This bill, submitted to the State Duma in Spring 2007, was scheduled for review by the Duma Agrarian Committee in 2008.  According to the Deputy Chairman of the Committee, work on the draft bill will continue in 2009.

Legislative and ministerial work has gone very slowly in part because of the regulatory and technical issues that must be addressed.  There are also broader reasons for the lack of progress.  First, renewable energy sources, including biofuel derived from grain or bio-waste, are a low priority on the legislative agenda, especially compared to the regulation of the gas and oil sectors.  Given the heavy dependence of the country on revenues from hydrocarbon production, this is quite understandable.  Second, there is limited interest in alternative energy in general and no desire on the part of business to jump into risky projects.  Third, the financial crisis has shrunk the pool of available investment for all types of energy projects.

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A global financial crisis and the subsequent economic slowdown in Russia have dampened Russian companies’ investment and plans to invest in the biofuel business.  Unlike in the West, Russia is not pushing to get on the biofuels bandwagon.  Yet, despite the many existing constraints on the development of the country’s infant biofuel sector, opportunities to develop this sector do exist.  In this series of posts, we examine the factors constraining a Russian biofuels industry, and the possibilities for overcoming those obstacles and developing a nascent market. In this first post, we examine the production and policy constraints on the industry.

Supply & Demand

On the supply side, Russian agriculture, as well as the forestry and the chemical industry could provide necessary inputs and labor under favorable conditions (such as subsidies in the form of production and blending tax credits).  The potential of the country’s idle distilleries could also be utilized. Grain-based ethanol (which can be produced from non-food grade grain), cellulosic ethanol (using wood waste, straw, etc.), or biobutanol (often called “a second-generation fuel” produced from the same feedstocks as ethanol) can be mixed with conventional gasoline. 

A 10-percent biofuel additive would work for most new cars.  Russian experts’ proposals have ranged from a 5 percent to 10-percent blend of ethanol.  The issue of how much biofuel should be blended with conventional gasoline has caused a debate even in the United States. In 2008, about 9 billion gallons of bioethanol were blended into U.S. transportation fuels in compliance with EPA’s mandated volume/RFS requirement. The output of about 90 billion gallons of E10 is about 70% of all gasoline sold in the United States in 2008.

There is currently no commercial, large-scale production of bioethanol or biodiesel for transportation purposes in Russia.  One of the main obstacles is production cost.  Factors that influence production cost include the choice of input and technology, the location of production facilities, and climatic factors.  A second important obstacle is an existing excise tax on ethanol makes production of a bioethanol additive for domestic transportation purposes cost prohibitive.  Third, Russian energy companies, which own the oil refineries and gas stations, see biofuel as a prospective additive to gasoline sometime in the future, but they are not eager to invest now in biofuel R&D projects.  Oil companies cite a number of impediments to the development of the biofuel business, such as biofuel production costs, the amount of arable land required, and the Russian climate. 

On the demand side, private individuals and businesses may see the benefits to the environment (in terms of GHG emissions on a full fuel cycle basis), but they are unlikely to push for more expensive biofuel blended fuel. 

Domestic Concerns and Challenges

In addition to the many commercial and business issues that have not yet been addressed, there are policy and legislative reasons why the biofuel sector has not developed. 

First, it will be challenging to develop a subsidy policy that would encourage both the use of non-food grade grain and bio-waste for biofuel production (thus benefiting farmers and chemists) and the use of a biofuel additive by oil refineries and fuel blenders (thus creating positive incentives for these businesses).  Over time, large-scale projects will have to become less dependent on subsidies and justified on the basis of economic efficiency and technological advances.  R&D funding is particularly needed to develop more cost-effective technologies for producing advanced biofuels.  Such technologies and equipment, however, can be acquired abroad and applied domestically.  The Russian federal government classifies “technologies for production of fuel and power from organic raw material” as “critical.”  The government considers these technologies “important from the socio-economic standpoint or for the defense of the country and state security,” but funding to develop them is still lacking.  The use of government subsidies is also being debated.  As the state begins to bail out faltering private businesses, critics are complaining that the last thing Russia needs is another heavily subsidized sector—one where the government, rather than business, chooses where investment should go, and favors certain recipients with financial incentives. 

Second, it will be necessary to remove the currently prohibitive excise tax on bioethanol used as a gasoline additive. 

Third, the traditional inertia against producing something new will have to be overcome.  Regulation and production standards for fuel bioethanol and biodiesel will have to be put in place.  Russian consumers continue to complain about poor quality gasoline, and even the best quality bio additive will perform poorly if mixed with low quality fuel.

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The Russian leadership has begun to task the Ministry of Energy and regional authorities with creating conditions for the greater use of renewable energy in electricity generation by Russian utility companies.

Overview of the Executive Directive

On January 8, 2009, Prime Minister Vladimir Putin signed an executive directive which calls for an increase in the energy efficiency of the Russian electric power sector on the basis of renewable energy sources.  The directive sets several specific targets for expanding the share of renewable energy in electricity generation from less than the current 1 percent to 1.5 percent in 2010, 2.5 percent in 2015, and 4.5 percent by 2020.

Hydropower plants with a capacity of more than 25 megawatts (MW) are not included in these figures, but the targets do include small hydro power plants, as well as tidal, geothermal, wind, solar, and biomass sources, according to a RusHydro presentation in the fall of 2008.  For example, Russia’s wind-power capacity (estimated at 12 MW in 2005) is projected to increase tenfold to 120 MW in 2010, 1,500 MW in 2015, and 7,000 MW (or 7GW) by 2020.  (For comparison, Canada’s installed wind energy capacity reached about 2.3 GW in 2008, supplying about 1 percent of the country’s electricity demand.  United States wind energy capacity grew by 50 percent in 2008 to 25.1 GW.)

To meet the targets set in the directive, the Russian Ministry of Energy is tasked with taking a large number of measures, including deciding on pricing for electricity produced from renewables; attracting private investment for new and existing projects; engaging domestic industrial sectors and services; improving statistical reporting on the use of renewables in electricity generation; and raising public awareness about renewable energy sources.

The federal policy on the use of renewables in electricity generation through 2020 is, however, more than declarative.  On the basis of the directive, the Ministry of Energy is to engage federal agencies and utilities and seek their input and cooperation in order to fulfill the tasks outlined in the directive.  The directive should also spur regional governments “to make provisions in their development programs” for measures that foster the implementation of the new government policy.

Implications of the Directive

RusHydro, a Russian state-controlled company and the world’s second largest producer of hydro-based electricity after Canada’s Hydro-Quebec, already produces approximately 15 percent of the country’s electricity.  The company has ambitious investment plans for new large and small hydro power projects and a vision for the development of the domestic wind power sector.  However, the company’s 2009 investment commitment (417 million rubles or about $13 million at the dollar exchange rate of 32 rubles) for small hydro, wind, and tidal power projects is conditional on the allocation of federal budget subsidies.  RusHydro relies on legislative and executive support for the expanded use of renewable energy sources.  If Putin’s directive is followed up with more executive orders (as RusHydro expects it will be in 2009), then this will in all likelihood influence domestic utilities and manufacturers.

There could also be greater use of renewables in future years if foreign and domestic investors in Russian utilities see cost-effective opportunities for generating additional income from renewables and remain committed to expanding the use of clean energy sources.  Likewise, Russian industrial manufacturers will produce and supply equipment if there is growing demand for their services.  Foreign suppliers of equipment and engineering services may come to see this as an area where partnerships and even joint ventures would be welcome.

Over the long-term, renewable energy initiatives can potentially create “green” jobs for blue collar workers and professionals.  However, before this happens, legal and regulatory issues would have to be addressed.

Challenges to Implementation

The presidential directive cites numerous hurdles to the growth of electricity generation based on renewable energy sources, but also outlines comprehensive measures to address these concerns.  If federal and regional authorities choose to cooperate with interested parties, domestic and/or foreign, more investment in small hydro, wind and solar power projects is likely to follow.  These projects will be limited by geographical factors, of course, and, to some extent, by competition for the attention of Russian authorities preoccupied with the present difficult financial and economic situation.  Success stories of foreign companies engaged in renewable energy business can encourage more Russians to think “green,” not only in terms of how these projects impact the environment, but also in terms of potential profit-making opportunities.

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Russia’s top leadership  is on record supporting the development of solar power projects in the country. At a March 2008 meeting with Vladimir Putin and Dmitry Medvedev, Chairman of the State Duma Boris Gryzlov stressed the importance of solar power for electricity generation and mentioned a patented Russian technology for solar power applications that could be marketed.  Gryzlov’s August 2008 article in the  Russian Journal “Expert” noted  that “Development of renewable energy will  make it possible not only to address the problem of energy supply, reduce dependence  on  hydrocarbon raw materials and improve the ecological situation, but also to make money from the production and export of high-tech products and engineering solutions.” 

In October 2008, Prime Minister Vladimir  Putin supported a proposal  made by  the state corporation Rosatom to invest in polysillicon production  and  to construct  a solar equipment plant in Krasnoyarsk Region to produce solar modules.   This project would involve Rosatom’s Zheleznogorsk polysilicon plant, the state-owned Krasnoyarsk Machine-Building Plant (Krasmash), and OJSC Krasnoyarsk Non-Ferrous Metals Plant (KrasTsvetMet).   Other state corporations, Rosnanotekh and Vheshekonombank, might participate in co-financing the project, whose goal is to create a vertically integrated manufacturing value chain  from the supply of  raw materials  to the assembly of solar modules.

In September 2008, Rosnanotekh signed a strategic cooperation agreement with Oerlikon, a Swiss industrial technology corporation partly   owned by  the  Renova Group of Companies,  a  leading asset management company  in Russia. In May 2008, Renova Industries Ltd increased its stake in Oerlikon to 39.1 percent.  Oerlikon’s subsidiary, Oerlikon Solar, is a  major producer of equipment for manufacturing solar cells.

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Kazakhstan’s only significant renewable energy source at present is hydropower, accounting for 3 percent of total energy consumption in 2006.  At a June 2008 meeting of the Foreign Investors’ Council, Kazakh President Nursultan Nazarbayev called on the Kazakh Government to address the need for the development of renewable energy, taking into account the country’s wind and solar resources.  Initiatives proposed by the government have the potential to help certain localities address existing electricity deficits and could provide economic incentives for blending gasoline and diesel with more eco-friendly bio-fuels.  Renewable energy initiatives in Kazakhstan are very modest in scope, however, and the main focus of the country will continue to be on the development of hydrocarbons. 

Hydropower Initiatives

Kazakhstan’s five hydropower plants produce about 12 percent of the country’s electricity, while coal-fired plants account for over 80 percent of electricity generation. The government is planning to construct a number of large and small hydropower stations in the Almaty region.  A major ongoing project is the 300 MW Moinak hydropower station, which is estimated to cost about $300 million, including a $200 million credit from China’s Development Bank. 

Bio-fuel Initiatives

Kazakhstan’s bio-fuel sector is in its infancy, and new legislation in the works will for the first time outline the scope of state regulation of this sector.  The Kazakhstan Bio-Fuels Association was founded only in 2007.  The Ministry of Agriculture is expected to present technical standards in 2009 for gasoline and diesel blended with up to 7 percent bio-fuel.

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Ways to increase energy efficiency, reduce environmental pollution, and produce electricity and fuel from renewable sources are being debated by Russian officials and industry experts.  However, unless a well-developed system linking legal, financial, regulatory, and technological issues is developed, regional authorities will have few incentives to encourage private investment in renewables.

The federal government is now working on a program aimed at increasing installed wind power capacity to 7 GW by 2020 (up from 16.5 MW at the end of 2007, according to the World Wind Energy Association).  One aspect of the program would subsidize much needed construction of transmission lines from wind power facilities, with some new wind farms built in close proximity to traditional power stations to supplement their electricity generation.  In addition to the need for investment in transmission infrastructure, the implementation of wind-power projects in Russia will require resolution of tariff issues, as well as various types of federal support, grid connection requirements for wind power plants, and imports for wind energy equipment.  Russian experts stress that Western experience in the area of renewable energy will require adaptation to Russian realities, including the production of equipment capable of operating during Russian winters.

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Akin Gump Senior International Advisor Toby Gati recently authored an important article discussing the future of Russia’s renewable energy industries.

Russia, currently the world’s number one gas producer and number two oil producer, also has the potential to be a giant in the area of renewable energy. The Russian government has recently signaled support for the introduction of technologies to improve energy efficiency, reduce the adverse impact on the environment, and produce electricity and fuel from renewable sources. The articulation of concrete national goals for the development of renewable energy and the creation of a more solid legal framework, including financial incentives and subsidies, can over time make both domestic and foreign investment in this area more attractive.

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In an op-ed published in today’s Moscow Times, Akin Gump Senior International Advisor Toby Gati analyzes emerging policy signals indicating an increased interest in renewable energy and energy efficiency projects in Russia.

Mrs. Gati is the former special assistant to President Bill Clinton for Russia and the Eurasian States and Assistant Secretary of State for Intelligence and Research.

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The Russian Federation’s carbon emissions are significantly lower than the limit placed on the country under the Kyoto Protocol, leaving Russia with the opportunity to sell a portion of its emissions quota. Under current prices, the total potential value of Russian carbon credits is estimated at around US$40 - US$60 billion. Given these facts, one would expect quite a bit of activity on the part of officials and companies to unlock this potential value - especially since the level of actual carbon credit trading in Russia has been quite low.

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