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REFORM OF THE RUSSIAN POWER SECTOR: the Development of Hydro Power as a Source of Renewable Energy

REFORM OF THE RUSSIAN POWER SECTOR: the Development of Hydro Power as a Source of Renewable Energy. Louis Skyner Associate Fellow, EEDP, Chatham House Senior Associate, Wikborg Rein, Oslo NUPI 8 May 2008. Introduction: Rhetoric versus Reality in Energy Policy(1:2). Rhetoric

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REFORM OF THE RUSSIAN POWER SECTOR: the Development of Hydro Power as a Source of Renewable Energy

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  1. REFORM OF THE RUSSIAN POWER SECTOR: the Development of Hydro Power as a Source of Renewable Energy Louis Skyner Associate Fellow, EEDP, Chatham House Senior Associate, Wikborg Rein, Oslo NUPI 8 May 2008

  2. Introduction: Rhetoric versus Reality in Energy Policy(1:2) Rhetoric • Russian government Energy Strategy for 2020 (published 2003): • increase in internal gas production (independents 25% of total output by 2020) • liberalisation of the gas market (10 bcm sold at unregulated prices – gas price 2X by 2010 and 3X by 2011) • replacement of gas by coal as fuel for power generation (2006 coal 15% of power generated cf. gas 52% – 2020 to be coal 30% and gas 40%) • USD 134 billion to be invested in power generation • construction of new transmission and distribution grids • increased energy efficiency • Announced 25 January 2008 by Ministry of Industry that increase in generation capacity by 2020 of: 200% for nuclear; 200% for coal; 45% for hydro; 40% for gas • Higher fuel costs and liberalistion + privatisation of power generation resulting in gas savings

  3. Introduction: Rhetoric versus Reality in Energy Policy (2:2) Reality • Projected production of gas fields to fall from 650 bcm in 2005 to 450 bcm in 2020 • 2007 Gazprom invested USD 17 billion in acquiring downstream assets and USD 12 billion in upstream development / infrastructure (growth in production for 2006 as 0.4%) • Shortage of gas supply due to: failure to adopt market-based pricing; and, failure to adopt energy efficient measures • Subsidised gas = lack of incentive to invest in alternative energy sources (current price as USD 40 tcm – 14% average German border price) • Inefficiency of transportation and transmission networks – need large-scale investment • Proposed Gazprom acquisition of SUEK – decrease in competition on fuel market • Gazprom acquisition of power generation capacity • Key question – is an increase in generation capacity of 50 GW in 5 years possible?

  4. Power Sector: the Need for Reform • Growing Electricity Demand (4 – 4,5 % per annum) • 2007: 1.030 TWh • 2008: 1.082 TWh • 2010: 1.197 TWh • 2015: 1.426 TWh • 2020: 1.710 TWh • Falling Generation: • More then 90% of generation assets in operation pre - 1991 • 70% of generation assets fully depreciated • 1990: 1.082 TWh • 2006: 965 TWh • 2006 - no surplus generation capacity and shortage of fuel to meet peak demand

  5. Power Sector Reform - the Key Acts (1:2) • The break-up of RAO UES and existing vertically integrated regional energos to create separate generation, transmission, distribution and retailing businesses • The physical separation of competitive elements of the value chain (wholesale generation and retailing) from natural monopoly elements (network services and system operation) • The privatisation of generation assets to promote the development of sustainable competition between generators (in 2007 USD 21.5 billion was invested in power generation) • The horizontal unbundling of retailing functions, including the creation of guaranteeing suppliers to serve regulated consumers and to operate as a retailer of last resort • All to be completed by 1 July 2008

  6. Power Sector Reform - the Key Acts (2:2) • The separation of network ownership and system administration functions • The creation of a separate market administrator for the wholesale market • Natural monopolies are being brought under the governmental supervision • Non – discriminatory access being introduced for all users of regulated services • Wholesale and retail markets for power are being created • Prices are being liberalised over a transition period (volume of electricity sold at regulated prices (i.e. at the tariff set by the FTS) to be decreased every 6 months so that by 2011 competitive market pricing will be introduced on the Wholesale Market)

  7. Competitive market Generation and Supply Electricity to be a freely traded commodity Prices are to be set on the basis of market supply and demand Natural Monopolies Federal Grid Company (FGC) will manage the transmission network, i.e. the high voltage grid Trading System Operator (ATS) will facilitate electricity trading System Operator (SO) wil manage the dispatch of electricity and coordinate the operation and maintenance of the grid and generators Regulated tariffs are to be set at levels that ensure cost recovery and a return on invested capital in the transmission network Power Sector Reform – the Key Principles: the Separation of Competitive from Natural Monopoly Elements (1:3) • The separation of competitive and non – competitive assets has been mandated and implemented • As of 1 April 2006 cross – over ownership of transmission and generation assets is forbidden

  8. Power Sector Reform – the Key Principles: the Liberalisation of Prices (2:3) Transition Period • Both electricity and capacity may be sold on the Wholesale Market under regulated contracts with a duration of one to three years (concluded under ‘take or pay’ conditions) • If buyer in a regulated contract consumes a higher volume than contracted he is to pay the day – ahead market price for the excess volume • In contrast non - contracted volumes of electricity may be sold / bought at competitive prices on the day - ahead market After Market Liberalisation (post 2011) • The price of generation on the Wholesale Market will be agreed by the parties of a bilateral contract, or based on supply and demand on the day - ahead market • NB on the Retail Market the pricing system is synchronised with the liberalisation of prices on the wholesale market although the cost of services provided by the Guaranteeing Supplier (the sales mark up) is to remain regulated by tariffs during the transition period • Planned introduction of a capacity market (i.e. when generators have complied with SO requirements)

  9. Power Sector Reform – the Key Principles: Ensuring Competition and an Integrated Regulatory Framework (3:3) • The legislative framework includes measures to promote and secure fair competition: • the compulsory submission of information to regulatory authorities to facilitate the effective monitoring of market participant conduct and enforcement • public contracts securing equal conditions for the use of natural monoply services • restrictions on maximum legal levels of generation capacity ownership within a wholesale pricing zone • the forced unbundling of assets where concentration restrictions are breached • Supervision of competition and non - discriminatory access • Federal Anti - Monopoly Service (FAS) has responsibility for competition supervision, and is also responsible for regulating non – discriminatory access to natural monopoly services and regulating the activities of the ATS • Separation of functions • ATS, FTS, SO, FGC

  10. Power Sector Reform – the Dynamic Increase in Generator Margins • Investment in new power generation is increasingly attractive due to: • the increasing upward pressure on margins of existing electricity assets resulting from rising supply / demand tension • the forthcoming sector liberalisation and privatisation which should allow upward margin pressure to translate into actual price hikes in margins and cash flow • Margin increases for existing capacities will also rise as by 2011 (wholesale price liberalisation) they will operate in the same pricing environment • Privatisation as demanding a profit – maximising approach and an increase in efficiency Hydro and Coal versus Gas • Expected rise in gas prices detrimental to existing gas-fired generators (but scope for large improvements in efficiency) • Hydropower as a leveraged play on electricity liberalisation and gas price increase (part of Federal Investment Programme – power plant construction and infrastructure development)

  11. Hydro Power and the State • In 2006 the generating capacity of hydro power plants represented 21% (44 GW) of installed capacity which constitutes only about 20% of its economically efficient hydro power resources • Expected that gas-fired plants, due to shortages in domestic gas supply, will not be able to accumulate enough fuel to meet peak load • Declared aim of the State to develop hydro power resources by: • The consolidation of existing hydro power facilities within Hydro OGK by 1 July 2008 (50% + 1 share to be owned by the State); • Financing of hydro power projects together with infrastructure development (i.a. Federal Investment Programme and Investment Fund); • Implementing measures to attract private investors (i.a. guarantees, tax benefits); • Co – ordinating infrastructure development (i.a. general programme on power capacity allocation until 2020) • Joint Ventures with the State becoming reality for both old and new hydro power plants (legislation does not prohibit private investors owning newly constructed hydro power plants)

  12. New Hydro Power Projects (1:2) New Hydro OGK projects: Angara, South Yakut, Baikal, Amur and North-East Groups Angara group: Boguchansk hydro power and aluminium plant (project cost 8,2 billion USD) • Hydro OGK and RUSAL investing in both hydropower plant and aluminium smelter • Hydro power plant capacity 3.000 MWh • Aluminium smelter output 597.000 tons • Operation to begin in 2009 • State participation: Hydro OGK; and 379 million USD for construction of a water reservoir; 1,5 billion USD for development of transmission and distribution infrastructure • Private investor / main consumer: RUSAL

  13. New Hydro Power Projects (2:2) Baikal group: Mokskaya hydro power plant • Hydro power plant capacity - 1.410 MWh; • Operation to begin 2016 – 2017 • State participation through: Hydro OGK; Federal Target Programme for development of the Baikal Region and the Far East of Russia • Private investors: electricity consumers in the region South Yakut group: South Yakut hydro power complex (project cost of phase 1: 3,3 billion USD) • Hydro power plants capcity: 8.500 MWh • Operation to begin in 2015 • State participation: Hydro OGK • Private investors: tender for long - term consumers

  14. Promotion of Small Hydro Power as a Source of Renewable Energy • Present hydro power potential as 850 TWh per year of which 200 TWh may be generated by small hydro plants, i.e. with an installed capacity of 15 MW or less • Currently 68 small hydro plants with an aggregate installed capacity of 630 MW • IEA Report of 2003 identified that 65.2 milltion tons of coal equivalent per year is recoverable from small hydro power (1 MW per hour of power generated from hydro results in a 456 Kg reduction in CO2 emission) • Establishment of New Energy Fund by Hydro OGK for the construction / reconstruction of a system of small hydro power plants with a typical installed capacity of 25 MW (with an aggregate of 1000 MW by 2020) • Adoption of supporting measures (in addition to legislation discussed below): • State Investment Fund participate in the co-financing of generation and infrastructure • Cancellation of payment imposed for use of water objects • Implementation of procedure for allocation of land plots for construction of generation facilities • Identification of budget procedure for funding establishment of flood zones

  15. Implementation of Legislative Framework Supporting the Development of Renewable Energy Sources (RES) (1:3) • Aims of RES support legislation: • Identify RES energy share in production and consumption national energy balances • Oblige government to adopt plans to achieve such targets • Attract investments and reduce RES energy generation costs • Ensure that the support mechanisms are market-based, i.e. they are proportionate to the volume of RES energy generated and volume of MWh sold on the wholesale market (and is only triggered when RES energy is produced) • Requirements of investors: • Legislation implements a long-term policy on RES energy sales and transparent procedures • Ensure low market entrance barriers, i.e. grid connection • Large – scale investment in transmission and distribution grids

  16. Implementation of Legislative Framework Supporting the Development of Renewable Energy Sources (RES) (2:3) • Key contents of legislation (FZ 250 of 4 November 2007): • Identifies energy sources considered renewable (includes hydro power with no limitation on installed capacity) • Provides federal budget subsidies, i.e. grid connection cost for RES energy generators with installed capacity of less then 25 MW • Imposes obligation on grid companies to prioritise purchase RES energy to compensate for their transmission losses • Introduction of green certificates for RES energy, i.e. certifying volume of RES energy generated • Introduction of price increment system supplementary to RES energy market price to be paid to generators by Wholesale Market participants

  17. Implementation of Legislative Framework Supporting the Development of Renewable Energy Sources (RES) (3:3) • Supplementary regulations that remain to be implemented: • Specification of criteria, rules and procedure for qualification as RES energy generator • Imposition of obligation to purchase and specification of procedure for purchase of RES energy by grid companies for their transmission loss compensation • Amendments to market rules to calculate and apply the level of RES increments to the market price • Specification of RES increments payment procedures for the Wholesale and Retail Markets • Establishment of a national body to issue RES certificates • Establishment of procedure for issuing, registering, and redeeming RES certificates • Specification of criteria, rules and procedure for the allocation of budget subsidies, i.e. for gird connection costs • Identify RES share in generation and consumption national energy balances • Identify programme and indicators for achieving aforementioned targets

  18. Availability of Carbon Credits: the Introduction of Joint Implementation Projects • Hydro power projects with an installed capacity of less then 15 MW are automatically eligible for carbon credits whilst larger projects may qualify if they comply with the additionality criteria (in addition projects must comply with UN and World Bank standards, i.e. reservoir construction • Joint Implementation approval desirable from investment perspective as an indirect increase in the price of energy contributes to capital cost recovery (approx. contribution of carbon credits towards a hydro power project equivalent to EURO 15 MWh) • Legislative approval of a carbon accreditation system • 75 – 80 projects validated but not approved • But no Joint Implementation projects currently registered due to the difficulty of complying with additionality requirements and the absence of approved methodologies • Legislation gives national authority a veto right if a project receives UN approval on ill – defined grounds, i.e. efficiency • Legislation establishes a limit of 300 million tons of CO2 equivalent for Joint Implemention projects with sectoral limits providing scope for non – transparent decision making

  19. Absence of Regulatory Framework and Economic Conditions for Investment • Development of small hydro plants requires: • The implementation of a strategic environmental assessment in compliance with international standards • The introduction of long-term power purchase agreements • The introduction of a mechanism for green certificate offtakes • The introduction of Joint Implementation Projects and carbon credits • In the absence of long term contracts + before the full liberalisation of electricity prices an investment in small hydro power is only economically viable if carbon credits can be earnt

  20. Conclusion: Challenges Ahead • Need for plurality of ownership of generating capacity (threat posed by acquisition of shareholing in OGK / TGK by Gazprom – November 2007 maximum level of generation capacity held by own owner in a single pricing zone from 35% to 20%)) • Need to ensure fuel supplied to thermal power generators on a non – discriminatory basis: • implementation of regulated fuel supply contracts (penalties for over consumtion) • threat posed by Gazprom acquisition of SUEK (Gazprom as supplying 65% of gas and SUEK 45% of coal used in thermal generation) identified by FAS • Need for investment in transmission networks to avoid network congestion (and network interconnection to hinder formation of regional monopolies) • Need to avoid unjustified State intervention in the price formation process (FTS authority to apply price caps to moderate price spikes due to supply shortage) • Competitive prices must be supplemented by consumer choice, i.e. metering • Need to implement measures for development of RES energy

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