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Russia tension with the US

May 2018
Marketing Material

The unintended consequences of sanctions against Russia

Why the latest sanctions may paradoxically hinder Russia’s efforts to cut pollution from power generation.

Turning inwards

The effects of April’s US sanctions on Russia in the financial markets were immediate. The stock price of Rusal, one of the world’s largest aluminum producers headquartered in Moscow, declined by over 40% after it was included in the US sanctions list. But rather than bend to the political rule of the US and Europe, Russia has responded by turning inwards, increasing protectionism through its own economic measures.

Russian retaliation has been particularly notable in the electricity sector.

These have included implementing new import quotas on food items, and prohibiting imports of US-originated IT equipment and software. 

Russian retaliation has been particularly notable in the electricity sector. In May this year, Deputy Minister of Energy, Vyacheslav Kravchenko, introduced draft legislation requiring 90% of new electrical generation equipment to be produced locally in Russia. That’s no small matter, given the country’s ambitious programme to upgrade or replace 40 gigawatts of old and outdated generation capacity via auctions over the next 10 years. By comparison, Norway’s total installed electricity capacity is roughly 34 gigawatts. Companies that fail to comply with the restrictions would be hit with severe financial penalties.

Modernising in isolation

Unfortunately, Russia lacks the domestic expertise and equipment to drive such a massive modernisation programme. In order to make its power infrastructure more environmentally friendly and efficient – in other words to meet the ESG criteria that we, as investors, look at – Russia needs foreign expertise and trade. 

Perhaps the most efficient way for the country to do this is by using combined-cycle gas turbine (CCGT) technology, which, in terms of thermal power, is 50% more efficient than the country’s existing steam turbines. If Russia were to replace all of its steam turbines with new combined cycle gas turbines – thus lowering its average fuel rate from 330 gfoe1/kWh down to 220 gfoe/kWh in the process – it would save 17 billion cubic meters of gas per year. This is roughly equal to Poland’s annual gas consumption and the equivalent of 310 million tons of CO2.

RussianSanctions3_center_201807.jpg
The control room of an old thermal power plant unit in Russia. The red zero displayed in the top right indicates that the unit is currently not producing capacity.
But to date, domestic Russian producers have faced several setbacks in their efforts to replicate international CCGT technology and remain in the early stages of development, according to industry participants. Moreover, utility companies have said that unless the new law is changed, at least the initial 9 gigawatts of old capacity scheduled for modernisation will be replaced by new, but still less efficient steam turbines. Unless the technology is acquired or developed, the unintended consequence of the sanctions will continue to pollute the Russian environment with more than just political antagonism.

Goods may be halted at the border, but pollution won't be

That’s when sanctions stop being just Russia’s problem. Goods may be halted at the border, but pollution won’t be. The valid goal of curtailing “malign activity” through sanctions may, paradoxically, hinder Russia’s efforts at cutting pollution from power generation.

Not that sanctions are wholly bad news for Russia’s environment. For instance, they’ve debatably reduced the environmental impact of Russian oil companies by curtailing their access to finance and thus forcing them to rationalise their capital expenditures. These financial constraints have also helped to improve minority shareholder returns and corporate governance.

More generally, as environmental concerns have become an increasingly important part of how we invest, any incremental deterioration of a firm’s emission profile will make it less attractive relative to its global peers. And Russia’s electricity producers are likely to suffer.