Russian renewables market: investment opportunities and market entry strategy
Russia has the potential to increase its use of all types of renewable energy technologies. Historically it has a well-developed hydropower segment. Its bioenergy potential is also significant, as this technology is used in the agriculture, forestry, infrastructure and trade sectors. But today, Russian renewable energy policy is focusing on accelerating the deployment of wind and solar.
Apart from the wind and solar focus, in 2017 Russia introduced a set of legislative amendments aiming to extend the existing renewable energy scheme to generating facilities operating on the basis of production and consumer waste usage, in certain regions. The first tenders were held in 2017, and we expect accelerated development in this sector in the coming years.
There are a number of drivers in Russia that explain the country’s increasing focus on renewables and decentralised energy. New energy solutions are seen as a way to modernise the power system, but they are also a part of a broader socio-economic development model to achieve higher living standards. In addition, Russia’s remote and distant regions are interested in a decentralised electricity generation system, as it is economically impractical to extend high-voltage electricity lines to these areas.
Decentralised electricity generation is also attractive for industrial complexes. It offers opportunities and allows them to become more independent from the centralised power system. The current situation of relatively high electricity prices is another reason to explore new energy solutions.
Russia’s response to EU and US sanctions is also a factor. The country’s local content requirements have become one of its main economic policy drivers supporting inbound investments and technology transfers to develop local innovative technologies in various sectors, including in the renewable energy business.
Market entry strategy
All renewable energy projects in Russia are being implemented within the framework set out by the Russian state development programme (“the Programme”). A favourable (guaranteed tariff) legal regime applies to projects involving wind, solar photovoltaic or hydro (with aggregated capacity of less than 25 MW) renewable energy sources.
The projects are awarded at an annual public tender carried out by the official commercial operator. The winners of the tender enter into the approved form Capacity Supply Agreement (hereafter referred to as “CSA”). Under the CSA, the tender winner is:
- awarded a 15-year capacity supply arrangement with fixed returns on investment
- obliged to build up and commission the photovoltaic/wind power plant by a specified deadline.
Failure to meet the deadline leads to significant fines being imposed on the winner each month. These fines are automatically debited from the winner’s account opened within the system, or from the special account of the winner’s surety.
The Programme covers the period until 2024 (inclusive). After 2024, the Russian government will continue supporting this market, but the form this support will take (legal regime and economics of the potential projects) is not yet clear.
Several market entry strategies are available to investors under current rules:
- a “greenfield” project, developed from scratch, through direct participation in the annual public tender mentioned above
- a “quasi greenfield” project, by partnering with a company that won one of the tenders and has already been awarded a CSA and/or received first stage documents (e.g. construction and other permits)
- a “brownfield” project, by partnering with a company that won one of the tenders and has already started project implementation (or fully/partially completed it).
The greenfield and quasi-greenfield projects are particularly relevant for investors who intend to use and implement their own technology and equipment/products.
However, in practice, we note that Russian companies often win the tenders – either with the participation of state-owned conglomerates or groups of companies owned by Russian oligarchs.
Also, because the Russian renewable energy sector is relatively new from a technical standpoint, working on projects here on a standalone basis may be quite challenging for foreign investors.
The technical and logistical aspects present significant challenges. The potential investor must draft a precise bid corresponding to the technical requirements at the tender stage (if any). Following a successful bid, the winner will have to document its rights to the land plot, organise the construction and installation process, and coordinate with suppliers to deliver components.
As mentioned above, due to localisation requirements, production in Russia may have to be set up. This is a complex and time-consuming process involving a great number of formalities and procedures. Investors are also bound by the deadlines set out in the CSAs.
Therefore, in practice, most foreign investors enter the market in consortium with local partners responsible for construction “in-land” and contacts with the local authorities. This approach helps them to deal more smoothly with the challenges outlined above.
The choice of local partner ultimately depends on the role that foreign investors are ready to play in the projects. If they do not want to participate in public tenders, they should seek a local partner who has already been awarded CSAs, but is struggling with their implementation.
Timing of investment
According to the commercial operator, at the beginning of 2018 approximately 78% of the targeted capacity covered by the Programme had already been awarded to the market players. If the state tenders are successfully carried out through 2018-2019, 95% of the targeted capacity will have been distributed. Thus, opportunities to enter the market through a public tender after 2019 will be fairly limited and uncertain.
The development of Russia’s renewable energy market is one of the government’s priorities and, as such, is to a certain extent politically driven. Leading Russian conglomerates – owned either by the Russian state or oligarchs close to it – have already captured a major part of the market and drive most of the substantial projects. These conglomerates have already attracted a number of foreign suppliers/investors to procure a high level of technology to be used in these projects.
Moreover, Russian “local content” requirements are relatively high (currently 70% for photovoltaic and 65% for wind projects)  and will keep that level in the coming years. Therefore, investors have to set up production facilities in Russia to meet the localisation requirements.
This raises two potential impacts on business strategy.
First, once key Russian players’ production facilities start operating in Russia, the need for foreign technology might decrease on the domestic market. From that perspective, and proceeding from a “first come, first served” approach, it might be more challenging to achieve a good pay back depending on the timing and type of investment envisaged (nature and amount of investment, potential markets).
At the same time, due to contractual limitations (securing impenetrability and patent protection), the R&D/technologies transferred by foreign investors to Russian counterparties will not automatically be available to future projects in which those foreign investors will not be involved. This will, de facto, somewhat limit any potentially adverse impact.
Second, when considering whether to localise its production in Russia for a particular domestic project, an investor will search for new markets to improve its return on investment. This is primarily because the amount of renewable energy that companies require in Russia might not be enough to effectively localise production. In the long run, this may mean that only export-oriented products can be really competitive.
The Russian market is often insufficient to justify the localisation of many products.
Investors may try to negotiate an increase in the percentage of renewable energy received and/or shift the cost of localisation to the tariff. But this is rather uncertain and, ultimately, comes at the expense of consumers, which may rise political concerns due to the growth of electricity prices and impair the chances of a positive outcome.
Therefore, the industry policy for renewable energy projects in Russia may well evolve in coming years towards a more balanced model, based on export growth commitments in exchange for a decrease in localisation requirements, but without direct public subsidy support measures.
Accordingly, the shape of the future business model for investment in renewable energy in Russia may be based on a commitment to bring projects to a certain level of localisation, within a specific timeline, with export obligations.