Quantifying barriers to decarbonization of the Russian economy: real options analysis of investment risks in low-carbon technologies

ABSTRACT

Russia has significant potential for reducing its carbon emissions. However, investment in new low-carbon technologies has significant risks. Ambiguous energy and climate policy in Russia, along with deterioration of the country's investment climate, create investment barriers that are well described in qualitative terms in the literature. This paper attempts to provide a quantitative analysis of these barriers. For this numerical experiment, we apply the RU-TIMES model. Using a real options methodology, we estimate the risk-adjusted cost of capital in the Russian energy sector (including energy production and consumption technologies represented in the TIMES framework) to be approximately 43% (including a risk-free interest rate) and demonstrate the high risk of investment into energy-efficient and low-carbon technologies. Any future low-carbon emissions pathway depends on the ability of the Russian government to reduce climate and energy policy uncertainties, and to reduce financial risks through improvements of the general investment climate.

Key policy insights

• The high cost of capital investment into Russian energy production and consumption may prevent the adoption of new energy-efficient and low-carbon technologies.

• These investment risks, if not addressed, will delay Russia's low-carbon transition for the coming decades.

• Adopting a clear and unambiguous long-term climate and energy policy is important to reduce these risks and alleviate some of the barriers to the new technologies.

• The first step could be ratification of the Paris Agreement and adoption of a long-term emission target for the period up to 2050.

KEYWORDS:

• Russia
• low-carbon transition
• investment risks
• real options analysis
• barriers to new technologies

Acknowledgements

We thank Dr. Michael Brody for valuable comments and help with the manuscript. We also wish to thank the four anonymous reviewers for detailed comments and constructive guidance for the paper revision and improvements.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 Russia proposed the following emissions target: ‘Limiting anthropogenic greenhouse gases in Russia to 70–75% of 1990 levels by the year 2030 … subject to the maximum possible account of absorbing capacity of forests’. We refer to INDC rather than to NDC due to Russian failure to ratify the Paris Agreement yet. For the latest Russian submission see: https://www4.unfccc.int/sites/submissions/indc/Submission%20Pages/submissions.aspx.

2 http://unfccc.int/files/national_reports/annex_i_natcom_/application/pdf/20394615_russian_federation-nc7-1-7nc.pdf.

3 The optimization algorithm chooses cost efficient technologies given exogenous parameters like cost of a technology, a fuel cost, carbon tax, cost of capital etc.

4 Risk –adjusted cost of capital is a sum of the risk free interest rate and a risk premium. Higher uncertainty of the future return on capital requires higher risk premium.

5 Examples of application of Real Options Analysis to climate and energy policy could be found in Anda et al. (2009), Golub and Brody (2017).

6 Deferral option is an option to delay risky investment.

7 Bottom-up models mimic the specific technological options in the energy sector (see: http://www.ipcc.ch/ipccreports/tar/wg3/index.php?idp=310).

8 A 35 GT of CO₂ cumulative emissions budget for Russian fossil fuel emissions represents an emissions target consistent with the global 2°C scenario. The emissions budget was calculated by the authors based on Potashnikov and Lugovoy (2014), Sachs et al. (2014) and Pye et al. (2016) and taking into account the IEA (2018) 450 ppm scenario.

9 In 2011 prices.