The Geopolitics of Decarbonization: The Russian Case

Global efforts to combat climate change and to decarbonize the world economy will have a tremendous impact on geopolitics and foreign policy. Climate discussion itself creates leaders and outsiders: countries that resist this global transition away from carbon are losing credibility, whereas those leaders promoting a climate agenda are gaining stronger positions in the international arena and using carbon restrictions to help reshape the rules of international trade and relations between different economies (like with EU ambition to introduce cost-benefit analysis and other restrictions on carbon-intensive imports). This dynamic will be at work despite the economic decline caused by COVID-19. There are also some strong sector-specific implications related primarily to the energy sector, the biggest carbon emitter.

According to the UN’s Emissions Gap Report 2019, fossil CO2 emissions from energy use and industry dominate total greenhouse gas (GHG) emissions, making fossil fuels use the primary target for reduction. Many approaches have already been developed to move towards zero-carbon development pathways: energy efficiency; massive deployment of renewable energy for electrification; coal phase-out for rapid decarbonization of the energy system; decarbonizing transport with electric vehicles; hydrogen and other alternative fuels; decarbonizing energy-intensive industries through recycling; materials substitution and dematerialization; deployment of carbon capture, utilization, and storage; and fundamental transitions in the industrial process itself. Implementing these measures will affect the geopolitical positions of the hydrocarbon producing and importing countries, as well as the positions of countries which are not reserve holders but technological leaders in new energy. Energy superpowers’ leverage in this world of energy transition will be decreasing dramatically, together with their resource rent. Their comparative negotiating power is already changing, resulting in a profound reconfiguration of the global energy market landscape.

More Inventory than Customers

Russia is one of the more glaring examples of the potential losers in this geopolitical transformation. Indeed, countries like Russia, heavily dependent on hydrocarbon export revenues, will need to adapt their foreign policy to a world economy less reliant on their supplies. Hydrocarbon exports will no longer be a bargaining chip in international negotiations, and “geopolitical” energy projects (like many gas pipelines) will not be able to provide additional geopolitical arguments and power to the reserve holders.

The recent turmoil on the global oil and gas markets—which began when a production agreement between Russia and Saudi Arabia collapsed and became much more serious due to the COVID-19 lockdowns—was a sort of stress-test for all hydrocarbon exporting economies. The shrinking demand and fierce competition has led to an unprecedented drop in the oil and gas revenues for producing nations and significantly destabilized their economies. Given the inevitable path of the energy transition, this episode has illustrated in a couple of months what will happen to the oil and gas exporters over the next decade or so as the world approaches peak oil demand. The Russian Federation, for instance, faces the equivalent of a 50 percent loss in expected energy export revenues (as gas prices are halving and oil prices reducing by one third, while volumes of Russian exports of oil, gas, and coal are decreasing by 20–25 percent). For the national budget, this decline means a sharp fall in income of about 25 percent, just as the public and business are in most need of state support.

This is a real wake up call for the resource-rich countries. Fossil-fuel exporters that refuse to accept the energy transition are most exposed to decarbonization and least resilient to its economic effects.

So far Russia, which ranks fourth in the world for primary energy consumption and carbon dioxide emissions and third in global primary energy production, has adhered to a strategy of "business as usual." Huge new investments were made during the last decade in new expensive infrastructure for hydrocarbon exports—not only to the traditional European markets (“Turk Stream”, NS, and NS-2) but also to the North-East Asia (ESPO, “Power of Siberia”), which Russian leadership regards as the most promising market for Russian oil and gas. Energy exports are critical for the state budget, for the key energy companies, and for many regions in the country that rely strongly on hydrocarbon revenues. But the changing global environment and the decarbonization agenda pose an existential threat to all key Russian stakeholders, challenging the very sustainability of the economic (and political) system in the country. In 2016, according to the OECD, oil and gas revenues accounted for 36 percent of the country's federal budget, and Russia’s main export market, the EU, is working fast to reduce its imports.

Although Russia joined the Paris Agreement in September 2019, domestic decarbonization of the energy sector is not yet on the agenda—a skeptical attitude about the problem of global climate change prevails among stakeholders. GDP energy intensity remains high, constrained by relatively low energy prices and high capital costs. The share of solar and wind energy in the Russian energy balance is insignificant and, according to the official forecasts, is not expected to exceed 1 percent by 2035. The challenge for Russia in the coming years will be to develop a new strategy for developing the energy sector (at least for energy exports) in the absence of a significant domestic climate change agenda—and in response to increasing global competition, growing technological isolation, and financial constraints.

The Green Recovery

The coronavirus crisis will create new momentum for energy transitions, especially in the countries that are Russia`s major energy trading partners: the European Union, Japan, South Korea, and to a certain extent China. National governments in these countries are increasingly vocal in their calls for low carbon economic recovery. The EU has confirmed its commitment to a green path of 100 percent climate neutrality by 2050, which will require colossal funds—between €175 and €290 billion of investments annually. In addition to €1 trillion of public funding for the next 10 years, the EU envisages a number of initiatives to develop green private financing. Such investment projects will get privileged access to money.

Against the background of excessive and extremely cheap hydrocarbon supply, importing country governments are now moving to introduce the long-discussed Carbon Border Adjustment Mechanism—the European Commission will put forward its proposal for one in 2021. This duty would mean additional costs for some carbon-intensive imported goods. It is intended to eliminate the competitive advantage currently enjoyed by countries that export to regions with tough eco-standards, where local industry faces higher costs. This is another disruption for hydrocarbons, metallurgy, and chemical industries. At the same time, oil market volatility has aggravated skepticism among investors, who even before the crisis had shifted massively from fossil fuel assets to low carbon and energy efficient projects.

Demand for energy will gradually recover in the wake of the COVID-19 lockdowns. But there are two trajectories for this recovery: the traditional one and that of an accelerated energy transition. In the first scenario, spurred by low oil prices, hydrocarbon demand will recover quickly and markets will inevitably be exposed to a deep investment gap, which will result in a new price hike. Rising hydrocarbon prices, in their turn, will once again stimulate interest in alternative energy sources and energy efficiency.

In the accelerated energy transition scenario, massive state support will be channeled into a green recovery. The EU has taken a step in this direction with a pledge to spend 30 percent of its €1.8 trillion budget from 2021-2027 on climate action. Such state support will advantage the industries competing with the oil and gas sector, creating pressure for those dependent on demand for fossil fuels. In short, importing countries have every opportunity to emerge from the crisis with transformed energy systems, strict carbon footprint limitations on imported raw materials, and irreversibly curtailed demand for hydrocarbons.

Going Down with the Ship?

An energy transition appears unavoidable; the only question is the speed of the process. Despite this, Russian regulations assiduously ignore the trend towards decarbonization. Combatting climate change is not mentioned in the Goals and Strategic Objectives of the Russian Federation to 2024. The Energy Security Doctrine defines “increasing international efforts to implement climate policies and accelerate transition to a green economy” as an external political challenge to Russia’s energy security. The term ‘energy transition’ and related external market changes are not mentioned in the text of the new “Energy Strategy for the Period to 2035,” which envisages a significant scaling-up of coal, oil, and gas exports.

Strategically, however, the Russian economy currently has an opportunity to make fundamental reforms that could provide the country with a long-term trajectory to a different, more innovative development track. In Russia, energy is utilized very inefficiently, particularly in heating. This problem has been discussed for several decades. Today might be the ideal time for measures that have long been urgent, namely support for energy efficiency projects. A breakthrough in this sphere would not only strengthen global competitiveness dramatically and reduce the global carbon footprint but also create a significant number of new localized production facilities and jobs.

The promotion of high-tech sectors could focus on a program of overall energy efficiency enhancement, localization of services and equipment production, promotion of renewable energy systems, establishment of a state fund for targeted investments in technology with low greenhouse gas emissions (hydrogen, etc.), and provide an opportunity to exit the crisis with a better, more modern structure for the economy. This means new highly qualified jobs, development of high value-added production, and faster growth, instead of catching-up. And it does not require eliminating hydrocarbons. A transformed oil and gas sector could continue to play the role of the national economic driver, while aligning with the green agenda perfectly well. However, this requires new solutions (e.g., carbon capture, storage, and utilization technologies, methane emission control, hydrogen, use of the whole spectrum of offsetting mechanisms) and, importantly, a strategic choice.

It is a complex, expensive process that requires new technologies and skills that Russia and the Gulf countries currently do not have. For now, however, there are no other options in sight for securing the long-term stability of its export-focused resource-based economy.

What the International Community can do

In this respect, the international community could take some steps to encourage a smooth energy transition for fossil fuel resource rich economies like Russia’s.

First of all, a clear and transparent communication of the long-term decarbonization strategies and schedules of the importing countries is an important signal for producers, so that they can adjust their strategies and investments accordingly. This would require high-level coordination and synchronization, which would be quite a challenging exercise. But without understanding it, producers inspired by calls for additional investments and exports in the short-term will find themselves with enormous stranded assets and shrinking revenues.

The second important component is technological cooperation and joint development of the new supply chains and of the appropriate regulation and certification mechanisms—for decarbonized oil and gas supplies, as well as for blue and green hydrogen and renewable electricity exports. This will be achieved and tested only with bilateral pilot projects, which are lacking at the moment.

And, of course, the interests of the producer economies should not be ignored during the global discussion: the rapid destabilization of any of these hydrocarbon producing countries could have extremely dramatic consequences for their regions and, potentially, for the whole world.