energy efficiency as an eu foreign policy tool: possible impact on russia

7/31/2019 Energy Efficiency as an EU Foreign Policy Tool: Possible Impact on Russia

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STUDENT: Federico Faleschini (student number: 10902214)

DEGREE: Master of Arts in International Relations (International Double

Award)

YEAR: 2011/2012

WORD COUNT: 14000

Energy Efficiency as an EU Foreign Policy Tool:

Possible Impact on Russia


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Table of contents

Introduction.......................................................................................................................1

i. Research design: theoretical framework..........................................................................................1

ii. Research design: operationalisation of key concepts and research hypothesis definition..............3

1 The development of the EU Energy Policy and Energy Efficiency............................6

1.1 Europeanisation of Energy Policy and role of EE...........................................................................6

1.2 The EU External Energy Policy: a multifaceted initiative..............................................................8

1.2.1 The Energy Charter Treaty..................................................................................8

1.2.2 The EU External Energy Policy and the Carbon Market initiative.....................9

1.2.3 The EU-Russia Energy Dialogue and the Partnership for Modernisation........12

2 Energy (in)efficiency in Russia: causes and potential for improvement...................14

2.1 Structural causes of energy intensity: economy and society.........................................................14

2.2 Institutional aspects of energy intensity: (lack of) economic and legislative incentives...............17

2.2.1 Energy tariffs and subsidies..............................................................................17

2.2.2 Energy Efficiency Legislation and Policy.........................................................18

2.3 Energy Efficiency potential in Russia...........................................................................................22

3 Policy options at the EU-Russia relations level.........................................................283.1 Options at the multilateral level.....................................................................................................28

3.1.1 The Energy Charter Treaty and the impact of Russia's WTO accession...........28

3.1.2 Joint Implementation: a great potential hampered on both sides......................30

3.2 Options at the bilateral level (Energy Dialogue)...........................................................................33

3.3 Barriers and how to remove (or soften) them through cooperation on EE.................................35

4 Conclusion.................................................................................................................40

Appendix 1......................................................................................................................42

Appendix 2......................................................................................................................43

Appendix 3......................................................................................................................47

Appendix 4......................................................................................................................49

Appendix 5......................................................................................................................50


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References.......................................................................................................................52


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INTRODUCTION

In today's carbon constrained world, energy efficiency is becoming more and more

important as a tool to limit global warming within acceptable limits. At the same timea new line of strategical thinking is appearing that promotes energy efficiency as a

clever, durable and mutually beneficial way to improve relations between energy

consumers and producers. Among these relations the EU-Russia relation is

tremendously important, being the EU the largest importer of energy and Russia the

largest exporter of energy in the world. The potential to be extracted from a

successful EU-Russia partnership on improving energy efficiency is immense. The

dissertation is dedicated to this topic. The main argument is that cooperation in

Energy Efficiency between the EU and Russia holds the largest potential of any area

in the Energy sector and should be much more forcefully pursued by the EU, since it

can dramatically improve its very own energy security and propel its status as leader

in the fight against climate change.

i. Research design: theoretical framework

The EU is conceptualised as a normative power as defined by Manners (2002,

2006) and more precisely as a Regional Normative Hegemon as defined by

Haukkala (2008).

Manners (2002) sees the EU as an entity other than the Westphalian nation-state and

argues that to understand its true nature the discussion must move away from

traditional, nation-centric concepts of civilian and military power/capabilities.

Normative power is defined as the ability to shape conceptions of normal in

international relations (ibidem), a concept not dissimilar from the Gramscian

concept of hegemony1. Such an approach is at work in the EU-Russia relation over

clean energy and environmental issues, as it is the EU which is more actively

involved into international environmental negotiations and is shaping the concept of

normal (i.e. sustainable development) in this field, with Russia taking a much

1 At the same time the normative power of the EU can be inscribed into the hegemonic discourse atthe international level of Global Governance such as developed by Brand (2005).

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more passive stance (Charap et al. 2010).

Haukkala (2008) starts its analysis from the concept of normative power Europe as

defined by Manners but adopts a descriptive rather than a normative stance. His

article is particularly interesting because it critically analyses the European

Neighbourhood Policy and the effects of the normative stance of the EU external

action when decoupled from the perspective of accession. The highly asymmetrical

relations between the EU and candidate countries impose heavy burdens on the latter

(i.e. there is a strong element of coercion), which are bearable only in light of the

advantages linked to full EU membership2. While the EU is openly playing an

hegemonic role only in its regional context, at the same time it is also trying quite

aggressively to promote its values on the global level (i.e. it is applying soft

power): the link between legitimacy of its normative power and the enlargement

process is a strong constraint on the EU's freedom of movement in respect to other

major international State actors and in the relation with these actors themselves.

The relationship between the EU and Russia can indeed be seen in many areas in this

light: by applying a high level of conditionality to its external relations with Russia

without offering concrete prospective benefits, the EU is not able to apply effectively

its normative power.

At the same time the conceptualisation of the EU as Normative Power allows to

identify a preference on part of the EU for multilateral instruments and forums

rather than power policies. Such a preference derives from the soft nature of the

EU's power and has important implications for the EU's relations with Russia. Indeed

as Boute (2012) argues the Commission may have well introduced the topic of EE

(where it already had vast competences even before the Lisbon Treaty) into the

External Energy Strategy to sneak in the realm of external energy relations, long

considered to be a privileged area of power politics.

2 Prange-Gsthl (2009) lists three factors which could motivate III countries with no clearmembership prospect to accept the export of the EU rule: the identification motive, theindependence motive and the economic motive. Unfortunately for the EU, none of this motives

could apply to Russia.

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ii. Research design: definition of key concepts and research hypothesis

Having defined the theoretical framework, the key concepts of Energy Efficiency

(EE) and (tool of) foreign policy must be defined and operationalised in order to

spell the research hypothesis.

EE can be defined in different ways according to the sector taken into consideration.

Relying on Patterson (1996), this study mainly refers to economic-thermodynamic

indicators of EE3. In these indicators the input is measured in thermodynamic units

and the output in economic units. The main indicators of this group are the

energy/GDP and energy/Y(/roubles/...) ratio (also known as energy intensity of

respectively an economy/country and sector) and the GDP/energy ration (measuring

the energy productivity of an economy/country). The main problem with these class

of indicators is that per se they don't distinguish between improvements in technical

EE and other factors which can influence energy consumption (e.g. changes in the

sectoral composition of the economy towards less energy-intensive sectors).

Being this dissertation in the realm of international relations, this class of indicators

is the most useful since it allows comparison of entire economies and allows to

calculate monetary costs and benefits of EE measures. In addition when assessing the

performance of specific sectors the physical-thermodynamic indicators come into

play. Indeed the Energy Charter Treaty (ECT)'s Protocol on EE and Related

Environmental Aspects (PEEREA) (ECT Secretariat 2004) defines EE in physical-

thermodynamic terms: article 2.6 defines Improving EE [as] maintain the same unit

[and quality/performance] of output [] while reducing the amount of energy

required to produce that output. On the other hand the EU Commission in its

Energy Efficiency Plan 2011 (EC 2011a) adopts the same definition (same output

with less input and/or more output with same input) but mingles it with the concept

of energy savings [i.e.] a broader concept that also includes consumption reduction

through behaviour change or decreased economic activity (ibidem: 2, footnote 2). In

practice these two terms and concepts are deemed interchangeable and are used as

equivalents, not only in the EU legal system but also in the Russian one (see chapter

3 See Appendix 1 for a description of all types of EE indicators.

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2.2). This study will follow the same convention and refer both to EE and energy

savings (ES), according to the circumstances and the dataset.

The most relevant definition of EE however may be that of full-fledged source of

energy, as stated in article 1.1 of the PEEREA and the Energy Efficiency Plan 2011.

EE is indeed a full-fledged source of energy because it can be conceived as an

alternative to building new generation capacity, especially where end-use energy

inefficiency is high. Thus, EE is operationalised as a proper source of energy and can

be measured in negajoules, i.e. the energy consumption avoided through

enhanced energy efficiency (ibidem: 2, footnote 3).

In this dissertation EE is also operationalised as a tool of [EU] foreign policy. By

this I mean that investments into EE can be seen as strategic by the EU since they

can concur to achieve not only internal political goals in the sphere of energy and

climate policy but also external goals . Two major EU goals in the energy sector are

improving Energy Security and be a leader in Climat Change Mitigation. Given the

complexity of energy security in today's Europe, I adopt the definition by Kirchneret

al. (2010: 864): the availability of energy in various forms, in sufficient quantity

and at affordable prices, delivered in an environmentally friendly, sustainable manner

which is also free from serious risk of major disruption of service.. How could

cooperation on EE help to meet both goals?

In respect to energy security concerns, an improvement in Russia's EE would

free considerable resources for export, thus eliminating concerns over future

energy supplies shortages by Russia. In addition, climate security, an essential

component of energy security and indivisible at the world level, would also

be greatly increased by the reduction of Russia's emissions;

In respect to climate change mitigation, addressing Russia's current very high

energy intensity would help the EU improve its international profile at

climate change negotiations and would provide a cheaper way to achieve its

ES targets through the Joint Implementation scheme.

Given that EE enhancement can indeed serve the EU foreign policy goals the

question to answer is whether the EU allocates enough importance to cooperation in

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the EE field. Another important question is whether cooperation in EE can create a

positive relationship between Russia and the EU. Therefore I formulate the research

question as follows:

Research Question: Does the EU allocates enough importance to EE as an instrument

of foreign policy in its relation with Russia?

The question will be answered in two steps. First, the current stumbling blocks in the

EU-Russia relation will be identified. Second, the potential of cooperation in EE to

remove these stumbling blocks will be assessed.

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1 THE DEVELOPMENT OF THE EU ENERGY POLICY AND

THE ROLE OF ENERGY EFFICIENCY

1.1 Europeanisation of Energy Policy and Role of EE

Ever since the Treaty of Maastricht came into force, the EU has played a significant

role in the development of international energy markets in Europe. In line with the

liberal agenda openly advocated by the EU in every sector, the EU pushes for the

creation of a truly interconnected continental energy market and the unbundling of

vertically integrated undertakings. In addition, the EU has taken an interventionist

role in the promotion of renewable energy and energy services and has also issuednumerous directives related to EE requirements in power generation, construction

and manufacturing. The EU is therefore strongly shaping all markets through its

energy and climate policy.

The liberalisation of the EU gas and electricity markets is covered in detail in

Appendix 2, since an in-depth review of such a complicated process is out of depth

for the goal of this dissertation. The section therefore focuses on how the EU is

shaping markets beyond liberalisation through the promotion of energy efficiency

and renewable energy sources and then assesses the place of EE within the EU

energy policy.

The measures the EU adopted in the field of EE and renewable energy sources are

quite different, since renewable energies are of course much more influenced the

liberalisation level of the EU energy markets, while directives on EE mainly contain

demand side management measures (I.e. push consumers towards more energyefficient products)4 and continuously updated technical standards (to force the

production of more energy efficient energy-using appliances). Targets in both areas

were set by the famous 20/20/20 Strategy (EC 2008), the main documentof the EU's

climate policy. The most notable directives are the following:

Renewable Energy Directive (directive 2009/28/EC): the pillar of the system

4 See Gillingham et al. (2009) for a comprehensive overview of the economic rationale of EE

policies.

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is an EU-level goal (by 2020: 20% of total final consumption generated by

renewable energy sources and 10% of total final consumption in

transportation generated by biofuels) combined with different national targets

(art. 3, 4 includes rules for the drafting of National Renewable Energy

Plans) and mechanisms for cooperation among Member States (art. 6-11). It

also establishes the possibility of cooperation between member States and

third countries through international frameworks (e.g. Joint Implementation

mechanism with Transition Countries). The directive is dependent on the

liberalisation of the energy markets to grant access to the network to

renewable energy;

Cogeneration Directive (2004/8/EC), Energy Services Directive(2006/32/EC), Ecodesign Directive (2009/125/EC), Energy Labelling

Directive (2010/30/EU) and Energy Performance of Buildings Directive

(2010/31/EU): all these directives strongly shape markets by enforcing

progressively stricter standards on manufacturing, construction and energy

industries. Overall they leave more discretion to national authorities in

respect to targets and penalties setting, also because the success of EE

measures is in no small part dependent on the consumers' behaviour. In terms

of market influence the stronger measures are the obligation pending on

member States' public sector to consider EE in their spending decisions

(Labelling and Building directives), the support to cogeneration plants (i.e.

producing heat and electricity at the same time) and the introduction of

mandatory EE requirements for buildings and electronic appliances.

In terms of energy policy, the Energy 2020 strategy (EC 2010) puts (the increase in)EE as the first priority in the internal market. In the internal market therefore EE is

the new cornerstone of the EU energy and climate policy. Indeed the Energy

Efficiency Plan 2011 (EC 2011a) defines EE as [potentially] Europe's biggest

energy resource (ibidem: 2). It is fair to say that in the EU the topic of EE has been

given implemented systematically and it has been given attention at the highest

political level. For a detailed presentation of the contents of the EU policy documents

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in terms of EE please see Annex 3.

1.2 The EU External Energy Policy: a multifaceted initiative

The first document proposing a common EU External Energy Policy was the Green

Paper on Energy Policy (EC 2000). While this was the first tentative to define a

common strategic European approach to international energy relations (IER), it was

not the first time that European countries had tried to devise a systematic approach.

Indeed since 1994 the Energy Charter Treaty (ECT), a brainchild of the European

countries, represents the most serious tentative to channel IER into an international

contractual law framework. The ECT and the External Energy Policy therefore canbe seen as two partially overlapping instruments which reflect the EU's values and

praxis in the sphere of IER. Parallel to these two initiatives, the EU has always been

an active participants in the international negotiations on climate change and in

particular a major player in the Carbon Market initiatives.

1.2.1 The Energy Charter Treaty

The ECT was written between June 1990 and December 1994, in an atmosphere of

enthusiasm over the huge potential offered by the end of the Cold War in the field of

East-West energy relations. Many of the countries of the Former Soviet Union were

endowed with rich natural resources but necessitated huge investments to continue to

exploit them after the complete economic disarray caused by the dissolution of the

Soviet system. Given the balance of power at the time the ECT text mainly addresses

Western concerns and basically was intended as a legal document to provide the legal

context necessary to unlock European investment into the ageing and extremely

inefficient energy industry of Post-Soviet countries. Such a context at the time was

an ordo-liberal order, based on good practises and incorporating environmental

concerns (Konoplyaniket al. 2006: 528). The ECT therefore may be seen as a diluted

version of the strongly liberal rules adopted by the EU in the energy field: it points to

merely facilitate investments and transactions and it does not and can not compel

member States to liberalise their own domestic market, although it does imply that

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liberalisation is the best way forward (ibidem: 532; Konoplyanik 2009).

Although the ECT was intended to be a commonly accepted foundation (ibidem:

524) the frictions between the EU approach and Russia's one became evident as soon

as high oil prices helped Russia regain confidence and autonomy. According to the

ordo-liberal narrative, investments into production and transport infrastructures

would on the one hand give consumers the opportunity to switch between suppliers

and on the other hand give suppliers access to multiple markets. Recently however

the Russian legislator has taken a much different stance in respect to access for

foreign investors to sectors deemed of strategic importance: under the Law of the

Russian Federation on Foreign Investments in Companies Having Strategic

Importance for State Security and Defence (Rossiskaya Gazeta 2008) foreign

companies and/or Russian companies with foreign participation suffer from severe

restrictions in the access to subsoil blocks [i.e. hydrocarbon and mineral fields] of

federal significance (ibidem) compared to the conditions enjoyed by Russian State

companies. Such a rule is clearly at odds with the broad definition of investments of

the ECT (article 1.6). Over the history of the Treaty however the major point of

disagreement between the EU and Russia was the Transit Protocol (ECT

Secretariat 2003), specifically the so-called REIO (Regional Economic Integration

Organisation) clause, i.e. making the Transit Protocol provisions count for the EU as

a whole rather than for every single Member State (Belyi et al. 2011; Konoplyanik

2009: 20-21). These tensions, together with the two Russian-Ukrainian gas crisis of

2006 and 2009, led Russia to drop the provisional application of the ECT starting

from 18 October 2009. Since then negotiations have been ongoing on the prospects

to adapt the ECT to suit both EU's and Russia's concerns (Belyi et al. 2011). Looking

at the history of the Treaty negotiations are going to be long and though, and the

words used by the European Commission in the latest External Energy Policy (see

next section) refers with sufficiency to the potential role of Russia: The EU

considers it would be mutually beneficial if Russia plays a full role in this

multilateral framework [i.e. the ECT] (EC 2011c: 13). However it must be said that

criticism of the behaviour of Russia within the ECT negotiations does not come from

the EU only but also from Russian academics and practitioners alike. See e.g. Belyi

et al. (2011: 391), Konoplyanik (2006: 540, footnote 23), Konoplyanik (2009: 32-39)

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This changes of course also affect the Protocol on EE and Related Environmental

Aspects, which is not in force any more in Russia. The content of such Protocol will

be further discussed in the 3rd chapter.

1.2.2 The EU External Energy Policy and the Carbon Market

initiative

TheLisbon Treaty set out three main objectives for the EU energy policy: security of

supply, competitiveness and sustainability (Article 194 of the Treaty on the

functioning of the European Union (Official Journal of the EU 2008)). Following this

new centrality of energy issues into the legal foundation of the EU and the 2009

Russian-Ukrainian gas crisis, the Commission has issued two major policy

documents: the Energy 2020 strategy (EC 2010) and the the latest EU External

Energy Policy (EC 2011c). The Energy 2020 strategy the onus is definitely put on

what can be called the EU strategy of self-centred multilateralism (Belyi et al.

2011: 397), i.e. the continuous drive of the EU to export its energy acquis not only to

willing partners (e.g. those included in the European Neighbourhood Partnership or

in the Energy Community Treaty process) but also to approximate international

legislation to the acquis, while at the same time making technical assistance

conditional to the reception of the acquis.

The 2011 External Energy Policy (EEP) document translates into policy directions

the external energy priority as outlined by theEnergy 2020 strategy. It is important to

note that the EEP is viewed as a complement to the internal -strongly liberalised-

energy market: The EU external energy policy is crucial to complete the internal

energy market (EC 2011c: 2). As such, the document identifies 4 priorities:

Building up the external dimension of [the] internal energy market (EC

2011: 4-9): specifically, in respect to Russia-EU relations: step up the

negotiations to conclude the New Agreement, effectively implement the

Partnership for Modernisation (see section 1.2.3), engage Russia in the

drafting and implementation of the EU 2050 Energy Roadmap, cooperate in

the Baltic region to agree on technical rules for the energy network;

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Strengthening partnership for secure, safe, sustainable and competitive

energy (ibidem: 9-14); specifically, in respect to the ECT: extend its

geographical coverage but without changing its contents (self-centred

multilateralism is clearly present in this approach);

Improving access to sustainable energy for developing countries (ibidem:

14-16);

Better promoting EU policies beyond its borders (ibidem: 16-18): notably,

by adapting policies and schemes to different (classes of) partners and by

creating a single EU voice in Energy matters within international

organisations (on the one hand through information sharing about Member

States' strategies towards third countries and on the other hand by enforcing

the Principle of sincere cooperation, including the duty to ensure unity [of

the EU representation by Member States] (ibidem: 17).

In respect to the place of EE in EU-Russia relations at the External Energy Policy

level, the importance of the Russia-EU energy relation is acknowledged by the latest

External Energy Policy in a dedicated section (EC 2011c: 8) but EE does not appear

to be the most salient issue: the greatest attention indeed is given to the need to agree

on the overarchingNew Agreementin order to proceed with the market convergence

process.

Turning to carbon markets, the EU is a world leader in the carbon market initiative.

As of 2010 the EU+3 (Norway, Iceland and Liechtenstein) Emission Trading System

(ETS) was the only relevant carbon market worldwide. The ETS covers especially

big emitters in the industrial and energy sector and is expected to account on its own

for a 21% GHG emission reduction by 2020 compared to 2005 levels (WB 2011:

24). The EU has also shown its strong determination in implementing the ETS by

extending the system to cover the emissions of the airline sector, a very contentious

issue with third countries therefore not an easy decision to take on the political level

(ibidem: 28). The EU is also committed to a reform and expansion of carbon markets,

supporting the evolution to a so-called Sector-based CDM5.

5 See the proposal of the EU in WB (2011: 15) and see the description of the concept of sectoral

CDM in Samaniego et al. (2002)

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Another arena where the EU has taken a very active stance are the so-called

Flexibility Mechanisms of the Kyoto protocol, i.e. the Clean Development

Mechanism (CDM) and the Joint Implementation (JI) schemes. Both schemes are in

theory devised to help achieve the largest reduction of GHG emissions at least

economic cost in industrialized (Annex 1) countries and at the same time promoting

technology transfer in developing and especially least developed countries6. Both

schemes thus work on the principle that industrialised countries can implement GHG

emission-abating measures in third countries to reach their own emission reduction

target.

Since the focus is on the EU-Russia relation only JI (the scheme dedicated to

transition economies) will be considered. The history and potential for EU-Russia

cooperation in the JI scheme will be analysed more in depth in section 3.1.2.

1.2.3 The EU-Russia Energy Dialogue and the Partnership for

Modernisation

The EU-Russia Energy Dialogue is a regular dialogue, established under the

Partnership and Cooperation Agreement7at the EU-Russia Summit in Paris on 30 th

of October 2000. Such a dialogue aimed at [enabling] progress to be made in the

definition of an EU-Russia energy partnership (EC 2011b: 63). Since 2007 the work

of the Dialogue is organised in 3 groups, which meet regularly and on average

multiple times per year:

Joint Thematic Group (JTG) on Energy Strategies, Scenarios and Forecasts,

with a Sub-Group onEnergy Economics;

JTG on Energy Market Developments, with a sub-group on Infrastructures

since 2009 (the group covers also investments and trade);

JTG onEnergy Efficiency.

6 See Schneideret al. (2008) on the relevant potential of CDM for technology transfer.7 The EU-Russia Partnership and Cooperation Agreement (PCA) is still the legal basis for any form

of cooperation between the two actors (EC 2011b: 63). The PCA was signed in 1994 and shouldhave lasted until 2007, when both parties agreed to start negotiations on a New Agreementwhereenergy would have a fundamental importance. At present (May 2012) the negotiations are stillongoing; in the meantime the PCA continues to be in force and represents the legal basis of

relations.

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In addition to the Working Groups, a Permanent Partnership Council takes place

once a year: the Dialogue thus is highly institutionalised. The 10 th Anniversary

Conference (ibidem) has been the occasion to revive the results of the partnership.

The common will to continue the cooperation was expressed very strongly by the key

participants as highlighted in the Joint Report EU-Russia Energy Dialogue 2000-

2010: Opportunities for our future Energy Partnership (ibidem: 62-69). Such a will

was and is no doubt supported by the consensus present among Conference

participants about two important facts: the interdependence of EU and Russia and the

increasingly important role that gas will play in the EU's future energy mix, due to its

abundance and low CO2 emissions. Taking also in consideration the increased

competences in the energy sector given to the EU by the Treaty of Lisbon, it is clear

that the EU-Russia Energy Dialogue enjoys strong political backing and an

increasing attention on the part of the energy industry, all elements which bode well

for its future. The third chapter will focus on the activities of the Thematic Group on

EE.

ThePartnership for Modernisation is another initiative recently born out of the PCA.

It was established at the EU-Russia Summit of Rostov-na-Don on 1 th of June 2010

and aims at channelling financial resources and involve the business community into

the activities of the existing sectoral dialogues (i.e. Energy Dialogue included)

(Council of the EU 2010). The most relevant International Financial Institutions

(IFIs) that have been officially involved up to now are the European Investment

Bankand its Russian homologue, the Russian Bank for Development and Foreign

Economic Affairs (Vnesheconombank 2011), while the privileged business forum is

the Round Table of Industrialists. A list of projects has been drafted in December

2010 (EU delegation to Russia 2010) covering a very wide range of topics (the list

essentially corresponds to the projects planned by the Joint Thematic Groups).

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2 ENERGY (IN)EFFICIENCY IN RUSSIA: CAUSES AND

POTENTIAL FOR IMPROVEMENT

Russia has by far the highest energy intensity among G20 countries: twice as high asthe one of the USA, China and South Korea and three times as high as the one of

Japan, Germany and France. Russia compares poorly also to other Post-Soviet

countries, since between 1990 and 2005 its energy intensity diminished at a slower

pace than most other post-Soviet countries (WBGr 2008: 28). Indeed a World Bank

report (ibidem) found out that 25% of Russia's emissions are not justified by

international comparison (see Appendix 4 for the comparison). Therefore there must

be factors specific to Russia accounting for this very high energy intensity. I dividethese factors into structural causes and institutional aspects of energy intensity:

Structural causes are grounded in the structural (sectoral) composition of the

Russian economy, the state of energy infrastructures and in the cultural and

behavioural attitudes towards EE and related topics;

Institutional aspects are grounded in the (lack of) economic incentives for EE

and in the legislative framework.

After having assessed these factors the chapter explores the potential for EE in everysector of the Russian economy.

2.1 Structural causes of energy intensity: economy and society

The Soviet legacy of heavy industry and cheap energy is at the hearth of today

Russia's high energy intensity: as Belyi et al. (2011b: 1) say Soviet command

economy required an availability of cheap energy for economic growth therefore EE

has almost never been incorporated into Russian culture and mores for the best part

of the last 100 years. Bornstein (1985), Chistovich (1990) and Nove (1986) (quoted

in Martinot 1998), highlight six major negative (in terms of low EE) characteristics

of the Soviet planning system: (a) enterprise managers lacked incentives to

minimize production costs; (b) energy quotas and allocations resulted in energy

being wasted or dumped to maintain allocations [this system is still in place among

public organisations and bodies see footnote 11]; (c) technological change was

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inhibited by a lack of incentives to innovate and because any changes could mean

problems in obtaining new inputs and greater risks in meeting production targets; (d)

single-enterprise monopolistic production of many goods meant that goods were

always in demand no matter what their characteristics; (e) the drives to produce large

quantities of apartments in the 1950s and 1960s left quality and energy

characteristics as secondary priorities []; and (f ) large centralized district heating

systems were assumed to have advantages a priori, and potentially more-efficient

alternatives were never considered. On the other hand Closson (2011) lists the

negative consequences of Russia's Soviet past and especially the negative impact of

the dependency on energy sources exports on the quality of institutions. Considering

this very unfavourable basis, it is easy to see why the Russian economy is still so

strikingly inefficient.

Although energy inefficiency is widespread in all sectors of economic activity in

Russia8, the problem is compounded by the over-reliance of the entire Russian

economy on heavy industry and -especially- the Fuel and Energy Complex (FEC)

(another legacy of the Soviet system). Comprehensive accounts of the transition

process and the Soviet industrial legacy are Gaddy (1996) and, on a more theoretical

level, Roland (2000). Such a broad subject is clearly out of reach for this dissertation,

therefore the focus will be circumscribed to the role of the FEC and in particular to

the gas sector. The gas sector is chosen because of its centrality in Russia's economy,

politics and society9: it is a good example of sub-optimal management practises

reflected not least in high energy inefficiency. According to slund (2010), Gazprom

is Russia's largest corporation in 4 dimensions: it is responsible of 8% of Russia's

GDP, 1/5 of its exports, 1/5 of its market capitalisation and is its single largest tax

payer (notwithstanding the much lower tax rates paid by Gazprom in respect to the

oil industry, arguably as a compensation for the subsidised prices in the domestic

Russian market). Its traditional strategy feeds into two sources its past as the Soviet

Ministry of Gas and its present as National Energy Company: both traditions are

heavily influenced by State ownership. The problem of this is the vast economic

8 See Appendix A of the WB-CENEF report for an international comparison of global energyintensity for 6 major economic sectors (WBGr 2008: 122-4). Russia ranks among the top 25energy intensive countries in seven major areas of economic activity [] Only Uzbekistan sharesthis distinction (ibidem: 29).

9 Indeed Sharples (2010) stresses the strategic nature of gas both in Russia and in Europe and talks

of a Social construction of Russia's [internal and] external energy policy.

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inefficiency in most of Gazprom's operations: its inefficiency prevents it from

profiting from domestic sales and Gazprom has indeed strong incentives to keep

energy inefficiency high in Russia. slund considers the likely reduction in gas

demand very dangerous for the company's current business model: this helps to

explain the resistance against improvements in EE within Russia.

The situation at the infrastructural level is desperate. One of the most starting

examples is that very few buildings in Russia have any means to control energy use,

such as thermostatic regulators (Belyi 2011: 18). This leads to a situation where

deployment of energy metering equipments and other relatively advanced measures

are made useless. Korppoo et al. (2012: 214) provide an eloquent snapshot of the

disastrous state of district heating infrastructure. However the true extent of the

disastrous conditions of infrastructures in Russia can only be shown by giving the

potentials for ES, which will be done in section 2.3.

Turning to the social attitudes towards EE, the World Bank-CENEF report on EE in

Russia (hereafter WB-CENEF report) notes that there is a diffused and persistent

lack of awareness about the truly crucial importance of EE in Russia. This is true at

all levels: businesses, households, banks, energy generators, regulators. The problem

of the low political salience of EE is well known (EE efficiency improvements are

invisible) thus people need political leadership to change their daily habits and

cultural perspective. In additions such cultural perspective in Russia is heavily

influenced by the Soviet legacy: the perception that utility services are public goods

is widely held and is not by definition conducive to EE improvements. Part of the

blame falls on the political lite which did not show a sufficiently strong political

will to promote EE and engage the public on the topic; in addition it does not

distribute enough data to raise awareness among the general public of the

tremendous potential of EE improvements in Russia (WBGr 2008: 65, 68).

It is worth looking at the situation in the residential heating sector (Korppoo et al.

2012), as it is the most relevant component of the communal services' bill (from 47%

to 65% of the total). Notwithstanding the fact that in Russia the price for utilities is

significantly lower even than in other countries with similar per capita GDP, the

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unwillingness to pay for EE measures was strongly expressed against attempts at

setting an incentive structure based on tariffs to promote energy meter equipment

installation. Two main problems can be identified:

Although the utilities' bill is low in international comparison, the strong

economic inequality implies that heating is indeed expensive for a

significant part of the population (ibidem: 6);

The quality of the heating service is so bad that the low willingness to pay is

all but understandable and justified, from the point of view of the individual

consumer.

This example shows well the kind of difficulties encountered in the promotion of EE

in Russia, particularly in sectors concerning the general population. It could thus be

said that the behavioural barriers are much higher in Russia than in any Western

country and are compounded by an objective problem of low quality of service.

2.2 Institutional aspects of energy intensity: (lack of) economic and

legislative incentives

Institutional factors have a decisive influence on energy consumption dynamics in

Russia, even more so than in European countries. This is mainly due to the fact that

energy market in Russia is more tightly regulated in order to keep energy prices low

for domestic householders. This however does not hold true for industrial consumers:

indeed market liberalisation in this sector has made significant progresses therefore

deeply changing the institutional setting of the whole internal energy market. The

section is divided into 2 parts: the first is going to analyse the price dynamic of utility

services and the practice of subsidies, the second analyses the EE legislation.

2.2.1 Energy tariffs and subsidies

The housing sector offers a good example of badly designed energy tariffs and

perverse incentives. In the residential housing sector (i.e. households) some barriers

to EE investments are intrinsic to the sector and are common all over the world, in

particular the problem of split incentives (see note 8). However badly designed

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subsidies are responsible for high energy consumption by households in particular:

vast cross-subsidies from industrial and/or public budget to household consumers

covers 1/3 of the real cost of utility services, but these subsidies are not targeted at

the most vulnerable consumers (indeed the threshold for specific support schemes is

households spending more than 22% of their income in utility expenses, which is

expensive in international comparison). This results in a situation where the poorest

consumers, which are not able to make EE investments, pay more than larger

customers, which as a result of subsidies do not feel the need of investing into EE

measures (Korppoo 2012).

Another relevant issue is that tariffs paid by customers do not cover yet full costs, but

are based on the cost-plus formula (calculated costs + regulated profits): this pricing

formula does not give energy industris any incentive to enhance EE and provides

huge opportunities for corruption and frauds. Lack of proper maintenance of energy

infrastructures and the very high energy intensity of the economy are among the

deleterious effects of cross-subsidies (ibidem).

2.2.2 Energy Efficiency Legislation and Policy

The WB-CENEF report laments that the single most important obstacle to an

increase in EE in Russia is due to the lack of a coordinated, defined national [EE]

strategy or policy, nor any authority responsible for improving [EE] (WBGr 2008:

65). Another important issue highlighted is the lack of proper statistical data. Not all

these issues unfortunately have been tackled but the legislation is getting closer to the

solutions advised in the report.

In its Regular Review on Energy Efficiency Policies 2007(ECT Secretariat 2007b)

the ECT Secretariat considered the legislative framework on energy efficiency in

Russia to have played a very marginal role in the improvement in energy intensity in

the period from 2000 to 2006, with 75%-80% of the (better-than-forecasted)

improvement resulting from structural changes in energy consumption [i.e.]

relatively low intensity [industries] developing faster than more energy intensive

[ones] (ibidem: 32). The report however commented positively on the

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implementation of market reforms in the energy sector, saying they were

implemented with sufficient overall consistency in the main areas, namely pricing

policies and the development of [] energy resources trading []; development of

competition; institutional development in the area of resource and energy saving

(ibidem: 34). According to the report the correct implementation of these reforms

would provide energy users the incentives to invest in EE measures thus creating a

market for such measures.

The positiveness of these reform measures as assessed in 2007 was dependent on the

future economic developments. Back in 2007 however no one could suspect that the

greatest financial crisis since the Great Depression was looming large. The financial

crisis strongly affected the Russian economy10and this had a twofold effect: on the

one hand it has pushed the government to act more decisively (for example by

requiring recipients of government funds provided by the anti-crisis program to have

an EE plan), on the other hand it has drastically cut corporate investments programs

especially among the most energy intensive sectors, being these sectors the most

exposed to the global economic downturn (Charap et al. 2010: 142). Therefore on the

positive side the combination of the really weak performance of the Russian

economy in 2009 together with the modernisation program of president Medvedev

(Charap et al. 2010: 144) gave a real boost to the topic of energy efficiency and to

related legislative activity, as can be seen by tracing the evolution of EE Russian

legislation.

Belyi et al. (2011) trace the history of EE legislation in the Russian Federation.

Tapping the immense EE potential of the country was deemed the highest priority

already in the 1995 Energy Strategy (a policy document), which also already

recognised the need for strong market/economic incentives. At the same time

however the main tool to increase EE was deemed to be an effective price policy

(ibidem: 3) i.e. top-bottom State regulation. The Strategy did not set any EE

10 In 2009 Russia suffered the largest fall in GDP among G20 countries at 7,8%, although it didmanage to contain the surge in unemployment levels and it avoided a dramatic depreciation of therouble. The really dark side of the crisis however is that the price for containing the crisis was toavoid the restructuring of -energetically and economically- inefficient industries, on top of thedepletion of international reserves (source: HSE 2012). For an account of the post-crisis recovery

and a comparison with the 1998 crisis see WB (2012: 8-9, Box 1).

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quantitative target nor deadline, significantly weakening its relevance as a policy

instrument. The same mistakes were repeated by the 2003 Energy Strategy (up to

2020), which did not set any EE target nor defined the concrete measures to be taken;

instead it just set out hypothetical ES targets based on forecasts rather than technical

evaluation.

The 2009 Energy Strategy (up to 2030) finally set a target, i.e. reach energy intensity

levels comparable to developed countries with similar climate (the closest peer being

Canada): to do so it envisions to halve the energy intensity in 2030 compared to 2005

levels. Most importantly, the Strategy defined specific targets, procedures and

instruments. The Strategy lists a very comprehensive set of measures, with the main

areas being:

Market liberalisation and improved business climate (especially important:

complete transition to market prices);

Increase cost of energy inefficiency through fines;

Implementation of State statistical energy inspections andfurther analysis of

it;

State support to strategic initiatives (especially in the public sector).

TheFederal Law on energy conservation implemented most of the measures set out

in the Strategy. Unfortunately (again) it does not set binding targets, nor it defines

specific measures and instruments. The Law lists five core practises to improve EE

(ibidem: 8):

Effective and rational use of energy resources;

Support and stimulation of [] EE improvement[s]: the best specified area

is the support of investments into EE measures. In respect to private

businesses, the government may compensate the part of the costs related to

the redemption of loans or credits, taken in Russian credit organizations

(ibidem: 9) to finance EE measures: government support is not guaranteed; in

respect to the public (regional) sector, the government may devote funds

from the federal budget to finance EE measures in the territorial subjects

(ibidem) but only up to a certain limit defined by a particular election

procedure, i.e. the amount of funds is defined each year in the federal budget;

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Consistency and complexity of activities in the field of [] EE

improvement: in the fields of goods turnover, the building sector and energy

metering devices. The most notable weaknesses of the Law in these sectors

are the following: ineffective provisions related to the phasing out of

incandescent lamp, too low requirements for EE in buildings to promote a

fast enough renovation of the existing building stock, a complicated scheme

to install energy metering equipment and (again) no informative campaign

about EE opportunities;

Planning of [] EE improvements: consisting of 3 actions: programming,

monitoring and informing. The first action is implemented not only at the

federal but also at the regional level, defining EE targets and instruments:

among the targets, the requirement to reduce governmental expenditure for

energy provision is very important, since public organisations themselves can

not reap the financial benefits of reduced energy expenditures 11. The second

action (monitoring) is implemented through mandatory energy inspections in

State-financed and -controlled organisations, the FEC and energy-intensive

industries: the data gathered from these inspections (once every at least 5

years starting from 2013) are then registered in the energy passportand are

analysed on a regular basis by a dedicated organisation12. The third action

(informing) should be carried on on the one hand through publicity in the

mass media and on the other hand (and most important) on the prospective

State Information System in the field of EE13.

The use of energy resources with due consideration to resort, production

and technical, ecological and social conditions.

A common trend in the Law is the absence of economic sanctions and incentives,

therefore it still relies on hard enforcement from the federal centre. This shows that it

is possible to trace a recurrent contradiction in EE legislation of the Russian

federation: a detachment between the stated objective of the creation of a market

economy in the economy sector and the effective implementation measures mainly

11 The budgeting rules for public organisations and regional and municipal entities are tremendouslyineffective in encouraging EE and are rather having the opposite effect. See WBGr (2008: 86).

12 For a blunt critique of the Energy Passport system and its potential for government interferenceinto businesses' activities see Divovich (2012).

13 For an overview of the development of EE indicators in Russia see IEA 2011.

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relying on Command and Control measures. Another common trait is the scattered

nature of legislation on Energy Efficiency among many different policy and legal

documents, which weakens the normative potential. However the distance between

words and (legal) deeds is becoming smaller and smaller and the latest Energy

Strategy and Law on EE pose for the first time real foundations for the creation of an

energy services market of immense proportions.

In respect to the institutional structure (APERC 2010: 156-9), the responsibility for

EE program definition and implementation has been of the Ministry of Energy since

2008. For the first time within the Ministry a dedicated Department of the State

Energy Policy and Energy Efficiency was created. In addition, two

intergovernmental groups linked to EE were set up: the Commission on the Fuel

and Energy Complex located within the prime minister's office and the Expert

Group on energy efficiency located within the Commission on Modernization and

Technological Development of the Russian Economy, headed by the President

himself. Another important actor is the Russian Energy Agency, an extended

network dedicated to analysis and coordination of clean energy projects, i.e. not a

regulator yet, but nevertheless a step forward towards implementation of best

practises in the field of EE policies.

2.3 Energy Efficiency potential in Russia

Russia is often referred to as the Saudi Arabia of energy efficiency; its vast [EE]

potential [] can be considered a significant energy reserve (IEA 2011). This

quote already gives an idea of just how immense the potential for EE improvements

is in Russia. The WB-CENEF report estimates the technical potential of ES at 45%

of total energy consumption, i.e. roughly 300 million tons of oil per year []

equivalent to all energy produced and imported [] by countries like France or the

[UK], or 2 percent of [the world energy production] in 2005 (WBGr 2008: 35). The

report breaks down potential savings by sector. Savings potential is divided into

technical, economical and financial potential:

Technical potential (TP): established by comparison to technologies

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commercially available and actually used in the world;

Economical potential: covers EE investments viable for Russia as a whole but

not for the single consumer/industry, i.e. viable with government support 14.

More precisely, an EE investment is economically viable if the cost of

saving a unit of energy [] is less than the cost of Russia [i.e. for the

government] of building a new unit of production capacity [] or the

opportunity cost of exporting a unit of gas, whichever the greater ( ibidem:

39);

Financial potential: covers EE investments which are financially viable, i.e.

they save money to the individual consumer which invest in EE measures 15.

More precisely, an EE investment is financially viable if the cost [for the

private investor] of saving a unit of energy [] is less than the cost of buying

an additional unit of energy16 (ibidem).

The report distinguishes 7 sectors, listed here in order of TP:

Buildings (23% of total TP, i.e. 68,8 mtoe/year): the worst offender in

buildings is water and (especially) space heating:

Residential buildings: only high-rise buildings erected after 2000 meet

modern thermal and heat efficiency standards, while buildings built

before 1990 consume three times as much. However half of Russias

multi-storey buildings were constructed before 1971, 43% in 19711995

and only 7% after 1995 (Aleksejev 2011 quoted in Korppoo et al. 2012:

14 Note that environmental externalities in the form of CO2 emissions are internalised by assumingthat ERUs (Emission Reduction Units) could be sold on the carbon market at 10 per ton of CO 2.The price of carbon however changes constantly so the economic potential in 2012 may bedifferent.

15 The section will primarily focus on the economically viable share of TP because of the focus onthe international cooperation between the EU and Russia and thus towards the potential forgovernment action. In any case the share of financially viable savings is always going to be lowerthan the share of economically viable ones due to the differential in the opportunity cost ofcapital.

16 Such a cost is calculated with 2007 tariffs. It should be noted that the share of financially viableES will no doubt increase given the long-term horizon of rising tariffs following the entry in theWTO and the objective of creation of a strong market environment posited in the latest EnergyStrategy for the period up to 2030. The will to increase energy prices is clearly stated in theStrategy: establishment of a rational system for domestic energy prices through their gradual andcontrolled liberalization to promote careful use of energy in the economy and by the population (Ministry of Energy of the Russian Federation: 31). Domestic gas prices for industrial customerswere supposed to reach netback pricing levels (i.e. EU level minus transportation cost) in 2011

(slund 2010: 167).

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214, footnote 2) . The renovation of space heating in buildings built

before 1990 would suffice to save 17 mtoe/year. With 2007 prices 38% of

the TP is financially viable and 78% is economically viable;

Public buildings: the public sector is responsible for 9% of end-use

energy consumption therefore is a fundamental actor. Space heating is by

far the most relevant item, accounting for roughly 60% of total

consumption in public buildings. TP for space heating and electricity is

roughly 49% of consumption in 2005 (in electricity an additional

advantage is the strong reduction in demand for peak load generation,

which comes largely from the public buildings and is inherently less

efficient than low- and middle-load generation). TP for educational

institutions in particular is even higher at 60% average but with peaks of

80% of total consumption.

Electricity generation (13,4% of total TP, i.e. 40,2 mtoe/year): Russian

electricity sector overall is vastly inefficient:

Condensing Power Plants (CPPs): TP is 22,5 mtoe/year, of which

roughly 80% is economically viable. Average efficiency of Russian CPPs

is 36%, while the value for OECD countries is 38% and 41% respectively

for coal- and oil fired CPPs and for gas-fired CPPs;

Combined Heat and Power Plants (CHPs): TP for gas-fired CHPs is 13,7

mtoe/year and it is 100% economically viable. Russian CHPs on average

operate at 36% (liquid- and solid-fuel fired ones) and 39% (gas-fired

ones) efficiency in contrast to average efficiency of respectively 51% and

46-48% in OECD countries;

Diesel Power Plants (DPPs): Russian DPPs operate at average 25%

efficiency, while modern equipment achieves up to 37% efficiency. TP

however is a relatively modest 0,59 mtoe/year, with 80% being

economically viable;

Transmission and distribution: distribution losses in Russia averaged at

12,2% in 2005, versus an OECD figure of 6-7%. TP is 3,4 mtoe/year (i.e.

roughly 35% of total losses in 2005).

Manufacturing (13,8% of total TP, i.e. 41,5 mtoe/year): 97% of the TP is

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economically viable and incisive action is facilitated even more by the

concentration of potential (53% of sectoral TP) into the three most energy

intensive industries:

Ferrous metals: TP is 16,4 mtoe/year, i.e. 44% of the industry

consumption in 2005. 99% of the TP is economically viable. The most

effective improvements are switching from open heart to oxygen furnaces

(5 Gj/t VS 0,28 Gj/t), change production mode of rolled steel (4,01 Gj/t

VS 0,4 and 0,9-1,6 Gj/t respectively for cold and hot rolled steel) and

change modalities of use of electric furnaces (halving energy intensity);

Pulp and paper: TP is 3,7 mtoe/year, i.e. 53,6% of the industry

consumption in 2005. Average intensity would thus be reduced from 18,1

Gj/tonne of pulp to the international average of 11-14,3Gj/t;

Cement and clinker: TP is 2,5 mtoe/year, i.e. 43,8% of the industry

consumption in 2005. The best improvement can be had by improving the

EE of clinker production: energy intensity of Russian producers averages

8,8 Gj/t versus an international best practice of 3 Gj/t;

Other (non energy intensive) industries: TP is 17 mtoe/year, i.e. 32% of

consumption in 2005. The main causes of existing inefficiencies are

outdated equipment (more than a quarter of companies use equipment

for more than 25 years (ibidem: 51) and management practises (part of

the problem described in section 2.3.1);

Transportation (12,8% of total TP, i.e. 38,3 mtoe/year): 83,6% of the TP is

financially viable. The most important sectors are road transport and gas

pipelines:

Road transport: responsible for 48% of total consumption in

transportation. The average energy intensity (i.e. fuel consumption) of the

Russian road fleet is generally higher than in European countries and this

is particularly true in the case of light trucks (KAMAZ light trucks

consume more than twice in respect to comparable modern Western-

manufactured models). In addition the trend is (strongly) towards

increased personal car ownership and use;

Gas pipelines: responsible for 37% of total consumption in transportation.

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The pipeline network is old and inefficient and the surge in exports in the

2000s has put it under great strain. Losses in the gas network remain

stable at 1 to 3% of all gas transported in Russia. More than 9% of

domestic gas consumption is used by compressors to transport gas to final

customers, a percentage which could be halved using modern technology.

Of course the issue grows even more serious in international pipeline

transportation17;

Heating supply system (9,2% of total TP, i.e. 27,7 mtoe/year):

Heat generation: TP is 10,4 mtoe/year (8,4% of total energy

consumption), with 90% being economically viable. Russian industrial

boilers, district heating boilers and small boilers operate respectively at

68,6%, 80,3% and 81,6%18 efficiency, against an international benchmark

estimated at 95% and 85% efficiency respectively for gas- and liquid-

fired boilers and for coal-fired boilers;

Heat distribution: TP is an astonishing 17,3 mtoe/year (9,3% of total heat

production), 99% being economically viable. Although according to

Korppoo et al. (2012) Russian district heating could potentially yield

huge savings in respect to a decentralised solution, the WB-CENEF report

notes that when distribution losses are above 10% district heating

becomes relatively inefficient: such losses in the municipal heating

system run as high as 20-25% even by official statistics (which are not

considered reliable);

Gas Flaring (6,9-10,5% of TP, i.e. 16,6-31,5 mtoe/year): gas flaring is a

dramatic waste of gas, but as evident from the numbers provided in the report

it is still a very uncertain issue: indeed there are no clear estimates of the

share of investment being economically viable. The highest number provided,

38 bcm/year of gas flared, would be similar to the volumes of gas exported to

Germany in 2006, or 5% of total gas production;

Fuel production and transformation (1,9-2,4% of total TP, i.e. 5,6-7,2

17 See the article by Lechtenbhmer et al. (2007) for a quantitative assessment of the problem oflosses in the long distance gas pipelines Russian network.

18 Energy audits conducted by CENEF show that this estimate is very likely overrated and real EE is

much lower.

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mtoe/year): the most important improvements can be made in the oil

production and refining sector. Gas production and processing also presents

opportunities for enhanced EE but not as good as investments into the

distribution network.

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3. POLICY OPTIONS AT THE EU-RUSSIA RELATIONS LEVEL

3.1 Options at the multilateral level

3.1.1. The Energy Charter Treaty and the impact of Russia's WTO

accession

As described in section 1.2.1 the outcome of the negotiations on the reform of the

ECT is still very uncertain. Konoplyanik (2010) lists 5 well-founded Russian

concerns over the unbalanced character of the ECT, mostly related to the lack of

enforcement measures of Treaty provisions and of crisis prevention measures. From

the point of view of cooperation on EE however the real added value of the ECT is

the high level of investment protection it provides for. Investments in the energy

sector are characterised by huge financial risks and a long payback time. It can be

argued that EE investments as outlined in the WB-CENEF report are less risky than

investments in the upstream sector because the ES resulting from EE measures can

be more precisely predicted than for example energy consumption in the long term (a

fundamental parameter in import/export contracts) and/or size of exploitable reserves

(in the case of investments in exploration). Nonetheless EE investments have a long

payback time and an healthy market environment in fundamental to raise the huge

capitals required. The ECT investment protection regime is tailored on the energy

sector and its specific investment characteristics and as such it would be desirable to

have it fully in place in Russia in order to promote EE investments, especially given

the latest developments in legislation outlined in section 1.2.1.

While the investment protection is an important foundation for increased cooperation

in EE, the other instruments provided by the ECT are not as important in this respect.

In particular the PEEREA is a weak instrument in that it only provides a framework

for the exploitation of opportunities in EE. The framework identified is of course a

well-functioning market economy: the contracting parties to the PEEREA basically

promise to stick to market principles and to use market instruments in the promotion

of EE. It may be said that the PEEREA essentially represents a forum for discussion

and sharing of best practises in the field of EE and encourages international exchange

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both of technology/knowledge and goods related to EE. It completely lacks a

political and financial dimension, both needed to carry out large-scale cooperation in

the field of energy.

The EU therefore has 2 options to utilise the ECT as an instrument enhancing

bilateral cooperation with Russia on the topic of EE:

Aim at a full ratification of the ECT by Russia by incorporating legitimate

Russian concerns into the ECT; this would essentially involve a cost/utility

analysis between the utility of a full ECT ratification by Russia and the cost

of incorporating legitimate Russian concerns;. This road is not bound to be

easy and fast, considering that the same issues have been on the negotiation

table for almost a decade now and not much progress has been achieved;

Concentrate the negotiations on the Investment chapter, where no major point

of contention exists between the EU and Russia, and on the upgrade of the

PEEREA to a significant tool with real political and financial capabilities.

This of course does not imply that the other parts of the ECT should be

discarded, rather the focus on these non-contentious areas would help on the

one hand to step up cooperation on EE projects and ease the tension on the

other, more contentious chapters of the ECT.

The II option looks like the more practical and easily achievable by the EU. Two

reasons in particular justify this choice:

Russia has already applied the ECT treaty on a provisional basis for a long

time, therefore advancements in the sole investment chapter is not a

procedural impediment (although of course is a less optimal outcome in

respect to full-on ratification). The upgrade of the PEEREA to a political tool

could be negotiated so to tie even closer Russian modernisation and European

technological know-how;

Russia's accession to the WTO is posed to greatly improve business climate

in Russia and will considerably lower political and economical risks. The

accession to the WTO shows the will of the Russian government to integrate

more closely with the world economy and play by the rule of the game. The

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EU should definitely strongly exploit this window of opportunity and assist

Russia in the first period of implementation of the WTO rules and at the same

time put the onus on the investment regime of the ECT and the PEEREA, as

the growing alignment of the Russian economy to market rules and practises

increases the chances of success.

3.1.2. Joint Implementation: a great potential hampered on both

sides

As described in section 1.2.2, the EU is a leader in the use of market mechanisms to

reduce GHG emissions. However after the 2010 Cancun conference pessimism about

the potential for a new, binding post-2012 (i.e. post-Kyoto) legal agreement on

climate change is widespread among climate negotiations insiders (WB 2011: 17-

18). Given its expertise and its commitment under the Kyoto protocol, the EU has a

strong interest for such an agreement in order to reduce the risk of carbon leakage19

and reap the gains of its leadership in EE and renewable technologies. The Flexibility

Mechanisms of the Kyoto protocol indeed can be a source of great savings for the

EU in its quest to reduce GHG emissions20. However the EU is doing exactly the

opposite, by strongly restricting the criteria for taking advantage of the Flexibility

Mechanisms of the Kyoto Protocol: from 2013 each EU country won't be able to

meet more than 50% of its own GHG emission reduction target through CDM and JI

projects, i.e. it will have to achieve at least 50% of it within the EU (ibidem: 24).

This limit was born out of concerns about the real quantity of emission reductions

achieved in third countries (mostly as a result of unclear legal frameworks and

shadowy policies in the latter countries, as in the case of Russia and the Danish

Energy Agency see later in this section) and out of the goal of providing poorer EU

member States with more emission allowances. The EU has therefore effectively

decided to drastically limit the reliance on the Flexibility Mechanisms of the Kyoto

19 Carbon leakage is described as the risk of de-localisation of energy-intensive industries from theEU to other countries with lax or non-existent emission reduction policies.

20 Fichtner et al. (2001) assessed the economic efficiency of JI and CDM for Germany. Theycompare two extreme cases (i.e. GHG emission reduction on the one hand only through domesticmeasures and on the other with the full exploitation of CDM and JI potential). A simplifyingassumption is that all JI projects are implemented in Russia and all the CDM projects inIndonesia. They find out that most likely a 25-50% share of GHG emission reductions would be

carried out through JI and CDM projects, leading to huge financial savings.

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Protocol, compounding the lack of clarity on the prospects for a legally binding

agreement on climate change and emission trading after 2012.

It must be said that the history of JI in Russia is quite saddening and can not be held

as a shiny success story. Back in 2004 Laroui et al. (2004) assessed the potential for

JI cooperation between the EU and Russia in positive terms. What is interesting is

that they gave such a positive assessment notwithstanding the issues that emerged in

the AIJ (Activities Implemented Jointly) phase21 and the challenges presented by the

state of the Russian economy in those years. In particular they cite as matter of

concern the difficult business environment, the lack of institutional capacity on the

Russian side, the lack of political backing to the AIJ phase and the inevitably steep

learning curve associated with the implementation of a project so complex as the JI

scheme.

It can be confidently said that all these concerns, although still relevant, have

significantly softened. In respect to the business environment, the situation in 2012

has improved in respect to 2004 (let alone the '90s). According to the World Bank

Doing Business 2012 survey, the Russian Federation was 23rd in closing the gap to

best practises overall, wit a 10% improvement (although it must be said that large

disparities among the various indicators remain) (WB 2012a: 10). Although its

ranking remains far from the top, being 120th in 2012, the upward trend is

encouraging.

As already highlighted in the previous section the WTO membership is going to be

decisive: indeed there is evidence that trade liberalisation not only enhances the

business environment but also the quality of institutions of the country (WB 2012).

The foreign business community is understandably excited about the prospects

offered by the WTO membership (see e.g. Kredler et al. 2010). Thus the situation in

respect to both the business environment and the institutional capacity has improved

since 2004 and it appears to be set on such a path.

In respect to the legislative action, in chapter two it was highlighted how EE has

been made a central part of the Russian energy strategy only recently and following a

21 The AJI program served as the pilot phase for the JI and CDM schemes and ran from 1995 to

2000 (see Samaniego et al. 2002).

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strong input by Russia's president Medvedev in the framework of the modernisation

of the Russian economy. The history of JI implementation in Russia is somehow

similar. Russian authorities were very slow in realising the potential of JI (Taminiau

2011). The atmosphere of uncertainty about procedural aspects and the lack of

political backing at the highest level of Russian politics resulted in practically no JI-

related activity up to February 2010, i.e. two full years after the start of the first

Kyoto commitment period (2008-2012). JI proposals have been queuing up in the

pipeline (ibidem: 8) already since 2006 but proper regulations were adopted only in

October 2009. These regulations identified the Russian bank Sberbankas Carbon

Unit Operator, i.e. the entity responsible for conduct the tenders for the selection of

JI projects and ERU (Emission Reduction Unit) credits, and defined the eligibility

criteria for JI projects: energy and environmental efficiency, technical and financial

potential (i.e. the projects proposals must provide for its own financing) and

economic and social effect (i.e. contribution to the modernisation of the economy).

Although the greater clarity allowed to finally launch the first tender, many

outstanding problems remain and the effectiveness of the Russian administrative

machine is still low. The continuous uncertainty even prompted the Danish Energy

Agency to withdraw from Russian JI projects in April 2011 (ibidem: 11).

Political momentum at the highest level proves to be decisive for the successful

implementation of the JI scheme. Indeed immediately after President Medvedev's

urgent call to better exploit the opportunities offered by JI in June 2011, 17 million

ERUs were issued in only two months (July-August 2011) (Shishlov 2011: 2),

compared to 58,53 mln ERUs issued from 2008 to June 2011 (Taminiau 2011: 10,

table 1) and an overall limit of 300 mln ERUs for the whole first Kyoto commitment

period (2008-2012) (Shishlov 2011: 2). In addition in October 2011 new regulations

were approved, the most important changes being: the stronger position of Sberbank

(as mandatory third party in any foreign ERU trading contract), the obligation to

invest revenues from ERU sales into EE and/or environmental projects and the

indication of precise time limits for each stage of the registration and issuance

procedures (ibidem). The combination of political visibility and improved regulation

is expected to boost JI projects approval delivering at best 200mln ERUs by 2012,

with a more likely outcome being 142 mln ERUs ( ibidem: 3). Although this is a

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notable improvement it still falls way short of the 300mln ERUs limit set for the

2008-2012 period. The EU must keep the topic of JI implementation high on the

agenda of the EU-Russia Energy Dialogue to help maintain the political momentum.

This is especially important in light of the heavy blunt given to the Kyoto Protocol

by the withdrawal from a II Commitment Period on the part of Canada, Russia and

Japan on occasion of the G8 Meeting on April 2011 (EUbusiness 2011). However the

Russian Socio-Ecological Union (RSEU 2011) affirms that while Russia is not

sustaining a Second Commitment Period it is very interested in further developing

the Flexibility Mechanisms. In light of this approach it may be more productive on

part of the European Union to stress the business side of JI projects rather than tying

the use of JI to advancements in international climate negotiations.

3.2 Options at the bilateral level (Energy Dialogue)

The strategical importance of the Joint Thematic Group on Energy Efficiency

(JTGEE) was highlighted by the EU-Russia Energy Efficiency Initiative, launched

in 2006, which confirmed the work of the Group and maintained its structure and

competences amidst the reorganisation of the EU-Russia Energy Dialogue

organisational structure (see section 1.2.3). The following are the objectives

confirmed in 2008 (JTGEE 2011: 2):

increasing [EE] while promoting economic growth;

improving the standard of living of the population and expanding the range

of level of services on offer

harmonising the range and legal and regulatory base and making it more

effective

reducing the impact on environment by introducing new energy efficient and

environmentally clean technologies and renewable energy sources.

Looking at these objectives it can be seen that the social and economic component of

EE is very important. The agenda for the JTGEE is thus very ample and not focused

on the practical introduction of EE measures. The review of the work undertaken by

the JTGEE in the period 2006-2010 shows that indeed the work of the group has

been focusing mainly on the legislative area, partially overlapping with the agenda of

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international forums such as the ECT under the PEEREA and the IPEEC

(International Partnership for Energy Efficiency Cooperation), i.e. forums in which

to share experiences and policy advices regarding EE. One can see however a very

positive trajectory in the intensity of the activities of the group.

Between 2006 and 2008 the JTGEE itself met 4 times, 4 conferences were organised

and 3 joint projects were implemented, while another project was due to start in

September 2007 and run for two years. All the projects focused on the legal and

legislative frameworks for improving EE (JTGEE 2008). Between 2008 and 2010 the

increase in intensity of the JTGEE's activity is noticeable. 8 conferences were

organised, 4 projects were implemented and 1 started in February 2010. Again, the

majority of projects focused on the legal and legislative framework, but also concrete

EE measures were implemented under the Northern Dimension Environment

Partnership (JTGEE 2011).

The peculiarity of the JTGEE activity is the cooperation at the regional level. In

2006-2008, experts of the JTGEE elaborated in-depth guidelines and identified

priority areas for EE improvement in the regions of Astrakhan, Arkhangelsk and

Kaliningrad. In 2008-2010, a study identified the potential for EE investments

projects in the Russian regions. Such a focus is not easily found in traditional

international cooperation between International Organizations and States and could

be an important card to play for the EU to strengthen its energy partnership with

Russia. However it is clear that the EU-Russia Energy Dialogue, ad the JTGEE

within it, are not tools studied to raise the huge investments needed to structurally

improve the EE of the entire Russian economy.

The need of raise investments is where the Partnership for Modernisation (PfM)

comes in. As explained in section 1.2.3, the PfM is meant to provide investments for

a wide variety of goals, covering every subject in the EU-Russia relations. This of

course implies that it is way too dispersed to be really effective in promoting

structural change in a single field. Indeed Longdi (2011) deems the Partnership as

one of the many steps taken by the EU and Russia to de-politicize their relation and

increase thrust. The fast implementation of the PfM after the decision taken at

Rostov-na-Don hints at the fact that the goals of the partnership (i.e. to modernize the

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Russian economy) are indeed shared by both parties and therefore the PfM should in

theory be conducive to such better relations. However the crack appears when

confronting how Russia and the EU define Modernisation. To the former,

modernisation means top-down selection and support of strategic sectors with very

high added value (such as nanotechnology, the biomedical sector, ), while to the

latter it means an open economy where market forces define winners and losers.

Barysch (2010) to underlines these different perceptions and the strong difficulties

arising from them, in particular the non-existent chances of changing the Russian

economy into a knowledge-driven one (ibidem: 32).

These differences between Russia and the EU are nothing new and in this sense the

PfM does not address them convincingly: the very lack of focus on specific topics

encourages the emergence of friction points in different sectors. Bayrisch (ibidem)

points to the example of the Russia-Germany PfM to show that focus on few, well-

defined areas can more effectively de-politicise relations thus making them more

productive.

3.3 Barriers and how to remove (or soften) them through cooperation

on EE

The barriers to increased cooperation between the EU ans Russia are numerous:

Different perceptions of energy security: each side has a different view of

what Energy Security means, stemming from its nature as energy exporter

and energy importer. According to Kirchneret al. (2010) the EU follows a

security of supply paradigm, with energy security being defined as in the

research design. On the other hand Russia seeks a security of demand, i.e.

a quest for a market for their energy exports w

energy efficiency as an eu foreign policy tool: possible impact on russia

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