Russia – Renewable Energy Project (RREP) – GEF Pipeline Entry (version 2003.10.27) 27 / 27

GEF Pipeline Entry

Project Concept and PDF-B Request

Country: Russian Federation

Project Title: Russia – Renewable Energy Program (RREP)

GEF Implementing Agency: The World Bank

GEF Focal Area: Climate Change

GEF Operational Program: OP6: Renewable Energy

GEF Grant Amount: US$20.0 million

Co-financing: US$60.0 million

PDF-B Requested: US$350,000

PDF-B Co-financing: US$1,910,000

Executing Agency: Ministry of Economic Development and Trade

Implementation Start: January 2004

Duration: 9 Months

1.  Project Summary

Objectives

The objectives of the project are to:

·  Change the current unfavorable investment and incentive conditions and create an enabling environment in Russia that fosters the development of biomass, geothermal and other renewable energy utilization for heating applications through providing financial, methodological, informational, and institutional support;

·  Increase the availability of financing for renewable energy investments, enterprises and intermediaries through the establishment of a financial facility with a long-term time horizon, which would provide soft loans or contingent grants for companies implementing renewable energy development projects;

·  Promote innovation in, and strengthening of the market for advanced renewable energy technologies in Russia through grant support to developers, manufacturers and consumers of advanced technological equipment in the field of renewable energy utilization;

·  Help alleviate rural poverty caused in large part by an underdeveloped local economy and unaffordable energy costs in certain regions of Russia due to high fossil fuel prices which result from long distance transport from far-away distribution networks, through supporting the development of local energy resources based on a broad involvement of stakeholders to ensure extensive development impact, and

·  Assist the Russian Government in its efforts to reduce the emissions of greenhouse gases in compliance with its commitment to the UN Framework Convention on Climate Change.

Background

Relatively low levels of renewable energy resources utilization in Russia are explained, among other reasons, by factors such as:

(a)  The country’s rich fossil fuel reserves, which means access to cheap energy in large areas around the sources of fossil energy, even after price distortions are eliminated;

(b)  An economy dominated by heavy industry that is best served by centralized power systems, and;

(c)  A distorting subsidy system that not only concealed the external costs of fossil fuel utilization associated with environmental damages but, especially in the residential heating sector, broke the link between consumer prices and production costs.

After the breakdown of the centrally planned economy the insustainability of the energy price subsidy system has become evident, but the transformation to market based energy pricing is a long, yet unfinished process, delayed by affordability problems and related social issues. Almost exclusive reliance on domestic oil, gas and coal continues therefore and the recognition by the government of the importance of these reserves as export commodities has resulted only recently in federal efforts to encourage local energy development based on renewable energy use. In particular, areas far from fossil fuel resources and being served only by very high-priced energy are prime candidates for quick development of local renewable energy.

There are five federal target programs (FTP): "Energy-effective Economy", "South Russia", "Ecology and Natural Resources of Russia", "Studies and Researches under the Priority Directions of Science and Engineering" and "Economic and Social Development of the Far East and Transbaikalian Region", which include components or tasks related to renewable energy resources development.

Revision of the subsidy system of municipal services in ways that increase incentives for service providers to make investments in increased efficiency and in the use of local energy resources is also underway.

However, the culture that relates to all aspects of renewable energy utilization, including developed technology, knowledge of resource potential, experience with planning, installation and operation of systems could not develop in the past.

These conditions create an environment for the development of renewable energies in Russia that is characterized by the following barriers:

Financial Barriers

·  Lack of domestic and foreign investment capital: Domestic companies have limited own resources and insufficient access to project financing resources. Foreign sources of capital are discouraged partly by the perceived risky business climate and unstable political and economic conditions and partly by the lack of strong legal institutions and contract enforcement;

·  Lack of longer-term affordable debt financing: Domestic commercial banks are unwilling to lend because investment returns in the longer-term are risky (fuel price volatility, etc.). Financial institutions are unfamiliar with analyzing the financial aspects of RE investments. Foreign borrowing is costly due to the high risk perceived by foreign commercial banks;

·  High project preparation and transaction costs: Project preparation costs accrue prior to – and without the assurance of – obtaining financing for the actual implementation of the project. Lack of demonstration projects increase transaction costs associated with project preparation;

·  High cost of special equipment: The equipment needed for renewable energy utilization, often determined by small scale production, is costly even when commercially available;

·  Absence of federal financing mechanisms (such as environmental funds, etc.): If there are such mechanisms, their use is limited by unaffordable co-financing requirements;

·  Uncompetitiveness due to low fossil fuel energy prices: The currently existing, distorting subsidy system does not reflect the external costs of fossil fuel utilization associated with environmental damages and, especially in the residential heating sector, breaks the link between consumer prices and production costs.

Information Barriers

·  Lack of information about technologies and opportunities: Lack of information on available technologies, such as conversion of existing large fossil fuel fired boilers to biomass use, knowledge of large-scale biomass co-generation systems, the establishment and operation of modern double-circuit geothermal heat supply systems and binary low-boiling geothermal power plants;

·  Lack of information about benefits: Lack of awareness about the potential benefits (financial, social and environmental) of renewable utilization, profitability of investments, lack of credible case studies;

·  Lack of information for cost/benefit analysis: Lack of heat meters in residential and service buildings and lack of historical heat consumption data for the preparation of baselines increase the costs of preparing credible projections about energy savings and investment and operational costs of RE investments;

·  Lack of information about Russian companies: Information about financial situation (earnings, profits, and debts) is often difficult to obtain. This increases transaction costs (outside independent auditor) and risks (again, costs) for banks considering loans, or potential joint-venture partners considering investments, and

·  Lack of high quality information about renewable potential: Only rough estimates exist on the potentially exploitable renewable resources.

Institutional Barriers

·  Lack of legislative support: Insufficient federal/regional support in the forms of funding mechanisms, electricity buyback policy, preferential taxation, etc.; this is compounded by the fact that fossil fuels are heavily subsidized directly as well as indirectly;

·  Insufficient enforcement of environmental regulations: Environmental regulations (emission standards) have become stricter over the past decade, enforcement (pollution fees, penalties) is still week though, and

·  Inflexibility of municipalities: Local administrations are unwilling to make funding decisions for multi-year projects (long-term benefits are hard to monetize for shorter prospective lifetime of local administrations).

Ownership Barriers

·  Mismatch between municipal ownership of district-heating systems and regulation of tariffs by federal/regional authorities. No price signals for residential sector and, therefore, lack of economic interest and capability of municipalities to participate in investment projects on development of renewable energy.

·  Insufficient private sector presence in the power and heat generation sector.

·  Fuel Choices. Ownership barriers are also resulting from the fuel choice, the project owner is facing: Gas is rather cheap only IF available near by (with short low cost pipeline only). However, logistics of alternative fuel oil and coal may be costly for remote areas and therefore may make RET attractive. On the other hand, in areas, which are well developed in terms of infrastructure, the project cannot expect immediately to change the Russian Government’s energy pricing policies.

·  Remote Areas. But in the remote areas with high energy prices due to poor logistics, the project will have a major demonstration effect. The owners face barriers with regard to (a) knowledge about RET, (b) management of new local fuel logistics and new technology (biomass), (c) technical (geological) barriers resulting from risks to find a geothermal reservoir, (d) technological barriers in respect of other RETs (wind, solar, small hydro), (e) financial risks, etc. Moreover, there is the problem of poor payment performance of customers, which induces the owner to “do nothing”.

Implementation Capacity Barriers

·  Undeveloped local project planning and implementing capacity; human resources only for routine operation, no high level human/technical resources, no energy managers; lack of capacity and guidelines for preparing feasibility studies, business plans and “bankable” project proposals.

Due to its decentralized, small-scale nature, the utilization of renewable resources is most often based on the residential heating sector.

In 1998, the World Bank started an Energy-Environment Review of Russia, which was completed in 2000. In this work, a number of Russian institutions participated. Key results of the study showed considerable renewable energy resources in the Northwestern part, the Southern part, the Far East, and the Baikal area. From the Review it also became clear that the level of utilization does not meet the requirements of the country and the regions mentioned above. Renewable utilization in Russia on a national level is less than 1%, compared to the 8% level of utilization in the European Union.

Among the immediate follow up work of this review were two project proposals for a Karelia – Biomass Project and Promotion of Renewable Energy Development in South Russia. Both projects were envisaged to be supported by the Global Environment Facility (GEF). The Russian GEF Focal Point also endorsed both projects. The GEF evaluated the proposals and advised the project team to place them in a more comprehensive framework to better meet the key GEF objectives of removing barriers to the utilization of environmentally friendly fuels and to the improvement of energy efficiency. Based on the recommendations of GEF after the evaluation of the previous proposals, the concept of a program called Russia – Renewable Energy Program (RREP) has been laid out.

Project Description

To overcome the barriers described earlier, and in particular, the financial barriers, it is proposed that a Russia – Renewable Energy Program (RREP) be established.

RREP would start with the support of projects in Northwestern Russia (biomass energy), in the South (geothermal, solar and wind energy) and in the Baikal region (solar and wind energy). As mentioned above, project pipelines exist already in these regions (For a short description of the proposed first components see Annex 3). RREP would support existing federal programs such as the “Energy Efficient Economy” of the Ministry of Energy, “South of Russia” of the Ministry of Economic Development and Trade and "Studies and Researches under the Priority Directions of Science and Technologies" for 2002-2006 of the Ministry of Industry, Science and Technologies of Russia. It is envisaged that RREP would eventually support programs and projects in all Russian regions.

Currently, there are several GEF/RES projects under preparation in Russia: Mutnovsky Geothermal project, Tomsk geothermal project, Geothermal Facility for East Europe and Central Asia, IFC medium-sized wind power project in Leningrad Oblast. These projects are at different phases of preparation, but it is already clear that for their realization Russia should create a transparent and reliable mechanism of co-financing of GEF projects both from state and non-state sources.

Thus, the necessity of close cooperation in the preparation of all specified GEF projects and in the development of effective mechanisms for attracting large-scale investments for RER development in Russia is obvious. It would be expedient to consider the focusing of the RREP preparation to the creation of conditions and infrastructures for attraction of large-scale investments in renewable energy resources projects. Annex 1 shows basic elements of RREP and their potential role in attracting international funds.

RREP would consist of two main components: (a) a technical assistance facility and (b) a financial facility.

The technical assistance component will support to implementation of following activities:

·  Provision of policy advice in the fields of energy policy and institutional support of renewable energy development:

§  Support to state policy development, improvement of legislation and regulatory basis, and standard design, with priority on the power sector regulatory framework and policies that provide fair and competitive grid access to renewable energy producers;

§  Assistance to building capacity for the implementation of progressive policies in the field of renewable energy utilization, including support to programs in the fields of education, training, awareness raising campaign in mass media, support to establishment or development of the operational centers, institutes, organizations, companies, and

§  Support of federal and regional programs of renewable energy development (refinement), realization of major projects and tasks of these programs

·  Promotion of information dissemination:

§  Collecting, assessment and updating of information about renewable energy resources in Russia;

§  Generation of up to date database containing current technologies and engineering knowledge on renewable energy utilization, and

§  Collection and dissemination of international and domestic project development experience in the field of renewable energies.

·  Fostering the establishment of joint-ventures with domestic and foreign energy companies for involvement in project preparation and implementation in order to secure financing and expertise;

·  Creation of standardized models for project preparation to reduce preparation costs;

·  Improvement of implementation capacity.

The long-term financial facility will be establish to help overcome financial and institutional barriers of renewable energy development. The facility would consist of:

·  Project preparation window for provision of shared financing on gratuitous and irretrievable or repayable basis for preparation of project documentation;

·  Revolving fund for provision of selective financial support to companies implementing renewable energy development projects, The support should be provided on a base of detailed project assessment in form of :