i Introduction

After years of being considered an 'oil-and-gas country', Russia now has an expanding renewable energy sector following a recent spate of foreign investment, and the installation and construction of several renewable energy projects.

The Soviet Union had a track record of developing renewable energy projects, especially large hydropower projects but also wind energy projects. Nevertheless, since 1970, low oil prices led to the complete abandonment of this sector, which was then neglected by Russian politics.

This situation changed only with the adoption of a national strategy for the development of renewable energy in 2009, such strategy becoming necessary after Russia joined the Paris Climate Agreement and had to meet the obligations in the Agreement to reduce its CO2 emissions.

As regulatory incentives were poor, the sector only started to develop after a serious shift in stimulation measures for the production of renewable energy in 2013 through the introduction of a capacity-based stimulation system.

ii The year in review

2017 saw the largest renewable energy capacity auctions and assignments under the new regulations of Decree 449 dated 28 May 2013 'On the mechanism for the promotion of renewable energy on the wholesale electricity and capacity market' (Decree 449).

As a result of tenders carried out in the wind power industry, wind farms with an aggregated capacity of more than 1,650MW will be constructed in Russia in the coming years. More than eight regions of Russia, including the northern territories such as the Murmanskaya region, will be involved in the implementation of the projects.

PAO Enel Russia, the key Russian company of Enel Group, won the tender for the construction of two wind parks with an aggregated capacity of 291MW. The total investments into the project are estimated at approximately €405 million.2 One wind park, with 90MW aggregated capacity, will be put into operation in 2020 in the Rostov region. Another wind park, with 201MW aggregated capacity, will commence production in the Murmansk region by 2021. It has been announced that the technological partner of the Murmansk project will be Siemens Gameza, a joint venture by German Siemens and Spanish Gameza.3

AO VetroOGK, a structure controlled by the State Atomic Energy Corporation (Rosatom), was awarded projects with an aggregated capacity of approximately 360MW.4 The wind power plants will be constructed between 2020 and 2022 in Adygea, Krasnodar Krai and other Russian regions. The company has stated that its total investments into the wind projects in Russia may exceed US$1,300 million. The technology for the project will be provided by Dutch Lagerwey.5

OOO Fortum Energy, a joint venture of Fortum and Rusnano, won tenders for the construction of wind parks with an aggregated capacity of approximately 1,000MW.6 The power generation facilities will be put into operation between 2018 and 2022. The two companies have announced their intention to invest approximately €400 million into the wind farm construction projects, which will be constructed in Ulyanovsk, Rostov, Krasnodar Krai and other Russian regions. Danish giant Vestas,7 one of the world's largest producers of wind turbines, will supply the turbines and components for the projects.

The above shows that legislative changes have succeeded in increasing the attractiveness of the sector for investors. 2018 auctions are currently under way8 and are also expected to be successful.

It appears that a standard structure for renewable energy projects has emerged from recent and current auctions consisting of the creation of joint structures where Russian state entities team up with foreign strategic investors in the renewable energy sector. Combined with localisation requirements stipulated by law, the new regulations have also initiated the creation of local high technology production facilities in Russia.

iii Policy and regulatory framework

i The policy background

In January 2009, the government approved the state policy on energy efficiency improvement (Policy)9. When adopted, the Policy covered the period until 2020 and provided key directions for the development of renewable energy projects in Russia. Later, the Policy was significantly amended. Through these amendments, the government set out the current legal framework based on the state-supported capacity supply system, and extended the effect of the Policy to cover the period until 2024.

In November 2009, the government approved the Russian energy strategy for the period until 2030 (Strategy).10 The Strategy aimed to announce a number of measures to ensure the efficient use of natural energy resources, and to set out key principles of government support to various energy sectors. In particular, the government announced certain efforts to create an environment that allows the development of renewable energy sources and their increased share in the Russian energy sector.

Through these two documents, the government laid a foundation for the further development of the renewable energy sector in Russia, determined its main directions and created a legal framework for further projects. Both documents became a legislative basis for the adoption of more specific regulations, which created the current legal regime for all activities within the sector.

The Policy, as a key source of basic principles, provided the main targets to be reached in the sector. The initial version of the Policy specified that renewable energy in the Russian energy sector should have reached 2.5 per cent by 2020. Amendments introduced in 2015 changed this target: according to the current version of the Policy, Russia aims to procure a 4.5 per cent share of renewable energy by 2024. The Ministry of Energy was empowered to allocate the targeted capacity among various renewable energy sources, being initially wind, solar (photovoltaic) and moderate-sized hydro sources.11 Since 2017, it also covers renewable energy facilities functioning on the basis of burning waste for energy. This is a new direction for the development of renewable energy projects. The government has determined12 the Russian regions where waste-burning plants will first be constructed: Moscow and the Moscow region (approximately 280MW) and the Republic of Tatarstan (55MW).

Russia's energy policy emphasises the importance of local production development in the renewable energy sector. Russia has been trying since 2012 to replace imports, particularly of technologically complex products, with locally produced products. The government encourages potential investors to run production of high-tech components for power-generating facilities in Russia to develop competitive local technologies and production in the country. A more detailed description of localisation rules is set forth in Section IV.

ii The regulatory framework

Legal framework and existing regulations

Russian lawmakers began focusing on renewable energy as early as 2007 with the passage of an amendment to the 13 that attempted to connect renewable energy sources into Russia's electricity generation system. Despite this attempt, a renewable energy programme was not successfully implemented until 2011, when further changes to the Law on Electricity created an incentive scheme for investment in this sector. These changes led to the passage of Decree 449 two years later and the renewable energy developments Russia is seeing today. The basis for the current expansion of Russian renewable energy was the passage in 2013 of Decree 449.

Initially, the government proposed to motivate renewable energy market participants through premium payments. In 2007, amendments to the Federal Law 'On Electric Power Industry' introduced a 'premium scheme' as a main promotion mechanism. This scheme envisaged that a certain premium on the equilibrium energy price in the wholesale electricity and capacity market was to be paid to the suppliers in renewable energy projects. However, this mechanism did not work in practice because of certain legal and technical issues, and the potential impact on prices for end customers.

Subsequently, in 2013, the premium scheme was replaced by the 'capacity supply scheme'. The government adopted one of the key regulations establishing the existing state support mechanism for Russian renewable energy projects – Decree No. 449.

The key idea of the capacity supply scheme consists in switching from a 'premium' component to a consideration payable to the provider of power generation capacity. Such consideration is calculated on the basis of the beneficial fixed tariff.

Applying beneficial tariffs fixed for 15 years allows market players to receive a guaranteed return on an investment made into the construction and operation of a power facility. Such tariffs take into account the capital expenditure amount, currency fluctuations and other factors, and provide a 12 to 14 per cent profit margin.14 We describe the structure of the beneficial tariffs in more detail below. However, to apply such a tariff, suppliers have to comply with the Russian localisation requirements.

Decree 449 deals with solar, wind, moderate-sized hydro and waste treatment power sources, and thus does not cover the entire field of renewable energy sources. Renewable capacities supplied must be equal to or exceed 5MW. Decree 449 is also restricted to the central tariff zone, and does not apply to 'non-tariff zones' and isolated territories.

The main mechanism under Decree 449 for encouraging the use of renewable energy is the conclusion of long-term energy capacity supply agreements with renewable energy source operators. A potential supplier is granted the right to enter into such agreements through a tender procedure conducted by the administrator of the trading system (ATS). Under such an agreement, a supplier will be obliged to create the renewable energy facility within a certain time frame and to supply capacity into the Russian energy system. The supplier will be entitled to receive remuneration for its capacity and for the energy it supplies based on 15-year fixed prices.

In particular, the procedure for concluding an agreement on capacity supply includes the following stages. Capacities are offered to potential suppliers once a year in a tender process organised by the ATS. Potential suppliers are invited to submit their bids according to the conditions provided for in Decree 449. Together with a technical description of the project, the bid shall specify the degree of localisation of the renewable energy facility as well as financial guarantees for the potential supplier's obligations. After the bids are submitted, the ATS will select the tender winners and conclude agreements on energy capacity supply with them.

The main obligation of a potential supplier under the agreement is creating a renewable energy facility within the agreed-upon parameters of capacity, localisation levels and timings. Agreements will always contain provisions on substantial penalties for delays in capacity supply.

Another central element of any agreement will be the localisation requirements. Decree 449 requires establishing detailed lists of localisation percentages for the different elements of renewable energy facilities. In addition, reaching the agreed-upon level of localisation plays an essential role in determining the price for the supplied capacity. If this level is not reached, the price will be significantly lower (35 per cent lower for solar power sources, and 45 per cent for wind, small hydro and waste treatment power sources), which will render the relevant projects economically disadvantageous.

After completing construction of a renewable energy facility, the supplier must apply for the recognition of such source as a qualifying generating facility to be able to supply capacity to the market. The qualification process involves both federal authorities (the Ministry of Industry and Trade of the Russian Federation) and the wholesale market organisation (Market Council).

When the supplier applies to the Ministry of Industry and Trade for determination of a renewable energy facility's degree of localisation, the Ministry will assign this determination to a special commission. Based on the commission's resolution, the Ministry will submit a statement to the Market Council, which will in turn allocate the renewable energy facility to one of three categories of localisation level: less than 50 per cent, between 50 and 70 per cent, or above 70 per cent. The corresponding price will be based on the Market Council's qualification.

In addition to incentives provided by Decree 449, the supplier is also entitled to apply for subsidies from the Russian federal budget, provided that it meets certain criteria. Such subsidies could include reimbursement of costs for the technological connection of the generating facility to the electrical power networks.

Institutional framework, and the regulators and their respective powers

The Russian electricity market is a two-level (wholesale and retail) electricity and capacity market. The retail market involves an end-consumers element, while the wholesale market mostly consists of generation companies, retail companies and large consumers.

The wholesale market commodities are electricity and capacity. Acquisition of capacity by an acquirer means that it has a right to demand from the supplier that electricity of a defined quality be generated by his or her generating equipment. Thus, the sale of capacity is in fact an arrangement for the provision of certain volumes of electric power in the future.

Provision of capacity generated through renewable energy sources is one of the mechanisms used in the wholesale capacity market. As already mentioned above, this mechanism is structured through the capacity supply agreements entered into as a result of the tenders for the selection of investment projects in the respective areas.

Such tenders are conducted four years in advance for each type of the generating facilities operating on the basis of different types of renewable energy sources: solar (photovoltaic), wind and water (moderate-sized hydro) energy. Since 2017, a similar procedure applies to waste-burning energy sources.

A first step to enter the market for the potential participant would be to adhere the Rules of Wholesale Electricity and Capacity Market Operation established by Decree No. 1172.15 Adherence is effected by way of entering into a wholesale electricity and capacity market accession contract and acquiring membership in the non-commercial association, NP Market Council. A mandatory form of accession contract is approved by law, and cannot be renegotiated or amended by the market participants. Once the accession contract is entered into, the market participant is deemed to be involved in the wholesale capacity market.

The following key entities regulate commercial activities within the market:

  1. a general regulator: a non-profit partnership association, the Market Council;
  2. a commercial operator of the wholesale market: the ATS, already mentioned above; and
  3. a settlement operator: the JSC Centre of Financial Settlements (CFS).

The Market Council:

  1. maintains the register of wholesale market participants;
  2. prepares wholesale market regulations and the standard form wholesale market contracts (including amendments to them);
  3. provides certain supporting services to market participants; and
  4. acts as a compliance controlling body and pre-court arbitrator in certain cases.

The Market Council also performs some authorities related to using the renewable energy facilities.

The ATS is primarily responsible for conducting state tenders and entering into contracts with wholesale market participants.

The CFS provides settlement services to all market participants and ensures the effective operation of the complex settlement system in the wholesale capacity market.

The activities of all three entities are regulated and controlled by the government.

Typical project steps, regulatory approvals and time frames

Based on what has been discussed above, the typical project steps for potential market participants would be as follows:

  1. entering into an accession contract and acquiring membership in the Market Council. A Russian legal entity will be required to be established for this purpose;
  2. participating in a tender. The tender procedure, with its specific formal requirements, will certainly be a challenge. Among others, the drafting of a precise bid corresponding to the technical requirements is one of the major tasks;
  3. in the event of wining the tender, a market participant will automatically become a party to the capacity supply agreement entered into with each of the buyers acting on the wholesale capacity market (currently 240-plus buyers). The form of the agreement is approved by law and cannot be renegotiated by the winner. If the form is amended by the government (which usually occurs several times a year), the amended agreement becomes automatically binding on all market participants;
  4. building a power generating facility with the technical and production characteristics described in the tender bid and capacity supply agreement;
  5. going through the qualification procedure and receiving a qualification certificate in respect of the power generating facility from the Ministry of Industry and Trade; and
  6. putting the power generating facility into operation by the date specified in the respective capacity supply agreements.

Particular time frames for projects are determined by the deadline indicated in the respective capacity supply agreements. In practice, the deadline is usually from one-and-a-half to four years from the date of the tender. If the deadline is missed, significant penalties will apply to the supplier. These penalties will automatically be discharged from the supplier's account, which is opened in the settlement system by the CFS. Subject to the provision by the supplier of additional financial security, the deadline can be postponed, but for not more than two years overall.

Recent renewable energy project developments

As can be seen from the above, there will be no classical project development in the Russian wholesale capacity market, as the activities thereon are strictly regulated by Russian law.

Usually, projects are financed by foreign investors in the beginning. However, Russian market players, being huge and reliable companies, also participate in the financing of projects. After a tender, the initial investors make efforts to attract borrowed financing: for example, it has been announced that Gazprombank will finance the construction of the wind parks by the Rosatom corporation, and that the amount of investment will be approximately 64 billion roubles.16

Potential capacity suppliers do not go alone into project tenders. The companies combine their efforts and create consortiums that involve global Russian players, foreign investors and local players responsible for issues that may arise in-land. Such structuring allows the creation of a strong team that can effectively resolve arising issues.

iv Renewable energy manufacturing

i Localisation requirements

Russian industrial policy has been trying since 2012 to replace imported materials with locally manufactured ones. This policy is generally described by such terms as 'import substitution' and 'localisation'. Since the Law on Russian Industrial Policy No. 488-FZ17 took effect in June 2015, the public procurement rules for many types of goods have changed, and a new rule requiring such goods to be made locally in Russia was established.

Russia has chosen a similar path for developing its renewable energy sources: both the distribution of capacity and the level of prices for the supplied capacity depend on the degree of the localisation of the power generating facility, namely:

  1. within the tender procedure for selecting investment projects involving the construction of power generating facilities using renewable energy sources (tender), the future operator undertakes to generate power using a generating facility whose construction meets a certain percentage of localisation. This obligation is one of the most important preconditions for winning a tender; and
  2. the power generating facility is subject to certification once its construction is completed. During the certification, the competent authorities verify, inter alia, the facility's compliance with the localisation obligations.

To be admitted to a tender, operators need to register as wholesale market participants. The minimum amount of supplied capacity by operators who are wholesale market participants is 5MW. Specifically, for operators of hydro energy plants, there is an additional maximum limit of 25MW. The volume of supplied capacity is estimated by each operator before the actual construction of the power generating facility by signing contracts on the design and construction of the corresponding facilities. The estimates are also set out in the capacity supply agreements that are signed with tender winners. A failure to honour these agreements will trigger contractual penalties.

Furthermore, when planning to participate in a tender, operators have to consider the requirements in terms of the maximum amount of capital expenditures for the construction of the power generating facility, which is one of the tender's criteria. This amount depends on the renewable energy resource and the year of participation in the tender. For example, the capital expenditures for the construction of solar plants for projects that are selected in 2018 may not exceed, inter alia, 105,262 roubles per KW in 2019 and 103,157 roubles per KW in 2020. For wind plants, the upper limit is, inter alia, 109,561 roubles per KW in 2019 and 109,541 roubles per KW in 2020. Finally, the upper limit for small hydro energy plants is 146,000 roubles per KW from 2019 to 2022. Therefore, companies participating in tenders only compete on the basis of the amount of capital expenditure that is needed to develop the facility.

As mentioned above, a certain degree of localisation must be reached to win a tender. Power generating facilities and their components and equipment have to be at least partly manufactured in Russia. Since 2016, 70 per cent of the generating equipment for solar energy plants has to be made in Russia. Wind energy plants have to attain a 55 per cent localisation level in 2018, and from 2019 this should reach 65 per cent. For small hydro energy plants, the localisation degree is 65 per cent. Government Decree No. 42618 defines the components and operations that are used for calculating the degree of localisation and its rate. Non-compliance with these requirements means that an operator can no longer participate in a tender. The declared localisation degree is also based on operators' forecasts, the planned local industrial capacity and their contracts with the suppliers or manufacturers of components and equipment. The localisation requirements are rather high and, at the same time, most components and equipment for power generating facilities are still not manufactured in Russia. Tender winners are, therefore, usually confronted with the need to produce such components and equipment themselves shortly after concluding a capacity supply agreement. If a tender winner fails to comply with the agreed timelines and the declared localisation degree, it may be subject to contractual penalties ranging from 85 to 100 per cent of the contract's total value.

After the construction of a plant, its certification as a power generating facility that uses renewable energy sources is the final step to set the price for capacity. For the purpose of this certification, the operator first has to file an application for the determination of the degree of localisation with the Ministry of Industry and Trade. After receiving this application, the Ministry passes the application on to the Commission overseeing the Determination of the Degree of Localisation of the Power Generating Facilities Using Renewable Energy Sources. After reviewing the submitted documents, the Commission then makes a decision that is used by the Ministry to determine the localisation degree and to send a copy of its decision to the Market Council. Finally, the Market Council classifies the power generating facility into one of three categories, depending on the degree of localisation: less than 50 per cent, between 50 and 70 per cent, and above 70 per cent. The price for the supplied capacity will be determined, in particular, based on its allocated category.

When establishing whether a certain component is produced in Russia, the general rules for determining the country of origin of goods (as provided for by the customs legislation) will apply, unless a component is produced within the special investment contract (SPIC) framework. This exception to the general rule is expressly provided for by law.

ii SPICs

Signing a SPIC has proved to be one of the decisive conditions for meeting the localisation requirements, since it enables any operator who has entered into a SPIC to treat imported components as if they had been produced locally in Russia for the purpose of calculating the localisation degree at the initial stages of the implementation of an investment project.

SPICs were first introduced in the Law on Russian Industrial Policy No. 488-FZ.19 Thanks to Government Decree 708,20 which contains, inter alia, a model for SPICs, SPICs eventually became applicable in practice. SPICs can be entered into either at the federal level or with the participation of regional and local authorities.

The investor's main obligation under a SPIC is typically to establish or modernise the production of specific goods, including those that were hitherto not produced in Russia, with certain minimum volumes of investment and production in accordance with the agreed business and production plans, which are to be incorporated into the SPIC. The competent authorities control the due fulfilment of the investor's obligations under the SPIC. In turn, the investor is granted certain incentives, usually in the form of tax reliefs and preferences in public procurement, as well as a special regime for determining the localisation degree. The scope of incentives available under a SPIC is limited to those provided by law. SPICs are entered into for a period that is equal to the time frame required to make the project operationally profitable according to the business plan plus five years, but in any case, this should not be more than 10 years.

v Conclusion and outlook

Implementing incentive mechanisms for the use of renewable energy in the Russian legal system has created significant activity in this sector, and renewable energy facilities are constantly under construction. Localisation requirements have brought new production facilities to the country, with suppliers able to produce components for renewable energy locally now being in high demand.

We expect the market to further develop and to encompass segments that are currently outwith the scope of Decree 449, such as energy supply sectors in isolated territories. Russian politics are supporting these developments. Today, Russian renewable energy offers more potential and opportunities than ever before.

It should be noted that according to a statement of the Market Council, as at the beginning of 2018, approximately 78 per cent of the targeted capacity has already been awarded to various market players. The awarded capacity was mostly allocated among wind and solar energy projects: if the proposed capacity is successfully awarded throughout 2018 and 2019, 95 per cent of the targeted capacity will already have been distributed in these two sectors. The market is still awaiting new regulations regarding the period beyond 2024. At present, there is uncertainty regarding future support for the renewable energy sector after the expiry of the current incentives.


Footnotes

1 Thomas Heidemann is a partner and Anastasia Makarova is a senior associate at CMS Russia.

9 Decree of the Russian Government No. 1-r dated 8 January 2009.

10 Decree of the Russian Government No. 1715-r dated 13 November 2009.

11 A moderate-sized hydro is a hydro power plant the aggregate capacity of which is between 5MW and 25MW.

12 Decree of the Russian Government No. 355-r dated 28 February 2017.

13 Federal Law On Electricity No. 35-FZ dated 26 March 2003.

14 Currently an investor may expect a 12 per cent profit margin; a 14 per cent margin was provided to renewable energy projects whose tenders were carried out in 2013 and 2014.

15 Decree of the Russian Government No. 1172 dated 27 December 2010 'On approval of the Rules of Wholesale Electricity and Capacity Market Operation'.

17 Federal Law on Industrial Policy in the Russian Federation No. 448-FZ dated 31 December 2014.

18 Decree of the Russian Government No. 426 dated 3 June 2008 'On qualification of the generating facilities functioning on the basis of the renewable energy sources'.

19 Federal Law on Industrial Policy in the Russian Federation No. 448-FZ dated 31 December 2014.

20 Decree of the Russian Government No. 708 dated 16 July 2015 'On special investment contracts for certain industrial sectors'.