The Renewable Energy Law Review: Russia
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, from 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, which became necessary after Russia joined the Paris Climate Agreement and had to meet the obligations in the Agreement to reduce its carbon dioxide 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.
The year in review
Unlike 2017 and 2018, when more than 2.5GW of contracts were successfully tendered 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), the renewable energy capacity auction launched in 2019 was less attractive because of the low volumes offered to bidders, namely 78.1MW for the wind power industry, 5.6MW for solar (photovoltaic) energy and almost 230MW for medium-sized hydro sources.2 As a result, only three projects were selected in 2019. The reason for this overall reduction is that more than 95 per cent of the power generation capacity targeted until 2024 by the state policy on energy-efficiency improvement (see Section III) has been already assigned, mostly in wind and solar energy projects.
The main market participants remain the same.
AO VetroOGK, a structure controlled by the State Atomic Energy Corporation (Rosatom), is currently implementing wind power projects awarded previously and has stated that its total investments in wind projects in Russia may exceed US$1,300 million. The technology for the projects will be provided by Dutch manufacturer Lagerwey.
OOO Fortum Energy, a joint venture between Fortum and Rusnano, previously won tenders for the construction of wind farms with an aggregate capacity of more than 820MW. The power generation facilities will be put into operation by 2023. The two companies have announced their intention to invest approximately €400 million in wind farm construction projects, which will be sited in Rostov, Perm, Krasnodar Krai and other Russian regions. Danish giant Vestas, one of the world's largest producers of wind turbines, will supply the turbines and components for the projects. In 2019, the consortium commissioned a 50MW wind power plant in the Ulyanovsk region.
PAO Enel Russia, the key Russian company in the Enel Group, won a 71MW wind power project in the 2019 tender. Notably, it managed to offer capital expenditure (one of the main tender criteria) that was almost two times less than the amount initially tendered. Apparently, the company will also concentrate on further implementation of projects it was awarded previously, with total investments in the projects estimated at approximately €405 million. It has been announced that one of the technological partners in the projects will be Siemens Gameza, a joint venture between German company Siemens and the Spanish Gameza.
These projects show that legislative changes have succeeded in increasing the sector's attractiveness for investors.
It appears that a standard structure for renewable energy projects has emerged from recent and current auctions, consisting of the creation of joint structures in which Russian state entities team up with foreign strategic investors in the renewable energy sector. The new regulations, combined with localisation requirements stipulated by law, have also initiated the creation of local high-technology production facilities in Russia.
In 2019, new legislative acts were adopted to support micro-scale generation and renewable energy use3 in isolated territories.4 However, the application of renewable energy sources in these spheres has yet to be developed.
Renewable energy project development
i Project finance transaction structures
Projects are usually financed by foreign investors at the outset. However, as Russian market participants are large reliable companies, they also participate in the financing of projects.
After a tender, the initial investors make efforts to attract borrowed financing, typically using standard project financing such as bank credit facilities; for example, it was announced that Gazprombank would finance the construction of wind farms by Rosatom, with investment of approximately 64 billion roubles.12
As mentioned above, pursuant to Decree 449, the main mechanism guaranteeing investors a return on their investment (thus allowing them to repay the borrowed financing) is the application of beneficial tariffs, fixed for 15 years under the relevant energy capacity supply agreements.
In addition to the incentives provided by Decree 449, suppliers are also entitled to apply for subsidies from the Russian federal budget, provided that they meet certain criteria. These subsidies could include reimbursement of costs for the technological connection of the generating facility to the electrical power networks. Such reimbursement currently amounts to up to 50 per cent of technological connection costs but not more than 30 million roubles per generating facility.
New incentives are currently being sought to increase competition on the market, in particular by increasing the sales of electricity (capacity) produced using renewable energy sources. At present, grid operators are primarily required to acquire electricity generated by qualified renewable energy facilities on the retail market only in order to compensate for circuit losses.13
ii Distributed and residential renewable energy
Distributed (on-site) and residential renewable energy is not widespread in Russia and thus it does not play any significant role in the national economy.
As mentioned above, in 2019, new legislation was adopted to support micro-scale generation in Russia. It provides that the owners of micro-scale generation facilities (up to 15kW) may sell any excess electric power produced to retail consumers (in this case, suppliers of last resort) and the latter may not refuse to purchase such electric power. In addition, during the period between 1 January 2021 and 1 January 2029, any proceeds from selling electric power generated by micro-scale generation facilities will be exempt from personal income tax.
Traditional energy sources such as oil, gas and coal are commonly used to supply power to isolated territories. However, relatively small generating companies, using renewable energy sources, are now emerging in these territories. To support such companies and to encourage the replacement of existing diesel power plants with autonomous hybrid power facilities that partially use renewable energy, the government implemented new rules in 2019. This new regime provides for the conclusion of energy service contracts (ESCs) for a period of 10–15 years under existing legislation on energy saving and energy efficiency. It is envisaged that, under an ESC, an investor that has implemented the use of renewable energy sources will have its investments recovered by the owner of the relevant modernised generating facilities, who will make regular payments to the investor at least during the payback period plus two years. Such payments will be calculated as fuel costs (which usually constitute up to 70 per cent of applicable electricity tariffs) saved through implementing the use of renewable energy sources.
iii Non-project finance development
Although the share of project financing in renewable energy projects in Russia is now increasing, most projects are currently implemented through structures or joint ventures established or controlled by state-owned corporations such as Rosatom and Rusnano (see Section II). These corporations can be considered equity investors in their respective projects.
Some relatively minor investors prefer to use their own funds or to attract financing from their parent companies.
Renewable energy manufacturing
i Participation in a tender and 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-FZ14 took effect in June 2015, the public procurement rules for many types of goods have changed and a new rule requiring these 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:
- 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
- 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 have 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 may not exceed, inter alia, 103,157 roubles per kW in 2020 and 101,094 roubles per kW in 2021. For wind plants, the upper limit is, inter alia, 109,451 roubles per kW in 2020 and 109,342 roubles per kW in 2021. Finally, the upper limit for medium-sized hydro energy plants is 146,000 roubles per kW from 2020 to 2024. Therefore, companies participating in tenders only compete on the basis of the amount of capital expenditure required 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 65 per cent localisation level from 2019. For medium-sized hydro energy plants, the localisation degree is also 65 per cent. Government Decree 42615 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 the components and equipment themselves shortly after concluding a capacity supply agreement. If a tender winner fails to comply with the agreed timelines and the stipulated 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 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 specifically on the basis of 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 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.
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 degree of localisation at the initial stages of the implementation of an investment project.
SPICs were first introduced in the Law on Russian Industrial Policy No. 488-FZ16 and as a result of Government Decree 708,17 which contains, inter alia, a model for SPICs, these contracts eventually became applicable in practice.
The investor's main obligation under the SPIC framework is typically to implement an investment project, in particular, facilitating the production of specific goods, including those hitherto not produced in Russia, using modern technology and 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 stability (grandfathering) clauses and preferences in public procurement, as well as a special regime for determining the degree of localisation. The scope of incentives available under a SPIC is limited to those provided by law.
In 2019, new rules for entering into SPICs (known as SPIC 2.0)18 were adopted. In particular, these new rules made the following provision:
- SPICs are available only to those investors who intend to introduce modern technologies (as indicated in a list to be approved by the government);
- a SPIC has to be entered into through a tender process initiated by the public party or the investor itself;
- a SPIC is implicitly a contract between the investor, the Russian Federation, the relevant Russian region and the municipality where the project is intended to be implemented;
- the duration of a SPIC will depend on the volume of investments but will not exceed 20 years;
- the previous minimum investment threshold (750 million roubles) no longer applies;
- one SPIC may only be concluded with one investor and it is no longer possible to add other participants on the investor's side who could also qualify for government support measures (such as co-investors or involved parties);
- the total amount of financial state support under a SPIC may not exceed 50 per cent of the total investment required by the SPIC. If this limit is exceeded, the provision of state support measures to the investor is suspended;
- the main tax benefit for a SPIC participant remains the zero per cent rate of income tax to be paid to the federal budget and the possibility of reducing the tax's regional component also down to zero per cent; and
- SPICs that were concluded under the previous rules remain in force. Such SPICs can be amended or terminated by the parties concerned on the basis of the laws in force at the time of the SPIC's conclusion. However, it is not possible to enter into a new SPIC under the previous regime.
The SPIC 2.0 regime is aimed at increasing the transparency of the procedure and introducing a number of positive aspects to the regulatory framework. However, a lack of required secondary legislation, initially meant to be adopted by the end of 2019, currently prevents all parties from implementing investment projects under this new regime. Secondary legislation is expected to be adopted in the second quarter of 2020.
Furthermore, another federal law19 has been introduced to regulate the conclusion of agreements affording support to investments in the Russian Federation. This law introduces a new type of agreement, the SZPK, on the protection and promotion of investments. Unlike SPICs, SZPKs are to be used not only in production-based industries, but also in other sectors, such as services, intellectual property and infrastructure. The SZPK legislation also provides for a less formal contract conclusion process. Since this federal law has only been adopted recently and no relevant secondary legislation has been adopted yet, it is difficult to forecast how SZPKs will be applied in practice.
Similarly to SPICs, SZPKs can include a stability clause and provide certain subsidies and tax incentives to the investor. However, the ultimate goals of these two mechanisms are different. SZPKs are mainly intended to support the development of private infrastructure projects whereas SPICs are intended to ensure the implementation of modern technologies in Russia's industrial sectors.
It seems that both mechanisms could be used (and even coexist) in renewable energy manufacturing, depending on the specifics of the particular investment project.
Conclusions 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 have even seen the first examples of locally produced components being exported.20
We expect the market to develop further and to encompass segments that are currently beyond 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.
Notably, and as mentioned above, according to a statement of the Market Council, as at the beginning of 2020, approximately 95 per cent of the targeted capacity has already been awarded to various market participants. The awarded capacity was mostly allocated among wind and solar energy projects. 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.
Large industrial consumers have objected to the extension of the Policy, calling instead for the adoption of alternative measures to support the renewable energy sector. The main reasons for their dissatisfaction are the price of power capacity and the increase in the costs of implementing renewable energy projects. However, the key investors in the Russian renewable energy sector (such as Rusnano) have requested the extension of the Policy until 2035. They believe the Russian renewable energy sector is still too young to function under the general competitive rules of the Russian energy market applicable in other sectors. It has also already been announced that, subject to certain modifications, the existing capacity supply scheme implemented under the Policy will be applicable until 2035. Preliminary estimates are that funds allocated to support investment projects in renewable energy in this period may reach approximately 400 billion roubles, and new capacity is expected to reach up to 10GW. However, the exact volumes have not been defined yet.
In parallel with these funding measures, the Market Council has initiated development of the concept of Russian green certificates, which may be used to supplement the existing structure. Work is being done by the Market Council in this respect; thus, for the first time in Russia, the concept of green certificates seems to be a potentially workable option. By selling these green certificates, consumers could reduce their total amount of payments for capacity under the current support mechanism of capacity supply agreements, while for power suppliers, the green certificates could act as a source of return on their investments.
Consequently, the Russian renewable energy market is now awaiting further changes to the legal regime and these changes will certainly provide a new impulse for further development in the industry.
1 Thomas Heidemann is a partner and Dmitry Bogdanov is a senior associate at CMS Russia.
2 A medium-sized hydropower plant is one whose aggregate capacity is between 5MW and 25MW.
3 Federal Law No. 471-FZ dated 27 December 2019 and Decree of the Russian Government No. 64 dated 30 January 2019 respectively.
4 Isolated territories are the regions of Russia not connected to the Unified Energy System. These regions comprise about 70 per cent of Russian territory.
5 Decree of the Russian Government No. 1-r dated 8 January 2009.
6 Decree of the Russian Government No. 1715-r dated 13 November 2009.
7 Decree of the Russian Government No. 355-r dated 28 February 2017.
8 Decree of the Russian Government No. 567-r dated 31 March 2018.
9 Federal Law on Electricity No. 35-FZ dated 26 March 2003.
10 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.
11 Decree of the Russian Government No. 1172 dated 27 December 2010 on Approval of the Rules of Wholesale Electricity and Capacity Market Operation.
13 Decree of the Russian Government No. 47 dated 23 January 2015.
14 Federal Law on Industrial Policy in the Russian Federation No. 448-FZ dated 31 December 2014.
15 Decree of the Russian Government No. 426 dated 3 June 2008 on Certification of Generating Facilities Functioning as Renewable Energy Sources.
16 Federal Law on Industrial Policy in the Russian Federation No. 448-FZ dated 31 December 2014.
17 Decree of the Russian Government No. 708 dated 16 July 2015 on Special Investment Contracts for Certain Industrial Sectors.
18 Federal Law on Amendments to the Federal Law on Industrial Policy Regarding the Regulation of SPICs No. 290-FZ dated 2 August 2019.
19 Federal Law No. 69-FZ dated 1 April 2020.