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The sleeping bear: Russian surplus permits threaten cuts at Copenhagen

October 30, 2009

In amongst the debate over which country will accept what form of climate change target (if any), there is a sleeping, giant, bear that threatens to undermine abatement commitments at Copenhagen  and the global carbon market.  This is the massive surplus of Assigned Amount Units (AAUs) – the tradeable emissions units under the Kyoto Protocol – amassed by the Economies in Transition over the period to 2012 – In particular Russia and the Ukraine.

In effect, when the economies of the former Warsaw Pact and Soviet Union contracted substantially in the 1990s, their Kyoto emissions targets based on previous high, inefficient, levels of industrial production became obscure, thus creating a substantial surplus of available credits to sell on the international market through the flexible mechanisms of the Kyoto Protocol.  In 2005, these countries were on average 35% below the emissions levels of 1990.  The Kyoto target for Russia and the Ukraine was 101% of base year emissions.

Colloquially, this phenomenon is known as ‘Hot air’.

While Annex 1 countries develop their domestic and international mandates and positions for emissions reduction commitments leading up to the climate change negotiations at the UNFCCC in Copenhagen, Russia remains substantially out of the press in terms of it being a determinant factor for success.  All the talk is of the US, China, and India.

Unless a workable agreement can be reached with Russia, there is a risk that the surplus AAUs, if sold into the market, could significantly undermine investment in domestic, and international, emissions reductions.  Downward pressure on carbon prices would be substantial, and investment in emissions reductions in emerging markets through the Clean Development Mechanism and other means would all but dry up.

I build upon my previous comments about the implications for distribution of mitigation within the economy and the prospects for substantial deficit in Australia.  A nation state would be able to assume a tough target on a national basis but confer modest targets on industry and the rest of the economy, while also avoiding potentially high cost of imported credits.  

How? This would be achieved through formation of a bilateral agreement with Russia to transfer large volumes of AAUs for the balance of the remnant emissions deficit – at a low price.

BarCap estimates Russia and the Ukraine, the two countries with the largest Assigned Amount Unit inventory (the national carbon ‘currency’ of the Kyoto Protocol), could have around 6.5 billion tonnes (6.5 GtCO2e) available for sale from the 2008-2012 Kyoto period which they have amassed.

These countries can bank surplus from the 2008-2012 ‘Commitment Period’ to a subsequent commitment period.

Anna Korppoo and Thomas Spencer have labelled this phenomenon ‘The Dead Souls’ in their recent paper for the Finnish Institute of International Affairs.

Korppoo and Spencer give a figure for a possible pre-2012 surplus of between 3.5-5 GtCO2e from Russia – likely at least at the upper end of this estimate now, as a result of the economic crisis.

To illustrate the scale of this surplus, this is more than three times the annual CO2 emitted by all industry under the EU’s Emissions Trading Scheme and nearly six times the estimated global demand for AAUs pre-2012. 

Australia’s entire annual emissions amount to less than 600 MTCO2e, while a 25% emissions cut by 2020 would represent 249 MTCO2e reduction from a business-as-usual scenario.  The existing Russian surplus alone is twenty times Australia’s future deepest cut target to 2020!

During the post-2012 Commitment Period, the Russian economy is likely once more to be substantially long.

The Russian Ministry of Economic Development analysis shows that only under the most ‘pessimistic’ emissions scenario for Russia will emissions in 2020 surpass the emissions level (3,048 MT) of 1990.

The best indication of Russia’s medium-term cut commitment is 50-80% on 1990 levels by 2050. This range potentiality is evident from the Russian signed statement at l’Aquila, and statements shortly thereafter.

Evidence suggests that there is strong potential for no-cost signficant greenhouse gas emissions abatement in the Russian economy, thus presenting the prospect of further surplus creation if a Russian national target for 2012-2020 is not at a challenging level.

A joint IFC/Centre for Energy Efficiency paper which examines in detail the potential for energy use reduction in the Russian economy states:

Russia can save 45 percent of its total primary energy consumption.  Russia’s current energy inefficiency is equal to the annual primary energy consumption of France.  Achieving Russia’s full energy efficiency potential would cost a total of $320 billion to the economy and result in annual costs savings to investors and end users of about $80 billion, paying back in just four years.  Benefits to the total economy are much higher: $120-150 billion per annum of energy cost savings and additional earnings from gas exports.

If its energy efficiency potential was to be fully realized, Russian CO2 emissions in 2030 would be approximately 20 percent below the 1990 level. Russia’s energy efficiency potential translates into a CO2 emissions reduction of 793 million tons of CO2 equivalent per year (about half of 2005 emissions).

The 10-15% abatement range by 2020 proposed by Russia does not reflect the efficiency potential or trends of the Russian economy.

From almost any angle, Russia is a large, inefficient, user of energy – a major contributor to national greenhouse gas emissions. Russia is the most energy intensive economy per unit of GDP of the top ten energy consuming countries, and is number three in absolute terms for energy consumption.  Russia ranks among the top 25 energy intensive countries in seven major areas of economic activity: agriculture, hunting and forestry; construction, manufacturing; transport, storage and communications; wholesale, retail trade, restaurants and hotels; and other activities. It has a relatively slow pace of reduction of energy intensity.  This should confirm the potential to easiliy reduce the energy intensity of the economy.

The Moscow Higher School of Economics suggests a possible 30% greenhouse gas emissions reduction on 1990 levels by 2030 purely as a consequence of the current economic crisis.

A curious effect of energy efficiency implementation in Russia will be the impact on international energy exports from Russia, and the potential relative downward impact on regional and/or global prices. At a current annual natural gas production of around 350 bcm the IFC reports a potential saving of 240 bcm. In addition, 43 million tons of crude and refined products, and 340 billion kWh of electricity could be saved.  Thus, through cutting domestic consumption, there will be greater availability for export, or reduced demand for imports, in the future. Russia therefore has a clear economic interest in the reduction of domestic greenhouse gas emissions.

At the same time, perversely, this will have the impact of marginally reducing global energy prices, thus reducing incentives for investment in energy efficiency and low-emissions research and development in other markets.  (The shadow of reduced, or fluctuating availability of fuel exports from Russia looms large in Europe in particular).

However, the main implication for climate negotiations is that, based on all but the very highest end of any Annex 1 country abatement targets, the cumulative Russian surplus will swamp demand.

As Korrpoo and Spencer clarify:

If the surplus AAUs from all countries is transferred, 700 – 1000 million AAUs would be available to replace domestic emission reduction measures in industrialized countries each year up to 2020. In total, this represents ca. 4-6% of total Annex 1 emissions in the base year, i.e. ca. a sixth of a 30% Annex 1 target or a third of the existing 10–16% reductions pledged by Annex 1 countries.

The following solutions are options proposed by Korrpoo and Spencer, and the World Bank:

– Encourage Russia to hang on to the surplus, for the future – thus not sell into the short-term market

– Have Russia and Annex 1 countries commit to deeper targets

– Sell AAU surplus to finance initiatives in developing countries, and/or domestically (Green Investment Scheme)

– Buy the surplus and cancel – government to government (where does the cash come from?)

– Simply not allow the AAUs to be eligible post-2012 – politically unfeasible if Russia is to be on board an agreement

Clearly the AAU surplus is a substantial issue to be addressed.

 Their worth is deemed a sovereign asset by those nation states.  Should the units be brought substantially into play to meet what appear to be modest mid-term targets, then environmental additionality of post-2012 targets and the carbon markets will be at risk. 

There is no obvious solution, and relatively little focus upon the issue.  While many criticise the institutional arrangments that allow for the trading of permits from one country to another as a threat to the integrity of targets, the establishment of the markets in permits was a major driver behind the political acceptability of assuming cuts. 

Now, it may be the existence of the permit markets which provide continued incentive for responsible governance by those countries that hold surpluses of the international climate regime.  This is because the countries that are substantially long on permits may place more value in banking much of the balance of their surplus into a post-2020 Commitment Period, rather than sell into the forthcoming period.  Targets are sure to become harder in time, and value and market prices for permits higher.

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