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Igor Makarov

PhD in Economics, Associate Professor of the World Economy Department, Academic Head of the World Economy Undergraduate Program at HSE- University, RIAC expert

It is not surprising therefore that both the expert and the academic communities continue to discuss the results of the Paris Conference. In particular, in August 2016, the British analytical center Chatham House published a report by John and Beth Mitchells “Paris Mismatches. The Impact of the COP21 Climate Change Negotiations on the Oil and Gas Industries.” The Mitchells’ report offers a well-structured explication of the consequences the agreement will have for two interconnected sectors which are of particular significance for Russia’s economy.

Based on: “Paris Mismatches. The Impact of the COP21 Climate Change Negotiations on the Oil and Gas Industries.” Chatham House Research Paper, August 2016.

In December 2015 in Paris, a new climate agreement was signed replacing the Kyoto Protocol. The US, China, India, and the EU have already ratified it, and on November 4, 2016, the Paris Agreement will come into force.

The document declares the goal of “holding the increase in the global average temperature to well below 2 °C above pre–industrial levels and pursuing efforts to limit the temperature increase to 1.5 °C.” The agreement is based on the “bottom to top” principle: the countries set their own goals for cutting emissions (the “nationally determined contributions”) based on their plans for developing the energy sector, other carbon-intensive sectors, and the economy as a whole.

The entrance of the Paris agreement into force is difficult to overestimate not only because it treats fighting the key environmental issue of the 21st century. Decreasing the emissions of greenhouse gases has long been intertwined with many key economic categories, such as economic growth and technological progress, population growth and inequality. It still largely determines the development of the world’s key industries such as energy, transportation, or agriculture.

The Paris agreement did not make a single state radically alter its development strategy, since all of them had begun moving toward a low-carbon future even before the Paris conference, even though each was doing it at its own pace.

It is not surprising therefore that both the expert and the academic communities continue to discuss the results of the Paris Conference. In particular, in August 2016, the British analytical center Chatham House published a report by John and Beth Mitchells “Paris Mismatches. The Impact of the COP21 Climate Change Negotiations on the Oil and Gas Industries.” This is not the first report dedicated to the consequences of the Paris agreement. The Mitchells’ report offers a well-structured explication of the consequences the agreement will have for two interconnected sectors which are of particular significance for Russia’s economy.

The leading countries’ goals

The principal “mismatch” of the agreement is between the declared goals to restrict temperature increases and the scale of measures the countries are prepared to take at the moment. The authors quote well-known estimates: if the countries make their contributions, it will lead to holding the temperature increase at 2.7 °C while the declared goal is 2°С, with the desired limit being 1.5°С. Nonetheless, it was agreed that the contributions will be revised every five years. Thus the gap between declarations and reality should be gradually overcome; still, even now the countries should be more ambitious in their plans to limit the emissions.

The report considers in great detail the contributions of the EU, the US, India, Japan, and Saudi Arabia, that is, of the countries whose policies will largely determine the future of the oil and gas market. It is important that the Paris agreement did not make a single state radically alter its development strategy, since all of them had begun moving toward a low-carbon future even before the Paris conference, even though each was doing it at its own pace.

Thus, developed countries have long been using domestic carbon regulations. Different countries use different instruments. The EU uses the European quota trade system; the US uses a differentiated system of market and administrative measures with the United States Environmental Protection Agency and the states’ administrations playing the key role; Japan uses an equally complicated mixture of regulatory instruments, many of which are tied to scientific and technical policies.

The developing countries, China and India, have built their emissions restrictions policies into their structural reforms. Thus, in China, the policy became one of the key areas in the 13th five-year plan and it is important for diversifying the energy balance, for decreasing pollution in the cities, and for creating new jobs. In India, developing renewable energy sources is one of the key instruments in solving the problem of access to electricity.

China’s situation is more favorable than India’s: emissions peak may be reached here even before 2030. Transitioning to a new development model will be conducive to achieving this result.

China and India’s clearly instrumental approach to cutting emissions (developing green technologies as long as they are needed to solve socioeconomic tasks) ensures gradual transition to low-carbon development, but excludes any possibility of breakthroughs. Not surprisingly, both China and India formulated the key goals for their contributions in terms of cutting emissions per GDP unit, not in absolute figures. At the same time, China’s situation is more favorable than India’s: emissions peak may be reached here even before 2030, the year mentioned in the contribution. Transitioning to a new development model will be conducive to achieving this result; this new model is based on stimulating domestic consumption, expanding the service industry, gradually abandoning the use of coal, and moving dirty manufacturing out of the country. Thus, by the end of 2015, coal consumption in China had fallen again, for the second year in a row, and 2016 will likely see this trend continue.

India’s situation is more complicated. Unlike China’s, its key challenges require increasing carbon-intensive manufacturing. India, therefore, openly demands climatic financing, justifying its demand by the fact that the developed countries are principally responsible for the climate change, and India cannot risk its economic growth for the sake of solving environmental problems.

Finally, Saudi Arabia insists that at the climate negotiations, it be treated as a representative of a special group of countries which depend on the energy commodities, and there should be no demands placed on Saudi Arabia that it make any ambitious plans for cutting emissions. Such countries should contribute to the fight against climate change by diversifying their economies, and Saudi Arabia is already taking steps in this direction. In particular, the 2030 Vision, a plan of reforms, has been approved; the Vision entails increasing the returns from competitive advantages not linked to natural resources, such as the country’s leading positions in the Islamic world, good opportunities to attract foreign investments, and an advantageous location for creating a global hub.

Consequences for the oil and gas industries

The Paris Agreement presupposes that the countries will transition to a low-carbon development, which is a challenge for fossil fuel producers. Firstly, the use of this fuel will inevitably become more efficient, which will curb the demand. Secondly, the competition between various energy sources will take place under altered conditions: particular emphasis will be placed on the greenest ones, i.e. renewable energy sources, partially on nuclear energy, and, to a lesser degree, on natural gas.

Natural gas gets an excellent chance to gain an increase in demand by replacing coal, particularly in those countries where the latter forms the basis of the electric power industry (for instance, in China).

Since the dynamics of the oil demand is shaped primarily by the use of oil in transportation, not in the energy sector, the first factor will be of greater significance for the oil market. Due to both tightened standards for automobile fuel and public transit system development, the oil demand in developed countries has come to a virtual halt. Thus, the International Energy Agency predicts that the OECD’s demand for oil will stabilize in the nearest future at the level of 46.4–46.5 million barrels per day (with 46.2 million barrels per day in 2014). In developing countries where the number of cars is still increasing, the demand for oil is still growing, too. The Chatham House experts see new technological solutions, such as electric cars, as the key factor of the oil market development in the nearest future. However, it is still unclear when these solutions will be massively introduced into everyday life on a large scale.

The situation with the natural gas is more complicated. Coal, its principal competitor in electric power industry, is having serious problems. Many companies abandon investments tied to coal. Under such circumstances, natural gas gets an excellent chance to gain an increase in demand by replacing coal, particularly in those countries where the latter forms the basis of the electric power industry (for instance, in China). The authors, however, do not agree with the predictions of the coming “golden age” for natural gas, at least long term. Their key claim is that the demand for gas will be shaped “residually,” depending on the possibilities any given country has to abandon coal on the one hand and to develop renewable energy sources (and nuclear power) on the other.

Unlike several works which proceed from the goals of decreasing emissions (and form suggestions concerning the changes in the structure of the countries’ energy balances based on the 2°С goal), the report in question bases all its predictions on nationally determined contributions, and not on general declarations. Such an approach is definitely more realistic, and still, the true reality will be somewhere between the two versions. In particular, the measures envisioned in the nationally determined contributions will be augmented by mechanisms developed through international cooperation. Thus, on October 6, members of the International Civil Aviation Organization signed ambitious goals for cutting airplane emissions. On October, 15 197 countries decided to proceed with reducing chlorofluorocarbon that are used to produce refrigerators and aerosols with high capacity. Cutting fuel subsidies will also be coordinated since, despite all efforts expended by G20, these subsidies still amount to nearly 5.3 trillion dollars (6.5 % of the global GDP). Rules will be possibly developed limiting the financing international organizations provide for fuel projects, and the issues of climate financing (about 100 billion dollars annually since 2020) will be tied to the energy policy of countries applying for that financing. It is possible that some international agreements putting a price on carbon, for instance, at the level of individual sectors, will be worked out, too. Even if successes are achieved only in some of these areas, the world will still proceed along the path of the low-carbon development quicker than nationally determined contributions give us grounds to believe.

Russia’s place in the new climate order

The world’s largest economies have already ratified the agreement signed in Paris, while Russia is in no hurry to follow suit.

In the entire report, Russia is mentioned only twice: in connection with exporting gas to Europe and China. On the one hand, it is odd; being the largest exporter of energy sources, Russia holds the fourth place in the world in the volume of emissions, ahead of Japan and Saudi Arabia. On the other hand, it reflects the fact that in the new climate order, Russia follows the leader and does not lead.

Still, if the authors of the report, who mainly focus on nationally determined contributions, had decided to consider Russia in detail, they would’ve had a hard time. Russia set the contribution for 2030 at 70–75 % from the 1990 emissions volume “given the forests’ maximum absorption capacity.” With the kindest interpretation of the forest-relation formulation, that goal implies a growth of emissions compared to the current level (which is at least 31 % below the 1990 level, primarily due to the transitional crisis of the 1990s). Russia will be hard put not to fulfill its program, especially given its current economic growth dynamics. Thus this figure is but a formality which imposes no real obligations on Russia.

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Other countries fail to understand such a passive position, and it also causes concern among Russian experts. This concern becomes particularly acute since the world’s largest economies have already ratified the agreement signed in Paris, while Russia is in no hurry to follow suit. Moreover, the domestic discussion of the consequences of ratifying the agreement is more and more dominated by skeptics. Russia views this document as a series of obligations which do not really exist since the nationally determined contribution is so small. At the same time, the document’s principal significance is being ignored: it is signed by 180 countries, and as such, it records the consensus concerning low-carbon development trends, making them essentially inevitable. In this connection, failure to ratify will have far more destructive consequences. Failure to ratify will essentially mean that Russia does not intend to join the trend of de-carbonizing the global economy, the trend that the Paris conference outlined.

Russia should not be wasting its efforts on denying the obvious future, it should start adapting to it. In particular, it should start looking for new niches on the gas market while striving to make its deliveries more flexible; it should attempt to use its own hydropower, particularly in Siberia and in the Far East, where green hydropower could become one of Russia’s crucial competitive advantages in the future. Yet the most important thing is to think about diversifying Russia’s economy and increasing its energy efficiency. Only then will Russia be able to find its place in the low-carbon world, and in their next report, the British researchers will be unable to pass Russia over.

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