Going for gold: Russia’s cogen expansion initiative

Russia’s energy minister, Alexander Novak (right) at an EU/Russia Roadmap meeting for Energy Cooperation in March, 2013 Credit: European Union, 2014

Plans to reform Russia’s CHP sector could transform the investment market for the industry in this vast country, already known for its extensive district heating networks and CHP capacity. However, political, structural and economic challenges certainly remain to be overcome if the dream of a new era of much-needed modernization can be realized. will use the open market to rejuvenate and update the industry, according to the country’s energy minister. By Mark Rowe, Keith Nuthall and Nick Holdsworth.

Russia’s combined heat and power sector is poised to undergo a radical transformation that will use the open market to rejuvenate and update the industry, according to the country’s energy minister.

Speaking to the upper house of the Russian parliament, the Federation Council, in November energy minister Alexander Novak announced that creating a competitive market for combined heat and power (CHP) was a key priority.

He wants to promote a new market-based ‘alternative boiler’ system ” to be established from 2016 to 2022 ” which would see new co-generation networks gain an enhanced foothold across Russia. The move, experts say, would address many of the shortcomings in Russia’s extensive, if creaking, CHP sector. The market-based system will generate investment to create new co-generation systems across the country, argued Novak, and will make far better use of CHP potential that is currently wasted, such as excess thermal energy from district heating (DH) systems and the heat emitted from the country’s substantial array of power stations and refineries.

Novak said the current state of the sector required a serious government review: “For our country, with its climate, heat systems have to be one of our main priorities,” explained the minister.

The problem is that Russian district heating systems are getting old and wearing out, he said, and more investment is needed, encouraging the installation of new cogeneration systems.

This would involve “creating a competitive environment for skilled and responsible investors,” with returns for CHP being made as profitable as alternative foci of investment.

A cogeneration plant in the Russian city of Vladimir, Vladimirskaya Oblast. Novak’s plan aims to see more such plants across Russia Credit: Alexxx Malev

A key change would be to offer more long-term contracts (of up to ten years) to supply heat and power services, “in order to create conditions for a guaranteed return on investment,” he said. And returns from heat services need to be sufficient to cover the costs of buying new boilers, added the minister, although he stressed consumers should not suffer from increases in prices.

The changing the regulation of CHP tariffs needed to change, he said, so that “more efficient market participants gain greater profits than less efficient operators”. He also said that changes to government heat supply regulations should dovetail with reforms to the electricity sector, especially as regards promoting innovation, to ensure the most effective cogeneration systems are installed.

“The transition in the coming years to the new market model will provide heating systems with an acutely needed influx of investment, transfer responsibility to qualified investors and the cogeneration industry to steadily increase the reliability and quality of heat supply,” Novak told parliamentarians. More details on exactly how the new system would work are anticipated in the coming year.

Strong starting base, but significant obstacles

Despite its ageing district heating (DH) systems, energy rich Russia comes from a relatively strong starting point. According to the International Energy Agency (IEA), Russia is just one of five countries that have successfully expanded the use of CHP to about 30 “50% of total power generation ” the others are Denmark, Finland, Latvia and the Netherlands. The country has a long tradition of heat supply to all sectors through DH networks linked to power plants. By 2030, the IEA estimates CHP could provide almost 45% of total electricity generation in Russia.

According to the agency, this latest move is part of a wider review of Russian energy policy and modernization which is looking into every sector ” with CHP very much at the heart of the process: “Russia’s electricity infrastructure largely relies on CHP,” says Marc-Antoine Eyl-Mazzega, IEA Russia programme manager.

Dr. Fiona Riddoch, managing director of industry association COGEN Europe, has also welcomed the development. “We clearly support the wider use of cogeneration in Russia,” she told Cogeneration & Onsite Power Production. “The country is one of the best potential markets for CHP, it has a culture and history and understanding of CHP.

“[This project] has a lot to offer Russia, which has historically had major inefficiencies in the energy system. The situation for co-generation ” like for the extensive district heating ” is that some of it is very old, dating back to the 1970s and even further than that. They have condensing plants that need to be upgraded. The equipment desperately needs to be replaced and that would allow a more customer-focused system to overcome some of the centralized approach.”

The IEA too is aware of the shortcomings that the reforms are intended to address. “The Russian electricity sector is split into two,” said Eyl-Mazzega. “The European part is an interconnected market, but there are places in Siberia that are not connected. A lot of the CHP plants are ageing and that’s a fundamental challenge. You need to modernize them, find funding for them or even better shut them down.”

Riddoch hopes that the moves will tackle some of the major obstacles that foreign CHP companies face in Russia. “Companies will be very glad to hear of the kind of market-oriented system the statement [by Novak] makes. There are still considerable barriers in Russia, largely to do with the uncertainties of doing business in Russia.

“These uncertainties can heighten the investment risk of a project. The main opportunity of developing a more robust market will be the introduction of a regulator who could give certainty to operators of CHP. Maybe what is being signalled from the Russian parliament is that they know what they need to do, and the good thing is they look ready to do it. The statement begins to look at the barriers to achieve that political ambition.”

A senior executive with a company that has dealt with CHP projects in Russia ” who did not wish to be named ” outlined the problems that the reforms may begin to address: “The problem lies with Gazprom, and the fact that gas supplies cannot be guaranteed. A project can be a long way down the track and then the gas does not run and the project is cancelled. It does seem to happen quite regularly. It’s not to do with corruption ” though that does exist ” but more to do with the centralized market and high level political interference. This all means the value of the customer and the contract are not seen as so important as the politics. From that point, these reforms are encouraging.”

However, an advisor to another company took a more pessimistic view. “If you need gas for a CHP project, you can only get it from Gazprom, or from its local subsidiary. You can all have all the market reforms you want, but if at the top of the chain Gazprom still monopolizes the supply, then it’s still in effect a state-controlled system.”

In practice, Eyl-Mazzega sees the reforms as tackling some of the fundamental state-controlled quirks and contradictions that underpin the present CHP system: “CHPs are often in large cities and the heat they produce has been under-priced,” he says. “They are mainly run for the electricity they supply, not the heat they produce. While Novak wants Russia to engage in entering the next phase of electricity market reform, before he takes that step he needs to get the heat reform right, and get rid of cross-subsidies. Russia understands it is a priority to increase the generation component of CHPs. On that basis, the decision by Novak is a sound one.”

Tariffs and pricing are other areas that the reforms will have to address, and these could be a tough nut to crack, according to Eyl-Mazzega. “All tariffs are regulated by a central tariffs service [who set a band of tariffs] – these are then negotiated locally. But private investors will need tariffs that enable you to recover your investment.

“Municipalities and politicians are reluctant to change tariffs because it upsets people and fuel inflation. [Russian President] Putin has already imposed a freeze on regulated tariffs for 2014 and said they cannot go higher than inflation in 2015 and 2016, so there is no room to increase the heat tariffs. That’s a key contradiction.”

The challenges will also involve tackling the disparate nature of CHP in Russia. “It’s a very large market, but it’s diverse,” says Eyl-Mazzega. “In large cities you have large CHPs run by a single company, such as Gazprom. But you also have smaller CHPs that require modernisation. In large industrial companies there will be an awareness of the need to invest, more so than in municipal authorities. The key is to make sure that what is proposed is implemented on a wide scale. The problem is that legislation sets out the framework, but you will need a lot of sub-legislation to make it work.”

System-wide approach to reform needed?

Experts also believe that a roll-out of a market-based approach to CHP needs to be accompanied by a wholesale review and rebuild of housing stock, with modernized capabilities. “They [the government] are aware of the high consumption of energy, and feel that even though internal resources are large they should not be wasted,” added Riddoch: “It’s a chicken and egg situation. The ideal would be to integrate everything because the housing stock requires addressing. The Holy Grail is supplying energy more efficiently and containing heat better ” but it’s not going to happen like that. It’s a piecemeal process. But if it is all upgraded it would be ideal and eventually upgrade to low-carbon fuels for CHP.”

Eyl-Mazzega agrees. “You have a lot of potential to run small CHPs on biomass and waste in smaller cities. That’s a totally untapped potential in Russia because everybody focuses on coal and gas. Very small-scale CHPS could be developed ” you could cut some districts off from district heating systems and put in a little CHP in the middle of 20 or 30 houses.”

A10-year, €52 million EBRD loan will finance the construction of a CHP plant in the Siberian city of Krasnoyarsk, improving energy efficiency and cutting pollution by 14% Credit: EBRD/Yevgeny Kondakov

The outdated nature of much of the housing stock will also make some of the benefits that a modern CHP system can bring difficult to achieve. “You’d want to install thermostats and meters,” said Eyl-Mazzega, but you just can’t install them in every old Soviet flat. So things need to be co-ordinated.

“We won’t see a heat market in Russia where you have competition between two district heating companies. You won’t have CHP, and another CHP company putting in a system 200 metres away.”

However, Mikhail Sapunov, a Moscow-based analyst with consultants AF, takes a cautious line towards the announcement. “One of the main problems is that the district heating is in many respects obsolete. It was built in the Soviet era and based on heat-only boilers.”

Sapunov does not doubt the potential for cogeneration in Russia, but believes it will face some major infrastructure challenges if it is to ever get off the ground and that equipment is already being locked into different methods of heat production. “Our own research suggests that CHP could produce 15 GW of electricity in Russia [a year], but you need the right equipment for that. All the power stations that have recently been built and are being built now do not have the technology fitted for CHP.”

The proposed CHP reforms are likely to appeal to outside investors, though given the shaky experience some have endured, it may take time for confidence to be rebuilt. “Russia will be happy with foreign investment. You need expertise and whether it is Russian or not doesn’t really matter,” said Eyl-Mazzega. “Whether these companies will feel comfortable enough to do that is another question. Maybe they will test it ” invest a little and then decide whether to go in a bit more.”

Nick Royal, regional sales manager for Russia for UK-based turbine supplier Centrax, certainly feels it will help companies such as his tap into the potential for CHP in Russia. Centrax has supplied gas turbine generator sets to the country for the past six years and Royal believes the Russian government’s aims are a positive development. “It’s all about taking steps to make it a more transparent environment. Suppliers who have more efficient parts should be rewarded financially, that’s welcome. If you can take out the random factor ” which is just a legacy of how things used to be ” things will become much more comfortable. It’s a step in the right direction, setting up an environment where the economics stack up and are attractive to investors.”

In conclusion, Eyl-Mazzega believes improvements through the CHP reforms will come, if incrementally. “It will take a couple of years. We may see quite strong progress once the new legislation tools are implemented. People will consume less but their bills will remain the same. Consumers will get greater leverage of supply, and quality of that supply. There will be an increase in heat meters in the medium term. The key strategic goal of the government is that modernization will take place without too much of an increase in tariffs. That means most development will take place in the oldest, most inefficient plants.”

The big bad wolf: Bureaucracy

In Russia, engineers and analysts have welcomed the new approach but there is widespread cynicism that anything much will change unless bureaucracy and red tape are also tackled to allow the development of environmentally efficient and cost effective district heating and power systems.

Alina Bakhareva, a renewable energy analyst at the Moscow office of international business and industry consultancy Frost & Sullivan, says support in principle for the plan is rooted on consensus that local power production is essential in a country as huge as Russia, where ageing infrastructure and vast electricity pylon networks mean much of the energy generated can be lost before it ever reaches the industrial or household consumer.

However, the lack of a “well-developed legal framework” and existing “administrative barriers” have been a major hindrance to progress in the past, she says: “Despite the fact that the need for the development of smaller power stations has been mentioned in government decrees and presidential orders since 2007, many of the legal and practical aspects of the issues remain unresolved.”

Indeed, Vitaly Polyakov, head of the Russian industry association Kogeneratsiya, observed that electricity consumers wishing set up small cogen plants under the existing system need “a detailed knowledge of the whole legislative framework.” Landowners, for instance those building country homes far from network power lines, technically have the right to have power brought to their door. But the system for acting on that right can be an exercise in futility, as Bakhareva explained: “Building your own power plants in such circumstances seems an endless fight with bureaucracy, many potential owners of small cogeneration plans often throw up their hands and continue to pay exorbitant prices for energy.”

Nonetheless, the fact that Novak has proposed a market-based system, with swift pay-backs for investors, is encouraging, she said: “Russia’s vast territory, depreciation of fixed assets in the power sector, difficulty in obtaining permission for a new connection to the network, should, it would seem, encourage private funders to invest in cogeneration, particularly since the payback period is just four to six years.”

Winning support at the Winter Olympics

Novak is only too aware that the current energy generating system, which relies on larger plants and larger infrastructure, is expensive and wasteful. The vast majority of Russian power stations ” 97% ” are bigger than 100 MW, there are more than 2.6 million km of power lines in Russia and electricity lnetwork losses is estimated to average 15″18%.

Igor Kozhukhovsky, deputy general director of the Russian Energy Forecasting Agency, who has presented studies on the potential of cogeneration to the Russian parliament’s energy committee, observes that large-scale projects tend to have “higher energy losses and higher prices.” There are fears, he said, that rising prices may soon see Russian consumers paying prices as punishing as those that dominate the winter headlines in Europe.

Bob Smith, a Moscow-based Canadian engineer with building contractor Saffron Projects says there are similar energy wastage problems with district heating systems: “Drive around any Russian city and look for two things: First, the amount of heating pipes that are above ground. These are mostly pipes replacing underground pipes that have failed. Second, in the spring and fall [autumn] it is easy to see where the underground pipes are located by the places where there is no snow. The heat loss from the poorly insulated pipes has kept the ground above freezing.

“Upgrading the plants that produce the hot water is only part of the problem, the system as a whole must be considered including the control and pumping methods.”

Looking ahead, it is noteworthy that Novak chose the Federation Council to flag up his new policy. It is a body made up of Kremlin-connected appointees and former parliamentarians that acts as a rubber stamp for law passed by the Duma, the lower house. Any change in the law to remove the bureaucratic barriers to ushering in a brave new world of energy conservation and flexible, localized generation, would need to be approved by parliament or ordered by presidential decree. So he is looking for his plan to be pushed through by political insiders at the highest level ” almost certainly with presidential support. And for that he will need to stay in Vladimir Putin’s good books over the forthcoming Winter Olympics, where the president will not want to see any power cuts in the Sochi region spoiling his global sports show.

Novak has certainly had to ensure that all 49 of the mostly newly built “large power facilities” in Sochi, would be functioning by the time the Olympic torch arrives on 7 February, as this edition goes to press.

At a recent meeting with Putin, Novak was warned by the president that: “There are still unresolved issues.” And Putin seemed to extoll the virtue of small stand-alone power plants in rather curt follow up comments: “You need to carry out not only the necessary works but also teach people to understand what to do and how. If the main sources for some reason suddenly go off, you need immediate automatic back up power.”

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