21.11.22 Review

A Shot in Both Legs: war and sanctions deprive the Russian economy of the opportunity to adapt to the energy transition, China will take advantage of Russia

As a result of the invasion of Ukraine and the ensuing sanctions, Russia will lose its competitive niches in the supply of traditional energy products and new types of energy, hydrogen in particular. Previously, it was assumed that Russia would be able to take up to 20% of the world market for its production, maintaining the status of a major energy power through this and other efforts. Lack of access to modern technology will complicate and slow down the energy transition making it impossible, and Russia's place in cleaner energy production will be taken by China, the experts of the American analytical center GMF believe. An earlier report by the International Energy Agency suggested that an energy crisis triggered by Russia would, on the contrary, accelerate the energy transition, leading to a faster decline in Russian revenues from trade in traditional fuel commodities. However, according to both scenarios, Russia will miss the chance to adapt to the energy transition and maximize the economic shock associated with it.

The energy transition was a challenge for Russia anyway, with its economic well-being based on the oil and gas trade. However, its protracted nature was conducive to adaptation: Russia could continue to earn significant revenues from trade in traditional energy commodities and invest them in adapting to the new conditions. In particular, Russia's main competitive advantage — enormous reserves of natural gas — would allow it to claim a significant share of the hydrogen market. However, war and sanctions, on the one hand, will accelerate the decline of Russia's fossil fuel revenues and, on the other hand, deprive it of the opportunity to use its competitive advantages to develop cleaner energy.

Experts from the United States analytical center GMF argue that in the near future hydrogen should become the basis of a new green economy. In terms of ecology, hydrogen is divided into four types: green is the hydrogen produced without any carbon dioxide emissions, gray and blue are the hydrogen produced with minimal emissions (the first is produced from natural gas, the second — from methane) and orange is the hydrogen produced with nuclear energy (no carbon dioxide emissions but nuclear waste remains after its production). At the moment half of all hydrogen produced is gray, which means it is made from natural gas, and green hydrogen remains the most expensive because of the underdeveloped technology and small production volumes. Only green hydrogen is supposed to be used in the future, but a transition period implies the use of gray, blue, and orange hydrogen types. 

In 2021 Moscow set a goal of capturing 20% of the global hydrogen market by 2030. Before the war, Russia had a high competitive advantage in creating large-scale and cheap production of green, orange, blue, and especially gray hydrogen due to geographical, infrastructural, and economic factors. Russia ranks first in the world (almost 25%) in reserves of natural gas and methane, which are essential for producing hydrogen with minimal CO2 emissions. The developed nuclear power sector allows to establish the production of orange hydrogen in Russia, and the vast territory makes it possible to find geographically suitable locations for the construction of green hydrogen plants. 

However, to develop the hydrogen industry, the Kremlin needs modern Western technology and investment.

For example, Russia still needs to develop technologies for water electrolysis, the construction of wind turbines, and the installation of solar panels, required for green hydrogen production. The investment needed to implement these projects is more than $20 billion. Before the invasion of Ukraine, Western partners were supposed to share technology and partially finance these projects, but sanctions have made this cooperation impossible. Such projects require preliminary agreements with future buyers. In 2021, the EU, Japan, and South Korea were seen as the main markets for Russian hydrogen, but the energy war against Europe has destroyed Moscow's reputation as a reliable energy supplier. 

The war has also destroyed another competitive advantage of Russia. From a technological point of view, it was relatively easy to retrofit Russian gas pipelines for hydrogen transportation, which could have significantly reduced the cost of Russian hydrogen to the end consumer in Europe. However, now the gas pipelines were blown up, the probability that Russia would be able to implement these projects without Western technology and investment is very low.

GMF experts warn that the lack of possibility to develop hydrogen energy in Russia due to the current geopolitical situation creates two new challenges for the world economy. First is the slowdown of the energy transition in Europe and in the world. The absence of cheap Russian gas and hydrogen on the world markets will make the development of hydrogen technologies more expensive and less attractive. The development of a green economy without Russia will require more time and resources. Second, it will increase the role of China, which is actively investing in hydrogen energy development and can become the main producer of the new type of fuel in the world (while receiving cheap gas from Russia, among other things). GMF experts believe that the EU and the United States should work together to develop joint hydrogen production to reduce their dependence on authoritarian Beijing.

The authors of the International Energy Agency's (IEA) October report, on the contrary, believe that the global energy crisis triggered by Russia will accelerate the energy transition, as high prices for traditional fuels will encourage investments in green technologies.