Emissions Trading Systems: Trajectories for Development – Modern Diplomacy

emissions-trading-systems:-trajectories-for-development-–-modern-diplomacy

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Since the autumn of 2020, the “Navalny Factor” has dominated the public and political discourse on Russia-EU relations. This factor fitted snugly into Brussels’ system of values that defines Europe’s principal approaches to its largest partner in the post-Soviet space. The nadir in the political dialogue was reached in October 2020, with the European Union adopting anti-Russian chemical cyber sanctions; November–December saw a period of somewhat smoothing out the particularly sharp angles. Yet, this was followed by Alexey Navalny’s return to Moscow from Berlin in January 2021, his subsequent arrest and several court sentences passed on him, as well as what Brussels deems a largely failed Moscow visit of Josep Borrell, High Representative of the Union for Foreign Affairs and Security Policy. All this doomed Russia–EU relations to an even deeper low. In early March 2021, the “insulted and injured” EU Ministers of Foreign Affairs spearheaded the adoption of new restrictive measures in the Council of the European Union as part of the Framework of Global Human Rights Sanctions Regime instituted on December 7, 2020. In addition, Charles Michel, President of the European Council, announced an upcoming revision of the EU’s strategic approach to Russia.

Frozen dialogues

The pressing political crisis backgrounded economic relations that had traditionally formed one of the key foundations of Europe–Russia relations. Nord Stream 2 was an exception, as many in the European establishment are attempting to turn this commercial project into an instrument for putting political pressure on the Kremlin.

Seven years ago, in the spring of 2014, Brussels one-sidedly froze the principal mechanisms of its economic and political collaboration with Russia, including bilateral summits, a number of sectoral/industrial dialogues, and inter-governmental consultations between EU member states and Russia. Additionally, stiff sectoral sanctions were imposed on several leading Russian financial and industrial entities. The well-known Mogherini guiding principles adopted in March 2016 became, in Andrey Kortunov’s opinion, something of the lowest common denominator for the diverse standings of EU members, as these principles enshrined a compromise between hard- and soft-liners in managing relations with Russia. The main economic issues were hidden behind the concepts of “selective engagement” and “bolstering internal stability”. In the summer of the same year, Sergey Lavrov proposed auditing the relations with a view to finding which connections would allow to restore constructive cooperation. Five years later, this proposal still elicits no response from his European colleagues. Ultimately, Russia’s Ministry for Foreign Affairs began to describe the European Union as an “unreliable partner” that bases its approaches to Russia on its short-term interests. Apparently, this applies to the economic area as well, including the Eurasian Economic Union track.

Bilateral cooperation

Over recent years, economic cooperation has mostly shifted to Russia working with individual EU states, primarily those forming the backbone of its economic potential: Germany, the Netherlands, Italy and France. These four countries [1] account for over half the mutual foreign trade that, together with investments, constitute the foreign economic framework of Russia–EU relations. Despite exports and imports significantly dropping from USD 262 bn in 2019 to USD 192 bn in 2020, the EU remains Russia’s leading partner, ahead of China. Its 27 states (without the UK) now account for 37% of Russia’s trade turnover (42.5% in 2019, over 50% in 2013), while China accounts for 20% (18% in 2019, about 11% in 2013). The commodity composition has not changed much since 2014: in exchange for primary and secondary energy sources, Russia receives machinery and equipment. The restrictive measures did have a negative impact on mutual trade but it was rather limited. Actors from other states, particularly from Southeast Asia, are successfully moving into the sanctions-affected segments. Russia’s sluggish economic and political reforms remain a traditionally negative factor. Russia never accumulated a critical mass of competitive small- and medium-sized businesses. In addition to red tape and corruption, European business complains of protectionism and of the Russian authorities demanding product localization and import substitution. 2020 saw added complaints that anti-COVID lockdown restrictions hindered cross-border travel for highly skilled professionals.

Transport and logistics offer good prospects for joint activities. In 2020, despite the pandemic and despite disruptions in global supply chains in the spring, European and Russian companies managed to expand their co-operation‒primarily in providing rail and truck container shipping. Russia’s objective advantages as an overland transit space between China and Europe lay the foundations for a long-term cooperation within China’s Belt and Road Initiative. Cooperation in using transport routes via the Arctic Ocean shows promise as well.

As the number of European economic entities in Russia’s economy shrinks [2] during the 2020 pandemic in particular, EU companies have continued to invest directly in Russia. The number of Russian investors in EU states is also gradually rising. Unfortunately, there is no reliable data broken down by their quantitative, cost, sectoral and regional structure. Recent high-profile deals include founding the Wintershall Dea energy concern in Germany, 33% of which is owned by a Russian partner. Total accumulated FDI of EU companies in Russia is about three times Russia’s investment in Europe.

Being a commercial project, Nord Stream 2 remains the most significant stumbling block in Euro-Atlantic and intra-EU relations alike. Even though most EU politicians and experts recognize the project’s importance for European energy security and sovereignty, hardliners support the American extra-territorial sanctions and continue to insist that the project be shut down [3].The key context is grounded in the need to continue transit shipping of the bulk of Russian gas via Ukraine as a guarantee of the latter’s treasury continuing to receive foreign currency payments from Gazprom and of its gas pipeline system’s modernization. The arguments used here focus on the need to maintain European solidarity and counter “the Kremlin’s gas aggression and uncontrolled expansion.”

The energy track shows a particular need for resuming full-fledged Russia–EU relations. As of today, the Gas Advisory Council (GAC) is represented by expert Work Stream 2, “Internal markets”, co-chaired by Andrey Konoplyanik for Russia and Wim Groenendijk for the EU (established in 2011 to reduce infrastructural and regulatory risks in bilateral gas relations). Two other GAC work streams (“Long-Term Gas Scenarios” and “Outlooks and Developing Gas Transportation Infrastructure”) have virtually stopped working. At the same time, trilateral Russia–EU–Ukraine talks on Russian gas deliveries and transit via the Ukrainian gas pipeline system were launched in May 2014. In 2019, the participants reached a new five-year transit agreement.

“Green” challenges and economic cooperation opportunities

In December 2019, the EU adopted the European Green Deal, a strategy determining the parameters for transitioning to a new energy paradigm by 2050. This paradigm will largely inform the way the EU will interact with Russia in the coming decades. In 2020, the European Commission adopted additional documents setting forth specific directions of the new course in industrial policies and digital transformation, in hydrogen energy, critically important raw materials, energy-efficient construction and building modernization, the closed-cycle economy, agriculture and forestry, and biodiversity. The particulars are still being actively discussed in the European political and expert communities. In 2021–2022, a new legal framework will be adopted and requisite mechanisms launched on the basis of these discussions.

All the areas announced in the New Green Deal open new avenues for European and Russian economic entities in implementing various cooperation projects. Hydrogen energy in all its aspects appears to be the most intelligible area in terms of possible co-operation. These aspects include manufacturing, storing, transporting and using environmentally-friendly hydrogen, which, in Russia’s view, includes not only green but also blue, turquoise and yellow Н2. Last summer, the Eastern Committee of the German Economy (ECGE) and the Russian-German Foreign Trade Chamber (RGFTC) protested against Russia not having been mentioned in the German and European hydrogen strategies. These actions triggered movement and, by the autumn of 2020, a discussion had been launched on a series of bilateral entrepreneurial projects. Germany’s Federal Ministry for Economic Affairs and Energy and Russia’s Ministries of Energy and of Industry and Trade launched informal contacts in the area. Despite operational difficulties in using Н2 and hydrogen technologies, the Russian-German initiative has good prospects for promoting joint projects on the EU market, including the European Clean Hydrogen Alliance [4] In addition to big reserves of methane and fresh water, besides major surplus capacities of low-carbon hydropower plants and nuclear power plants generating cheap energy, coupled with the significant potential of renewable energy sources and unique Russian know-how (such as research conducted by the Technological Hydrogen Valley consortium established in November 2020), European stakeholders are interested in using Gazprom’s existing pipeline and storage infrastructure as well as in deliveries of various equipment, including that for hydrogen electrolysis and pyrolysis. In mid-February 2021, Denis Manturov, Russia’s Minister for Industry and Trade, speaking at a conference on Russia-Germany strategic cooperation, announced the intention to put hydrogen technologies on the list of priorities for second-generation special investment contracts.

Russia is extremely wary (adopts a de-facto negative stance) of the “carbon border adjustment mechanism” that entails imposing a tax on the “carbon footprint” of imported goods as part of the energy transition, which could result in multi-billion losses for Russian exporters of oil, gas, coal, steel and several other “carbon-intensive goods.” Moscow still has a chance to stand up for its interests, though the window for action is very small. It might be expedient to establish specialized expert groups on the issue, both in Russia and at the level of international multilateral dialogue, including by submitting the results of the discussion to the relevant UN agencies, including UNIDO and UNCTAD.

Let us note as an aside that the European Union is continuing to collaborate with Russia on a series of initiatives as part of long-term partnerships in climate and the environment: these are cross-border cooperation, the Northern Dimension programs, and partnerships for implementing the Paris Accords. Specific projects, including those in waste disposal and processing, wastewater treatment, increasing energy efficiency, entail equipment deliveries from the EU, which creates the prerequisites for cooperation in these areas. Bilateral initiatives implemented by Germany’s Federal Ministry for the Environment, Nature Conservation and Nuclear Safety and Russia’s Ministry for Natural Resources and the Environment also hold a special place in this process. These projects are, for instance, “Climate-neutral economic activities: introducing best available technologies (BAT) in the Russian Federation”, “Climate-neutral waste management” and “Peat bog restoration in Russia with a view to preventing fires and mitigating climate change”. In 2019, the parties agreed to resume the activities of the Russian-German Coordination Council on Environmental Protection. The German-Russian Agricultural and Political Dialogue has never ceased its activities; among other things, it works on forestry-related interactions.

Prospects

Another positive note is that Russian academic bodies can continue their collaboration with their EU partners under the 9th EU research and innovation framework program Horizon Europe, which runs until 2027. Some of the results obtained (such as in medicine, IT, digital, hydrogen and other technologies) might ultimately be put to commercial use. This applies fully to bilateral cooperation as well, for instance, cooperation with Germany: in late 2018, implementation was launched of a ten-year roadmap for academic and educational partnership.

Despite the evidently crying need to resume sectoral dialogues between Russia and the EU, this is unlikely to happen in the near future. The principal reason for this is a deep value-based conflict and a lack of progress in implementing the Minsk Agreements, which makes it impossible to put on the agenda the issue of lifting or at least mitigating the many restrictive measures introduced by the EU. In the near future, economic interaction will still be based on market entrepreneurial cooperation that partly relies on government and regional support instruments as well as on bilateral inter-agency mechanisms (such as the Russian-French Council for Economic, Financial, Industrial, and Trade Matters (CCIFR) and the Russian-German High-Level Working Group on Strategic Cooperation in Economy and Finance (JWG)).

An important role is played by interest groups; the above-mentioned Germany ECGE and RGFTC are traditionally seen as the most advanced of these. In addition to their own existing lobbying mechanisms, which have acquitted themselves well, in December 2020 these groups spearheaded the establishment of a German-Russian Economic Council. The French-Russian Chamber of Commerce and Industry, the Economic Council of French and Russian Enterprises, and the Russia-France Business Cooperation Council represent the interests of French companies, while Italian businesses are represented by the Italian-Russian Chamber of Commerce, with the European Business Association [5] standing for European businesses.

Russian business operating in the EU is essentially disorganized and can only count on the Russian state for support. We are mostly talking about Trade Missions, which were transferred in 2018 from the purview of the Ministry for Economic Development to that of the Ministry of Industry and Trade. Currently, the difficult process of reforming them is under way, and it will show whether they will be able to fit into the system that supports market interests of Russian businesses‒small- and medium-sized in particular‒on international markets, including those of Europe. We believe the activities of the Trade Mission in Berlin deserve special attention. On 6 May, it will celebrate its centennial. It has been active in introducing new instruments for co-operation with Russian economic actors. Internationally-based bodies of the Russian Export Centre are only now finding their way around European countries and seeking their niche in this area.

The current level of Russia’s bilateral interaction with EU states could advance preservation of their present potential and help achieve progress in some cooperation niches, including the European Green Deal. Russia’s negative image in the European media remains a powerful hindrance. This image is being formed, among other things, by the decisions of the European Council, including prolongation of existing sanctions and imposition of new ones. This picture makes small- and medium-sized businesses more wary of possible business ties with Russia and indefinitely postpones their willingness to establish contacts. Joint state formats, such as the Russian-French Cross Year of Regional Cooperation (2021), the Year of Germany in Russia (2020–2021) and the Russian-German Cross Year of Economy and Sustainable Development (2020–2022) are intended for countering these negative trends.

No breakthrough in Russia’s economic and political cooperation with EU states should be expected in 2021–2022. Co-operation dynamics will be informed by the EU’s successes in combating the coronavirus pandemic and by possible positive signals from the Russian regions to European and Russian business concerning planned steps for improving the framework state of the economy. As of the early spring of 2021, European entrepreneurs were mostly pessimistic. For instance, while the German business community positively assessed the prospects for their economic cooperation with China, the US and the Eurozone (a poll conducted by the German Chamber of Commerce and Industry (DIHT)) (with figures of +15, +11 and +6 points for bottom line expectations), the prospects for cooperation with Russia were mostly viewed negatively (-19 points). Unlike their parent companies, the top management of their Russian subsidiaries were more optimistic in late 2020 about the prospects for working in Russia (a poll conducted by the ECGE and the RGFTC). They particularly noted the importance of and the need for the EU to co-operate more closely with Russia on such matters on the bilateral agenda as industrial modernization and increased efficiency, waste processing and management, energy and climate, alignment of rules and standards. It is noteworthy that the respondents did not view such areas as space, mobility, and production of natural resources in 2021 as particularly significant.

In conclusion, I would like to refer to the opinion of Oliver Hermes, Head of the Eastern Committee of the German Economy, expressed at the 24th Potsdam Meetings in mid-November 2020 to the effect that only a powerful joint economic space stretching from Lisbon to Vladivostok would allow German and, consequently, European industry to pool the technological know-how and market potential of Western and Eastern Europe and Central Asia and become the leader in digital and green technologies in the future. He believes that specialized institutions need to be established right now to launch EU-EAEU talks on a single market. Yet, the signal sent to Brussels during Germany’s presidency of the Council of the European Union has so far fallen on deaf ears of the European Commission. Apparently, the time for a constructive response has not yet come.

From our partner RIAC

1. Germany is the backbone partner in Russia-EU relations who largely defines their qualitative and quantitative contents.

2 For instance, there were 4,274 legal entities with German capital in 2019, with 3,971 in 2020.

3 It appears that the EU failed in its attempts to introduce an effective mechanism for counteracting third countries’ extra-territorial sanctions by late 2020. See also Ivan Timofeev’s opinion.

4 Russian companies’ experience of interacting with the European Clean Hydrogen Alliance is interesting in terms of the participation by Russian actors in other similar alliances with the status of an “Important Project of Common European interest” (IPCEI)

5 The EU–Russia Industrialists Roundtable Association was established in 1997 and was active until 2014. It held its last events in 2015. Apparently, its participants are not interested in restoring this once-effective mechanism for discussing existing problems and possible solutions to them.

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