Energy Transition and Sustainability Challenges For The Russian Downstream Sector

According to IPCC analysis, mankind has 10 years to change the dynamics of anthropogenic climate change before they become irreversible. According to certain calculations, Russia accounts for 5% of global GHG emissions. This is why it is important for Russia to develop realistic plans to reduce carbon emissions in the Downstream Sector.

In addition to the social context, it is necessary to take into account the influence of external economic factors: Russian exporters "supply" to EU countries a part of their own direct and indirect emissions. The introduced border carbon tax (BCT) will affect exports from Russia, and companies will need to reduce carbon intensity of products in order to maintain competitiveness.

Looking at the prospects of "traditional" refining and petrochemicals, the development of synthetic fuels from fossil fuels will depend on both the price of conventional fuels, and the development of alternative energy. Despite the plans of international industry leaders to achieve NetZero (zero emissions) by 2050, few have decided to completely abandon the use of non-renewable energy sources.

In 2020, development programs of international companies were revised, but fast-forward a year and a number of large-scale projects are expected to be reinstated. Diversification towards more oil and gas chemical products (from basic olefins to fertilizers and specialty chemicals) allows companies to expand product line with a smaller carbon footprint and higher added value.

Key Elements for Sustainable Development include Technology, Government Support, Investment, People, Culture, and Partners. Global companies are all at different stages in their transitions – recent IEA publications and corporate reports show 3 main approaches:

1. Decarbonization of Oil & Gas operations
2. Reconversion into chemical & alternative assets
3. Transformation into an energy company

In Russia, most major companies seem to be looking primarily at option 1 - this seems logical taking into account the access to natural reserves and comparatively low utility costs for many of them.

Improving Energy Efficiency

When talking about decarbonization strategies, most companies list energy efficiency as being centre to their plans. When looking at Russia, we see that domestic oil refining and petrochemical production is more energy intensive than their foreign counterparts and this indicates a great potential for reduction of energy requirements and hence reduction in emissions just by improving energy efficiency in such facilities.

It is important to create a more energy efficient business and implement sustainable energy practices and develop green energy resources as this will not only lead to savings but also increase the market value of the Companies business.

Investing in energy efficiency demonstrates that the Company about the environment projects a responsible image to business partners. Energy efficiency, sustainability and clean energy are important metrics around the world, and this will impact the market valuation of the Company. Examples of energy efficiency methods and energy saving approaches include:

• Improved heat recovery systems from flue gases and process streams
• Replace of older inefficient equipment such as heaters and heat exchangers

Hydrogen

Hydrogen is another sector that has been promoted as a good example of a prospective sustainability area. However there remains a certain degree of uncertainty, notably regarding:

• Hydrogen and hydrogen technology market volume
• Volumes & geography of cross-border hydrogen trade, which will determine the global, regional or local nature of the market
• Requirements for marketable hydrogen in terms of carbon footprint and guarantee of origin
• Requirements for the form of storage and transportation of commercial hydrogen

Although many challenges still remain regarding the market, transportation, cost etc., major Russian companies have announced plans to develop green and blue hydrogen production. At a state level, a Hydrogen strategy – first revision – was published in Russia (summer 2021). The target in the energy strategy is the production of 2 million tons of hydrogen in 2035 (world demand in 2019 was about 80 million tons).

Global demand for hydrogen is set to rise to reach 350 million tons by 2050 (Rystad). Of which the annual demand of importing countries to buy hydrogen from abroad is estimated at 25 million tons by 2040, which defines a potential market of $80 - 90 billion.

Chemicals and Petrochemicals

Looking at the Global chemical market – this is estimated to double by 2030 from 2016 figures and will exceed €6.3 trillion. This will open up huge opportunities for producing countries, with China alone accounting for 44% of global share, Europe and North America about 15% each.

Key factors for oil, gas and chemical companies worldwide when considering Investment projects include prices for raw materials for oil and gas processing, the cost of logistics of finished products, as well as specific capital costs for the construction of new and expansion of existing production facilities. One of the most important factors affecting profitability is production cost. Observed market trends:

• Consolidation of production capacities (+40% to >2 bln tpa by 2027)
• Relocation of large-scale production facilities to regions with cheaper & available raw materials
• Flexible logistics and/or dynamically growing demand
• Active role of the government in the development of the industry in new oil and gas chemical centers

There are certain ‘identified’ challenges:

• Lower 2020 investments  suspension of projects
• Commodity price volatility especially for Natural gas
• Change in priorities (methanol prices have been falling all last year)
• Difficulties with delivery and storage
• Surplus volumes of basic olefins on the market
• Green product & recycling requirements

But also a number of opportunities:

• Companies still see O&G chemistry as a promising area
• Product mix expands - R&D stimulates new materials - Demand for products is sustained
• Stable product margins as opposed to upstream and refining
• Improving the efficiency of processes
• Emerging growth markets
• Potential Mergers to strengthen market position

In January 2021, the Russian Prime Minister announced the strategic importance of speeding up the development of the country's petrochemical industry, including in terms of production and exports.In regions such as the Middle East or Russia, there are processes of consolidation and integration, mergers and acquisitions. In Russia, successful development will require solving structural problems - to eliminate the shortage of monomer production capacity (first of all pyrolysis). On the one hand, Russia has a surplus of petrochemical raw materials, which will keep growing till 2030. On the other hand, there is a potential for a significant increase in demand for petrochemical products, the feedstock for which is the pyrolysis process. It is believed that Russia has good prospects with regards to producing petrochemical products on a large scale - plastics, rubbers, organic synthesis products - both by increasing domestic consumption by reaching the global average level and import substitution, and by expanding export potential to the key regions, Europe and China.

By the end of the forecast period, consumption of light products for chemical needs will increase nearly fourfold compared to current levels, and the share of processed raw materials will increase to 55% of its production against 28% in 2010. According to the Ministry of Industry and Trade, one-third of the volume of manufactured chemical and petrochemical products is exported. Until 2019, the volume of exports increased rapidly - up to 21 billion dollars, last year it decreased by 17%.

The chemical sector accounts for 4% of GDP. By the end of 2020, the industry has shown cumulative production growth of about 5%, in monetary terms this corresponds roughly to the volume of products sold by the largest international chemical company BASF - about $60 billion

The Russian Government has drawn up a roadmap for the development of the chemical industry to boost polymer production by 2025. Experts consider the numbers to be quite realistic and sufficient in terms of mechanisms of state support for domestic enterprises. The corresponding decree of the government says that 8 largest potential petrochemical projects can provide commissioning of over 8 million tons of capacities for polyethylene and propylene production, with export potential of over $5 billion a year and the aggregate revenue potential of over $10 billion a year.

In 2020, petrochemical companies went through a difficult period, particularly in methanol production, due to price fluctuations affecting business activity and forcing the suspension of a number of projects. At the same time, fertilizer producers were "on the crest of the wave" during the surge in prices for urea etc. and were the only sector to show profitability during the crisis year.

However, at present, given the surge in natural gas prices and the shortage of gas before the heating season, the prospects for production and even more so for construction of new ammonia (including green ammonia) facilities do not seem as attractive as they did a year ago. This market shift is expected to have a negative long-term impact on all gas processing and chemical assets, yet gas monetization issues remain one of the most pressing in Russia.

Russian oil and gas companies need to reassess future development strategies in this changing environment. We are now seeing a greater focus on renewable energy and sustainable solutions for petrochemicals. They also need to consider this issue if they want to maintain access to export markets. The sustainability movement has become increasingly significant and widespread in recent years. Last year it reached new levels: according to BNEF, the value of global ESG assets reached over $137 trillion, showing a 24% growth and setting a record.

Companies face many challenges to implement sustainability goals: an ambiguous understanding of the business value of sustainability; certain lack of defined competencies; and a lack of data and uniform approach to collecting it to measure sustainability and track progress. To overcome these and other challenges, most companies have taken a systems approach and created a separate organizational unit to implement and manage sustainability.

Companies that have progressed along this path note several major visible effects:

• motivation of employees increases;
• shareholders & stakeholders begin to evaluate business performance higher;
• company becomes more attractive to customers & partners - all of which can ultimately be measured in monetary terms.

Indeed, some companies are already noticing the impact of sustainability on profitability, but have difficulty measuring it. On the other hand, the question that still haunts some people on both the corporate and customer sides is whether the costs of developing clean energy will become a burden on investors or consumers, by increasing the cost of final products or taxes?

It is important to understand that each company has a different starting point when assessing sustainability goals. Some are simply looking for an answer as to why sustainability is necessary for business, while others have long prioritized their ESG program and have begun to integrate it into all business processes.

That's why an open discussion, where success stories and challenges can be shared and others can help advise, is so important for building a proactive business environment.
We discussed with our partners what they consider to be their current priority areas for achieving the Clean Zero goals by 2050, and most responded accordingly: CO2 reduction, employee development and social well-being, safety and reliability, waste reduction and recycling, energy efficiency/renewable energy, reducing negative impacts on water and land, creating a sustainable supply chain, gender equality, moving towards a circular economy.

Another trend worth mentioning is the use of digital tools and technologies to move more quickly and efficiently towards sustainable development. So-called 'hybrid' (process + digital) projects are expected to dominate the portfolio over the next 10 years.

The energy transition and sustainability will dominate the discussion for years to come and each region, Russia included, will need to decide what this means for the downstream industry. The world has an appetite for energy and the downstream sector will continue to play a leading role in the energy mix.