Tag: Market Structure

Navigating Market Exits: Companies’ Responses to the Russian Invasion of Ukraine

Posted on May 20, 2024 | Policy Brief

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Russia’s invasion of Ukraine on 24 February 2022 led to widespread international condemnation. As governments imposed sanctions on Russian businesses and individuals tied to the war, international companies doing business in Russia came under increasing pressure to withdraw from Russia voluntarily. In the first part of this policy brief, we show what kind of companies decided to leave the Russian market using data collected by the LeaveRussia project. In the second part, we focus on prominent Swedish businesses which announced a withdrawal from Russia, but whose products were later found available in the country by investigative journalists from Dagens Nyheter (DN). We collect the stock prices for these companies when available and show how investors respond to these news.

Business Withdrawal from Russia

The global economy is highly interconnected, and Russia forms an important part. Prior to the invasion, Russia ranked 13th in the world in terms of global goods exports value and 22nd in terms of imports (Schwarzenberg, 2023). In the months following the full-scale invasion of Ukraine, Russia’s imports dropped sharply (about 50 percent according to Sonnenfeld et al., 2022). Before February 24th, Russia’s main trading partners were China, the European Union (in particular, Germany and the Netherlands) and Belarus (as illustrated in Figure 1). While there is some evidence of Russia shifting away from Western countries and towards China following the annexation of Crimea in 2014 and the resulting sanctions, Western democracies still made up about 60 percent of Russia’s trade  in 2020 (Schwarzenberg, 2023). In the same year, Sweden’s exports to Russia accounted for 1.4 percent of Sweden’s total goods exports, of which 59 percent were in the machinery, transportation and telecommunications sectors. 1.3 percent of Swedish imports were from Russia (Stockholms Handelskammare, 2022).

Figure 1. Changes in trade with Russia, 2013-2020.

Source: IMF Direction of Trade Statistics, data until 2020. From Lehne (2022).

In response to Russia’s invasion of Ukraine in February 2024, Western governments imposed strict trade and financial sanctions on Russian businesses and individuals involved in the war (see S&P Global, 2024). These sanctions are designed to hamper Russia’s war effort by reducing its ability to fight and finance the war. The sanctions make it illegal for, e.g., European companies to sell certain products to Russia as well as to import select Russian goods (Council of the European Union, 2024). Even though sanctions do not cover all trade with Russia, many foreign businesses have been pressured to pull out of Russia in an act of solidarity. The decision by these businesses to leave is voluntary and could reflect their concerns over possible consumer backlash. It is not uncommon for consumers to put pressure on businesses in times of geopolitical conflict. For instance, Pandya and Venkatesan (2016) find that U.S. consumers were less likely to buy French-sounding products when the relationship between both countries deteriorated.

The LeaveRussia Project

The LeaveRussia project, from the Kyiv School of Economics Institute (KSE Institute), systematically tracks foreign companies’ responses to the Russian invasion. The database covers a selection of companies that have either made statements regarding their operations in Russia, and/or are a large global player (“major companies and world-famous brands”), and/or have been mentioned in relation to leaving/waiting/withdrawing from Russia in major media outlets such as Reuters, Bloomberg, Financial times etc. (LeaveRussia, 2024). As of April 5th, 2024, the list contains 3342 firms, the companies’ decision to leave, exit or remain in the Russian market, the date of their announced action, and company details such as revenue, industry etc. The following chart uses publicly available data from the LeaveRussia project to illustrate patterns in business withdrawals from Russia following the invasion of Ukraine.

Figure 2a shows the number of foreign companies in Russia in the LeaveRussia dataset by their country of headquarters. Figure 2b shows the share of these companies that have announced a withdrawal from Russia by April 2024, by their country of headquarters.

Figure 2a. Total number of companies by country.

Figure 2b. Share of withdrawals, by country.

Source: Authors’ compilation based on data from the LeaveRussia project and global administrative zone boundaries from Runfola et al. (2020).

Some countries (e.g. Canada, the US and the UK) that had a large presence in Russia prior to the war have also seen a large number of withdrawals following the invasion. Other European countries, however, have seen only a modest share of withdrawals (for instance, Italy, Austria, the Netherlands and Slovakia). Companies headquartered in countries that have not imposed any sanctions on Russia following the invasion, such as Belarus, China, India, Iran etc., show no signs of withdrawing from the Russian market. In fact, the share of companies considered by the KSE to be “digging in” (i.e., companies that either declared they’d remain in Russia or who did not announce a withdrawal or downscaling as of 31st of March 2024) is 75 percent for more than 25 countries, including not only the aforementioned, but also countries such as Argentina, Moldova, Serbia and Turkey.

Withdrawal Determinants

The decision for companies to exit the market may range from consumer pressure to act in solidarity with Ukraine, to companies’ perceived risk from operating on the Russian market (Kiesel and Kolaric, 2023). Out of the 3342 companies in the LeaveRussia project’s database, about 42 percent have, as of April 5th, 2024, exited or stated an intention to exit the Russian market. This number increases only slightly to 49 percent when considering only companies headquartered in democratic (an Economist Intelligence Unit Democracy Index score of 7 or higher) countries within the EU. Figure 3 shows the number of companies that announced their exit from the Russian market, by month. A clear majority of companies announce their withdrawal in the first 6 months following the invasion.

Figure 3. Number of foreign companies announcing an exit from the Russian market, 2022-2024.

Source: Authors’ compilation based on data from the LeaveRussia project.

Similarly to the location of companies’ headquarters, the decision to exit the Russian market varies by industry. Figure 4 a depicts the top 15 industries with the highest share of announced withdrawals from the Russian market among industries with at least 10 companies. Most companies with high levels of withdrawals are found in consumer-sensitive industries such as the entertainment sector, tourism and hospitality, advertising etc.

Figure 4a. Top 15 industries in terms of withdrawal shares.

Figure 4b. Bottom 15 industries in terms of withdrawal shares.

Source: Authors’ compilation based on data from the LeaveRussia project.

In contrast, Figure 4b details the industries with the lowest share of companies opting to withdraw from the Russian market. Only around 10 percent of firms in the “Defense” and “Marine Transportation” industries chose to withdraw. Two-thirds of firms within the “Energy, oil and gas” and “Metals and Mining” sectors have chosen to remain in business in Russia following the war in Ukraine.

Several sectors have been identified as crucial in supplying the Russian military with necessary components to sustain their military aggression against Ukraine, mainly electronics, communications, automotives and related categories. We find that many of these sectors are among those with the lowest share of companies withdrawing from Russia. Companies for which Russia constitute a large market share have more to lose from exiting than others. Another reason for not exiting the market relates to the current legal hurdles of corporate withdrawal from Russia (Doherty, 2023). Others may simply not have made public announcements or operate within an industry dominated by smaller companies that are not on the radar of the LeaveRussia project. Nonetheless, Bilousova et al. (2024) detail that products from companies within the sanction’s coalition continue to be found in Russian military equipment destroyed in Ukraine. This is due to insufficient due diligence by companies as well as loopholes in the sanctions regime such as re-exporting via neighboring countries, tampering with declaration forms or challenges in jurisdictional enforcement due to lengthy supply chains, among others. (Olofsgård and Smitt Meyer, 2023).

And Those Who Didn’t Leave After All

The data from the LeaveRussia project details if and when foreign businesses announce that they will leave Russia. However, products from companies that have announced a departure from the Russian market continue to be found in the country, including in military components (Bilousova, 2024). In autumn 2023, investigative journalists from the Swedish newspaper Dagens Nyheter exposed 14 Swedish companies whose goods were found entering Russia, in most cases contrary to the companies’ public claims (Dagens Nyheter, 2023; Tidningen Näringslivet, 2023). For this series of articles, the journalists used data from Russian customs and verified it with information from numerous Swedish companies, covering the time period up until December 2022. This entailed reviewing thousands of export records from Swedish companies either directly to Russia or via neighboring countries such as Armenia, Kazakhstan, and Uzbekistan. All transactions mentioned in the article series have been confirmed with the respective companies, who were also contacted by DN prior to publication (Dagens Nyheter, 2023b). DNs journalists also acted as businessmen, interacting with intermediaries in Kazakhstan and Uzbekistan, exposing re-routing of Swedish goods from a company stated to have cut all exports to Russia in the wake of the invasion (Dagens Nyheter, 2023d).

For Sweden headquartered companies exposed in DN and that are traded on the Swedish Stock Exchange, we collect their stock prices and trading volume. Our data includes information on each stock’s average price, turnover, number of trades by date from around the date of the DN publications as well as the date of each company’s prior public announcement of exiting Russia. Table 1 details the companies who were exposed of doing direct or indirect business with Russia by DN and who had announced an exit from the Russian market previously. In their article series, DN also shows that goods from the following companies entered Russia; AriVislanda, Assa Abloy, Atlas Copco, Getinge, Scania, Securitas Tetra Pak, and Väderstad. Most of the companies exposed by DN operate within industries displaying low withdrawal shares.

Table 1. Select Swedish companies’, time of exit announcement and exposure in Dagens Nyheter and stock names.


Source: The LeaveRussia project, 2023; Dagens Nyheter, 2023b, 2023c, 2023d. Note: The exit statements have been verified through companies’ press statements and/or reports when available. For Epiroc, the claim has been verified via a previous Dagens Nyheter article (Dagens Nyheter, 2023a).

In Figure 5, we show the average stock price and trades-weighted average stock price of the Swedish companies in Table 1 around the time when the companies announced that they are leaving Russia.

Figure 5. Average stock price of companies in Table 1 around Russian exit announcements.

Source: Author’s compilation based on data from Nasdaq Nordic.

There appears to be an immediate increase in stock prices after firms announced their exit from the Russian market. Stock prices, however, reverse their gains over the next couple of days. In general, stock prices are volatile, and we also see similar-sized movements immediately before the announcement. Due to this volatility and the fact that we cannot rule out other shocks impacting these stock prices at the same time, it is difficult to attribute any movements in the stock prices to the firms’ decisions to leave Russia.

The academic evidence on investors’ reactions to firms divesting from Russia is mixed. Using a sample of less than 300 high-profile firms with operations in Russia compiled by researchers at the Yale Chief Executive Leadership Institute, Glambosky and Peterburgsky (2022) find that firms that divest within 10 days after the invasion experience negative returns, but then recover within a two-week period. Companies announcing divesting at a later stage do not experience initial stock price declines. In contrast, Kiesel and Kolaric (2023) use data from the LeaveRussia project to find positive stock price returns to firms’ announcements of leaving Russia, while there appears to be no significant investor reaction to firms’ decisions to stay in Russia.

When considering the effect from DN’s publications, the picture is almost mirrored, with the simple and trades-weighted average stock prices dipping in the days following the negative media exposure before not only recovering, but actually increasing. Similar caveats apply to the interpretation of this chart. In addition, the DN publication occurred shortly after the Hamas attacks on Israel on October 7 and Israel’s subsequent war on Gaza. While conflict and uncertainty typically dampen the stock market, the events in the Middle East initially caused little reaction on the stock market (Sharma, 2023).

Figure 6. Average stock price for companies listed in Table 1 around the time of DN exposure.

Source: Author’s compilation based on data from Nasdaq Nordic.

Discussion

As discussed in Becker et al. (2024), creating incentives and ensuring companies follow suit with the current sanctions’ regime should be a priority if we want to end Russia’s war on Ukraine and undermine its wider geopolitical ambitions. Nevertheless, Bilousova et al. (2024), and Olofsgård and Smitt Meyer (2023), highlight that there is ample evidence of sanctions evasions, including for products that are directly contributing to Russia’s military capacity. Even in countries that have a strong political commitment to the sanctions’ regime, enforcement is weak. For instance, in Sweden, it is not illegal to try and evade sanctions according to the Swedish Chamber of Commerce (2024). There is little coordination between the numerous law enforcement agencies that are responsible for sanction enforcement and there have been very few investigations into sanctions violations.

Absent effective sanctions enforcement and for the many industries not covered by sanctions, can we rely on businesses to put profits second and voluntarily withdraw from Russia? Immediately after the start of Russia’s invasion of Ukraine, as news stories about the brutality of the war proliferated, many international companies did announce that they will be leaving Russia. However, a more systematic look at data collected by the LeaveRussia project and KSE Institute reveals that more than two years into the war, less than half of companies based in Western democracies intend to distance themselves from the Russian market. A closer look at companies who are continuing operations in Russia reveals that they tend to be in sectors that are crucial for the Russian economy and war effort, such as energy, mining, electronics and industrial equipment. Many of these companies are probably seeing the war as a business opportunity and are reluctant to put human lives before their bottom line (Sonnenfeld and Tian, 2022).

Whether companies who announce that they are leaving Russia actually do leave is difficult to independently verify. A series of articles published in a prominent Swedish newspaper (Dagens Nyheter) last autumn revealed that goods from 14 major Swedish firms continue to be available in Russia, despite most of these firms publicly announcing their withdrawal from the country. The companies’ reactions to the exposé were mixed. A few companies, such as Scania and SSAB, have decided to cut all exports to the intermediaries exposed by the undercover journalists (for instance, in Kazakhstan, Uzbekistan and Kyrgyzstan). Other companies stated that they are currently investigating DN’s claims or that the exports exposed in the DN articles were final or delayed orders that were accepted before the company decided to withdraw from Russia. Another company, Trelleborg – a leading company within polymer solutions for a variety of industry purposes – reacted to the DN exposure by backtracking from its earlier commitment to exit the Russian market (Dagens Nyheter 2023b, 2023d). Wider reaction to these revelations was muted. Looking at changes in stock prices for the exposed companies, we find little evidence that investors are punishing companies for not honoring their public commitment to withdraw from Russia.

In an environment, where businesses themselves withdraw at low rates and investors do not shy away from companies contradicting their own claims, the need for stronger enforcement of sanctions seems more pressing than ever.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Can Farmland Market Liberalization Help Ukraine in its Reconstruction and Recovery?

Posted on March 20, 2024 | Policy Brief

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The Russian full-scale invasion of Ukraine has inflicted massive damages and losses on Ukraine, already amounting to more than 2.5 times Ukraine’s 2023 GDP. Despite substantial and continuing international political and financial support to help Ukraine in its recovery and reconstruction, it is becoming increasingly clear that it will need to mobilize its own resources and private financing as well – not just for the country’s reconstruction but also for its long-term development. From a government perspective, it is important for Ukraine to leverage scarce public and donor resources and to undertake necessary reforms to facilitate and crowd in private financing. Farmland market liberalization is one of the key reforms in this respect. Its scale, with farmland accounting for more than 70 percent of Ukraine’s territory, and capacity for private financing generation for agriculture and rural areas is, however, often underestimated.  

An Unbearable War Toll and the Need for Private Financing

The raging Russian war on Ukraine enters its third year, imposing an immense toll in terms of human life, economic stability, and regional security. About 20 percent of Ukraine’s territory has been occupied. More than 10 million Ukrainians have left their homes, including 6.45 million refugees that have resettled across Europe (UNHCR, 2024). Ukraine’s military casualties are reported to be approaching 200,000 (The New York Times, 2023) and at least 10,000 civilians have been killed (United Nations, 2023). Ukraine’s GDP plunged by 30 percent in 2022, and the documented total damages to Ukraine’s economy have reached US$ 155 billion, as of January 2024 (KSE, 2024). Similarly, economic losses amount to around US$ 500 billion (as of December 2023). At the same time Ukraine’s reconstruction and recovery needs are estimated at about US$ 486 billion (World Bank, 2024). This immense number make up more than 2.5 times Ukraine’s 2023 GDP.

While there is a substantial and continuing international political and financial support for Ukraine’s defense, recovery, and reconstruction, this will not be enough (World Bank, 2023). Ukraine needs to mobilize its own resources and private financing, not just for its reconstruction but also for its long-term development. The Ukrainian government must leverage scarce public and donor resources and undertake necessary reforms to facilitate and crowd in private investments. One of the crucial reforms in this regard is the ongoing liberalization of the farmland market. The scale of its impact and capacity to generate private financing for agriculture and rural areas is frequently undervalued.

Ukraine’s Farmland Market and Reform

Almost 71 percent of Ukraine’s territory (or 42.7 million ha, including occupied territories) is farmland and 33 million ha is arable. This is far more than in the largest countries in the EU. Ukraine also has one-third of the world’s most fertile black soils. This resource has however been heavily underutilized for agricultural and overall economic development (KSE, 2021). Over the last two decades, Ukraine has turned into an increasingly important global supplier of staple foods (von Cramon-Taubadel and Nivievskyi, 2023), but this has largely happened without a full-fledged farmland market in Ukraine capable of facilitating even further agricultural productivity growth.

The farmland sales market was virtually non-existent for over three decades, instead rental transactions dominated. The farmland sales market began operating only in July 2021, and in a very limited format. Only individuals could purchase farmland plots and with a 100-ha cap per person. The minimum price was set at the normative monetary land value, and tenants had pre-emptive purchase rights while foreigners and legal entities were excluded; state and communal farmland remained under the 2001 sales ban. The farmland sales market opening was part of a large-scale land reform to support an efficient and transparent farmland market. This included a legislation package aimed at preventing land raiding, decentralizing land management, introducing electronic land auctions, establishing tools for land planning and use, creating a national infrastructure for geospatial data, establishing institutions for supporting small scale farmers, and empowering small scale farmers capacity to compete for land (KSE, 2021).

In general, there are two broad benefits of sales and lease transactions. First, the farmland market, via transactions, sorts out more efficient farms from less efficient ones, thus increasing the overall sector value added. Another important benefit, specifically linked to the farmland sales market, is that a functioning farmland sales market makes farmland a collateral which can generate productive investments in increased agricultural and non-agricultural productivity growth (Deininger and Nivievskyi, 2019).

Early Reform Outcomes

Almost two out of the first two and a half years of the reform phase unfolded amidst the profound shock from Russia’s full-scale invasion of Ukraine. Following this, nearly 20 percent of Ukraine’s farmland has been occupied (Mkrtchian and Mueller, 2024), almost a third of the agricultural sector has been ruined – the total damages and losses to the agricultural sector amount to US$ 80 billion (Neyter at al., 2024). As a result, a very restrictive first-phase format of the market, on top of the war challenges, effectively limited the expected benefits of the market liberalization.

The war has put a sizable drag on the farm-land sales market development, effectively slashing the transacted volume almost by half (see Figure 1).

Figure 1. Cumulative market transactions and the effect of the war.

Source: Nivievskyi and Neyter, 2024.

Overall, about 1.1 percent of total farmland area, or about 1.3 percent of Ukraine’s total controlled farmland (equivalent of 200,000 sales transactions or 444,300 ha) has been traded since the opening of the market. Regionally, the outcome is quite diverse (see Figure 2).

This is nonetheless an encouraging outcome as it is quite comparable to developed countries benchmarks where, on average, roughly 1 percent (and up to 5 percent) of the total agricultural land area is transacted annually (Nivievskyi et al., 2016). Another important outcome is that the transacted farmland has remained in agricultural production.

Farmland price development is also positive, especially for commercial farmland (see Figure 3). Since the commencement of the farmland sales market in Ukraine, the capitalization has increased by US$ 5.5 billion (KSE Agrocenter, 2024).

In fact, farmland market capitalization might be even greater. There are indications that the actual market price should be much higher, on average, than the officially registered one, as transacting parties may try and evade fees and taxes (Nivievskyi and Neyter, 2024).

Figure 2. Transacted area as share of total oblast (administrative region) area.

Source: The Center for Food and Land Use Research at Kyiv School of Economics (KSE Agrocenter), 2024.

Continued Farmland Market Liberalization and Associated Expectations

As of January 1, 2024, legal entities gained the right to acquire farmland that had, from 2001, been under sales ban. Also, in this second stage, the farmland accumulation cap per beneficiary increased to 10,000 hectares. Other restrictions remain, including that legal entities with a foreign beneficiary still cannot purchase farmland.

The first results of the second stage are premature, and firm conclusions cannot be drawn, yet the preliminary results are quite encouraging. The new market participants have already increased the volume of transactions and corresponding price by 13 percent, on average (see Figure 3).

Figure 3. Average farmland prices, in thousands UAH.

Source: KSE Agrocenter (2024). Note: Demonstration and estimations are based on the State GeoCadaster Data.

Another encouraging result highlights that legal entities bring further transparency into the market. For half of the transactions involving individuals, the sales price did not exceed the minimum price by more than 1.5 percent, while in half of the farmland transactions with legal entities, the price exceeded the minimum one by more than 44 percent.

These early results provide insight into the market’s direction and the associated benefits. The expected economic benefits from liberalizing the farmland market for legal entities could amount to an annual increase of 1-2.7 percent of GDP over the next three years.  The scale depends on many factors, including the availability of financing and financial support for small farmers (KSE Agrocenter, 2023).

Rural and agricultural financing is of particular interest as land is generally considered a high-quality collateral which could be utilized to attract loans and investments. This is particularly important during the current wartime period, as agricultural producers are facing significant collateral damage and severe financial difficulties for the third consecutive year. Currently, despite its potential, only a meager share of all farming loans is secured by farmland – far below global benchmarks.

Under current registered farmland prices, the total farmland market capitalization is equivalent to roughly US$ 35.5 billion. This could potentially generate an additional US$ 12.4 billion of loans (under the current low liquidity risk ratio of 0.35), already much greater than the current agricultural debt of about US$ 3.5 billion. Adding legal entities to the pool of farmland buyers (as of January 2024), is expected to increase farmland prices by an additional 40 percent. Thus, the farmland market will grow to almost US$ 50 billion, and the volume of land-secured financing could amount to US$ 17.5 billion. Further liberalization of the farmland market, such as a strengthening of its transparency, boosting the market liquidity, and accumulating necessary market statistics, may allow the National Bank of Ukraine to reconsider the liquidity risk ratio for farmland – potentially considering it as collateral similar to other types of real-estate (see the National Bank of Ukraine Resolution #351, June 30, 2016). A liquidity risk ratio at the level of developed countries (0.6-0.8) could further increase the volume of potential land-secured financing available to agriculture and rural areas/landowners to at least US$ 35 billion. This would, in turn, close the more than US$ 20 billion current financing gap for agricultural reconstruction, recovery and development. It would also contribute to Ukraine’s nearly US$ 500 billion reconstruction and recovery needs.

Further significant strides toward liberalizing Ukraine’s farmland sales market are anticipated as part of the country’s journey towards EU membership (European Commission, 2024), aligning with Chapter 4 ‘Free Movement of Capital’. Specifically, this pertains to allowing foreigners (EU citizens and legal entities) the right to purchase Ukrainian farmland (Nivievskyi and Neyter, 2024).

Conclusion

Russia’s full-scale invasion of Ukraine have inflicted massive damages and losses to Ukraine, already amounting to more than 2.5 times Ukraine’s 2023 GDP. The recently estimated reconstruction and recovery needs measure at nearly US$ 500 billion. This is an unbearable burden for Ukraine alone. Despite substantial and continuing support from international partners and donors, Ukraine will need to heavily draw on its own resources and capacity to generate private financing, not just for the country’s reconstruction, but also for its long-term development. It is therefore essential, from the Ukrainians government’s perspective, to focus on necessary reforms and optimize policy decisions to leverage the scarce public and donor resources and facilitate and crowd in private investments. Continued farmland market liberalization is one such critical reform, providing hope to generate substantial private investment in the agricultural sector and rural areas.

The size of the farmland market is immense (with farmland accounting for more than 70 percent of Ukraine’s territory). The first two years following the opening of the farmland sales market demonstrate a substantial potential for private financing generation for agriculture and rural areas. The results from regular market monitoring and the early findings, as discussed above, suggest that further farmland market liberalization and increased transparency could generate about US$ 35 billion of financing for agricultural producers and rural areas/landowners. That could, in turn, close the current agricultural financing gap of more than US$ 20 billion for rebuilding and recovery, as well as partially close the nearly US$ 500 billion financing gap for Ukraine’s overall reconstruction and recovery. The expected economic benefits from liberalizing the farmland market for legal entities are estimated at 1-2.7 percent of GDP annually, over the next three years. A further liberalization of the farmland market, and a step towards EU membership, would include granting foreigners (EU citizens and legal entities) the right to buy Ukrainian farmland – expected to bring even further benefits.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Energy Storage: Opportunities and Challenges

Posted on April 26, 2021 | Policy Brief

Wind turbines in a sunny desert representing energy storage

As the dramatic consequences of climate change are starting to unfold, addressing the intermittency of low-carbon energy sources, such as solar and wind, is crucial. The obvious solution to intermittency is energy storage. However, its constraints and implications are far from trivial. Developing and facilitating energy storage is associated with technological difficulties as well as economic and regulatory problems that need to be addressed to spur investments and foster competition. With these issues in mind, the annual Energy Talk, organized by the Stockholm Institute of Transition Economics, invited three experts to discuss the challenges and opportunities of energy storage.

Introduction

The intermittency of renewable energy sources poses one of the main challenges in the race against climate change. As the balance between electricity supply and demand must be maintained at all times, a critical step in decarbonizing the global energy sector is to enhance energy storage capacity to compensate for intermittent renewables.

Storage systems create opportunities for new entrants as well as established players in the wind and solar industry. But they also present challenges, particularly in terms of investment and economic impact.

Transitioning towards renewables, adopting green technologies, and developing energy storage can be particularly difficult for emerging economies. Some countries may be forced to clean a carbon-intensive power sector at the expense of economic progress.

The 2021 edition of Energy Talk – an annual seminar organized by the Stockholm Institute of Transition Economics – invited three international experts to discuss the challenges and opportunities of energy storage from a variety of academic and regulatory perspectives. This brief summarizes the main points of the discussion.

A TSO’s Perspective

Niclas Damsgaard, the Chief strategist at Svenska kraftnät, gave a brief overview of the situation from a transmission system operator’s (TSO’s) viewpoint. He highlighted several reasons for a faster, larger-scale, and more variable development of energy storage. For starters, the green transition implies that we are moving towards a power system that requires the supply of electricity to follow the demand to a much larger extent. The fact that the availability of renewable energy is not constant over time makes it crucial to save power when the need for electricity is low and discharge it when demand is high. However, the development and facilitation of energy storage will not happen overnight, and substantial measures on the demand side are also needed to ensure a more dynamic energy system. Indeed, Damsgaard emphasized that demand flexibility constitutes a necessary element in the current decarbonization process. However, with the long-run electrification of the economy (particularly driven by the transition of the transport industry), extensive energy storage will be a necessary complement to demand flexibility.

It is worth mentioning that such electrification is likely to create not only adaptation challenges but also opportunities for the energy systems. For example, the current dramatic decrease in battery costs (around 90% between 2010 and 2020) is, to a significant extent, associated with an increased adoption of electric vehicles.

However, even such a drastic decline in prices may still fall short of fully facilitating the new realities of the fast-changing energy sector. One of the new challenges is the possibility to store energy for extended periods of time, for example, to benefit from the differences in energy demand across months or seasons. Lithium-ion batteries, the dominant battery technology today, work well to store for a few hours or days, but not for longer storage, as such batteries self-discharge over time. Hence, to ensure sufficient long-term storage, more batteries would be needed and the associated cost would be too high, despite the above-mentioned price decrease. Alternative technological solutions may be necessary to resolve this problem.

Energy Storage and Market Structure

As emphasized above, energy storage facilitates the integration of renewables into the power market, reduces the overall cost of generating electricity, and limits carbon-based backup capacities required for the security of supply, creating massive gains for society. However, because the technological costs are still high, it is unclear whether the current economic environment will induce efficient storage. In particular, does the market provide optimal incentives for investment, or is there a need for regulations to ensure this?

Natalia Fabra, Professor of Economics and Head of EnergyEcoLab at Universidad Carlos III de Madrid, shared insights from her (and co-author’s) recent paper that addresses these questions. The paper studies how firms’ incentives to operate and invest in energy storage change when firms in storage and/or production have market power.

Fabra argued that storage pricing depends on how decisions about the storage investment and generation are allocated between the regulator and the firms operating in the storage and generation markets. Comparing different market structures, she showed as market power increases, the aggregate welfare and the consumer surplus decline. Still, even at the highest level of market concentration, an integrated storage-generation monopolist firm, society and consumers are better off than without energy storage.

Fabra’s model also predicts that market power is likely to result in inefficient storage investment.

If the storage market is competitive, firms maximize profits by storing energy when the prices are low and releasing when the prices are high. The free entry condition implies that there are investments in storage capacity as long as the marginal benefit of storage investment is higher than the marginal cost of adding an additional unit of storage. But this precisely reflects the societal gains from storage; so, the competitive market will replicate the regulator solution, and there are no investment distortions.

If there is market power in either generation or storage markets, or both, the investment is no longer efficient. Under market power in generation and perfectly competitive storage, power generating firms will have the incentive to supply less electricity when demand is high and thereby increase the price. As a result, the induced price volatility will inflate arbitrage profits for competitive storage firms, potentially leading to overinvestment.

If the model features a monopolist storage firm interacting with a perfectly competitive power generation market, the effect is reversed. The firm internalizes the price it either buys or sells energy, so profit maximization makes it buy and sell less energy than it would in a competitive market, in the exact same manner as the classical monopolist/monopsonist does. This underutilization of storage leads to underinvestment.

If the model considers a vertically integrated (VI) generation-storage firm with market power in both sectors, the incentives to invest are further weakened: the above-mentioned storage monopolist distortion is exacerbated as storage undermines profits from generation.

Using data on the Spanish electricity market, the study also demonstrated that investments in renewables and storage have a complementary relationship. While storage increases renewables’ profitability by reducing the energy wasted when the availability is excess, renewables increase arbitrage profits due to increased volatility in the price.

In summary, Fabra’s presentation highlighted that the benefits of storage depend significantly on the market power and the ownership structure of storage. Typically, market power in production leads to higher volatility in prices across demand levels; in turn, storage monopolist creates productive inefficiencies, two situations that ultimately translate into higher prices for consumers and a sub-optimal level of investment.

Governments aiming to facilitate the incentives to invest in the energy storage sector should therefore carefully consider the economic and regulatory context of their respective countries, while keeping in mind that an imperfect storage market is better than none at all.

The Russian Context

The last part of the event was devoted to the green transition and the energy storage issue in Eastern Europe, with a specific focus on Russia.

Alexey Khokhlov, Head of the Electric Power Sector at the Energy Center of Moscow School of Management, SKOLKOVO, gave context to Russia’s energy storage issues and prospects. While making up for 3% of global GDP, Russia stands for 10% of the worldwide energy production, which arguably makes it one of the major actors in the global power sector (Global and Russian Energy Outlook, 2016). The country has a unified power system (UPS) interconnected by seven regional facilities constituting 880 powerplants. The system is highly centralized and covers nearly the whole country except for more remote regions in the northeast of Russia, which rely on independent energy systems. The energy production of the UPS is strongly dominated by thermal (59.27%) followed by nuclear (20.60%), hydro (19.81%), wind (0.19%), and solar energy (0.13%). The corresponding ranking in capacity is similar to that of production, except the share of hydro-storage is almost twice as high as nuclear. The percentage of solar and wind of the total energy balance is insignificant

Despite the deterring factors mentioned above, Khokhlov described how the Russian energy sector is transitioning, though at a slow pace, from the traditional centralized carbon-based system towards renewables and distributed energy resources (DER). Specifically, the production of renewables has increased 12-fold over the last five years. The government is exploring the possibilities of expanding as well as integrating already existing (originally industrial) microgrids that generate, store, and load energy, independent from the main grid. These types of small-scaled facilities typically employ a mix of energy sources, although the ones currently installed in Russia are dominated by natural gas. A primary reason for utilizing such localized systems would be for Russia to improve the energy system efficiency. Conventional power systems require extra energy to transmit power across distances. Microgrids, along with other DER’s, do not only offer better opportunities to expand the production of renewables, but their ability to operate autonomously can also help mitigate the pressure on the main grid, reducing the risk for black-outs and raising the feasibility to meet large-scale electrification in the future.

Although decarbonization does not currently seem to be on the top of Russia’s priority list, their plans to decentralize the energy sector on top of the changes in global demand for fossil fuels opens up possibilities to establish a low-carbon energy sector with storage technologies. Russia is currently exploring different technological solutions to the latter. In particular, in 2021, Russia plans to unveil a state-of-the-art solid-mass gravity storage system in Novosibirisk. Other recently commissioned solutions include photovoltaic and hybrid powerplants with integrated energy storage.

Conclusion

There is no doubt that decarbonization of the global energy system, and the role of energy storage, are key in mitigating climate change. However, the webinar highlighted that the challenges of implementing and investing in storage are both vast and heterogenous. Adequate regulation and, potentially, further government involvement is needed to correctly shape incentives for the market participants and get the industry going.

On behalf of the Stockholm Institute of Transition Economics, we would like to thank Niclas Damsgaard, Natalia Fabra, and Alexey Khokhlov for participating in this year’s Energy Talk. The material presented at the webinar can be found here.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.