The energy market in Ukraine has always been in the limelight of both government and investors looking for investment opportunities.
Unfortunately, brutal and unjustified large-scale warfare of the Russian federation against Ukraine affected all the aspects of the Ukrainian economy, including the energy sector.
In this article, I would like to briefly outline the most crucial events as well as challenges the Ukrainian energy market faced in 2021, the current situation in the Ukrainian energy sector as well as contemplated top priorities for the Ukrainian energy sector once the war is over.
Top events of 2021
For the first time since 2013, Ukraine conducted a dozen of production sharing agreements (PSA) tenders and selected the winners which are both international and domestic prominent oil&gas investors. The process of PSAs negotiation took more than a year and finally the energy market was marked by the successful execution of ten PSAs. The relevant PSAs were supposed to attract at least circa USD 0,5 billion in gas production, and the PSAs were concluded for the duration of 50 years.
One PSA is yet to be signed.
Historical indebtedness before RES producers was mainly repaid
Over the last five years or so Ukraine has become a lucrative market for large-scale construction of "green" energy power stations, which was marked by the influx of more than USD 10 billion of investment into the industry.
However, such extensive and expedient growth encountered several obstacles preventing the market from further development and moreover casting a shadow on the viability and sustainability of market operation at its current modus operandi. In March-July 2020 as well as partially (but not so severely) in 2021 Ukrainian RES producers felt the adverse effect of the payment deficit of the Guaranteed Buyer, whereas the indebtedness of Guaranteed Buyer before the RES producers remained largely unpaid despite the government promises manifested in the Memorandum of Understanding signed by and between RES associations and Government of Ukraine.
Finally, in November 2021 Ukrenergo, state-owned TSO (which serves as a cash donor for the Guaranteed Buyer) issued a debut 5-year Green and Sustainability-linked Eurobonds and attracted USD 825 million on international markets to cover the historical indebtedness before RES producers. Quite rapidly the monies were transferred to their intended recipients.
Switch from the "green" tariff to "green" auctions has not occurred
To have the lower price for RES-produced electricity the Parliament of Ukraine decided to introduce the "green" auctions as a substitute of the existing "green" tariff support scheme. The auctions are aimed at a fair distribution of the state support (via auction prices) based on the quotas determined by the Cabinet of Ministers of Ukraine.
Despite the changes had been passed almost two years ago, no auctions have yet been conducted.
Additionally to the problem with "green" auctions, there are issues related to lack of legislation (and thus inability to enter into) on corporate PPAs and absence of green energy certificates of origin, which together restrained the development of "green" energy in Ukraine.
Constitutional proceeding against the "green" tariff is still pending
The Constitutional Court of Ukraine (CCU) has been considering a constitutional proceeding on the constitutionality of some provisions of the Alternative Energy Sources Law and Electricity Market Law.
The main arguments to declare the "green" tariff as unconstitutional are the following:
- The Parliament of Ukraine (Verkhovna Rada of Ukraine) acted ultra vires and had no power to set up the "green" tariff value, as this power is vested into executive authority (Cabinet of Ministers of Ukraine)
- The mere "green" tariff is too high, and thus:
- the title of the Ukrainian people to its resources is infringed
- the "green" tariff is not aimed at social justice
- the "green" tariff does not meet the requirement of the state budget to be balanced (i.e., the reimbursement for green energy constituted 7.9% of total produced energy value, while the share of RE in total energy production was only 1.9%)
- the protection of competition is not respected due to a favorable "green" tariff regime.
Most of the commentators state that CCU has no legal basis to declare the "green" tariff in Ukraine as unconstitutional.
Inter alia, the following arguments are in place:
- The Alternative Energy Sources Law does not set the size of the "green" tariff, but only the main criteria for calculating the "green" tariff to be used by the National Energy and Utilities Regulatory Commission of Ukraine (NEURC) when setting a "green" tariff for electricity producers from alternative energy sources. The establishment of the size of the "green" tariff is attributed to the NEURC discretionary powers, as it is authorized to decide whether or not to provide a "green" tariff for a particular producer, as well as whether or not to provide increment for the use of Ukrainian components and other powers. Therefore, Verkhovna Rada of Ukraine, adopting the main criteria for calculating the "green" tariff, acted within its constitutional powers and in no way took over the powers of other state bodies.
- The "green" tariff is not financed by the State Budget of Ukraine, and therefore in no way affects the balance of the state budget. The "green" tariff is paid by the Guaranteed Buyer at the expense of funds received from the sale of electricity on the market, as well as from funds received from Ukrenergo, Ukrainian TSO
- the Energy Strategy of Ukraine for the period up to 2035 "Security, Energy Efficiency, Competitiveness", approved by the Cabinet of Ministers of Ukraine in 2017, focuses on expanding the use of all types of renewable energy as one of the instruments for guaranteeing the energy security of the state, etc.
The CCU's consideration of the case has been put on hold due to the dismissal of a presiding judge from his post and his litigious challenge of such a dismissal.
Therefore, there is still pending the Sword of Damocles hanging over the Ukrainian RES sector.
After 24th February 2022
Many power generation objects were captured, shelled, or destroyed
The biggest nuclear power plant in Europe, Zaporizhzhia Nuclear Power Plant, Kakhovka Hydroelectric Power Plant, Luhansk and Zaporizhzhia thermal power stations were captured by russian occupant forces, and we do not know whether these facilities will operate after presumable Ukrainian Victory. Okhtyrska combined heat and power plant was destroyed, Chernihiv combined heat and power plant was damaged. Many oil products bases, refinery plants, separate parts of gas transmission systems, and gas storages were seized.
Circa 40% of the installed RES capacity is occupied or affected by hostilities.
At the same time, on 31 March 2022 the Chornobyl Nuclear Power Plant was liberated from the russian occupants. As of today, the plant is controlled by Ukrainian nuclear specialists and secured by the National Guard of Ukraine.
"Green" tariff payments were dramatically decreased
In March-May 2022 Guaranteed Buyer paid less than 25% of "green" tariff to RES producers. In conjunction with the significant damage and seizure of numerous generation objects, it put Ukrainian RES industry on the brink of the bankruptcy.
Ukrainian power system is fully synchronised with ENTSO-E
The power systems of Ukraine and Moldova are fully synchronised with the Continental European network. The relevant decision was approved by the association of system operators ENTSO-E on 11 March 2022. Physical operations to interconnect the power systems were performed on 16 March 2022.
Ukraine resumed export of electricity to Poland and Moldova
The first auction for the allocation of interstate interconnections on electricity export to Poland was conducted on 28 March 2022. The auctioned profile volume was 210 MW (per hour). On 12 May 2022 Ukraine started exporting electricity to Moldova. The auctioned profile volume was 135 MW (hourly).
Amendments of the rules of rent rates for gas production
From 1 March 2022 the approaches to the calculation of the relevant rent rates were updated.
Firstly, to calculate the natural gas sale price the arithmetic mean of gas prices for the reporting month on the Dutch gas hub (TTF) should also be considered. The natural gas sale price is used for rent rate calculation purposes.
Secondly, the gas sale price for the respective period affects the rent rate for gas production: the higher the gas sale price, the higher the rent rate is.
Thirdly, Ukraine preserved reduced rent rates for the new wells. For example, if the gas was produced from the new wells deeper than 5,000 meters, the rent rate will comprise three percent (gas price is 150 US dollars per 1000 m3 or less), six percent (gas price is higher than 150 US dollars and not higher than 400 US dollars) and if the price is higher than 400 US dollars – six percent of the existing gas price of 400 US dollars and 18 percent of the existing sale price of gas exceeding 400 US dollars per 1000 m3.
The abovementioned rent rates regulation will be valid only during the period of the martial law. I suppose that after the war is ended rent rates, specified by the relevant regulation, will be decreased.
Finally, from 1 April 2022 and until martial law termination, gas producers should not pay the rent related to the natural gas:
- produced but not alienated, and
- injected in Ukrainian gas storage facilities.
Gas production volumes remain stable
According to the information of Energy Suppliers Association, in January 2022 public and private companies increased production of natural gas to more than 1,7 billion m3, which is 10% more than in January 2021. In February, the positive trend continued until the beginning of russia's military aggression: Ukrainian companies produced more than 1.5 billion m3 and improve the result by almost 9% compared to the February 2021.
After the Russian invasion, production declined in March and April, but not as much as experts expected, by 1% and 3% compared to the March and April 2021, respectively.
Ukrainian energy after the war is ended
We do believe that Ukraine will win the war and restore its control over temporary occupied territories.
We do not know when exactly the war will end. Notwithstanding that, Ukrainian State should already update the national energy policy and prepare rigorous and comprehensive step-plan on reconstruction the Ukrainian energy infrastructure.
The updated energy policy should include the answers to some of the most challenging questions, inter alia:
1) whether the damaged energy infrastructure should be rebuilt as status quo ante or built from scratch using new (renewable) technologies and approaches
2) how to attract private capital to reconstruction of Ukrainian energy sector and which stimuli should be used
3) which legislation and approaches from the US/EU law should be transposed to Ukrainian law, etc.
The good news is that Ukrainian government starts elaborating such vision. Inter alia, in a "roadmap" for Ukraine's economic recovery presented by the Ministry of Economy of Ukraine, the following principles are enumerated:
- Self-sufficiency. It will be gained via increasing domestic gas production and developing nuclear energy
- Energy independence in three-five years
- Energy efficiency
- Application of "green economy" principles.
Some of the aspects raised are debatable (for example, a number of renewable energy generation technologies are already more cost-effective than nuclear energy generation facilities: therefore, there is a dilemma whether Ukraine should keep a focus on nuclear energy).
Nonetheless, the general direction of the vision is correct. In addition, the subsequent postulates should be treated as fundamentals of recovery of Ukrainian energy sector:
- Development of the regulation to facilitate "green" energy development: launch of the "green" auctions, introduction of corporate PPAs, green energy certificates of origin and feed-in premium mechanisms, etc.
- Further implementation of Acquis Communautaire in respect of the energy regulation: REMIT, etc.
- Providing of the maximum legal, tax and regulatory stimuli for gas production
- Repayment of the debts under the "green" tariffs.
- Launch of bilateral cross-border capacity allocation auctions to facilitate import-export operations between Ukraine and ENTSO-E countries, etc.
Ukraine has many challenging tasks on the table. In spite of it, we believe Ukraine will recover its economy (including energy sector), will gain promising pace of economic and social reforms and will be an upstanding member of European and Euro Atlantic communities.
By Dmytro Melnik, Associate, Arzinger