Ukraine’s green energy disaster is sliding towards a power crisis

Ukraine’s green energy disaster is sliding towards a power crisis
Foreign investors pumped $4.5bn into Ukraine's green energy sector in two years to create some 6 GW of capacity, but the sector is in crisis now the government wants to slash tariffs retroactively / wiki
By Ben Aris in Berlin June 10, 2020

Ukraine is heading towards a power crisis in the next few weeks if the government cannot come to terms with the irate owners of the country’s burgeoning green energy sector. Among the very few foreign investors that the country has managed to attract in recent years, the leading green energy companies warn that a failure to resolve the problems could lead to a wave of bankruptcies that may spark an electricity crisis and have an adverse impact on the banking sector.

The problem is that the government is trying unilaterally and retroactively to reduce generous green tariffs that were introduced in 2008 to boost investment into the sector. And the initiative has been a huge success. Investment really took off in 2019, when the leading domestic power companies, foreign investors and a raft of Ukrainian entrepreneurs poured $4.5bn into building wind and solar power stations across the country. 

Ukraine’s renewable sector has been booming as investors have rushed in to take advantage of generous tariff deal. Power generation from renewables surged to 6,328 MW at the end of last year from 981 MW just a few years ago, with solar plants showing the biggest increase.

If anything, the reform was too successful.

It all started with the new electricity market, which was launched on July 1, 2019. The country was neither ready for it technically or legally. The system is handicapped now, bogged down by a mounting pile of debts that are being accumulated between all market players. It needs fixing. In addition, when assuming the amount of tariff which would cover green energy, the government almost halved the real production, leading to a situation when there is not enough money to pay for green energy.

“The debts to the green producers could have been avoided if the government (national energy regulator) used the correct numbers,” says Alina Sviderska, the business director of Norway’s Scatec Solar, one of the bigger investors in Ukraine’s green power sector.

The state has budgeted to buy 4 GW of green power from all these companies but they will produce some 7 GW this year. Under the terms of the green tariff deal, both the price of the power is fixed and the state is obliged to buy all the power these companies produce. And that is where the problems started.

“The state doesn't have any money and the system they have set up doesn't work,” says Sviderska.

Investors were up in arms when the government proposed in February to drastically cut the green tariffs and, moreover, to do so retroactively.

The Rada Energy committee commented several times that they want to cut the tariff by 30%-50%, whereas the investors, in a concession to the crisis that has hit the country, are prepared to take a 15% cut as long as the agreements between the investors and the state are also prolonged, as well as to speed up projects under auctions. The dispute is not just about prices, but also about predictability.

The motivation of the committee is that Ukraine has a habit of subsidising power costs for the population. As part of the last IMF deal negotiations, the multi-lateral lender insisted that the cost of gas to households be tripled to bring it in line with international prices, but the government had to be dragged kicking and screaming to finally make this concession. On at least one occasion the government promised to hike the cost of household gas in the spring only to renege as the heating season started in the autumn. Nuclear power supplies to homes have also long been subject to household tariffs, and the energy committee seems to be assuming the same logic should be applied to the privately owned green energy producers.

“The investors are prepared to reduce the tariffs to the point where they at least cover their loans,” adds Sviderska.

And that is where the row has got stuck, with neither side prepared to make any more concessions. In the last few weeks the tensions have escalated as time runs out.

“The Rada is due to break up for summer in three weeks. If there is no agreement and new legislation before that then there might be a power crisis. The companies need a new agreement to take to their banks, as many of them have borrowed money for their projects. There will be a wave of defaults and some of the smaller investors could lose everything, including their houses,” says Sviderska.

Most of the investors have already hired lawyers to look at instigating arbitration proceedings against the government, and a representative group sent a letter to the International Monetary Fund (IMF) calling on Ukraine’s biggest donor to intercede, as the row has badly undermined Ukraine’s investment image.

Prices and promises

The Oslo-listed Scatec Solar is a good example of exactly the kind of investor that Ukraine needs to attract if it is going to start the process of long-term sustainable development.

The company focuses on renewable energy investments in emerging markets around the world, and apart from one small investment in the Czech Republic, its Ukrainian solar plant was its first serious European investment – a 320-MW solar farm.

Under the Ukrainian green tariff deal the government promised to pay €0.15 per kWh, which is more than the €0.10-0.12 that power earns in the EU.

“But on top of that you have to add the cost of the capital. In Europe you can borrow [at] 1-2% but in Ukraine the cost of capital is more like 8%, so the projects are about twice as expensive to run than in Western Europe,” says Sviderska. “That means the tariffs are not as generous as they first might seem.”

In general, Sviderska estimates that the cost of producing power in Ukraine is about €1000 per kW vs around €600 per kW in Europe once these additional costs are taken into account.

And the price is only part of the deal; equally important are the guarantees to buy the power that is produced, which allows investors to borrow against the promise of production when setting their projects up. Not only has the government proposed to cut the tariffs, but it is also not intending to extend these guarantees under the new regime it is proposing to put in place.

“Since independence in 1991 Ukraine has developed no new energy generating capacity. All the existing facilities are Soviet-era coal and nuclear facilities. Green energy is [the] only new investment that has gone into the energy sector,” says Sviderska.

Taking the government to court and starting an arbitration process will be easy. In addition to the investment guarantees in Ukraine’s Energy Charter there are some bilateral investment treaties with many of the countries involved that Sviderska says makes it possible to launch arbitration proceedings against the Ukrainian government.

Frozen and in debt

The row came to a head in March, when the government simply stopped paying out for the power it was receiving from the green producers completely.

“The government is running up a debt into the millions of euros and lots of companies are now in technical default of their loans. These debts and potential retroactive legislative measures might trigger the arbitration process for many companies,” says Sviderska.

The halt in payments is a function of the failure of Ukraine’s reforms to the power sector that were designed to create a market for power that was launched in July 2019. The newly created Guaranteed Buyer of Electricity, known locally as GarPok, is now already half a billion dollars behind in payments to green producers, according to the acting Minister of Energy, Olga Buslavets, UBN reported on June 9.

According to the GarPok website, the level of its settlements with renewable producers was 11% in March; 5% in April; and 7% in May. According to Ukrenergo, the installed capacity of wind and solar plants in Ukraine now is 5.2 GW, about triple the level of 18 months ago. 

And if this row is unresolved then the government would run up over $1bn a year in losses from the lawsuits with green energy producers, predicts Oleg Gramotenko, general director of Tesla Energy, a big solar and biomass investor in Ukraine.

“More than half of investors in renewable energy are already negotiating with international law firms regarding the preparation of lawsuits against the state of Ukraine,” he said at a press conference at Interfax-Ukraine on June 8. He said that nine months of talks over green tariffs have not resulted in a compromise. 

Part of the reason for the delay in payments is confusion in the new power market. Although GarPok is responsible for making the payments, its budget is determined by the Ministry of Energy, which has the final say. And there are half a dozen other state bodies and agency that have a say in the power business, according to Sviderska. In short, the re-make of Ukraine's energy sector has not been a success.

Moreover, thanks to Ukrainian President Volodymyr Zelenskiy’s reshuffles, there have been three Energy Ministers this year already and the investors complain of chaos at the ministry, which has not been able to focus on the process.

On top of this, the Rada’s Energy Committee, which is the responsible body for drawing up any new legislation, has not been involved in the negotiations between the investors and the ministry, apart from attending one meeting.

“No one is taking responsibility. No one is in charge. Everyone says only Zelenskiy can make the decision, but we have been unable to meet with him and green power is not an issue that he is focused on,” says Sviderska.

The Energy Committee representatives have not been co-operative, according to Sviderska. “They have proposed to reduce the tariffs by 50-30%, but when we asked them how they got to that number, they only said: “It's a nice round number.” There is an element of popular politics at play here.”

Sviderska says the energy sector reforms were premature and not properly thought through. The state bodies were set up but the system was not ready technically. The GarPok created by the payment system quickly collapsed, as there was no one with any authority to ensure the money flowed around the system, other than the Ministry of Energy, which has been effectively decapitated this year.

Politics of power

To a Western ear Ukraine’s push to invest into green power is a no-brainer. The country currently needs some 40bn cubic metres of gas a year to power its economy but only produces some 20 bcm from its own gas fields. The rest has to be imported and that is both expensive and also opens Ukraine up to pressure from Russia, which is the ultimate source of most of this gas.

However, domestically the opponents of green energy have called it an oligarch scam, as some of the biggest domestic energy companies have invested heavily in the sector to take advantage of the guaranteed tariffs. Green energy has been sold by its detractors as yet another sweetheart deal to make rich oligarchs richer.

The reality is that while some of the country’s leading oligarch-owned energy groups, such as DTEK, have invested heavily into green energy, they only make up some 15% of the total, with foreign investors accounting for another 30% and the rest made up from a slew of domestic entrepreneurs, big and small.

With all these factors in place to stymie the talks Ukraine is rapidly headed towards an energy crisis, says Sviderska.

“There has never been an energy crisis like this one,” says Sviderska. “There are some 600 companies that can’t service their loans. We need a new agreement (based on a compromise with investors) in some new legislation in place in three weeks and we need the president to endorse it to make it happen. And [the] solution is not only about cutting tariffs it’s about complex energy market reforms.”

One of the consequences of a failure to resolve the issues before the summer recess is that it may trigger a wave of defaults amongst the green energy companies that will affect the banking sector. Companies have raised credits from a variety of banks, ranging from the European Bank for Reconstruction and Development (EBRD) to the big state-owned banks. However, the state-owned banks are particularly vulnerable, because if their green power clients default that may bring their statuary capital down below the mandatory minimums and then they will be forced to turn to the budget for recapitalisation. While no one is suggesting the green energy debts will spark a financial crisis, these defaults could make the summer uncomfortable for the National Bank of Ukraine (NBU).

The investors are clearly frustrated and have ramped up their PR campaign as the summer recess deadline approaches. Sviderska argues that part of their frustration is that if the power sector reforms are put in place and the system made to work efficiently then power costs will come down by themselves.

“The country needs to modernise its system, both technically and legally. Bring new technologies and enforce competition. Only with long-term state policy aimed at real market reforms will there be a chance for Ukraine to have lower prices for electricity,” says Sviderska. “That is the experience of other markets like Germany, but today in Ukraine there is no competition at all.”

Creating a functioning energy market will take time. Although green energy has grown rapidly in the last two years it still only accounts for 10% of the total generating capacity.

The bottom line is Ukraine is in desperate need of foreign investment. Last year foreign direct investment (FDI) amounted to some $2bn, so the money that has poured into the green energy sector has been by far the biggest success the government has achieved in attracting investment. Indeed, it is pretty much the only sector of the economy that has attracted broad-based foreign investment inflows. Reneging on its promises, and doing so in such a chaotic fashion, is extremely harmful to Ukraine's already extremely weak investment image. Zelenskiy recently introduced an “investment nanny” programme to help ease inbound investors through the traps and tricks of investing in Ukraine, but pointedly the government is ignoring the needs and problems of the few serious foreign investors it already has.