Assocation agreement beetween the EU and Ukraine: electricy market reform

Ukraine has accepted the obligations to implement the basic provisions of the Third Energy Package adopted by the EU. After failing to launch the gas market reform, the Ukrainian government is now willing to force changes within the electricity market at any given cost. However, less than 2 months are left for these reforms to get started. If the situation will not improve, the proposed model may lead to a nonpayment crisis and a significant worsening of economic development due to current market peculiarities.

Why is it important?

The electricity market in Ukraine should start working from July the 1^st 2019 onwards. However, the recent presidential elections have caused this topic to disappear to the background of political priorities.

Ukraine and the European Union have agreed on the integration of gas and electricity markets. Simultaneously, the Ukrainian government must conform its legislation to European directives. In theory, this should “destroy” energy monopolies and lead to more honest market pricing. Moreover, it will guarantee “visa-free energetics” for Ukraine.

The Ukrainian government understands the importance of energy security issues. This is evident from the fact that Ukraine has not yet launched an effective gas market. This means that gas prices remain rather high, which in turn has caused entire industries, especially the chemical production, to no longer be able to function at the minimum profitability rates.

Thus, the parties expect to progress with the Annex XXVII to the Association Agreement, which sets a list of rules for the functioning of the energy market to be implemented in Ukrainian legislation. As a result, Ukrainian government is eager to launch at least the electricity reform during this year to partially fulfil the obligations.

Currently, electricity is being sold to the state-owned enterprise "Energorynok", which delivers it to the final consumer. The delivery itself is carried out by:

Wholesale buyers who purchase electricity at an unregulated tariff and sell it at a bargain price, mainly for large enterprises.

"Oblenergo", who sells electricity at a regulated tariff for the population and for small and medium businesses.

According to the proposed reform, electricity prices won’t be determined by the National Energy Commission as before, but by the companies under the direct contracts between suppliers and consumers, thus allowing free choice. It’s also planned to create a "Day Ahead Market", "Intra Day market", "Balancing Market and "Ancillary Services Market" on the basis of bilateral stock exchange contracts.

However, there is a risk that, as always, the Ukrainian population will be paying for this reform out of its own pockets.

What’s the current state of the electricity market?

The Ukrainian market has its peculiarities. They are the following:

· Unlike in Europe, where there are dozens of energy suppliers, there are only 2 producers of electricity in Ukraine: the state-owned "Energoatom" and the private company DTEK. Their total market share is equal to 90%. Moreover, lately (as of 25^th of April 2019) DTEK has acquired Odesaoblenergo and Kyivoblenergo. This means DTEK has control over 35% of the electricity supply market and has strengthened its monopoly.

Despite the possible threats of uncontrolled price increase and a nonpayment crisis, the authorities of the Ministry of Energy and the National Commission for the State Regulation in Energy and Utilities report that they’re fully prepared to shift to the new electricity market model starting from July the 1^st 2019.

There is a difference in tariffs for thermal and nuclear power generation. Electricity of thermal power plants and "green energy" is more expensive than the standard market prices and therefore requires financial "leveling" in order for someone to buy it. Currently this is provided due to subsidies from the nuclear power sector. In turn, all the payments are accumulated in the "Energorynok", which then distributes the money between different types of generations.

· There are several lobbying groups in the context of electricity. The first one is thermal generation and renewable energy (DTEK). DTEK is highly interested in launching the electricity market. In this case, all the losses of thermal generation will firstly be compensated by "Energoatom" (nearly 64 billion UAH per year), and then they will be compensated by the population through the "Ukrenergo" tariff. This creates a situation where, without such “assistance” it becomes almost impossible to maintain the thermal generation.

However, "Energoatom" stands in contrast to such interests. Such a financial burden can become unbearable for it. In addition, nuclear power plants require large investments to maintain their normal operation.

Moreover, large producers are also not interested in launching the reform due to the risk of uncontrolled tariff increase, which may worsen their chances of survival in such a market.

The process of alignment of prices for the industry and the population will commence this year. As a result, the tariffs will increase for the communal spheres. At the same time, the average monthly salary in 2018 was equal to 318 USD and the average bill for utility services in the heating season amounted up to 2693 UAH (nearly 100 USD).

The government has spent 336,6 mln UAH on subsidies in winter. In turn, the share of payments for housing and communal services was only 70%. Thus, the debt of the population amounted up to 69.4 billion UAH.

Regarding electricity, the consumer debt is 33.6 billion UAH (the debt of the population is 4.8 billion UAH; the remaining share is the enterprises' debts). Taking into account the mentioned facts, higher tariffs will worsen the situation and will lead to higher inflation rates.

At the moment, Ukraine's foreign trade in electricity is a one-sided operation. In particular, DTEK exported the subsidized electricity in the amount of 6.2 billion kWh (it is equivalent to 3 million tons of coal) in 2018. This is 19.4% more than in 2017. At the same time, Ukraine still hasn’t removed administrative barriers for the import of electricity from EU countries, which could guarantee an inflow of cheaper.

What should be done?

Due to the previously stated contradictions, some lobbyists (oligarchs that are energy monopolists) will advocate the market launch date, whereas others will postpone it.

Under the current scenario, the electricity market will cause the prices to go up in the coming months. According to the proposed model, this will result in the compensations for the generation of thermal power being paid out of the pockets of the population through “Ukrenergo”s tariffs [Yegor9] .

Thus, there is a need for better transition to the electricity to omit and to solve the existing problems. Therefore, to minimize the negative consequences of the electricity market reform, special attention must be payed to the following:

Tariff inclusiveness should not take place entirely at the expense of the final consumers, but, on the contrary, should be regulated through the thermal generation’s “appetites”.

Minimization of tariff imbalances between nuclear and thermal generation is needed.

The roles of the antimonopoly and regulatory bodies of the state are important for limiting the possibility of monopolizing the market and uncontrolled growth of tariffs.

· The market should be opened in both ways (exports and imports) and should guarantee the inflow of cheaper foreign electricity to create fair competition.

· The international community should differentiate the interests of private companies and the real goals of the electricity market reform.

As a result, a socially responsible decision should be made and a fair market, with all its competitive advantages, should be created. Otherwise, the tariff reforms will lead to negative consequences for the whole Ukrainian society, while strengthening the on-going private monopoly on the market.