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Only an increase in the transmission tariff will not solve the crisis in the electricity market

On June 26, the National Commission for State Regulation of Energy and Utilities (NEURC) made a preliminary decision to increase the tariff for electricity transmission 2.1 times from August 1, 2020. The final decision is expected to be made on July 11. The tariff increase will not affect electricity prices for household and small non-household consumers, but will be felt for industry and other consumer groups. The main purpose of this step is to ensure stable revenues for timely payments to producers of electricity from renewable sources.

Tariff and “compensators”

As you know, in previous periods, the “Guaranteed Buyer” was unable to make full and timely payment for generation from RES. As a result, in June 2020, the Guaranteed Buyer’s debt to producers amounted to UAH 14 billion. The reason for this was the insufficient amount of revenues from energy sales and the rapid growth of RES capacity, which increased the amount of required payments. In 2020, the situation was exacerbated by declining demand for electricity due to the warm winter and quarantine measures. Thus, consumption in April decreased by almost 8% compared to April 2019. At the same time, demand mainly decreased due to the commercial sector.

As Guaranteed Buyer’s debts continue to accumulate, tariff increases are an inevitable step in securing payments to RES producers in the future. However, even doubling the tariff will not be enough to completely solve the problem. Thus, in the previous draft resolution, the NEURC planned to increase the tariff almost four times, which in theory could fully cover the debt. However, such a decision would be quite radical and would create too much price pressure on the industry, so it was abandoned.

In addition to ensuring timely payments in the future, the “Guaranteed Buyer” will have to repay the debt that arose earlier. Among other additional sources of financing, the draft decision of the NEURC provides credit funds from international financial institutions, namely UAH 3.8 billion from the European Bank for Reconstruction and Development (EBRD) and UAH 2.8 billion from the European Investment Bank (EIB). In addition, it is planned that part of the revenues (about UAH 1.4 billion) will be provided by revenues from the sale of interstate capacity. However, the use of credit funds and revenues from the use of interstate crossings can only be a temporary solution that works in the short term. To overcome the crisis in the electricity market, the state will need to take a set of measures and gradually change some basic principles of the market operation.

View ASO

One of the mechanisms that necessitates cross-subsidization is the assignment of special obligations (ASO). Special obligations have been created to prevent the rapid rise in electricity prices for household consumers. Although this is one of the acceptable mechanisms of social protection, it should still be temporary, as it worsens the business environment, hinders the creation of a competitive environment among electricity producers and leads to market distortions. The current Regulation on assignment of special obligations will remain in force until the end of 2020, but may be extended.

As a transitional model, a financial ASO agreed with the Energy Community Secretariat is currently being prepared for adoption. Under this mechanism, universal service providers (USP) and state-owned producers (Energoatom, Ukrhydroenergo) will enter into swap contracts under which USP will provide the population with electricity and receive compensation from the state generation to cover the difference between the market price and the price for the population. However, the ultimate goal remains the abandonment of cross-subsidization and the transition to a model with market prices for all consumers. In any case, the period of special obligations should be used to gradually move to the next stage, i.e. to gradually bring electricity prices for the population to market levels.

At the same time, the government should ensure the protection of vulnerable consumers by providing targeted assistance to individual groups instead of subsidizing all households. It is important to understand that raising the transmission rate for entrepreneurs should only be part of a comprehensive strategy to overcome the market crisis.

What does this mean for business?

On the one hand, the increase in the transmission tariff does not directly affect households that buy electricity at a regulated price, but the population will still indirectly feel it due to rising prices for other goods and services, the cost of which includes companies’ electricity costs. On the other hand, it means worsening the conditions for doing business and, as a result, creating additional barriers to new investment. Thus, in 2019, Ukraine took the 128th place out of 187 in the Doing Business rating in the grid connection component – one of the worst indicators. Although the number of required connection procedures in Ukraine is small, they take a long time (267 days).

Thus, in addition to the difficulties in the procedural component of the grid connection, investors can now be repelled by the final electricity prices, which are already close to the EU average. Higher tariffs can lead to a deterioration in the competitiveness of certain businesses, a general reduction in production and consumption in the economy, which will also be reflected in GDP and other macroeconomic indicators. Ultimately, losses in the real sector of the economy may lead to some reduction in tax revenues.

Positions of the parties

Immediately after the publication of the draft decision of the NEURC on tariff increases four times, representatives of the Ministry of Energy, Business and Energy Companies expressed their negative assessment. Thus, one of the companies noted that such a step would lead to an excessive burden on industry and exacerbate the energy market crisis. It was also stressed the need to find compromises on the part of the Regulator that will work for all market players, as has happened in the market of “green” energy. The Ministry of Energy also believes that the tariff increase was not necessary, and there are other measures that can be taken to stabilize the situation. Acting Minister Olga Buslavets pointed out the possible rise in prices for goods and services for the population due to higher tariffs for enterprises and noted that such a measure should be the last, when all other opportunities have already been used.

At the same time, Ukrenergo claims that the tariff revision is a consequence of deficits in the market and should be used in conjunction with other solutions. Among other key measures, the company points to the reduction of tariffs for RES, changes in the mechanism of special obligations and other recommendations developed by the Anti-Crisis Energy Headquarters. Thus, most market players expectedly disapprove tariff increases, noting the need to use other tools and emphasizing the possible negative consequences for business.

Risks of introduction of new tariffs

A sudden twice increase in the transmission tariff carries certain risks. One of the main risks is the possibility that for some reason the decision will not be implemented. First, it is likely that the decision of the Regulator will be appealed by the business. This situation occurred after the launch of the market in July-August 2019, when at the claim of JSC “Nikopol Ferroalloy Plant” the decision of the NEURC on new transmission tariffs and dispatching services was suspended. And although this time the situation is unlikely to be repeated, as in 2019 the very powers of the NEURC to set tariffs were questioned, there are still some risks of appeal.

Another risk is that some companies, in the cost structure of which the cost of electricity is high, will indeed be unable to pay their bills. For Ukrenergo, this is a threat of late payment or incomplete payment. The consequence may be the closure of some of these enterprises, which will not be able to adapt.

What in the end?

An increase in the transmission tariff will have a number of negative consequences for the industry, as will any increase in costs. At the same time, the new tariff does not eliminate market distortions caused by the cross-subsidization mechanism. It is obvious that in order to solve the crisis situation in the electricity market, a holistic strategy is needed, and not targeted measures that temporarily remove the symptoms of the problems.

Such a strategy should aim to prepare the market for the phasing out of special obligations and to subsidize household consumers at the expense of industrial ones, to bring electricity prices to market levels for all consumer groups. Raising prices for the population is certainly an unpopular step for the authorities, so it requires a balanced approach, accompanying outreach and informational support to households in order to increase their efficiency of electricity consumption. At the same time, the introduction of market pricing is an international obligation of Ukraine and a prerequisite for the full functioning of a competitive market, reducing the country’s regulatory risks and normalizing the investment climate in the sector.

It is important to understand that increasing the tariff burden on business and taking loans every time there is a debt is not an option. The only way out is for well-thought-out systemic transformations, taking into account previous experience and context, as well as European best regulatory practices.

Roman Nitsovych, Research Director, DiXi Group 

Darina Kulaga, expert consultant

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