It is two year’s time since the beginning of the market operation (1 July 2019), yet the model retains administrative interventions in the form of price caps, market participation and trade restrictions, non-cost reflective tariffs, public service obligations (PSO), and the opportunity for the electricity imports from countries – nonmembers of the European Energy Community. 

The existing electricity market model is functioning with distortions in all of its segments and in the conditions of financial instability of the state-run energy generating companies, debt crisis, unfavorable investment climate, unstabilized renewables (RES) sector.

This article presents an analysis of the factors that have influenced the operation of the wholesale electricity market in Ukraine over the first half-year of 2021 and outlines proposals for stabilizing the market model.

1. Factors that have complicated the market operation

1. Price caps

In the transition to the new market model in Ukraine, price caps were considered to be the best way to prevent possible price shocks for the households. Although such measures are considered temporary, they are still used, depriving players of full participation in all market segments and hindering market competition.

 

To introduce effective legal and regulatory instruments at the stage of the formation of the new market model, the Energy Community Secretariat suggested the Recommendations[1] on increasing competition and liquidity in wholesale electricity markets and energy exchanges. However, they seem to have been ignored. Also, according to the Law of Ukraine "On the Electricity Market" (EML), the energy generating companies were allowed to sell 10% of produced electricity on the Day-Ahead Market (DAM) only in the first year of this segment’s work.

The National Energy and Utilities Regulatory Commission (NEURC, Regulator) has set the price caps that have caused the DAM prices to decrease to a level that was lower than the cost of generation, and even less than the break-even point of the power system as a whole (UAH 850/MWh in April, UAH 500/MWh in May and UAH 426/MWh July 2021).

The urgent measures were undertaken by Regulator. On June 25, NEURC has set the price cap for electricity on IDM at 100.5% of the DAM price for the period of electricity surplus in the power system,  until October 1. 

The price caps have been reviewed several times recently: on 18 June 2021 the day cap was set at the level of UAH 2 655,99/MWh (against the previous UAH 2048/MWh), and a nightcap - at the level of UAH 1 243,71/ MWh without VAT (against UAH 1228,9/MWh). This was followed by the price caps increase[2] on 1 August 2021: day cap (from 00:00 to 07:00 and from 23:00 to 00:00 hours) was raised by 50.6 %, or up to UAH 4000/MWh, and the nightcap (from 07:00 to 23:00 hours) - by 60.8%,

1.2 Dishonest behavior of traders

The current Market Rules enable the traders to sell electricity at DAM  without contracted volumes of electricity that they can physically supply, and then purchase such volumes at the Intraday market (IDM) at a discount, thus earning the margin. 

In the II quarter 2021, despite the decreased electricity consumption level and growing electricity production from RES, the wholesale electricity prices at DAM in Ukraine were much lower than those in Europe (by 30-40%): the DAM prices in mid-May 2021 within the Unified Energy System (UES) in Ukraine have decreased by €23/MW, while in Poland, Hungary, Slovakia, and Romania the price was €70-72/MW.

The energy generating companies showed limited interest to trade on the DAM and Intraday Market (IDM) as they could not compensate for the cost of electricity produced. This discouraged them from participating in these market segments, as otherwise, they would be able to set higher prices.

On the other hand, the energy generating companies were forced to significantly reduce the price of electricity in order to be able to sell at least part of their production. The electricity producers having failed to sell more than 50% of the declared volumes at DAM, were "falling out" to the intraday market (IDM) and/or balancing power market (BPM) where the discount ranged from 6% to 80% as compared to DAM. Thus, the Guaranteed Buyer (state trader), Energoatom, the National Nuclear Generating Company, Ukrhydroenergo PJSC, Centrenergo PJSC as well as thermal power plants incurred losses, while unscrupulous traders profited by purchasing real volumes of electricity at IDM and BPM at large discounts.

The prices at DAM went up in June by 1300-1400 UAH/MWh, followed by 32% prices increase - up to UAH 2019/MWh in July, meanwhile, the low interest of market participants reflected the lack of incentives, i.e. liquidity measures, to stimulate trade on this market segment.

The volatility of DAM occupying up 30% of the electricity trade volume, proves the fact that its function as the price indicator should be reviewed.  The Ministry of Energy has initiated a bill providing that the indicative electricity prices would be formed on the basis of the Bilateral Contracts Market (BCM), which should operate under transparent market rules.

The very recent regulating measures (No. 3508-d Act dated 4 June 2021) concern the obligation for the producers of all forms of ownership to sell electricity between  September 1, 2021, and  April 1, 2022, under the Bilateral Contracts Market (BCM) solely through the electronic auctions. Traders and suppliers are to sell on DAM no more than 10% of the resource purchased in the BCM.

The last-minute introduction of additional restrictions on the Ukrainian electricity market is inappropriate. The Secretariat of the European Energy Community has urged the Regulator to use its powers to monitor the market and investigate, once the signs of manipulations are detected based on the number and frequency of cases, price incentives, and potential gains.

1.3 Public Service Obligations (PSO).

To date, preferential electricity tariffs for the households are subsidized by the state-owned Energoatom and Ukrhydroenergo.

The Resolution by Cabinet of Ministers of Ukraine (CMU) No. 483 dated 5 June 2019, which determined the PSO in the Electricity Market, has been amended many times, however, the financial system of the electricity market remained unbalanced.

At the end of 2020 changes to the PSO (by the CMU decision dated 28 December 2020) affected electricity prices for household consumers: the preferential electricity tariff of 0.9 UAH/kWh for the first 100 kWh was canceled and the fixed price at the level of 1.68 UAH/kWh was set beginning 1 January 2021.

The further amendments were introduced by CMU Resolution No.238 dated 24 March 2021.  The fixed price for households and equated to them consumers (at the level of UAH 1.68/kWh), as well as the differentiated (zone) tariff rates, were retained. Energoatom has got an obligation to sell the amount of electricity required for the supply of household consumers under the PSO to Guaranteed Buyer at regulated electronic auctions at a price of UAH 150/MWh.

The last iteration of the PSO model was introduced by CMU Resolution No.239 dated 24 March 2021 leaving tariffs for households at the level of 1.68/kWh (until 30.06.2021), but changing the functions of the main PSO players. Beginning 1 June 2021 the Guaranteed Buyer was excluded from the model of electricity supply to the households, while Energoatom and Ukrhydroenergo were assigned to ensure the supply of electricity in the trading areas of the UES of Ukraine and Burshtyn Energy Island, respectively.

Both Energoatom and Ukrhydroenergo have reacted to the PSO amendments, claiming that they would cause potential financial losses in the amount of UAH 3.0 billion for Energoatom and UAH 2.3 billion for Ukrhydroenergo.

The price of electricity at which generating companies sell it to universal service suppliers (USS) is defined as the difference between the weighted average fixed price for the households (UAH 1.68/kWh) and tariffs for transmission, distribution, and USS service but not less UAH 10/MWh (UAH 0.01/kWh). Currently, a fixed tariff of UAH 150/MWh is set for Energoatom and UAH 10/MWh for Ukrhydroenergo.

It is under the latest CMU Decision of 28 July 2021 that the current household tariffs shall stay in force until 1 September 2021. According to Energoatom’s CEO, the Company is to sell the electricity required for the supply of household consumers under the new PSO to Guaranteed Buyer at regulated electronic auctions at a price of UAH 300/MWh.

1.4 Electricity imports from Belarus and Russia

One of the factors deteriorating the financial condition of generating companies was permission to import electricity from Belarus and Russia. Imports from non-Energy Community countries have been suspended and resumed several times. 

The latest ban on electricity imports from Russia and Belarus (until 1 October 2021) was imposed by the decision of 13 May 2021 (on the basis of the Law of Ukraine No.1396-IX). The Regulator obtained the right until the end of 2021 to limit the capacity allocated at monthly and annual auctions for cross-border transmission with countries – non-members of the Energy Community.

As the electricity market in Ukraine is in surplus, the import of electricity from Belarus and Russia also affected the wholesale electricity prices in Ukraine. 

Even though the volumes of imports from these countries are insignificant, the focus on the import of electricity from the countries outside the Energy Community threatens Ukraine's energy security and slows down the process of separating the UES of Ukraine from the energy systems in Russia and Belarus. The isolated mode of UES operation is compulsory for the integration of Ukraine's energy system into the European network of electricity transmission system operators (ENTSO-E), announced for 2023.

1.5 Debts on the market

Apart from the debt that was formed prior to the introduction of the wholesale electricity market, significant debts between market participants have accumulated.

In the background of declining demand and the imperfect PSO mechanism, the financial imbalances resulted in chain debts. Ukrenergo has a debt before Guaranteed Buyer which in turn has accumulated debts before RES producers and Energoatom (Fig.1).

There is a fear to fail preparation for the 2021/2022 heating season due to lack of funds for fuel and scheduled repairs; the risks of the accidents of thermal power plants (TPP) and nuclear power plants (NPP) remain as in the autumn-winter period 2020/21. Ensuring that the repair campaign is carried out in due time requires a prompt review of the electricity balance for 2021 (developed by Ukrenergo and approved by the Ministry of Energy).

According to the TSO, it has been warned that in case of the electricity shortage in the coming heating season, ENTSO-E may reject Ukraine’s synchronization of its electricity grid with the European one. Also, in 2021-2022 the compliance of the Ukrainian UES with the ENTSO-E standards should be monitored.

The compensation to electricity market participants having public service obligations (primarily Energoatom) could be possible if the weighted average price of electricity for household consumers would cover the production cost (of state energy-generating enterprises) and the weighted average price of electricity transmission.

2.Proposal to phase out PSO and establish reasonable market prices for households by the end of 2022

2.1 Changing the role of Guaranteed Buyer in the PSO model

Guaranteed Buyer’s obligations to purchase electricity in large quantities from Energoatom and sell it on organized market segments in order to provide sufficient income for the purchase of electricity at “green” tariffs, have been canceled.

The state trader shall remain responsible only for PSO in relation to RES producers. To enable the Guaranteed Buyer to perform such a function, the issue of debts repayment to RES producers should be resolved.

The legal source for payments under the "green" tariffs is the revenues from the TSO’s electricity transmission tariffs. The current tariff is set at UAH 293.93/MWh (NEURC Resolution No. 2353 dated 9 December 2020). Recently, TSO initiated to review the electricity transmission tariff to raise it up to UAH 355.55/MWh beginning 1 August 2021) to be able to cope with the existing obligations under PSO.

A different source of income for Guaranteed Buyer is the purchase and sale of electricity under bilateral contracts (except for organized markets) on auctions at the price equal to the other DAM participants.

Once the issue of compensation to RES producers is resolved and the activities of the Guaranteed Buyer are balanced, the company will be able to fulfill its PSO in relation to RES producers. Initially, it was envisaged by EML that the Guaranteed Buyer could not support cross-subsidies between different PSOs: the company only had the right to compensate green tariffs for the RES producers.

2.2 Compensation to participants of the PSO model

Market participants involved in PSO must receive compensation in a non-discriminatory and transparent manner (Article 3 (6) of Directive 2009/72 / EC). The NEURC refers to the Resolution of the CMU No. 420 dated 23 May 2018 on approval of the PSO list (“List of services presenting general economic interest”), adopted on the basis of Article 3 of the Law of Ukraine “On State Aid to Business Entities”). The process of providing compensation for fulfilling the PSO  duties should be monitored by the Antimonopoly Committee of Ukraine (AMCU), in particular, to avoid excessive compensation for the provision of services under PSO. Despite repeated amendments to the Law (last in May 2020), the situation has not significantly improved.

2.3 Stabilizing Energoatom's financial condition

Energoatom's fulfillment of  PSO had a negative impact on the company's financial condition. Investments in Company’s fixed assets decreased from UAH 11,737 million in 2018 up to UAH 9,773 million in 2020. In addition, for the past 2020, the company's losses amounted to UAH 4.8 billion (instead of the planned profit of UAH 1.6 billion). Overall, the Company’s cost of PSO has raised up to UAH 13 billion.

Energoatom and Ukrhydroenergo should gradually exit the PSO  model to be able to sell up to 100% of electricity generated in organized market segments at a price that would ensure the companies’ financial stability.   

It is worth mentioning that the President of Ukraine has assigned the  Company to achieve $500 million profit by the end of 2021 and to double it over the next two years.

This could work out only if the corporate governance system is introduced in the Company in accordance with the principles of the Organization for Economic Cooperation and Development (OECD) and if Company is compensated relevantly for fulfilling its PSO obligations.

One of the factors affecting the company's financial condition is the non-transparent bidding rules. At the end of April 2021 ferroalloy plants could purchase the electricity in large lots at a price that was much less than the market price.

It is urgent to accomplish as follows:

- reduce the volume of lots, providing access of all interested participants to bidding;

- lift up restrictions on the sale price of nuclear electricity and set the optimal sales price of no less than 1.4 UAH/kWh.

If  Energoatom enters the free market until the PSO model is completely abolished, other options are possible, for example, using part of Energoatom's profit to compensate for USS for supply to households until prices reflect electricity generation and transmission costs by concluding financial contracts on monthly/quarterly/yearly basis depending on the bilateral auctions’ outcome.

In the event that PSO is abolished, the funds should be used to improve the financial condition of the state generation and partially directed to the state budget in the form of dividends.dividends.

 

2.4 Price reform for electricity supply to households. 

The question arises of which tariff would be optimal for households in order to eliminate market imbalances and cross-subsidization. If PSO was eliminated on 1 May 2021,  the electricity tariff for households would have doubled. To avoid social tensions, it is necessary to steadily stop subsidizing electricity prices for households.

The following action algorithm could be offered:

From now until the end of the year i.e. 31 December 2021, fixed prices for different categories of households shall be set at the level of 30% higher than the current tariff (UAH 1,68/kWh). For the six months period - from 1 January 2022 till July 2022 fixed prices increase by no more than 30% of the level of regulated tariffs set by the NEURC; during the period of July 2022 till 31 December 2022 fixed prices increase by 30% from the price determined as of a previous period, however, in any case, fixed prices should reach the level of USS prices, which are currently applied only to non-households (Table 1). USS prices shall be determined on the basis of the methodology approved by the relevant NEURC Resolution.

Table 1.  Reviewing of electricity tariffs  for households, 2021-2022.

To date, the electricity tariff (fixed) for households makes 1.68 UAH kWh, regardless of consumption volume. According to the Ministry of Energy, the average cost of electricity for household consumers is about 1.60 UAH/kWh (including zone metering and electricity consumption in the "night" hours), of which the weighted average transmission cost is 1.51 UAH/kWh. Thus, direct payment to generating companies under the PSO mechanism at the current tariff is UAH 0.09/kWh, excluding imbalances in the Burshtyn Energy Island’s trade zone.

Annual electricity consumption in Ukraine is about 150 billion kWh. The total cost of electricity for the population is about 104 billion UAH excluding VAT. This amount includes as follows:

- the cost of electricity (about 1.4 UAH/kWh);

- TSO’s transmission tariff (Ukrenergo) (about 0.3 UAH/kWh);

- distribution tariff of regional power companies (on average 1 UAH/kWh);

- USS margin (on average 0.1 UAH/kWh).

According to published data from the State Statistics Service of Ukraine[3], about 16.8 million households in Ukraine consume 36.6 billion kWh/year. The share of average household expenditures on electricity is about 2.67% of total expenditures (Fig. 2), and subject to the gradual establishment of reasonable market prices (Table 1) may increase to 3.46%; 4.26% and, 5.05% respectively, and this level is not critical.

 

Given the average total income of a household in Ukraine amounted to UAH 12,317.00 in 2019, with the monthly average payment for electricity of UAH 328.5, the gradual increase (till the end of 2022) of 1.68 tariffs by 30% up to UAH 2.18/kWh (UAH 2.68/kWh, UAH 3.18/kWh), the monthly payment may amount to UAH 426.32 (UAH 524.10; UAH 621.88), respectively.

Revenues to the budget after setting the price of electricity at 1.68 UAH/kWh are estimated at about 27.8 billion UAH per year, and in the case tariffs increase up to 2.18 UAH/kWh (2.68 UAH/kWh, UAH 3.18/kWh) may raise (Fig. 3) to UAH 36.09 billion per year (UAH 44.7 billion per year and UAH 52.65 billion per year, respectively).

 

Important note. Setting up economically feasible prices for households has to be accompanied by a number of measures eliminating all of the other shortcomings on the electricity market in Ukraine.

On one hand, setting up market tariffs for household consumers may turn out to be a heavy burden for them, and on the other hand, can help encourage energy efficiency and energy-saving measures. 

The transition to savings mode in electricity consumption is ensured by the installation of energy-efficient electrical equipment, household appliances, replacement of lighting lamps with energy-efficient ones, etc. To reduce the load on the electricity grid during peak hours, the "night" tariffs could be utilized for electricity consumption and "smart" meters can be installed.

Today there are two-zone (night and day) and three-zone (night, half-peak, peak consumption periods) tariffs, which stimulate the replacement of conventional meters with "smart" meters. For the consumers using dual-zone meters, the tariff from 23:00 to 7:00 is UAH 0.84, for the remaining time the tariff is UAH 1.68. Owners of three-zone meters during peak consumption hours (from 8:00 to 11:00 and from 20:00 to 22:00 hours) have an increased rate of UAH 2.52/kWh, normal tariff (from 7:00 to 8:00 and from 11:00 to 20:00) of UAH 1.68, and night tariff (from 23:00 to 7:00) of UAH 0.672. On average in the country (including zone accounting), the tariff for household consumers is about 1.6 UAH/kWh.

In order to avoid stressful tensions in the conditions of reviewing the household’s tariffs, a smooth and balanced approach is deemed expedient. An effective extended system of subsidies (targeted, monetary), that cares for the "vulnerable" consumers, as well as a differentiated approach should be used. An example is, the Government's decision to compensate households using electricity for heating[4]. Similarly, households within the NPP 30 km zone could be subsidized.

The existing procedure of subsidies’ accrual is non-transparent and the concept of "vulnerable consumer" still remains legally vague.

EML should be amended at the initiative of the CMU, introducing the provisions concerning the socially "vulnerable consumers", with a clear definition of this category of consumers. The Cabinet of Ministers (through the Ministry of Social Policy and the Ministry of Energy) should also provide the measures to protect such consumers. 

To summarize the above: cancellation of the  subsidized prices for households may also have positive effects as follows:

- Stimulating energy savings.

- Improving the market conditions and the financial state of the generating companies.

- Promoting the debt crisis resolution.

- Reducing tariffs for the industry.

- Increasing the competitiveness of Ukrainian products,

- Reducing the cost of goods and services.

Conclusion

1. 1. To date, the key issues in the wholesale electricity market are as follows: eliminating constraints in its segments, phasing out cross-subsidization, and setting up economically feasible electricity tariffs for households.
   2. Reforming the electricity market and eliminating cross-subsidization of tariffs are part of Ukraine’s commitments to the European Union. In particular, the Association Agreement Agenda includes a requirement for Ukraine to continue the reform of the electricity tariff and measures that would guarantee full payment for electricity supply.
   3. This situation is detrimental to both industrial and domestic consumers. Industrial consumers are forced to pay high electricity tariffs, which reduces their profits and increases the cost of production. The households have no incentives to save energy. As the state generation subsidizes the households, there is a much higher price burden than in the case of economically justified levels of electricity tariffs for household consumers while providing targeted social assistance to vulnerable consumers.
   4. Price caps should be phased out. Although the price caps have been constantly changing in Ukraine, they have not been eliminated or, at least, adapted to the market level, moreover, they have destabilized it. Price caps set by the NEURC in 2021 have caused an artificial reduction of DAM prices (in April, May, and, July 2021) lowering them below the level of generation costs and break-even point of the power system. Despite the fact that price caps are used also in other countries, including the EU Member States, at the outset of organized market establishment and may be justified in an oligopolistic market, these measures need to be limited in time and phased out in order to stimulate participation in these market segments and allow for competition to develop.
   5. Dishonest behavior of the traders on DAM is inadmissible. Distorted market regulation violates the principles of pricing, creates a basis for manipulation, and leads to generation losses. Wholesale electricity prices in Ukraine are currently much lower than in neighboring European markets. The rules of the NEURC allowed unscrupulous traders to dump prices and oust real producers from the market, forcing the real generating entities to sell electricity at low prices and suffer losses. The recent actions, undertaken by NEURC still do not help rehabilitate the market.
   6. To improve the electricity market conditions, the PSO mechanism should be eliminated. The electricity market has to be liberalized today, while the Government's populist actions would inevitably lead to negative consequences. PSO model was introduced as a temporary measure at the stage of the electricity market formation, and since then has created unequal conditions for participants.
   7. It is possible to balance the financial condition of electricity market participants having obligations under the PSO (primarily, Energoatom) only if the weighted average price of electricity for household consumers covers the cost of its production by state energy-generating enterprises and the weighted average price of electricity transmission.
   8. Introducing the market prices for electricity for households in 2021-2022 is one of the elements of a competitive electricity market in the conditions of the energy transition. In order to avoid the growth of social tension, it is necessary to gradually bring electricity prices for households to the market level. An effective extended system of subsidies (monetary), caring for the "vulnerable" consumer, should apply.
   9. It is worth noting that setting up economically feasible electricity prices for households will not help rehabilitate the market model unless disparities between market segments are eliminated and appropriate conditions for state-owned generating companies are provided. All incremental funds from increased electricity tariffs for household consumers should be directed to energy generating companies and state budget (in the form of dividends).
   10. The reimbursement of debts to the market players is of urgency. Apart from the debts of the population for utilities, significant debts to RES producers, the debts between Ukrenergo, Energoatom, Guaranteed Buyer have accumulated. There are risks regarding the sustainable heating season 2021/2022 due to the lack of funds for fuel and scheduled repairs; insufficient funding of the industry (due to market model distortion) was the main reason for accidents at TPPs and NPPs during the autumn-winter period 2020/2021. It is expedient that the sources of debt repayment in the energy sector are identified, and a balance between the interests of generation, suppliers, and consumers is ensured.
   11. Imports from Belarus and Russia should be terminated. Although the electricity imports from countries outside the Energy Community are insignificant, it threatens Ukraine's energy security and slows down the trial of Ukraine's UES functioning separately from the energy systems of Russia and Belarus.  This is a principal condition for integrating the electricity grid of Ukraine into the European network of electricity transmission system operators (ENTSO-E), announced for 2023.
   12. In order to prevent administrative regulation of the market, it is urgent that the electricity market is operated in accordance with European standards. The Regulation (EU) № 1227/2011 of 25.10.2011 on the integrity and transparency of the wholesale energy market (REMIT[5]) is to be properly transposed into the legislation of Ukraine.
   13. If the wholesale electricity market is recovered, the reliable operation of the UES can be ensured, maintenance of the infrastructure in the proper technical condition is provided, which is essential for the integration of the Ukrainian electricity grid with the ENTSO-E.
   14. Ukraine has joined the path towards the energy transition. The recently adopted Ukraine's Economic Strategy until 2030 provides for the achievement of the country’s carbon neutrality no later than in 2060, and this requires sustainable development of the RES sector and wholesale electricity market operation.

 

 

[1] POLICY GUIDELINES by the Energy Community Secretariat on increasing Competition and Liquidity of Wholesale Electricity Markets, including Power Exchanges PG 01/2019/08 May 2019, https://energy-community.org/legal/policy-guidelines.html 

[2] EXPENDITURE AND RESOURCES OF HOUSEHOLDS OF UKRAINE in 2019 http://www.ukrstat.gov.ua/druk/publicat/kat_u/2020/zb/06/zb_vrd_19_ue.pdf

[3] REGULATION (EU) No 1227/2011 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 25 October 2011 on wholesale energy market integrity and transparency, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32011R1227
[4] Government has introduced compensation for citizens who have electric heating, says the Prime Minister https://www.kmu.gov.ua/en/news/uryad-zaprovadiv-kompensaciyi-dlya-gromadyan-u-yakih-vstanovlene-elektroopalennya-premyer-ministr
[5] REGULATION (EU) No 1227/2011 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 25 October 2011 on wholesale energy market integrity and transparency, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32011R1227