Achieving climate goals is the economic policy priority

Back in July 2020, Ukraine has politically supported the European Green Deal[1] (EGD) that aims at achieving the EU’s climate neutrality by 2050. Meanwhile, the same goal articulated in Ukraine’s National Economic Strategy 2030, approved in March 2021, is to be achieved by 2060, which is also rather ambitious given the country’s economic capacity.  

Energy transition to a carbon-neutral economy in the coming decades should become an absolute priority for the Ukrainian government, the parliament and businesses, as this is the only possible option to ensure the country’s competitiveness and its progress in civilizational development. In fact, Ukrainian Green Deal[2] is the best economic tool for Ukraine’s gradual entry into a single European political and economic space and its achievement of sustainable development goals, as defined by the UN resolution of 25 September 2015[3].

Approval of NDC2 pursuant to the Paris Agreement is one of Ukraine’s key international climate commitments. If not done in time, Ukraine will not only be left without European investment, but will lose a significant share of the European market, being deprived of the opportunity to apply an individual plan within the EU Carbon Border Adjustment Mechanism implementation (CBAM[4]).

As practice shows, the Ukrainian government still suffers from an old “bug” — first, undertaking overly unrealistic commitments, and then failing to fulfil them. Therefore, in formulating the country’s NDC2, it is vital to determine the ambitious yet achievable indicators that should be performed in the least costly way based on current technological and financial conditions of the economy.

The draft Analytical Review of the 2^nd Nationally Determined Contributions to the Paris Agreement (Analytical Review) presented by the Ministry of Environmental Protection and Natural Resources (Ministry of Environment) in April rationalises the NDC2 formation. It was developed based on the Modelling Report (Report 3) in collaboration with the NASU Institute for Economics and Forecasting with the EBRD and the Government of Sweden support[5].

The extensive work completed by the team of experts on modelling various scenarios for reducing greenhouse gas (GHG) emissions deserves plenty of respect. However, the author would like to briefly present his own views on the above-mentioned project with a focus on the energy sector.

Ukraine’s achievements in decarbonisation

First of all, it is worth noting that decarbonisation is the only ​​activity area where Ukraine has achieved impressive results over the years of independence, becoming a world leader in reducing GHG emissions to 341.9 million tons of CO₂ per year during the period from 1990 to 2018, or by 61.3%. In the energy and heat production, this reduction was even greater — 64% (to 99 million tons of CO₂).[6]

However, this reduction was largely due to changes in the structure of the economy, including a several-fold decrease in the share of heavy engineering and general industrial production, along with an increase in the share of services. Renewables development and increased investment in energy saving have started to play a noteworthy role in decarbonisation only in the last few years.

In 2005–2020, the renewables sector has become the most attractive for investment in Ukraine following the introduction of a “green” tariff. This is evidenced by investment of about EUR 6.0 billion in the construction of solar and wind power plants. Such an input allowed exceeding the planned annual production of wind and solar farms, determined by the Energy Strategy of Ukraine until 2035 (ESU) for 2020 in the amount of 9 billion kWh[7]. The baseline indicator of the National Renewable Energy Action Plan until 2020 — 11% of renewables in total final energy consumption — has also been exceeded.

However, these achievements are eclipsed by the huge debt crisis caused by short-sighted government policy. After all, the growth of renewables generation has resonated with effective demand due to high “green” tariffs, shortage of manoeuvring capacities and current destructive model of the electricity market. In fact, the Ukrainian energy sector today follows the Venezuelan rather than the European path. For more detail, see the article “The electricity market that ZE built”[8].

Overall goals and measures to reduce GHG emissions (the Ministry of Environment proposals)

According to the Ministry, by 2030 NDC2 should be reduced by 65% compared to GHG emissions in 1990. This will require funding in the amount of EUR 102 billion. It is assumed that the energy and heat production sector will be the largest driver of GHG reduction, as it is expected to reduce emissions by 38 million tons of CO_2, or by 36%. Until 2030, this will allow reaching 61 million tons of CO₂, or 23% of the 1990 level. Implementation of such measures until 2030 will require EUR 26 billion.

The outlook presented in the Ministry’s Analytical Review envisages an increase in electricity consumption by 30% — up to 190 billion kWh. In addition, it is planned to replace or decommission most coal-fired units in line with the National Emissions Reduction Plan for Large Combustion Plants (NERP).

By 2030, it is also expected to triple the electricity production from renewables (including HPPs and PSPPs) from 18.4 to 60 billion kWh, which will increase the share of renewables in the overall electricity production to 30%.

Compared to the energy sector’s extremely ambitious climate targets, the industrial sector is in clear discordance with it. Specifically, the Analytical Review predicts that the latter will not only not reduce GHG emissions, but rather increase them at an unprecedented pace to 89 million tons of CO₂, or by 16%.

How realistic is the Ministry of Environment scenario?

Speaking of reduction of GHG emissions by 65% ​​by 2030 compared to 1990, this goal is not only achievable but also insufficiently ambitious. Therefore, it is necessary to set higher goals, but this would require changes in the conceptual approach to the implementation mechanisms. So, the measures proposed by the Ministry of Environment are far from optimal — instead, they are extremely costly and unrealistic. This thesis needs clarification.

First, as noted in the document, the rapid growth of additional renewables capacity will imply the need to increase the electricity tariff by 70%. This will make Ukrainian industrial products uncompetitive, forcing basic enterprises to cease their activities.

Second, the shortage of manoeuvring capacities already causes the need to limit solar and wind power plants production, and addressing this problem will require additional EUR 3–4 billion.

Third, the government has created an inoperable model of the electricity market, which in 2020 led to almost UAH 40 billion losses of basic energy companies[9], while the debt of the state-owned Guaranteed Buyer company to RES electricity producers amounts to UAH 20 billion. The Investor confidence in the government is next to none, as the latter ignores its obligations enshrined in law. These factors indicate that the investment pause in the renewables sector may continue at least until 2024, with limited funding for new projects.

Fourth, more than EUR 4 billion were not taken into account to meet NERP indicative targets to close or replace about 15 GW of coal-fired heat generation capacities. No proposals with practical financial instruments and revised energy balance to implement a more realistic plan were put forth.

Fifth, the rationale behind the need in sharp increase in GHG emissions by the industrial sector due to expected growth of its output is very questionable. After all, the competitiveness of production in a fierce struggle for markets can be only achieved through the introduction of innovative energy- and carbon-intensive technologies, which elsewhere are much more efficient than those existing in Ukraine. Moreover, the CBAM will not allow Ukrainian companies to increase their GHG emissions, as they will be forced to pay unaffordable customs duties or taxes.

Sixth, the forecast of growing demand for electricity by 30% by 2030 is unsubstantiated, because according to the ESU provisions, economic growth can be achieved at a constant total primary energy supply (TPES)[10] by halving the energy intensity of GDP. Therefore, even with the increasing electrification of the economy, the growth of demand for electricity will hardly exceed 5–10%. In this context, one should also take into account the expected significant population decline by 2030 (by at least 5–7%) due to natural demographic reasons and migration abroad.

Conceptual proposals for adjusting NDC2 measures

While fully supporting the Ministry of Environment’s aspiration to timely approve NDC2 and shift to climate-neutral economy, it is still advisable to set a more ambitious goal — reducing GHG to 70% by 2030 compared to 1990 — by adjusting the structure of measures and placing other emphases.

Moreover, this can be achieved in a more efficient way, by reducing financial costs by 15–20%. The following actions have the greatest potential for reducing GHG emissions, including revision of forecast indicator (reduction of GHG emissions) in the industrial sector, reduction of energy and carbon intensity of production and decommissioning and dismantling of obsolete TPP units. The development of energy storage systems (ESS) can become vital, as it will be impossible to achieve the renewables sector goals without ESS due to a critical shortage of manoeuvring capacities.

Detailed proposals for adjusting NDC2 measures by 2030 provided below:

1. For the industrial sector, change the indicative indicator for the growth of GHG emissions to 16% to GHG reduction to 10% due to investment in modernisation of metallurgy and mechanical engineering through the introduction of energy efficient and carbon-neutral technologies.
2. Revise the forecast for increased electricity consumption from 30% to 10%, as economic growth may occur primarily due to the dynamic reduction of energy intensity of GDP, as stipulated by the Energy Strategy of Ukraine until 2035 (ESU) — from 0.28 in 2015 to 0.15 in 2030 (TPES in tons of oil equivalent / $ PPP[11]).
3. Reduce the forecast for the renewables share in electricity production from 30% to 22%. Change the disproportion between the development of solar and wind power plants in favour of wind generation. The skew towards solar power in the last five years has led to a shortage of manoeuvring capacities. At the same time, achieving a 30% share of renewables is unlikely given the large deficit of manoeuvring capacities and the investment climate in the country.
4. Set up energy storage systems (ESS) with 2.5 — 3 GW capacity through the formation of a stimulating environment for investment in this promising area and the development of market of ancillary services. ESS are more economically feasible than balancing facilities based on gas turbine systems. Implement pilot projects on the use of hydrogen technologies as ESS.
5. At the legislative level, obligate Ukrenergo to issue permits for new projects in the renewables sector, depending on the plan of availability of manoeuvring capacities. One of the mechanisms to eliminate the shortage of such capacities may be an option for investors to build the renewables generation in combination with ESS (the latter should make 30% of RES design capacity).
6. Develop and approve the Hydrogen Strategy of Ukraine with a focus on the provisions of the EU Hydrogen Strategy. Adopt legislation to stimulate investment in the production, transportation, supply and storage of “green” hydrogen.
7. Form a climate governance architecture.
8. Ensure brand new quality of the investment climate in the electricity sector: during 2021, repay 100% of debts to RES enterprises; improve the Special Obligations (PSO) model; eliminate price restrictions from administrative intervention; introduce market prices for all categories of consumers; introduce auctions to set tariffs for renewables; increase transparency and impartiality of the National Energy and Utilities Regulatory Commission.
9. Within the framework of implementation of Directive 2010/75/EU and the EU-Ukraine Association Agreement, propose a new version of NERP providing for cost saving from EU 4.2 billion to EUR 1.3 billion by optimising the integrated energy system via replacement of coal-fired power plants with renewable generation. Instead of spending money on modernisation or construction of new TPP units with a total capacity of more than 15 GW, it would be sufficient to reconstruct units with a total capacity of 6 GW and dismantle the remaining units by 2030, using their ancillary infrastructure for the construction of ESS and hydrogen generation. In addition, it is necessary to provide special financial mechanisms for NERP implementation, such as a special fund to be replenished by public funds, international grants, environmental payments and tariff surcharges[12].
10. Introduce a market for GHG emission quotas as more advanced mechanism for stimulating environmental modernisation of companies compared to the environmental tax. This should be based on Europe’s Emission Trading System (ETS) model. The quota market is an alternative to the export tax to EU countries. Cooperation and coordination with all stakeholders is essential for moving towards low-carbon energy and building strong negotiating positions to mitigate the impact of CBAM[13].
11. At the government level, intensify efforts to obtain a country-specific terms of CBAM application. Ukraine may count on special, less strict CBAM requirements if it demonstrates practical cases and results. At the same time, Ukraine’s accession to the European Green Deal should occur recognising the different starting positions of Ukrainian and European companies.
12. Develop a concept for the creation of the Ukrainian “climate fund” (or “energy transition fund”) — a separate legal entity with the mandate to attract international funds and adopt programmes for stimulating domestic enterprises to improve decarbonisation of their production.
13. Given the socio-economic situation of the country, the loss of large territories due to Russian aggression, and the need in significant expenditure to curb Russia’s expansion, Ukraine alone is unlikely to attract more than EUR 80 billion to implement NDC2 measures. Therefore, such measures should include provisions that Ukraine can only meet its obligations if receives relevant financial assistance and EU loans to the amount of at least 40% of the total need.
    

[1] European Green Deal

[2] Unofficial name of Ukraine’s green course with the focus on European Green Deal

[3] Transforming our world: the 2030 Agenda for Sustainable Development

[4] Carbon Border Adjustment Mechanism — for more detail, see S.Chekunova, “EU carbon border adjustment and challenges for the Ukrainian economy / energy”, the Razumkov Centre, https://razumkov.org.ua/statti/prykordonne-vugletseve-koryguvannia-yes-ta-vyklyky-dlia-ukrainskoi-ekonomiky-energetyky

[5] Source: The Ministry of Environmental Protection and Natural Resources of Ukraine — https://mepr.gov.ua

[6] Draft Analytical Review of the 2^nd Nationally Determined Contributions to the Paris Agreement, developed by the Ministry of Environmental Protection and Natural Resources of Ukraine, April 2021, p. 4 and 7, https://mepr.gov.ua

[7] Actual production was 10.84 billion kWh — ExPro Consulting, https://expro.com.ua/novini/virobnictvo-elektroenerg-v-ukran-protyagom-2020r-znizilos-na-33-do-1488-mlrd-kvt-god

[8] See V.Omelchenko, The electricity market that ZE built, the Razumkov Centre, 16 November 2020, https://razumkov.org.ua/statti/rynok-elektrychnoi-energii-shcho-zbuduvav-ze

[9] Ibid.

[10] TPES — total primary energy supply

[11] PPP — purchasing power parity

[12] See V.Omelchenko, S.Chekunova, M.Biliavsky, Energy sector of Ukraine: Challenges and initiatives, Kyiv 2020, www.razumkov.org.ua

[13] Proposals 7–9 previously formilated in S.Chekunova’s article “EU carbon border adjustment and challenges for the Ukrainian economy / energy”, the Razumkov Centre, 7 April 2021, https://razumkov.org.ua/statti/prykordonne-vugletseve-koryguvannia-yes-ta-vyklyky-dlia-ukrainskoi-ekonomiky-energetyky