Commitment to Stabilization
The regulatory developments surrounding the establishment of the electricity market in Ukraine and commitments undertaken by the Government towards the renewable energy investors are part of a long-lasting, ongoing battle on all fronts involving stakeholders and the state. We discussed the situation with new and existing investment projects with Ivan Bondarchuk, counsel, head of energy and natural resources at LCF Law Group, as well as the state’s performance to stabilize the situation and relaunch the confidence of investors.
What trends could you single out on the energy market of Ukraine?
Ivan Bondarchuk: Generally, the first two years since the launch of the electricity market could be described as the pending battle for cash flow between existing power generation stakeholders, traders and the state, with its political interests. Therefore, the market was unstable, full of trading manipulations and abuses. This situation resulted in the current situation when a ‘winter energy crisis’ is highly foreseeable.
How would you comment on the developments around competition on the electricity market?
I.B.: Competition on the electricity market could be assessed as low. Until recent times, state-owned nuclear and large-scale hydrogeneration (Energoatom and UkrHidroEnergo) did not efficiently participate in the market serving the supplying of low-cost electricity for households under the PSO mechanism.
Additionally, state-owned Tsentrenergo (CHP operator) and Energoatom were suspected of carrying out discounted electricity sales of electricity for the benefit of privately-owned traders.
In this scenario traders competed with other generating companies in their attempts to set the most favorable price for electricity.
Traders affected the day-ahead electricity market with unsecured bids, causing dumping on the electricity market. In response to that, power-generation units (specifically, private CHPs) reduced their sales in this segment, moving to the balancing market (where electricity is more expensive) or to bilateral PPAs executed with affiliated entities.
What were the regulatory responses from by the National Energy and Utilities Regulatory Commission?
I.B.: The Regulator has permanently made efforts to stabilize the market.
First of all, the National Energy and Utilities Regulatory Commission (NEURC) has installed price caps for the balancing market — low cap (sales cap) at the level of 55% of the day-ahead market price, and high cap (purchase cap) of 115% of the day-ahead market price.
This regulation has not been very efficient. Particular market players dumped the day-ahead market, forcing the power generation unit to sell electricity at the low balancing market cap.
The NEURC has responded and cancelled the low cap.
The next series of market abuse happened in spring 2021. In response to the low market price, power generation has left the day-ahead segment and moved to the balancing market (where electricity is more expensive) or to bilateral PPAs executed with affiliated entities.
In response, the regulator ordered mandatory minimum salling on the day-ahead market amounting to 10% of the producer’s load. Additionally, the Regulator has prohibited power generation companies from selling more than 50% of their load to affiliated utilities.
However, all these responses are tactical. In order to ensure competition on the electricity market the NEURC shall build up efficient cooperation with the Antimonopoly Committee of Ukraine to investigate such abuses. Implementation of REMIT legislation could be also helpful.
Draft law No. 4503 provides for implementation of regulations on the wholesale energy market for its integrity and transparency. In particular, it envisages a list of violations and abuses which could be committed by stakeholders of the electricity market, including insider trading, unsecured bidding and manipulative behavior and strict sanctions applicable thereto.
Over the last couple of years, we saw the so-called crisis around the feed-in tariff and state commitments before investors. Do you see any stabilization in this area?
I.B.: This issue has still not been resolved by the Government. However, we see their commitment to stabilizing the industry. At first glance, the criterion for assessment are pretty obvious — i.e. performance of the commitments undertaken by the Government before the renewable energy industry under the Memorandum of Understanding signed on 10 June 2020.
The most critical provisions of the MoU provide for repayment of the ‘feed-in’ tariff debts by the end of 2021 and avoidance of subsequent hostile actions against renewable energy projects.
In the last few months the Government made significant progress on debt repayment — the Cabinet of Ministers and NEURC approved state guarantees for the Green Bonds to be issued by NEC Ukrenergo to repay the debt owed to the SE Guaranteed Buyer.
This demonstrates the dedication of the Government towards its commitments and adds trust in the eyes of the investors.
The investors also succeeded in protecting themselves from the initiative to implement additional excise tax for renewable energy, which could, in fact, result in additional 3.2% fall in revenue of these projects.
At the same time, we’ll be able to speak about stabilization of the industry once new projects appear. At this point the industry requires clear and transparent conditions for the development and elimination of policy and regulatory risks.
For instance, there is currently ongoing discussion on the implementation of ‘feed-in’ premium (FiP) support mechanism for existing projects. Generally, market players assess FiP as a reasonable opportunity. However, FiP should be available as an alternative to the ‘feed-in’ tariff. Mandatory replacement of the feed-in tariff with FiP could be regarded by the investors as another breach of state guarantees and investment expectations.
Could you please explain the current situation around domestic and foreign investment projects in the renewable sector in Ukraine? Basically, there were several high value project finance deals and entry by some of the biggest international developers.
I.B.: Sure. Over the last year we have observed several high-value investments. The most prominent and famous are, probably, the acquisition by Nebras of majority shares in the projects developed by UDP Renewables, and purchase of Ukrainian solar portfolio by Total Eren.
This demonstrates the trend of the market — acquisition of operating projects. The most important reason for this is simple. The conditions for the new development of renewable energy projects remain unclear.
The second aspect is that the acquisitions are driven in the main by big international investors who enjoy significant financial resource and could sustain turbulent times. These stakeholders are ready to purchase the projects if there is a local developer willing to exit the business at a reasonably low price.
You are highly active in the community of investors and developers. How would you comment on the mood of investors towards implementing new renewable energy projects and constructing new facilities? Does it affect the incoming requests from your clients?
I.B.: In the second half of 2021 the most active investors began their search for new projects specifically in wind energy.
The rise in prices on the electricity market creates additional incentives for that. In October the average price for electricity on the day-ahead market reached UAH 2,516.91 per 1 MW*hour. In the first days of November the price index exceeded UAH 3,000.00. In other words, today the electricity market offers the investor more than the Government under the feed-in tariff.
Such pricing policy creates an opportunity for the development of new generation facilities under the Corporate PPA (C-PPA) scheme. That is, for a long-term direct power purchase agreement between the offtaker (trader or industry-scale consumer) and the producer.
At the same time, C-PPA, as a market-based agreement, requires additional services for efficient trading to mitigate price hedging and the pike shaping risks of the unstable electricity market. Therefore, the development could be accelerated if the Government implements additional incentives like FiP, contract for difference or green certificates.
We know about your growing GR work in the sector. In particular, your team was a legal counsel to the Ukrainian Association of Renewable Energy in mediation with the Government on review of the feed-in tariff, and coordinated protection of its members during consideration by the Constitutional Court of Ukraine. Could you explain the specifics of GR practice in the highly-regulated energy sector?
I.B.: The GR practice on the energy market is highly dependent on the fact that it involves a variety of stakeholders and affects all segments of the economy.
For example, one cannot simply increase the tariff without abusing consumers. On the other hand, in the end somebody will pay the market price for electricity, generation facilities and grid infrastructure. This consequence becomes even more complicated when the climate-related aspect is on the table. Somebody will pay additionally for the emissions or invest in climate-neutral generation facilities. For example, it is no coincidence that the EU is promoting changes on the electricity market as a ‘fair deal for consumers. That is, as a compromise between the energy industry, households and business consumers.
For example, in addition to the mentioned Mediation and Constitutional Court case, we are now dealing with a complex state aid matter.
Starting from 2022, Ukraine has a commitment to apply EU regulations prohibiting state aid, namely support for business entities by the state, which affects competition. It also provides for very strict rules allowing so-called ‘compatible’ state aid programs.
In the light of this, the Ministry of Energy, NEURC and AMCU will cooperate to ensure qualification of the ‘feed-in’ tariff or alternative support schemes (such as ‘feed-in’ premiums) under state aid regulations. We, in unison with our clients, provide stakeholders with analytics and arguments which could be used to achieve this goal.
For example, our team, together with the expert on EU state aid legislation, Dr. Leigh Hancher from the Florence School of Regulation, have prepared the amicus curiae on this matter. Therein we have explained how EU state aid regulations and the applicable case law of European Court of Justice could be applied to the Ukrainian electricity market.
Therefore, in addition to excellent knowledge of the client’s business, a successful GR team shall demonstrate excellent understanding of the market and how it could be affected by various regulatory decisions. Furthermore, understanding the interests and powers of different market stakeholders and the Regulator is of vital importance.
In April 2021 the first investment arbitration was initiated by Modus Energy International B.V., and it’s likely that the decision is a highly-anticipated one for its precedent-setting nature. What is your view on this? Would you anticipate new investment claims in the near future?
I.B.: We are currently aware of the second claim against Ukraine brought by Belgian wind farm developer SREW N.V. to the International Centre For Settlement of Investment Disputes.
We discussed this issue a lot with our arbitration team and international colleagues. First of all, there are no strict case law rules in investment arbitration, and every case shall be assessed individually. Therefore, existing cases will hardly form precedents for ones which could follow them.
On the other hand, the outcome of the Modus case and the SREW N.V. case will form the background and framework for assessment of any subsequent FiT-based claims against Ukraine. The quality of the legal position, document production and discovery will form the attitude of arbitrators to a Ukrainian case and could affect subsequent initiatives. Therefore, all investors and the legal community will keep an eye on it.
At the same time, the most important thing is the fact that the existence of both cases demonstrates problems in the implementation of commitments undertaken by the Government before investors in mediation. The vast majority of investors are waiting for the Government to perform its commitments specifically for the sake of debt repayment. Should the Government fail to perform, then more investment arbitration claims could be expected early next year.
What about regulatory disputes? Are they politically motivated or quite reasonable?
I.B.: The first regulatory dispute that comes into my mind is the challenge to the imbalance settlement formula brought by renewable energy producers against the NEURC.
According to the law, RES producers shall compensate the SE Guaranteed Buyer for the share of the imbalance settlement costs caused by wrong generating forecasting. The formula for calculation of the compensation for each power producer defined the individual imbalance (deficiencies between generation forecast and actual electricity output).
In January 2021, the Regulator introduced the new vision. The basis for compensation was calculated as the overall imbalance settlement cost of the Guaranteed Buyer calculated as the difference between purchases at the FiT and sales on the electricity market. In other words, as a result of the new formula renewable energy producers compensated the Guaranteed Buyer for the imbalance caused by its trading policy in addition to forecasting imbalances.
Such an approach obviously contradicts the Law of Ukraine On the Electricity Market and to state guarantees given to renewable energy producers for offtake of all generated electricity at the feed-in tariff.
The new formula is currently subject to judicial review. If the court is reluctant to cancel it, then Parliament will be able to restore the interests of investors through relevant legislative amendments.
What are your expectations for 2022?
I.B.: First of all, we believe in the future growth of businesses on the electricity market.
Early next year (probably by mid-spring) businesses will receive the information required to update their plans and prognosis. That is, regarding performance/misperformance of the Government’s commitments before RES producers, fair price indicatives on the day-ahead market, future rules for renewable energy project development.
If the Government is successful in the performance of its commitments and plans, a new cycle of investments coming to the electricity market could begin. My bet is that as early as spring 2022 we will hear announcements about new significant projects and investments. On the other hand, if the Government were to fail, we will watch new arbitrations and regulatory claims.