Six months ago a new model of the electricity market was launched in Ukraine, and companies received more flexibility for operations. Along with that, the National Commission for State Regulation in Energy and Utilities (NEURC), as the regulator, became indispensable in the national energy and utilities sectors. The NEURC introduces price caps, regulates tariffs for natural monopolies, has the right to restrict imports, influences Guaranteed Buyer SE and its finance, and, consequently, payments due to offset the national renewable energy generation, as well as remains a key decision-maker in a number of other important issues.
In this interview with ExPro, the NEURC's Chairman Valerii Tarasiuk shared his vision of price caps and their functions, approaches towards electricity imports, Public Service Obligations (PSOs), management of crucial issues impacting the sector, offsets for conventional and renewable energy generations, functions of NEC Ukrenergo as the national transmission system operator (TSO), RAB tariffs for power distribution, other challenges looming over the Ukrainian energy sector.
How can you give an overall assessment of the changes that have taken place in the electricity market since July 1, 2019? What were the results of the first half of 2019?
An overall assessment is a challenge in kind. The changes that have taken place in the electricity market since July 1, 2019, are controversial, I must say. We all know that our electricity market is very volatile. Although six months have passed, but I still view it as if it were a start of the process. Nowadays, no one fully understands how the market works. In fact, this is a market, which no one can predict for 100%. The market is so volatile that there are times when one has to intervene administratively. It happened that with the launch of the market the price for electricity soared by 30% for businesses. Then, after changes in PSO mechanisms, and after suppliers learned how to import (because prior to that we did not have electricity imports, except for Ukrinterenergo deliveries in 2014, in particular, imports from non-member countries of the EU Energy Community - Russia and Belarus), and then electricity prices plummeted record low. Now, prices have risen again following appropriate government interventions, changes in PSO mechanism, and some other measures urgently taken, so that electricity prices became reasonable.
We are monitoring the behavior of electricity prices and benchmark them against the electricity imports. We also oversee the operation of nuclear power units, and we expect another nuclear power unit to be put into operation in a week. Then it will be more or less clear how the market works under the PSO mechanism that is in place today.
You’ve mentioned electricity imports. Recently, Energy and Environment Minister Oleksiy Orzhel sent a letter to the NEURC proposing to limit Russia and Belarus cross-border electricity interconnector capacities when auctioning them by NEC Ukrenergo. What is your opinion on this?
In our opinion, this is a controversial topic, and one should handle it very carefully. The Ministry's concerns are clear: they are not much concerned about the legal component of the letter, rather than about coals to be stockpiled in warehouses. We have always been afraid that we have little coal, but today there is a non-standard situation of warm weather, and coals are not burnt. In addition, we still have large capacities of nuclear power generation, we have increasing volumes of renewable energy, we have thermal generation running at minimal output.
I talked to the minister, in this case their approach is to burn more coal, then more money will go to thermal generation, and, in particular, more money to pay salaries to miners. But, as the regulator, we can't have a one-sided view on all that, but take into our view the interests and concerns of all pertinent parties. That is what we are trying to do. Import restriction is a very responsible and important decision, which may entail serious implications for the sector. What is between the lines?
Well, we have a highly concentrated market, we have few players that are overtaking nearly entire market, are influencing the market, including electricity prices, as such. Import is a factor that somehow attends to competition.
As a new powerful factor...
It is not even so powerful, just a new attending factor. What do I mean when I say we monitor imports? We look at the volume of imports and track NEC Ukrenergo's dispatch curtailments [of excessive imports - Ed.] to prevent a negative impact on the country's grid. There were many occasions when imports make us to temporary shut down our electricity generating units. It is not acceptable when our market price for electricity is below the production cost of domestically generated electricity. However, when imports are within reasonable limits, for example, within 25-3%, they do not pose any threat to the grid or the national generation of power, rather than fuel and stimulate the competition. And, one sees market mechanisms working better.
Whenever we restrict imports on a whim, we seriously affect the competition, the one created through imports as well. This may send negative signals to Belarussians and Russians: after our businesses, traders and government officials (the Minister himself agreed to interact with Belarusians) have agreed on something, and we just of a sudden administratively switch off the interconnectors. Then how can we negotiate in future with them? Prior to joining the NEURC, I worked for a company, we planned to trade in electricity, including its import. We communicated with Belarusian companies as well. I imagine myself there communicating with, say, Belarusian companies. We have talked, we have tried hard to negotiate out acceptable volumes, and we have our interlocutors as saying: "What are we negotiating with you? You, as traders, want to come to an agreement with us on price, volumes, but your government treats imports in a voluntary and unpredictable way." Well, what am I driving at? There are times when one needs to do this [to limit import capacity at auctions - Ed.]. But there should exist urgent and reasonable grounds for doing that. Currently, just doing it, I think, is irresponsible from the perspective of the regulator.
Whenever we restrict imports on a whim, we seriously affect the competition, the one created through imports as well
Even if we come to the conclusion that we need to restrict imports by curtailing the interconnector capacities traded monthly or daily on auctions, something should be done to regulate the price. Because, by limiting imports, we reduce competition in the market, and this undoubtedly leads to higher prices, make them uncontrollable, and that in turn make our consumers and our economy suffer. I mean, first of all, industrial consumers, though household consumers will also be affected.
We say that this is a self-deception, that residential consumers pay less. The latters in full cover the price of electricity paid by industrial or commercial consumers, because households and residents buy goods manufactured by industry for them. Manufacturers simply include the cost of electricity into the price of their goods sold to residents as end-users. But this affects competitiveness of our goods in foreign markets, starts the inflation flywheel. We can't just disregard this. Therefore, even if we ought to do something, for example, to limit the upper price caps. I say this,so that the generation wouldn't think that the NEURC can simply switch imports off. We can't do that, we have to think about all the parties pertained.
Regarding the price caps. At the end of the last year, the Parliament amended the law "On the Electricity Market" empowering the NEURC with the right to introduce price caps when critical circumstances arise. What could those critical circumstances be like?
I would ask you the same question. Wonder, why? Because the law or by-laws do not any longer define the limits of critical circumstances. This means that the legislators have entrusted us with wide authority to determine that. How wide the authority is, excessively wide, or not? It is probably much depends on the regulator's competence. Such authority can inflict harm or be for good. We are doing our bests to be balanced as much as we can in this regard. We see this norm, we see that we have been given a broad authority, we see that the notion of "critical circumstances” is nowhere clearly defined. This means that the regulator themselves must determine how critical the given circumstances are. If there emerges an urgency in the grid, would one debate whether it is critical or not? Besides us, we see no one who can properly determine whether circumstances are critical or insignificant ones.
How do you evaluate the effect of using current price caps? Have they accomplished their task?
Especially during the first months, they certainly fulfilled their function. We were watching at what time of the day the market prices bumped into the price caps. In July and August of 2019 that cases were most frequent. Just after the launch of the new model of electricity market, prices almost reached the price caps, but now market prices have bounced down... Though, even these days, market prices at some hours reach the upper edge of price caps. On the one hand, if only for two hours a day prices reach price caps, then it would be good to cancel them altogether. Then it looks like a real market, without any price caps or restrictions. And consequences are small, should for two hours the market prices jump higher the price caps. But we see the volatility of our market, imports are limited, prices soar, and so on.
I have on my finger tips a counter argument for power generators, who are constantly nudging about cancellation of the price caps: Why should we cancel them when the market prices are still below the price caps? They simply do not affect anything right now, rather than perform the function of a cautionary trigger, a watchdog, which is dormant for now but is on alert [over the market prices - Ed.). In such a case, let the price caps be as they are. I understand that in terms of a developed market, there is no future (hopefully very soon) for price caps, although a regulation authority could be appropriate. Currently, at the early development of the market (I believe that the electricity market is only in its early stages, though it has already been functional for six months), the price caps are essential indeed. We are communicating with our international partners (such as USAID), and they provide us with all due information to facilitate our activities as the regulator.
I feel confident that at this milestone the price caps are really essential.
Could you please comment on the price situation in the balancing market? Ukrhydroenergo says that according to NEC Ukrenergo, the company is impelled to buy daytime electricity at higher price when pumping water into the upper reservoirs of the PSHPs, though to sell their PSHP-generated electricity at prices below the ones spent for. Have the NEURC studied this situation?
We’ve heard about that issue, but I haven't had a meeting with Ukrhydroenergo yet. We are engaged in regulating prices in the balancing market, we have more or less adjusted their minimum and maximum. The most important thing for Ukrhydroenergo is the ancillary services market, which is in fact not in place so far. However, we all hope that Ukrhydroenergo will be the main stakeholder in this segment. We have a meeting scheduled for tomorrow [January 23, 2020 - Ed.] to discuss the market for ancillary services. The steps we think to be made is to ensure purchases of ancillary services. We have already done this through inclusion of their costs into the tariff for NEC Ukrenergo. Last year we allocated more than UAH 400 million for that purpose, but the funds were not actually used. This year we put much more. Some initial amount to launch the market is available, and we track it.
As of current, the Guaranteed Buyer SE is lagging behind the schedule of offsets for renewable generation. Has NEURC examined the scarcity of funds at this enterprise and sources for its replenishment? What could you suggest?
I think your information is a bit outdated. They have settled the issues with universal service providers, who somehow did not accurately reflect the volumes and schedules of electricity purchased for the needs of domestic consumers, i.e. small non-household consumers, as well as for technological losses. After this adjustment in place, the Guaranteed Buyer SE have collected or will collect about UAH 2 billion. These funds will be sufficient to offset the previous periods of the renewable energy generations. In future, the electricity consumption schedule for customers of universal service providers will be better, this was one of the lapses in the market during its initial stages. The Cabinet of Ministers, the Ministry of Energy, NEURC, and the universal service providers (we must pay tribute to everyone!) have corrected this.
Have the funds for the Guaranteed Buyer SE's been released?
Yes, they have been released, but with funds we covered payments arrears of 2019. We are regularly meeting with Guaranteed Buyer SE, though, during the last meeting they did not raise the issue that they have a lack of funds. I understand this was because it is still winter, the sun is not shining bright enough, and the wind is still not blowing as it will soon.
Do you mean the spring season?
Precisely, in spring this problem will emerge again. At such a capacity of renewable generation, without proper balancing, these measures [full offtake and offset of "green” electricity- Ed.] will become very expensive. How can one address it from a formal point of view, without really delving much into this issue? Well, no matter how costly could be that generation, the legislator has an instrument: everything that lacks Guarateed Buyer SE should be offset by NEC Ukrenergo. One just have to include the lack amount into the tariff of NEC Ukrenergo. But, it just does not work that way, because to simply offset the shortage of funds through the tariff of the TSO means a rise in electricity price for all consumers, a low competitiveness, a start of the flywheel of inflation. The low competitiveness, in turn, brings extra inflation. This is a deadlock, and where in the end do we get at? Should we make the country to knee? That won’t do, to say the least about the technical component: who should be curtailed first of all by Ukrenergo when the sun shines and all of our solar plants stations start operating in full swing? Therefore, this is a strategic issue for the state.
The main initiator should be the Ministry of Energy. Today we have a competent Minister, whom we support and respect. We are cooperating with the Ministry, and this is a historic point that the regulator and the Ministry of Energy cooperate quite productive. We tell them, they hear us, and promise in the next couple of weeks to finally submit a draft law to brace up together and balance this system. It will be a hard work, because no one likes to be labeled as an enemy of "green" energy, of investors, of international image of the country.
Renewable energy is a very good thing, I like it too, and I am all for "green” energy. But its players have to understand that there is no other way out.
I understand that you do not support Draft Law № 2543 by Lyudmila Boymister?
We do not support it, it is insufficient in its content. It's akin to an anointing a large wound with brilliant green tincture [cheap first-aid alcohol tincture in ex-Soviet countries- Ed.]. We have sent a letter with our concerns to them. I have heard that some of us have already been called opponents of "green” energy. This is not true, we are not against "green” energy, but we have openly voiced our position at the Parliamentary Committee that the Draft Law should be more decisive in ensuring both the financial and the technical aspects.
You mentioned the Law on Grid Balancing. What is the NEURC doing to create, a legal framework to stimulate, balancing services for the grid?
Yesterday I saw a Draft Law introducing energy storages. It is submitted to the Parliamentary Committee. I have a lot of questions to it, it looks sloppy. NEURC is involved in the process: there is a Draft Law and we will express our opinion on it. That they [energy storages and other approaches - Ed.] are needed - yes, no one doubts that. The core thing is in the nuances: we do not have to create grounds for misinterpretation. Lest it happen that renewable generators construe the Law that the construction of energy storages for renewable energy generators shall be offset in the tariff of NEC Ukrenergo, and then formers shall enjoy the enhanced "green" tariff for their renewable energy. Are energy storages needed? Sure, they are. On the terms that have been suggested? This is questionable. So that we do not repeat the mistake alike 45 Euro cents for kWh of electricity from renewable energy sources at the onset of the new electricity market.
How is the NEC Ukrenergo's certification process moving?
We have been a little distracted by the latest certification of gas transmission system operator in the lead-up to gas transit negotiations. Though, we see currently how certification practices with the GTS operator can be applied for certification of NEC Ukrenergo and how to follow the ISO model. The preliminary certification of NEC Ukrenergo has been made somehow hastily. Now we all agree that it is necessary to adopt a law on the model for certification of NEC Ukrenergo, a draft of which will be submitted shortly by us.
In the light of recent changes in the legislation, how will the staffing of the NEURC change?
The composition of the NEURC, after the new law enters into force, will remain for the period of 6 years minus the time that the staff worked out prior the law came into effect. In parallel, according to the presidential decree, the process of rotation of the NEURC staff has begun. This very year one member of the commission will be laid off and re-appointed based on a competition selection. In 2021 the same process will be for the second member of the NEURC, in 2022 for the third NEURC member, in 2025 for other two NEURC members, and in 2025 for the last two NEURC members in a row. The rotation plan is approved by the presidential decree, and we are all ready for the rotation process. All are interested in certainty and the soonest time when the competition commission to start their work.
As to the electricity market, Market Operator SE advocates for market coupling of the Burshtyn TPP Energy Island with the neighboring countries (Hungary, Romania, Slovakia, and the Czech Republic). Our neighbors can include it into their day-ahead market, and then the price in the Burshtyn TPP Energy Island would go down. What does the NEURC think about this?
We preliminary support this. This is the European practice. As to possible negative impacts, I have not yet heard about possible negative implications. This idea should be promoted by the NEURC, the Ministry, and the NEC Ukrenergo. Of course, there will be regulatory difficulties, but everything can be resolved.
Is it currently possible to define a set of measures that can help to offset the deficit of Guaranteed Buyer SE and solve systemic problems in the Integrated Power System of Ukraine?
We should sit down and re-write those set of measures. Because it is akin to building of a beautiful house, but first we have to approach the construction site of it. This set of measures will address both the pricing in the renewable energy sector and the leveling of electricity prices in the country as a whole. We must keep in mind that the problems that we have today have a significant current component: abnormal weather.
A very warm winter...
As long as I live, I don't remember a winter alike. The next factor is the decrease in consumption, this is the reality we’ve faced. Right now we are at times when the national metallurgical industry is consuming less electricity than ever before. This is also related to trends in the global steel and metal sector, where consumption fell by 30%. Altogether, it adds up a heap upon tariffs. Therefore, we cannot address the problems of the Guaranteed Buyer SE apart from the problems of the whole industry. Therefore, we have to put on paper a set of measures that we incidentally are addressing now. We are the initiators of solving problems with renewable energy sector, the initiators of solving current problems regarding cross-subsidization, pioneers of other measures.
With regard to PSOs in the electricity market, the Ministry of Energy offered to raise, the price for residents using more than 500 kWh per month. What is the NEURC position in this regard? It is the NEURC who passes such a decision?
In fact, it is not the NEURC, who ought to do that. This decision is made by the Cabinet wth the PSO mechanism. The law now provides that procedure. In fact, since July 1, 2019, electricity prices are liberated. However, the Cabinet can make exceptions through the PSO mechanism [the PSO regulation in the electricity market - Ed.]. And the Cabinet made an exception for the category "consumer" by referring to the resolution of the NEURC, which actually became void on July 1, 2019, though was in effect until June 30, 2019, with incidentally established tariffs for households and residents. The government made a cross-reference. That is, the Ministry actually made this initiative before the Cabinet, although, I think, our opinion is also to be asked for. By according to our calculations, we do not see a very strong effect it may bring. It may have sense or may not, but politically one need to think,whether one should touch the tariffs for the households and residents. If one touches them, then it is essential to align prices rather than toss them without any significant effect in return. It is a questionable approach. Although the logic of the ministry is clear: conditionally, wealthy citizens, who consume more than 500 kWh, should pay more.
What is the amount of cross-subsidization in the electricity market? How much does the industry pay off for household consumers a year?
According to our estimates, this amounts over UAH 60 billion.
Does the NEURC have a vision how to balance these tariffs?
This is definitely a political decision, but one has to be careful there. If you raise the tariffs for the population, one needs to understand where the revenues should go.
There was already one attempt at a phased (five-step) price, increase, but somehow it was receded. It was not receded, it was accomplished. The matter is, where that money did go? In order to balance the prices, we need to understand where the funds should go. So that it won’t be alike the case with subsidizing the renewable energy. Let's level everything up and direct the revenues to recover the deficit of Guaranteed Buyer SE. This is a common assumption among "green” energy lobbyists. The latters suggest one would recover the deficit of funds through the raise of prices for the population. It is not only the "green” energy generation we have issues with. We also have issues with the depreciation of electricity transmission and distribution grids. They need to be replaced, and one should introduce an incentive regulation for electricity distribution network operators and transmission system operators. Certainly, it is necessary, there is no doubt about that.
Next is the gradual reduction of thermal generation and closure of unprofitable mines. It is also a process that has no alternative in future. All that takes money. We have to reduce the nuclear power generation. Everyone agrees that large NPPs will have to be curtailed gradually and be reduced in the long run. This also needs money. In aggregate, these are huge funds, and we have only one pot to boil. To level prices, eliminate cross-subsidization in order to resolve a sole problem - is a wrong approach. We must consider, we need to resolve the problem comprehensively. So that the consumer understands what we are doing it for.
You've mentioned the tariff for distribution network companies. Does the NEURC have in mind a kind of incentive tariffs for them?
One needs funds for that. An incentive regulation without raise in tariff will be a pseudo incentive regulation. One cannot implement it for free, a kind of increase in tariff there will still be. Another thing is, whenever in the previous years the NEURC calculated that, it came to an excessive tariff increase. We are now re-calculating it afresh with other options in mind. With the help of our international consultants, we are exploring options to work out an incentive regulation with the least financial burden possible. Our goal is to introduce such incentive regulation starting next year. But definitely not with a single rate of return, but with two. At present, the regulatory framework provides us only with a single one of ...
... 12.5% both on the old and the new asset base?
Well, I know, we will change it for a new asset base, so that it really wouldn’t turn into a pseudo-incentive for investment. We want this to be a real incentive, the one that encourages investment, to help an investor, the same is true about a business owner, understand that when he invests, he will really get the due rate of return. Definitely, there will be a minimum rate of return on the old asset base. But, these are just preliminary calculations. We want to increase this, so that, for example, in the first year the increase be within 10%.
Is this a 10% increase in the tariff for distribution network companies?
Exactly. And, the tariff increase for the end consumer will be not more than 2% in general.
You've said one needs a higher rate, of return on new assets. Earlier, experts said that it should be raised to the NBU's base, rate, so that it at least, more or less, could recover the cost of capital ...
Yes, we are calculating together with experts to make sure that the rate takes into account not only the NBU’s base rate, but also other important factors, such as forecasts, country rating, predictability, and so on. The preliminary calculations of our consultants yielded the rate of 16 % -17%. They suggest that we use this rate. It is high on the one hand, but on the other hand one can not say that there is no incentive to invest with this rate in place. The 16%-17% for business, without a risk, because it is an infrastructure business akin to monopoly. That would be a very good rate, but we still need to hear feedbacks from all participating parties.
Dmytro Sydorov, Anna Govorukha Interview with the Head of the NEURCAuthor: ExPro