Ukraine: Ukraine's Renewable Energy Outlook Under The New Electricity Market Design

Last Updated: 29 May 2019
Article by Svitlana Teush
Most Popular Article in Ukraine, May 2019

Svitlana Teush, counsel at Redcliffe Partners law firm in Kyiv, Ukraine, discusses the country's new electricity market design and what it means for renewables. Currently, she says, the renewable energy sector in Ukraine is an attractive investment prospect and has considerable potential for further growth in the coming years.

In 2017, the new Law of Ukraine, On Electricity Market, was adopted, which improved the outlook for the country's renewable energy industry and stabilized the legal framework, having enshrined all key components of the support mechanism introduced for power production from renewable energy sources (RES) in 2015, namely:

  • A feed-in tariff (FIT), which is relatively high, compared to that in other countries; for example, currently, for ground-mounted solar power plants put into operation during 2017 – 2019, the FIT pays ca. 15.02 euro cents/kWh, or ca. 10.18 euro cents/1 kWh for wind power plants consisting of wind power units with a single installed capacity exceeding 2MW1, fixed until 2030 and referenced to the Euro;
  • "Bonuses" for the use of locally produced equipment applied as a 5% or 10% surcharge to the FIT, depending on the share of such equipment in the composition of a power plant; and
  • The statutory obligation of a single offtaker (currently, State Enterprise, Energorynok, and subsequently, the so-called "guaranteed buyer", which will replace that) to buy from producers all electricity produced at energy facilities which obtained the FIT during the entire term of validity of the FIT.

This support mechanism, and the guaranteed channels for the sale of the electricity, provide additional security and protection against the market challenges relating to the search for buyers and sale markets, as well as against currency and/or price fluctuations.

Aссording to the data provided by the Ukraine's energy regulator, the National Energy and Utilities Regulatory Commission (NEURC), as of January 1, 2018, the cumulative installed capacity of renewables under the FIT (without those plants located in the territory of the Autonomous Republic of Crimea) totaled 1,374.7 MW, of which solar power plants accounted for ca. 55% (741.9 MW), and wind power plants, ca. 33.8% (465.1 MW).

In 2017 alone, 257 MW of the installed capacity of renewables under the FIT were operational, which is more than double the capacity put into operation in 2016 (ca. 127 MW), and eight times the capacity in 2015 (ca. 30 MW). The solar power plants put into operation in 2017 accounted for ca. 82% of the cumulative capacity of renewables under the FIT, while wind power plants accounted for ca. 10.6% of such cumulative capacity.

The role of RES

Under this law, the role of RES was established and integrated in the design of the new electricity market, aimed at introducing a liberal, open and competitive market in Ukraine in compliance with the Third Energy Package.2

Under this model, a single-buyer wholesale market model will be rejected, and a multi-segmented liberal market will be established in line with the common European pattern, including a day-ahead market, an intra-day market, a balancing market and an ancillary services' market, as well as a market of bilateral contracts, in line with customary practice across many EU countries.

The Electricity Market Law became effective on June 11, 2017 (except for certain provisions relating to changes in the launch of the new market segments, scheduled for July 1, 2019).3

There are plans to open the electricity market to international cross-border trade and exchanges; and to continue synchronisation with neighbouring markets and integration of the Ukrainian power system into the European setting.

To this end, in the summer of 2017, Ukraine and Moldova signed agreements regarding the conditions for future interconnection with the electricity transmission system operators of the ENTSO-E Continental Europe Region. In the next five years, the transmission system operators of Ukraine (Ukrenergo) and Moldova (Moldelectrica) should implement a catalogue of measures, including a series of technical requirements to facilitate synchronisation with European power systems.

Responsibility of renewable energy producers for imbalances

Clearly, integration of power from RES in the general power system is associated with challenges and constraints; and raises the need for system balancing and the allocation of responsibility among market participants responsible for the associated costs.

The Electricity Market Law provides for the gradual introduction of RES producers' responsibility for imbalances. Those producers that want to sell electricity under the FIT should join the so-called "balancing group" led by the offtaker (the guaranteed buyer), with the guaranteed buyer being responsible to the transmission system operator for the settlement of imbalances of such balancing groups.

Producers should pay a certain share of costs incurred by the guaranteed buyer to settle imbalances. From January 1, 2021, producers should pay 10% of the imbalance settlement costs to the guaranteed buyer; this share will increase by 10% each year, until it reaches 100% by 2030. In order to settle imbalances, the transmission system operator will sell electricity on the so-called "balancing market", which is scheduled to be launched on July 1, 2019.

The responsibility for imbalances will not apply, if a producer does not exceed the permitted volumes of deviations – in their actual hourly volume output – from the hourly schedules. Such tolerance margins (which will not entail responsibility for power producers) are set at 20% for wind power, 10% for solar power, and 5% for hydroelectric power generated by micro, mini and small hydroelectric power stations.

After the share of all market participants producing electricity from RES reaches 5% of the annual energy balance of Ukraine, such permitted deviation will be set at 10% for wind power, and 5% for both solar and hydroelectric power.

Responsibility for imbalances will not have a retroactive effect, and will not apply until December 31, 2029, (the date of expiry of the FIT) to those facilities put into operation before the enactment of the Electricity Market Law. Beginning in 2030, all RES power producers will bear full liability for their imbalances, whatever the date a facility becomes operational.

Recent legal developments around PPAs

Power purchase agreements (PPAs) are concluded based on the template form approved by the National Energy and Utilities Regulatory Commission. Although by its legal nature, this form is not mandatory, in practice the offtaker (currently, State Enterprise Energorynok) closely follows this form.

The major criticism around the template form of the PPA has always been that it is not quite bankable and insurable. In 2017, major regulatory changes aimed at resolving this problem began.

On September 14, 2017, the regulator approved amendments to the template form of the PPA, with a view to enhancing its bankability and increasing investment in the industry, which became effective on October 29, 2017. Following the amendments, the PPA should remain valid until January 1, 2030, which corresponds to the term of validity of the FIT.

This was one of the most sought-after amendments. Previously, PPAs were concluded for a one-year term, subject to annual extensions. This practice did not provide sufficient safeguards and comfort to power sellers so as to ensure that the required long-term validity of PPAs would correspond to the term of validity of the FIT.

The amended form expressly allowed PPAs to be concluded before the completion of construction or putting a plant into operation. However, it is not until the occurrence of certain prior conditions that PPAs will enter into force (for example, obtaining a licence for electricity production; granting the FIT to a producer, and the producer joining the Wholesale Electricity Market; obtaining approvals of the technical assignment and design documentation for construction of the automated commercial electricity metering system; etc.).

Not all of the conditions depend solely upon the developer, but may also require decisions of the regulator or third parties. With these "conditions precedent" in place, certain risks persist, which are associated with ambiguity and a lack of guarantee for a producer.

Following the amendments, creditors obtained additional securities relative to a PPA, such as step-in rights. Producers can assign, pledge or otherwise encumber the rights to receivables under a PPA to third-party creditors.

The right for parties to refer PPA disputes to international arbitration was recognized (subject to jurisdictional rules), and the role of extrajudicial dispute settlement remedies – including mediation – was enhanced. It has been expressly established that parties can refer disputes for mediation under the auspices of the Dispute Resolution and Negotiation Centre of the Energy Community Secretariat. Previously, disputes arising out of, or in connection with, the PPA could be brought only before Ukrainian courts.

A major question remains open as to how reorganization of the offtaker and the launch of the new electricity market will affect PPAs. Under the amended PPA template form, parties to a PPA agree that the obligations of State Enterprise Energorynok, regarding the purchase of power, should cease to exist upon the commencement of the new electricity market; and that a new PPA should be entered into between the producer and the guaranteed buyer (the successor to Energorynok) for the remaining term of validity of the FIT.

Such new agreement will be concluded based on a new standard form of the PPA, which will be approved by the regulator following consultations with the Energy Community Secretariat.4

In practice, it can be difficult to enforce such provisions whereby parties commit to enter into a future PPA without knowing all the terms of an agreement beforehand; this notwithstanding that the invariability of the FIT and its validity period are established by law, and a strong argument can be made that they should not be changed in a future form of the PPA.

The assignment should be completed no later than the date of launching the new electricity market (i.e. July 1, 2019). Energorynok will remain jointly liable for the performance of its obligations under the PPA, by the new offtaker, upon such assignment.

On January 9, 2018, the regulator adopted further amendments to the template form of the PPA5, aimed at enhancing the bankability and insurability of PPAs and strengthening protection of producers' and creditors' rights in the context of the ongoing reform of the electricity market.

Most of the risks associated with changes in the law or events beyond the control of parties are expressly vested in the offtaker. Direct agreements are allowed, whereby creditors can enter into a PPA without any additional consent of the offtaker in the event of a producer's default. Producers will have broad rights to terminate and seek reimbursement from the offtaker, including by triggering the change of law clause.

The reimbursement amount is broadly defined to include, amongst other things, the principal and interest on the loan extended by creditors. It is not yet quite clear whether the offtaker will be able to undertake and perform under such obligations.

Some of the amendments may raise competition or state aid concerns, or provide different interpretations as to their exact scope or enforceability, due to the lack of clarity and precision (e.g. references to producer's profits, direct agreements, procedures of negotiation or "challenging" arbitral awards, etc.).

It remains to be seen whether the new approach, particularly in terms of risk allocation and indemnification of damages, would prove feasible and sustainable, and to what extent that benefits the entire power system.

As a result of a series of the amendments introduced in September 2017 and January 2018, the form of the PPA has improved considerably in terms of its bankability and insurability.

The main question is how the electricity market reform and reorganization of the offtaker will evolve, and what the impact on the renewable energy projects will be. The prevailing understanding is that it is vital to ensure the stability and continuity of offtake of power produced from RES at the FIT, as guaranteed by the law.

There are also other factors affecting RES industry growth. These include limited opportunities for fundraising and the high cost of capital, over regulated and lengthy land allocation procedures, a lack of necessary grid infrastructure, and problems with grid connection.

RES to face a more competitive and diverse future

An indicative trend observed in European and other international markets has been towards the gradual "equalization" of the legal status of different power sources, the reduction or curtailment of state support mechanisms and subsidies for power production from RES, and the introduction of conditions for free market competition for producers of power from different sources.

This is particularly justified in those countries where power production from RES is already achieving a considerable share of total energy production.

Market-based instruments are gaining ground in Europe, such as, for example, "contracts for difference" (CfD). A CfD is a financial, typically long-term, instrument setting a contract price at which parties agree to sell and buy power throughout the term of the agreement (the "strike price").

Effectively, this is a financial risk management tool ensuring steady, predictable profitability for power producers, as it hedges them against the risks associated with market price fluctuations by fixing the strike price in the contract. This also helps reduce the cost of capital and fosters competition among different power production technologies and sources, as CfDs are normally signed following an auction.

With the introduction of market-based incentives for renewable energy production, more complex, diversified and flexible approaches are being developed in the use of such incentives, or a combination of them. For example, microgeneration sells electricity under a FIT, whereas other types of generation compete at auctions for the award of CfDs. Such auctions can be "technology-neutral", and not discriminate between bidders or grant any benefits dependent on the type of power production technology or its source.

In Ukraine, there are already proposals to consider new approaches to selling electricity produced from RES, such as power sale auctions, which are increasingly coming into focus, or feed-in premiums. It can be foreseen that incentives for power production from RES will become more diversified in Ukraine in the years to come, and will not be solely limited to a FIT.

The general consensus is that auctions or other novel structures – notwithstanding their being progressive, and matching objective global trends in the development of the renewable energy industry, or corresponding to technology maturity and cost – should be introduced gradually, so as not to undermine the stability, consistency and continuity of the regulatory framework in the country, and prevent any adverse effects on ongoing projects.

[1] The amount of the FIT will be gradually reduced in future, depending on the date of a power plant becoming operational.

[2] Including Directive 2009/72/EC of 13 July 2009 concerning common rules for the internal market in electricity, Regulation 714/2009 on conditions for access to the network for cross-border exchanges in electricity, as well as some other core EU electricity acquis. Ukraine undertook to transpose the requirements of the Third Energy Package into its national legislation within the context of its membership of the energy community and association with the EU.

[3] There are already signs suggesting that the market is likely to begin operating later than planned. These concerns around the timely launch of the new market include the transformation and institutional reform of the Regulator, which is ongoing.

[4] As of the writing of this article, it has not been adopted.

[5] As of the writing of this article, this Resolution was awaiting official publication, following which it will become effective.

Originally published in pv magazine

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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