Energy market actors
Electricity market
The Power Market
Ukraine’s Wholesale Electricity Market (WEM) began to operate in 1997. The state company Energorynok (or “power market”) operates the market, serving as a single buyer of power. In principle, the large thermal gencos compete to sell power to Energorynok. Energoatom and Ukrhydroenergo also sell power (nuclear and hydro) to Energorynok, but at prices set by NERC. Thus, the competitive wholesale supply accounts for only about 35-40% of the power sold to Energorynok. Energorynok then sells power to the oblenergos and large industrial firms. NERC sets the regulated prices for transmission and distribution services. In turn, the oblenergos (regional energy supply companies) sell to customers at rates that are based on the wholesale price plus the transmission and distribution tariff.
Several pieces of legislation regulate the market, including the 1997 Law on Electricity, Presidential decrees, orders from the Cabinet of Ministers and NERC, and the agreement between the members of the WEM. Since the electricity law was adopted, parliament has passed several important amendments. These amendments cover issues such as payments in the WEM, reducing fines on customers in arrears, ensuring fairness in tenders and proportional payments for electricity sold on the WEM.
In the mid-1990s, the government re-structured the power sector to allow for competition between electricity producers. It split the ownership and management of the sector into generation assets, the transmission network, distribution assets and the power market (Energorynok). In principle, this split was a wise move. However, blurring of roles (for example distribution companies’ ownership of significant generation assets) limits its effectiveness. The sector was unbundled in the mid-1990s as part of broad power sector reform that included establishment of an independent regulator and steps toward privatisation. At present, most of the Ukrainian power sector is still in state hands, as privatisation did not proceed as quickly as initially anticipated. In 2004, most of the non-nuclear generation and distribution assets were consolidated into a single state company, the Energy Company of Ukraine. The wholesale power market still exists and operates, but it is even less clear than before how much competition the sector supports, particularly given the dominance of the Energy Company of Ukraine.
Generation
Generation is divided into three categories. Thermal power plants are owned by regional generation companies, known as “gencos”. Ukrhydroenergo owns the 11 hydro power plants. The Energy Company of Ukraine holds the government’s shares of both the gencos and Ukrhydroenergo. In contrast, the four nuclear power plants are owned by the state company Energoatom. Initially after the reforms, there were four regional gencos: Zakhidenergo, Centrenergo, Dniproenergo and Donbasenergo. These companies managed 14 large thermal power stations. A new genco, Skhidenergo, emerged out of a debt restructuring process through which Donbasenergo transferred three of its five power plants to settle unpaid claims. This transfer of shares has been very controversial because of complaints about asset stripping and what was effectively a non-competitive privatisation of state assets. While Skhidenergo is privately held, the Energy Company of Ukraine owns the majority of shares in the other companies. Still, even the majority state-owned gencos have significant volumes of shares traded on the stock market: all four are among the top ten companies by market capitalisation on the Ukrainian stock exchange. The gencos theoretically compete on the power market, called Energorynok. Energoatom and Ukrhydroenergo also sell power to Energorynok at regulated prices representing about 60% of traded volumes. Skhidenergo had profit margins of 12% in 2005 and of 28% in the first half of 2006, compared to Energy Company of Ukraine’s margins of 4 and 8%, respectively.
Total capacity of electric power plants of Ukraine amounts to 52,017 mill kW of which capacity generated by TPP of GCs is 27.1 thousand MW (52.1%), CHPP and others TPP – 6.27 thousand MW (12.1%), NPP – 13.83 thousand MW (26.6%), HPP and HPSP – 4.73 thousand MW (9.1%), WPP – 0.074 thousand MW (0.1%).
Distribution
There is a distribution company in each of Ukraine’s 25 regions, plus one each in the cities of Kyiv and Sevastopol. Among these 27 regional distribution companies, there is a mix of state and private ownership. The distribution companies, called oblenergos, also own small cogeneration assets, mainly to produce heat for district heating. Kyivenergo is somewhat unique in that it is a vertically integrated joint stock utility, which both generates and distributes power and heat to the capital, Kyiv. In general, the distribution companies buy power from Energorynok and sell it to all. The largest industrial consumers buy electricity directly from Energorynok.
The National Electricity Regulatory Commission (NERC) sets distribution tariffs on a cost-plus basis. It also reviews investment proposals of each oblenergo. Since September 2005, while NERC still reviews and approves costs regionally, it also sets a unified distribution tariff for the whole country.
Local authorities also play an important role in that they determine whether customers in arrears are disconnected. In the past, they have often tried to delay disconnections for social reasons, which contributed to growing debts in the electricity sector. Collection levels have significantly improved in recent years; in 2005, they stood at an 99.3%. The government privatised six distribution companies in two privatization rounds; the first round was criticised because of the lack of transparent criteria for bidders; the second round brought in two international investors (AES and the Slovak/Dutch company VS Energy). The remaining distribution companies are partially privatised, with a mix of free floating shares, state owned shares and shares owned by other major shareholders.
In addition to the distribution companies, there are also several hundred supply and service companies that operate the last kilometer or so of electric wires going to households and other small consumers.
Regulation and pricing
NERC plays several roles in the power sector. It licenses power plants to connect to the grid and participate in the wholesale market. It also sets the price of power from nuclear, hydro, wind and cogeneration plants, based on a cost-plus type methodology.
NERC also sets retail electricity tariff s with a cost-plus formula that factors in the market price of electricity purchased on the wholesale market, losses, operation and maintenance costs, and the allowed rate of return on investments by distribution companies. On average, the wholesale price of electricity makes up about 77% of the tariff, the transmission and distribution tariffs are, respectively, about 12% and 1% of the total, and covering the cost of losses on power lines makes up the remaining 9%. The cost of electricity is calculated based on the average wholesale price of all types of power. NERC sets the tariff for power distribution and local supply at a level that should cover costs and provide some profit, though oblenergos have expressed concerns that the tariff does not allow them to make all the necessary investments. NERC’s strategic objective is to optimise the retail price of electricity in each link of the energy chain and to balance the interests of all participants in the energy market. It sets the retail price according to customer class, which involves a cross-subsidy from industry to residential users.
Until September 2005, NERC had separate retail prices for each region, reflecting the different costs for each distribution company. However, it was decided to set unified national prices. The logic behind this decision is that this approach is fairer to all consumers. In reality, unless costs are broadly equivalent across the country, a unified tariff introduces another cross-subsidy.
Oil and gas market
Overview
The industry is heavily regulated. The government has many direct and indirect controls over the terms of investors’ access to reserves and infrastructure, pricing and tariff setting, import and export transactions, and other key aspects of the market. Oil refining and distribution are the only elements of the Ukrainian energy sector that have well-developed competition and market set prices. Refineries do not use state-of-the-art technology, and need significant investments in modernisation.
Natural Gas and Oil Industry Structure
Generation, Distribution, Transmission
The largest company in the oil and gas industry of Ukraine is the national joint-stock company Naftogaz of Ukraine (which literally means “oil & gas of Ukraine”). Table 3.1 demonstrates that Naftogaz of Ukraine dominates the exploration and production (otherwise known as the upstream), as well as main oil and gas pipelines, gas processing, the imports and transit of gas, and gas distribution in Ukraine. The presence of other actors is significant only in the oil refining and oil product retail markets, which are liberalized and open for competition.
Naftogaz of Ukraine
Naftogaz of Ukraine was created in 1998 as a holding company and is 100% owned by the state. Via its affiliates, it produces, transports and trades oil and natural gas, processes gas and condensate, distributes some oil products and holds shares in gas distribution companies. It also handles oil and gas transit, exports and imports. Natural gas operations far outweigh other company business: until 2005, some 51% of the company’s revenues were from the sale of gas, and about 20% from gas transportation (primarily transit) (Naftogaz of Ukraine, 2005). In 2004, Naftogaz of Ukraine accounted for some 13% Ukraine’s GDP and approximately 10% of the state budget. As a consequence, any change in the terms of gas business has a large-scale and immediate impact on Naftogaz of Ukraine’s financials and on the economy at large.
Naftogaz of Ukraine owns 100% of its three subsidiary companies, five subsidiary enterprises, two state joint-stock companies and one open joint-stock company. It also owns 50+1% share in another open joint-stock company, Ukrnafta. Naftogaz of Ukraine has majority holdings in 19 regional gas distribution companies and several industrial and service companies. It has minority holdings in several other companies.
Other Actors
In January 2006, a Swiss-registered company, RosUkrEnergo, became an important actor on the Ukrainian gas market, handling all gas imports to the country (Chapter 6 of [2]). A joint venture between RosUkrEnergo and Naftogaz of Ukraine, called UkrGaz-Energo, began supplying gas to industrial consumers in the spring of 2006. Several foreign companies (TNK-BP, Lukoil, Tatneft, ExxonMobil and Shell) control a large share of oil refining and distribution in Ukraine. The Pryvat Group, a Ukrainian industrial and financial group, owns significant assets in the oil industry, including 42% of Ukrnafta’s shares, the majority of shares of the Nadvirnya refinery and 32.9% of shares in the Drohobych refinery. The Pryvat Group also controls several hundreds gas retail stations, mostly in the East and the South.
Coal and lignite market
Overview
Ukraine’s coal industry is economically troubled. Most of its mines are more than 40 years old. Most of Ukraine's coal is mined in the Donetsk/Donbas basin in the eastern region of the country. These mines are among the deepest, most dangerous and most inefficient in the world. Coal seams are typically less than 1.3 meters thick, more than 700 meters underground and have high levels of coal-bed methane. Ukrainian coal production has been in decline for decades, though production has stabilised and even grown slightly since the mid-1990s, when Ukraine began reforming its coal sector. Initial reforms had limited results, though a new round of reforms launched in 2001 has succeeded in boosting production, closing unprofitable mines, improving efficiency and reducing mining deaths. Several mines have been privatised and now account for a large share of total production.
The country's coal industry, which counts slightly less than 200 mines and employs about 500,000 people, is managed by a hierarchy of state organizations and suffers from numerous problems including labor strikes, hazardous working conditions, inefficiency and low productivity.
Coal is the only segment of the energy sector in which there are explicit government subsidies to support production. Today, average coal prices are below short-term production costs, in part because of rapidly increasing prices for mining equipment and materials. Many mines are in dire financial condition and unable to invest in their future. There appear to be governance problems in the coal sector that drive up the price of materials at the same time that the private industrialists selling these materials seek to keep coal prices down. This is particularly problematic in state-owned mines, which are under the supervision of the Ministry of Coal Industry. The government has a detailed plan to close additional mines and privatise most of those that will remain in operation. The Energy Strategy to 2030 envisages major increases in coal production to reduce Ukraine’s reliance on imported natural gas. However, Ukraine’s ability to accomplish this, hinges on the success of further reforms.
Ownership and administrative structure
Ukraine currently has 164 active mines. Three privately-held companies – Krasnodonvuhillya, Krasnoarmeiska-Zakhidna and Pavlohradvuhillya – own 25 of these mines. These 25 mines are primarily coking coal mines and they attract the majority of the investment in the sector. The remaining mines are owned by 24 state enterprises, which, in turn, are held and supervised by the Ministry of Coal Industry. The coal industry has seen numerous administrative changes in recent years. In the late 1990s, the Ministry of Coal Industry oversaw coal issues and state production. That Ministry was closed in 2000, and its functions were transferred to the new Ministry of Fuel and Energy. Then, in 2005, the government re-established the Ministry of Coal Industry. Around the same time (early 2005), the government also created a new state company called Coal of Ukraine, to which it transferred 24 state enterprises that own most of the coal mines. Later the same year, the government closed Coal of Ukraine and transferred the enterprises to the new Ministry of Coal Industry. Such frequent reshuffling is expensive and disrupts work, making continuity in reforms much more difficult. The changes also make it more difficult to monitor and address corruption and price fixing.
