European electricity prices and their impact on the Ukrainian economy

More than 90% of steel in the EU is produced in countries with cheaper electricity than Ukraine

A year ago, one of the key topics of discussions on EU integration was Ukraine’s climate commitments. This seemed the most important for understanding the prospects of domestic industry and steel sector. Now we have a shortage of electricity and, in fact, a simultaneous transition to European prices. And this issue has become the cornerstone, the main problem for the industry of Ukraine. High electricity prices make climate issues secondary. After all, there is no industry – there is no subject of discussion about climate ambitions.

To operate without outages, each enterprise must import 80% of the electricity consumed, which is almost impossible to accomplish. But even if there is electricity, its cost calls into question the expediency of its consumption and the work of enterprises.

For understanding, the wholesale price of electricity in Ukraine increased by 62% y/y in July. Currently, the price in Ukraine is higher than in most EU countries. More than 90% of steel in the EU is produced in countries with cheaper electricity than in Ukraine.

EAF steelmakers are very sensitive to energy prices with up to 25% electricity share in cash costs. If electricity rises 62% it means a 15.5% increase in cost y/y in July. Despite the fact that global steel prices showed a decrease of 10% y/y. Ukrainian EAF steelmakers who survived during the 2.5 years of the war were again on the verge of stoppage.

But mining enterprises will suffer the most. The share of electricity in the cash costs of iron ore concentrate reaches 60%. The largest export market of concentrate is China, where Ukraine, after the start of the «sea corridor,» supplied 1.5 million tons monthly. For half a year, exports amounted to 600 million US dollars. Currently, the export of concentrate to China is a big question due to the increase in energy costs in Ukraine, expensive logistics and lower prices for iron ore in China. Because of this, one of the largest mining enterprises in Ukraine is on the verge of stopping.

The dependence of the Ukrainian economy on electricity prices is one of the highest globally due to its high energy intensity. In 2022, 2.1 kWh is consumed for every dollar of GDP in Ukraine. In neighboring European countries, these numbers are several times less. In Poland – 0.96 kWh per dollar of GDP, in Slovakia – 1.2, Hungary – 0.94. So, in countries that determine the cost of electricity in Ukraine, the sensitivity to the cost of electricity is lower. In other words, they can afford higher electricity prices. Ukraine doesn’t .

But in autumn, with cold weather, seasonal growth in electricity prices in the EU is expected. It`s worth saying that the situation with the energy balance in Europe is very thin, so we should be prepared for any scenarios, even a new energy crisis. Of course, this will have very negative consequences for Ukraine.

Instead, the European economy have already prepared for the worst case scenario. The past crisis allowed to create certain mechanisms for subsidizing electricity prices. In 2022, the European Union spent 25 billion euros to compensate for rising prices for industrial enterprises, and 69 billion were cross-sectoral, so part of these funds could also be directed to the needs of the industry.

These running mechanisms are medium-term in nature. Despite the fact that this year electricity prices returned to the level of 2021, subsidies will still continue in 2024 and 2025, and 20% of measures – even after 2025.

Also I would like to draw  your attention to another fact. European electricity prices include the cost of emissions, offset by consumers in the form of subsidies – so-called «carbon indirect cost offsets» when buying electricity. Electricity imports to the EU are very limited. Therefore, carbon cost in the energy sector was completely transferred to the end user, to electricity prices. To mitigate this effect, the design of the EU ETS allows member states to use the revenues from emissions payments to compensate large consumers (industrial enterprises). Member countries are actively taking advantage of this, spending €2.4 billion in compensation in 2021.

Currently, the price of electricity imports from the EU determines the cost of electricity in Ukraine. And it turns out that Ukrainian industrial companies pay European carbon price to domestic energy generators for emissions that they don’t generate. Accordingly, Ukrainian industrial enterprises are not able to receive any compensation from the state and, thus, the gap in competitiveness is deepening.

In Ukraine, subsidizing energy prices works in the opposite direction – at the expense of business, the state is trying to subsidize the households, deepening the crisis in industry. It is worth mentioning the latest innovation – the draft resolution of the National Energy and Utilities Regulatory Commission on averaging tariffs for distribution for consumers of the first and second voltage classes. This initiative should shift to large industrial consumers part of the obligations of state-owned generating companies to compensate the difference between regulated tariffs for households, compared with market prices. Thus, the tariff for industry should be increased by 5 times, or by 22 euros per MWh, while for small consumers the tariff will be reduced by 25%. This initiative is absurd, as it violates the key principles of tariff formation, does not correspond to European practices and deepens imbalances in our energy system.

The discussion about electricity prices in Ukraine comes down to overcoming the generation deficit, which is quite logical. When electricity generation in Ukraine reaches a sufficient level, then prices will decrease. This goal can be achieved by rebuilding coal power stations, but they can again become targets for Russian attacks. And there remains a big issue of financing the construction of coal power stations, that should be decommissioned during the green transition in the perspective of integration into the EU.

Great hopes are placed on industry – on large consumers who have to build their captive generation, gas power stations first of all. But we do not hear mass announcements from enterprises about the construction of gas power stations. This is a complex process that requires a quick search for equipment that is scarce. These are financial risks when making decisions. Gas generated electricity is not cheap. Currently, gas power facilities may be justified, but when the key issues are resolved and other types of generation are restored, gas generation will not be in demand. Or a possible and worse option – the era of cheap electricity in Ukraine is over.