Importing expensive electricity will bring Ukrainian industry to a standstill

Ukrainian industry will lose the last factors of competitiveness amid rules requiring the import of 80% of electricity to guarantee non-stop operation

Since the end of March, Russia has launched multiple large-scale missile and drone attacks on Ukrainian energy facilities – almost all generating shunting capacity of TPPs and HPPs, as well as many substations. These attacks resulted in the loss of about 9 GW of generation and, as a consequence, a shortage of electricity, which was dealt with through blackouts and imports from neighboring countries.

At the end of June and beginning of July, the Cabinet of Ministers’ decision on the level of imported electricity consumption, made without discussing it with business and assessing its impact on industry, threatened to shut down Ukraine’s iron and steel enterprises.

“Imported” surprise

In order to combat the shortage of electricity they resorted to the tool already tested in the winter of 2022/2023 – planned (stabilization) and emergency shutdowns. Only government agencies, healthcare and critical infrastructure facilities, defense industry enterprises, etc. have guarantees of non-disconnection.

Another solution to reduce the deficit was a sharp increase in electricity imports. If in May Ukraine imported 448 thousand MWh, in June – 858.3 thousand MWh. The imports come from Romania, Slovakia, Poland, Hungary and Moldova.

Last fall, the government approved (Resolution No. 1127 of 27.10.2023) the «Regulation on the peculiarities of electricity imports under martial law in Ukraine», according to which enterprises are guaranteed stability of energy supplies if the volume of electricity imports in the consumption structure is at least 30% from May to September and 50% from October to April. However, already at the end of May this year, the Cabinet of Ministers replayed the conditions (Resolution No. 611 of 30.05.2024) and set the minimum import quota at the level of at least 80%.

This decision was met with unpleasant surprise by Ukrainian business, as it was made without any discussion. According to Maxim Zhuravlev, director of the strategic raw materials and energy resources procurement department at Metinvest Group, the Cabinet’s decision to increase the share of electricity imports to 80% came as a complete surprise, while the company tries to plan its work for a long period.

Consequences of the decision

This decision by the Cabinet of Ministers has already led to a large number of additional problems that complicate the already difficult activities of Ukrainian industrial companies, which are not related to critical infrastructure and defense industry. Energy-intensive industries are particularly hard hit.

The key problems that could lead to an increase in the quota of electricity imports to 80% in the short term are as follows.

1. Excessive prices

The cost of electricity for industrial consumers in Ukraine is already the highest in Europe. According to a GMK Center study, the June day-ahead market price in Ukraine was €112.3/MWh, while in Poland and Germany it was €105/MWh and €72.6/MWh, respectively.

Raising the quota forces the industry to increase the volume of imported electricity, which encourages an artificial increase in demand at interstate interconnection allocation auctions and is a prerequisite for speculative price increases.

«In practice, this could lead to an artificial, even speculative increase in demand for imported electricity, the price of which could rise to any level. However, to avoid disconnection, only those companies that have minimal electricity costs in their production cost structure will be able and willing to pay for it», Interpipe notes.

2. Decline in production and competitiveness

in the competitiveness of products on domestic and foreign markets and, as a consequence, a forced reduction in the level of production.

«In such conditions, further production becomes significantly unprofitable and the plant cannot be competitive on the world market of metallurgical products. Hence the company will be forced to significantly reduce production and lay off approximately 1,200 employees,» reads the letter that ArcelorMittal Kryvyi Rih sent to the authorities.

Also, when importing electricity, it is necessary to spend additional funds on its transportation, pay duties and excise duty.

“This leads to the loss of competition of our energy-intensive enterprises. For example, the price of imported electricity for Arcelor Mittal Kryvyi Rih, taking into account the cost of delivery, is more than twice the price of electricity compared to the price of electricity paid by their competitors in this industry in Western Europe,” emphasizes Olga Buslavets, energy expert, Minister of Energy of Ukraine (2020).

3. Inability to plan production

The instability of the electricity supply creates obstacles to production planning, which negatively affects industry and related industries as well as logistics.

4. A decline in production and exports may have a negative impact on government budget revenues

According to ArcelorMittal Kryvyi Rih, the 80% quota will lead to such negative consequences :

•  reduction of tax payments from personal income tax and social security to UAH 30 million per month;
• reduction of fees for subsoil and environmental payments by about 60 million hryvnias per month;
• reduction of VAT on the import of raw resources by about UAH 120 million per month;
• a decrease in foreign currency receipts by approximately 90 million US dollars or 3.6 billion hryvnias per month due to reduction in the export of finished products.

5. Negative social consequences

«Increasing the cost of electricity leads to a decrease in competitiveness in the world market and puts the company on the brink of survival. This fact can be felt especially tragically in the frontline Nikopol, which is under daily shelling of Russian aggressors. This plant employs about 3,000 people, which is 30% of Interpipe employees. It hurts us to realize that the already difficult and risky work of our people in the city on the front line is under threat because of one decision on electricity imports,» emphasizes Vasily Goncharuk, director of Dniprostal-Energo, which is part of the Interpipe group.

In addition, another problematic issue in the near future may be the possible harmonization of distribution tariffs for the 1st and 2nd class of electricity consumers, which is currently under discussion in the relevant agencies. This could hit industrial consumers hard, who will have to pay for infrastructure they do not use.

Impact on steel industry

The impact of the 80% quota on electricity imports could hit many segments of steel sector in a big way. According to Andrey Tarasenko, chief analyst of GMK Center, among the most affected industries will be mining, as the share of electricity in the cost of pellets is 32%, and iron ore concentrate – even up to 60%.

Rising electricity costs lead to a sharp increase in production costs, which makes it economically unprofitable to continue production. Thus, Inguletsky GOK in a letter to the Prime Minister and a number of heads of parliamentary committees warned that the purchase of imported electricity in the amount of 80% of its own consumption may lead to a complete shutdown of the plant.

«An additional negative impact on the mining business is the fall in iron ore prices on global markets,» adds Yaroslawna Blonska, executive director of Ferrexpo.

According to GMK Center estimates, the decline in iron ore exports in the second half of the year may amount to 15% or 2.7 million tons, which means a loss of $250 million in export revenue.

In metallurgy, energy-intensive electric steelmaking may suffer. For example, the cost of electricity accounts for about 25% of the cost of steel billets, which are later used to produce Interpipe’s main products – pipes and railroad wheels.

Thus, according to Andriy Tarasenko, the restriction of electricity supplies may lead to a significant decrease in production and exports. For comparison: the expected steel output in the second quarter of 2024 is 2.1 million tons, while in the fourth quarter of 2022, during the first wave of mass blackouts, it was only 0.7 million tons. Accordingly, the output of iron ore is expected to be 12 million tons against 4 million tons in Q4 2022.

In addition, stable electricity supplies are important to ensure safety and prevent accidents at steel production.

Solution options

In such conditions, it is necessary to take measures to prevent the collapse of production and reduction of revenues to the state budget. Among the options for solving the problems, business proposes to consider the following:

1. Reducing the share of the minimum volume of electricity imports to 50%.

«Increasing the cost of production after raising the import quota to 80% casts doubt on the economic feasibility of our company. We ask the Ministry of Energy to reduce this figure to at least 50%,» says Vasyl Goncharuk.

2. Increasing the permitted capacity of interstate crossings.

Fulfilling the requirement to import 80% of electricity consumption is limited by the existing capacity of 1.7 GW of energy interconnectors with the EU. Therefore, there is a need to increase the import limit to 2.2 GW, which Ukraine is technically ready for, but European companies must modernize their cross-border capacity. So far, the Europeans are not very inclined to increase the limit, but perhaps by the end of July there will be some positive decision on this issue.

3. Resumption of long-term auctions (for a month, a quarter, a year) for interstate crossings.

This will allow companies to obtain cheaper electricity compared to the expensive ones on the spot market.

“We would like to have a more robust production planning process. Therefore, the option of purchasing the intersection for a long period is very interesting to us,” emphasizes Maxim Zhuravlev.

4. Weighted and justified distribution of mandatory volumes of purchases of imported electricity between consumer groups.
5. Finding ways to provide financial support – subsidies for electricity imports, similar to the funding available to European industry in similar situations.

To solve the problem, active participation of the Ministry of Economy, Ministry of Finance and other relevant government agencies is required. Since the negative consequences of the shutdown of enterprises in the form of reduced tax deductions will have a strong impact on the state economy and socio-economic situation. However, at the moment the authorities have not publicly offered any options for dialog with business and solving the problem.

The prospects for revision of the decision on the 80% quota remain uncertain at the moment. According to Yuriy Vlasenko, the first deputy head of the Ministry of Energy, the revision is impossible now because of a significant capacity deficit in the energy system. At the same time, the difficulty of predicting the situation under the current conditions does not allow us to speak now about the possibility of relaxing this norm after the end of the summer repair campaign at several NPP units.

It is fair to say that the Cabinet of Ministers is considering the possibility of guaranteeing energy supplies for some frontline areas and for enterprises that will install their own generation, which will provide 80% of their energy consumption. However, these measures in the first case can help a small part of industrial enterprises, while in the second case they require large investments with the implementation period of at least a year, i.e. they are not suitable for solving the current problems.

On July 4, a working meeting between business and government took place on the site of the FRU. Olga Kulik, Director of the Department of Ecology, Energy and Green Economy of the Federation of Employers of Ukraine, said that within a week an official appeal with the position of the Federation of Employers of Ukraine will be formed and sent to government institutions. The current situation in the energy sector is so complicated that it requires cooperation between government and business for systemic stabilization of energy supply. At the same time, business expects the authorities to take a responsible approach – to assess the impact of important decisions on the economy in the war conditions, to hold a preliminary discussion of draft decisions and to take into account the comments and suggestions of companies.