Energy tariffs unification threatens stop Ukrainian industry

This decision contradicts not only the economic sense, but also the country’s European integration plans

Recently, the Ukrainian authorities have taken a number of measures that have led to a sharp increase in energy costs for large industrial consumers. It is clear that in the face of the destruction of many power generating capacities and a severe energy deficit, it is difficult to do without unpopular solutions.

However, the authorities repeatedly make decisions that have a significant impact on the industry, without discussing with the business itself and assessing the impact on the overall economic situation in the country. Moreover, some of the planned solutions are now moving beyond economic logic, and together they threaten to have dire consequences for the entire economy of a country that is already struggling with war.

Essence of change

In addition to the cost of electricity, each consumer pays regulated tariffs for its transportation (transmission). As of 17 July, the National Commission for State Regulation of Energy and Public Utilities (NEURC) scheduled the consideration of the draft decree «On approval of changes in the Order of establishment (formation) of tariffs for services for distribution of electric energy» (changes to the NEURC Resolution of 05.10.2018 1175)».

The draft resolution envisages unification of the electricity distribution tariff. Currently, this tariff is divided into voltage classes:

1. 1st class – large enterprises, which are connected to power lines with a voltage of 27.5 kV and higher, consuming more than 150 thousand. MW-h per month.
2. 2nd class – Other consumers with negligible electricity consumption connected to power lines up to 27.5 kV.

The formal motivation for unifying the tariff for electricity distribution is to help small businesses. According to Denis Sakva, senior analyst at Dragon Capital, the implementation of such a solution will lead to a reduction in electricity costs – about 15%, given its price, delivery rates and VAT – for a very small number of consumers in the small business category. At the same time, a small reduction in the distribution tariff will not create additional stimulus for development, which is possible only by improving the business climate.

«This could be a completely unacceptable and critical mistake. We live in war, and now we are talking about the destruction of the economy by such decisions. The authorities need to think about how to save a business that pays taxes, brings currency revenue, preserves jobs, that is, works no matter what», stresses Olga Busslavets, Minister of Energy of Ukraine (2020).

The real motivation is to transfer subsidies to industry for distribution to domestic consumers.

«We understand the motivation of this decision – to take even more funds from industrial consumers. However, here the appetites of the state go beyond the level of permissible», – says Olexander Kalenkov, president of the «Ukrmmetalurgprom».

Illogical decision

Plans to unify the distribution tariff have no economic meaning, as different classes exist for specific reasons. In the case of large consumers who use high-voltage electricity, they are:

1. Electricity supply requires less energy equipment.
2. They are cheaper than second-class deliveries.
3. Grid losses are much lower.

The idea of levelling the tariff for class allocation violates the cascading principle of tariff formation (cost cascading principle of tariff construction), which is one of the basic ones in the system of European energy policy. In fact, for losses in networks should pay those categories of consumers who use networks in which the corresponding losses are formed», says Andrian Prokip, an expert on energy of the Ukrainian Institute of the Future.

In addition, large consumers themselves maintain their energy infrastructure (transformers, substations and power lines), pay for the emerging losses of electricity.

The second contradiction is the incompatibility of the idea of tariff unification with the established practice in the European market, whose experience Ukraine seeks to adopt. All EU countries except Malta have differentiated tariffs (3 and more classes).

An attempt to introduce a single tariff in Ukraine will contradict Directive 2019/944 and Regulation 2019/943, the implementation of which is provided by the Ukraine Facility program. These instruments require that distribution tariffs be transparent, non-discriminatory and cost-effective. In turn, the European Union Agency for the Cooperation of Energy Regulators (ACER) considers it necessary to «avoid setting a single tariff for all types of voltage».

In other words, in the context of European integration processes, Ukraine should improve the system of classification of consumers according to stress classes, rather than unify tariff policy.

Question price

Until recently, the distribution rate for 1st class (0.24 UAH/kWh) was about five times lower than for the second (1.61 UAH/kWh). In turn, the tariff for the 2nd class covered the costs of electricity delivery to the public and small businesses. The tariff increase will lead to a 5-fold increase for 1st class consumers, while for 2nd class it will decrease by about 25%. As a result, the uniform tariff will be 1.23 UAH/kWh.

According to Olexander Kalenkov, large enterprises will pay twice – for the maintenance of their existing energy infrastructure and, in part, for the general infrastructure and losses in the networks of distribution operators, which they do not actually use.

Steel enterprises, cement plants, ore-processing plants, agro-enterprises and other export-oriented enterprises will be the first to suffer from tariff harmonization. The total increase in the costs of large consumers will be about 26 billion UAH – from 6.4 billion UAH to 32.5 billion UAH per year, notes Olexander Trofimets, vice-president on energy issues of the Ukrainian National Committee of the International Chamber of Commerce (ICC Ukraine). In this case, we are talking only about the direct expenses of the promoters, which they will pay for losses in networks of small consumers.

«We ask the government to intervene in the situation and prevent the NEURC from making a decision that will damage the Ukrainian economy and contradict the European rules that Ukraine will actively integrate into its energy sector», summarized in «ArcelorMittal Kryvyi Rih».

Practically the only beneficiary of tariff unification will be ANCEX «Energoatom», since its expenses for distribution of electricity to the population will be reduced by 0.38 UAH per kWh or by 5-10 billion UAH per year. Recall that the state company compensates the difference between the tariff for the population (4.32 UAH/kWh) and the market prices within the framework of the PSO (services for ensuring the availability of electricity).

«In fact, this change will lead to another cross-subsidization – a chronic disease of the Ukrainian power industry. And first-class consumers will cover the costs and losses of consumers of the 2nd class of voltage», says Andrian Prokip.

As Denis Sakva notes, our country has already had experience of cross-subsidization between regions («uniform tariffs» for the regions). This practice was introduced in the early 2000s, but later abolished as it distorted the market.

«And again we are seeing incorrect market signals being given,” the expert explains.

Impact on steel industry

Steel sector is one of the largest consumers of electricity. According to the Ministry of Energy, before the war, in 2020-2021. Steel accounted for 23% or 27-29 million kWh of electricity consumption in Ukraine. For obvious reasons there is no more recent open information, but it is clear that in 2022-2023. Consumption fell due to the destruction of about 40% of capacity and the reduction of production. It is known only that in 2022 steel industry reduced electricity consumption by 52% y/y.

Any increase in electricity costs would have a significant impact on steel sector because of the high energy intensity of production. According to the GMK Center study, the share of electricity in the cost of pellets is 32%, and iron ore concentrate – even up to 60%. The steelmaking industry has the highest rate of 25% in the steel smelting process of electric arc furnaces.

In case of introduction of the unified tariff for distribution of MMK enterprise, according to estimations of OP «Ukrmetalurgprom», in addition will be forced to pay about 10 billion UAH per year. Costs of the industry companies may increase by €22 per MW-h, says Andriy Tarasenko, chief analyst at GMK Center.

To the general increase in energy consumption of the industry enterprises can be added the consequences of previous decisions. Recall that at the end of May, the maximum tariff limits (price caps) for industrial consumers and the requirement of a minimum share of imported electricity (80%) for power supply without disconnections were increased. And this is against the background that the cost of electricity for industrial consumers in Ukraine is the highest in Europe. The wholesale price of electricity in Ukraine in early July increased to €127 per MW, which is 62% more than the EU average.

«We already see how acute the issue of electricity prices is for the GMC with the introduction of the requirement to import 80% of electricity to guarantee its stable supply. Industry is affected by a combination of factors – expensive European electricity plus the cost of access to the crossing, as well as the rise in the cost of Ukrainian electricity since June due to the introduction of new price caps. In addition, prices in global commodity and steel markets are falling, resulting in reduced marginsqueeze (marginsqueeze) margins. It is possible that under such conditions, industry players will «maneuver» in terms of production volumes. Therefore, before making such proposals, in my opinion, the regulator should present the appropriate economic justification, hold discussions», said Denis Sakva.

The increase in operating costs will have an impact on cost growth and reduced competitiveness in export markets. This in turn will lead to consequences at the level of the whole state in the form of «domino effect».

«The abolition of class separation will stimulate further reduction of production or even a complete shutdown of enterprises, which will lead to a decrease in tax and foreign currency revenues, which are critical in the war. In addition, the state of the MMK has a direct impact on the development of construction, engineering, railway and port infrastructure, as well as OPK», stresses Olexander Kalenkov.

In addition, according to Dmytro Kisilevsky, Deputy Head of the Verkhovna Rada Committee on Economic Development, the decision on unification will lead to a direct deception of industrial investors who previously invested in the development of their own energy infrastructure.

Root causes of contradictions

This situation has arisen due to the imbalance of power in Ukraine in general and in war conditions in particular, as well as due to the failure of state bodies to perform their direct functions. The demand for unification of tariffs arose on behalf of Stavka Supreme Commander-in-Chief, while the specialized body – the Ministry of Economy – did not raise any objections to the draft document. In turn, NEURC – although independent regulator, but just took the document «to execution», despite all its contradictions.

To avoid negative impacts on industry and the national economy, the industry is asking the authorities not to harmonize electricity distribution tariffs.