Is Ukrainian Energy Sector Prepared for Winter Season?

CO coal plant
Jimmy Thomas || Creative Commons

The forthcoming heating season of October 2015–April 2016 may be the most challenging season for the Ukrainian energy sector since Ukraine’s independence. Each subsector of energy sector (coal sector, electricity generation, and gas sector) has its own challenges in addition to the general problems such as the military conflict in the East, currency depreciation, debt accumulation, and high inflation. Tackling those challenges is essential for the smooth passing of the coming heating season.

Coal sector was devastated by the loss of mines on the East of Ukraine. Coal extraction decreased by 48% yoy in January-August 2015 to 26 m t (these figures may include reports by mines on uncontrolled parts of Donbas). This caused problems in the electricity sector, mainly at thermal power plants (TPPs) that use coal for electricity generation and generate about 40% of electricity. The biggest problem is with the anthracite coal (type A) used at 5 out of 11 currently working TPPs as it is extracted on the occupied territory of Donbas. Thus, it has to be either sourced from the occupied area or imported from other countries. Coal from the uncontrolled territory of Donbas is cheaper (at UAH 1100 per tonne or USD 51 per tonne), but it can be difficult to transport due to the military operations. Besides, it is subject to checks by security and fiscal services to ensure that minimum of proceeds go towards financing terrorism. Imports of coal from Russia are more expensive (coal costs USD 64-67 per tonne) and supply is tightly controlled by Russian authorities and can be easily disrupted due to political reasons. Finally, imports from South Africa are the most expensive (USD 74-78 per ton) with long delivery time. Besides, this coal may have insufficient quality, while coal delivery depends on sea ports capacity.

On the other hand, these supplies do not depend on negotiations with Russia or self-proclaimed “republics” in the East of Ukraine. As of October 9, there were 2.05 m tonnes of coal stored at TPPs, which is 6% more than a year ago (1.93 m tonnes on October 1, 2014) but still below the official target defined at 2.8 m tonnes. However, this figure includes 0.7 m tonnes of coal at Burshtyn and Luhansk TPPs, which operate as energy islands and do not transmit electricity to the Unified Energy System of Ukraine.

Thermal power plants together with hydro power plants (HPPs) are used as peaking and reserve capacity to regulate the energy consumption in the peak hours. HPPs generate around 10% of electricity in Ukraine. However, due to extremely dry summer hydro power plants experience water shortage and their use for shunting purposes is limited. In particular, the Dnieper cascade of HPPs was in September at the lowest production level in its history (6.5-10 m KWt*h daily), Dniester water inflow was the lowest since 1985. As a result, the HPPs in 2015 are expected to generate 20-25% less of electricity compared to the previous year.

Half of the electricity in Ukraine is generated by nuclear power plants (NPPs). Usually NPPs are used as baseload units generating a steady stream of electricity independent of consumption peaks during the day. But de facto NPPs were used to level out peak loads due to high share of nuclear capacity in production and deficit of coal.1 With limited production by coal and hydro plants, the NPPs have to work with minimum off-line time during winter season. Unscheduled repairs in NPPs may unbalance the system. In addition, the NPPs depend on nuclear fuel supplies from Russia. Their waste is also stored in Russia and has to be transported there.

Overall, in January-August 2015 electricity consumption decreased by 12% yoy due to the drop in industrial production, lower private consumption (against the background of warmer winter), and the use of energy saving technologies. Electricity generation decreased by 14% yoy and exports of electricity dropped by 60% for the same period. Taking into account the low levels of coal stock at TPPs and vulnerability of coal supplies the repetition of last year’s blackouts is quite possible.

The gas sector has been not just important as main heating fuel in Ukraine but it is also politically sensitive. Ukrainian major gas supplier for many years – Russia – often used gas prices as a tool to influence Ukrainian international policy. However, last year showed that it is possible to diversify gas sources and use resulting competition to negotiate lower prices. So, this year the agreement on gas supplies during the winter season was reached much quicker and did not require nine rounds of negotiations as in 2014. The parties agreed on the price of gas for October-December 2015 and on the price setting mechanism for January-March 2016. Ukraine still needs Russian gas for the winter as reverse gas supplies from Europe are not enough to cover the transit needs and domestic consumption. In 2014, Ukraine consumed 42.5 bn cubic meters (bcm) of gas, 19.5 bcm of which was imported. In eight months of 2015, Ukraine consumed 21.8 bcm (decrease by 20% yoy), 11.7 bcm of which was imported (decrease by 23% yoy).

According to the Naftogaz estimates, in April 2015 – March 2016 Ukrainian population may consume 21.3 bcm of gas out which 12.8 bcm could be covered with domestic production and 8.5 bcm needs to be imported. Agreement with Russia ensures sufficient import supplies. However, the Naftogaz would still need to ensure that it collects sufficient payments from gas sales to pay for gas imports. Uncertainty remains on how well Ukrainian households would be able to pay newly increased tariffs for gas and heating. Over eight months of 2015 households paid 94% of gas bills and 116% of heating bills (this reduced debt for previous years by 25% and corresponds to seasonal pattern). If payment rates remain high, rules requiring immediate transfer of share of consumer payments due to the Naftogas may provide the company with sufficient liquidity. In addition, the World Bank together with the European Investment Bank provided USD 520 m to the Naftogaz for gas purchases.

Overall, to ensure smooth heating season Ukraine needs to solve several problems simultaneously. First, it needs to guarantee a steady stream of coal of the required type to TPPs to avoid power shortages in winter. Electricity generating companies have already contracted the required amounts of coal in South Africa and Russia but the TPPs might need the Government’s help in financing the purchases as their heating tariff covers only the price of coal produced domestically. Second, Ukraine has to finalise gas negotiations with Russia, sign the agreement and start pumping gas into storages. Sufficient amount of gas in storages will send a positive signal to the European partners and ensure a stable winter season. Third, Ukraine has to finish all required maintenance works at TPPs and NPPs before the winter especially taking into account the possibility of increased load on nuclear power plants. All in all, Ukrainians may need to face a cold winter as gas production declines, the Government experiences lack of funds, and coal supplies to TPPs remain vulnerable. In case of severe shortage of electricity generation capacity the Ukrenergo may return to its practice of limiting electricity supplies to industrial consumers inducing them to move to night shifts. As a worst case scenario, the population might experience blackouts.

In the longer run the Government should finish the electricity and gas market reforms moving to cost-covering tariffs and compensation mechanisms for low income individual consumers. This work should be coupled with the introduction of energy saving technologies on the industrial and private levels which would allow Ukraine to reduce its energy consumption.

The article was originally published on October 13, 2015 as a Highlight of the Month in the Issue #10 (180) of Monthly Economic Monitor of Ukraine (http://www.ier.com.ua/en/publications/regular_products/monthly_economic_monitoring?pid=5017)

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The Institute for Economic Research and Policy Consulting - Kiev