10 November 2015
On Development of Energy Market in Ukraine and CIS | commentary by Markiyan Kliuchkovskyi and Roman Stepanenko, The Lawyer

Special report: CIS – power change

With a traditionally strong energy market hit by political instability, CIS nations are diversify into green energy. Will law firms do the same?

Q:  How strong is the CIS and Ukraine’s energy sector at the moment?

Ilchuk Maryna, associate, Arzinger: Because of its geographical location and its gas storage capacities, Ukraine plays a specific role in both the European and global fuel and energy markets. On the one hand, Ukraine is an energy-dependent country, having no sufficient volumes of its own conventional energy sources (oil and gas). On the other hand, Ukraine is important for global energy markets because it is a critical transit centre for exports of Russian oil and natural gas to eastern and western Europe.

However, [the current situation] has affected the energy sector in general and the companies that operate in it. The state energy policy has also faced challenges due to the situation. Because of the suspension of gas supplies from Russia, Ukraine is taking all possible measures to diversify supplies and stimulate local gas extraction. Also the government was compelled to revise tariffs for utilities, as the state is no longer able to subsidise households and artificially restrain growth in energy prices. Improving the energy efficiency has became a necessity for the country.

Markiyan Kliuchkovskyi, co-head of energy, and Roman Stepanenko, head of banking, finance and capital markets, EPAMThe strength of the energy sector is broadly dictated by oil prices. For energy-producing countries, low prices for oil and natural gas are a challenge. In the CIS region several countries, including Russia, have state budgets that rely on a high market, and the downward pressure is being felt. 

For Ukraine, being an importer of energy, this is a time of opportunity. For instance, when it comes to natural gas, Ukraine is enjoying a buyer’s market, and a choice of suppliers gives Ukraine some leverage with pricing. Alongside the internal reforms in the field, Ukraine’s vulnerable energy sector is gradually strengthening.

Q: Which nations have the strongest presence in green energy?

Kliuchkovskyi and Stepanenko: The CIS region has traditionally relied on hydrocarbons and nuclear power as a source of energy, and green energy has not been developed as dynamically as elsewhere in Europe. Additionally, the bulk of renewable energy comes from older hydropower, while solar, wind, biomass and other sources are barely tapped. 

Percentage-wise, Russia is ahead of the curve, with approximately 16 per cent of total power generation coming from renewables. For comparison, Ukraine stands at approximately 6 per cent. Russia, however, still relies heavily on traditional sources of energy, while Ukraine is attempting to put more emphasis on renewables.

“Local Ukrainian business people are finally dominating the green energy market” – Mikhail Ilyashev

Oleh Malskyy, head of corporate and M&A, Astapov: I would say Ukraine has the strongest presence in green energy. We know of several projects completed in wind energy and other renewable energy sectors and financed through international institutions and private parties.

Mikhail Ilyashev, managing partner, Ilyashev & Partners: Unlike many CIS countries, Ukraine pays great attention to the promotion of green energy. In the last decade, the country has adopted a green tariff, and it also guaranteed 100 per cent payment of the supplied energy generated from renewable resources by the state energy market. As a result, it attracts many local and foreign investors.

It is difficult to determine which nations dominate this market, as many Ukrainians use foreign legal entities for their investments. So, we may find many investors from Cyprus, and other EU countries like Austria and Italy. At the same time, I believe that finally local Ukrainian business people are dominating this market.    

Q:  How does the political situation in Ukraine impact the energy markets in both Ukraine and the wide CIS nations?

Kliuchkovskyi and Stepanenko: The political situation has had a major effect on the region’s energy markets. For Russia, it has created a number of difficulties, from sanctions and their consequences to downward pressure on energy prices, though this may not be directly attributable to the Ukrainian crisis. 

For Ukraine, while the crisis has created significant macroeconomic hardship, a number of opportunities have emerged in the energy sector. Once Ukraine has overcome these macroeconomic difficulties, the energy sector is expected to liven up in all areas – upstream, midstream and downstream.

“Once Ukraine has overcome the macroeconomic difficulties, the energy sector is expected to liven up in all areas” – Roman Stepanenko

Malsky: There are several consequences of the political situation but mainly that the conflict is leading to modernisation of the industry. There is a dispute going on between Gazprom and Naftogaz, and Ukraine is rethinking its transitional status. 

Ukraine is undergoing the implementation of the EU third package, which requires the segregation of state monopolies into specific businesses. Locally we see much more private parties getting involved in trading, and that corresponds to EU policy in general. As to investments, we see quite a lot of interest but the market is not there yet because of the political situation.

Ilyashev: Ukraine’s energy sector suffered greatly during the last year due to the war in Donbass, and the situation in the Crimea. Problems occurred in the functioning of the electricity market, as producers tended to be in the territories not controlled by the government while consumers were located in areas under control of the government, or vice versa. 

In order to keep the financial balance of the electricity market the government decided to cut the tariffs paid to power producers and as a result faced many claims from them. Producers of power from renewable resources in particular suffered from the tariffs cut. The renewable energy market was very attractive for investors but the tariffs cut has seriously damaged the reputation of the government and frightened off potential investors. 

Maryna: When the president of Russia declared Crimea to be a part of Russia, investors in businesses operating in Crimea faced an unpredictable situation, particularly those involved in energy facilities producing electrical power from alternative sources, the majority of which were solar power plants.

These had been guaranteed green tariff treatment until 2030, and many investors had bought the equipment on credits calculated to include the promised tariff. At the same time the state enterprise Energorynok had officially stopped purchasing all electricity produced in Crimea.

Thus, the change of political regime in Ukraine has given rise to a number of contractual disputes.

Q:  What do you think of Ukraine’s energy market opening up to investment? Will this have a major impact on the market?

Kliuchkovskyi and Stepanenko: The Ukrainian energy market has been largely monopolised for many years. The liberalisation of the internal market, implementation of the EU third energy package and expected unbundling of the state energy monopoly and influx of investment is meant to bolster competition in the market. This in turn should convert the market from being a largely seller-friendly one to buyer-friendly. Investment is also expected to strengthen the struggling upstream market, which should also have a significant economic effect for the entire country.

Ilyashev: Due to the problems with Russia, the Ukrainian government decided to open its gas market to non-residents and de-monopolise it. We have already received some requests from foreign gas traders for our input into feasibility studies of possible activities in Ukraine.  

Q:  Which jurisdictions does the region want to develop closer ties with?

Kliuchkovskyi and Stepanenko: Over the past two years, the Ukrainian government has been consistently trying to depart from the decades-old dependence on Russia in the energy sector, and is seeking deeper integration with the EU. Ukraine aims to become part of the European energy market, and the recently signed EU-Ukraine Deep and Comprehensive Free Trade Agreement will help that process. This builds closer ties with countries such as Germany, France, Norway and others that play a role in shaping the European energy market.

Maryna: Ukraine has been working on diversifying its gas supply, and according to data provided by Naftogaz, last year it managed to significantly diversify its sources of imported natural gas for the first time. Gas imports from Europe rose 138 per cent, from 2.1 to 5.0 billion cubic meters, while Russian imports fell 44 per cent, from 25.8 to 14.5 billion cubic meters. The main gas supplier to Ukraine for now is Slovakia. Among other countries importing gas to Ukraine from time to time are Hungary and Poland, and Ukraine intends to strengthen its relationships with these countries. It also intends to make its gas storage facilities attractive for foreign companies by means of the third energy package.

The Lawyer, 6 November 2015 | By Becky Waller-Davies