Even as the EU-Ukraine dialogue on energy issues focused primarily on secure transit of oil is gaining momentum in geopolitical quarters, more fundamental internal problems face Ukraine's energy balance. At current GDP growth rates and with increases in demand for electricity, Ukraine could experience electricity shortages in less than five years.
The only way to fill this inevitable energy gap, according to industry insiders, is to open the sector to private investors the way Bulgaria and Romania did in recent years.
The situation in Ukraine, however, is much more acute. The Donetsk-based DTEK, Ukraine's only domestic private electricity company controlled by Rinat Akhmetov's System Capital Management (SCM), estimates that in the absence of meaningful investment Ukraine's total electricity generating capacity could be 10GW (gigawatts) below market demand by 2010.
Dire predictions
This figure represents 22% of Ukraine's total installed capacity, which is expected to reach 45GW by 2010. By 2015 the gap could be as wide as 27GW, which would mean that Ukraine would have to cover some 60% of its total needs from imported electricity. This would clearly be absurd in a country so rich in electricity generating coal, hydro and uranium resources as well as the technology and tradition to utilise them.
There are also plenty of international companies ready to pour in the capital needed to rehabilitate Ukraine's power generation assets and meet rising demand. According to the modest estimates of the Energy Strategy of Ukraine, energy sector capital needs between 2006 and 2010 will be approximately USD18 billion. Between 2011 and 2020 this should rise to USD 56 billion. It is clear that the public sector alone cannot finance the modernisation of the energy sector.
And yet, so far, policy makers have remained unmoved. Despite high rhetoric and apparent appreciation of the seriousness of the situation, there have been no significant signs of any shift in favour of privatisation in the electricity sector.
State inefficiency
The state sits on some 90% of all power generating assets and some 60% of electricity distribution assets and the overall level of efficiency and capital utilisation is quite dismal. For example, the state-owned Dneprenergo uses only 21% of its capacity while the privately-held Vostokergo (owned by DTEK) uses 51%.
Apart from a reluctance to allow the private players to run the energy sector more efficiently, there are few incentives in place that would actually attract foreign investors in this capital-intensive industry.
The current wholesale electricity market framework, where power generators are required to sell their electricity to one pool is fundamentally non-market oriented and discourages private sector participation.
There is now provision for the so-called power purchasing agreements (PPA) that would guarantee producers a fair price for electricity but at the moment the tariffs are dominated by the regulator and subject to frequent policy change and revisions.
More importantly, the tariff system has not yet moved to a market based “costs plus” system which guarantees a rate of return to investors in power generation sector.
This is regular practice in the many countries across Eastern Europe which have already moved to a more successful and efficient market based model.
As always, Ukrainian policy makers have chosen the ultra-gradualist path, reluctant to unleash the full impact of electricity price hikes on the population. The result has been years of underinvestment and lost opportunities.
Fortunately, the current government of Viktor Yanukovych has realised that the situation with electricity tariffs has become untenable and to its credit introduced a sharp electricity price hike earlier this year, which will help at least to cover the costs of power generation.
A slow process
Brave foreign investors like AES (the only foreign power generator operating in Ukraine) have welcomed the move. But the government needs to be braver still.
To really tackle the problem of the widening energy gap, it needs to act resolutely and radically by opening up the energy sector to private investors. The window of opportunity to reverse this trend is quite limited.
Rehabilitation of existing energy assets and privatisation turnaround is a notoriously slow process. Even if the government were to tackle the problem now, Ukraine is likely to be a net energy importer, given its rising energy needs fuelled by an increase in residential consumption.
Drives for efficiency among industrial producers and fresh EU funding to improve the sector are unlikely to have much of an impact in solving the fundamental issues.
Once again it will take a determined and forward-looking politician to admit it is best to leave the development of Ukraine's energy assets to the private sector.
Regrettably, no such figure is currently visible on the scene, with privatisation and liberalisation continuously held off the political agenda.
