Foundation for the Development of Environmental and Energy Markets

Ukraine`s Green Tariff: Great news in 2008, but what happens in 2009?

2009 will be an interesting year for clean and renewable energy investment. On one hand, the global financial downturn plays somber backdrop as funding sources dry up and cash grows hard to find. On the other hand, certain international markets are attacking the credit crunch with heavy new incentive packages that aim to boost investment interest in alternative energy to its highest level ever. So although times are tight, countries like Ukraine seek to overcome investment inertia with new laws purporting to double the revenues from green power projects.

Government efforts to jumpstart alternative energy investment aren’t happening only in the former Soviet Union; numerous legislative incentives are in either force or under review on four continents. The United States may soon join this group under President-elect Barack Obama and his emphasis on forward thinking components to energy policy.

Do these new laws have a decent chance of success, or will they stumble in their transition from paper to practice? It's too early to judge and each case is unique. Energy markets are complex and Adam Smith’s invisible hand sometimes can grasp new variables in an unpredictable manner. But regardless of how each individual country case works out in 2009, the fact that governments are making this type of effort is a strong positive industry signal.

This article highlights Ukraine’s Green Tariff due to the country’s potential foreign direct investment (FDI) draw with regard to clean and renewable energy. Ukraine is a large country, roughly the size of Texas, that could theoretically develop into a major energy exporter based on its abundance of natural materials for alternative energy production. Ukraine is motivated to increase new domestic energy production for sovereignty and national security reasons, and its power grid is largely outdated. On the surface Ukraine offers privatization and new energy investment opportunities that, in light of the country’s strategic geopolitical importance, make it unquestionably attractive for FDI. But Ukraine also has an intermittent difficulty converting opportunities and resources into successful business transactions with foreign parties and investors.

Last September, Ukraine’s Parliament adopted the Law “On Amendments to Certain Laws of Ukraine Concerning the Introduction of a Green Tariff” by an overwhelming 292 vote margin. Nicknamed the “Green Tariff” within the local investment community, the law aims to jumpstart new FDI into Ukraine’s clean and renewable energy space by allowing power suppliers to charge higher electricity tariffs to the wholesale energy market than ever before.

The Green Tariff covers wind power, hydropower, biomass, biogas, and several methane capture power producing activities. With regard to hydropower, only stations with 10 MW or less in capacity may participate. According to the Green Tariff’s language the National Electricity Regulatory Commission of Ukraine (NERC) will roughly double the amount of money that energy producers in these areas could normally charge for the next 10 years. Specific tariff levels can be revised annually by NERC as needed, but essentially the Green Tariff allows eligible Ukrainian energy producers to charge double the previous year’s average wholesale market energy rates, so long as these prices do not more than double current average wholesale market energy rates.

By and large, Ukraine’s Green Tariff can be viewed as a landmark effort to take Ukraine’s energy sector into the advanced twenty first century. The high tariffs should trigger more investment activity and a corresponding new inflow of technology transfers, energy supply, export possibilities, and capital injection into the economy. To actually attain these goals, however, further work is required to take the Green Tariff from a conceptual legislative stage to a practical working stage.

As an initial matter, NERC and the government have yet to determine the exact Green Tariff prices, and they still must articulate how the Green Tariff will operate from a functional point of view. The investment community has present concerns about the likelihood being able to collect full Green Tariff rates in practice. Ukraine is in the middle of a banking and currency crisis, and one of the government’s most stable features is, ironically, political instability. Some regional energy companies are so much in debt that they swap energy production for debt relief. In such an environment, the success and credibility of the Green Tariff as an investment incentive will depend in large part on the safeguards added in to ensure the collectability of new rates once they are applied.

The basic definition of what constitutes renewable energy probably also should be revisited with some minor clarifications. For example, the 10 MW capacity ceiling for hydropower facilities has no apparent relation to the Joint Implementation Mechanism under the Kyoto Protocol, where the market typically does not discriminate between hydropower projects until they exceed 20 MW. These types of counterintuitive discrepancies create continuity gaps that can confuse or deter FDI.

The investment community has responded positively thus far to Ukraine’s Green Tariff despite acknowledging that it needs some further work to become a functional market mechanism. Traditionally overlooked energy sectors in Ukraine, such as wind power, are now enjoying a newfound level of interest and activity. From a more grass roots point of view, it is clear that the Green Tariff buzzword has sustained FDI interest in Ukraine’s clean and renewable energy markets during the financial downturn; that is something many other countries cannot claim at the moment.

The Green Tariff may even place Ukraine in a very strategic investment position compared to neighboring countries if it is finalized and implemented properly. Theoretically the Green Tariff could help create an alternative energy renaissance in heart of the former Soviet Union. Pareto optimality could occur for the Ukrainian government, investors, individual energy consumers, and the environment. But clearly without proper finalization the Green Tariff could fall short of its intended effect and, in the worst case, perhaps even represent a disappointing failure.

Ukraine has had occasional difficulties capitalizing on FDI opportunities in the energy sector. As a case in point, consider Ukraine’s multi-billion dollar unsold national stockpile of Kyoto Protocol carbon allowances. Ukraine got this highly valuable stockpile, at one time worth around 50 billion dollars, as a byproduct of Russia’s hard negotiations with Europe before signing the Kyoto Protocol. By setting Kyoto Protocol carbon targets at 1990 indexes (the year before the Soviet Union’s 1991 collapse), Russia deftly avoided the costly compliance burden now faced by other large European economies.

If Ukraine had sold or pre-sold part of this stockpile last year at competitive prices, it could have satisfied the world’s demand for carbon credits and the Ukrainian government would be a global leader in energy and environmental policy today. The sales revenues would have averted Ukraine’s financial crisis and could have reversed the country’s present fortunes. This is not hyperbole; if it sounds farfetched, ask a carbon market analyst. Despite this historic unique opportunity, Kiev policy makers have been unable to complete a major national carbon allowance deal because they are unhappy with market price levels.

By failing to grasp that decreasing carbon market prices are the terminal result of reduced international demand, limitless supply and an expiring Kyoto Protocol period, Ukraine soon could miss its window to cash a multi-billion dollar free check. This sort of misstep is not specific to Ukraine and the European Union countries made similar mistakes during Phase 1 of the European Union Emissions Trading Scheme when carbon allowance prices dropped from 30 Euros in June 2006 to zero in 2007.

So what will be the Green Tariff’s future in Ukraine, and how will it impact the 2009 energy markets? Will the Green Tariff succeed and create a working blueprint for other countries to emulate, or will it miss the mark? Everything depends on the Green Tariff’s finalization process before this spring; both the degree of domestic political stability and the participation by seasoned energy market experts will be crucial factors.

Regardless of what happens in the coming months, right now the Green Tariff – like the type of energy it covers – represents a bold step in the right direction. Hopefully the Kiev lawmakers will accomplish precisely what they set out to achieve, and the Green Tariff will become a success story that inspires several neighboring countries to follow suit. If Ukraine and other governments create successful stimulus packages this year, 2009 could witness a steady rate of new FDI into alternative energy projects and new clean technologies despite international snags with liquidity.

Given all of the negative economic and market commentary that is floating about, it is nice to see one space where the investment outlook may be looking up, not down.

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