New electricity market: what was before and how is it now?

The first step in the transition from the old to a new model of the electricity market has been taken by establishing a wholesale market where generating companies or electricity producers make direct contracts with buyers

“Every month, I pay 395 euros in electricity bills, because my house is quite large. Small households usually pay for electricity 120 euros at the most,” Stefan Nimmesgern who lives in Münsingen, a small town in Baden-Württemberg, Germany says. “We can select any [supplier] we like, which is very easy to do. You go to a special online platform where you’ll be asked how much electricity you need per year and how much kilowatts you consume. After you complete the form, the website will give you options. And if you change the supplier, they [supplier companies] will see it and the first thing they’ll do is to offer you discounts so that you stay with them. It could be 20 percent, could be 10 or even 30 – everyone is different. It all depends on how many kilowatts you are going to buy from them. You just click on it and change the provider.”

That’s how the retail electricity market for households and businesses works in Germany. That’s how Germans buy gas also. And that’s roughly the system Ukraine wants to create as well. A new model of electricity trade was launched on 1 July. What changes took place and what consequences they could create?

 

A nonmarket electricity market: how was it before?

Since 1995, Ukraine’s electricity market operated on the basis of the “single buyer” model. Power stations were generating electricity and selling it to the state in the person of Energorynok state enterprise. The latter was selling it to supplier companies (oblenergo) at a regulated tariff set by the National Commission for Regulation of the Energy and Utilities Sectors (NCREUS). Then, oblenergo companies were selling electricity to businesses and household consumers.

One way or another, the price they paid at every stage was regulated by NCREUS. The National Commission was approving the formulas for calculation of the price paid by Energorynok to generating enterprises (power stations). In addition, the Commission was setting the tariff received by oblenergo companies for transmission services and the tariff for consumers.

What was the problem with this system? The sole buyer — Energorynok state enterprise — also became the sole seller for the equally sole oblenergo company in every region and, separately, in Kyiv. The price was determined not by the market (i.e. by the balance between supply and demand) but artificially, by the state via NCREUS as the sole regulatory authority. Often, the formulas for calculation of these prices were very questionable.

The most publicized of these schemes was the “Rotterdam+”. It was a methodology of forming the coal price for thermal power stations in Ukraine, set by NCREUS effective May 2016. As a result of the War in Donbas, Ukraine lost control over a part of the Donets Coal Basin. In order to solve the problem of coal deficit, the National Commission introduced a formula for calculation of the coal price based on the price of import (via Rotterdam) plus transportation costs.

In the meantime, thermal power stations continued to buy some of the coal they needed from the occupied territories or Russia at a much lower price ranging between 600 and 1100 hryvnias per ton. Then, they were selling electricity to the state at a totally different price, as if they were buying coal not from the occupied territories but at the international commodity exchange in the Dutch city of Rotterdam. Coal was coming there from South Africa and South America at an absolutely different price of 1800-2000 hryvnias per ton. It bore upon the formation of electricity price for end consumers.

On 1 July, the wholesale sales model was changed. Energorynok was liquidated, and from now on, oblenergo companies have to buy electricity from generating companies at an auction. The price is regulated by the market, just like for any other good or commodity.

 

What does gas have to do with it?

The situation with gas is similar to the situation with electricity, but there are certain differences. Ukraine produces the bulk of gas it needs domestically (via Ukrgazvydobuvannia state enterprise), importing almost 40% of gas from Europe from some 40 traders.

35% of gas is sold to businesses (companies and enterprises) on the absolutely market terms. There are over 500 gas traders operating in Ukraine. They compete among themselves for the buyer, in particular, by offering a better price. These companies pay Ukrtransgaz for access to the gas transmission system of Ukraine (simply put, to the pipeline). Ukrtransgaz is a state enterprise (a subsidiary of Naftogaz of Ukraine NJSC) for transmission and storage of natural gas, formally independent from Naftogaz; it is the operator of the integrated gas transmission system of Ukraine.

But the situation with the sale of gas to households is quite different. The de-facto sole seller in this market is the state in the person of Naftogaz, and the tariff for this commodity is set by the Cabinet of Ministers. Naftogaz sells gas to oblgaz companies, which deliver it to the homes of Ukrainians at the price regulated by the Cabinet of Ministers, adding to it the transmission tariff (the oblgaz company’s cut for its services is determined by NCREUS). In other words, this scheme is similar to the one that existed in the electricity market before 1 July, with the only difference is that in this case, there is Naftogaz instead of Energorynok and oblgaz instead of oblenergo companies. Accordingly, the problems are the same. The absence of market conditions leads to unfair pricing practices and nontransparent sales terms.

 

How should it work?

The first step is to create a wholesale market, where generating companies (in the case of electricity) or importer or producing companies (in the case of gas) make direct contracts with buyer companies. Today, this scheme is already working. It ensures transparency, competition and fair pricing. “The market gives consumers a fair price. Not low, not high, but fair,” Timur Khromaiev, Chairman of the National Securities and Stock Market Commission (NSSMC) explains.

For that purpose, the European Union has been implementing its Project of Helping NSSMC with Harmonization of Ukrainian Legislation to Create Organized Trade in Modern Financial Goods and Commodities in Ukraine since September 2018. As part of this project, experts of the Frankfurt School of Finance & Management provided consultations to the National Securities and Stock Market Commission (NSSMC) on what a new model of energy trade could be.

Commodity exchanges must become a platform for the market’s efficient operation. Why them? “At present, companies in Ukraine often cannot guarantee the settlement of debt,” Timur Khromaiev complains. “Therefore, a contract and the paid price still do not guarantee that the commodity will reach the buyer. And vice versa: a delivered commodity does not guarantee that the seller will get the money”.

The trading system works differently. “There is a commodity exchange, a seller with a commodity and a buyer with money. What does the commodity exchange do as an intermediary? Creates rules to ensure that both the buyer and the seller meet certain criteria,” Timur Khromaiev says. “It is the exchange’s headache to make sure that the buyer and the seller settle their accounts, not their problem. In other words, the commodity exchange guarantees the settlement of debt and delivery. It also has capital. If the seller fails to deliver to me the goods for which I have already paid, I will still get the goods.”

There are more than 620 exchanges operating in Ukraine today. However, they do not perform this function of risk management. Rather, they just “stamp” contracts, the expert believes.

“Under favorable conditions, two or three years should be enough to implement this reform,” Timur Khromaiev says. “If the conditions are unfavorable, we’ll “break this rock””.

Today, the wholesale energy market has finally become fully operational in Ukraine. It means that in the future, there will be an opportunity to create a retail market for household consumers. They will get the chance to select a supplier. In order to make all that happen, the government and the Verkhovna Rada must be ready for changes in energy and financial legislation (to facilitate operation of commodity exchanges).

 

By Samira Abbasova