After a decade of Ukrainian economic decline, which halved the country’s economic output and raised the poverty rate to almost a third of population, GDP has rebounded by over 30 percent since 2000, and indications are that the poverty rates are beginning to decrease.
After a decade of Ukrainian economic decline, which halved the country’s economic output and raised the poverty rate to almost a third of population, GDP has rebounded by over 30 percent since 2000, and indications are that the poverty rates are beginning to decrease. The recent economic growth in Ukraine has been a mixture of revival of old and emergence of new activities, both supported by access to inexpensive energy supplied from aging, inefficient and often environmentally polluting sources through extensive electricity, gas and oil networks inherited from the FSU. Furthermore, the low priced domestic coal (and electricity) is one of key resources helping revival of the steel industry which accounted for 37% of the total exports of Ukraine in 2003. Ukraine now faces the difficult task of ensuring the sustainability of the economic growth and the consolidation of market reforms which are critical if the country is to fulfill its stated aspirations with regard to increasing integration with the EU and with the WTO.
Developments in the energy sector closely mirror the aforementioned changes in the economy. After a sharp decline in the 1990s, the production of electricity in the last three years stabilized at about two thirds of the production in 1990, while the primary energy production (coal, gas and oil) bottomed out at about 40 percent of the 1990 level. While significant spare capacities freed by declining demand enabled unconstrained energy supplies in 1990s, albeit of low quality and poor reliability, the recent economic revival is exposing a significant loss of available capacity and deterioration of energy infrastructure which is facing serious challenges in maintaining security, reliability and quality of energy supply due to (i) lack of investments and deferred maintenance in aging infrastructure; (ii) poor financial condition of energy enterprises; and (iii) delays in sector reforms. These are not independent problems, but, actually, form a vicious circle which, if left to itself, would undermine sustainability of economic growth, reduce competitiveness of country’s products and services, degrade environment and increase the cost of social services. Furthermore, attracting investments, creating jobs and increasing productivity — key drivers of sustainable economic growth — can not be effectively stimulated without improvements in security, reliability and quality of energy supply.
Ukraine is the most important transit country for Russian gas to Western Europe [see 1 below], with between 80% to 90% of Russian gas exports moving over Ukrainian territory. Furthermore, Ukraine has a large electricity grid which in 1990 exported 28 TWh to the nowadays EU member countries (Poland, Czech Republic, Slovakia and Hungary) as well as to the EU prospective members in the South East Europe (Romania and Bulgaria). The economic restructuring in the Central and Eastern Europe (CEE) countries practically eliminated the need for electricity imports from Ukraine in early 1990s and the transmission links between CENTREL [see 2 below] and Ukraine (except with the Burshtyn Island [see 3 below]) were disconnected in 1993. The demand for electricity imports from Ukraine started to grow after 1999 and reached 4.3TWh in 2003, which is close to the limit of available capacity in the Burshtyn Island. Therefore, harmonization and increasing integration with the EU Internal Energy (Electricity and Gas) Market is essential for improving security and reliability of energy supply in Ukraine, as well as for improving efficiency in the Ukrainian power system and facilitating energy trade with the EU.
The World Bank has supported Ukraine in its efforts to reform and restructure its energy sector through policy dialogue, technical assistance and financing since the early 1990s. The Bank has now proposed to provide a $370m "Energy Sector Reform and Development Program Loan" (known as an ”˜Adaptable Program Loan (APL)). The overall APL objective is to improve security and reliability of the energy supply and facilitate unimpeded operation of the energy market, both domestically and internationally. Also, the program will support Ukraine’s aspirations with regard to legal and technical harmonization and increasing integration of its energy market with the EU Internal Energy Market through priority investment projects and technical assistance.
The first priority investment project will aim to improve stability of power grid through increased reliability and efficiency of hydroelectric power plants; improve reliability and reduce cost of meeting peak electricity demand by increasing capacity and production of hydropower plants; improve dam safety and reduce risks of failures of hydro-mechanical equipment; reduce emissions from thermal power plants by increasing production of environmentally friendly, renewable hydroelectric energy; help introduce modern environmental standards in operation of hydropower plants; improve environmental monitoring of thermal power plants; and support further implementation of the wholesale electricity market reforms.
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If successful, the program would support sustainable economic growth through consolidation of energy sector reforms, improved security, reliability and quality of energy supply, and fostering of energy trade in the domestic and international energy markets. The first phase of APL would help launch the program and provide investment support for rehabilitation of major hydropower plants on the Dnipro and the Dnister rivers and for introduction of modern systems for monitoring of emissions at selected thermal power plants. Furthermore, the first phase of APL would help strengthen institutional capacity in the Ministry of Fuel and Energy and the National Energy Regulatory Commission (NERC) to develop and implement energy sector policies and reforms. The key performance indicators will be designed accordingly.
The Bank will support the proposed multi-phase long-term energy sector reform and development program by the APL. The APL instrument will provide flexibility in adapting project design and financing over time to meet agreed development objectives as the country’s conditions evolve. Each phase of the Energy APL will be supported by a specific investment loan. Each investment loan within the APL will build on the previous one and together help fund a long-term reform and development program — with an explicit up-front agreement on the long-term development objectives and with defined milestones, performance indicators and triggers for moving from one phase to the next. These features allow adaptation and broadening or deepening of Bank support in line with changing country circumstances.
The program will have links to the energy policy benchmarks and milestones which were established some years ago under the Bank’s Programmatic Adjustment Loans (PALs) to Ukraine. As agreed under the PALII, the Government of Ukraine is preparing a comprehensive action plan for improvement of financial solvency of Ukrainian energy sector. This plan will help establish a road map for consolidation of energy sector reforms and identify the near, medium, and long-term targets for the energy market development. Furthermore, the Cabinet of Ministers established an inter-ministerial Commission for Energy Sector Reforms and Development chaired by the Vice Prime Minister. The Commission will provide leadership in designing and implementing sector strategies, including review and approval of changes in the legal and regulatory framework; and identification of priority investment projects and technical assistance to be supported under the APL. In performing its duties, the Commission will be assisted by a permanent working group of local and international experts to be hired by the MFE under the PHRD Grant approved for preparing the proposed APL. After the Loan effectiveness, the APL will continue to fund this technical assistance to the Government during the program implementation.
The first investment project supported by the proposed Energy APL (up to US$100 million) will deal with the rehabilitation of hydropower plants. This project will build on the previous Hydropower Rehabilitation and System Control Project which was successfully completed in 2002 [see 4 below]. The Project would primarily finance rehabilitation and replacement of obsolete and outdated hydro-mechanical and hydroelectric equipment. However minor civil works associated with improvements of dam safety (e.g. refurbishment of drainage channels to stop water leaks, cementing damages/ cracks in water conduits, installation of dam safety monitoring systems etc.) may be included. The results would be increase in hydropower capacity of about 130 MW and the additional annual production of peaking hydroelectric energy of about 240 GWh. The rehabilitation would be carried out step wise at each station, so that the current electricity production would be only slightly interrupted. Thus negative effects on the water flow can be minimized. Based on the updated feasibility study prepared by UkrHydroEnergo (UHE) and its consultants in 2004, the project will include rehabilitation of about 70 hydroelectric units at nine hydropower plants built for more than 30 years ago. The second phase of Energy APL will support priority investment projects to be identified by the Commission for Energy Sector Reforms and Development in line with the agreed development objectives of APL. The Bank would therefore be prepared to consider a broad range of investments for support under the APL, including the strengthening of transmission network, modernization of power system dispatch, improvements in environmental monitoring and protection and harmonization of technical standards in the energy sector with the EU standards and regulations. Along with the investments, the APL could finance a wide range of technical assistance, particularly for institutional development and capacity building in establishing and operating modern energy markets.
Preliminary Financing:
Source: ($m.)
BORROWER: 270
INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT: 100
BORROWING AGENCY: 0
Total: 370
Footnotes:
1: In 2001, about 20% of total net EU oil imports (16% of EU total consumption) and over 40% of EU gas imports (19% of EU total consumption) came from Russia.
2: CENTREL is the regional power grid of the CEE countries which was formed in 1992 and started parallel operation with the Western European power grid (UCTE) in 1998.
3: Burshtyn Island includes three power plants (TPP Burshtyn, TPP Kalush and HPP Tereblia-Kikskaya) with a combined export capacity of up to 600 MW. Burshtin Island is fully integrated with the UCTE power grid and disconnected from the rest of the Ukrainian power system.
4: During the first stage of hydropower rehabilitation supported by the Bank (1996-2002), UHE refurbished 16 hydroelectric units.
ENN would like to thank Urban Age Magazine for their permission to reprint this article.
