Why Ukraine and Europe still can’t unite commercial electricity markets

Ukraine is readying to launch Market Coupling, a process that will help reduce excessive concentration in the Ukrainian electricity market.

More than half of Ukraine’s electricity is generated by Energoatom, the state-owned nuclear power plant operator. Taken together, state-owned companies and Rinat Akhmetov’s DTEK energy holding account for over 90 percent in the electricity market.

On the other hand, DTEK Group provides more than half of the demand in the key market segment, the Day-Ahead Market (DAM).

Market Coupling is a combination of spot market trading areas in European countries, allowing freely trading electricity with other countries within the technical capabilities of the interconnection capacity.

The concept of Market Coupling was introduced by the European Union’s CACM Regulation, approved in July 2015.

The CACM [Capacity Allocation & Congestion Management] Regulation is a set of rules for the interconnection of commercial electricity markets in the EU.

For Ukraine, Market Coupling will make it possible to connect the DAM with the relevant markets in the EU, allowing the electricity to flow to trading zones (countries) with high spot prices – and not only to neighbouring countries.

This will smooth out price spikes, make the price of electricity more predictable for consumers, and weaken domestic monopolists.

DAM in Ukraine is a pricing segment of the market that affects the cost of electricity for the end consumer.

Simply put, Market Coupling will reduce DTEK's ability to manipulate the market price. If the group suddenly reduces its demand, as it did in July 2021 and May 2020, the unbought electricity will flow to other countries’ DAM rather than lead to a rapid price collapse.

Clearly, Market Coupling is a necessary and useful step towards Ukraine’s integration into the EU – but is hampered by several fundamental problems.

Excise tax on imports

In Ukraine, electricity is an excisable commodity. It is subject to a 3.2-percent excise tax. The excise tax on electricity produced in Ukraine is paid by the generators; and, in the case of imports, by the importer.

In Europe, there is no excise duty on electricity.

The principle of trading on the DAM means that buyers and sellers anonymously place offers for sale and purchase in each hour, specifying the volume and price. When the volume / price of both sellers and buyers match, the system automatically accepts the orders.

If the total ‘mix’ includes, say, 10 percent of imported electricity, it is unclear who should pay the excise tax for it. After all, the participants do not trade with each other, but in fact with the DAM operator, that is, the relevant exchange. In Ukraine, it is Market Operator (MO), a state-owned company.

The most logical solution would be for the exchange itself to pay the excise tax. However, it is unclear where the money to compensate for the tax – which, according to MO, is about UAH 70 million per year – would come from.

VAT on exports

The same problem will arise in terms of managing VAT on exports.

In Ukraine, VAT is charged on each transaction in the chain of counterparties. The VAT rate for exports is zero, meaning the state will refund the VAT to the exporter after a certain period of time.

However, under the DAM, the exchange is considered to be the exporter, as it cannot allocate the export volume to any particular participant in the ‘common pot’ of trading.

At the same time, VAT refunds are often delayed. There is no such problem in the EU; for a Ukrainian exporter, however, this means a washout of working capital for a significant period of time.

When the exchange accumulates the entire volume of exports from the DAM, this burden will lead to its rapid bankruptcy. Market Operator estimates the shortfall in export VAT at UAH 1.5 billion per year.

A working model to resolve the problem is appointing a large state-owned company as a trading agent – that is, intermediary in the case of exports / imports – which will take on the risks of export VAT refunds. Energoatom is being considered for this role.

In EU countries, the system operator – like Ukraine’s Ukrenergo – most often acts as a trading agent.

Status of a nominated market operator

The key link in the Market Coupling process is the exchange that actually operates the DAM. It has the status of a NEMO (Nominated Electricity Market Operator).

In Ukraine, this function is monopolistically assigned to Market Operator. However, in twenty EU countries, there are several exchanges that are connected to a single information base, the EUPHEMIA algorithm (European Union + Pan-European Hybrid Electricity Market Integration Algorithm).

EUPHEMIA has developed European exchanges for interoperability within the framework of the combined markets.

In the case of a competitive model, the DAM will still be single for the country, but each participant can choose which platform to trade electricity on.

Ukraine has to choose which NEMO model – monopolistic or competitive – it will develop.

The market operator, of course, is in favour of the monopoly model. Its deputy head, Daniil Petrenko, names such arguments in favour as imperfect Ukrainian mechanisms of liability for market participants' abuses.

For instance, if there are several exchanges, state-owned generation will sell resources to Market Operator and buy them on some other private exchange. If a large buyer fails to pay the exchange for at least one trading day, it will ‘bring down’ the whole market.

There have already been such precedents. In March 2022, United Energy, a company associated with Ihor Kolomoiskyi, took advantage of the inactivity of Ukrenergo due to the start of Russia’s full-scale invasion and took electricity from the balancing market for about a week without paying for it.

As a result, the buyer owes Ukrenergo UAH 1.1 billion. The state-owned company is still trying to recover the money through court, although chances are rather slim.

The competitive model is advocated by Rinat Akhmetov’s DTEK and MO’s competitors, including Ukrainian Energy Exchange (UEEX) of Oleksii Dubovskyi and European NEMOs, such as Sweden's Nord Pool and Germany's Epex Spot.

Their interest is obvious: Making money in a competitive market from the provision of services. DTEK’s interest is to minimise government control through the state exchange in the case of a monopoly model.

"We need to look at European markets: monopoly markets are underdeveloped, while competitive markets are developed, it's simple," says Mr Dubovsky of UEEX.

Uncertainty about the NEMO model and conflict between market participants may delay the Market Coupling process.

Indecision of the Ukrainian regulator

In June, Ukraine’s energy ministry proposed draft amendments to the legislation to integrate the CACM Regulation, overcome tax problems, and approve Market Operator as a monopoly NEMO.

The proposal, drafted by Market Operator itself, faced criticism from the European Energy Community, which instead recommended introducing the rules of the CACM Regulation into the law on the electricity market and certifying the nominated operator or several operators through the National Commission for State Regulation in the Field of Energy and Utilities (NERCEP).

Meanwhile, on 15 June, the NERCEP refused to amend the licence conditions of Market Operator, which would automatically lead to its certification as a NEMO.

"I believe that the current model of NEMO certification by the Regulator is wrong. The certification can only take place when the Verkhovna Rada [parliament] determines who is the nominated operator and who it can be," said Olha Babii, a member of the NERCEP.

In the EU, nominated operators receive their status after verification by local energy regulators, the process itself based on contracts concluded between market participants and not on regulations.

Thus, to launch Market Coupling, it is necessary to figure out how to solve tax issues and make appropriate changes to the tax and customs codes; integrate the CACM Regulation into the electricity market law; and persuade the regulator to certify one or more operators.

After that, the participants in the process will need to conclude appropriate agreements with European NEMOs and system operators – and most importantly, with each other.

Given the specifics of regulation of the Ukrainian electricity market and the different interests of its participants, Market Coupling is unlikely to happen in the near future.