Limiting the cost of feed-in-tariff subsidies

Executive summary

Ukraine has guaranteed to pay eligible renewable energy producers a fixed feed-in tariff, which is set above wholesale market tariffs. Although, the current feed-in-tariff regime will be replaced by an auction scheme by 2020, for existing installation the feed-in-tariff is guaranteed until 2030 This is meant to provide a stable environment to RES producers and thus incentivise them to invest.

And indeed, this policy had been successful in the sense that it led to a significant increase of RES capacity. We estimate that RES capacity eligible for feed-in-tariffs is likely to increase to 5.6 GW by the end of 2019 when no more new applications will be accepted – up from 3.2 GW as of June 2019. Annual expenditures of subsidising feed-in-tariffs above market prices are expected to rise to UAH 28 bn in 2020 (ca. 0.85 bn EUR) and to remain at similar levels until 20301. Amidst, this increase, it legitimate to ask how to limit the cost of RES support and how to avoid the increase to translate into higher electricity prices.

While FIT expenditures are significant – equal to 0.6% of GDP or 1.5% of public expenditures – this increase will only partially translate into higher electricity costs. This is due to the fact that feed-in-tariff subsidies are financed both, through a TSO tariff surcharge – which indeed has a direct impact on prices – but also through proceeds from electricity sales from state-owned generating companies – which effectively resembles budget financing and does not affect electricity prices.

Amidst the increase of FIT subsidy cost, there have been calls to reduce the FIT levels for existing renewable energy installations. Such a proposal is understandable from policy-makers’ perspective but problematic as this means reneging on the FIT tariffs guaranteed to investors until 2030. Breaking these guarantees would inevitably damage the investment climate and undermine trust in any future government contract. International experience suggest that such a move may also increase borrowing cost and also carries the risk of legal action especially from foreign investors seeking arbitration.

Amidst the risks of an outright reduction of FIT levels, it is sometimes proposed to stretch support. That is, paying RES investors the same amount of revenue but stretched over a longer period of time. It needs to be understood that this is effectively the same as cutting the FIT levels. Any revenue postponed into the future has to provide sufficient interest in order for investors not to be worse off.

Policy makers may therefore decide to compensate investors for having to wait longer for their revenues – for example by guaranteeing them the present value of revenues as before the FIT adjustment. While this may mute protests from the investors, it also implies additional cost of financing the prolongation of subsidies.

Amidst the cost and risk of changing existing FIT contracts, we advise against it. Instead, we recommend to focus on more effective and less risky measures. First of all, the government may consider a moratorium stopping any new applications for FIT tariffs for all projects which have not yet started. Additionally, it should be analysed if the financing of RES support could be changed so as to de-couple it from electricity prices and to allow Energoatom and Ukrhydroenergo to sell their full capacity on the wholesale markets. This would increase liquidity thus diminishing market power of dominant players and thus reducing prices for the population and industry.

Oleksii Mykhailenko, Jörg Radeke, ABT

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