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17 August 2017
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Andriy Herus: "Rotterdam formula" only beneficial to heat generation, coal mining business, most of which owned by one man

Ex-member of the National Energy and Utilities Regulatory Commission (NEURC) Andriy Herus in an interview with UNIAN has told, what the outcome will be of implementing a "Rotterdam + shipping" pricing formula for Donbas coal, and how much the heat generation, 70% of which is owned by a businessman Rinat Akhmetov, will earn from these changes.

Herus:
Herus: "Rotterdam formula” categorically does not suit Ukraine

Andriy, here in Ukraine, we are all accustomed to the fact that industrial customers year after year, have remained in arrears for gas consumed. But as it turns out, the situation with electricity is even worse – the market participants owe to each other almost UAH 29 billion. A working group has already been established to resolve the issue. It offers to write off part of debts, restructure another part and include the rest in the tariffs so that the debts were repaid by conscientious consumers. Do you know anything about this?

Yes, I do. At present, a draft law has been developed, which provides for three stages of elimination of debt in the electricity market. One of these stages assumes the establishment of target premium to the rates to collect from the market about UAH 10 billion and thus eliminate part of the debt. De facto, it turns out that instead of consumers who have not paid for electricity, other consumers have to pay. It is obvious that this will lead to an increase in tariffs. This draft is quite controversial. Hopefully, there will be more discussion and information, so that we could hear the opinions of the parties, including those of consumers, who will have to pay someone else's debt.

According to the Energy Ministry, there are several components that comprise the emergence of debts for electricity. This is the lifting of subsidies to state-owned coal mines, resulting in these mines owing UAH 10 billion for electricity over two years. More than UAH 1.3 billion is owed by the occupied areas of Luhansk region and another UAH 200 million – by the occupied parts of Donetsk region. Is this true?

The problem is not only that the territories are occupied. It is also important, which power companies operate there and how. If you take Luhansk Energy Association, owned by a businessman Grigorishin, we see that it somehow managed to still not be registered in the Ukraine-controlled territory. It remains registered in the militant-occupied Luhansk. And no one knows what payments it collects. But I can’t but wonder why such a big gap between the volumes of electricity debt repayment between the two occupied territories. After all, the situation in Donetsk is no different from that in Luhansk.

That is, we can’t avoid another increase in electricity tariffs, can we? What are the wholesale prices of electricity in Ukraine and in Europe?

In the first quarter of this year, the average wholesale market price was higher in Ukraine than in Eastern European countries. For example, it’s 20% higher than in Poland, 25-30% higher than in Slovakia and Romania.

Why is that? That’s because they have an actually functioning market. There is stock exchange, there is competition. Therefore, when there is a decrease in coal and gas prices in Europe, it is immediately reflected in the electricity price. In Ukraine, de-facto, there is no market. Our regulator, the NEURC, simply sets the wholesale market price. In this regard, the cost of domestic electricity becomes pretty high.

Here is an example. The transformers in the rate of Ukrenergo for 2016 were calculated at a price of UAH $20,000-25,000 per MV-A. Although a tender held for the purchase of transformers showed that their actual price is just $8,000-10,000.

Such overpricing of individual components gives an expected result: the wholesale market price in Ukraine today is overstated.

Here is a question regarding another important component of the electricity price – the cost of coal. On the world market, it is based on the (API2) CIF ARA Index, where “ARA” stands for the ports of Amsterdam, Rotterdam and Antwerp. In 2014-2015, the NEURC categorically opposed the introduction of the “Rotterdam plus shipping” coal pricing formula. But in 2016, the Commission decided to implement it. Does this formula fit Ukraine to determine the price of Donbas coal?

This formula is totally unsuitable for Ukraine. We have enough Mark G coal in reserves and we maintain high production levels. In addition, there are ongoing deliveries of Grade A coal from a temporarily uncontrolled territories. That is, coal is not imported.

Ukraine currently does not import coal from South Africa – there is no need to do it, which was confirmed both by previous Energy Minister Demchyshyn and the current one - Nasalik. This is also stated in the balance sheet forecast for 2016, approved by the Energy Ministry. There is a logical question – why set a formula and become tied to imported coal? The second logical question is why can’t our farmers set a formula for pricing potatoes "New York supermarket plus shipping." Ukraine has never imported coal from Rotterdam and it's not going to do.

Perhaps, the pricing of Donbas coal by the formula would not look so cynical if they just set the price in the Port of Rotterdam, without this "plus shipping" thing. After all, there are no coal supplies from Rotterdam.

Supporters of the "Rotterdam" coal price argue that the price of gas is also defined by a formula. But there is a real import of gas, there are real transport costs to deliver natural gas from the German hub. Hence the conclusion: a "Rotterdam formula" for coal is clearly unfair, leading to an overpricing of electricity.

Why did the NEURC set a $45 ceiling in the "Rotterdam formula"?

The price in Rotterdam varies. It used to be $42. Now it’s about $ 50. In the formula, which is being implemented in Ukraine, there is laid a median of 12 months. But I don’t know how it was calculated. The Commission members took their decision almost 2 months ago, but they didn’t show their calculations.

Let's compare the prices of our neighbors: the cost of Polish coal is lower than that in Rotterdam by 5% -10%. And with this formula, we’ll have a price 30% higher than in Rotterdam.

Who benefits from the "Rotterdam formula"?

The answer is obvious. It’s the heat generation and coal mining businesses, with more than 70% of both owned by the same man.

It is also advantageous to those who control Centrenergo. It gets coal delivered including from the illegal mines in "LPR-DPR." There has been a lot of fuss in the media over constant corruption scandals, so they are no secret to anyone. However, some officials choose to pretend they know nothing and understand nothing. But these are our realities.

According to the "Rotterdam formula," logistics costs should be at $15 per tonne. How much can Akhmetov earn on this alone, given the mines he owns produce 80% of Ukraine’s coal?

The forecast balance for 2016 says Ukraine will consume 25 million tonnes of coal. Multiply 25 million tonnes by $15 and, at today’s exchange rate, you get around UAH 10 billion. But if the illegal and, therefore, cheap coal from “LPR-DPR mines” is delivered than even more money can be earned, but that’s not DTEK which deals with this. That’s other people.

If the formula is enforced, the price for Donbas coal will rise. Is it logical to assume that the thermal generation, 70% of which, once again, is in the hands of Akhmetov, will demand higher electricity prices?

In fact, the formula has been enforced since May 1. Not surprisingly, from May 1 the tariffs for the industry were raised by 5%-6%. It is expected that the tariffs will be further raised from July 1, and then – one more time, from October 1. Before year-end, electricity tariffs can increase by 12% -15%. It means this goes beyond the earlier approved schedule.

The "Rotterdam formula” will result in tariffs being reviewed each quarter. If the price grows in Rotterdam (and it is already growing), then the electricity price will rise as well. If the formula is not adjusted, the Ukrainian consumers will see a very significant increase in electricity tariffs.

By the way, the price of coal in Rotterdam can jump as high as $100 per tonne. In this case, electricity tariffs may grow as high as 50%.

Who will be more affected by the expensive "Rotterdam coal" – the industry or population?

On September 1, the electricity tariffs for the population will grow by 25%. The tariffs for the industry rose from May 1. But in general, I think, we should be more wary of the growth of tariffs for the industry.

At the same time, we must understand that increased electricity tariffs will automatically be reflected in the price of products. As a result, it’s the end customer who will pay for this. A striking example is water utility companies. Electricity prices were raise for them, so they raised the tariffs for cold water supplies. In particular, in Kyiv, cold water will cost 30% more.

Is it possible to calculate the earnings of "Akhmetov’s" heat generation?

Whether it is Akhmetov’s or not, I’d say the following. In the first quarter, the tariff for heat generation was at UAH 0.96. There was no "Rotterdam formula," but even at this rate, the state-owned Centrenergo in the first quarter recorded a profit of UAH 270 million. Net profit was 10% profitability. These are normal figures.

But NEURC has decided to also raise the rate of heat generation. In April, it was UAH 1.18. It is logical to assume that, if Centrenergo’s profitability was at 10% with the UAH 0.96 rate, then at a rate of more than UAH 1, profitability can reach 20%. In the second quarter, heat generation sees high profits.

Thus, it is now possible to earn both on coal and heat generation. I think that the NEURC is now taking decisions with specific preferences for heat generation.

Earlier, head of NEURC Dmytro Vovk wrote on Facebook that he would never allow for the Ukrainian coal to cost UAH 1,500. But this is exactly the price that DTEK has required to set throughout 2015. What could happen for the Commission to change its position so dramatically?

We are all witnesses of this fact, and everyone can draw their own conclusions. This question is better to be addressed to the head of the regulator. But as far as I know, it was not really a collective decision of the commission. Many people were just told that "this needs to be done." One of the members of the Commission (Valery Tarasyuk) even chose to resigned from NEURC shortly before the vote.

Will the state-owned Centrenergo be buying coal from Akhmetov or will there be deliveries directly from the occupied territories?

In fact Centrenergo gets its "anthracite" coal from the occupied territories. It comes from illegal mines, the mines most likely controlled by commanders of local militant groups. Sometimes, according to the documents we see that it is a South African coal, brought through Russia. Come on, coal from South Africa delivered through Russian railway – this is ridiculous.

I think that in the future, the supplies will continue exclusively from the occupied territories unless there is a political decision to refuse to buy coal from terrorists.

Here is a question regarding profitability of coal mining. For example, DTEK has repeatedly stated throughout 2015 that it is more than UAH 1,000 and, based on logistics costs, required to set the price of UAH 1,500 UAH per tonne. Some experts say that the cost of coal mining in state-owned mines is even higher, at UAH 2,000 ...

As for me, the cost is a very subjective thing. One can put any production cost on paper – that’s not difficult. In fact, it is not necessary to look at the production cost. It’s much more important to pay attention to the market price of coal. For example, it’s important to check out what the coal price is in Poland. If there is the price of $40, then why do we have $60?

Of course, many nuances would have been regulated by the market itself, but we don’t have this market. And we can’t possibly have it. That’s because, according to statistics, over 80% of the coal produced in Ukraine is in one pair of hands. Purchasers of this coal are heat generation companies, 70% of which belong to, once again, the very same company. The circle is closed.

How can the use of "Rotterdam formula" be blocked? Is it possible through litigation?

Filing a suit in the court could quite possibly help cancel the "Rotterdam formula." The Commission has taken a decision with a lot of violations. So there is a good chance to sue and win. But this is not enough. The country needs to hold serious discussions on a fair pricing of coal. And the country needs an independent regulator.

How true is information that DTEK and Ukrinterenergo sought authorization from the Energy Ministry to export electricity abroad at prices below cost?

Yes, it's true. The Cabinet’s draft resolution has been developed to subsidize the export of electricity. It is about not taking into account subsidized certificates (which are to be paid for by all other wholesale electricity buyers) if electricity is exported. But at the same time, the losses during export should be covered by domestic consumers. This means that the tariffs will have to be further raised. I think that there are not enough arguments to give such preference to exporters of electricity. By far, the Cabinet has not received the appropriate decision and I hope it won’t.

Why are the authorities suddenly presenting such expensive gifts to Akhmetov? By the way, is it true that President Poroshenko regained his share in the largest private gas company Naftogazdobycha owned by Akhmetov? What do market participants say about this?

I don’t know anything about it. The company’s operations have been unblocked. This is good – the greater the gas supply on the market, the greater the competition and lower the price.

Mykola Babych (UNIAN)

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