Ukrenergo CEO: Integration into European power system will take 11 billion UAH

What significant changes that have happened during the period of your position in office can you mention?

The most important is the fact that for the first time in its history, the company launched structural reforms. Previously, it was largely a closed system with politically determined rotation of management, which remained unchanged for many years.

The most important structural change is that we almost halved the number of management levels. Management positions in the company were very strongly denominated during 1990-2000.

The hierarchy could look like this: director, deputy director, head of the department, deputy head of the department and then the same story at the territorial and regional levels. Management positions were multiplied simply because otherwise it was impossible to raise the salaries for valuable employees. As a result, in order to make a decision, it was necessary to lead it through 20-25 steps, or, as my colleagues-veterans of the company say, through the "trampled ant trails".

For a long time, these convoluted routes helped people to work and kept the company stable. Therefore, the transition from functional verticals to developed horizontal connections, to the project approach in management became stressful for many people. Naturally, it is easier to do everything from scratch, when establishing an enterprise, rather than try to rebuild a huge mechanism employing thousands of people.

At the time of my arrival, the company employed approximately 11,900 people. This was already after the annexation of the Crimea. 6,500 of them held managerial positions.

Today, there are about 3,000 managers at various levels. This is still quite a big number compared to the best management practices for this kind of companies.

How long did it take to implement these processes?

They are still being introduced. It is impossible to do everything at once. The company"s reform is a long-term multi-operation process.

What else has been changed?

The second big victory is the complete elimination of corruption in procurement. In less than three years, we have saved more than one billion hryvnias for electricity consumers. The prices at which we purchase basic equipment and materials have fallen by an average of 40-50% compared to 2014. And for individual items, the prices decreased 5-6 times. Due to what? We fought against the simplest corruption: artificially high prices and redistribution of the profit of contractors or suppliers in favour of the management.

The number of participants taking part in tenders constitutes a reliable indicator of their openness and transparency. For example, in 2015, the majority of our tenders had only two participants, sometimes three. And for the first six months of my work, there have already been an average of seven. In principle, no other control is needed. It is enough just to make sure that everyone can participate in tenders. Thus, in the course of trading, this will lower the price.

We optimised the tender offer, divided our lots into smaller purchases, where the merger was unnatural. For example, tyres. Typically, different companies sell tyres for cars and for tractors, almost none of them sell both types. Therefore, if both types are included in one lot, it is immediately clear that it was made for a certain supplier. Honest companies do not want to waste their resources on a losing tender and do not submit their applications. We created the conditions for large foreign manufacturers to participate in tenders, which was impossible previously. As a result, we now have direct contracts with Siemens and other similar companies.

But there were also many questions regarding the direct contracts you had concluded with Ukrainian producers. In particular, for transformers.

The tender for transformers marked the first victory of competition in the procurement processes of Ukrenergo. The tender for the purchase of transformers was announced once again after the first one ended with a scandal. The Antimonopoly Committee prohibited Zaporizhzhia Transformer Plant from participating in the tender because of a conflict of interest, a secret deal with another legal entity.

A new tender was announced with a certain expected value, which was high enough at that time — about 2 billion UAH. There were standard conditions. The manufacturer of transformers was supposed to have a certified centre on the territory of Ukraine, capable of servicing transformers within the factory environment, replacing windings with special equipment and so on. There is only one plant in the country that can provide such production conditions and one and a half service centres, which theoretically meet these criteria. Therefore, in the very first days after I took over the management, we postponed the date of submission of the proposal and began to change the documentation.

To begin with, we removed the requirements for the service centre and allowed resorting to the rented ones. Then we divided the offer into lots.

If previously we had a situation when all transformers, namely 25 units in voltage class from 35 kV to 750 kV together with reactors, went in one lot, now we do not have such conditions. After all, there are only two or three producers in the world who could supply it all together.

We sent letters to the embassies of those countries where there are producers of good transformers. As a result, not two, as before, but five companies participated in the tender. The total cost of purchase of the same transformers in the same quantity amounted to UAH 930 million rather than UAH 2 billion. That is, we saved 55%.

This was the largest single purchase conducted for tariff money without ProZorro procedures, which became mandatory only after a few months. We saw the same situation with all subsequent smaller tenders. On average, the prices fell by 42%.

What is the stage of preparation for the synchronisation of the Ukrainian IPS with ENTSO-E?
This has been on everyone"s lips for almost 20 years.

The successful conclusion of the agreement on the future synchronisation of our power system with ENTSO-E is a big victory for Ukrainian energy diplomacy. The importance of this process was stated for the first time back in 2001. Then, it was confirmed after the Revolution of Dignity, in early 2014. In 2016, the study of the possibility of synchronous integration of the Ukrainian and Moldovan power systems into ENTSO-E was successfully completed. Its results showed that synchronisation is possible provided that we take a number of technical steps. All of them formed the basis for the catalogue of measures for synchronisation with ENTSO-E and the road map, which became an integral part of the Agreement on the conditions for the future interconnection of our power system with ENTSO-E, which we signed last year.

This agreement obliges Ukrenergo, as a transmission system operator, to prepare the Ukrainian integrated power system for synchronisation. Upon the expiry of six years after the signing of the Agreement, we must demonstrate that the Ukrainian IPS is able to operate autonomously, without synchronisation with the power system of the Russian Federation.

In 2018-2019, power plant units in Ukraine should pass a testing, on the basis of which a study of the power system"s dynamic stability will be prepared. All technical conditions and configuration of these studies are consistent with ENTSO-E requirements.

Who will finance these activities?

The United States Agency for International Development (USAID) allocated funds for the testing of power units through the United States Energy Association (USEA). We also have an agreement with the World Bank, specifying that within the framework of the loan for our joint Project on Transmission of Electricity, the necessary funds will be allocated for the studies to be conducted based on the results of testing.

Now we follow the schedule without delay. We are constantly coordinating our actions with Moldova, we signed the respective memorandum at the government level. We also signed a memorandum with all Ukrainian companies — electricity producers. All of them declared their readiness for the integration.

I think that when the studies are completed, it will be possible to start investing in modernisation of generating equipment.

How much money will the whole process of integration into ENTSO-E require?

It is difficult to assess investment programmes. According to preliminary assessments, altogether it will take about 11 billion UAH (352 million EUR). At the same time, one must understand that it is extremely difficult to separate the money needed for the activities in the framework of integration processes from that required for the maintenance of the reliability of our own power system. For example, it is necessary to modernise the tools for automatic frequency and load control at TPP units and connect them to the central controller. All NPP need an additional modernisation of the generator excitation system. We estimate the investments on the side of generating companies at the level of approximately 150-200 million euros.

Will this money be included in the tariff?

In the second half of next year, Ukraine should already have a new operating market (for electricity — Ed.) and pricing model. Therefore, it is not yet clear from which source these investments will come. Given that the payback of synchronisation is shorter than one year, it does not really matter where this money comes from. Both the Ukrainian economy and the population will benefit if the synchronisation is accomplished as soon as possible — this is an opportunity to unite the Ukrainian electricity market with the European one. As a result of this integration, we will create a competitive environment that will restrict the increase in prices for electricity, quite inevitable in the course of the market liberalisation. Today, both the wholesale price and tariffs for industry in Ukraine are higher than in some European countries. Therefore, the competitive advantage of our economy due to cheap electricity has already been lost. At the same time, the experience of countries that synchronised with ENTSO-E and integrated their markets shows that wholesale electricity prices are going to fall by 25% during the first year.

After synchronisation, we will be able to import an additional volume of electricity equal to approximately 12% of our domestic market.

But this does not mean that the cross-border capacity will be used only for imports, which sounds so threatening for the producers of electricity. This is an erroneous opinion. This just means that a full-fledged electricity trade will begin.

The new market model specifies that the price will be formed mainly for the day-ahead market rather than for long-term contracts. The system will work either for export or for import during specified hours. I think that Ukrainian electricity producers will not allow intra-market prices to make imports economically profitable.

Integration will simply lead to a natural decline in prices in the domestic market under pressure from the price proposals of the Eastern European market.

Does that means that such a pricing formula will force thermal generation to look for options to reduce the price of fuel purchases?

They do not need to do this. The existing price of fuel ensures quite a good profitability for Ukrainian producers of thermal coal, in particular, due to vertical integration.

Competition should be tangible. Now, during certain days of the year, the competitive segment of the market does not exceed 15%, while the remaining 85% means a fixed price.

After the launch of a new market model, its competitive share will increase to 30-35%. However, this is still not enough for the end consumer to have the minimum possible price.
In any case, the vertical integration of the largest power producer at TPP ensures a competitive advantage over other participants in this market. Therefore, only the emergence of large potential electricity suppliers from Europe can change the situation.

In general, do you consider it realistic to launch a new model of the electricity market in July next year?

On one hand, as developers of a significant part of the documents, we definitely rely on the fact that there will be no problems with the launch of the market in time. From our side, everything will be done timely. We see quite a high activity from the regulator, the Ministry of Energy and Coal Industry, the readiness of market participants.

And how about resistance?

It is not yet obvious, except for the usual bureaucratic delays inherent in all reforms. But they are not critical yet to say that the market will not be launched timely. For example, we are delaying the corporatisation of Ukrenergo, which is necessary for us to receive a certificate of the transmission system operator. So far, there is no model using which the Ministry of Energy and Coal Industry could fulfil its obligations regarding the distribution of state assets management: generation (Energoatom, Ukrhydroenergo — Ed.) and transmission companies (Ukrenergo and Main Gas Pipelines of Ukraine — Ed.).

October-November of this year will be indicative.

The matter is that Ukrenergo is to receive a certificate of a transmission system operator by 11 December. Thus, the Ministry of Energy and Coal Industry has to complete the corporatisation of the company and the establishment of the Supervisory Board by that time. Unbundling of oblenergos should be completed as well. So, we will have another half a year to select general suppliers for each region of Ukraine, the "last hope" supplier, and accomplish a number of other tasks.

If this delay could be managed and the current political will remains the same, the market will start its operation timely. On the other hand, I see how the gas market is being introduced and what difficulties its participants face, so I understand that there could be risks.

However, fortunately, the electricity market is less politicised and commercialised in the bad sense of this word compared to the gas market. Therefore, I think that our chances of introducing a new market in time are significantly higher than they were in the gas industry.

Since we are talking about reforms. At what stage is the corporatisation of Ukrenergo now?

I hope that by October we will become a private joint-stock company. A corporate governance reform is a global process lasting for 11 years already. This is the requirement, which has been put forward for a very long time, starting from the first joint project with the EBRD, related to the expansion of the output capacity of NPP. From 2011 to 2013, the relevant draft laws were submitted to the parliament three times. Moreover, the previous law of 2013 "On the fundamentals of the functioning of the electricity market" even contained the rules on the division of Ukrenergo into several different companies.

People talked about this a lot in 2013 in a negative context.

Certainly. Then, against the backdrop of privatisation in the power industry, it was natural to expect that at least the trunk power grids would be sold using the common schemes of that period.

But now the company should work as a single unit. This model is more common in Europe, but there are other models in the world. For example, in the countries of America and Asia, an independent operator does not own trunk power grids. There are also models, similar to that in China, when a single company performs all functions in the market.

Let us talk about auctions for the sale of interstate cross-border capacity. What has been changed and what will be changed in the work of auctions for cross-border export capacity, in particular, after integration into ENTSO-E?

I believe that the introduction of electronic auctions is our great victory. The works regarding the creation of a relevant platform started back in 2014. There was a prolonged tender, which could not be completed for a long time. At the same time, we tried to develop our own software product.

I unblocked the implementation of the concluded contract for this software, and as a result of the negotiations, we lowered the cost of the contract by approximately 20%. This happened despite the fact that the company originated from the Czech Republic, the software was produced in Europe and hryvnia depreciated two and a half times. As a result, the platform was introduced, and starting from the spring of last year, auctions have been held exclusively in an electronic form.

But, unfortunately, the rules of the auctions have not changed yet. There was an agreement with the regulator that the rules would resolve the issues of electricity transit and enable the holding of coordinated auctions with our neighbours. However, all this remains at the project stage.

Does this mean that the annual auction in December will follow the old rules?

To hold an auction in accordance with the new rules, they had to be approved not later than on 1 July. After that, it will take about three months to finalise the software, i.e. the platform itself. If they are approved after 1 August, there will not be even a theoretical possibility that the new format will be launched the same year. Definitely, this is a reputation loss for Ukraine. However, there could be no claims against Ukrenergo since we have completed everything, and the Energy Community understands this.

Nevertheless, the auction platform was launched and confirmed the classic rule: competition ensures transparency. The revenues increased several times. This is a significant milestone in our history. However, I think we will not have the same growth next year because our domestic prices for electricity make exports economically unattractive for everyone, except for the generation itself.

It turns out that only DTEK, the company that previously purchased all cross-border capacity, will be interested in buying.

Definitely, there will be buyers. The question is how much they are willing to pay. After all, the higher the payment for the cross-border capacity, the lower their earnings from the difference between the sale price and the wholesale price of electricity in Ukraine.

Next year, for at least six months, we will have the same wholesale price, which is not very attractive for electricity exports. At certain hours it may be different, and these hours will be the objects of the most serious competition at daily auctions. As for long lots (annual and monthly auctions), competition is unlikely to be high because the margin is often knowingly negative there.

How will the balancing of export peaks work?

The principle is very simple. At the annual auction, we sell lots with the period of continuous supply of electricity of a certain capacity of more than one month. Then, at monthly auctions, we sell those with the period of more than one day. Then, at daily auctions, we have hourly trade. Daily auctions "see" the actual load of the previously won cross-border capacity (many refuse it, many do not use 100% of the won capacity).

Everything that is left to be distributed after the annual and monthly auctions, as well as the unused or refused capacity, is to be sold at daily auctions.

We have 650 MW of possible supply towards Hungary annually. For the annual and monthly auctions, we distributed 455 MW. Another 195 MW we offer for a daily auction with hourly breakdown. There will be separate hours when the supply has economic sense, and we will have some kind of struggle there. And there will be hours when there is no economic gain, so no one will compete.

Do you see this as an opportunity for Ukrenergo to attract additional funds?

This year was unique, we have never received so much money from auctions before. I talk about 300 million UAH obtained only upon the results of the annual auction. The forecast is constantly increasing due to daily auctions.

It is very difficult to forecast for next year because the demand for access to the cross-border capacity will be determined, first of all, by the price conditions in the markets themselves.

"Green" energy is actively developing in Ukraine. You have repeatedly voiced concerns about the growing imbalance in the system. Will integration in ENTSO-E help to deal with this imbalance?

This problem has two sides: technical and economic. The "green" tariff in Ukraine is one of the highest. The government is now leaning towards a model of auctions, but there are a lot of questions and yet no answers. At the same time, new initiatives suggest that for those who signed the accession agreements before the new law enters into force, the old rules regarding the "green" tariff will remain effective.

As of today, we totally issued the technical conditions for the construction of 7.9 GW, of which the capacities of 1.5 GW have already been built. The construction of about 2 GW is under the question because we are not sure that these developers have enough financing. Another 2 GW are now at different stages of coordination with Ukrenergo and with oblenergos. We assume that approximately 5 GW of the constructed capacity may be covered by the current legislation.

How will it be possible to balance all these "green" power plants?

Before answering this question, it is necessary to understand how much it will cost our customers to support "green" generation. Definitely, alternative generation is a good business that will pay taxes. But it should be remembered that the price of electricity in Ukraine will grow as the share of renewable energy increases.

According to our calculations, if 7.5 MW of renewable energy will operate in the power system, and we do not change the generation structure, the prices will rise by at least 57.7%. And when there is not enough capacity to balance the "green" generation, the prices will double. Among the consequences of such a rise in prices of electricity, we will see a significant increase in inflation, a decrease in the competitiveness of the economy, etc. This is the moment that should raise concerns the most.

Therefore, the balancing of RES in a new market model is just a matter of price. When we do not have enough balancing capacities and we are ready to buy electricity to cover the imbalances (just give us!), a new segment of the market will emerge. Then new balancing capacities will be built.

Where do we get the money for these purchases? From our tariff, which is formed based on the price of electricity for consumers. Therefore, it is once again all about the price.

At the same time, we understand the inevitability of the transition to clean energy because this is our future. Otherwise, we would not be so active in the matter of simplifying access to trunk power grids for new RES facilities.

But what capacities and how much do we need to balance "green" generation?

Here everything is very simple. Per MW of capacity of new solar and wind power plants we need 300 kW of balancing capacity for any facility with the capacity exceeding 3000 MW.

Based on this calculation, it is now clear that our power system in its present form will not be able to painlessly balance more than 3000 MW of installed capacity of RES. In order to accept more "green" generation, we will need to build additional balancing capacities. According to preliminary calculations, our power system will need about 2500 MW.

In this case, after synchronisation with ENTSO-E, we will have 2200 MW of a cross-border capacity of interstate lines. This means that it will be possible to import electricity for balancing. But this is not so simple. The balancing energy is expensive everywhere because it is in short supply. And then the question arises: why should we pay for a high "green" tariff, pay for expensive thermal generation and, at the same time, buy expensive balancing energy from abroad? Therefore, it is necessary to build new highly manoeuvrable capacities inside our power system.

Do you consider the manoeuvring capacity of nuclear power units?

First of all, this question requires that we understand the technical capabilities of our nuclear power plants. I can say that it is impossible to quickly load and unload nuclear power units as it is done in France. Ukrainian nuclear power plants use reactors of a different type, which do not allow doing such things.

Nevertheless, our nuclear power plants can still find additional opportunities for balancing the system if they reach the projected number of cycles for loading and unloading reactors. The regimes under which Ukrainian nuclear power plants are currently operating do not provide for even a half of their maximum quantity.

In general, each power unit can receive 50-80 additional loading/unloading cycles. This approach will allow us to turn off one of the nuclear power units during the periods of large consumption gaps or large surplus of electricity in the system on a weekly basis. This will be cheaper than paying for RES restrictions. However, it is not possible to quickly load a nuclear power unit at full capacity when the "green" cannot generate sufficient amount of electricity.

Can the construction of new hydropower plants solve the problem of balancing RES?

Hydropower plants, in principle, can solve this issue. But we will have to deal with the protests of environmentalist groups and the high cost of such construction. Hydropower plants are very reliable, they have a very long service life, but we will not have enough time to build them by the time the capacity of the new SPP and WPP exceeds the threshold of 3000 MW. Moreover, HPP are still the assets for secondary, not primary, balancing reserves. And we need more manoeuvrable capacities and, preferably, cheaper power plants.

WPP and SPP often seriously affect the balance of the power system, creating millisecond fluctuations, which must be managed immediately. Therefore, we believe that choosing from what we have on the market today, we need energy storage capacities and highly manoeuvrable gas reciprocating power plants. 2500 MW in total.

Gas reciprocating power plants will operate a small number of hours per year, so it will not affect the gas balance. There is no alternative from the point of view of the unit price per MW of installed capacity or from the point of view of the speed of full load of units. If we build this all in time, the price of electricity will only grow by 47%. This is the most money-saving option.

What investors may be interested in such projects?

There are quite rich Ukrainian investors who may be interested in energy storage systems. Perhaps, there will be those who are interested in gas reciprocating plants. If the state announces appropriate tenders for such construction, where the price for capacity is the subject, it is likely that they will attract foreign investors with access to cheap loans.

The guarantee of repayment of the service is the only thing that is not available for such projects in our legislative field. In this regard, it is necessary to amend the existing codes. We will initiate these amendments, and we hope that together with the Ministry of Energy and Coal Industry and the NEURC, we will be able to ensure the adoption of the necessary amendments to the secondary legislation and start the procedure for holding a competition for the construction of capacities by the end of this year.

If we talk about your investment programme for this and next years, what are the main priorities?

A year ago we approved the first strategy of our company. It is still an internal document but it can be found on our corporate website. This strategy formed the basis for a three-year strategic development plan, approved by the Ministry of Energy and Coal Industry. Therefore, the investment programme this year and the forecast for the next year slightly differs from the programmes approved for the last two years due to a change in our investment strategy. We are now starting to rely more on financing through loans from international financial organisations rather than on a request regarding the company"s tariff for financing.

In any case, we need, if possible, to complete the construction of large infrastructure facilities without delay.

The first and the most important project is the completion of 750 kV line from Zaporizhzhia nuclear power plant to Kakhovska substation. It will remove restrictions on the power output of Zaporizhzhia NPP and expand the possibilities for connecting RES facilities at this site since they are almost exhausted there.

The second very important project is the construction of 500 kV substation Kreminska in Luhansk region. Starting from 2014, there was a huge problem with reliability of power supply to the north of this region. Next year, we plan to start the construction of 330 kV line Novoodeska — Artsyz to solve the problems with reliability of power supply to the south of Odesa region.

At last, this is our joint programme with the European Investment Bank for the automation of substations, which now only starts to unfold. It covers almost 50 high-voltage substations. The main works here will begin in 2019. Historically, the power lines used to be the main objects of investments, while substations were in some sense undeservedly forgotten.

Are there any other regions in Ukraine that you still consider unreliable?

We need to build additional lines in the regions adjacent to the Russian Federation. We need to strengthen the links between Zaporizhzhia and Kharkiv energy centres since we lost a number of lines used for transit through the territories that are not currently controlled by Ukraine. Therefore, we need to build 4 more small power transmission lines instead of them.

The line Novoodeska — Artsyz is a part of a large project aimed to restore the potential transit of electricity from Ukraine to Romania. We completed a large-scale study together with the EBRD, they are ready to initiate a new project to close the southern half-ring of 750 kV, the construction of a new substation 750/400 kV Prymorska.

This will increase the reliability of supply not only for us, but also for Moldova. For Romania, this construction should bring a significant advantage due to the fact that they have built many wind farms in this region and they have problems with the allocation of cross-border capacity. Some volumes of their electricity could be transited through our and Moldovan territory, and will facilitate the output of capacities of these wind parks. This is a very profitable project.

For what purpose does your company advocate a stimulating tariff?

It is hard to say that we advocate it. We are ready for it. We believe that the methodology of its formation is not optimal, especially for us. We do not agree that the methodology is the same for oblenergos and Ukrenergo. An increase in the tariff, including for Ukrenergo, will be too high if the stimulating tariff is applied in this way. We do not understand how to ensure the effective investment of such large resources without having enough investment projects now. We have already held working meetings with the regulator and we expect that the methodology will be adjusted to find the necessary balance.

If there is a new competition for the position of CEO of Ukrenergo, will you participate?

The Charter prescribes that a new CEO of the company is appointed by the Supervisory Board. On the basis of the competitive procedure, however. The terms of the competition and the procedure for its passage will be formed by the new Supervisory Board of the company.

What is the purpose of the Supervisory Board? It should bring the corporate culture, the culture of business in the company.

It will consist of the managers with extensive experience in international companies, who do not need to invent anything. They come and they know how it should be. Stability is yet to come with them. The fact that the company"s CEO is approved by the Supervisory Board, isolated from the direct influence of politically motivated people, will contribute to the company"s stability and the possibility of choosing professional management. Among whom to choose? This is another question.

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