Possible Impact of CBAM on the Ukrainian Electricity Market 1. INTRODUCTION Since 24 February 2022, Ukraine has been valiantly defending itself from despicable, unprovoked and unjustified military aggression. The determined resistance of the Ukrainian people has shown that they share the same values as Europeans, and that in the new geopolitical environment the Ukrainian movement towards joining the EU will be much faster than previously anticipated. In line with this, on 28 February 2022 Ukraine submitted its application to join the EU. On 11 March 2022 during European Council summit held at the Palace of Versailles, the aspirations and the European choice of Ukraine were acknowledged and it was noted that Ukraine’s membership application had been swiftly transmitted to the European Commission, which started its consideration on 21 March 2022. One of the steps towards joining the EU, is for Ukraine to align its environmental legislation with the EU’s, which is at the forefront of international efforts to fight climate change. On 30 June 2021, the EU Parliament and Council approved, within the framework of the European Green Deal, the European Climate Law, which sets a binding target for EU Member States of achieving climate neutrality by the EU by 2050. As an intermediate step towards climate neutrality, the EU has established that by 2030 its emissions must be cut by at least 55% compared to 1990 levels. This ambitious aim requires current greenhouse gas emission levels to drop substantially in the next decades and thus increases costs related to the climate policies of various industries, especially for energyintensive ones. Such increase in costs for various industries may result in an increased risk of so-called “carbon leakage”, which refers to businesses transferring their manufacturing to other countries with laxer emission constraints or to the import into the EU of goods that have been produced in countries with laxer climate policies. This could even result in an increase in global emissions, thus further undermining all of the efforts to reduce greenhouse emissions. Given this, the EU aims to introduce various mechanisms aimed at combating carbon leakage, and the carbon border adjustment mechanism (CBAM) is one of them. Although the draft of the CBAM Regulation was presented on 14 July 2021, it is still under consideration and would have to go through the ordinary legislative procedure in the Parliament and Council (consideration is expected to start in the second half of 2022). 2. CBAM 2.1 What is CBAM? CBAM essentially imposes a charge on imports of goods with a significant carbon footprint, such as cement, iron and steel, aluminium, fertilisers and electricity (Goods) that reflect additional costs that EU domestic industry bears under EU climate policies. CBAM will apply to imports from all non-EU countries, unless such non-EU country has: (a) implemented the EU emission trading system (ETS) or has unified and linked (have the same goals for reduction of greenhouse gasses emissions) its local ETS with European ETS; and (b) the price paid for emissions by the industry of that country is the same as the one paid by EU industries and the industry of that country has not obtained any reimbursement in connection with emissions charges. CBAM defines three types of greenhouse gas emissions described in this Picture 1: Picture 1. Types of emissions under CBAM As envisaged in the current proposal for the CBAM Regulation, CBAM will apply only to direct greenhouse gas emissions emitted during the production process of the Goods, and it does not cover indirect emissions (including emissions necessary to produce electricity to manufacture the Goods and downstream products using the Goods). Electricity producers can also voluntarily choose to use embedded emissions instead of direct emissions to calculate CBAM charges in the case of electricity (as described in item 3.3 below). However, by the end of the transition period of 2023–2026, the EU Commission will evaluate CBAM and will consider extending its scope to more goods and services, including downstream products (products created from the Goods) and indirect emissions. 2.2 CBAM Procedure CBAM will work as follows (please also see Picture 2 for a brief description of the procedure): ― An EU Company that intends to import Goods into the EU (Importer) will be required to become accredited with the competent authority (to be established once CBAM is implemented) of the EU member state in which it is incorporated in order to import Goods into the EU. ― By 31 May each year, each importer must submit a declaration (CBAM declaration) to the competent authority for the previous year in which, among others, it must state the total quantity of each type of the Goods imported during the preceding calendar year and the total embedded emissions. Where an importer cannot determine the embedded emissions, the CBAM foresees a system of “default values” (the actual values of greenhouse emissions that will be calculated on the basis of the methodologies and guidance established by CBAM) to be applied. The number of CBAM certificates to be acquired by importers of the Goods is determined. ― On the basis of these CBAM declarations, importers will need to buy CBAM certificates annually from the competent authorities of the respective EU Member State to cover the embedded emissions of their imports. The CBAM certificates’ price will be established on the basis of the weekly average price of carbon allowances auctioned by the EU ETS, which has been functioning since 2005. It should be noted that contrary to the EU ETS (under which carbon allowances can be sold back to the EU ETS), unused CBAM certificates cannot be sold to other importers, but can only be surrendered to the competent authority. ― Declarants are required to surrender CBAM certificates depending on the amount of embedded emissions in the Goods imported. Declarants that fail to surrender by 31 May of each year a number of CBAM certificates corresponding to the embedded emissions in their Goods, or which submit false information, will be liable to a penalty equivalent to three times the prior year’s average price for CBAM certificates that the declarant failed to surrender. Picture 2. CBAM Procedure It should be noted that CBAM envisages that measures aimed at achieving CO2 reductions taken in the countries of origin of the Goods will impact the number of CBAM certificates to be acquired by an importer of the respective Goods into the EU. In particular, an importer can claim a reduction in the number of necessary CBAM certificates that reflects the carbon price paid in the country of origin of the Goods. However, sufficient proof that the carbon price was paid for the respective emissions must be provided. 2.3 CBAM implementation It is intended that CBAM will gradually enter into force between 2023 and 2026: ― Transitional implementation: After 1 January 2023, importers will be required to report on a quarterly basis the actual embedded emissions in imported Goods, detailing direct emissions and indirect emissions, as well as any carbon price paid abroad (i.e. not paying CBAM charges). ― Full implementation: CBAM will become fully operational in 2026. Thus, after 1 January 2026, importers of Goods will have to declare annually the quantity of Goods and the amount of embedded emissions in the total amount of Goods they imported into the EU in the preceding year, and pay the CBAM charges for the embedded emissions. 3. IMPACT ON THE UKRAINIAN ENERGY SECTOR 3.1 Ukrainian electricity exports that may potentially be subject to CBAM Exports of Goods from Ukraine to the EU that may be subject to CBAM potentially amount to EUR 2.9 billion1 . In 2019, imports into the EU of Ukrainian Goods that may be subject to CBAM amounted to 6% of all imports of Goods that may be subject to CBAM in the EU from the whole world (please see Picture 3 below)2 . 1 Research on the impact on the economics of Ukraine from the implementation of CBAM by the EU done by the Kyiv School of Economics (available at https://kse.ua/wp-content/uploads/2021/12/211115-KSE_CBAM_for-publication.pdf). 2 CBAM! – Assessing potential costs of the EU carbon border adjustment mechanism for emerging economies (available at https://helda.helsinki.fi/bof/handle/123456789/18179). 1 •Accreditation with the competent authority (to be established once CBAM is implemented) of the EU member state in which it is incorporated in order to import the Goods into the EU 2 •By 31 May of each year, each importer must submit to the competent authority a declaration (CBAM declaration) for the previous year in which, among others, it must state the total quantity of each type of Goods imported during the preceding calendar year and the total embedded emissions 3 •Purchase of CBAM certificates from the competent authorities of the respective EU Member State sufficient to cover the emissions of their imports 4 • Declarants are required to surrender CBAM certificate by 31 May of each year, depending on the amount of embedded emissions in the Goods imported Picture 3. Share of Ukrainian Goods that may be subject to CBAM in the total volume of CBAM Goods that may be subject to CBAM imported into the EU from the whole world Electricity is among the Goods that may be subject to CBAM, and the total exports of electricity in 2020 (which was previously possible only from Burshtyn Island and certain generating blocks of Dobrotvirska CHPP, the parts of the Ukrainian energy system that were synchronised with ENTSO-E) that may be subject to CBAM amounted to approximately EUR 281 million3 . It should be noted that since 16 March 2022, the entire Ukrainian energy system has been synchronised with ENTSO-E and thus exports of electricity to the EU that may be subject to CBAM can be significantly higher. As the level of CBAM charges is tied to the amounts of greenhouse gas emissions generated during the production of the Goods, CBAM has the potential to have a significant impact on Ukrainian electricity exports to the EU, due to the high carbon intensity (the amount of carbon emissions necessary to generate 1 MWh) of electricity generation in Ukraine, which is twice as high as the carbon intensity of electricity generation in the EU (please see Picture 4 below which provides an approximate status of carbon intensity in the production of the Goods)4 . 3 https://finbalance.com.ua/news/eksport-elektroenerhi-v-2021-rotsi-skorotivsya-na-265-import--na-259. 4 Possible Implications of the European Carbon Border Adjustment Mechanism for Ukraine and Other EU Trading Partners (available at: https://erl.scholasticahq.com/article/21527-possible-implications-of-the-european-carbon-border-adjustment-mechanism-for-ukraineand-other-eu-trading-partners). Picture 4. Comparison of the carbon intensity in the production of the Goods that may be subject to CBAM 3.2 Exemptions from CBAM that may apply to Ukraine General grounds for exemption from CBAM As a contracting party to the Association Agreement with the EU and a Member of the Energy Community, Ukraine is in general committed to decarbonisation processes that should eventually result in the adoption of carbon pricing mechanisms similar or equivalent to the EU ETS or in its participation in the EU ETS. As a result, Ukraine can be exempted from CBAM on general grounds5 , if it complies with its obligations envisaged by the Association Agreement with the EU and by the Energy Community. Specific CBAM exemption in relation to electricity In addition to the abovementioned general grounds for the exemption of Ukrainian Goods from CBAM, there is also special exemption procedure from CBAM that may apply to electricity, if the following conditions are met: ― Ukraine’s electricity market is integrated with the EU internal market for electricity through market coupling and it has not been possible to find a technical solution for the application of the CBAM to the importation of electricity into the EU from Ukraine; ― it is not possible to find a technical solution for the application of CBAM to the import of electricity into the EU; ― Ukraine has prepared and submitted a roadmap to the EU Commission, which contains a timetable to adopt measures to implement climate neutrality by 2050 and to demonstrate substantial progress towards the alignment of domestic legislation with the EU in the field of climate action, including towards carbon pricing at an equivalent level as the EU; ― Ukraine will finalise the implementation of an emissions trading system for electricity, with a price equivalent to the EU ETS. 5 Ukraine must perform the following: (a) implement the EU emission trading system (ETS) or unify its local ETS with the European ETS; and (b) the charges paid for emissions by Ukrainian industry is the same as those paid by EU industries. Please also note that Ukraine may lose this exemption status in the event of the following: ― if the EU Commission has reasons to consider that Ukraine has not shown sufficient progress to comply with one of the requirements listed above, or if Ukraine has taken action incompatible with the objectives set out in the EU climate and environmental legislation; ― if Ukraine takes steps contrary to its decarbonisation objectives, such as providing public support for the establishment of new generation capacity that emits more than 550g of CO2 of fossil fuel origin per kWh of electricity. Furthermore, the EU will in any case in 2030 revisit any exemptions granted before 2030, thus making Ukrainian electricity subject to CBAM if it does not comply with the general grounds for exemption from CBAM by this time. 3.3 Methods of calculating potential CBAM charges on Ukrainian electricity exports CBAM charges for imports of electricity to the EU will be calculated on the basis of CO2 emissions under one of the two following methods: Calculation on the basis of the default values of CO2 direct emissions defined by the EU Commission (Method 1) Calculation on the basis of the actual values of CO2 embedded emissions (Method 2) 1. After the implementation of CBAM, the EC will determine the average CO2 emission factor in tonnes of CO2 per MWh. The average CO2 emission factor will take into account direct emissions and will reflect the share of the fossil fuels in the mix of fuels used for power generation in Ukraine regarding the electricity that can be exported to the EU. 2. The average CO2 emission factor that will be defined by the EC for electricity exports will probably be quite high due to the high share of fossil fuels in the mix of fuels used for power generation in Ukraine. 3. Individual levels of CBAM charges for power generating installations will be calculated by multiplying the average CO2 emission factor by the amount of electricity produced by such power generating installation. 4. As a result, the application of Method 1 will likely make exports of electricity from Ukraine economically unviable, as it will increase the price of such electricity by approximately 1.5-2.5 times6 (CBAM charges range from EUR 23 to 83 per MWh7 ). 1. Power producers from Ukraine can alternatively choose to apply to calculate CBAM charges on the basis of the actual values of CO2 embedded emissions, provided that the following strict conditions are met: a) the importer of electricity into the EU has concluded a direct power purchase agreement with the Ukrainian exporter of electricity for volumes of electricity generated regarding which this calculation method of CBAM charges was used (thus, electricity that will be imported into the EU cannot be bought on the day-ahead and intra-day markets); b) the generating installation is either directly connected to the EU transmission system or it can be demonstrated that at the time of export, there was no physical network congestion at any point in the network between the installation and the EU transmission system; c) an equivalent amount of electricity to the electricity for which this method is used has been firmly nominated to the allocated interconnection capacity by all responsible transmission system operators on the route of electricity transmission (in Ukraine, Ukrenergo), the country of destination and, if relevant, each third country of transit, and the nominated capacity; 6 The Impact of Carbon Border Adjustment Mechanism (CBAM) on EU-Ukraine trade (available at https://www.rac.org.ua/uploads/content/624/files/impactcarbonmechanismcbamukrainesummaryen.pdf). 7 The Impact of Carbon Border Adjustment Mechanism (CBAM) on EU-Ukraine trade (available at https://www.rac.org.ua/uploads/content/624/files/impactcarbonmechanismcbamukrainesummaryen.pdf). d) meeting the above criteria is certified by an accredited verifier. 2. If the above conditions are met, Method 2 can be applied in calculating CBAM charges. 3. As a result, Ukrainian producers of electricity from sources with low carbon emissions such as renewables and nuclear will not suffer significant additional charges due to CBAM (except for expenses related to complying with CBAM procedural formalities). Thus, exports of electricity generated by such power generating facilities seem at first glance to be more economically viable. In addition, although exports of electricity from highly manoeuvrable capacities using natural gas will suffer from CBAM charges, the export of electricity generated by them will be still viable, considering the relative cleanliness of natural gas as an energy source compared to coal (thus reducing CBAM charges to EUR 10-35 per 1 MWh) and the fact that such capacities are used when electricity is in high demand and expensive. 4. IMPACT ON UKRAINIAN ENERGY SECTOR CBAM will affect Ukrainian electricity exports to Europe unless Ukraine either qualifies for one of the two possible exceptions from CBAM (as described in item 3.2 above). Otherwise, electricity exporters will be required to pay CBAM charges and only if CBAM charges will be calculated on the basis of actual values of CO2 embedded emissions (Method 2 above) will the export of electricity from Ukraine to the EU remain economically viable. The calculation of CBAM charges under the two methods described in item 3.3 above will impact Ukrainian electricity exports as follows: ― Method 1. In Method 1, electricity exports to the EU might not be economically viable, as CBAM charges will increase the price of electricity exported to the EU by approximately 1.5-2.5 times. ― Method 2. Method 2 will create opportunities to export Ukrainian electricity generated from sources with low carbon emissions, such as renewables, nuclear and highly manoeuvrable capacities using natural gas8 . Authors: Vitaliy Radchenko Partner, Head of Energy T +38 044 391 3377 E [email protected] Maryna Ilchuk Counsel, Energy T +38 044 391 3377 E [email protected] Anatolii Doludenko Associate, Energy T +38 044 391 3377 E [email protected] ____________________________________________________________________ Comment narrative provided by Oleksii Khabatiuk, energy expert, ex-deputy departmental head in Naftogas 8 The Impact of Carbon Border Adjustment Mechanism (CBAM) on EU-Ukraine trade (available at https://www.rac.org.ua/uploads/content/624/files/impactcarbonmechanismcbamukrainesummaryen.pdf).
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