Unsinkable Rotterdam+ Coal Price Formula: How the Ruling Elite Fooled Everyone in Ukraine – Investigation

Power generation companies, primarily oligarch Akhmetov’s DTEK, were the ones that benefited from “Rotterdam+” coal price formula. The whole country lost, both industrial and residential consumers, still dependent on the coal supply from Russia.

The National Energy and Utilities Regulatory Commission (NEURC) introduced with ease the notorious “Rotterdam+” coal price formula in Ukraine about a year and a half ago.

We remind that this formula is the basis for the price calculations of the coal supplied to the Ukrainian thermal power plants, which eventually has an impact over residential and business electricity rates. The fuel price makes up to 80% of the electricity pricing.

As the rates increased, the expert community keenly questioned the validity of the formula application; the discussion continues to this day.

Experts and mass media, including the Ukrayinska Pravda, demonstrated more than once that “Rotterdam+” aims mostly to enrich the electricity producers, notably Rinat Akhmetov (DTEK Group – Economichna Pravda), a major player in the market.

The National Commission managers took other view. Dmytro Vovk, NEURC Chief, argued that the formula adoption was to be highly advantageous for the country, with self-sufficient resources accumulation independent from the ATO zone temporarily occupied territory of Ukraine, non-adherence to the manual price determination, linkage to the world coal prices.

Moreover, the Government defined elimination of the economy dependence on the monopoly sources of energy supply among major priorities of the energy sector within the next few years.

However, the real circumstances introduced some revisions. Due to the war in Donbas, all the anthracite mines supplying coal to a number of thermal power plants were in the occupied territory of Ukraine. The need to look for new thermal power supply sources became more acute.

The blockade of the railway coal traffic from the occupied territory of Ukraine served a major catalyst of the problem. The anthracite deficit made the Government declare state of emergency in the power engineering. Until May 2017, 5 of 6 anthracite thermal power plants temporarily ceased production.

Why was the country left unprepared to the energy crisis? Was there any alternative option other than coal supply from the occupied territory of Ukraine?

The approach developed by the Commission seemed to be able to solve a problem of the supply security. However, when the complicated situation emerged in the power engineering, neither state operator “Centrenergo”, nor private DTEK and “Donbasenergo” companies turned out to be ready for it.

Moreover, meanwhile the state officials and major market players were into discussing and applying “Rotterdam+” coal price formula, the electricity wholesale prices went up, and the coal stock at the power plants decreased critically. At the same time, despite deep crisis, market participants managed to improve their financial statements.

What is “Rotterdam+coal price formula?

Since March 2016, NEURC approved a new methodology of determining estimated Wholesale Market Price of electricity. The price of the power-generating coal was defined according the formula: the average market price of the imported coal in the ports of Amsterdam – Rotterdam – Antwerp in previous 12 month plus its freight rate.

“We changed the philosophy from “expenses plus” formula, on which we could not agree, to linkage to the international coal prices. Such linkage can be a short-term solution before transition to the market model, when the regulator does not fix the power generation pricesVovk explains.

“Rotterdam+” formula was launched in Q2 2016. In fact, 2015 coal import parity price, with freight charges added, was put into the rate for thermal power plants. It was thermal power plant rate, not subjected to regulation, that turned out to be the weakest point, which allowed to adjust the procedure of the Wholesale Market Price recalculation.

The trends of estimated Wholesale Market Price of electricity, 2016-2017, UAH per 1 MWh

red – Approved estimated Wholesale Market Price | blue line – Adjusted estimated Wholesale Market Price

Q1 2016                                                                                                 Q4 2017                          Source: NEURC Regulations No. 721 and No. 2326 (revised).

For instance, in 2016 NEURC approved steady increase of the estimated Wholesale Market Price of electricity by 12% – up to UAH 1,318.69 per MWh. Nevertheless, later the regulator made amendments by adopting its Regulation No. 1178 that adjusted Wholesale Market Price of electricity increase by 26.5% – up to UAH 1,490.63 per MWh.

The estimated Wholesale Market Price in Q1 2017 being set at UAH 1,341.57 per MWh, the Commission planned at first to decrease the Wholesale Market Price by 6% down to UAH 1,263.76 MWh, but instead it was again increased – by 1.8% up to UAH 1,365.72 per MWh.

The author of the article asked Dmytro Vovk, NEURC Chief, to give his commentary on such abrupt change of the price trend and another increase of the Wholesale Market Price in 2017; besides he wondered whether “Rotterdam+” formula boosted resources accumulation to ensure the energy security of Ukraine.

NEURC Chief responded to the inquiry explaining the Wholesale Market Price increase in 2017 by numerous factors: changes in the production pattern, decrease of the subsidy certificates share, revision of various rates, and necessity of additional coal procurements due to halt of fuel supply.

Yet, Vovk did not answer why the strength reserve was not created in Ukraine in the energy security sector, or whether there is a corruption component in “Rotterdam+” formula.

A year ago NEURC Chief claimed that 40% of coal is mined in the territories, over which Kyiv lost control, and its delivery is very expensive. “To avoid unnecessary heroism, we made a decision to provide power-generating companies with a budget, that for sure allows not to put coal supplying under question”, – Vovk underlined.

It means, the regulator deliberately put overstated coal price into estimated Wholesale Market Price using “Rotterdam+” formula.

The Rates Are Increasing, the Security Level Is Not

Since adoption of the scheme of “Rotterdam+” formula and “planned” Wholesale Market Price increase, the industrial enterprises came to pay for electricity by 20.6-23.4% more, depending on their consumer profile class. Residential electricity rates increased by 2.46-2.67 times.

However, due to the gap of the industrial rates, the increase of the residential rates fail to achieve its goal – to flatten out prices and decrease cross subsidizing.

Apparently, the regulator placed a burden of expenses on the consumed electricity that bears a load of extra profit for power-generating companies on the pockets of its citizens and industrial customers – by no means acting for their benefit.

The customers, paying high price of the electricity, might have hoped they were making financial contribution to the state energy security and national power engineering reforms, or assisted in building up a sufficient supply of the power-generating coal for thermal power plants. At least, creators of “Rotterdam+” formula told so.

But it did not happen. Why? To answer the question, one needs to take a look over the events in the power-generating coal market in a recent year and a half, operating the open source data.

The fuel component is 80% in the price structure of coal thermal power plants electricity. To guarantee the national energy security it is important how much coal, of which rank and whereabouts, is supplied to the power generation. According to “UkrZaliznytsia” State-owned Railway Public JSC, in 2015 8.1  million tons of coal were transported from the occupied territory of Ukraine; 6.2 million tons – in 2016. 

What is to happen after full blockade of supply from the occupied Donbas?

Under the estimated fuel structure for 2017, the Ministry of Power and Coal Energy plans annual supply of 7.9 million tons of anthracite and 20.1 million tons of gas coal.

The domestic anthracite supply is 40%, the rest is imported, including about 1% from Russia. In the structure of gas coal import (from Poland) makes less than 1%, the rest is domestic production. On the surface, the situation is not that bad. The 2017 plans are approved.

We move on. DTEK contracts anthracite not only from Russia, but also from South Africa.

State-owned Public JSC started modernization of two power units of Trypilska thermal power plant, their conversion from anthracite to gas group of coal. DTEK has similar plans for Prydniprovska thermal power plant. There is also an agreement on supply of 2 million tons of coal to Ukraine from the USA.

At the same time the pace of implementation of such plans is very slow. Planned volume of imported anthracite procurements arouse alarm about their achievement. This can be exemplified by the actual coal stock at Ukrainian thermal power plants in the recent years that did not meet the ministerial plans.

red – A-Grade and blue – Г-Grade Coal in stock at thermal power plants, thousand tons

Source: Ministry of Energy and Coal Industry of Ukraine.

Examining quarterly changes of thermal power plants’ coal stock in pre-war 2013 and “Rotterdam” 2016, one observes annual average decrease of coal stock by 2.7 times: Grade A coal by 3.7 times, Grade Г – by 2.1 times.

It shows that the war had destructive effects over the energy potential of the country. Coal supply blockade has only precipitated the process.

Grade A coal power plants’ stock decreased by 43.3%, Grade Г – by 17.8% in Q1 2017 compared to Q1 2016 (before “Rotterdam+” introduction).

In Q1 Grade A coal stock decreased by half. Although Grade Г coal stock increased by 30% in the same period, it cannot replace the anthracite at the non-modernized thermal power plants. The blockade caused a halt in production at Trypilska, Zmiyivska, Prydniprovska, Kryvorizka and Slovianska thermal power plants for several months.

Approving “Rotterdam+” scheme, the regulator hoped to decrease supply from the certain areas of Donetsk and Luhansk oblasts, conversion of anthracite thermal power plants to gas coal, development of the fuel accumulation plan. But the facts tell a different story. According the State Statistics Service, Ukraine imported 170 thousand tons of anthracite, including 169 thousand tons from Russia, in Q1 2017.

There is a single running anthracite thermal power plant in Ukraine – Luhanska TPP. It is part of DTEK Skhidenergo. Due to special logistics, 66 thousand tons of anthracite arrived to this station in Q1 2017. The fuel was procured from the related company – Obukhivska Mine Management extracting coal in Rostov region (Russia) – at the price of 70 US dollars per ton in January, and 80 US dollars per ton in February-March.

Thus, until 2017 the coal was supplied to Ukraine not from overseas, but from Russia and the occupied Donbas at prices close to “Rotterdam”. Dmytro Sakharuk, Acting Director General of DTEK Energo, reported in July that anthracite is purchased from Russia for 95 US dollars per ton, from South Africa – for 100 US dollars per ton. Due to the blockade of the coal supply from the occupied territory of Ukraine its thermal power plants’ stock was dwindling. In three week of April 2017 it decreased by 33.8% – to 172 thousand tons.

It means, the country did not have any energy security cushion with enough solid fuel reserve to guarantee functioning of Ukrainian thermal power plants.

What for then has estimated electricity Wholesale Market Price that anticipated import supply of the deficit fuel at world rates, been valid for a year, if expensive coal was delivered from the occupied territory of Ukraine and from the adjacent region of Russia? Where was the money of Ukrainian consumers paying increased electricity rate, spent?

Who was fooled

Main players of the coal power-generating market are DTEK companies (up to 30% of country’s power generation), “Centrenergo” PJSC, and “Donbasenergo” PJSC. These generating companies – thermal power plant operators – increased their power prices by 15-20% after the formula “Rotterdam+” was introduced.

They claimed that they operate at a loss when importing anthracite and “Rotterdam+” formula does not cover the expenses when purchasing coal on the world market.

Another problem of the formula is that the power generation rate is calculated according to the residual model. It can be demonstrated on the following example: “Energorynok” State Company, a centralised wholesale buyer of all the electricity in Ukraine, does not have enough money to fully compensate the coal generation for its expenses.

Therefore when this enterprise receives money for power energy, the money is initially divided among other power energy producers (nuclear and alternative power generation – Ekonomichna Pravda), and only after that it is given to coal generation. Then the thermal power plant operators settle accounts with the solid fuel suppliers.

In order to calculate wholesale price “Energorynok” does not need to take into account where the thermal power plants import fuel from. Consequently, middlemen were incentivised to purchase cheaper coal from the mines situated on the uncontrolled territory instead of the more expensive foreign coal, necessary to replace the Donbas anthracite.

The additional earnings were pocketed by the generating companies’ owners and various shell intermediaries they purchased the fuel from. The latter ones, as a rule, are trading companies of the operators themselves, such as “DTEK Trading”, or other traders.

The amount of money received by “Energorynok” went up along with every wholesale price increase for consumers. Further redistribution of this money was immensely profitable for the generation companies. Coal suppliers had no incentive whatsoever to spend extra costs on SAR or USA imports when the Russian Federation’s Rostov oblast and certain areas of Donetsk and Luhansk oblasts are so conveniently close.

Clearly, the increasing earnings did not endear sensible purchasing policy and risk insurance through import to operators. They did not buy the expected amounts of fuel on the world market, even though that “Rotterdam+” was meant for.

In this situation, private companies had no interest to spend their money on energy independence and safety of the country. State bodies are supposed to ensure such safety and independence, but they either could not or would not directly interfere with business practice of thermal power stations’ operators in order to make the latter act for the state’s benefit.

No sanctions system was put in place when the operators failed to hit the coal stockpiling target, no liability occurred for violating of the state body’s regulation.

As a result, the lion’s share of the surplus profits from the electricity sales went to the vertically integrated DTEK that dominates the power and energy market and accumulated the whole production line – from coal mining to heat and electricity generation.

In 2016 its annual indicator EBITDA – Earnings before Interest, Taxes, Depreciation and Amortization – increased by 2.37 times and reached UAH 17.8 billion. In H2 2016 this indicator went up by 4,6 times compared to H1 2016.

The DTEK increased its monetary funds and their equivalents by 10.7 times that year, according to exchange bulletin. This positive for the company tendency is still going strong.

Net profit of “Centrenergo” state JSC went up in 2016 by 17,7 times reaching UAH 386.7 million. In Q1 2017, the company increased its net profit by more than three times compared to the same period last year, peaking at UAH 851 million.

The statement of Oleh Kozemko, “Tsentrenergo” acting director, made at the stockholders’ meeting on April 25, 2017, is striking, as he claims the company lacks floating assets because of “Energorynok” State Company running into an almost UAH 1 billion debt for electricity – despite its accounting dated March 31, 2017, showing UAH 1.23 billion balance.

The third player in the market of producing electricity from coal – “Donbasenergo” PJSC, allegedly connected with ex-president Viktor Yanukovych – has also improved its financial figures. The company increased its net income by 25% to UAH 4 billion in 2016, its gross profit increased by 20.4% to UAH 1.7 billion. Company’s positive financial trends are carried over into 2017.

According to the estimations of the Ukrainian Exchange experts, “Energorynok” State Company’s rate for the thermal poer plants increased by 47% in Q1 2017 compared to Q4 2016. Despite that, electricity production of “Centrenergo”, for instance, decreased by 30% – down to 1.7 billion kWh in the same period. Such economic paradox became possible only due to the regulator-approved scheme of calculation of estimated Wholesale Market Price for electricity in 2016.

It means, that after “Rotterdam+” formula as introduced, big power-producing companies won, having started to make ultrahigh revenues. The whole country lost, its industrial consumers and indirectly – residential clients, still dependent on the coal supply from Russia, paying overstated “Rotterdam” electricity rate.

Unbending “Rotterdam+”

The adequacy of “Rotterdam+” formula was immediately questioned by the concerned experts and society. Using coal mining “DTEK Pavlohradvuhillia” Private JSC as an example, journalist Serhiy Holovniov revealed how through “Rotterdam+” scheme DTEK managed to accumulate the profit margin of UAH 9.6 billion in the last year in this company alone.

Former NEURC member, independent expert Andriy Herus believes that “Rotterdam+” formula is used for setting the electricity rates, while not taken into account when setting the cost of the coal from state-owned mines.

The expert demonstrated how the thermal power plants paid the mines only UAH 1,330 per ton though having the coal price of UAH 2,200 hrn per ton covered in their rate.

Moreover, the mines extracting coal for electricity production are actually in a great debt to the power stations, as all “Rotterdam+” scheme profit goes to power generating companies and traders, whereas the state coal mines are still running at a loss.

In September 2016 Herus took the matter to court asking it to declare the NEURC Regulation No. 289 of March 3, 2016, unlawful and to revoke it. The expert believes that the regulation was prepared and made public with grave violations of the procedures, thus causing an intolerable energy price increase.

The court, however, did not sustain the plaintiff’s motion. The court believes that major advantages of the NEURC approach are mostly the same cited by the Chief of the Regulation Commission Vovk.

The court’s ruling stresses the following:

“Decision on “Rotterdam+” formula indicators… are at the discretion of the NEURC, therefore lawfulness of this decision is a form of interference with the discretional powers and is beyond responsibilities of the administrative courts”.

According to Herus, experts have been trying to have a specialized discussion with the NEURC managers on the validity of “Rotterdam+” formula, but Vovk and other officials avoided the public discussion.

“More than UAH 10 billion has been collected from the consumers, which instead of being invested in the country’s energy safety, was simply pocketed. If the Regulation Commission acts as a part of energy business instead of being an unbiased arbiter, then the oligarch businessmen get astronomical profits. “Rotterdam+” is nothing but a corruption scheme,” – concluded the expert.

The activist is planning to go all the way in Ukrainian courts of law, and unless our national Justice sees the Commission’s actions for what they are, he is prepared to take the matter to the European Court of Human Rights.

Deputy Head of the Committee on Corruption Prevention and Counteraction, MP Viktor Chumak took interest in the activists’ fight against the contradictory decision of the Regulation Commission.

On February 21, 2017, he sent a claim to the National Anti-Corruption Bureau. MP mentioned that the NEURC actions caused a significant unfounded increase of utilities prices which illegally and significantly benefited members of a certain group.

In three days criminal investigation on the grounds of abuse of office by members of the NEURC was opened.

Yulia Usenko, leading expert of the “Energy Sector Reform” group of the “Reanimation Package of Reforms”, believes that “Rotterdam+” formula is just a manipulation to create a corruption scheme. Usenko is hoping that NABU investigation will clarify the matters, even though judicial system now is far from conducive to such clarity.

Instead of the Afterword

“Rotterdam+” case may prove to be a challenge for law enforcement and judges as well as a catalyst for profound changes in Ukrainian society. It affects the interests of citizens and companies as well as political and economic elites.

On May 24, 2017 Prosecutor General Yurii Lutsenko when reporting to the MPs said that the budget money can be embezzled via “Rotterdam+”, while the scheme itself is a “mafia threat”.

It is hardly a secret that the shareholders of the generating assets are the main beneficiaries of the scheme, namely DTEK owner oligarch Rinat Akhmetov.

Is it just a coincidence that the cheap DTEK shares were bought by ICU company, where Head of the National Bank of Ukraine Valeria Hontareva used to work alongside ex-Minister of Energy Volodymyr Demchyshyn, NEURC Chief Dmytro Vovk, and the subsequent quick rise of the shares value after the scheme was approved? Did President Poroshenko have any say in how the estimated Wholesale Market Price was being formed?

Law enforcement forces have got their work cut out for them.

Oleh Peretiala, for the Ekonomichna Pravda, August 14, 2017

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