The Future of Ukraine's Energy Industry: Challenges and Opportunities

Brian Bonner: Hello everybody, this is Brian Bonner, your host for Ukraine Calling. We have a very serious topic today because, as everybody in Ukraine knows, our energy sector is being pummeled by Russian missiles on a regular basis. We’ve lost the capacity we used to have before the big war, from 55 gigawatts, and now through damage and Russian occupation, we’ve basically lost energy resources like the Zaporizhzhia nuclear power plant.

We’re down to 20 gigawatts, which is less than half capacity. It looks very dire. Helping us explain this is probably one of the top experts on the Ukrainian energy industry that we have, Oleksandr Kharchenko, longtime director of the Energy Industry Research Center. Welcome to the program.

Ukraine needs to prepare for winter and do it fast

Oleksandr Kharchenko: Thank you for the invitation. Let me start with some figures because it’s important. The day before the war started, Ukraine had an energy system with an available capacity of 37 gigawatts. If we are talking about today, exactly today, when we have all the nuclear available for controlled territory, we will have about nine and a half gigawatts.

Brian Bonner: This is a dark winter.

Oleksandr Kharchenko: I can’t say it will be apocalyptic. We have some experience and understanding of what has to be done, how we have to act to prepare the system for winter. A lot of things are moving. It’s rare in Ukrainian history to see progress in the energy industry week by week. But at the same time, it will be very complicated. In my mind, December, January, and February can be very similar to what we have today.

Brian Bonner: With blackouts basically, most of the day.

Oleksandr Kharchenko: We have six to eight hours of supply per day on average around Ukraine. In some frontline zones, we have a worse situation, but the average situation is six to eight hours.

Brian Bonner: That’s bearable in summer, but not in winter. It’s going to get pretty rough.

Oleksandr Kharchenko: I could say yes and no. What is very important is that all critical infrastructure is covered. That means fresh water and heating will be operational.

Brian Bonner: We’re not in danger of losing our water and sewage system?

Oleksandr Kharchenko: Yes, that’s critical infrastructure and is on the safe side. I can see how much municipalities and cities invest to keep these critical systems operational, even if we have more troubles on a national level. They invest in backup capacity and preparation for winter. They optimize their electricity needs and make backups for this optimized amount of critical infrastructure. I know of 15 to 20 cities, including Kyiv, Kharkiv, Odesa, Zhytomyr, Dnipro, Cherkassy, that are preparing for this winter. It’s unique in my memory to see such focused and impressive work.

Brian Bonner: Is the water and sewage system protected from Russian bombing? Can they just bomb once and knock out the entire system?

Oleksandr Kharchenko: No, it’s a huge infrastructure of small pumping stations. It’s decentralized, unlike the electricity system. In each city, like Kyiv, there are thousands of objects to manage. It’s not possible to knock out the entire system.

Why is Russia attacking the Ukrainian energy system?

Brian Bonner: That’s good news. I was at an event sponsored by Ukraine Business News, and we’re going to play some clips during this program. It had UkrEnergo CEO Volodymyr Kudrytsky and DTEK Executive Director Dmytro Zaharuk on the program:

“Of course, the Russians do this not just to make us sit without power for four or eight hours a day. Their plan is to destroy the power system to initiate a full-fledged, long-term national blackout, which would cause catastrophic consequences for Ukrainians, our economy, and our ability to fight.”

Do you agree with that?

Oleksandr Kharchenko: Absolutely. They target the energy systems very clearly. They want to kill the Ukrainian energy systems and economy. It’s absolutely clear.

Brian Bonner: And that kills the war effort, which sends more civilians fleeing.

Oleksandr Kharchenko: Civilians for sure. It has nothing to do with military targets, all these targets are civilian.

Brian Bonner: But they justify it by saying the electricity supports the domestic defense industry.

Oleksandr Kharchenko: In this case, if we justify the Russian energy system, I believe that all the civilized world will say, «Ukraine, you are not right.» We’ve already seen what happened in Israel. In my mind, if you have a military target, and you know that military production happens somewhere, attack that site, that production unit.

If you can argue that it is military-related production, but you attacked critical infrastructure that supplies electricity to 25-27 million people, it means you are attacking their fresh water supply, sewage operation, and winter heating, which cannot operate without electricity. You just want to kill all these people. It’s clear. If you attack this infrastructure, you try to kill all these people.

Decentralized energy system: Ukraine’s last hope?

«We have to roll out new generation facilities to make sure that if Russians undertake these attacks, they cannot concentrate on 10 or 15 big power plants but would have to deal with hundreds of smaller ones.»

Brian Bonner: How do we get from here to there?

Oleksandr Kharchenko: It’s maybe a little bit paradoxical, but it’s not rocket science. Let’s start with a simple example: imagine you are the owner of a retail store network and you have, around the country, I don’t know, 500 retail stores. Each of them has a roof. You install some solar panels on the roof. Each of them has a backyard and logistics center and you install a two-megawatt battery storage in the backyard and a small gas piston engine with a five-megawatt capacity.

This setup makes your retail store absolutely independent from the national grid if something happens. At the same time, you add seven megawatts capacity to the national grid. If you have 500 stores, that’s 3 gigawatts capacity in the grid, you are going to help.

Brian Bonner: What is the peak usage on a day to day basis?

Oleksandr Kharchenko: Last winter, peak usage was 18 gigawatts, and now we have half of this.

Brian Bonner: So, we can get there?

Oleksandr Kharchenko: Absolutely, but we need some time and money. Money will come if you can say: “Guys, you will invest money, it means you will make more money.” We have done a lot of calculations, and the last financial model for the installation of gas piston engines shows a payback period of four and a half years.

Brian Bonner: It seems like forever now, but it’s not a long time.

Oleksandr Kharchenko: But for energy, it’s nothing. The usual energy industry payback period is over ten years. Now, we have a great opportunity to jump into the energy business in Ukraine. Before, it was a high-top monopoly in each segment of our electricity market.

State-owned Energoatom has a monopoly for base load production, which can only be produced by nuclear reactors. They generate a flat line of capacity and cannot adjust quickly. To manage the system, you need two kinds of generation capacity. One works like our nuclear reactors, generating a basic load. The other needs to jump up and down quickly to cover changes in consumption because no one wants to wait for half an hour and send an SMS asking to switch on the electricity in a room. Everyone wants flexible capacity that can change generation at any moment.

In the Ukrainian system, this was traditionally managed by state-owned hydro generation and the private monopoly DTEK, which operated coal-fired generation. Now we lost coal fired generation. We’ve had trouble with our big hydro, and it will take maybe three years for renovation. We need as much flexible capacity as possible, as soon as possible. This is a huge opportunity for small, now middle or even big businesses to operate this kind of decentralized network. Nova Poshta, Epicenter, State-owned UkrZaliznytsia, State-owned UkrNafta, and many other players are jumping in right now to build some capacity.

Brian Bonner: Capacity, but how are they generating the electricity? Is this renewable or something else?

Oleksandr Kharchenko: This is a separate discussion because choosing technology requires considering several things. First of all, you need flexible capacity, which is manageable.

Solar and wind are very good renewable capacities, but they are not manageable. You can’t tell a station to switch on at 9 pm on December 24th. With wind, you have operational wind farms only when there’s wind. Without wind, you have nothing. The Ukrainian system now needs exactly manageable capacity.

It can’t be coal. No one in the world now finances coal, and no one except some countries like India and China is building coal generation. This is not the case for Ukraine. We will not build coal at all. The next point is that you need a fuel supply in Ukraine. Under current conditions this is natural gas. It is available everywhere in Ukraine, of sufficient quality, and can be deployed very quickly.

At the same time, we need technology that helps us install something quickly because no one wants to wait five or six years to normalize our energy supply. Everyone wants to return to normal as soon as possible. When we consider all these factors and grade the technologies, we see that we need some manageable generation capacity based on natural gas, as close to green transition as possible.

It has to be something that can be applied quickly. The answer is modern gas pistons and gas turbine equipment. What does «modern» mean in this case? It means two things. First, they are ready to use biogas and hydrogen instead of natural gas; you just need a source of biogas or hydrogen. Second, they have a high-efficiency rate. We found the answer to what we need technically. After some discussion, it took time, but now everyone agrees that the Ukrainian energy system needs a fast-track installation for this capacity.

Next question. A very good question. First of all, you will never build a decentralized generation with a centralized approach. If you create a Ministry of Decentralized Generation, it will never happen. Create conditions for business. Give businesses and municipalities ready to go in this direction the opportunity to do business with this kind of equipment. Now, this is very close to being done. The government has already taken several very important regulatory steps to open this market as very commercially interesting. They have given some regulations, simplified some procedures. What has to be done is they need to solve the problem with debts in the Ukrainian electricity market.

Now, figures are good, and all models present show that it is interesting for business. You will build a good business if you go in this direction. But the problem of debts remains because you might wait for one year or more to receive payment. This is not acceptable for many investors. It must be solved.

It’s a problem for everyone on the electricity market, but it’s now the main bottleneck stopping many investors from jumping in and investing in this equipment in a fast track. I know that Ukrenergo and Volodymyr Kudrytsky, whom you mentioned, are leading this process, trying to solve this issue. They have proposed to the government how they see this problem can be solved. I think they have a brilliant idea and a very good market-related approach to how it can be done. I hope the government will go in that direction, which can open a window for a very good business case in one to two months.

I know that many businesspeople in Ukraine have already started. They are looking for equipment, loans, and sites. Everything has already started. We already have some successful cases, with installed capacity in Kharkiv, Cherkassy, Zhytomyr, and Kyiv. But it’s a very small part of the volume that we need.

Can Ukraine recover from attacks on its energy system?

Brian Bonner: I wanted to talk about the Ukraine business news event. DTEK was also there, represented by its executive director, Dmytro Sakharuk. Tale of Woe. We have a funny situation, where the richest billionaire in Ukraine is trying to raise money, because Russia destroyed 90% of the capacity. All thermal-plants were hit four or five times.

He had a very dire message saying we can repair them now but we have no air defenses to stop this from happening again. That’s a very stark message. He also said that the government approach is very wrong in not favoring private investors. It favors government-to-government financing.

He mentioned the water and sewage issue. And basically laid out a stark case where they can only recover, I don’t know how much they produce five gigawatts, maybe more, but they can only recover half maximum of what they had by winter. That’s pretty dire. Does that sound about right to you?

Oleksandr Kharchenko: It’s a little game, I think. From one side, they announced investments outside of Ukraine. For example, DTEK announced a big project for battery storage in Poland, investing hundreds of millions there. This won’t help the Ukrainian system at all. You answered your question yourself.

Brian Bonner: How did we end up in this situation? We made a huge mistake after the collapse of the Soviet Union by keeping basically the same energy system. Should we have anticipated this? If we did anticipate it, what could we have done? If we didn’t anticipate it, why? If we didn’t anticipate the Russian massive bombings, what else are we not anticipating that Russia will do regarding energy?

Oleksandr Kharchenko: It’s just the end of the Soviet Union in Ukraine’s energy industry. Of course, it’s a huge stress, and it’s very painful. It’s an extremely hard time. No one in the world has experienced what Ukraine is going through now. But at the same time, we have a huge opportunity. We even joke in small circles of energy-related people that Ukraine is undergoing a stress-induced decarbonization of its energy system.

In three years, we can have an extremely reliable, very sophisticated, and very clean energy system. We will still have one monopoly owned by the state, Energoatom, and all the nuclear stations. There will still be a monopoly in the base load on the electricity market. But at the same time, all other markets will be absolutely free of monopoly, leading to huge competition among small players.

For example, Denmark’s market is so fragmented that no player has more than 10% of the market. It means each kilowatt is sold on a very competitive basis, with everyone fighting for consumer money. This is the right path for the Ukrainian energy industry in the next two to three years.

Brian Bonner: So Denmark has reliable supply at an affordable price because of the competition.

Oleksandr Kharchenko: Denmark is a very interesting country. They are very green-oriented. It was a decision of the entire country to be the most green country in Europe and, ideally, in the world. They invest heavily in various renewables and have a very clear energy mix.

It’s quite expensive compared to other countries in Europe. Denmark is not cheap, but they decided to follow this path and can afford it. It’s a social contract in Denmark. In Ukraine, we also have a social contract: «We will pay nothing for energy, and you will not push us in that direction at all.» As a result, we have gradually decreased the reliability of our energy industry, with no new investment and nothing changing.

Brian Bonner: DTEK is right about that. The tariffs are very low, and consumers are subsidized.

Oleksandr Kharchenko: Yes, absolutely. For all 30 years of Ukrainian history, consumers have been subsidized. Private consumers have never paid the full price.

Players on Ukrainian energy sector

Brian Bonner: Then how did DTEK make money?

Oleksandr Kharchenko: I could spend several hours explaining how they make money, but the short version is very smart corruption. Very smart, very professional, dancing around all regulations. But it’s still corrupt. Rotterdam Plus and other schemes are just the most famous examples. They have many different methods that I personally consider corruption.

Brian Bonner: Give me one more example.

Oleksandr Kharchenko: The electricity market is a special thing, hard to explain quickly. It’s not just selling and buying something; electricity is both a service and a product. With enough power to manipulate, and they had more than 50% of flexible capacity in Ukraine for many years, they could always lobby for regulations that allowed them to make more money than other players. They took care of themselves through very smart and professional manipulation of the market.

Brian Bonner: Is that going to come to an end?

Oleksandr Kharchenko: I think so. Now it’s the end of this story. They have to start a new story.

Brian Bonner: The energy sector has been the foundational wealth for many oligarchs. You’ve written on corruption in the gas sector, from Naftogaz to regional energy companies, which you once said is basically legalized corruption. They would get gas cheaply from Naftogaz, sometimes not pay for it, we’re talking about Dmytro Firtash, and then sell it at a high price.

Is there an analogous problem with regional electricity distribution companies? It seems like almost a majority were owned by a Russian nationalist. Is that kind of corruption prevalent in electricity as it is in gas?

Oleksandr Kharchenko: It’s at the same level but with different owners. Distribution companies in electricity are owned by DTEK and others. Formerly, some were Russian-owned, now state-owned. It’s the same situation as with gas, but the manipulation methods differ due to the nature of electricity. If you have something supplied cheaply to citizens and a market with higher prices, you resell to business consumers.

Brian Bonner: So they manipulate subsidies by saying consumers are buying this cheaply?

Oleksandr Kharchenko: Yes, they manipulate again.

Brian Bonner: Who should own these regional companies? Is it Ukrenergo?

Oleksandr Kharchenko: Ukrenergo is a cleaner company in the last five to six years.

Brian Bonner: That’s good news for us.

Oleksandr Kharchenko: But in real life you can check this. Who in the energy industry received a lot of grants and loans at low-interest rates. Ukrenergo has $1.4 billion in support from donors during wartime. All other support to the energy industry for other countries is about $450 million. You can compare two figures: $1.4 billion for Ukrenergo and about $450 million for everybody else.

Brian Bonner: So they’re favored?

Oleksandr Kharchenko: Of course. But why? Because they have transparent procedures, corporate governance, internal audits, and are open to communication. They present all their pricing in each procurement.

Brian Bonner: What about the Energy Ministry? Historically, we’ve had opaque, figurehead energy ministers helping monopolies. Is that still the case?

Oleksandr Kharchenko: The current Ministry of Energy focuses mainly on nuclear direction, working with Energoatom. They aren’t much interested in anything else.

Brian Bonner: On nuclear energy, Bill Gates is investing in TerraPower, new generation nuclear power plants. Do you see that as a possibility? Plants that don’t produce the nuclear waste that old plants do.

Oleksandr Kharchenko: Nuclear waste from old reactors is fuel for the next generation of reactors. I’m a big fan of nuclear power, but this next generation technology will be ready in 10-15 years. It won’t help Ukraine now. To build new old-style reactors, the last example is a reactor in Finland – it took 18 years and 20 billions of euros. We need to maintain and polish our current nuclear capacity and invest in its maintenance to ensure it remains operational.

Brian Bonner: We have to get our six reactors back in Zaporizhia.

Oleksandr Kharchenko: Of course, if we deoccupy Zaporizhia, it is a game changer.

Brian Bonner: Now investors and this Ukraine Business Forum also talked about how we’re not friendly to investors. Look at what we did with renewable energy. We promised sky-high tariffs and didn’t deliver. We have currency restrictions, so who’s going to lend money if they can’t get it back? We have the tariff problem.

It seems like we’re still not there. Banks were also brought up at this forum. They would rather lend money to the National Bank of Ukraine, collect the easy, guaranteed interest, rather than invest in the private sector. Are you sure that we’re going to be able to get these private investors?

Oleksandr Kharchenko: First of all, you’re absolutely right. Secondly, people who invest in Ukrainian renewable energy have a very clear understanding. Many people have said that the green tariffs were created by corrupt individuals during Yanukovych’s time, just for their own projects. One day you will have problems because you jumped into this direction. No one was ready to hear this. People invested.

Of course, problems happened because, in one day, eight percent of generation capacity in renewable energy wanted to take 26 percent of the money from the market. No chance, guys, because you are not the main generation capacity. You can’t cover people; you can’t even create security for people. You are just not operational most of the time. Sorry, guys, you did what you did. You think about risks. You have a huge procedure to evaluate each risk.

I don’t know why it’s okay. Let’s be honest, a lot of time ago, they took their money back quickly because it was huge. It was absolutely unreal.

Brian Bonner: Why does Dimitri Firtash, who’s in exile and has managed to manipulate the Austrian Supreme Court to avoid extradition to America, not face any criminal charges in Ukraine? Does he still have all of his assets, like the regional distribution companies? Did he pay them back?

Oleksandr Kharchenko: No, it’s taken away. It’s now under Naftogaz management, which manages all the regional distribution gas networks. It was officially announced during the war, but now it’s finished and everything is in Naftogaz’s hands. This eliminates a lot of corruption. It cuts off Mr. Firtash from this money flow.

Brian Bonner: He’s no longer a big player in the energy sector. That’s an improvement. Kolomoisky?

Oleksandr Kharchenko: Is out.

Brian Bonner: Athmetov?

Oleksandr Kharchenko: The same situation. Akhmetov is out of the monopoly game. They still have some capacity, but this capacity, even with maintenance, is 50 years old or more. Without a huge investment in modernization and rebuilding, all this coal-fired generation will be out in two to three years. The main target is not to think about this old coal-fired generation. Akhmetov is no longer an oligarch in energy.

Now we have to think about how to push the new ones, how to build new capacity quickly, and how to avoid monopoly in this sector. We need to open the market for 12, 30, 50 players who will build a lot of small-sized and middle-sized capacity around the country, like supermarkets or municipal companies building generation for their own consumption and the city’s consumption. Fuel stations can also build some capacity to supply the network, five megawatt, ten megawatt, twenty megawatt

Brian Bonner: So we shouldn’t count the oligarchs or monopolies out, but they would need government favors in the future to reestablish monopolies.

Oleksandr Kharchenko: To reestablish a monopoly, they will have to fight other players. And that’s the warranty that monopoly will be hard to establish.

Brian Bonner: So this is because of the war, which is horrible in every way, but inadvertently helped speed up the end of the Soviet era. We’re now connected to the European grid.

Oleksandr Kharchenko: Many people say that Putin created the Ukrainian nation with his approach. At the same time, he killed the old Soviet-style energy in Ukraine. It’s killed. It’s nothing more.

Brian Bonner: The death of the empire, that’s great news.

Will Ukraine continue to transit Russian gas?

Brian Bonner: How about the contract on gas? Will that be renewed in 2024? Because we’ve got Austria, Hungary, Slovakia, and others buying gas, and it seems absolutely absurd that we’re transiting Russian gas.

Oleksandr Kharchenko: For me, it doesn’t seem absolutely absurd because we have to consider several things when we’re talking about transit. First of all, for Ukraine to supply gas to our southern and eastern regions, we need the gas transportation system. If transit stops and nothing moves through the system, it opens a window for Russia to attack it, especially compressor stations they don’t need anymore.

Brian Bonner: So, their gas has sort of protected that infrastructure.

Oleksandr Kharchenko: Absolutely. If they attack compressor stations and destroy them, it’s not possible to defend them properly. Believe me. We have other things to consider, not only security. We’re using the money from the transit to cover expenditures for transiting gas and distributing gas to suppliers in Ukraine. If this money flow stops, we would need to take 300 million dollars from consumers who don’t have more money at all. We need additional financial flow to cover expenses to transport gas inside Ukraine. The best solution with Russia would be to build a concrete barrier five meters high around all of Russia.

But in this situation, we have to measure what we would lose if transit stops. We would have huge trouble in the eastern and southern regions, including Kharkiv and Odesa, for heating because gas is key. We don’t have a clear technical alternative to cover these needs.

That’s why I believe the right thing to do is this Azerbaijan contract announced by the president. If it is swapped with Azerbaijan, with European countries, and Ukraine uses our gas transportation system to transport Azerbaijani gas to our European partners, it’s the best case for us.

Brian Bonner: Because Russia won’t hurt Azerbaijan.

Oleksandr Kharchenko: Yeah.

Brian Bonner: Very interesting geopolitics and energy. Well, yes, you’re right. This is a complicated subject, but thank God for Oleksandr Kharchenko who can make it simple. You’ve been the energy expert on top of everything for many years. To summarize, if I got it right, we’re headed for a dark winter. We’re going to have power cuts for sure. If we don’t get better air defenses, it’s going to be worse. There are no quick fixes here, but it’s not completely dire.

We’ve ended the old Soviet energy monopolies. The oligarchs are mostly out of the energy sector. We see that the future, because of this war, is in decentralized energy. We need investment. As you explained, the water and sewage systems look to be pretty safe.

Oleksandr Kharchenko: You got that right. This crisis, this war, creates a huge opportunity for Ukraine. Yes, it’s a hard time, but we have to use this hard time to be better, to stay better, to win, and to build something that will be a good example for Europe and maybe for other parts of the world on how to use your crisis if you are smart enough and never give up.