The outbreak of COVID-19 has stirred up the world. Epidemics are always both a standalone business risk and an amplifier of existing trends and vulnerabilities. In this article, we will describe the problems the energy companies in Ukraine are concerned about.
Long-term reform of the Ministry of Energy and Environmental Protection, cross-subsidization of the population at the expense of industrial enterprises, chronic non-payments, force majeure under the contracts in energy sector, probability of failure to comply with the equipment delivery/installation schedule due to logistic difficulties during the quarantine, restrictive measures, fear among investors and banking sector actors as to further project financing – all these reasons have unbalanced the fuel and energy sector amid the emergency situation.
Mass claims of force majeure by contractors, default, and delays in construction
Energy projects that are currently in the active construction phase cannot organize remote work for all their employees due to the specific nature of the industry. Such companies have been confronted with the effects of legislative loopholes, according to which from the date of quarantine until recently it was not clearly determined whether construction activity is subject to any quarantine restrictions. As a result, law enforcement bodies have carried out many raids on the construction sites of solar and wind power facilities under the guise of asking the following questions: "Does the company comply with the legislation requirements regarding holding large-scale events involving more than 10 people,"; "Does the company provide the employees at the construction site with necessary personal protective equipment: gloves, masks/respirators, goggles/face shields"; "Does the company comply with the requirements of transportation to/from the construction site during the period of partial closure of the regular transport service?".
Fortunately, on 08 April 2020, Resolution of the Cabinet of Ministers of Ukraine dated 11 March 2020 No. 211 "On Prevention of COVID-19 Coronavirus Spread in Ukraine" was amended and construction activities were excluded from the list of restrictions, which means granting permission for carrying out any construction works subject to compliance with other requirements, including sanitary and epidemiological legislation. In addition, please note, that in accordance with Ukrainian legislation local councils and administrations are entitled to establish tougher quarantine restrictions, and therefore, electricity facilities and oil & gas companies in different regions may become subject to certain restrictions.
The implementation of energy projects, supposedly, should continue, but later the businesses became faced with mass notifications from the contractors and subcontractors of the occurrence of force majeure circumstances under the EPC contracts, supply, installation, maintenance agreements, etc. and their inability to fulfill obligations for an indefinite period. However, it is important to remember that although COVID-19 is legislatively recognized as a force majeure circumstance, its occurrence needs to be confirmed by a certificate issued by the relevant Chamber of Commerce and Industry (the "CCI") for each particular contract, tax and/or other obligation. On top of that, the applicant must prove how quarantine and COVID-19 have affected the performance of the contracting party's obligations. Monitoring of the official site of the CCI of Ukraine leads to the conclusion that there is number of requests for certificates and this number is continuously increasing, while the term of consideration of applications is much more than 7 business days, as established by the CCI Regulation; and the reasons for refusal to issue a certificate usually include failure to submit a complete package of documents, which has been reduced for the convenience of applicants during the quarantine, and absence of proof of a connection between the force majeure circumstance and the breach of contractual obligations. Thus, the applicants should carefully prepare all the documents for submission and bear in mind that an eventual challenge of the CCI's decision refusing to issue a certificate and a demand of its issuance will collapse, based on the current Supreme Court practice, which does not allow any interference into the discretionary powers of the entity (http://reyestr.court.gov.ua/Review/73081565).
Quarantine influence on prePPA validity
The prospects for the commissioning of renewable energy facilities and the subsequent generation and sale of electricity are also quite pessimistic.
Indeed, prePPAs concluded between the renewable energy facilities and the State Enterprise "Guaranteed Buyer" clearly indicate that if a power facility or a stage of construction of the power plant, in respect of which the feed-in tariff power purchase agreement was concluded, is not commissioned within two years (for solar power plants) or within three years (for wind power plants) from the execution of the power purchase agreement, such an agreement will be terminated. The power purchase agreement has a standard form approved by the NEURC (Regulator), and therefore the parties cannot, at their sole discretion, change the term of the agreement and extend it for the duration of quarantine and/or force majeure.
Developers and lawyers see this as a threat and a risk in the implementation of renewable energy projects. The situation is compounded by the fact that under the feed-in tariff reform, the Ministry of Energy is trying to shorten the duration of the prePPA. It is important that the bill currently being drafted by the Ministry considers the effects of quarantine on the project implementation timeframes.
Oil & gas sector work routine
During the quarantine period, the critical infrastructure facilities, including oil & gas companies, continue to work. According to the Law of Ukraine “On the Basic Principles of Ensuring Cyber Security of Ukraine” No. 2163-VIII dated 5 October 2017, the enterprises, institutions and organizations, regardless of ownership, which (i) operate and provide services in the energy sectors, (ii) provide services in the areas of public life, in particular in the areas of centralized water supply, sewerage, electricity and gas supply, and (iii) are listed as enterprises of strategic importance for the economy and security of Ukraine, etc. may be considered as the critical infrastructure facilities. They meet many difficulties conducting their activities under this regime of restrictions.
Currently, oil & gas companies in Ukraine are trying to tighten travel restrictions, organize individual control for site management and screening to control access to mine sites, emergency medical care preparedness, develop supply chain contingency plans, and are working with health authorities to closely monitor local and global developments. Considering that some employees are working from home, if possible, the processes are slowing down. Just like other companies in Ukraine, companies involved in oil & gas sector have difficulties in communicating with state authorities in terms updating their permits, licenses and everything that can secure the normal functioning of the enterprise.
At the same time, the companies are in charge of ensuring the electricity and gas supply to consumers in the conditions of prohibition to apply sanctions to violators of payment discipline in the sphere of housing and communal services. Unfortunately, up to 50% of consumers in different regions have not paid for gas supply.
Andrii Kobolev, director of Naftogaz of Ukraine has announced that Naftogaz, one of the largest oil and gas producers in Ukraine, is well prepared for the situation. Since last year, Naftogaz has expected gas prices to fall, saved funds, and steered clear of investments in any projects that could only be implemented with a high gas price, such as production projects, because it understood that the price would be definitely lower than expected.
Anticipated investments in the Ukrainian energy projects
The influence of coronavirus is not limited to energy sector, but also impacts banking sector, reducing ability to finance future energy projects. In Ukraine, COVID-19 and quarantine have complicated the already existing problems of the energy market – the uncertainty of the "rules of the game" and the intentions to review the feed-in tariff.
During this time, we can observe the disruptions in global supply chains of necessary equipment, complications of business contacts, and the creation of a situational shortage of labor. Another negative consequence has been added – a decrease in global demand for energy, in particular, of renewable energy, as reported by most of the countries. According to the report of Bloomberg New Energy Finance (BNEF) dated 12 March 2020 on the likely effects of COVID-19 outbreak over the next year on the transition to a clean economy: there will be a decrease in the demand for renewable power, energy storage, electric vehicles, heating, cooling and circular economy systems, solar power, and batteries. In 2020, the demand for solar energy is expected to drop by 16% (from 121-152GW to 108-143GW). Battery demand in an optimistic case scenario will be 3GWh lower in 2020 than initially forecast, and 9GWh lower in a pessimistic case scenario.
The exception is wind energy which has other peculiarities. BNEF attributed “considerable downside risk” to their forecasts for 2020 of 75.4GW, expecting 2020 to be a record year for new wind installations. According to the BNEF, the size of the drop will depend on how quickly Chinese suppliers ramp up to full production as staff slowly return from isolation, and the severity of delays to already-tight construction schedules from late component deliveries.
The situation in Ukraine is unclear and, in most cases, follows the international trends. Currently, the electricity consumption is decreasing and is expected to drop by 8% compared to the same period last year, in particular due to quarantine measures and emergency response. The uncertainty of the "rules of the game" and the intentions to review the feed-in tariff does not lure the potential investors.
The international environment does not outline any bright prospects for the Ukrainian oil sector. The recently adopted declaration of the Organization of Petroleum Exporting Countries (OPEC+), its impact on the market, and the global coronavirus situation will have a negative impact on the Ukrainian energy sector as well. In particular, the OPEC+ countries have agreed to reduce oil production by May 2022, provided that Mexico joins them. According to the experts, the declaration adopted by OPEC+ will not allow to reach the previous levels of prices, and in principle, oil prices will range from $30 to 35 per barrel. It will be extremely difficult for Russia to fulfill these conditions, as according to the declaration Russia must reduce its production by 1.5 million barrels per day. Additionally, hryvnia has weakened, which has influenced the oil price for Ukraine.
The situation with gas sector is more optimistic, as due to warm winter, Ukraine has finished the heating season with the largest gas reserves in the last 30 years. Regarding the sector development, recently the Regulator approved the gas transportation system development plan prepared by LLC "Operator of GTS of Ukraine" (OGTSU) till 2029. The volume of financing of projects for construction, overhaul, reconstruction and technical re-equipment of gas transportation infrastructure facilities will be 38.717 billion UAH. The plan determines four ways of the Ukrainian gas transportation system (GTS) development where the main investments will come to supply security, sustainable development and eco-friendliness, market integration, and efficiency. Some of the outlined projects require active reconstruction and construction in the territories outside of Ukraine.
In the words of a famous classic writer: "If you wait for a more favorable moment, you risk staying where you are." Taking into account the daily changes at the market, one should not count on a quick exit from the crisis and painless implementation of the projects, but should constructively and honestly approach the possibility of pre-trial and pre-administrative dispute settlement with contractors, partners, investors, in particular, to agree on the most effective ways for proper fulfillment of the contractual obligations, make necessary changes to the contracts regarding the new conditions, and continue the economic activity in the fuel and energy sector one step at a time.