Zelensky initiates power pricing revision at cost to DTEK

Ukrainian President Volodymyr Zelensky will submit to
parliament a bill to change the pricing approach of electricity produced by
coal-fired power plants, Andriy Gerus, the presidential representative to the
Cabinet, said on June 14. The bill will propose postponing the launch of the
new model of the wholesale electricity market by one year to July 2020. Also,
“it is suggested that the Rotterdam Plus formula will be cancelled, and instead
a new approach will be introduced, which can be called Rotterdam Minus,” Gerus
said, as reported by Interfax-Ukraine. He clarified that there will be no
logistics surcharge to the API2 coal price (hence the “Plus”), but
instead some discount will be applied to the coal price that is a function of
coal’s quality. The discount will be 1% to 10%, Gerus estimated.

Recall, a new electricity market is scheduled to be
launched on July 1, 2019 according to current law. Under its conditions, power
producers will be allowed to sell their electricity by bilateral contracts with
consumers, as well as on a day-ahead market, an intraday market and a balancing
market. This new model replaces the current system in which all power producers
are selling their electricity to a single buyer based on predetermined prices.
For coal-fired thermal power plants (TPPs), such a price covers the costs of
coal based on the Rotterdam Plus approach, or the 12M trailing price in
Rotterdam (API2 index) plus the costs to ship it from Rotterdam to Ukrainian ports
and the costs of unloading coal in Ukrainian ports. Among the key beneficiaries
of the Rotterdam Plus approach is DTEK Energy (DTEKUA), which controls eight
TPPs out of 12 total TPPs currently operational in Ukraine.

Alexander Paraschiy:
Parliamentary approval of such legislation presents the worst possible scenario
for DTEK Energy. Until the end of 1H20, the holding could have no ability to
sell electricity at free prices (which could have been at the same level, or
even higher than achieved with the Rotterdam Plus approach), and it will suffer
from reduced regulated prices set for the electricity of TPPs for this period.
The Rotterdam Minus approach, which Gerus has consistently supported, means a
certain discount for sulfur content in coal, as compared to the benchmark (1%
for coal from the API2 index). With such an approach, coal costs that are
covered by TPPs’ electricity rates could decrease by about 30% from the current
level already by 2H19, and by another 20% in 1H20. Needless to say, such discounts
to the current price will be damaging for DTEK Energy’s fundamentals.

There is a high likelihood that the current
parliament won’t support Zelensky’s legislative initiative. However, after the
parliamentary elections, when Zelensky’s party is expected to form the
parliamentary coalition, such an initiative is very likely to draw enough
support. If so, we expect some temporary drop in DTEK Energy’s profits for 1H20
and for some part of 2H19. So far, however, we do not see a significant risk
from such an initiative on DTEK Energy’s ability to smoothly service its debt.
Still expecting that the liberalized electricity market will be launched not
earlier than July 2020, we maintain our bullish view on DTEKUA Eurobonds.