E N E R G Y S U B S I D Y R E F O R M FA C I L I T Y ( E S R F ) JANUARY 2017 UKRAINE • 2015, 2016: Combined tariffs increase of 470% for residential gas and 193% for district heating W • 2016: First financial surplus for gas sector ith an energy intensity that was more than double that of the European Union, Ukraine, • 2017: Housing and Utilities Subsidy program historically, was one of the most energy-intensive beneficiaries increase from 1 million to 6.5 million economies in the world. In particular, energy subsi- households dies created a significant financial burden. Only when severe gas supply bottlenecks forced the government to take drastic energy conservation measures in the winter of 2014 was heat and electricity tariff increases and district heating companies, a high fiscal burden, and recognized as the solution to reduce energy spending. energy inefficiency. THE CHALLENGE THE RESPONSE Until recently, Ukraine’s residential gas and district Since 2014, ESMAP, through the Energy Subsidy Reform heating tariffs were among the lowest in Europe, but Facility (ESRF), has supported a cross-sectoral team from the country’s average cost of gas supply was one of the World Bank that has provided advice and support the highest. In 2013, Ukraine suffered from regressive the Government of Ukraine in implementing energy subsidies that benefited larger, mainly richer household tariff and subsidy reforms in an affordable and socially consumers. The average Ukrainian households used to acceptable manner through continuous high-level dia- pay around 20% of the full import price of gas. Overall, logue, investment, and budgetary support operations the bottom quintile used to get 13% of the (implicit) with the objective of achieving cost-reflective pricing. subsidy in gas and district heating tariffs. Root causes were policies that underprice gas and district heating The initial phase of assistance included assessments of services. As a result, one saw deteriorating quality of the poverty, social, and fiscal impacts of reforms, and gas and heating delivery due to underinvestment in gas dissemination of the results to the Government. E N E R G Y S U B S I D Y R E F O R M FA C I L I T Y ( E S R F ) SUMMARY OF 2015-2016 REFORM IMPACTS 2015 2016 180% 470%** Residential gas tariff average increase and annual average tariff* 2,893 UAH/tcm 5,885 UAH/tcm 58% 193%** Residential DH tariff average increase and annual average tariff* 509 UAH/Gcal 949 UAH/Gcal Financial gain/loss for gas sector (UAH billion) (11.9) 30.3 Financial gain/loss for DH sector*** (UAH billion) (1,5) (3,5) Share of energy expenditure for bottom 30% households 16.6 25.2 Poverty incidence without HUS 21.9 24.3 Simulated share of households eligible to apply for social assistance 43.0 60.7 Fiscal impact of social assistance programs (% of GDP) 1.05 2.39 Poverty incidence with HUS 20.2 17.2 * Comparison of annual average tariff (including VAT) to 2014 (baseline) average tariffs of UAH 1032/tcm for gas and UAH 32/Gcal for DH ** The increase against 2015 is around 104% for natural gas and 84% for heat supply *** Based on data f 130 DH companies accounting for 79% of overall heat supply by NEURC licensees analyses of impacts of a number of scenarios (fiscal, ESMAP’s $20 million Energy Subsidy Reform Facility poverty, and social protection) to help the government (ESRF) was set up in 2013 to help countries remove in making an informed decision. fossil fuel subsidies while protecting the poor. ESRF provides technical assistance to governments, Since 2014, the team has supported the government to develops tools for assessment and decision-making, communicate energy tariff reforms, saving energy, and and facilitates knowledge-exchange for a global mitigation measures to the public. This communication community of reformers. support included opinion research to assess public atti- tudes about reforms, messaging workshops to design A campaign to communicate on energy subsidies reforms key campaign messages, 7 training sessions for 278 was launched and further support in strengthening social journalists, media monitoring to enhance press coverage assistance mechanisms was provided, including: materials of reforms, development of an animated ad for print, and training guides for simplified social assistance pro- internet, and TV, as well as 51 trainings for 3000 social grams; strategic rebranding and outreach mechanisms to workers at HUS to improve their customer orientation. promote awareness of the Housing and Utilities Subsidy (HUS) program; trainings to improve the efficiency of OUTCOMES local welfare offices to improve their efficiency, thereby accelerating program coverage expansion and use. Based on the analytical work and assistance provided, The later phase of assistance included assessments regular tariff increases were taken from 2014 to 2016 to of energy tariff and subsidy reform outcomes to date, meet cost recovery. The government increased tariffs in capacity building and knowledge exchanges, and various 2015 and 2016 for a combined increase of 470% for res- financial analyses of the natural gas and district heating idential gas and 193% for district heating. In April 2016, sectors based on 2016 tariff revisions. There was an, Ukraine moved to further eliminate unsustainable energy assessment of the HUS’s performance and fiscal impli- subsidies by unifying household and industrial natural cations, and focus group discussions were conducted gas tariffs and setting them at the level of import parity. as part of a national survey to assess public perceptions In 2016, gas tariff increases for households and district and attitudes toward the reforms. heating significantly improved the financial situation of Supporting both the government and IMF discussions, the gas sector and its production, trans-mission, and the cross-sectoral team has conducted rapid response distribution sub-segments. Household district heating E N E R G Y S U B S I D Y R E F O R M FA C I L I T Y ( E S R F ) tariff compensated for the increased fuel costs of the To ensure that subsidy payments are settled in a timely and district heating companies and otherwise had little impact transparent manner, the current system that consists of a on the financial situation of the district heating sector. On the social protection front, in 2014 and 2015, the government worked towards simplifying social assistance mechanisms by eliminating privileges and providing an option for eligible household to enroll into HUS. It also approved the Gas Sector Reform Implementation Plan, which includes the tariff increases and associated social protection measures. As a result of the team’s efforts, Social Assistance Program reforms have increased the share of targeted assistance reaching low-income households. Improved targeting helped contain regres- sive social assistance spending. From a coverage of approx. 1 million to 6.5 million households in early 2017, the scaling up of the HUS program was a successful The Number of Households Receiving Subsidies, mln Households mitigating policy measure to the large gas and district 6.0 heating tariff increases especially for the bottom 30%. 4.9 5.1 5.2 5.0 5.0 4.5 4.6 4.6 In 2016, the program covered 40% of households at a 4.0 3.9 4.0 3.4 total fiscal cost of around 2.0% of GDP (in contrast to 2.7 3.0 0.13% of GDP spent in 2014). 2.0 2.0 1.2 1.3 1.2 1.4 1.1 1.1 1.1 1.2 0.9 1.1 1.0 0.7 1.0 0.4 0.4 0.4 0.5 0.4 This would have been impossible without the media 0.3 0.1 - engagement plan that endeavored to improve the Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec general understanding of subsidy reforms, especially 2014 2015 2016 among journalists. In regions where media trainings were conducted, the quality of reporting on energy long chain of mutual offsets should be abandoned and, reforms improved. It is estimated that these newly trained in the initial phase, subsidies should be provided directly journalists reached approximately 14.1 million people to the retail gas suppliers and district heating companies. (more than 30% of population), resulting in an extremely positive response from the government. Gas tariff setting for households and district heating companies past the expiry of the existing Public Service Operation (PSO) should be clarified and transition LOOKING FORWARD measures (e.g. revising subsidy settlement scheme, separating retail supply margin in customers’ bills) should While Ukraine has made significant progress in this be adopted towards eventual full market liberalization. complex area of reform, there remain important areas that now need attention. Targeting of the HUS program needs continued improve- ment to ensure fiscal sustainability of the program, Gas and district heating tariffs need to be adjusted increased coverage and level of support to low income based on movements of import prices and the exchange households, and reduced leakages to higher income rate; these adjustments should be made simultaneously households. In the shorter term, targeting can be for household gas and district heating supply, and for improved via changes to the HUS eligibility rules, the companies across the gas and district heating supply benefit formula, tighter social norms, imputation of chain. Recovery of non-fuel operating expenses and income, and use of ex-post inspections. In the longer investment financings remains an issue for the district term, this requires strengthening of income and wealth heating companies. verification, reducing errors and fraud. E N E R G Y S U B S I D Y R E F O R M FA C I L I T Y ( E S R F ) Proactive national communication efforts should continue latest tariff increases, awareness of HUS support, and – however, emphasis should now be on explaining to evaluate the effectiveness of last year’s communications. the public the simplified procedures and the eligibility Reporters will be informed, and regionally tailored infor- rules so as to encourage self-selection and full take-up mation about tariffs and HUS will be provided through a among low-income households. second round of journalists’ training sessions. Support to improve coordination among donors’ public outreach efforts on tariffs and energy efficiency will be offered. NEXT STEPS The government and the World Bank are continuing to CONCLUSION partner with main stakeholders to facilitate timely imple- mentation of reform plans for gas and district heating ESMAP’s assistance, through the Energy Subsidy Reform through continual implementation of the communication Facility, helped the World Bank teams conduct an strategy on energy reforms and development and imple- in-depth analysis and provided hands-on support to mentation of an energy efficiency campaign. The team is enable a strong policy response to wasteful energy assessing achievements, failures and lessons learned of subsidies.As a result, the government increased tariffs the early reforms to make necessary corrections in course in 2015 and 2016 for a combined increase of 470% for of action for the coming years. The team is continuing residential gas and 193% for district heating. This helped capacity building of counterparts, learning and just-in-time to improve the financial viability of the gas sector, which technical assistance, support creation and monitoring of made a financial surplus for the first time in 2016. In the consumer feedback mechanisms in local authorities, terms of sheltering the poor from price increases, the energy utilities, communal housing companies and/ government remarkably increased the number of poor or administrators of energy efficiency pro-grams. The beneficiaries under the Housing and Utilities Subsidy regulator and energy companies will be supported with (HUS) program from 1 million to 6.5 million households the implementation of new tariff setting methodologies in early 2017. Other work also included training for in the gas and electricity sector in response to the reor- journalists to ensure informed coverage of the policy ganization of the gas and power markets. decisions and support to the government to strengthen social assistance mechanisms. The World Bank is now Drawing upon recent focus groups that showed mixed exploring the option of providing monetary subsidies attitudes and a need for better information, the World (actual funds instead of price or tax rebates) and refining Bank will support communication through a second the Housing and Utilities Subsidy to better target the poor. round of opinion research to understand attitudes about ABOUT ESMAP The Energy Sector Management Assistance Program (ESMAP) is a global knowledge and technical assistance program administered by the World Bank. It provides analytical and advisory services to low- and middle-income countries to increase their know-how and institutional capacity to achieve environmentally sustainable energy solutions for poverty reduction and economic growth. ESMAP is funded by Australia, Austria, Denmark, the European Commission, Finland, France, Germany, Iceland, Japan, Lithuania, Luxembourg, the Netherlands, Norway, Sweden, Switzerland, the Rockefeller Foundation, and the United Kingdom, as well as the World Bank. ESMAP | 1818 H Street, NW | Washington DC 20433 | 202.522.3018 | www.esmap.org