Rebuild, Decarbonize, and Integrate: Ukraine, the EU, and the Road to a Net-Zero Energy Sector

June 04, 2024
More than half of Ukraine’s power production capacity has been damaged by Russia since February 2022. Reconstruction is already underway, but to meet EU accession requirements, Ukraine will have to rapidly decarbonize as it rebuilds.

As the frontline situation points to a longer war than was projected early on, uncertainties about Ukraine’s long-term economic path and prospects have inevitably increased. At the same time, noticeable political progress has been made given the EU’s agreement to start negotiations for full Ukrainian membership. This step provides the fighting Ukrainian people with a long-term perspective and a destination point as a prosperous, democratic, European market economy.

Anchoring Ukraine’s economic future in the EU will have transformative implications for the country’s economy, not least its energy sector. That sector, which is still exposed to Russian military attacks, is now compelled to assimilate into the rapidly decarbonizing EU. More than half of Ukraine’s power production capacity has been damaged by Russia since February 2022 or is situated on territory now controlled by Russia. The Net Zero World Initiative (2023) estimated that 43% of nuclear, 68% of coal-fired, and 33% of combined heat and power generation was lost to the war as of mid-2023. Despite continuing attacks, more than two gigawatts (GW) of electricity production capacity were restored during 2023. Reconstruction of the Ukrainian energy sector is already underway despite the war. With it, the country’s energy transformation has begun.

Yet, in March 2024, Russia returned to large- scale saturation missile attacks against Ukraine’s energy infrastructure, including its large hydropower plants and thermal power stations, inflicting further long-term damage. Putin seeks to exploit the apparent drop in Ukrainian air defense efficiency as Western supplies of air interceptor missiles have grown scarcer. Military risk consequently continues to cloud the outlook for Ukraine’s energy production. It also reduces the interest of foreign and domestic investors in committing resources to the sector. Uncertainty plagues the prospects for Western public support for Ukraine, too. Despite the recent passage of a funding package, future US funding will remain hostage to domestic politics. In Europe, various veto players—led by Hungary—as well as other internal divisions pose an ongoing political challenge to the EU’s financial support for Kyiv.

The scarcity of public and private investment funding sources for Ukraine stands in stark contrast to the level of ambition for the energy- sector transition inherent in Ukraine’s EU accession process. One of the major energy- sector challenges facing Ukraine will be the expectation in Brussels that Ukraine will either enter fully into the EU Emissions Trading System (ETS) or implement an ETS-aligned national carbon-pricing system of similar ambition. It will not be possible for the Ukrainian economy to be granted a prolonged transition period here, and—for instance—enjoy free carbon-emission credits for affected industries, when these same industries will have been partially or fully phased out in the rest of the EU at the time of Ukraine’s EU accession. While the EU ETS price is currently adjusting to the new post-2022 energy shock demand level (for example, prices have declined so far in 2024 to around €60–65/ton), the ETS auction price forward curve slopes upward. This indicates that carbon market participants continue to believe that EU carbon prices will rise during Ukraine’s EU accession process.

Adapting the economy to the EU’s carbon price level will require urgent action on the part of the Ukrainian government as it prepares the long-term National Energy and Climate Plan (NECP) that will lay out the country’s energy strategy for the rest of the 2020s. Certainly, Ukraine’s Environmental Protection Minister, Ruslan Strilets, displayed the necessary ambition when he spoke after the UN Climate Change Conference (COP28) in Dubai in late 2023. He reiterated earlier government statements from 2021 and committed Ukraine to launching a pilot emissions trading system in 2025 with a full launch in 2026. This would enable Ukraine’s entry into the ETS, and thus avoid negative effects of the EU’s Carbon Border Adjustment Mechanism (CBAM) for Ukrainian exports. This is a timetable that necessitates immediate and sizable climate investments in Ukraine.

Ukraine has further committed itself in recent months to a significant scaling up of its already large nuclear power-generation capacity. The Ukrainian government has signed memoranda of understanding aiming at the construction of up to nine new power units using Westinghouse AP1000 technology. Just as the accelerated introduction of carbon pricing in Ukraine will be costly, construction of new nuclear power units, even if located at one of Ukraine’s existing nuclear plant facilities, will require large sums of capital investment upfront. The issue of upfront costs will similarly weigh on the broader issue of reconstruction of Ukraine, as more energy- efficient buildings will only gradually earn back the higher building and materials costs through lower long-term energy consumption.

Ukraine must be applauded for aiming to seize the opportunity to rebuild its energy sector and integrate it with the EU as quickly as possible. This follows the recommendations of several expert groups, including GMF’s earlier (2023) report on this issue, which called for rapid Ukrainian adoption of carbon pricing and highlighted the need to phase in EU-level building codes expeditiously. This paper will focus on the implications for both Ukraine and the EU of the Ukrainian government’s recent energy-sector choices. What do these plans require institutionally and financially to succeed, and how will they alter not only the Ukrainian but the entire EU energy sector in the process?