Ukraine could potentially join the EU carbon market in 12 years by following the EU’s experience

14/ 09/ 2023

Representatives of the business and industry experts discussed this on September 12 during the event of the Committee on Industrial Ecology and Sustainable Development of the European Business Association, European Experience for Implementing ETS in Ukraine. Stanislav Zinchenko. Director of GMK Center, Chairman of the Committee on Industrial Ecology and Sustainable Development of the European Business Association. The integration of the Ukrainian economy into the EU is essential for us primarily to access markets - energy, cement, agriculture, and steel. The carbon emissions trading system is one such market. Companies purchase emissions quotas on this market, allowing them to conduct their economic activities and providing incentives for decarbonization. For Ukraine, this issue is even more relevant not only because it is a mandatory requirement under the Association Agreement with the EU but also because, in the conditions of port blockades, creating value chains and getting closer to the EU is our only way forward. This means we should adapt to European regulations and become full-fledged players. The European Business Association has taken the lead in this matter because the EBAs member companies share the same values as businesses in the EU - they do everything possible to combat climate change, thrive on sustainable development, and implement eco-modernization projects. Thats precisely why the study on the concept of the ETS in Ukraine was created, noted Stanislav Zinchenko, Director of GMK Center and Chairman of the Committee on Industrial Ecology and Sustainable Development of the European Business Association, in his opening remarks. European experience is crucial in building Ukraines ETS since Ukraine aims to join the European Union. For instance, Andrii Glushchenko, an analyst at GMK Center, highlighted the main elements of the EU ETS and explained how the system works. Enterprises participating in the ETS must transfer to a dedicated account a quantity of allowances that fully cover their CO2 emissions for the reporting year. Some allowances may be allocated to companies free of charge if this is provided for by the current rules. The remaining allowances have to be purchased on the primary or secondary market. On the primary market, allowances can be obtained through auctions conducted on behalf of the state. On the secondary market, companies can acquire allowances from other enterprises, for example, if they have surplus allowances. Transactions on the primary and secondary markets precisely determine the price of CO2, which, unlike a carbon tax, is not fixed and is purely determined by the market. At the same time, as Mr. Glushchenko pointed out, carbon pricing addresses only one barrier to the adoption of low-carbon products - their high cost. Increasing the prices of traditional carbon-intensive products, in turn, enhances the competitiveness of low-carbon products. However, other barriers, such as technological and investment barriers, cannot be resolved solely by raising the price of CO2 emissions. Andrii Glushchenko. Analyst at GMK Center. According to the World Bank, the application of carbon pricing alone is unlikely to promote increased investments in decarbonization. Therefore, as we can see, the EU ETS is a central element of the EU′s climate policy, but it is complemented by other tools such as grants, subsidies, investments, trade protection, etc. In general, it′s a complex system of measures that requires ongoing regulatory activity. This is entirely expected and normal. We need to prepare to operate within such a framework of climate initiatives. As we understand it, it won′t be possible to establish a consistent climate policy in Ukraine based solely on the current carbon tax. From this perspective, European experience is important for us, as it can help Ukraine adopt the best climate practices. The post-war economic reboot of Ukraine must exclusively be based on a green transition. This is as crucial for the countrys security as its military and geopolitical considerations. Carbon emissions trading, as a central element of climate policy, plays a pivotal role in the successful implementation of green recovery. Considering the prospects of Euro-integration, Ukraines ETS should closely align with the architecture of the EU ETS while taking into account Ukraines specific characteristics. These include a high carbon intensity of production, export orientation, a lack of domestic financial resources for decarbonization, limited access to low-carbon project financing instruments, institutional immaturity, corruption risks, and the impact of war, including the constantly increasing losses, unstable energy system operation, and limited access to affordable low-carbon electricity. These factors form the basis of the concept of ETS in Ukraine, as presented by Olga Boiko, Coordinator of the Committee on Industrial Ecology and Sustainable Development of the European Business Association. The overall transition period to align with the EUs ETS can take place over 12 years. This is even faster than European practice; the EU took 17 years to reach its current model, and changes are still ongoing. Ukraine should take into account the EUs experience, particularly regarding the prerequisites for developing the ETS concept. This includes having a working system for monitoring, reporting, and verification of greenhouse gas emissions (MRV) in place for three years, as well as Ukraines climate goal within its Third National Determined Contribution to the Paris Agreement (NDC-3). Its also essential to maintain a three-stage approach, starting with a test period dedicated to refining procedures and studying the functioning of the market and market processes. The next stage involves targeting an economically justified price for CO2 emissions, taking into account the participants ETS carbon payments based on their emission levels. The final stage is a gradual transition to European price levels to avoid economic shocks from a sudden rise in CO2 prices. Olga Boiko. Industrial Ecology and Sustainable Development Committee Coordinator. The EU ETS is aimed at reducing carbon emissions in an economically efficient manner. The emissions reduction goals in Ukraine should align with the objectives of economic growth and post-war recovery. This is precisely why the primary goal of the ETS in Ukraine should be the adaptation of the Ukrainian economy to integration into the European economic space and future accession to the EU ETS. This also includes transitioning to European prices for CO2 emissions, which is why adaptation is necessary. It′s essential to establish the appropriate governance institutions and learn how to operate under these conditions. Emissions reduction serves as both a prerequisite and a consequence of successful adaptation. It′s a kind of balance. The ETS should create conditions for economic growth and incentives for emissions reduction. The need to develop and adopt the Law on the Ukrainian ETS was emphasized by Natalia Kushko, a senior expert at the European Roundtable on Climate Change and Sustainable Transition (ERCST). She particularly emphasized the importance of defining the competent authorities responsible for shaping ETS policy and implementing it, as well as the functioning of the registry and its administration. As Ms. Kushko mentioned, there is currently no such registry in Ukraine. Natalia Kushko. Senior expert at the European Roundtable on Climate Change and Sustainable Transition (ERCST). Look at the experience of the MRV registry. It still doesn′t function, even though it should be super simple, a basic and straightforward algorithm. In other words, we understand the complexity of this issue. Moreover, this registry should interact with Ukraine′s reporting under the Paris Agreement, comply with the requirements of Article 6 of the Paris Agreement, and potentially align with the new ETS within the Energy Community framework. After all, in the future, we might have to deal with an international carbon bank and market. Maryna Denysiuk, Senior Project Manager at the Office of Reforms of the Cabinet of Ministers of Ukraine, emphasized the need to develop and approve a corresponding roadmap at the government level as quickly as possible to meet the proposed deadlines for implementing the ETS. This roadmap will help assess the necessary resources, allocate responsibilities, and determine whether there is a need to create an additional authority for administering the ETS. It will also serve as a signal to our international partners, including in terms of securing funding for post-pollution recovery efforts. Within the framework of the Ukrainian Facility (a program to support financing Ukraines recovery needs amounting to 50 billion euros for 2024-2027, allocated by the European Commission), this aspect is currently not addressed. Maryna Denysiuk. Senior Project Manager at the Office of Reforms of the Cabinet of Ministers of Ukraine. However, considering that the Ukrainian ETS will not be able to accumulate sufficient funds for industrial decarbonization, the Ukrainian Facility could be beneficial. It is developing a tool for interaction between the Ukrainian and European budgets regarding partner contributions. This will serve as a good example. If the tool becomes operational for Ukraine on January 1, 2024, we will see how such co-financing works in practice. However, a full understanding of how this mechanism operates will only emerge after the first quarter, particularly in terms of meeting conditions and actual receipt of funds. Afterward, we can proceed to create green funds and utilize them. Pavlo Masiukov. . The introduction of the ETS should be gradual and start with a pilot phase, incorporating specific flexibilities that we can borrow from the EU′s example in the years 2005-2007. However, we should avoid replicating the entire process and making the same mistakes. It′s essential to retrospectively examine all elements of the ETS design and their modification. Mr. Masiukov also pointed out the need to clarify what is meant by joining the EU ETS. Does it refer to becoming part of the EU ETS or linking with the EU ETS, allowing for the existence of a national ETS that would be accepted by the EU, similar to Switzerlands case? This is an intermediate option, especially if the EU accession process is lengthy. Additionally, Mr. Masiukov discussed the scope of coverage of the ETS in Ukraine. According to him, the MRV in Ukraine, as a preparatory stage for gathering baseline emissions data before implementing the ETS, covers 10 sectors of activity. In the EU ETS, there are 30 sectors of activity. This means that 20 sectors do not properly collect such information, partly because not all of them are present in Ukraine; for example, we dont have carbon capture and storage. However, some sectors are present but are somehow not covered by the current MRV system in Ukraine. Moreover, emissions data collection in Ukraine started in the pre-war year 2021 and continued during wartime, which is not the traditional approach. Therefore, an estimated approach to establishing emission values may also be necessary. Volodymyr Buzhan, Head of the Energy and Climate Department at the Economic Recovery Center, drew attention to how the war and the energy crisis revealed the unpreparedness of the EU and the EU ETS for economic shocks. We witnessed the shutdown of cement and metallurgical production in various European countries and a 13% increase in coal usage in the energy mix. This had an impact on ordinary consumers and required the EU to employ unprecedented measures to support the population and industry. Additionally, the EU is tightening reporting requirements for companies with a significant presence in the EU in terms of CO2 emissions. Volodymyr Buzhan. Head of the Energy and Climate Department at the Economic Recovery Center. Therefore, the thesis about the possibility of forming a global ETS is likely, as voluntary markets already exist. If Ukraine delays the establishment of an ETS, companies may join such markets to justify their contributions to emissions reduction and the impacts of mechanisms like carbon offset projects. He also noted that the effectiveness of the EU ETS is determined by the targeted direction of funds received within the framework of the ETS. Besides decarbonization itself, attention should be paid to the social consequences of green transformation. In the EU from 2005 to 2018, the industrial sector reduced its emissions by 1%, while the energy sector reduced emissions by 22%, partly due to a significant reduction in quotas for coal generation. During the second phase of the EU ETS, additional cost burdens on households in Romania and Bulgaria were 18%, while in France and Germany, they were 31%. This is why, in the recovery process, Ukraine needs to ensure that the industry gains access to the funds that will be accumulated. Additionally, addressing social risks resulting from coal transformation, the closure of certain industries, and the creation of new ones with fewer employees is crucial, Mr. Buzhan cautioned. Regarding institutional capacity, Mr. Buzhan subscribes to the idea that policy development can be carried out by the Ministry of Environmental Protection and Natural Resources, while the actual implementation could be entrusted to the Ministry of Economy. Maksym Fedoseienko. Head of Strategic Projects at the KSE Institute. Due to its broader coverage and base, the ETS will have a more significant impact on the economy than even carbon offset projects, which, by our estimates, will amount to 500-700 million euros per year. In the ETS, we need to strike a balance that, on one hand, supports industry and, on the other hand, encourages industry to decarbonize and adopt green technologies. As an example from Europe, we should consider what incentives can be provided during the pilot period for the industry to facilitate decarbonization. This system must be transparent so that investors can calculate all the metrics that will subsequently affect project profitability and, as a result, the choice of technologies. In general, the most debated issues revolved around institutional capacity, while experts reached a consensus that the ETS in Ukraine should be implemented gradually and linked to economic indicators to prevent the burden from falling on the population.

Stanislav Zinchenko Director of GMK Center, Chairman of the Committee on Industrial Ecology and Sustainable Development of the European Business Association

The integration of the Ukrainian economy into the EU is essential for us primarily to access markets - energy, cement, agriculture, and steel. The carbon emissions trading system is one such market. Companies purchase emissions quotas on this market, allowing them to conduct their economic activities and providing incentives for decarbonization. For Ukraine, this issue is even more relevant not only because it is a mandatory requirement under the Association Agreement with the EU but also because, in the conditions of port blockades, creating value chains and getting closer to the EU is our only way forward.

“This means we should adapt to European regulations and become full-fledged players. The European Business Association has taken the lead in this matter because the EBA’s member companies share the same values as businesses in the EU – they do everything possible to combat climate change, thrive on sustainable development, and implement eco-modernization projects. That’s precisely why the study on the concept of the ETS in Ukraine was created,” noted Stanislav Zinchenko, Director of GMK Center and Chairman of the Committee on Industrial Ecology and Sustainable Development of the European Business Association, in his opening remarks.

European experience is crucial in building Ukraine’s ETS since Ukraine aims to join the European Union. For instance, Andrii Glushchenko, an analyst at GMK Center, highlighted the main elements of the EU ETS and explained how the system works. Enterprises participating in the ETS must transfer to a dedicated account a quantity of allowances that fully cover their CO2 emissions for the reporting year. Some allowances may be allocated to companies free of charge if this is provided for by the current rules. The remaining allowances have to be purchased on the primary or secondary market. On the primary market, allowances can be obtained through auctions conducted on behalf of the state. On the secondary market, companies can acquire allowances from other enterprises, for example, if they have surplus allowances. Transactions on the primary and secondary markets precisely determine the price of CO2, which, unlike a carbon tax, is not fixed and is purely determined by the market.

At the same time, as Mr. Glushchenko pointed out, carbon pricing addresses only one barrier to the adoption of low-carbon products – their high cost. Increasing the prices of traditional carbon-intensive products, in turn, enhances the competitiveness of low-carbon products. However, other barriers, such as technological and investment barriers, cannot be resolved solely by raising the price of CO2 emissions.

Andrii Glushchenko Analyst at GMK Center

According to the World Bank, the application of carbon pricing alone is unlikely to promote increased investments in decarbonization. Therefore, as we can see, the EU ETS is a central element of the EU′s climate policy, but it is complemented by other tools such as grants, subsidies, investments, trade protection, etc. In general, it′s a complex system of measures that requires ongoing regulatory activity. This is entirely expected and normal. We need to prepare to operate within such a framework of climate initiatives. As we understand it, it won′t be possible to establish a consistent climate policy in Ukraine based solely on the current carbon tax. From this perspective, European experience is important for us, as it can help Ukraine adopt the best climate practices.

The post-war economic reboot of Ukraine must exclusively be based on a green transition. This is as crucial for the country’s security as its military and geopolitical considerations. Carbon emissions trading, as a central element of climate policy, plays a pivotal role in the successful implementation of green recovery. Considering the prospects of Euro-integration, Ukraine’s ETS should closely align with the architecture of the EU ETS while taking into account Ukraine’s specific characteristics. These include a high carbon intensity of production, export orientation, a lack of domestic financial resources for decarbonization, limited access to low-carbon project financing instruments, institutional immaturity, corruption risks, and the impact of war, including the constantly increasing losses, unstable energy system operation, and limited access to affordable low-carbon electricity. These factors form the basis of the concept of ETS in Ukraine, as presented by Olga Boiko, Coordinator of the Committee on Industrial Ecology and Sustainable Development of the European Business Association.

The overall transition period to align with the EU’s ETS can take place over 12 years. This is even faster than European practice; the EU took 17 years to reach its current model, and changes are still ongoing. Ukraine should take into account the EU’s experience, particularly regarding the prerequisites for developing the ETS concept. This includes having a working system for monitoring, reporting, and verification of greenhouse gas emissions (MRV) in place for three years, as well as Ukraine’s climate goal within its Third National Determined Contribution to the Paris Agreement (NDC-3). It’s also essential to maintain a three-stage approach, starting with a test period dedicated to refining procedures and studying the functioning of the market and market processes. The next stage involves targeting an economically justified price for CO2 emissions, taking into account the participants’ ETS carbon payments based on their emission levels. The final stage is a gradual transition to European price levels to avoid economic shocks from a sudden rise in CO2 prices.

Olga Boiko Industrial Ecology and Sustainable Development Committee Coordinator

The EU ETS is aimed at reducing carbon emissions in an economically efficient manner. The emissions reduction goals in Ukraine should align with the objectives of economic growth and post-war recovery. This is precisely why the primary goal of the ETS in Ukraine should be the adaptation of the Ukrainian economy to integration into the European economic space and future accession to the EU ETS. This also includes transitioning to European prices for CO2 emissions, which is why adaptation is necessary. It′s essential to establish the appropriate governance institutions and learn how to operate under these conditions. Emissions reduction serves as both a prerequisite and a consequence of successful adaptation. It′s a kind of balance. The ETS should create conditions for economic growth and incentives for emissions reduction.

The need to develop and adopt the Law on the Ukrainian ETS was emphasized by Natalia Kushko, a senior expert at the European Roundtable on Climate Change and Sustainable Transition (ERCST). She particularly emphasized the importance of defining the competent authorities responsible for shaping ETS policy and implementing it, as well as the functioning of the registry and its administration. As Ms. Kushko mentioned, there is currently no such registry in Ukraine.

Natalia Kushko Senior expert at the European Roundtable on Climate Change and Sustainable Transition (ERCST)

Look at the experience of the MRV registry. It still doesn′t function, even though it should be super simple, a basic and straightforward algorithm. In other words, we understand the complexity of this issue. Moreover, this registry should interact with Ukraine′s reporting under the Paris Agreement, comply with the requirements of Article 6 of the Paris Agreement, and potentially align with the new ETS within the Energy Community framework. After all, in the future, we might have to deal with an international carbon bank and market.

Maryna Denysiuk, Senior Project Manager at the Office of Reforms of the Cabinet of Ministers of Ukraine, emphasized the need to develop and approve a corresponding roadmap at the government level as quickly as possible to meet the proposed deadlines for implementing the ETS. This roadmap will help assess the necessary resources, allocate responsibilities, and determine whether there is a need to create an additional authority for administering the ETS. It will also serve as a signal to our international partners, including in terms of securing funding for post-pollution recovery efforts. Within the framework of the Ukrainian Facility (a program to support financing Ukraine’s recovery needs amounting to 50 billion euros for 2024-2027, allocated by the European Commission), this aspect is currently not addressed.

Maryna Denysiuk Senior Project Manager at the Office of Reforms of the Cabinet of Ministers of Ukraine

However, considering that the Ukrainian ETS will not be able to accumulate sufficient funds for industrial decarbonization, the Ukrainian Facility could be beneficial. It is developing a tool for interaction between the Ukrainian and European budgets regarding partner contributions. This will serve as a good example. If the tool becomes operational for Ukraine on January 1, 2024, we will see how such co-financing works in practice. However, a full understanding of how this mechanism operates will only emerge after the first quarter, particularly in terms of meeting conditions and actual receipt of funds. Afterward, we can proceed to create green funds and utilize them.

Pavlo Masiukov

The introduction of the ETS should be gradual and start with a pilot phase, incorporating specific flexibilities that we can borrow from the EU′s example in the years 2005-2007. However, we should avoid replicating the entire process and making the same mistakes. It′s essential to retrospectively examine all elements of the ETS design and their modification.

Mr. Masiukov also pointed out the need to clarify what is meant by “joining the EU ETS.” Does it refer to becoming part of the EU ETS or linking with the EU ETS, allowing for the existence of a national ETS that would be accepted by the EU, similar to Switzerland’s case? This is an intermediate option, especially if the EU accession process is lengthy.

Additionally, Mr. Masiukov discussed the scope of coverage of the ETS in Ukraine. According to him, the MRV in Ukraine, as a preparatory stage for gathering baseline emissions data before implementing the ETS, covers 10 sectors of activity. In the EU ETS, there are 30 sectors of activity. This means that 20 sectors do not properly collect such information, partly because not all of them are present in Ukraine; for example, we don’t have carbon capture and storage. However, some sectors are present but are somehow not covered by the current MRV system in Ukraine. Moreover, emissions data collection in Ukraine started in the pre-war year 2021 and continued during wartime, which is not the traditional approach. Therefore, an estimated approach to establishing emission values may also be necessary.

Volodymyr Buzhan, Head of the Energy and Climate Department at the Economic Recovery Center, drew attention to how the war and the energy crisis revealed the unpreparedness of the EU and the EU ETS for economic shocks. We witnessed the shutdown of cement and metallurgical production in various European countries and a 13% increase in coal usage in the energy mix. This had an impact on ordinary consumers and required the EU to employ unprecedented measures to support the population and industry. Additionally, the EU is tightening reporting requirements for companies with a significant presence in the EU in terms of CO2 emissions.

Volodymyr Buzhan Head of the Energy and Climate Department at the Economic Recovery Center

Therefore, the thesis about the possibility of forming a global ETS is likely, as voluntary markets already exist. If Ukraine delays the establishment of an ETS, companies may join such markets to justify their contributions to emissions reduction and the impacts of mechanisms like carbon offset projects.

He also noted that the effectiveness of the EU ETS is determined by the targeted direction of funds received within the framework of the ETS. Besides decarbonization itself, attention should be paid to the social consequences of green transformation. “In the EU from 2005 to 2018, the industrial sector reduced its emissions by 1%, while the energy sector reduced emissions by 22%, partly due to a significant reduction in quotas for coal generation. During the second phase of the EU ETS, additional cost burdens on households in Romania and Bulgaria were 18%, while in France and Germany, they were 31%. This is why, in the recovery process, Ukraine needs to ensure that the industry gains access to the funds that will be accumulated. Additionally, addressing social risks resulting from coal transformation, the closure of certain industries, and the creation of new ones with fewer employees is crucial,” Mr. Buzhan cautioned.

Regarding institutional capacity, Mr. Buzhan subscribes to the idea that policy development can be carried out by the Ministry of Environmental Protection and Natural Resources, while the actual implementation could be entrusted to the Ministry of Economy.

Maksym Fedoseienko Head of Strategic Projects at the KSE Institute

Due to its broader coverage and base, the ETS will have a more significant impact on the economy than even carbon offset projects, which, by our estimates, will amount to 500-700 million euros per year. In the ETS, we need to strike a balance that, on one hand, supports industry and, on the other hand, encourages industry to decarbonize and adopt green technologies. As an example from Europe, we should consider what incentives can be provided during the pilot period for the industry to facilitate decarbonization. This system must be transparent so that investors can calculate all the metrics that will subsequently affect project profitability and, as a result, the choice of technologies.

In general, the most debated issues revolved around institutional capacity, while experts reached a consensus that the ETS in Ukraine should be implemented gradually and linked to economic indicators to prevent the burden from falling on the population.