President of VR Capital Group: We would not have made investments if we had not firmly believed in Ukraine
Exclusive interview for the Interfax – Ukraine agency with the Managing partner of ICU financial group Makar Paseniuk and VR Capital Group (USA) President Richard Deitz about joint projects in alternative energy.
When did ICU begin its cooperation with VR Capital Group in international financing and why did you decide to jointly invest in “green energy”?
Makar Paseniuk: I’ve known Richard since 1999 when I worked at ING Bank, around the same time that he founded VR Capital Group. Our first project together was a restructuring of Ukraine’s sovereign debt. Since then, our paths have crossed frequently over the years as co-investors in various financial instruments.
We started analyzing opportunities in alternative energy independently. Given the current state of our financial markets, ICU has been looking for opportunities to invest in the sector for some time.
It is our strong belief that the future lies with alternative energy. In my view, current conditions are ripe for attracting investment into green energy with the support from the state to help a transition to more sustainable energy sources.
Ukraine signed the Paris climate agreement, committing the country to a series of emission reduction goals. Following this, the Cabinet of Ministers adopted a new energy strategy for the country which reaches out to 2035 and assigns a significant role to alternative energy. For this reason, there’s no doubt about the promising prospects for investment in renewable energy.
We believe this is the right strategy for the country because currently 65% of Ukraine’s energy is generated from imported resources – coal, gas and nuclear fuel. The development of alternative energy sources will put the country on a self-sufficiency path and, in the medium-term, will help reduce energy costs.
Tell us about your joint projects.
Richard Deitz: We currently have three joint projects at various stages of implementation. The first is the Kamianets-Podilsk solar power plant with a capacity of 64MW (with Podilskenergo as the managing company) which we opened on the 19th of March. Investment in the company was approximately $55 million, and the plant will enable CO2 emissions to be reduced by 67,000 tonnes a year.
The second project is a solar power plant with a capacity of 35 MW in Kherson region. It’s also completed and will begin operating in the near future.
We will soon complete a third, decentralized project consisting of 11 medium size plants in the Mykolaiv region. Total peak capacity will be about 127 MW.
In total, the combined capacity of these three projects is 225 MW, and the total investment stands at $180 million.
What are your impressions about the results of the implementation of the first “green” projects in Ukraine?
Richard Deitz: I would say that the projects have been very successful. So far, we have completed the Kamianets-Podilsk only. All stages of the construction went smoothly. There has been none of the challenges which traditionally raise investors’ concerns, such as, for instance, timely customs clearance of imported equipment and VAT refunds. The contractors delivered on schedule, we received regular reports at all stages of construction. Today, I can conclude that everything was also done at a sufficiently high level as far as the quality of construction is concerned. Of course, only time will tell because the service life of the equipment is 20-25 years.
Makar Paseniuk: I was also impressed how smoothly all the work was carried out, beginning with the import of the panels and ending with the construction. Two leading Ukrainian EPC companies were employed: KNESS and Rodina-Enerparc AG. Together with our colleagues from VR Capital Group, we were quite vigilant about controlling the quality of the work.
Did you have any problems connecting the plants to the power grid?
Makar Paseniuk: Everyone understands that the connection situation depends on the network load in a specific region. In the Khmelnitsky region, there are generally no connection difficulties; all the tasks for which the operator of the distribution grid and the NPC Ukrenergo were responsible were carried out and within both the agreed timeframe and limits of the initially approved budgets.
In the Kherson region, the situation is more complicated and work is still under way. Ideally, it would make sense for us to build up to 300 MW there, but this not feasible at the moment due to the connection restrictions. That is why we are building only 35MW on such a large plot.
There are also limitations on the capacity for the Mykolaiv region but fortunately there were no problems connecting with the volumes we requested.
I think that the situation with non-standard connections to the grid will generally improve this year. This is partly due to policy decisions by the National Commission for State Regulation of Energy and Public Utilities at the end of 2018 should make the non-standard connection process more seamless in going forward.
At the beginning of the year the Antimonopoly Committee allowed VR Capital Group to acquire three Ukrainian projects from the Cypriot Volterra Energy Group…
Richard Deitz: Yes, in addition to ICU, we cooperate with other Ukrainian partners, in particular the Volterra Energy Group. We have already built about 20 MW with them.
So far, we’re only talking about the development of solar power, but to what extent are you interested in other areas of renewable energy?
Richard Deitz: As a matter of fact, we first started with looking at wind energy projects in the Ukrainian market. We decided to switch our focus to solar power as these facilities looked more feasible then. However, we continue to consider wind projects, and we hope we will be able to build a wind power plant in Ukraine in the near future.
Strategy of VR Capital Group as regards its presence on the Ukrainian market of renewable energy sources - partnership?
Richard Deitz: All our work in alternative energy in Ukraine has been carried out with local partners. These partnerships make sense when we enter a market; local companies have a better understanding of the country, the industry and are better positioned to deal with the challenges that come up, and this is a big bonus for us. We either work as 50%-50% partners, as has been the case ICU, or seek a controlling interest in the project. We plan to follow the same strategy in wind power projects.
What are your future investment plans?
Richard Deitz: As with any other infrastructure project, investments in alternative energy are long-term. We simply would not invest had we not had a strong belief in Ukraine and in its reforms program for the future.
Our primary goal is to form a solar power projects portfolio with ICU and manage it throughout life of the power plants.
In the past two years, activity in renewable energy and especially in solar power has spiked. How do you assess the risks of a retrospective reduction in the “green tariff”? Do you anticipate the adoption of a law on “green” auctions concerning future investment?
Richard Deitz: We fully support the idea of a new law - the introduction of a new pricing system for renewable energy. I believe that the current «green» tariff has been set up to stimulate the development of the sector and it has fulfilled its purpose. It helped launch the market and brought in initial investments. But such a system cannot last forever, especially as technology gets cheaper and the market becomes more competitive. We believe that the new auction-based pricing system is a step in the right direction for Ukraine. We expect it to be adopted and signed into law.
In my opinion, the implementation of the tariff will not preclude investments. I predict that after the introduction of green auctions, the market for renewable energy will remain competitive, and we will complete additional investment projects.
At the same time, we think a potential retrospective reduction of the «green» tariff would be a huge mistake. Reforms should take place within the framework of the law. And this means that the rules established in due course cannot be changed retroactively.
We are in close touch with the Ukrainian authorities – both members of the Parliament and the Government – as well as the international financial institutions. We know first-hand that practically no one in Ukraine supports this kind of reduction today.
Everyone understands that such a decision would dramatically worsen the investment climate in the country. Therefore, we do not expect this to happen, but naturally we consider it a risk.
Makar Paseniuk: The current efforts to develop renewable energy in Ukraine represent the first large-scale national project to create an investment product of this sort. In 2014-2018, we had gone through a tremendously difficult political and economic period, and this resulted in investors largely steering clear of Ukraine. Even in such adverse environment, we still saw some $2.4 billion invested in renewable energy over the past five years. But in 2019 alone, we expect another $2 billion flow into the sector.
We are seeing global multinationals coming to invest in Ukraine and bringing with them large amounts of capital, the likes of Total, NBT, Scatec Solar, Acciona Energia, Akuo Energy and others.
Therefore, I think it would be extremely damaging to change the state policy to renege the initial terms, especially after the investments have been made. This would also affect Ukraine’s emission reduction commitments under the Paris accords. Moreover, this would deter future investments as the creditors of green projects include international financial institutions such as the EBRD, which last year alone invested around $300 million in the sector, the European Investment Bank, and European state and private investment funds.
Breaking agreements is wrong both from a strategic perspective and for other reasons - from the point of view of observing the rule of law and building the image of Ukraine as a reliable and trustworthy partner. Going this way stalls investment, the main driver of economic growth in the existing fiscal conditions.
Furthermore, this could destabilize the banking sector. Ukrainian banks actively lend against renewable projects as these projects offer strong cash flows and a low credit risk. Alternative energy accounts for about 3.5% of the total loan portfolio of Ukrainian banks, about $1.1 billion in total. The level of overdue payments is one of the lowest and 100% of the portfolio is in hard currency. And this, among other things, allows banks to pay a higher deposit rate.
Is ICU open to other investors partnering with you to build the household waste recycling plant in Ukraine?
Makar Paseniuk: The technology needs to be rolled out before it is offered for joint investment. MBO-T – the mechanical, biological and thermal treatment and processing of solid municipal waste – is a state-of-the-art technology that is new to Ukraine. We need to first finish the plant that we are building in Zhytomyr, and then we will be able to offer this as model for potential joint investment.
We expect to get the plant going by the end of this year, and we will be able to draw some conclusions from the results only at the end of 2020. This is a rather dynamic business, affected by a multitude of factors. First, however, it is necessary to see how the technology works, especially from a risk management point of view.
We still have to “do our homework”, learn from our mistakes and only then invite partners to join us. Still, I consider the municipal waste sector to be exciting and very promising.
What opportunities do you see for opening a wholesale electricity market that is scheduled for July this year?
Richard Deitz: We are waiting for the liberalization of the market to see how this will play out. For now, we are studying related areas, including energy storage. This is a promising space for the industry and for us.
When we have a solid reserve of renewable energy capacity, and especially if they include not only solar power but also wind power, I think we will begin actively considering other segments within renewables.
And finally, in light of the upcoming presidential and parliamentary elections in Ukraine, I would like to ask: How do you assess the political risks from the perspective of a foreign investor?
Richard Deitz: As with any investor, we have some fears about the elections. Understandably, we take risks like these into account before making an investment decision. But for us, the main thing is that, regardless of who comes to power, Ukraine maintains a course targeted at developing the economy and becoming a developed country. In the current situation, it seems to us that the risk of this direction being changed is very small.