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The policy framework for green reconstruction

Towards an EU-readiness of Ukraine's carbon pricing

The country faces a significant challenge of reconstructing its energy and industrial sectors, which the World Bank estimates will cost US $115 billion over the next decade. This reconstruction effort is compounded by the need for transformation toward a modern green asset base to thrive in a rapidly decarbonizing global economy. Carbon pricing will be important in guiding reconstruction investments to sustainable and future-proof assets and technologies. As Ukraine aims to join the European Union (EU), it should determine, negotiate, and communicate a credible convergence path toward integration into the EU Emissions Trading System (EU ETS), while Carbon Border Adjustment Mechanisms (CBAMs) – in particular, the EU CBAM – will provide additional incentives to decarbonize in the short term.

Deloitte Germany in cooperation with Deloitte France is providing its knowledge for the pivotal challenge of facilitating Ukraine's green reconstruction in collaboration with GIZ (German Agency For International Cooperation), which is implementing the “Capacities for Climate Action” (C4CA) project, and the Ukrainian Climate Office, commissioned by the German Federal Ministry for Economic Affairs and Climate Action (BMWK) under the International Climate Initiative (IKI) and co-financed by the European Union.

Joint study: A framework for green reconstruction. Toward EU-readiness of Ukraine's carbon pricing

 

 

Green reconstruction in the energy and industry sectors

 

Due to the widespread destruction caused by the war, Ukraine and its international partners face the daunting task of rebuilding the country. While estimates of the costs of reconstruction vary and critically depend on the future course of the war, a report jointly published by the World Bank, the Government of Ukraine, the United Nations, and the European Commission in February of 2024 estimated that the total cost of reconstructing Ukraine would amount to approximately US $486 billion over the next 10 years1.

Figure 1: Total estimated recovery and reconstruction needs by sector

Alongside the reconstruction, Ukraine faces a significant green transformation challenge. Ukraine’s pre-war industrial and energy sectors’ capital stock was highly energy-inefficient and dependent on fossil fuels, resulting in an economy-wide carbon intensity 4.5 times higher than the global average and more than 8 times higher than the average in European OECD countries2. Reconstructing with more efficient fossil-based technologies will not suffice. To maintain and enhance its competitiveness in a decarbonizing world, Ukraine needs a modern asset base using carbon neutral technologies and renewable energy.

Fossil-based products are facing shrinking global markets and penalization from instruments such as the EU-CBAM. As Ukraine’s Western trade partners transform their asset bases, rebuilding with fossil-based technologies that  have long amortization periods would leave the country with stranded assets. Although green reconstruction will be economically efficient in the long run due to market access, efficiency gains, and cost savings from renewable energies, it requires higher upfront investment costs.

Carbon pricing as key instrument for green investment

 

Ukraine’s aspiration for EU membership implies adopting carbon pricing as a primary instrument to incentivize green investment. As part of the EU accession process, Ukraine must implement relevant EU legislation, including the EU-ETS, a cap-and-trade system to price carbon emissions. Establishing a concrete path towards implementing the EU-ETS in Ukraine is required for the EU accession process and will help anchor investor’s expectations and hence guide their decisions towards green investments. 

In the near term, the EU Carbon Border Adjustment Mechanism (EU-CBAM) serves as an incentive to fast-track domestic carbon pricing in Ukraine. EU-CBAM is a duty on certain categories of fossil-based goods imports from countries without sufficient carbon pricing into the EU, ensuring a level playing-field. It will gradually reflect EU carbon prices on the embodied carbon-content of some Ukrainian exports beginning in 2026. 

How large would Ukraine’s CBAM payment obligation be without domestic carbon pricing?

 

In the hypothetical case that Ukraine does not establish an ETS, total payments of Ukrainian exporters to the EU could reach up to €1 bn (in 2021 prices) by 2030, about 0.5% of Ukraine’s pre-war GDP3. Iron and steel exports would account for more than 80% of total CBAM payments followed by electricity (about 8%) and cement and fertilizers (about 6% each). If derived based on the post-2021 export levels, the cost would be almost halved due to the sharp decline of exports, particularly for iron and steel. 

Figure 3: Annual gross financial CBAM burden for Ukraine with a €/50 per tCO2 effictive carbon price (representative of the 2030 horizon) and assuming full reconstruction of the pre-war economy, in € million

To avoid CBAM payments, Ukraine could implement a domestic carbon trading system, with revenues benefiting Ukraine’s budget. In contrast to CBAM, this domestic carbon pricing would however affect the entire output of these sectors, not only EU exports. 

Is a quick convergence to the EU-ETS feasible for Ukraine?

 

Estimating the financial burden of domestic carbon pricing on the Ukrainian economy involves considering ambitious policy scenarios of Ukrainian carbon prices in 2030 covering the same sectors as the EU-ETS with an effective price level of €50/tCO24. This is still below what would be required for full EU-ETS integration, as the market price level is expected to exceed €100/tCO2 by 20305.

Figure 5: Annual gross financial burden of ambitious carbon pricing for Ukraine by 2030 under full reconstruction of the pre-war economy, in Bn Euro

With up to €11.3 bn of carbon pricing payment, the upper-bound cost estimate would be a large burden on the Ukraine economy, with a direct impact for the power and industry sectors. This would equate to about 7.0% of Ukrainian pre-war GDP6, a very high impact compared to EU countries. In 2022, ETS revenues represented less than 0.25% of the EU GDP and below 0.8% in Poland7, while the market price of emissions allowances in the EU was about €80/tCO2.

Overall, such a policy scenario appears very ambitious, and full EU-readiness of Ukraine’s carbon pricing would be even more demanding. Given that Ukraine can realistically only phase in carbon pricing in substance after 2026, the described policy scenario would imply a very rapid increase in effective carbon prices. To fully integrate Ukraine into the EU-ETS by 2030 would require an even higher increase in carbon prices.

Considerations for Ukraine’s carbon pricing development

 

Investors need predictability in carbon pricing and stability in climate policies to plan investments in green reconstruction. It seems to be a good time to determine and negotiate a substantive carbon pricing trajectory for Ukraine. First, Ukraine should determine what is in its economic and strategic interest, using the results of this analysis and further modeling of the impact of a carbon price on investment decisions. This then could be negotiated with the EU to ensure the robustness and compatibility of the approach with EU accession.

If a smoother convergence path of Ukraine to the ETS price level is required, a special regime of more free allocations for Ukraine under the ETS could be negotiated. Ukraine will most likely have room to negotiate on this, given its particular situation and the increasingly ambitious carbon price. While multiple dimensions could be open, free allocations appear to be the most attractive option for Ukraine. Negotiating a convergence path for a later phase-out of free ETS allocations in Ukraine would allow Ukraine to fully participate in the ETS, applying the ETS price at the margin, while reducing the income effect on Ukrainian industry.

Download the report „A framework for green reconstruction. Toward EU-readiness of Ukraine’s carbon pricing” for more information.

1 World Bank Group: Ukraine - Third Rapid Damage and Needs Assessment (RDNA3): February 2022 – December 2023 (English), last access 09.10.2024.

2 United Nations Economic Commission for Europe (2023): Renewables could power almost 80% of Ukraine's economy by 2050, says UN report | UNECE, last access 05.06.2024.

3 The cost of CBAM is compared to the average of the average GDP level over the 2020-2021 period.

4 The price level is chosen to reflect the effective CO2 price for EU-CBAM sectors (slightly more than €100/tCO2 statutory price, slightly less than 50% effective CBAM charge that reflects the phase-down free allocations for CBAM goods).

5 Free allocations in the EU-ETS market reached about 41% of verified emissions in 2023, a share that will decrease by 2034 as the CBAM phases in.

6 The cost of CBAM is compared to the average of the average GDP level over the 2020-2021 period.

7 Computations based on data from the EEA ETS data hub and Eurostat.

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