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Due to the widespread destruction caused by Russia’s war of aggression, Ukraine and its international partners face the daunting task of fully rebuilding the country. While estimates of the reconstruction cost vary and critically depend on the further course of the war, the World Bank estimated in February of 2024 that the total cost would amount to approximately $486 billion over the next 10 years1.
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 countries.2 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.
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. There is political momentum to turn this candidacy into full EU membership. 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.
Ukraine has already taken first steps towards carbon pricing. In 2019, the “MRV law” was passed to implement the EU-ETS methodology for monitoring, reporting, and verifying emissions. The current draft of the National Energy and Climate Plan for 2025 -2030 (NECP) envisages that the framework conditions for the UA ETS will “gradually approach the EU-ETS”. However, the relevant policy scenario of the NECP forecasts a revision of the rate and tax base that would result in a UA ETS price of €16/tCO2 by 2035 and €100 /tCO2 by 2050 – substantially lower than what would be required to integrate with the future EU-ETS price level.
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 0.7% of Ukraine’s pre-war GDP3. Iron and steel exports would account for more than 75% of total CBAM payments followed by electricity (about 10%) 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.
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.
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 a carbon price level of €50/tCO2.4 This is still below what would be required for full EU-ETS integration in terms of the official (statutory) carbon price but accounts for the effective financial burden as firms in the EU will still receive some EU-ETS allowances for free.5
With up to €11.5 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 7.5% 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 in 2022 and below 0.8% in Poland7, while the statutory 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.
Investors need predictability in carbon pricing and stability in climate policies to plan investments in green reconstruction. The time is now 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 needs to 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.
1 The World Bank, Rapid Damage and Needs Assessment (RDNA3), February 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.