Ukraine: Energy insecurity creates opportunities

02 October 2017

Fighting in eastern Ukraine has largely stabilised along a line of contact in Donetsk and Luhansk, although foreign firms will continue to face terrorism risks associated with the conflict throughout the country. Energy insecurity caused by the conflict will create investment opportunities in Ukraine’s renewables sector, as the government seeks to diversify away from coal.

Security Environment

Intermittent fighting between the Ukrainian military and separatist forces continues in eastern Ukraine, despite the signing of the Minsk II ceasefire agreement in February 2015. Violence is now concentrated along a stable line of contact between the two sides in the separatist Donetsk and Luhansk regions. Fighting largely involves small arms, grenades and mortars, although on occasion it escalates to include heavy artillery. 

Despite calls from both Ukraine and Russia in September 2017 for the deployment of a peace keeping mission to eastern Ukraine, this is unlikely in the one-year outlook due to the lengthy negotiations that will be required to reach a mutually acceptable agreement. Commercial operations in eastern Ukraine will face a significantly elevated risk of property damage, death and injury in the medium term.

Firms operating outside the conflict zone will be largely insulated from these risks, although terrorist attacks linked to the conflict may occur in Kharkiv, Odessa and Kiev. Incidents by anti-government forces usually involve grenades and/or improvised explosive devices and target government assets and infrastructure. 

In June 2017, a military intelligence officer was killed by a car bomb in Kiev. Protest risks will be elevated in Kiev in the 12-month outlook, with regular demonstrations staged by ultranationalist groups and pro-Russian activists. Both sides may use firearms and Molotov cocktails in resultant clashes, elevating death and injury risks for bystanders. At least 48 people died in such fighting on 2 May 2014.

Trading Environment

Ukraine’s sovereign credit position remains precarious, given its elevated debt burden and widening fiscal deficit. Public debt is forecasted at 86.3% of GDP in 2017, whilst the budget deficit is forecasted to reach 3.3% of GDP in 2017, from 2.8% in 2016. Ukraine is also exposed to exchange rate risks, as two-thirds of debt is foreign currency denominated. The imposition of a trade blockade with the Donbas region will also drive the current account deficit higher, which will reach 4.4% in 2017. This will weigh on Ukraine’s foreign currency reserves, which were equivalent to just 3.5 months of imports in April 2017. 

Despite downside risks, a default is unlikely in the short term. Just USD 1.51 billion of interest payments are due in 2017 and 2018, whilst a successful bond issuance in September 2017 has eased redemptions of state-owned enterprise debt in 2019 and 2020. Moreover, if Ukraine continues to implement economic reforms under the terms of its International Monetary Fund (IMF) Extended Fund Facility, it should be able to maintain investor confidence beyond 2018, facilitating the rollover of debt. Any stalling of reforms or escalating conflict in Donbas would significantly hamper this outlook.

Investment Environment

Ukraine’s current reliance on the IMF and Western financial support should mitigate expropriation risks for foreign investors across all sectors in the medium term. However, Russian companies and firms associated with the previous Party of Regions government, which was ousted in 2014, will face elevated risks. In April 2017, USD 1.5 billion of former President Victor Yanokovych’s assets was transferred to the state. Assets located in Ukraine’s Donetsk and Luhansk regions will also face a significantly elevated risk of expropriation by the separatist governments.

Muted consumption growth, infrastructure damage in the East and disrupted coal imports following the trade blockade will weigh on the medium term outlook for Ukraine’s power sector. However, energy insecurity caused by the conflict will also drive efforts to diversify the energy mix away from coal and gas. This will create investment opportunities in the non-hydropower renewables sector, which is expected to grow by 4.5% in 2017. Amendments to feed in tariff rules in 2015 removed local content requirements and structured payments in euros, supporting investor interest. Forty-four applications were received for the contract to construct a number of solar parks in the Chernobyl exclusion zone, with French-firm Engie reportedly in talks with the Ukrainian government to participate in a USD 969 million solar facility.

Ukraine: Energy insecurity creates opportunities in renewables

** There is limited appetite on the Ukraine with some underwriters completely closed. The Ukraine will be considered on a case-by-case basis. Full political violence and terrorism and sabotage pricing assumes assets are not located in the conflict zone or separatist regions.

In this month's Risk Outlook, we also provide a detailed forward looking assessment of developments within the security, trading and investment environments for China, Myanmar, Mexico and Democratic Republic of Congo, all of which have been the subject of recent enquiries from JLT's client base.

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