Pacific Northwest National Laboratory, Washington, D.C.
Published in the proceedings of the Industrial Energy Technology Conference, held April 17-18, 1996 in Houston, Texas.
The bulk of the energy efficiency market is in industry, for several reasons. Industry accounts for 60% of energy use in Ukraine (1). In recent years, industrial enterprises have felt increasing pressure to reduce their energy use: energy subsidies are disappearing and many enterprises are privatized or on the path to privatization, which means they can no longer rely on the state for general subsidies. Most industrial enterprises in Ukraine use energy very inefficiently because the cost of energy was never a limiting factor. Now, these enterprises see that energy is often their largest production cost, and they know they must reduce their energy use if they are to survive. Fortunately for them, their very inefficiency means that many of the most cost-effective energy efficiency opportunities remain; in other words, they have yet to pick the proverbial low-hanging fruit.
One might ask why enterprises ignore these cost-effective energy efficiency opportunities, given the rising energy costs. Part of the reason is that there are several barriers to energy efficiency and business overall in Ukraine, including high risk, the non-payments problem, lack of financing, and lack of infrastructure.
The risk of doing business is high in Ukraine. Laws governing business activities are not well developed and are constantly changing. For example, the laws on contracts do not adequately protect those entering into contracts or provide for sufficient recourse if contracts are broken. Securities law is similarly in its infancy in Ukraine. Inflation adds to the risk of doing business in Ukraine by making it difficult to set prices and predict future earnings.
Much of the risk in Ukraine is tied to the non-payments problem. Ukraine is experiencing a liquidity crisis: companies are often not paid, which forces them to default on their suppliers, thereby creating a cycle of debt and default. When working with individual Ukrainian enterprises, it is important to find out whether they are in good standing on their obligations and whether their customers have been paying them regularly. Obtaining this information of course adds to the transaction costs. Later I will suggest some ways of minimizing these added costs.
In part because of the high risk in Ukraine, financing is often scarce or prohibitively expensive. Ukraine does have private commercial banks, but they have not built up large capital bases yet, and they usually charge very high interest for short-term loans. Few foreign commercial banks operate in Ukraine, and those that do usually require extensive guarantees, in many cases above and beyond sovereign guarantees. International development banks and export credit agencies do offer financing. They usually prefer to finance large projects and require sovereign guarantees from the Ukrainian Government for most projects. For smaller projects, the best sources of financing are often cash payments from Ukrainian enterprises and counter-trade. Counter-trade is a form of trade in which, for example, a Ukrainian firm sells its goods abroad through a middle man and uses the hard currency earnings to purchase energy efficiency equipment.
Lack of infrastructure also makes doing business in Ukraine difficult. Communications lines are often faulty and scarce, particularly outside big cities. Traveling within the country can be time-consuming because of poor transportation links between cities. Likewise, shipping networks leave much to be desired. All these factors, directly or indirectly, add to the cost of doing business.
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The Ukrainian Center for Energy Efficiency and Ecology (ARENA-ECO) is one resource available to foreign companies interested in the Ukrainian energy efficiency market. ARENA-ECO can provide basic market data and certain marketing services free of charge and can help companies with more specific needs through individual contracts. For example, ARENA-ECO has introduced a U.S. energy service company (ESCO) to potential Ukrainian industrial clients. ARENA-ECO has conducted detailed market and industry scans for other private Western firms. The Center has also helped two U.S. companies in their negotiations and work in preparation to build Ukrainian manufacturing facilities for energy efficiency equipment.
Ukrainian engineering firms, research institutes, and business development/marketing companies can also assist foreign firms interested in the Ukrainian market. The Ukrainian Institute for Energy Savings Problems in Kiev is one such institute.
Foreign companies usually wait until they have established a successful business in Ukraine, before they consider expanding their operations in Ukraine. When they do expand, the logical step is often to establish a permanent office in Ukraine. While this involves financial commitment and risk, establishing a local presence is usually key to expanding one's customer base. Most Ukrainian enterprises prefer working with firms that employ Ukrainian salespeople and that have a local customer service or maintenance office.
Later, if business is truly going well in Ukraine, a foreign firm might consider more costly undertakings, such as opening multiple offices throughout the country or building a manufacturing facility in Ukraine. Very few foreign firms to date have undertaken such measures in Ukraine.
By developing business in stages, a company can reduce its risk and build its business based on its experience.
By focusing on enterprises with proportionally large energy costs, a company can help ensure that it is talking to potential customers with a need for energy efficiency products. The bottom line in making a sale in Ukraine, however, is convincing the enterprise's management. An enterprise with market-oriented management is more likely to grasp the need to reduce energy costs. In Ukrainian enterprises, the general director usually must approve all contract awards, so it is essential to meet with and persuade this individual. The plant's energy manager or chief of equipment operations may be able to lobby the general director on your behalf, so meeting with these individuals is also important.
Finally, the enterprise must be financially viable if sales and deals are to be secure. Getting a sense of an enterprise's financial standing early is important, so as not to waste time. Ukrainian partners will be indispensable in helping you assess this quickly. If you have other contacts in Ukraine, such as contacts in banks, industry, or government, they may be able to provide some feedback on whether a plant is worth pursuing based on its financial record. Within the Ukrainian Government, the Ministry of Economy, the State Committee on Energy Conservation, the Ministry of Finance and the Ukrainian Export-Import Bank can be very helpful. The Ministry of Industry, which owns most of the chemical and metallurgical plants in the country, generally does not provide objective information on its plants. Another source of information is an enterprise's track-record in paying other foreign suppliers; Ukrainian enterprise executives will usually be willing to tell you the names of other foreign firms with which they are working.
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Metallurgical, chemical and oil refining enterprises are likely to export their products and have hard currency earnings. In part because of the export earnings, these enterprises are more likely to be financially viable than the average Ukrainian enterprise. Enterprises in these industries also consume large quantities of energy because of the nature of their business. However, the management style of these enterprises in these sectors varies significantly. As a rule, an enterprise that is slated for privatization or is currently privatized is more likely to have a market-oriented management team than one that is protected from privatization and market forces.
The food processing and paper and pulp industries may also be good choices. The food processing industry accounts for almost 6% of Ukrainian exports (3). The financial position of this industry is better than most, although there are many exceptions to this rule. In general, energy does not account for the majority of production costs in food processing enterprises. Most food processing enterprises do not employ energy managers, however, so cost-effective opportunities for energy efficiency abound. The paper and pulp industry is very energy intensive, although it too consumes less energy per unit of output than Ukrainian metallurgical, chemical, and oil refining industries. The paper and pulp industry exports a large portion of its merchandise, and most of these exports are sold for money, not bartered, as is common with most Ukrainian exports. In 1994, paper and pulp industry's export sales equaled $130 million (3).
An example of an industry to avoid is the textile industry. Ukrainian textile companies are facing fierce competition from importers who can provide better quality products with more reliability. As a result, this industry is experiencing great financial difficulties.
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During the enterprise visits, the team met with the general directors, energy managers, heads of operations, chief accountants, financial officers, and marketing staff. The team talked to these enterprise staff about the markets, exports, sales volume, products, marketing strategies, indebtedness, energy use, and process lines of their enterprises, as well as, their interest in energy efficiency. The team also tried to get a sense of the management's vision, style and understanding of market economics through these discussions. The team was looking for enterprises that used large amounts of energy, were financially viable, had export earnings, and were interested in energy efficiency. Of the seven enterprises visited, the team felt that four would be good sites for large energy efficiency projects. These include Krivorozhstal, a steel plant in central Ukraine; Dniprovsky Metallurgical Plant, also in central Ukraine; and Lisichansk Oil Refinery and the Severodonetsk Chemical Plant, both of which are in eastern Ukraine.
Since then, PNNL has promoted these projects with several banks and U.S. companies. The European Bank for Reconstruction and Development has indicated that it would like to finance energy efficiency projects at most of these plants if feasibility studies are positive.
A more detailed description of Krivorozhstal provides a better understanding of the potential opportunities in Ukraine. Krivorozhstal is one of the largest metallurgical plants in Ukraine. The enterprise employs 25,000, produces 10% of all metallurgical output of the former Soviet Union and 25% of Ukrainian output. The plant has two blast furnace workshops with nine furnaces, one open-hearth furnace, three steel cast workshops and ten rolling mills. Krivorozhstal's main products include wire, semi-finished pipe, structural steel and small, shaped steel. The plant is undergoing a major modernization.
Krivorozhstal is currently state-owned, although it is scheduled to be privatized. The enterprise exports about half its products. Krivorozhstal's largest foreign markets are the former Soviet republics, China, the Middle East, Turkey and Central Europe. Products generating the largest sales revenues are structural steel and cast iron.
The management at Krivorozhstal is relatively progressive. The energy manager, for example, fully understands the need for energy efficiency. The general director and chief engineer are not quite as firm believers in energy efficiency, but they do understand markets and the need to expand their customer base. The modernization program is one example of this; the enterprise's efforts to boost exports is another.
Because of the economic downturn and the high cost of energy, Krivorozhstal is now operating at about 50% of capacity. The chart below describes its electricity and gas consumption:
| Percent of Capacity | Electricity | Natural Gas |
| 50 | 250 MW/hour | 170,000 |
| 100 | 450 MW/hour | 250.000 |
Besides electricity and natural gas, the enterprise uses fuel oil, coke, coke gas, and blast furnace gas. Raw materials and energy account for about 85% of total current production costs.
The plant has many energy efficiency opportunities. For example, 90% of the electricity is used for drive power, primarily in the plant's 60,000 motors. These motors are very old. The plant has very few variable speed drive motors, although most of the motors need to operate only a fraction of the time. Likewise, the plant has about 250 km of aboveground steam pipes. Most of these pipes are not insulated or are very poorly insulated. To make matters worse, these steam lines have very few steam traps. In general, Ukrainian and Russian steam traps are of very poor quality, so energy managers try to minimize their use. Overall, the most cost-effective energy efficiency measures at the plant would likely be installation of high-quality steam pipe insulation, steam traps, variable speed drives, and boiler controls.
While the management at Krivorozhstal has not done much in the past to improve the plant's energy efficiency, it is now interested in efficiency. This is primarily because of the potential cost savings that will improve the plant's competitive position as it moves toward a market environment. Most likely, Krivorozhstal would purchase energy efficiency equipment with sales from its exports, although it would also be interested in barter. Furthermore, the enterprise has a capital investment fund that it could use to pay for energy efficiency investments (2). In the past, most Ukrainian enterprises maintained such funds, but with the economic downturn, these funds have been drawn upon to meet other expenses. Thus, the existence of a capital investment fund at Krivorozhstal is one indication of its relatively good financial health.
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2. Evans, M., J.W. Currie, N.V. Raptsoun, J.D. Duane, K.E. Nelson. Energy Efficiency Business Opportunities in Ukraine: A Report on the Mission of the U.S.-Ukrainian Expert Working Group on Energy Efficiency Options for Closing the Chernobyl Reactors, October 17 to November 18, 1994, Washington, D.C.: Pacific Northwest Laboratory, 1994.
3. Ministerstvo Statistiki Ukrajiny. Ukrajina v tsifrakh u 1994 rotsi, Kiev: Tekhnika, 1995, p. 133.
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