BankTrack and the National Ecological Center of Ukraine today sent an investor alert to relevant financial institutions, bringing to their attention a number of issues related to the operations of Ukraine coal giant DTEK, which they may want to consider when engaging with the company on a debt restructuring proposal. The full text is below:

Dear Sir/Madam,

It is our understanding that Ukraine's biggest private power producer DTEK is currently trying to conclude a debt restructuring agreement with your bank and several other European banks, and is seeking a delay in the payment of most of the company's $3 billion debt. In light of this, we would like to bring to your attention a number of issues related to the way DTEK is operating, issues which we believe should be taken into account by your bank when discussing a new agreement with the company.

As you know, a significant part of DTEK's business comprises its activities in the coal sector. In 2013, DTEK controlled 53.8% of coal production in Ukraine and 38.3 per cent of the distribution and sales of electricity; it operates ten coal-fired power plants across Ukraine through three subsidiaries. The average age of DTEK operated thermal power plants (18.6 gigawatts in total) is now 45 years. The high operational costs of its power plants, their low energy efficiency and the increasing maintenance costs due to their ageing are contributing to the tight financial prospects for DTEK.

DTEK's financial situation has, of course, also become perilous as a result of the conflict situation which has affected eastern Ukraine since spring 2014, leading to a severe disruption of the shipment of coal by DTEK out of rebel-held eastern Ukraine.

DTEK's inability to comply with common EU environmental and business standards imposed by the EU Association agreement and Energy Community Treaty

As a state with ambitions to become an EU member state and to become a part of the emerging common energy market, Ukraine will be pressed to curb its pollution levels. Under the decisions of the Ministerial Council of the Energy Community, Ukraine is obliged to develop a National Emissions Reduction Plan by 1 January 2018, and to begin implementing it thereafter.

In the next 10-15 years the energy sector of Ukraine will have to face the decommissioning of 12 GW of coal capacity, this because of the EU's Industrial Emissions Directive (IED 2010/75/EC) and the EU's Large Combustion Plants Directive (LCPD 2001/80/EC), which Ukraine is now obliged to adhere to under the Energy Community Treaty and which calls for the closure of unmodernised, polluting units. This will further affect the operations of DTEK.

Furthermore, DTEK's operations are also out of step with EU norms relating to:

• market rules (fair competition and equal access to the grid, especially trans-boundary power lines for exports);
• energy rules (the requirement to unbundle and separate vertically integrated utilities' generation and sales operations from their transmission networks, to encourage fair competition).

Indeed, as regards market rules, in 2013 the Energy Community opened a formal dispute settlement procedure against Ukraine, which is effectively a case concerned with DTEK's monopoly on electricity exports from Ukraine to the EU. This dispute has not been resolved and the procedure is ongoing. As for energy rules, specifically the EU's 'Third Energy Package', a large vertically integrated utility such as DTEK will be fully affected and have to comply with the requirements.

How DTEK's coal activities are adversely impacting the environment

Emission levels per kWh of electricity produced in Ukraine are much higher than in the EU due to the low efficiency of the country's power plants and inadequate equipment for pollution control. None of the coal-fired power plants operated by DTEK has primary pollution control for sulphur (SOx) or nitrogen oxide (NOx) and at some DTEK power plants dust emissions are more than 50 times above the limits stipulated by EU regulations.

None of these plants would be allowed to operate in any EU country because of their emissions, or they would have a strict deadline for closure, as happened with the Varna power plant in Bulgaria which was closed down on 1 January 2015 due to non-compliance with EU environmental regulations.

Moreover, between 2010 and 2013, DTEK strategically increased its coal production and power generation. This included DTEK's acquisition of two coal-fired power plants in western Ukraine (Burstyn and Dobrotvir) and a significant increase in their output, allowing increased electricity exports to Ukraine's neighbours Hungary, Slovakia, Romania and Poland. However, the cheap electricity from Burstyn and Dobrotvir which EU businesses and households have received has resulted inincreased greenhouse gas emissions and toxic air pollution in Ukraine.

Financing from European commercial banks has been central to this export of carbon intensive, coal-based electricity from Ukraine to the EU. In 2013 Deutsche Bank, together with Raiffeisen Bank, Erste Group, UniCredit Austria and the Russian Gazprombank, granted a structured pre-export financing loan for DTEK, providing $375 million for export-oriented activities.

Recommendations

In the view of our organisations, and illustrated by the far from exhaustive description of problematic issues outlined above, DTEK is a company operating with an outdated business model, that has a deep negative impact on the environment, climate change in particular. It needs fundamental restructuring, not only to bring it into compliance with relevant EU legislation but also to move its current operations away from the coal sector, towards renewable energy generation - currently renewables account for only 1% of DTEK's total electricity production. 

Whether the company is capable and willing to restructure itself along these lines remains to be seen, but the debt restructuring process now under discussion with your bank provides a rare opportunity to help steer it in this direction.

Should your institution agree to extend DTEK's debt liabilities without addressing the way the company is currently operating, it would be seen by many observers in the Ukraine and elsewhere to be condoning and allowing the continuation of the company's irresponsible approach to managing its carbon emissions and other environmental impacts.

Such a perception could be mitigated if, as part of any debt restructuring agreement, the banks involved in the restructuring process insist on conditions that would reduce DTEK's impacts on the environment and climate change.

We believe that the minimum conditions to be attached to any agreement reached with DTEK should be: a substantial decrease in the carbon intensity of the company's electricity production, through efficiency improvement, switching to natural gas and an increased share of renewables (and in due course the closure of obsolete coal power plants), and; a commitment from the company to promptly undertake a restructuring strategy which can ensure compliance with EU energy and environment regulations, including the Industrial Emissions Directive.

While we understand that such a restructuring process will lead to an extension of your institution's current relations with DTEK, we also would urge you to seek - in due course - to completely disengage from a company that is so deeply rooted in the old, fossil fuel based economic model that Ukraine, as with all other countries in the world, urgently needs to leave behind.

Instead we recommend that in the future, when considering further investments in the Ukrainian energy sector, you look to support only low carbon, renewable energy initiatives. In spite of the current challenging conditions in Ukraine, renewable energy has become a dynamically developing sector in the country, providing the bulk of newly installed capacity in recent years - the sector doubled its share in electricity production from 1% in 2013 to 2% in 2014. 

These gains now need to be ramped up, and financial support from international commercial banks can play a vital role if Ukraine's renewables sector is given high priority.

We hope this letter will be of use to you in your discussions with DTEK. If you require further clarity on any of these issues, we would be very happy to discuss further with you or your relevant staff. 

Yours sincerely,    

NECU and BankTrack