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CEE at the energy crossroads — can it choose the green path?

Wind farm Poland nr Baltic in 2016 from Alamy 28Jun21 575x375

The next 10 years will be tough for central and eastern Europe, economically and politically. Willingly or not, it will have to cut carbon emissions. States in the EU have agreed deep reductions by 2030. But exactly how, when and where the changes come remains to be thrashed out. None of it will be easy — and one of the most important tasks will be to retain the confidence of financial markets. Jon Hay reports.

In December, the arcane world of EU sustainable finance regulation was rent by a fierce controversy. Ten countries so strongly disliked the bloc’s draft Taxonomy — intended to guide markets on what investments are sustainable — that they threatened to veto it.

Their objection: they wanted natural gas included as a ‘transition’ fuel. All were from eastern Europe, including most of the former Communist EU members, plus Malta, Greece and Cyprus.

The fight was not over whether these countries could carry on using gas — that is not in question. The CEE countries were so sensitive about the issue that they wanted gas officially classed as sustainable. But according to the EU’s technical advisers, doing so would blow the Taxonomy’s credibility.

The incident points to two struggles looming in the region’s path. Faced with the climate emergency, the EU has committed to cutting greenhouse gas emissions 55% from 1990 levels by 2030 — an enormous task, necessitating reform of almost every industry and domestic activity.

For Europe’s poorer eastern half, where many countries rely on coal for power, it feels doubly daunting.

At the same time, the finance sector has become hyper-alert to sustainability. While this is often painted as an unmixed good, many in CEE fear the green finance craze could lead investors to cut off their access to funding.

“We address ESG-related themes to every issuer we are speaking with,” says Sergey Dergachev, head of emerging market corporate debt at Union Investment in Frankfurt. Borrowers must show they have “a credible plan to think about ESG themes, including the low carbon transition”.

Union Investment considers each issuer on its merits. Other investors may not be so careful. A tick-box approach to ESG could put CEE issuers on investors’ red lists.

Even Dergachev says “it is too early to tell whether the transition to a low carbon economy presents risks or opportunities to CEE”.

 

 

EU money at stake

The battle over the Taxonomy rattled on until April, when the European Commission struck a compromise. It will propose a separate law later this year to bless certain uses of gas for their role in decarbonising the economy.

The eastern states are not worried only about private investment. In a policy drift that some consider rash, the EU has begun using the Taxonomy to guide some of its own spending.

Crucially, under NextGenerationEU, the €724bn loan and grant scheme to help the EU get over Covid-19, at least 37% of payouts must go to climate investments and reforms.

The struggles over this issue are a foretaste of the tensions likely to fill European politics over the next 10 years, as countries wrench their economies on to greener paths.

Late this year and in 2022, tough negotiations will be required on how the 55% commitment should be shared out between states in the revised National Climate Action Plans due in 2023.

But these arguments are over the pace and means of change — not the principle. “The energy transition is becoming more acceptable now, even in countries that had been slower and more hesitant, afraid of various challenges and pressures,” says George Gkiaouris, the EBRD’s head of energy for southeast Europe.

The details of NextGenEU may provoke squabbling, but overall, it is proving a magnet for green policy reform. Gkiaouris has noticed a change even in the last few months. Governments are reaching out to ask for support, especially to scale up renewables, “partially because they want to benefit from the recovery funds available.

“Even the most sceptical see a great opportunity to transition and recover from Covid,” he adds. “Now the challenge is: are we doing it in the most efficient and effective way?”

 

 

Different journeys

Grzegorz Zieliński, head of energy Europe at the EBRD, distinguishes three bands of countries in CEE. Member states are bound by EU commitments. Countries aspiring to membership want to be seen in a good light by Brussels. The third group have no prospect of joining the EU soon, and are likely to chart more independent courses, but still have reasons to go green.

Ukraine, for instance, is eager to escape its energy dependency on Russia. The major exception is Russia itself, where there has been very little renewable energy development. “In Russia they will fight this as long as they can,” says Kingsmill Bond, energy strategist at Carbon Tracker, the climate change think tank, in London. “It’s eastern Europe where the change will happen.”

There are big differences within the EU, too, Zieliński points out — sometimes surprising ones. States like Latvia had been ahead of the game because of their high share of hydroelectric power. But as emissions reduction targets get steeper, they are having to get into gear on reforms, and are not used to it.

Others have zigzagged. Czechia was one of the first countries to stimulate photovoltaic power, but the over-generous scheme provoked a legislative backlash that burnt investors and angered the public. “There’s still very little social acceptance of solar power,” Zieliński says.

Nevertheless, in March, Czechia — the only country to have graduated from receiving EBRD support — agreed to re-engage with the Bank for five years, specifically to get help with transitioning its energy sector.

  

 

Smoke and sunlight

Greece has made such a screeching U-turn on coal that even enthusiasts are worried it may be going too fast. The government and state-controlled Public Power Corp have decided to close all existing coal power plants by 2023. One is still under construction — by 2025 it will have converted to another fuel or closed.

The new Greek policy was marked in March by the world’s first high yield sustainability-linked bond. The €650m deal, of which the EBRD bought €50m as an anchor investor, gave PPC its first access to the capital markets since 2016.

There are ambitious moves outside the EU, too. Serbia was developing coal-fired power stations until recently. It is now designing a low carbon transition strategy.

“It’s not as hard as it looks,” says Bond. “A lot of countries have already passed peak demand for fossil fuels in their electricity systems.”

In Poland, this happened in 2006. Like other CEE countries, Bond says, “It’s a low growth market where solar and wind are coming in, providing all the growth and starting to push fossil fuels out.”

 

 

Easy wins and losses

There is plenty of low-hanging fruit in the energy transition, for two reasons.

Many CEE countries have great potential for solar and wind power. The pace at which renewables have become cheaper has astonished even their biggest fans.

In March, Voltalia, the French renewables company, won an auction in Albania to build a 100MW solar farm with a bid of just €0.03 per kilowatt hour — about half what fossil energy would cost.

And, as in western Europe, poorly designed policies leave great space for improvement at minimal cost. In Hungary, it is all but impossible to build a wind turbine — the law requires it to be at least 12km from any settlement.

Designing the right support regimes is crucial. For utility scale solar and wind, contracts for difference are now seen as the best option. Producers get paid the difference between the guaranteed price they bid and the market price for power. If the market price ends up higher, the producer pays the government.

However, there is still plenty of scope for policy errors. Hungary has brought forward its coal phase-out date from 2030 to 2025 and will close its 880MW Mátra lignite power plant. But it will replace it with a 200MW solar farm and 500MW gas plant — a classic example of “locking in” fossil fuels by building new infrastructure for them.

“The Hungarian government has decided to do something, but it’s not going in the appropriate direction, or with massive enough measures,” says an official in CEE.

The EBRD’s attitude to gas has changed. Until recently, it was eager to finance its expansion, as a replacement for coal. Now, Gkiaouris says: “We are very selective in our approach. We no longer finance coal and lignite and are increasingly moving away from all fossil fuels. Although natural gas is an important transition fuel for some of our countries of operations, eventually we will stop financing it too.”

After 2035, he thinks gas will mainly be used as a back-up, with renewables providing the baseload.

 


All-encompassing issue

The transition is not just about the power sector, however. “There is so much more to be done,” says Zieliński, “in areas like quality of air, decarbonisation of transport, electric mobility, energy efficiency of public buildings.”

In these fields, investors get the need for green progress and are supportive. So do many businesses. “We see more and more large companies which have to become greener because of pressure from their customers,” says Zieliński. “That’s bringing a new wave of potential consumers of green energy who didn’t really care a year or two ago.”

The problem, again, is policy design. Buildings will only be upgraded en masse when regulations require it; complex systems such as urban transport can only be reformed by governments working with multiple stakeholders.

There is a long way to go. In Hungary, for example, “there is no transition planned in a forward-looking way to really switch the whole economy towards low carbon,” says the official. “One of the main pillars of cutting back by 55% is the energy efficiency of households, but the government is not really supporting this.”

 

 

Dialogue needed

From this point of view, CEE governments may have less to fear from investors’ lurch towards greenness than they think. On the contrary, it could help them.

“CEE is slightly ahead of other regions, since a lot of investors do come from the eurozone, where ESG requirements are more restrictive than in other regions,” says Dergachev.

At its best, the investor-issuer relationship allows what Dergachev calls an “avenue for mutual two way feedback to improve ESG awareness.” Issuers can put their best feet forward to please investors — and receive guidance on how to improve.

One opportunity for such conversations is labelled debt such as the €500m green bond from Polish oil refiner PKN Orlen in May and Slovenia’s €1bn sustainability bond in June.

Bonds like this do not directly make any new green projects happen. But since they are often very popular with investors — Slovenia’s was eight times oversubscribed and priced with no new issue premium — they provide valuable reinforcement and encouragement.

Bad-tempered though the arguments over the Taxonomy may be, financial markets are not the CEE region’s enemy when it comes to the low carbon transition — they are its ally.

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