Simulation and Economic Impact Evaluation of Ukrainian Electricity Market Tariff Policy Shift

Abstract

Among all types of economic activities in Ukraine the power industry is the only one that utilizes cross subsidization mechanisms. Electricity tariffs for the residential consumers are set far below the estimated retail level, while industrial consumers have to pay higher prices in order to compensate for these costs. In 2012 electricity consumption subsidies exceeded 31 billion UAH, which is over 8,7% of Central government budget and 2,3% of Ukraine’s GDP.

In this study a static computable general equilibrium model with heterogeneous households is applied to investigate distributional and poverty-related effects of price reform in the electricity sector of Ukraine, considering 30%, 50% and 100% subsidies elimination. In addition, different compensating mechanisms for various households’ groups are studied. In particular, direct transfers from Central government budget, partial preservation of cross-subsidization and compensation through increase of taxes on production and import of goods and services.

The results indicate that essential positive effects from subsidies elimination – lower production costs, output gain and investment intensification are seen, mostly by industrial activities. The highest growth rates are observed for those industries that not only actively consume electricity but also energy intensive goods and services. Regardless of the nature of implemented compensation mechanisms, the decrease in cross-subsidization leads to investments growth: for some scenarios up to 18 billion UAH. At the same time, residential consumers suffer with poor households loosing relatively more than rich.

In this context, according to the investigated scenarios, the most appropriate compensatory option is partial preservation of cross subsidization. This approach bears no additional burden on the Government budget and does not require significant regulatory changes. However, given the specific nature of this concept, it should be used only in the case of 30% subsidies reduction.

In general, key positive effects of cross-subsidization reduction come from the production costs decrease, manufacturing capacity rise and investments volumes increase in the real sector of Ukrainian economy.

Keywords: electricity subsidies, reform, social and economic effetcs, compensating mechanisms, computable general equilibrium model

JEL Classification: D58, Q43, Q48