12 minute read 12 Oct 2021
Windturbines in field at sunset in Constanta Romania

Why Eastern Europe is stepping up a gear in the drive for net zero

By Jarosław Wajer

EY CESA Power & Utilities Leader

Enthusiastic leader. Committed to supporting clients to achieve the best results through transformation.

12 minute read 12 Oct 2021

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  • RECAI 58th edition, October 2021 (pdf)

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RECAI 58: Innovative and ambitious routes to becoming low carbon economies are needed if the EU is to achieve its 2050 emissions target. 

This article is part of the 58th edition of the Renewable Energy Country Attractiveness Index (RECAI).

In brief
  • In the push to accelerate the world’s transition to renewable energy, Eastern Europe’s diverse markets face particular challenges and geopolitical influences.
  • The EU target for cutting GHG emissions to 55% of 1990 levels by 2030 poses difficulties for economies currently largely dependent on coal-fired power.
  • EU and government support will be crucial to upgrade distribution networks and develop the technology and financial instruments for the low-carbon transition.

The EU’s increasing ambition in respect of renewable energy is putting economies across the continent under pressure to step up their transition. While Western Europe still has a long way to go, it nonetheless has an advantage over many of the EU’s more recently added Member States from Eastern Europe, where the war in Ukraine and its impacts have exacerbated the challenges.

Many countries and regions – from the Baltics to Romania and the Balkans – face a broad range of challenges, including updating legacy infrastructure and reducing energy dependency on Russia.

Common themes include the need to move swiftly on building renewable capital, and the potential financial backing from the EU and its institutions, designed to help with the transition. Further, the markets are highly diverse, and politics and geography are key. The further north in the region, the stronger the argument for wind power, while, in the south, it is solar power farms that are more evident – for example, across acres of Romania and Hungary.

The countries and regions that joined the EU in the first wave of post-Soviet accessions in 2004 (the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia and Slovenia) have relatively developed capital markets, but several have a long way to go in building renewable energy infrastructure.

Those experiencing the most advanced stages of transition – Poland, for example – are often where new ideas, both in terms of renewables technology and the capital market instruments that support them, can be tried out, according to Grzegorz Zielinski, Head of Energy Europe at the European Bank for Reconstruction and Development (EBRD).

As an example, he cites the green bond issued last year by Poland’s TAURON Polska Energia. It raised €324m (US$383m) to support decommissioning of the company’s coal-fired facilities and the build-out of its solar and wind power capacity, with the EBRD taking almost a quarter of the issuance.

With a Lithuanian bond issue being the first green bond raised by a power utility, and a floating offshore wind platform being financed in Albania, Eastern Europe is clearly a site of innovation and change. 

While many of Western Europe’s economies have well-developed green energy infrastructure, Eastern Europe has much further to go along this path. Poland and Hungary are the only two to make it into the RECAI top 40, compared with 13 regions from Western Europe. 

This appetite for change will be very necessary in years to come, as the EU targets for carbon emissions abatement become more ambitious – and the need for them more pressing. While many of Western Europe’s economies have well-developed green energy infrastructure, Eastern Europe has much further to go along this path. Poland and Hungary are the only two to make it into the RECAI top 40, compared with 13 regions from Western Europe.

In 2020, the EU target for cutting greenhouse gas emissions by 2030 was raised from 40% to 55% of 1990 levels. Although this ambition may be essential for keeping climate change within manageable limits, it will pose significant difficulties for economies such as Poland, currently largely dependent on coal-fired power.

In particular, the question of whether natural gas is acceptable as a transition fuel may make or break the transition for nations with bitter winters that rely on urban district heating systems. Without the ability to move swiftly to the much less carbon-intensive natural gas, these systems will struggle to make significant cuts to emissions with any speed.

The EU’s ambition, however, is supported by the Green New Deal, to help countries and regions build the necessary infrastructure. The European Commission has created a Just Transition Fund of nearly €17.5b (US$20.7b) to support economic diversification in the coal- and carbon-intensive regions most affected by decarbonization, and to help retrain the workforce whose main industry is falling rapidly into obsolescence.

Poland is set to be the largest recipient of the Just Transition Fund, with a proposed allocation of €3.5b (US$4.1b). 

Signals from governments in this new market are positive and, with greater support from EU institutions, the region is experiencing greater interest from established investors that are exploring opportunities for the first time or in more depth. 

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Chapter 1 – Poland

Wind power rises as it becomes Poland’s alternative to coal

Technology has great potential, thanks to ideal offshore conditions along the Baltic coastline.

Poland, the region’s economic leader, is also a leading emitter of carbon. In 2020, coal-fired power accounted for 70% of electricity produced, down from 74% the previous year. As coal mining employs around 80,000 people directly, with probably the same again indirectly dependent on the industry, closing the mines by 2049, as the Government has pledged to do, is a huge undertaking.

Support from the Just Transition Fund is clearly a help, but internal political pressure is changing the Government’s view of the need for transition. Domestic protests about local air quality have added to the climate change voices both at home and abroad, while a number of older coal-fired plants are nearing their end of life, so the Government is looking for alternatives.

Nuclear fuel is one option being examined, but the lead-in is long and costly, and it comes with its own environmental issues. Wind power, on the other hand, is relatively easier to install and increasingly popular with investors.

“A decade ago, people thought of renewables as inefficient, costing too much,” says Zielinski. “But renewable energy is now cost-competitive, particularly for EU countries and regions that are part of the EU Emissions Trading Scheme.”

Poland’s Baltic coastline offers great potential for offshore wind power, as it has strong steady winds over shallow waters with weak tides, making for ideal conditions. Since putting a contract for difference (CfD) system in place to guarantee stable income for investors, the Polish Government has seen huge interest from investors in its offshore wind industry. Northland Power, Equinor and Ørsted have, for example, all announced partnerships with Polish companies to build capacity in the Baltic Sea.

The pricing system is an essential element of implementing Poland’s, or any nation’s, shift to renewable energy, adds Zielinski. “A well-designed and well-introduced CfD system makes a great difference,” he says.

With more than a dozen wind farm projects under consideration in Poland’s Baltic Sea territory, it has the potential to generate a quarter of Poland’s energy needs by 2040. For that to happen, however, investors need to be confident that the Government’s commitment to renewable energy is reliable. One way for it to demonstrate that would be to smooth out regulatory obstacles to other green energy sectors, such as onshore wind. In 2016, for example, a regulation barring wind turbines from being placed within a certain distance of buildings put a significant damper on that sector. This restriction is now expected to be rolled back so that wind farms will be permitted as long as they have local community support, giving reassurance to investors that renewable energy is welcomed by the Polish Government.

Recent auctions for wind farms allow for 6GW of capacity, which should at least be doubled in the next round, bringing the total offshore wind capacity to 10GW–12GW by 2030. However, with pressure on the Polish Government to aim for carbon neutrality, future plans are likely to be subject to change.

“The transition pathway is still to be developed,” says Maciej Markiewicz, Senior Manager at Ernst & Young spółka z ograniczoną odpowiedzialnością Consulting, “but the direction is good.”

Despite this, it is not necessarily straightforward to gain exposure to this huge industry growth, especially for investors in public equities.

“The whole transition from 70% coal is a massive project,” says Eglé Fredriksson, Portfolio Advisor at East Capital, a Swedish asset manager specializing in emerging and frontier markets. “But our interest is connected to how liquid the sector is.”

Although the giant state-owned PGE is listed and a relatively liquid stock, Fredriksson is cautious. “It is responsible for the whole transition, so we have some concerns about protections for minority investors – who will pay for the costs of transition?”

Smaller energy companies exist, but are not traded frequently enough to be attractive to an asset manager intent on maintaining a flexible portfolio. So, for now, Poland is a “watch and wait” market for East Capital. 

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Chapter 2 – Baltic states

Lithuania, Latvia and Estonia still seek energy independence

The Baltic states require infrastructure investment to synchronize their electricity grids with Europe.

The Baltic states – Lithuania, Latvia and Estonia – also stand to benefit from the Baltic offshore wind boom, but they have their individual challenges.

Although they are now connected to other EU markets by the Baltic Ring, a system of interconnectors between markets, they are still synchronized with the Russian and Belarusian markets rather than the EU. The disconnection from the Russian and Belarusian electricity system is an ongoing process expected to conclude in 2025, when all three Baltic countries will be synchronized with the grid of the continental Europe.

Improvement in energy efficiency and economies tilting away from carbon-intensive industries have made it easier for these states to lower their emissions, but energy independence is yet to be achieved. 

Problems encountered earlier on have pushed Lithuania ahead of its neighbors – Lithuania agreed to decommission its Ignalina nuclear power plant, the sister of Chernobyl, as a condition of joining the EU. This has left it heavily dependent on imported power, with two-thirds of energy consumption based on imports, largely from Russia. The combined drive to energy independence and carbon neutrality has led to an ambitious national energy plan, targeting 70% domestic electricity generation by 2030, and complete energy independence by 2050.

Of that domestic production, the Lithuanian Government aims for 45% of electricity consumption and as much as 90% of heat energy to be produced from renewable sources by 2030, and 100% of both by 2050.

With targets this ambitious, Lithuania is likely to be a very active market in renewables for the coming decades.

Latvia and Estonia may not have previously felt the same pressure as Lithuania to become sustainable, but that is changing. Estonia is still heavily dependent on carbon-intensive shale oil, so cutting its emissions by 2030 will require a swift transition. Biomass is likely to be a major focus, with Europe’s largest biomass pellets producer, Graanul Invest, based in Tallinn.

Although biomass has come under fire from climate activists questioning its sustainability, recent advances in technology and creating pellets that burn more cleanly, have allowed it to be designated a green fuel by the EU.

With significant hydropower capacity in place, 40% of Latvia’s total energy consumption is already from renewable sources, and it aims to reach 50% by 2030. This will entail expanding wind power and biomass usage into the total fuel mix, leveraging its geographical strengths of a Baltic coastline and more than 50% forest cover. 

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Chapter 3 – Other markets

Romania and Hungary attract strong solar interest

Regulatory framework must be ironed out and obstacles removed if international investment is to grow.

The size and diversity of the region leads to a divided picture, with natural resources pointing to wind power in the north, solar in the south and hydropower resources concentrated in the Alpine region. With the cost of solar power equipment shrinking quickly, new solar capacity is growing rapidly, with inward investment to countries such as Romania and Hungary.

Although Hungary’s recent auctions for solar power generation have been oversubscribed, showing strong interest in the market from international investors, there are still some obstacles. The regulatory framework, including a tax intended to support smaller domestic heat producers, needs to be ironed out if international interest is to increase further. The recent imposition of further non-tariff barriers as part of COVID-19 crisis changes – including closer scrutiny of foreign investments under the guise of “national security” – will be regarded with caution.

Of the Eastern European states, Romania is leading the way in terms of renewable energy, with significant hydropower generation helping it reach its 2020 renewables target (24% of production) several years ahead of schedule.

To reach its 2030 target of 30.7%, Romania plans to add around 7GW of new renewables capacity, more than half of which is likely to be from solar projects.

While there has been pressure for the Eastern Europe region to increase the mix of renewables in the past decade, that pressure will be stepped up significantly in the next few years. Although the EU target of cutting emissions by 55% by 2030 is a whole-EU project – meaning there will be leeway for some countries to move a bit more slowly – the deadline of carbon neutrality by 2050 will not allow for any complacency.

With support from the EU and national governments, these Eastern Europe markets are already showing they are able to find innovative and ambitious routes to their destination. Distribution networks are being upgraded, technology is being developed and financial instruments are being designed as each country navigates its particular economic, social and political obstacles to a green future.

Ukraine’s renewable meltdown

Ukraine has huge potential for renewable energy, both solar and wind power, thanks to its huge, sparsely populated territory, with reliable sunshine and steady winds. The EU saw it as a potentially huge supplier of green energy but, instead, its largest energy company, DTEK, is looking to build 1GW of renewable power plants outside of Ukraine, largely in the EU.

The collapse of its guarantee system for investors is to blame. The feed-in tariffs (FIT) scheme, set up in 2008, created a government agency called Guaranteed Buyer to reassure investors they would be paid for their product. Unfortunately, it ran out of money in 2019, so developers went unpaid.

An EU-mediated settlement has not yet been implemented, and investors have become very wary of the market.

Even if a settlement is reached, and an attractive and reliable pricing system for renewable energy is put in place, Ukraine will still face problems in reaching its potential as a producer of green hydrogen.

In ideal circumstances, hydrogen is transported from the point of production to the point of use via pipeline, but, failing that, it can be carried by road in cryogenic liquid tanker trucks or gaseous tube trailers.

“The lack of interconnection for distribution is a problem,” says Maciej Markiewicz. “It would have to be imported in vehicles.”

In addition, he adds, the unstable political environment will put off many investors. 

Summary

The countries and regions in Eastern Europe are coming under ever-greater pressure to increase their mix of renewables and ensure the EU deadline of carbon neutrality by 2050 is not missed. Each area is navigating its own particular economic, social and political obstacles to a green future, with distribution networks being upgraded, technology developed and financial instruments designed to support their transition to low-carbon economies. 

About this article

By Jarosław Wajer

EY CESA Power & Utilities Leader

Enthusiastic leader. Committed to supporting clients to achieve the best results through transformation.