Ukraine’s Local Content Requirement in the Light of WTO Rules: is a Win-Win-Win Approach Possible?
Volodymyr M. Matenchuk
Until recently, electricity in Ukraine has been produced essentially from conventional sources (i.e. fossil fuels and nuclear power). The idea of increasing the share of renewable energy in Ukraine’s energy mix has recently been gaining ground.
Starting from 2008, Ukraine introduced a Green Tariff (more commonly known as a feed-in tariff, or in other words, a preferential guaranteed price) applicable to electricity produced by electric power generators which use alternative energy sources.
At the same time, the application of the Green Tariff is subject to certain conditions and limitations, one of which is a minimum required domestic content level with regards to works and materials used for construction of the power plant (i.e. local content requirement) which determines eligibility to a Green Tariff.
Access to the Green Tariff is crucial to increasing the share of renewable energy production and attracting investments in this field. Of particular interest, is Ukraine’s implementation of local content requirements as one of the main eligibility criteria for approving the application of the Green Tariff to specific renewable energy projects. This article is focused on the specific question of whether current Ukrainian rules are consistent with the country’s fair trade obligations as a WTO member or risk being considered an illegal subsidy.
Background
Around 66 countries, states and provinces around the world now use feed-in tariffs to pay for new renewable generation, according to the Renewables 2012 Global Status Report and feed-in tariffs now dominate policy for renewable energy worldwide. However, when coupled with a local content requirement, they have a clear subsidizing effect aimed at encouraging local development of equipment production.
Starting from 2009, different support policies for production of equipment of renewable generators became sources of controversies at the WTO.
For example, China has been found to be in violation of WTO rules for export restrictions applied to rare earth materials (e.g. containing rare materials used in production of renewable energy equipment). Later, its allegedly subsidized wind towers and solar cells became subject to countervailing and anti-dumping duties in the EU and the US. China, in turn, accused the US and the EU of subsidizing their renewable sectors of economy, and finally requested consultations with the EU about feed-in tariff programs in Italy and Greece because of their domestic content restrictions (case DS452, complaint filed on 15 November 2012).
This was done on the heels of Canada’s feed-in tariff (FIT) program being found inconsistent with WTO rules, a dispute which is now serving as a precedent to outlaw many other similar schemes, including the Ukrainian one.
In that dispute Japan, and one year later the EU, brought similar complaints against certain measures relating to domestic content requirements in the FIT program, established by the Canadian Province of Ontario (respectively, cases DS412 of 13 September 2010 and DS426 of 11 August 2011).
Japan and the EU claimed that Ontario’s FIT program unfairly discriminates against foreign companies, as it mandates the use of domestic over foreign products to qualify for financial support offered by the program. Thus, it violated national treatment rules in the General Agreement on Tariffs and Trade (GATT) and the Agreement on Trade-Related Investment Measures (TRIMs), and constituted a prohibited subsidy under the WTO’s Subsidy and Countervailing Duty Agreement (SCMA).
The local content requirement in Ontario varies depending on the technology being used and the scale being promoted, but ranges from a minimum of 25% (wind) to a maximum of 60% (solar) domestic content required to be eligible for FIT support.
The disputes are not about “trade and environment” but about “trade and investment”. Development policies using local content requirement are prohibited at the WTO, and a special agreement called TRIMs is dedicated to that effect. At the moment of creation of the WTO, in 1995, TRIMs established a longer transitional period for developing countries in order to phase out their local content requirement policies, and all attempts at developing countries which aimed at prolongation of transitional periods met fierce opposition on behalf of the North. The issue was a North-South one as such policies are used to boost transfer of technologies and to sustain emerging industries. Interestingly, such measures are now also used by countries of North to promote their emerging industries of renewable energy equipment and components.
The report of the WTO’s Panel (e.g. Panel composed of 3 members, deciding disputes in the first instance) was circulated on 19 December 2012 with a substantial delay due to a complexity of the case. Of the three WTO agreements cited in complaints, Canada was found to be in breach of two, the GATT and TRIMs.
Evaluation of Ukraine’s local content requirement with regard to the principle of national treatment
In order to establish possible violation of GATT and TRIMs Agreement, it is necessary to establish that i) Ukraine’s local content requirement requires purchase of goods of Ukrainian origin or from Ukrainian source, ii) compliance with this requirement is necessary to obtain an advantage, and iii) the Green Tariff is not a government procurement measure for government purposes but, eventually, for commercial resale.
Whether the local content requirement requires the purchase or use of products of Ukrainian origin or from a Ukrainian source
After the amendments introduced by the Act of Ukraine No.5485-VI of 20 November 2012 to the On Electric Energy Act of Ukraine, the Ukrainian domestic content level clearly requires purchase or use of products of Ukrainian origin or from a Ukrainian source. The previous version of the Electric Energy Act set the obligatory content with regard to the products only for solar facilities. Starting from 1 of January 2013, solar modules must be produced with 30% of Ukrainian components or raw materials. The percentage of local content requirement for other alternative sources facilities used to be rather low and, in addition, the coming into force of this requirement has been postponed several times.
Once the amendments come into effect, it is clear that purely service activities related to generating facility construction are not sufficient to meet the minimum required domestic content levels. For power generating facilities (wind, solar, biomass) which will be commissioned after 1 July 2013, the new Act No.5485-VI sets the minimum local content requirement at 30%. Furthermore, it provides the obligatory percentage of different parts of equipment of Ukrainian origin, and defines the percentage which can be attributed to construction and works. In case no such equipment is produced in Ukraine, at least in sufficient quantity and quality, development of any project in the renewable energy field would be subject to prior investments and technology transfers into the national economy in order to create a sector for such equipment production.
Whether compliance with the local content requirement is necessary to obtain an advantage
It is evident that compliance with the local content requirement is a necessary condition and prerequisite for electricity generators to benefit from the Green Tariff. The Green Tariff guarantees a fixed price for every kWh of electricity delivered into Ukraine's electricity system over the period by 2030. The law sets coefficients, applied to a basic (consumers) rate in order to establish the Green Tariff for specific renewable energy sources. For example, the current price for electricity from solar power plants is 4.8 times the base tariff. In addition, the tariff may not be lower than the minimum amount defined in 2009. In this case, the amount of the tariff in Hryvnias is linked to the Euro and may be recalculated in case of fluctuations in interest rates. Thus, the mere granting of the Green Tariff may be viewed as obtaining an “advantage” within the meaning of the TRIMs Agreement.
Green Tariff as a government procurement for commercial resale
The Green Tariff is awarded to a producer following an administrative decision by the National Energy Commission of Ukraine which is obliged to verify whether the producer has respected the Ukrainian content requirement.
The Ukrainian electricity market is not deregulated and is highly monopolized. Ukrainian legislation provides for the mandatory state regulation of pricing, customer access and other terms of business activity of natural monopolies.
The passage to a balanced marked is far from complete and, as a rule, electricity is sold on the Wholesale Electricity Market of Ukraine (WSM). All entities of the energy sector — licensees (generating company, distributing companies, suppliers of electric power) form the WSM. State Enterprise (SE) Energorynok is the commercial operator of the WSM and a “single buyer”. Purchase of electric power from its producers and its wholesale supply by the suppliers of electric power is carried out on the basis of bilateral agreements executed per forms which must comply with the model contract.
Thus, like the Ontario’s FIT programme, Ukrainian measures, from the standpoint of the Panel’s analysis, can be viewed as government procurement of electricity for commercial resale, contingent upon the use of domestic over imported goods, and be qualified as violating TRIMs Agreement and GATT’s national treatment requirement.
Evaluation of Green Tariff payments and financial incentives as prohibited subsidy
According to the WTO SCM Agreement, the subsidy contingent upon the use of domestic over imported goods is deemed to be prohibited. But it is important to qualify the Ukrainian measures as “subsidy”, for which two criteria must be met: that the Green Tariff payments constitute a financial contribution and that the payments also confer a benefit. While the first criterion is easily met, as government purchase is one of the forms of financial contribution, it can be difficult to establish the benefit.
According to the WTO jurisprudence in similar matters, “benefit” must be established by determining whether the financial contribution makes the recipient better off vis-a-vis the market than it would have been in absence of that financial contribution.
The Canadian case shows the evidentiary problems that may arise in seeking to establish “benefit” by reference to the market, particularly where no “market” benchmark exists. Like in Ukraine, in Ontario electricity is first sold on the Wholesale electricity market, which is not competitive. The WTO Panel considered that the Hourly Ontario Electricity Price (which can be compared to the Ukrainian “consumer retail price”) that was at the centre of complainants’ main benefit arguments could not serve as an appropriate benchmark against which to determine whether the challenged measures conferred a “benefit” as the WEM is not competitive. In that case, the Panel showed a sensibility towards taking into account governmental needs when regulating the electricity system. However, one member of the Panel expressed a dissenting opinion on subsidization claims, finding that the challenged measures were subsidies because the pricing offered to relatively high cost energy sources enabled renewable energy generators to enter the wholesale electricity market when they would otherwise not have been able to in the absence of the feed-in program.
In addition, there are also fiscal incentives in Ukraine for renewable energy generators which can be also considered as a form of prohibited subsidies. Under the Ukrainian Tax Code, profits of companies producing only energy from alternative sources shall be exempt from corporate profit tax for a period of 10 years, starting from 2011, on condition that these revenues are used to cover the development costs of renewable energy projects or to repay funds used for their establishment. Meanwhile, the SCM Agreement qualifies as a subsidy, a form of a financial contribution as “government revenue that is otherwise due but is foregone or not collected (e.g. fiscal incentives such as tax credits)”. In addition, establishing the “benefit” may not be such a problem in such case as the “marketplace” has not been explicitly used as a benchmark to determine whether financial contributions taking the form of fiscal incentives confer a benefit.
Overall, a more thorough evaluation of Ukrainian legislation would depend on the final interpretation which would be given by the Appellate Body to the Panel’s conclusions. In such a case, such aspects as the qualifying feed-in tariff scheme as government procurement and review of whether it confers a benefit will be of particular interest. With regard to the first aspect, Canada has already filed an appeal against the Panel's conclusion that renewable electricity is purchased “with a view of commercial resale”.
Reciting Japan’s statement in Ontario’s FIT case, Ukraine’s Green Tariff legislation is a de jure discriminatory measure that is designed to promote the production of renewable energy generation equipment in Ukraine rather than to promote the generation of renewable energy.
In any case, Ukraine’s recent shift to more stringent local content requirements is not a good sign for investors and may have a doubtful effect on attracting investment for construction of renewable energy generators in Ukraine.
