Ukraine’s new state coal giant – reform conduit or corruption sinkhole?

On 6 December 2017 the Cabinet of Ministers of Ukraine created a new coal giant - the National Coal Company (NCC). It happened after months of fruitless negotiations in parliament. However, even though the creation of the company has been announced, not much has been released in terms of specific details. It was declared that the company was created to optimize the structure of government coal mining enterprises in Ukraine through the creation of a single legal entity. However, the idea of such a company is not new, and previous experience shows that the idea is full of risks for corruption. The creation of the NCC is the result of a concept to reform of the coal industry in Ukraine by 2020. The corresponding strategy was approved in May 2017. According to the legislation, the extraction of coal at state enterprises should increase by up to 8.7 mn tonnes in 2018, and up to 10 mn tonnes in 2019. This is compared to the 5.8 mn tonnes extracted in 2016. Experts say that now the productivity of work of the state mines is very low. “For a long time, there is no reserve equipment - everything is stolen,” says Mykhailo Volynets, Head of the Federation of Free Trade Unions of Ukraine and Independent Trade Union of Miners of Ukraine. Because of that, the cost of coal production in government mines is much higher than it is in private mines. Therefore, the mines do not generate enough profit to continue activities and pay employee salaries. Before the creation of the NCC, the problem was solved by allocating funds which were budgeted for covering the losses of the state mines. In the 2015-2016 budget this practice was discontinued. According to an agreement reached by a coalition of parties in the Verkhovna Rada [Parliament] the amount of subsidies was to be gradually reduced by 2018, while at the same time the sector is to be reformed. However, because of protests by miners, the Verkhovna Rada of Ukraine reallocated a part of money which had been earmarked for the restructuring of mining enterprises and subsidies to state mines. The Ministry of Energy and the Coal Industry says that there is a disastrous lack of funds for the support of the state coal mining enterprises. This problem, according to a source of 112.ua in the Ministry, is another argument for the creation of the NCC. However, the creation of NCC has faced criticism from the very beginning from a number of critics. For example, the Ministry of Finance and the Ministry of Economic Development and Trade have stated that there is no economic justification for allocating such a large portion of the budget to this enterprise. At the same time, many experts are confident that the real reason of creation of the company is far removed from the one which was published:

“The are few reasons [for creating the NCC]. The main one is an attempt to concentrate by one office the access of the state mines and state coal unions, including repair enterprises,” said Yuri Korolchuk, Member of the Supervisory Board of the Institute of Energy Strategy.

So let’s take a closer look at the possible risks associated with the creation of the NCC.

Risk number one – centralization

It seems this danger is obvious to everyone except the Ukrainian authorities with their populist speeches:

“Creating this company will allow to form a single state policy: to conduct centralized purchases and save UAH 1.5 bn ($52 mn) on the administrative apparatus of coal associations,” told Volodymyr Kistion, the Deputy Minister on Energy.

It was announced that the company will unite 19 state enterprises and 33 mines in Ukraine’s government-controlled territory - this is roughly ⅓ of the total 102 mines, most of which are now on the territories controlled by the self-proclaimed Donetsk and Luhansk “People’s Republics.” Compared to private mines, these state mines are immensely inefficient: although there are only 17 private mines on Ukrainian territory, they produce more than 85% of the coal. Moreover, only three of them make profits; the rest are sinkholes for state subsidies. The UAH 1.5 bn in savings are mere pennies compared to the debts of the state mines. Speaking to Euromaidan Press, Oleksandr Lemenov, an anti-corruption expert of the Ukrainian reform coalition Reanimation Package of Reforms, countered the words of Kostion:

“The absolute majority of these 33 mines are too unprofitable. Moreover, maybe Volodymyr Kostion forgot, but it is the corresponding ministry which forms the state policy in the sector, not the newly created company.” Lemenov said that Ukrainian society had been fed various promises about potential savings over the last 25 years, however each time the result is additional operational expenditures and new corruption schemes.

Lemenov assumes that it is quite possible that that the key aim of creation of the NCC is redistribution of funds allocated in the form of subsidies and spent through the procurement system:

“Centralization of any structure in Ukraine turns into creating additional corruption risks. Usually they appear during public procurement, the services of coal dressing and carrying out functions which structures are not eligible to implement.”

Risk number two – the managers

Volynets doubts that the new company will be independent. In his opinion, the oligarchs will try to take it under control by appointing their person to head it:

“The question with appointing the head of NCC raises the most questions. The company hasn’t been created yet, but there is already a queue of those who want to head it. To be honest, the majority of these people don’t even imagine what the purpose of the company is and what tasks it should implement. There is fear that those with sticky fingers will try to take the company under control.”

Also, Volynets stated that the authorities tried to receive a formal agreement from the trade unions, in order to say later on that it were the trade unions which asked to create the NCC, “to cover up the corruption aspects which are literally embedded in this company.” Also, the expert said that one of the candidates for the position of the head of the NCC was Maksym Fedotov, who allegedly used to work in the structure of the son of the runaway president Viktor Yanukovych, Oleksandr Yanukovych. According to Ukrainian media, the unofficial curator of coal matters in Ukraine from the President’s Office is an MP from Petro Poroshenko’s Bloc and President Poroshenko’s old business partner Ihor Kononenko.

“As a result, not a single global decision is not made without preliminary agreement with him,” says Lemenov.

Kononenko, in his turn, has his right-hand man in the energy sector - a businessman from Donetsk Oblast, ex-MP from the Party of Regions (the party of Viktor Yanukovych) Vitaliy Kropachov. Ukrainian media call him an “observer” of the coal industry. Recently, a journalistic investigation revealed that private companies of the inner circle of ex-president Yanukovych which in 2012 illegally took over coal beds on the territories of state mines came under the umbrella of people from Kropachov’s circle in the last two years. According to the investigation, the businessman now oversees the majority of the coal assets which Yanukovych stole from the state.

And what about the main actor in the energy sector?

“Of course we should not forget about the role of Rinat Akhmetov [the richest oligarch in Ukraine, who has strong assets in the energy sector - Ed], and his holding DTEK which is a significant player on the domestic market. Moreover, his interests are deeply related to the president Poroshenko through the scheme Rotterdam+,” says Lemenov.

Rotterdam+ is a methodology for calculating the price of coal in the production of electricity from thermal power plants in Ukraine, which account to nearly half of all energy production, based on the price of coal in the eponymous international exchange in The Netherlands. Introduced in 2016 to account for the lack of anthracite, a high-energy type of coal, the mines of which are now in non-government controlled parts of Donbas, Rotterdam+ has been widely criticized for giving super profits for energy producers, was named as the “Corruption scheme #1” by the Ukrainian business outlet Liga.net, and has led to energy price hikes for domestic and business consumers. As Akhmetov’s company, DTEK, controls 70% of the thermal plants and 80% of the private mines, he is considered to have profited from Rotterdam+ the most. Lemenov explains that the newly created NCC will not affect Akhmetov’s business, as the cost of mining coal at his mines is nearly two times cheaper than at the state mines which will be united in the company. However, the oligarch can earn huge amounts of money on the supply of mining equipment through the companies of NCC.

Not the first state giant 

The company Vuhillia Ukrayiny (Coal of Ukraine) can be seen as a predecessor of the NCC. It was created in 2003, went bankrupt in 2016, and now is being liquidated. Its goal was to support the state mines, which produced high cost and low quality coal. The Ukrainian media Ekonomichna Pravda investigated the corruption schemes in the state-owned coal sector which developed during 2009-2013. But first let's first take a look at some important features of the coal market in Donbas. Besides the mines which belong to large holdings, there exist hundreds of small private mines called kopankas. Before the Russian occupation of Donbas, kopankas were illegal. One of the reasons was that the owners of these private mines neglected all safety measures. Nevertheless, they were still widespread in Donbas, where coal is the main source of revenue. The business was overlooked by law enforcement, because they also got a share of profits. Nowadays, these dangerous businesses are used to the benefit of the pro-Russian forces fighting against Ukraine. Back in 2009-2013, they worked to enrich the authorities. The coal extracted from kopankas was formalized as coal from state mines. In fact, it were the structures controlled by the ex-leader of the Party of Regions Oleksandr Yefremov and Oleksandr Yanukovych who supervised the processes of selling the kopanka coal. After the real state coal and coal from kopankas was mixed, it was sold to the power generation companies through Vuhillia Ukrayiny at a single price, a part of which was compensated due to subsidies from the state budget. The state incurred huge losses from the scheme, because the production price of the coal was nearly three times more than its selling price. The price difference, $100 per ton, was covered by the state. When the so-called family (a term used for the businessmen and politicians related to Viktor Yanukovych) was presenting the coal extracted from kopankas as state coal, it profited from the money for the state subsidies. Talking about the NCC, Lemenov assumes that the so-called Luhansk and Donetsk “People’s Republics” will try to sell coal to it:

“There can be attempts to sell coal from kopankas under the guise of coal from NCC [to the state energy production ]. It is direct corruption and it can be implemented only with the involvement of the so-called ‘observers’ who have the support of the top-officials.” Experts name Kropachov as one of those observers.

In 2014, the total debt of Vuhillia Ukrayiny amounted to UAH 3 bn (almost $104 mn). Its main part was formed in 2010, when there were not enough subsidies for the sector. It lead to a significant decrease of extracting at state mines. And Vuhillia Ukrayiny is not NCC’s only predecessor. According to Yuri Korolchuk, after 2014, two more short-lived players appeared - and vanished shortly afterward - on the state energy market: the State Coal Company and Derzhvuhlepostach. The Head of the Bureau of Integrated Analysis and Forecasts Serhiy Diachenko drew parallels between NCC and the gas giant Naftogaz:

“It is not a secret that Naftogaz was created in 1996 for financing the election campaign.Of course, it would be a state company, but it would be controlled by the people from the inner circle of the president.”

Lemenov doubts that society can significantly influence the situation. However, some mechanisms of control exist. Among them, the expert names monitoring of the public procurement, and amounts of state subsidies and appointments from the viewpoint of political connections.

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