Energy payments crisis

2. Energy payments crisis

Energy trade is one of the most profitable business in Ukraine, despite the fact that there is a payments crisis in the energy sector. Official statistics about the financial situation in the energy sector are not reliable because most actors involved are opposed to transparency. In many ways tax-authorities are cheated. The fact that large part of energy is traded in barter deals makes energy trade very opaque. Barter gives ample opportunities to siphon of profits and hide revenues for tax authorities. This situation is further complicated by the fact that energy traders often get the exclusive right to provide energy to designated enterprises. This gives them the opportunity to squeeze these enterprises, usually with the collaboration of these manufacturing enterprises.

For example, a steel enterprise buys gas from a trader that is imposed upon the enterprise by political authorities. The trader delivers the gas for a high price and receives in exchange, apart from a small amount of cash, the larger part in the form of undervalued steel. On paper, the steel enterprise pays only for part of the delivered energy. The energy trader sells the undervalued steel for a low price to an off shore steel trader, owned by the energy trader. Subsequently the offshore company makes big profits selling the undervalued steel for the world market price abroad.

On paper, both the steel enterprise and the energy trader are making losses with this deal. On paper, the energy trader receives only payments for part of the delivered gas. The steel enterprise becomes indebted with the energy trader.

In many cases, steel enterprises are loss making (on paper) and receive direct or indirect subsidies from the state. Energy traders are often on paper also loss making and do not pay for all energy delivered by energy producers. Often, the state jumps in and subsidises the energy traders and energy producers. Energy traders often bought from energy producers energy on loans, guaranteed by the state. When the energy trader failed to pay, the state paid back the loan.

Independent energy traders can buy cheap gas, for example by paying immediately in cash and bypassing Gazprom. According to Yulia Timoshenko, in such a case gas could be bought for 25-30 dollars per 1000 m3, while Ukraine buys gas from Gazprom for 80 dollars in barter deals. Itera, the Russian/Ukrainian joint venture can, according to her, sell gas at 60 dollars per 1000 m3. The advantage of paying by cash gives the small private traders enormous profits. [xii]

The whole set up favours the energy traders, not the energy producers. As President Kuchma said in early 2000: 'By getting hold of and monopolising the (energy) market, countless intermediaries are making super-profits, looting energy facilities and enterprises.'[xiii] Unfortunately, the president himself helped to create such a situation.[xiv] The energy producers are all state owned, therefore the state pays here the bill. Despite the fact that energy traders are the winners in the equation, they do not invest in the energy transportation infrastructure, because non-reported profits are channelled abroad. The deteriorating state of the electricity grid generates each year more power outages. Gas leakage increases each year due to bad maintenance of the pipeline system.

Government placed a lot of enterprises and institutions on a list of entities that can not be disconnected from the energy grid under any circumstances. Among these are the most chronic non-payers of energy. This further aggravates the payments crisis.

3. Energy production

 

Almost half of the energy Ukraine consumes is produced domestically. Almost all consumed coal is produced in Ukraine. An important asset is the nuclear power stations that produce almost half of the electricity consumed in Ukraine.

Of all Ukrainian energy needs, 26 per cent are accounted for by oil, 35 per cent by gas, 34 per cent by coal and 4 per cent by nuclear power and hydroelectric power. [xv]

The output of coal, the major part mined in South-Eastern Ukraine, declined from 216 million tons in 1975, to 189 million tons in 1985, 165 million tons in 1990, 84 million tons in 1995 and 81 million tons in 1999. Since the independence of Ukraine, 1991, coal production declined by more than half while employment dropped by more than one third. While the coal industry employed 650 000 employees in 1995, the beginning of restructuring, it counted 410 200 employees in January 2000.[xvi]

Table 1 Energy production in Ukraine

1990 1995 1999

coal (million tons) 165 83.8 81.7

electric energy (kWh) 298 194 172

gas (m3) 28.1 18.2 18.1

oil (million tonnes) 5.3 4.1 3.8

Source: Ukraine v Tsifrax 1999, p. 65

The loss making coal mining sector is still for the larger part not privatized and receives large direct and indirect subsidies.[xvii] Coal mines are being kept afloat that produce coal twice the world market price while conditions for coal mining are deteriorating, given the prospect of even more expensive coal in the future.

The easily available coal had been extracted so that what remained lay in thin and sloping seems, often more than 1200 meters deep with each passing year average depth of the coal faces increased by 10-15 meters. Quality of coal was declining. Mining technology is very primitive: 75 per cent of all jobs in the mines are done manually (from the mid-seventies onwards investments in coal mining were channeled to other regions than South Eastern Ukraine). One third of the mines is more than 50 years old, and some date of the 19th century. Many key pieces of equipment, including one third of the ropes hauling the mine elevators, are well beyond their service time.[xviii]

Miners found themselves in a downward spiral of declining rates of productivity and investment leading to the increasing hazards of their work. In 1998 every thousand tons of coal cost the lives of four miners.[xix]

The United Kingdom produces with only 3.8 per cent of miners 57.9 per cent of coal produced in Ukraine. Labor productivity of American miners is 58.7 times as high as that of Ukrainian miners. Here we do not take into account the fact that on average, Ukrainian coal contains 4000-5000 kcal/kg, while internationally, 7000 kcal/kg is usual.[xx]

On average, in Ukraine production costs of coal are 40 dollars per ton compared with a world price of 35 dollars a ton, requiring huge government subsidies. According to the former minister of coal industry, Mr Tulub, coal enterprises owed late 1998 8.5 billion hryvnas to creditors and 63 per cent of mines were operating at extreme losses.[xxi]

Support by the state is provided to cover 'accounting losses' which equals to 'profit on paper', reduced by the sum of operational losses. 'Profit on paper' is calculated by multiplying listed prices by the sales amount, provided by financial estimation. In fact, the real price of coal sold by the mines is much less than the listed price. That is why the mines which fulfil their production plan can not cover the operation costs, even when subsidized by the state.

Well functioning mines are punished by siphoning off profits while badly performing mines are rewarded with subsidies. In Donetsk, fifty per cent of mines, all loss making, produce only 15 per cent of coal output. These mines take, however, two thirds of all subsidies to the coal mining sector.[xxii]

A lot of (expensive) coal is consumed by electricity power stations. There the economic situation is disastrous as many clients, including industrial clients, do not pay, or have big payment arrears. In Ukraine as a whole, only 7 per cent of delivered electricity is paid in cash, half is paid in barter, and the rest is not paid for at all (1999).[xxiii] Electricity tariffs are still below cost price. On top of that, government has denominated 645000 energy consumers as privileged energy payers. The government does not compensate the energy enterprises for these discounts.[xxiv] As a result, electricity power stations do not pay for a large part of coal supplies.

Also, big state enterprises, like cokes and steel enterprises, consume a lot of coal that is only partially paid.

End 1998, 60 per cent of paid coals was paid in barter, down from 77.5 per cent in early 1997.[xxv] In January/February 1999, just 20 per cent of coal sold to consumers was paid for using cash. This contributed to wage arrears.

Private middlemen selling coal, keep one third of the proceeds from coal sales, according to federal tax police.[xxvi]

In 1998 a middleman sold 6.3 million m3 gas to Krasnodonugol, a local mining company at a price of 88.7 dollars per 1000 m3. However, other suppliers sold for 66 dollars. Gas sold at auctions sold even lower. However, in 1998 Krasnodonugol shipped 33, 457 tons of coal to the middleman for a total amount of 564 722 dollars.[xxvii]

Another example: a fiscal report of government dated 1998, showed the case of a middleman who sold a piece of machinery to a mine six times the market price.[xxviii]

It means that the performance of coal mines is on paper worse than it would be in a situation of open competition. Of course, other factors are involved, such as hidden and open state subsidies, that makes an assessment of the performance of coal mines even more complicated. However, is it safe to say that with the elimination of corruption in the coal sector, many more coal mines would be profitable and less state subsidies would be needed.

An important mineral resource is the methane accumulated near coal seams. Estimates of reserves vary from 1 to 20 trillion cubic metres (depending on the depth of occurrence). The problem is that big investments are needed to extract methane. Foreign investors could do the job but are not interested due to bad investment climate in Ukraine.[xxix]

Ukrainian gas consumption was 90 billion m3 in 1999. 18 billion m3 was domestically produced. Within Ukraine the state owned company Naftogaz, founded in 1998 to unite all state oil and gas enterprises, is responsible for all gas and oil extraction. (5-96).

Early 1998, the gas price was 83 dollars for industrial consumers and 66 dollars for budgetary organizations and households. Von Hirschhausen calculated that under competitive conditions the price could be 40 per cent lower. One cost factor is the salaries of workers in the Ukrainian gas sector where employment is 20 to 30 times higher than in comparable market economies.[xxx] By mid 2000, the gas market was divided among Naftogaz and 10 private firms who accounted for 80 per cent of gas turnover. All private firms depended heavily on government protection.[xxxi]Naftogaz supplies a large part of gas consumed in Ukraine. However, only 34 per cent of gas is paid, 11 per cent is paid in cash.[xxxii] As a result, Naftogaz accumulated huge debts with the government.

Ukraine has six oil refineries, four of which have halted production, due to insufficient supplies of oil. Only half of the rude oil is refined into benzene, diesel and other clean fuels while half of it is forwarded to thermal power stations for fuel. With modern refining methods 80 to 90 per cent of crude oil could be transformed into high quality fuels.[xxxiii]

About half of Ukraine’s electricity is provided by nuclear power stations. As all power stations, they are faced with non-payment of the energy bills. This resulted, among others, in non-payment of wages, lack of investment funds, lack of funds for maintenance and even non-payment of supplied fuels from Russia. The Ukrainian government sought to remedy the situation by designating the most liquid industrial enterprises as privileged customers of Enerhoatom, that is the umbrella organisation for all nuclear power stations in Ukraine. It was argued that in such a way, Enerhoatom could get cash payments for delivered energy and so generate the cash needed to buy fuel supplies in Russia.[xxxiv] This drained liquid consumers from the thermal power stations.

However, Enerhoatom is still in big financial problems. This is partly related to corruption in Enerhoatom. Vice premier Timoshenko accused Enerhoatom of embezzlement.[xxxv] A ministry's report calculated that 40 per cent of Enerhoatom's costs had nothing to do with the actual production of energy.[xxxvi] Intermediary companies supplying nuclear fuel charge 30 per cent commission. Also, 23 per cent commission is charged for sending spent fuel to Russia. Also, Enerhoatom supplied electricity for 20 per cent of the market price.[xxxvii] According to president Kuchma, Enerhoatom provided in 1999 intermediaries worth 1.5 billion hryvnas (approximately 300 million dollars) worth of electricity at a one third discount.[xxxviii] Timoshenko accused Ukrainian Credit bank of squeezing Enerhoatom by levying an interest rate of 1 per cent a day for loans provided to Enerhoatom.[xxxix] In 1999, Enerhoatom recorded a 1.4 billion hryvnas loss that was covered by the state.

 

The situation in thermal power stations is even worse. They are mostly built in the 1950s and 1960s and already passed their anticipated service life. Operating expenses are very high.[xl] Increasingly the electricity power stations are overloaded with the result that nuclear power stations are automatically switched off due to too low frequency in the electricity grid, As a result thermal power stations are even more overloaded and forced to cut off energy supplies to part of customers, especially in the countryside. In Kharkiv, the second town of Ukraine, electricity is cut off twice or three times a day.[xli]

A general problem with energy producers is that Ukraine depends on former Soviet republics, primarily Russia, for a range of electricity transforming and transmission equipment, units of refinery equipment, pumping stations and parts of nuclear reactors. The disruption of the Soviet division of labour affected the Ukrainian energy complex very much. For example, uranium is extracted in Ukraine, it is processed into fuel for nuclear power stations in Russia, then sent to Ukraine. Subsequently, the used fuel is again sent to Russia for processing.

The conclusion is that energy producers are squeezed by intermediaries and do not get incentives to invest. A reformed energy sector and better investment climate could lead to less subsidies and turning loss making energy companies into profitable ones. In some areas, like methane and nuclear power, production could be enhanced. To replace the nuclear power station Chernobyl, two new nuclear power stations will be finished, in Rivne and Khmelnytsky, with Western help.