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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.^xxxiNaftogaz 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.

4. Reform of the energy sector

It was mainly under the pressure of IMF, World Bank and other international financial donors, that the government under Prime Minister Victor Yushchenko embarked upon a reform of the energy sector in early 2000. Surprisingly, it was Yulia Timoshenko, head of United Energy Systems of Ukraine during 1995-1997, who became the vice prime minister responsible for energy. While being Prime Minister, Pavel Lazarenko gave United Energy Systems in 1996 monopoly rights and a tax break for five years. This gave the company and Lazarenko, who is now prosecuted in the United States for money laundering, hundreds of millions of dollars profit.

The energy sector reform was aimed at boosting cash receipts for the energy producers and distributors by forbidding barter trade and forcing the settlement of energy deals through special, government controlled accounts in the Oshchad bank. All consumers must deposit electricity payments into special accounts at Oshchad bank. Subsequently the cash is distributed among oblenergos and energy generators.^xlii

The impact of these reforms is difficult to assess given contradictory information from government sources. When Timoshenko presented before parliament figures about payments in the energy sector, in October 2000, she told parliament that cash payments of energy consumers increased considerably since the onset of reforms. She claimed that tax authorities received much more in 2000 compared to 1999. However, these claims were denied by the tax authorities and a commission investigating these conflicting claims came to the conclusion that Timoshenko misinformed parliament. It was stated that payments to the budget from the side of actors in the energy consumers did not increase in 2000. Debt for electricity deliveries rose in 2000, according to tax authorities. ^xliii The consumer debt to Naftogaz was up from 2.6 to 4.4 billion hryvnas in the first 9 months of 2000.^xliv Electricity supplied by state owned generators was only half paid in cash

Conflicting figures were, among others, based on the fact that Timoshenko allowed oblenergos to offset debts owed to energy providers with tax debts of these energy providers. The Cabinet of Ministers permits mutual settlements of government financed entities' energy debts.^xlv Also, government ordered Oshchad bank to provide government backed loans to oblenergos to allow them to pay for energy supplies. In this way, the payments record of oblenergos was artificially boosted. The World Bank expressed concern about this.^xlvi

Moreover, Yevhen Marchuk, the director of the national security service, accused Yulya Timoshenko that she used credits of Oshchad bank to purchase expensive energy from offshore companies.^xlvii

Oblenergos started to pay more to electricity providers, but do not collect any more from their customers.^xlviii With Lvivoblenergo. the collection rate increased from 60 to 70 per cent from 1999 to 2000. However, there are cash flow problems because of increased payments to the energy providers. Therefore, there is less money for salaries and basic supplies. Formerly, energy providers were paid with goods and promisory notes.

The energy producers profited from the energy reforms and received initially more cash that was used to pay wage arrears. The financial situation of coal mines improved. Cash payments for electricity supplied by state generators was 50 per cent paid for in cash during the first nine months of 2000, while it was only 19 per cent during the same period in 1999.^xlix Government figures show that, on paper at least, losses of coal mines gradually diminished over the first 10 months of 2000 and turned into profits in July and August. During the first three months approximately half of all payments was in cash, but this ratio declined subsequently to approximately 8 per cent in October 2000. The share of mutual settlement rose to 10-20 per cent during July-October 2000. The share of barter rose from approximately 50 per cent of all payments during the first three months of 2000 till approximately three quarters during August-October 2000.^l

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