KyivPost

How To Go Broke Owning Monopolies

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March 19, 2010, 12:48 a.m. | Business — by Mark Rachkevych

For many Westerners, the sight of a Soviet-built locomotive pulling passenger wagons out of Kyiv’s main train station is like a rare glimpse into the distant past. (Yaroslav Debelyi)

Mark Rachkevych

Mark has been a reporter for the Kyiv Post since 2006, but joined full-time in 2009. A native Chicagoan where he was the co-founder of the now defunct Glasshouse Magazine, Mark currently is an editor of business news and still contributes stories on an ongoing basis. He is a former U.S. Peace Corps volunteer, a graduate of St. Norbert College in Wisconsin, and fluent in the Ukrainian and Russian languages.

In the Monopoly board game, the object is to buy up businesses, eliminate all competitors and then watch the money pile up. The real-life Ukrainian version has variations that can be even sweeter for millionaire moguls: Let the government keep the giant monopolies, but find complicated ways to bleed their profits and then stick the nation and its long-suffering taxpayers with the losses. At least that’s how it appears that three of the nation’s top monopolies are run.

The three biggest and baddest are: Ukrtelecom, which controls the nation’s fixed-line telephone network and 3G technology; Naftogaz Ukraine, which controls the all-important natural gas and oil trade; and Ukrzaliznytsia, the railway giant.

Through their services, Ukrainians keep fed and warm, travel all over the nation and communicate with each other.

These government entities should be the country’s pride and joy. They also should be moneymaking machines and they are – but only for well-connected insiders, not for the state budget and taxpayers.

To critics, these government-mismanaged industries have refined corruption to a fine art, while creating serious – perhaps crippling – long-term financial problems for the nation in the process.

“These state monopolies have been stripped of revenue with which to invest in infrastructure and modernization,” said Ildar Gazuzillin, an economist with Kyiv’s International Center for Policy Studies.


All face decline


When the telecommunications giant Ukrtelecom recently became the third state-controlled monopoly to technically default on a loan, the debacle yet again exposed how the monopolies have been mismanaged and ravaged.

Ukrtelecom was once valued as high as $3 billion by analysts and has long been slated for privatization. Now, analysts don’t believe Ukrtelecom will fetch anywhere near that price. Besides a weak market, mismanagement is one of the reasons why.

Ukrtelecom had to write an embarrassing letter asking creditors for a a three-month extension to make a $41 million loan payment that came due on Feb. 25 on a $500 million loan.

The others, Ukrzaliznytsia state railway and Naftogaz Ukraine, have also been treading in dangerous financial waters.

Both have been forced to restructure billions of dollars in loans owed to foreign creditors amid reports of severe cash-flow problems. The lack of oversight of these companies makes it difficult to ascertain how much money the Ukrainian people have been shorted and where the money went.


Corruption reigns


So what went wrong at such behemoths with privileged positions in the market? Just about everything, it seems, including Ukraine’s constant companion: rancid and widespread corruption.

From independent industry analysts to Russian Prime Minister Vladimir Putin, the assessments are similar. Putin made a broad indictment of the Ukrainian political and economic structure on Jan. 8, 2009, during the three-week gas cutoff between the two nations.

“The incumbent Ukrainian leadership is incapable of organizing the normal and transparent functioning of the economy on market principles and, moreover, by its actions is causing heavy damage to the Ukrainian people,” Putin said then. “I regret to say that it indicates a high level of corruption in Ukrainian government structures which today are fighting not over the gas price, but for the possibility to keep certain mediators [RosUkrEnergo] in the game in order to use the dividends for personal enrichment…”

In January 2009, Putin and his Ukrainian counterparty, the now former Ukrainian Prime Minister Yulia Tymoshenko, cut the murky RosuUkrEnergo firm out as a middleman in the multi-billion-dollar monopoly business of supplying Ukraine with natural gas.

But outside of this, little has changed, and many fear other schemes will remain in place despite the change in presidential leadership from Viktor Yushchenko to Viktor Yanukovych.

Those who designed the way that the monopolies operate also aided in their schemes by government’s lack of oversight and “slow and incomprehensive regulation,” Gazuzillin, the economist with Kyiv’s International Center for Policy Studies, said.

Such opaque schemes are no accident. Some of the most vicious political struggles in the nation are over who controls these monopolies. So the natural result is highly politicized – as opposed to professional – management of these monopolies.

Corruption, however, doesn’t explain everything.

People have gotten used to the idea that these monopolies – perhaps a holdover of Soviet attitudes, or merely the philosophy of the government’s role – should provide cheap services.

“These companies for years have had to carry the Soviet-style social burden of the state in providing key services cheaply to the public,” economist Gazuzillin said.
But this comes at a huge cost to the nation, through various schemes that amount to shell games.

A case in point is Naftogaz, which controls most of Ukraine’s lucrative and vast natural gas chain, ranging from exploration, transit and production (including import).

It has long provided gas to households and key industries at below-market prices, relying on subsidies from the government to cough up the difference. It has further exacerbated its problems by not ensuring payment of gas that it resells.

But the main problem has been the prevalence of mysterious intermediary companies that, critics charge, serve no purpose other than to skim off profits from Naftogaz’s supplies through the re-selling to other intermediaries before eventually reaching the consumer.

“It’s a road to nowhere,” said Oleksiy Blinov, an economist with Astrum Investment Management. “Naftogaz is losing more than $1 billion per year.”

There are 52 “oblogaz” distribution companies that provide natural gas to consumers, according to the National Energy Regulatory Commission. They are all private structures, some of which are jointly owned by the state and controlled by a select few businessmen, allegedly billionaire Dmytro Firtash, former deputy Naftogaz head Oleh Bakhmatiuk and Russian billionaire Viktor Vekselberg, among others.

According to estimates, these “oblogaz” companies collect nearly 100 percent cash owed by household consumers for utility bills but pass on as little as 60 percent of this up to the original supplier, Naftogaz. They are considered to be a huge ingredient in Ukraine’s internal grey gas market.

While premier, Tymoshenko tried to clean up the regional gas distribution sector by bringing them under Naftogaz’s control during her rule, but political opponents and businessmen with vested interests blocked her attempts to change the status quo.

In January 2009, Firtash, who owns a 45 percent stake in RosUkrEnergo compared to a 50 percent share by Russia’s Gazprom, admitted controlling 75 percent of the domestic market that distributes and supplies gas to consumers, according to an interview he gave to Russia's Vedomosti newspaper.

Later that same month, Firtash denied that he controls any regional gas companies. Instead, he said that he had the option of buying shares in a number of gas companies. And in April 2009, the Anti-Monopoly Committee said that Firtash didn’t control any regional gas companies, following a review of the ownership structures of 52 regional gas companies. Bakhmatiuk, the former Naftogaz official, didn’t respond to Kyiv Post inquiries.


Cheap addiction

Ukraine has the most energy-intensive economy in the world, given its reliance on heavy industries such as steelmaking. The nation’s inefficient consumption of historically cheap natural gas has discouraged energy efficiency projects. Ukraine’s international partners have long pressed for change.

Ukraine’s energy infrastructure has, meanwhile, deteriorated. Its vast natural gas pipeline network – which transports 80 percent of Russia’s exports to Europe – literally leaks gas along the way. In 2007, for example, one of the main gas transmission lines near Kyiv exploded.

All of this is directly related to the lack of capital to invest in modernization.

“If [the state] didn’t use Naftogaz as a social policy vehicle and liberalized the energy sector by making it more business-oriented, Ukraine would greatly reduce gas imports,” Astrum’s Blinov said.

But the path to a market-based sector would hurt entrenched commercial and bureaucratic interests, economists Anders Aslund and Oleksandr Paskhaver wrote in “Proposals for Ukraine: 2010 – Time for Reforms.”


Russian Prime Minister Vladimir Putin in Moscow on March 15 (AP)

Doling out access

Problems can also be found with Naftogaz oil distributor, UkraTransNafta, which determines pipeline access for private investors.

In other words, “the parties who control the Ukrainian oil and gas sector use their positions to block development, to extract economic rent, and to pick commercial winners and losers for their personal convenience,” Edward Chow and Jonathan Elkind wrote for the Washington Quarterly in January 2009.

Another lucrative scheme for those who control it involves the procedures for auctioning oil produced by state-owned ventures to private companies. Investment banks said Ukrnafta, another Naftogaz subsidiary, sells oil in a way that allows one business group – the so-called Privat Group led by billionaire Igor Kolomoisky – to reap most of the profits. This competition-stifling method ends up cheating the state budget, robbing the nation of capital needed to expand domestic production.


Criminal probes

Naftogaz also has a horrible reputation for financial transparency, failing to publish annual reports for years on end. This opacity has allowed personal enrichment schemes to flourish. Naftogaz’s first chairman, Ihor Bakai, was in recent years wanted by law authorities for alleged corrupt practices.

Almost all of these allegations, however, never get investigated or prosecuted.

The lone exception involved former Prime Minister Pavlo Lazarenko, who served ex-President Leonid Kuchma from 1996-1997. He was convicted in the United States for laundering millions of dollars in state money. The charges related to abuse of his state position for private enrichment in the gas sector.

International partners are starting to take action. The European Bank of Reconstruction and Development held off on issuing a $300 million loan to Naftogaz in 2009 “subject to reforms in the gas sector and within the company,” reforms that have not been forthcoming.


Firtash’s RosUkrEnergo

The main intermediary fingered by critics when energy-sector corruption is discussed is RosUkrEnergo, co-owned by Russia’s oil and gas monopoly Gazprom and Ukrainian businessmen Dmytro Firtash and Ivan Fursin.

RosUkrEnergo had no assets or no track record when it was chosen in 2004 to be monopoly supplier of gas to Ukraine. In the years that followed, it was even given wholesale rights on the domestic market, further cutting into Naftogaz’s profit-making activities. It entered this lucrative trade without any public competition.

Firtash, allegedly a backer of President Victor Yanukovych, reportedly reaped enormous profits in this middleman role. Energy-sector experts can’t understand why obscure businessmen were given control of such a large swath of a strategically-important sector. For his part, Firtash has portrayed his involvement as a money-losing proposition. “Ukraine for us is a subsidy. In 2005-2007 we subsidized the Ukrainian [state] budget by nearly $5 billion,” Firtash said in January 2009.




A welder is fixing a gas pipe in Dnipropetrovsk region in this September 2009 photo (top). Clients are sorting out their paperwork in an Ukrtelekom service center in Kyiv. (Ukrinform)

But RosUkrEnergo is only the latest in a line of intermediaries between Naftogaz and Russian gas monopoly Gazprom, the presence of whom even confounded Kuchma, the nation’s president from 1994-2005.

Kuchma said in 2000, when Firtash-linked Eural Trans Gas was the middleman: “I cannot help but to pay attention to the fuel and energy complex, because the situation there has crucial importance for the economic and political stability of the state, for the economic development and life of the people. Unfortunately, this key sector is the most criminalized, according to the opinion of all experts. It is also too politicized.”

The long and short of it, Astrum’s Blinov said, is: “There’s always opportunity for corruption whenever there are black boxes in place, when there is no accountability and no clear links between government and [companies like] Naftogaz.”

Whether the Yanukovych administration reverts to the murky middleman schemes removed in 2009 is yet to be known. But already analysts and others are alarmed by the re-emergence of Firtash-connected people among top presidential appointments. Tymoshenko, for instance, claims that the appointment of Yuriy Boyko as energy minister had brought to power “the RosUkrEnergo squad.” Rosukrenergo was, afterall, introduced while Boyko headed energy policy under previous Yanukovych governments.

Meanwhile, Firtash has taken the Ukrainian government to court to retrieve 11 billion cubic meters of gas controlled by Naftogaz. If the ruling is against Naftogaz, the state could lose out on $4 billion.

One thing is clear: All these schemes have taken their toll on Naftogaz’s bottom line. It has such large debts and liabilities that it could go bankrupt. The problems for the nation could get even more serious.

Ukraine has repeatedly damaged its reputation as a reliable gas transit country to Europe. Therefore, many pipeline projects are in the works that threaten to bypass the nation altogether, cutting it out of a $3 billion per year gas transit business. Russia is the main instigator of these bypass pipelines, including Nord Stream and South Stream.

If Ukraine loses its vital gas transit role, the nation will have no one to blame but it’s own leaders for allowing such an uncompetitive, murky trade.

“Legitimate domestic and foreign investors are discouraged from fully developing Ukraine’s ample oil and gas endowment while revenue and stripping of state assets are prevalent,” wrote energy expert Chow. “International financial institutions, the European Union and the United States may no longer be so interested to offer financial and technical assistance as they are today. The world will have moved on, with or without Ukraine.”


Working on the railroad

Ukraine’s railroad holding is another poster child of government ineptitude or worse. Late in 2009, Ukrzaliznytsia missed a $110 million principal payment on a $550 million loan and had to restructure.

Considered one of Ukraine’s largest holdings, it for years has provided passengers with cheap tickets at the expense of its bottom line. And since late 2008, the government has kept freight transportation tariffs frozen for the nation’s largest private industries – including chemical and steel plants. These direct subsidies help the wealthy owners of these businesses, but rob the state budget of cash.

“This [railway] conglomerate has all the problems of a state monopoly. It has poor tariffs, it’s not transparent and it is very inefficient,” said Oleksandr Paraschiy, a senior analyst with Bank of Georgia Capital.

In 2009, the Transportation Ministry reported that Ukrzaliznytsia received Hr 13 billion less in sales, attributable to freight transportation sinking by 22 percent, subsidization of passenger traffic at the expense of freight, and other discounted transportation rates. Yet the railroad monopoly said it made Hr 245 million in 2009 because of cost-cutting measures.

“It’s difficult to see how they made a profit,” said Igor Bilyk, a financial analyst with Astrum.

Financial figures are not good indicators of the effectiveness of Ukrzaliznytsia, said Dmytro Pidturkyn, who works for Consortium Management Consulting Group, a company contracted by Ukrzaliznytsia. “Historically, the holding has had to function within the boundaries of tariff setting from above and is always beholden to discretionary practices of tax authorities,” Pidturkyn said.


Ildar Gazuzillin, the economist with Kyiv’s International Center for Policy Studies


Dmytro Firtash became a billionaire by monopolizing natural gas supplies to Ukraine


Valentyna Semenyuk, head of parliament’s privatization watchdog in 2005


The late Heorhiy Kirpa, Ukraine’s former Transportation Minister

Ukrzaliznytsia has invested little into its aging fleet of rail cars, many of which are on the verge of collapse, according to Bilyk. In January 2009, the European Bank for Reconstruction and Development approved a $62.5 million loan to Ukrzaliznytsia to purchase new freight wagons in a program to renew its rolling stock.

However, it failed to replace any of its fleet of 7,500 passenger – 40 percent have exceeded their 28-year lifespan – and 120,400 freight cars in 2009. The EBRD loan is still on hold as only a tender to purchase freight cars has been developed.

Ukrzaliznytsia’s net income since 2000 has fluctuated from losing Hr 1 billion in 2000 to making as much as Hr 1.6 billion in 2005, the year after the notorious transportation minister, Heorhiy Kirpa, died under mysterious circumstances. Under Kirpa’s rule (2002-2004), he oversaw billion-dollar projects including the reconstruction of train stations, railways, highways, bridges and other public works, as well as the lucrative telecoms sector.

Kirpa’s career was riddled with questionable activities, including unproven allegations that a large share of state railway profits were siphoned to private interests. Kirpa, suspected of channeling public money to Yanukovych’s 2004 presidential campaign, was found dead at his home on Dec. 27, 2004, in a death ruled as a suicide.

Just days before his death, Kirpa had transferred $35 million from the state budget to a commercial company controlled by “Donetsk fellas” for the construction of a bridge, said Valentyna Semenyuk, head of parliament's privatization watchdog in 2005, according to London's Telegraph newspaper.


Bad wiring

The information age has fueled enormous profits for many of the world’s top telecommunications firms. By contrast, Ukraine’s big telecom company has managed to perform poorly.

Ukrtelecom controls over 75 percent of the local Ukrainian fixed-line market and up to 65 percent of the inter-city fixed line market. But it has not leveraged this position for a significant share of the more lucrative cell phone and Internet business.

Also burdened by legislation that forces it to provide “universal telephone access” to customers, even in rural areas, the government giant couldn’t concentrate on developing other niches. Estimates show that Ukrtelecom has incurred more than $1 billion in losses to meet the mandate of universal coverage.

Many of its investment and expansion projects have gone bust, leaving Ukrtelecom with combined debt obligations of Hr 3.6 billion, according to Bank of Georgia’s Paraschiy. And, despite having the country’s only 3G license, Ukrtelecom has lagged in delivering this cutting-edge technology.

“What it has needed was a strategic investor who would’ve come in to develop products in niche markets, bring in profits and investments,” Blinov said.

The drag of government bureaucracy and inefficiency also looms large, with one Ukrtelecom employee serving only 100 customers, far less than comparable figures for Europe and even Russia. Procurement issues also raise suspicions of corruption, said Ukrtelecom board member Mykola Honchar, who said that since 2005 the telecom giant has purchased products and services such as modems at above-market prices

The Kyiv Post could not reach Ukrtelecom chairman Heorhiy Dzekon for comment.

Ukraine’s leaders have stalled on privatizing Ukrtelecom, despite the urgent government need for cash. These delays may mean that, when the government finally gets around to selling the asset, it may fetch much less than predicted before the 2008 global financial crisis.

Yet another missed opportunity in a nation full of them.


Kyiv Post staff writer Mark Rachkevych can be reached at rachkevych@kyivpost.com.
The Kyiv Post is hosting comments to foster lively debate. Criticism is fine, but stick to the issues. Comments that include profanity or personal attacks will be removed from the site. If you think that a posted comment violates these standards, please flag it and alert us. We will take steps to block violators.
Anonymous March 19, 2010, 8:20 a.m.    

I have a house in the center of a city in Ukraine. I applied for a telephone line 18 months ago. I will use my phone line for international calls and to have OHO 8, which means spending about 500-600 UAH a month. They won't give me a line. "There are no numbers avaoilable." And I'm not the only one facing this problem.

Until all of the soviet neanderthals who basically run Ukrainian business, and whose only business acumen is finding area to cheat and steal, are dead, business here will be a joke.

Fortunately, the life expectancy for these people are on par with Africa (as are the roads, hospitals, water and sewage, etc...)

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Anonymous March 19, 2010, 9:58 a.m.    

Only in Eastern Europe, and especially Ukraine, can a monopoly go bankrupt.

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Anonymous March 19, 2010, 11:47 a.m.    

nice, profesional informative article, keep it up!

I've already encountered proposals of establishing such middle-men companies, shamelessly by bureacrats. Why am I not surprised since these guys earn 1000 USD at best in monthly salary (if they get paid even) whereas their fellow class-mates who went private is driving around in 100 000 USD jeeps, consuming every penny their earned instead of re-investing it in something useful.

Good move would be to increase salaries for judges, release a good 25% of the workforce in the police force and increase salaries for those who are left instead. There needs to be a sense of rule of law in order for the society to turn around the corruption culture

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Anonymous March 19, 2010, 12:10 p.m.    

The former head of the &quot;loss-making&quot; UkrTransNafta compnay now lives in a 25-million-dollar mansion in Hollywood.

Where is the CIA? Where is the FBI and Justice Department? Why aren't they going after this trash? They should kick them out of the US and expropriate their wealth to pay for USAID to Ukraine...

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Anonymous March 19, 2010, 7:24 p.m.    

At least once a month, UkrNafta sells millions of dollars worth of oil to Igor Kolomoyskiy's Privat Group at a rigged auction, at a 35-45% discount from the world price.

This is one of the most obvious examples of energy sector corruption in Ukraine and should be stopped immediately.

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Anonymous March 19, 2010, 12:41 p.m.    

This is the best article i have read in KP in a while. The author gets beyond the often-repeated clichees that Ukraine's big state-run monopolies are &quot;loss-making&quot;.

In fact these monopolies earn a huge amount of money for the private, and often anonymous, individuals who have access to their vast resources.

But i don't get why only RosUkrEnergo is a &quot;murky intermediary&quot;. NaftoGaz, when it was controlled by Tymoshenko's people wasn't &quot;murky&quot;? NaftoGaz is the most murky intermediary of all...

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Anonymous March 25, 2010, 1:29 p.m.    

Thank you very much for this wonderful article! Are sending it to some of those people who decide over more loans and investments into Ukraine???

So sad.. how far will these people pull their own people down.

keep on doing the good job!

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