Ukraine’s vast coal sector has long been characterized by too much state ownership, too little development and some deadly mine disasters.
But this picture is about to change, as rising domestic demand for electricity captures the interest of foreign capital.
Coal mining, despite its negative environmental image and infamous safety record, is making a comeback as a source of power in Ukraine.
And foreign investors are helping to facilitate the industry’s recovery, and may introduce cleaner and safer technology as they pursue higher productivity and profit.
Last month, Sadovaya Group, a Luxembourg-registered holding company representing two underground mines and other coal industry assets in eastern Ukraine, took in just over $30 million from an initial public offering (IPO) of 25 percent of its shares on the Warsaw Stock Exchange.
Zasyadko coal mine workers dig graves at a cemetery near the mine in Donetsk on Sept. 21, 2006, one day after their colleagues were killed in an explosion caused by a gas leak. (AFP)
Sadovaya Group boasts fourth place among Ukraine’s largest private producers of energy coal, used in power stations, which differs from the coking coal used in the steel-making process.
The company’s co-owner and founder, Oleksandr Tolstoukhov, is a former manager at Ukraine’s Alchevsk Steel Mill in the early 1990s.
Tolstoukhov now owns 38 percent of Sadovaya Group, with the remaining 37 percent in the hands of his partner Serhiy Stetsurin.
The company will use the external equity financing from mostly institutional investors, in addition to its net profit of $7.9 million for the first nine months of last year, to modernize and develop its mines, equip its coal waste recovery and enrichment facilities, and expand.
In the mean time, Sadovaya is now Ukraine’s only foreign-listed coal mining company, and only one of a handful of public energy coal companies from Eastern Europe, including Russian Kuzbass Fuel Company, Czech New World Resources, and Polish Bogdanka, according to the analytical department at BG Capital, the lead manager for the placement in Ukraine.
Foreign interest
But investor interest in the coal business is even more far-reaching. Last October, the world’s largest coal producer, Coal India, completed a $3.4 billion IPO.
Other large-scale international mergers and acquisitions activity in the global coal market is in the making.
Action is expected to pick soon in Ukraine, which has a large coal sector with vast untapped deposits but desperately needs modernization.
Foreign investors have declared serious interest in Ukraine’s coal sector in 2010, while this interest was rather sporadic previously.”– Roman Topolyuk, an analyst at Kyiv-based investment bank Phoenix Capital.
Coal is the only energy source whose share in primary energy consumption has grown globally in the last decade, according to research recently published by energy giant BP. This makes coal producing countries such as Ukraine potential destinations for foreign capital.
“Foreign investors have declared serious interest in Ukraine’s coal sector in 2010, while this interest was rather sporadic previously,” said Roman Topolyuk, an analyst at Kyiv-based investment bank Phoenix Capital.
In addition to Polish investor interest in Sadovaya, the Czech Republic’s New World Resources recently announced that it was considering the purchase of coal mining assets in Ukraine.
“The major reason for such interest is that Ukraine has rich reserves of coal (34 billion metric tons), putting the country in 6th place globally,” Topolyuk said.
The bulk of Ukrainian coal, both energy coal and coking coal, can be extracted with substantial profit, he added.
In 2009, Ukraine extracted 72 million metric tons, making it the world’s 12th largest producer, according to BG Capital.
That same year, however, only around 7 percent of Ukrainian-produced coal was exported, Topolyuk said.
Ukraine could have exported more but current levels of production are largely absorbed by domestic demand, he added.
“In 2010, we expect an 11 percent increase that would turn into 5.9 million metric tons to be sold abroad,” said Topolyuk.
The country’s main export markets are Bulgaria (1.48 million metric tons) and Turkey (0.92 million metric tons) but also other countries in Europe, as well as Brazil, India and Russia.
But already countries with even larger appetites such as China, the world’s largest producer but a net importer, are knocking at the door.
Ukraine’s coal industry and China’s State Development Bank signed a framework agreement on financial cooperation in September 2010 during Ukrainian President Viktor Yanukovych’s visit to China.
Under the agreement, Ukraine’s coal ministry presented to the Chinese side a package of seven investment projects with an estimated cost of more than $1 billion, the Xinhua news agency reported.
Domestic demand
Analysts at BG Capital also emphasize the growing domestic demand for Ukrainian energy coal, predicting that it is expected to increase by 60 percent over the next five years.
“Domestic demand for electricity is forecast to rise by 3-4 percent annually, but the country’s nuclear reactors, which supply around half of the country’s power, are going to have to start being shut down next, at least long enough to have their life cycles extended,” BG Capital analyst Alexander Paraschy said.
Hydro-electricity plants are maxed out, and alternative fuel such as solar and wind are still in their infancy. So thermal plants, which run on mostly coal but also natural gas and heating oil, are well placed to fill the gap, he added.
Domestic demand for electricity is forecast to rise by 3-4 percent annually, but the country’s nuclear reactors, which supply around half of the country’s power, are going to have to start being shut down next.”
– Alexander Paraschy, BG Capital analyst.
But for coal to pick up the slack left by Ukraine’s nuclear industry, thermal plants, which currently account for about 40 percent of the nation’s electricity, would need investment to significantly increase output.
Moreover, as some 60 percent of Ukraine’s 150-plus coal mines are still under state control, many will have to be privatized in order to improve efficiency.
Last month, Ukraine’s Energy Ministry published a list of over one dozen state coal mining companies that it considers attractive to investors.
The list follows pledges made by Ukrainian President Viktor Yanukovych last year to open up the sector to privatization.
Other mines could be leased out long term or be included into a joint venture between a strategic investor and the state, Topolyuk said.
Cleaning house
An influx of investment could help lift an increasingly heavy burden off state coffers, which continue to heavily yet non-transparently subsidize coal mines.
Ukraine’s government reported that that average losses for coal mines grew from $4 per metric ton in 2004 to $33 per metric ton in 2009.
And out of Hr 10.8 billion in 2009 budget financing ($1.4 billion, or 3.5 percent of the country’s consolidated budget expenditures) into state mines, only 4 percent was directed for investment programs, the ministry acknowledged.
Volodymyr Omelchenko, an energy analyst at Ukrainian think tank Razumkov Center, said the state’s current management of the majority of the country’s coal mines is a recipe for corruption and disaster.
No one takes responsibility.”
– Volodymyr Omelchenko, an energy analyst at Ukrainian think tank Razumkov Center.
He said there are three kinds of mines in Ukraine: private ones that are profitable and were long ago taken over by well-connected business interests; less profitable ones which are de jure owned by the state but de-facto rented out to private businessmen who are less than concerned about miner safety or the environment; and purely state-owned ones “which are the scariest of all.”
In November 2007, an accident at Ukraine’s Zasyadko mine in Donetk claimed the lives of over 100 miners – the worst coal mining disaster in the country’s history, but by no means an isolated incident.
“No one takes responsibility,” Omelchenko said, referring to Ukraine’s state-owned mines.
One of the main threats to safety comes from the practice of paying miners by the amount of coal that they produce rather than by the hour, forcing them to break safety rules to earn a decent wage.
Bringing in a foreign investor could improve the situation with miner safety as well as environmental protection, but only if the government were to draft and enforce appropriate operating regulations.
Topolyuk said investment received from future IPOs and other forms of foreign investment should go toward the purchase of newer equipment, “which provides higher productivity and safety, implying stronger profits and sustainable operations.”
Investment should also go towards modernization of infrastructure and the opening of new coal seams to meet rising demand.
“The Ministry of Fuel and Energy outlined an anticipated 2011 increase in demand from power plants by 12 percent to 36 million tons. Therefore, the average purchase price is expected to climb by 19 percent to Hr 675 ($85) per ton.”
