Privatesector P U B L I C P O L I C Y F O R T H E Note No. 170 December 1998 Laszlo Lovei Coal Industry Restructuring in Ukraine The politics of coal mining and budget crises Many countries are Restructuring Ukraine’s coal industry has been even more difficult and politicized than reforming struggling to liberalize their energy markets its electricity and gas industries. Coal reform has divided Parliament and the government into and to replace rigid state controls with two camps—one supporting populist policies and the other supporting fiscal realism—and the private initiative and ownership. Ukraine balance of power between these camps has changed frequently. Despite mounting financial illustrates the extreme difficulties losses, coal miners and managers have blocked attempts to rationalize production and of this transformation when a country’s employment practices. The government has, however, managed to close several highly macroeconomy is severely imbalanced, uneconomic mines. Speeding up mine closures seems to be the only way to arrest the enterprise governance is poor, and political accumulation of payment arrears—nearly US$4 billion (including wages) by mid-1998—and leadership is ineffective —shortcomings that of payments due for coal supplies—more than US$1.5 billion by mid-1998 (figure 1). also exist in several other countries of the former Soviet Union. This Note is the third of three on Ukraine’s FIGURE 1 COAL INDUSTRY ARREARS energy reforms; the other two are on the electricity and gas US$ millions industries. 4,000 Payables (including wages) 3,500 Receivables 3,000 2,500 2,000 1,500 1,000 500 0 January August January August January August January July 1995 1995 1996 1996 1997 1997 1998 1998 Source: Ukraine Ministry of Coal Industry. The World Bank Group ▪ Finance, Private Sector, and Infrastructure Network 2 Coal Industry Restructuring in Ukraine In 1995, when reform in the power industry was FIGURE 2 COAL INDUSTRY VIABILITY, 1995 well under way and the gas industry had em- barked on the first steps toward reform, Ukraine’s coal industry remained untouched by the changes Coking coal mines happening in the country. In that year the coal Unit production cost (US$ per ton) Number of personnel industry employed 650,000 workers, who pro- 80 250,000 duced 66 million tons of coal in 276 mines and 70 64 washing plants. In addition, 200,000 people Cumulative personnel 200,000 were employed in supporting functions such as 60 mine construction, machine building, and social services (such as kindergartens). 50 150,000 Labor productivity was far lower than in other 40 countries, and about one-third of the mines 30 Import parity level 100,000 produced coal at a cost above the import par- ity level (figure 2). While a coal miner in Unit cost 20 Ukraine produced on average about 100 tons Unit cost 50,000 of (washed) coal in 1995, the comparable fig- 10 including ures were 200 tons in Russia, 400 tons in Po- social services land, 2,000 tons in the United Kingdom, and 0 0 4,000 tons in North America. High-cost mines 0 20 40 60 80 100 received US$400 million in cross-subsidies from Percentage of run-of-mine coking production low-cost mines. The coal industry as a whole Note: The figure shows, for example, that in 1995 about 30 percent of coking received US$240 million in budget subsidies, coal was produced in mines with a unit cost above import parity, and to and US$500 million more from the rest of the produce this uneconomic coal the mines employed over 100,000 miners. economy in the form of an increase in the stock of (net) accounts payable during that year. Labor costs were too high, with payroll and Steam coal mines disability allowances making up more than 40 Unit production cost (US$ per ton) Number of personnel percent of operating costs in 1995 (figure 3). 120 350,000 Additional labor-related expenses are included in the notional profit margin. (Little funding 300,000 100 was available for capital investment. Depre- Cumulative personnel ciation charges were negligible as a result of 250,000 80 undervaluation of assets, suggesting that true operating costs were even higher than the of- 200,000 ficial figures show.) 60 150,000 The 383 coal industry enterprises were man- 40 Import parity level aged by the coal ministry, which, following the 100,000 tradition of central planning, appointed enter- 20 Unit cost prise managers, set production targets and Unit cost 50,000 including prices, and allocated physical and monetary social services flows. But this old industry model was under 0 0 severe strain: 0 20 40 60 80 100 ▪ Profitable mines were reluctant to transfer rev- Percentage of run-of-mine steam production enues to unprofitable mines, bringing them Source: Ukraine Ministry of Coal Industry. to the brink of financial collapse. The accu- mulation of uncollected receivables by the The World Bank Group 3 central coal marketing agency (Uglesbyt) cre- FIGURE 3 HIGH LABOR COSTS ated strong incentives for mines and mining associations to arrange their own sales (mostly Composition of operating costs for all mines, 1995 through barter to minimize the risk of the coal ministry confiscating their revenues). Lump sum Depreciation ▪ Lower prices, better availability, and supe- Monthly disability 1% rior quality led imported coal to capture an disability increasing share of the domestic market, Fuel reaching 20 percent in 1995. The lower prices 4% 3% and better service would gradually erode 5% Industrial Payroll public sympathy for coal miners. services 34% ▪ Miners were angered by delays in wage pay- 8% ments and by the deterioration in their wages relative to those of other industrial employ- ees in Ukraine. 16% To prevent social unrest in the main coal re- Power gions, the government had to pump liquidity into mines using unplanned budget outlays and credit guarantees. The coal industry and the 29% Cabinet realized that fundamental changes were needed in industry operations. The proposed reform program, adopted in a presidential de- Other cree in February 1996, was discussed at a con- ference in April 1996 attended by central and local government officials, parliamentary rep- resentatives, labor leaders, and mine manag- Distribution of revenue from coal sales for all mines, 1995 ers. Many of the labor leaders expressed support for the reforms, including the closure Incentives of nonviable mines, subject to the availability and Capital of adequate social assistance. To cover part of bonuses Social investment the cost of the program, the World Bank ap- development proved a US$300 million loan to be provided to the budget in two equal tranches. The first 5% 2% Other 5% tranche was disbursed in December 1996. objectives 7% Initial achievements Taxes Capitalizing on a rare consensus in government 7% and temporarily muted opposition in Parlia- ment, reformers pushed through several im- portant measures in 1996–97: ▪ The 276 coal mines were divided into four categories. In the first category were 76 prof- 74% itable mines intended to be privatized in the Operating medium term. The second category contained costs 105 mines that were given one year to re- gain profitability and graduate to the first category; otherwise they would be moved Source: Ukraine Ministry of Coal Industry. 4 Coal Industry Restructuring in Ukraine to the third category. In the third category seling, reemployment support, microcredit for were 75 mines, scheduled to be closed within small businesses, and labor-intensive public three to five years. At the 20 mines in the works projects. fourth category production stopped in an- ticipation of immediate closure. In late 1996 and in 1997 budget support to the ▪ Mines in the first and second categories were coal industry was refocused on restructuring. corporatized and placed under fifteen state- Of the US$800 million budgeted for the coal owned holding companies. (These holding industry in 1997, US$300 million was earmarked companies also included washing plants and to cover the physical cost of mine closures, marketing organizations.) Mines in the third statutory benefits to dismissed miners, the cost category were put under the direct supervi- of maintaining and rehabilitating social assets sion of the coal ministry. Mines in the fourth transferred to municipalities, and special assis- category were transferred to a newly created tance programs for the unemployed. Produc- mine closure agency, the UDKR. tion subsidies were to be concentrated on mines ▪ The use of accounting prices to effect cross- in the second and third categories and delinked subsidies from low-cost to high-cost mines from the volume of raw coal produced. was abolished. Corporatized mines became free to market their own coal domestically Relative to coal industry reform in other coun- and abroad at liberalized prices. (Retail prices tries (Belgium, France, Germany, Hungary, paid by households remained controlled by Poland, Russia, the United Kingdom), Ukraine’s the Ministry of Economy, but the difference program was notable for combining a market- between wholesale and retail prices was cov- driven approach to select the surviving mines ered from the budget.) Noncorporatized with a centrally controlled process to close mines were required to report to and agree mines that did not make it. Especially innova- on their prices with the Ministry of Economy. tive was the establishment of a single agency ▪ Managers of mines in the second and third to implement mine closures and manage most categories were prohibited from making in- of the associated social mitigation programs. vestments or recruiting new staff. Average wage increases were limited to the level of Emerging reform difficulties inflation. Bonuses were to be tied to reduc- tions in operating costs. Actual implementation of the 1997 coal bud- ▪ Financing of new mines was cut from the get was skewed in favor of production subsi- budget, and investment projects that were dies, while a major shortfall appeared in not economically justified were canceled. funding the closure of loss-making mines and ▪ Noncore activities were separated and priva- associated social mitigation measures. Although tized. A program to transfer mines’ social as- closure of the first twenty mines commenced sets to municipalities was drawn up (and on schedule, there were delays in payments of implemented for fifteen mines), including statutory benefits to laid-off miners and in pay- temporary financial support from the central ments to contractors implementing the physi- government to municipalities to cover oper- cal closures. Several additional mines applied ating costs. for transfer to the agency responsible for mine ▪ A target was adopted to close twenty mines closures, but it could not accept them for lack a year. Mine closure procedures were devel- of funds. After the social assets of fifteen mines oped with attention to social and environ- were transferred to municipalities, the social mental mitigation measures. Social mitigation asset transfer program also came to a halt for measures included the payment of overdue lack of funds, and special assistance programs wages, severance pay equal to three months’ for unemployed miners encountered major wages, free coal for the winter, and special delays. The closure of three mines was funded assistance programs such as job search coun- directly by the World Bank in the context of a The World Bank Group 5 pilot project, and these mines were less affected try also developed new “reform” proposals, in- by the problems mentioned above. cluding centralizing all coal sales under the min- istry (that is, reestablishing Uglesbyt), transferring The activities of mine managers remained mines in the third category to holding compa- focused on lobbying for production subsidies. nies (that is, reestablishing previous coal asso- Employment was not rationalized, and the ex- ciations), and transferring responsibility for mine pected concentration of mining activities on closures from the UDKR to these companies. At better mines did not emerge. The accumula- the end of 1997 the ministry submitted a bud- tion of payables, including wage arrears, con- get request of US$2.6 billion for 1998. When tinued unabated, increasing by US$1 billion the Cabinet denied the request and proposed between August 1996 and August 1997 (see figure 1). Actions designed to contain cost in- creases were not implemented, and budget con- Arranging barter trades and straints on the coal industry remained soft. Most mines in the first category continued to receive bombarding the finance ministry and production subsidies that remained tied to the volume of coal produced. The coal ministry Cabinet with requests for additional argued that providing production subsidies to the low-cost mines was the only way to en- investment funds and production sure the timely payment of wages, since these subsidies were virtually the only source of cash subsidies became the main occupation for the mines as a result of the widespread use of barter. Few employment reductions took of the coal ministry. place in operating mines. Neither a bankruptcy framework nor a debt restructuring mechanism was put in place. And no effective supervision the same coal budget as in 1997 (US$800 mil- mechanism was established for mines in the lion), senior ministry officials began soliciting third category. Given these deviations from the additional funds from Parliament. This effort, agreed reform program, the World Bank could however, was cut short by upcoming elections. not release the second tranche of the US$300 million loan in 1997. As soon as the new Parliament was formed, about forty mines went on strike, demanding Pressures to reverse reform the payment of overdue wages, additional wage increases, restrictions on coal imports, and a Arranging barter trades and bombarding the fi- new system of coal purchases to be operated nance ministry and Cabinet with requests for by the state. In one of its first resolutions, Par- additional investment funds and production sub- liament asked the Cabinet to develop a pro- sidies became the main occupation of the coal posal for increasing budget support for the coal ministry. Seven new mines were under construc- industry, reviving state orders for coal, devel- tion when the budget stopped providing invest- oping the 1999 budget for the coal industry ment grants. The coal ministry strongly argued based on the estimates provided by the coal for the completion of these projects despite clear ministry, and preparing—without the help of indications that several of the new mines would foreign consultants—a new law on the long- not have been able to cover even recurrent costs. term development of the coal industry. If funded through a loan, the additional capital cost of the best of these mines would have im- A window of opportunity reopens plied a debt service obligation of US$50 per ton of coal produced while the estimated market Attempts to reverse reform backfired, however. value of the coal was US$28 per ton. The minis- Popular support for miners weakened when, 6 Coal Industry Restructuring in Ukraine starting in mid-1998, representatives of other the trading of coal, and to restore the privi- professions that were also suffering from un- leged status of coal miners. These efforts will paid wages (such as teachers and nurses) ar- probably meet with sympathy in Parliament, gued publicly against giving special treatment but they will be opposed by the Ministry of to miners. Recognizing an opportunity, the gov- Finance, Cabinet of Ministers, and presidential ernment decided to revitalize the process of administration, because Ukraine simply cannot afford the associated costs. Large coal consum- ers such as the power and steel industries will In the long run rationalization of the also oppose the rollback of reforms. Ukrainian coal industry is an economic It is difficult to predict the outcome of the con- flict between those supporting reform and those imperative, and will likely include the opposing it. Reversing reform would place a severe burden on the budget and prolong the closure of at least half the mines and an depression in the regions where most mines are located. In the long run, however, rational- even larger reduction in the labor force. ization of the Ukrainian coal industry is an eco- nomic imperative, and will likely include the closure of at least half the mines and an even coal industry restructuring. A new coal minis- larger reduction in the labor force. ter was appointed in early June, and agree- ment was reached with the World Bank about Lessons a revised reform program—including the clo- sure of twenty-four additional mines by the Although far from complete, coal industry re- UDKR in the second half of 1998 and early structuring in Ukraine offers several lessons that 1999 (bringing to fifty-two the number of mines can be of use for reformers in that country as closed or under closure). well as in others: ▪ A looming financial crisis was a necessary In addition, the government asked the Bank to but insufficient condition for starting reform prepare a project that would support further in 1996. Traditionally, coal miners were the restructuring of the coal industry, including ad- best-organized group of workers and enjoyed ditional mine closures and rationalization of widespread political support. The launch of the operations of potentially profitable mines. reform was made possible by the split of the Despite pressure to use all available funds to former “official” union into several compet- settle overdue wage bills, the budget provided ing groups advocating different solutions to enough money to the UDKR to commence the the crisis and accepting the need to close closure of ten mines (of the agreed twenty- the costliest mines. four), and the Bank approved the release of ▪ Liberalization of coal imports and prices part of the remaining US$300 million loan. helped dispel the myth that maintaining a large coal industry is essential for the secu- Implications for the future rity of Ukraine’s energy supply. The favorable price, quality, and reliability of steam coal Although the depreciation of the hryvnia in from Poland and Russia made it increasingly August and September 1998 is expected to re- clear that coal industry subsidies simply re- duce the losses of operating mines, coal in- distribute income in favor of an extremely dustry managers and labor unions will likely vocal group of workers and managers. continue their efforts to increase budget sup- ▪ Reforms need national champions with strong port for the coal industry, to reduce coal im- line authority over branch ministers and in- ports from Poland and Russia, to remonopolize dustry managers. The weak position of the The World Bank Group 7 Ministry of Finance within the Cabinet nega- tively affected coal reform. The ministry failed to protect fiscal interests by controlling the coal industry’s use of budget resources. The lack of a powerful player demanding results on the ground in return for every hryvnia spent increased the coal industry’s appetite for production and investment subsidies. ▪ Assigning the sector ministry to implement reform was a costly mistake. The coal ministry’s desire to maintain operational au- thority over mines and to stop (or at least slow) the shrinking of the industry has proven stronger than the vision of a reformed, healthy mining sector. In the long run this ministry should be dismantled and its legiti- mate functions entrusted to a new Ministry of Trade and Industry. In the interim a stream- lined Ministry of Fuel and Energy should be established based on the coal and power ministries, Ministry of Power and Electrifica- Viewpoint is an open tion, and State Oil and Gas Committee. forum intended to ▪ The closing of uneconomic mines proved less encourage dissemina- tion of and debate on controversial and progressed better than the ideas, innovations, and rationalization of the activities of potentially best practices for ex- economic mines. Possible explanations in- panding the private sector. The views pub- clude the ease of selecting mines for closure lished are those of the given the hopeless situation of many of them; authors and should not the attractiveness of the severance package, be attributed to the World Bank or any of which includes the payment of several its affiliated organiza- months of overdue wages to workers in tions. Nor do any of the closing mines; and the lack of incentives for conclusions represent official policy of the managers of state-owned mines to initiate World Bank or of its layoffs. Executive Directors ▪ A quick-disbursing loan with one or two or the countries they represent. tranches is not the right instrument for World Bank support to a long and unpredictable re- To order additional form process. The Bank’s new adjustable pro- copies please call 202-458-1111 or contact gram loans might be better suited to achieving Suzanne Smith, editor, a balance between signaling long-term com- Room F11K-208, mitment and maintaining the flexibility needed The World Bank, 1818 H Street, NW, to respond to implementation problems. Washington, D.C. 20433, or Internet address Laszlo Lovei (llovei@worldbank.org), ssmith7@worldbank.org. The series is also Lead Specialist, Energy Markets and available on-line Reform Thematic Group (www.worldbank.org/ html/fpd/notes/). Printed on recycled paper.