Ben Aris & Olesya Oleshko -

The "Donbass-isation" of the government is progressing as power in the energy and financial sectors is ceded to the allies of Ukraine's leading oligarch Rynat Akhmetov.

After parliamentary elections in March, Ukraine's leading oligarch Rynat Akhmetov, head of the Donbass-based Systems Capital Management, has been quick to cash in on the political victory he paid for over President Viktor Yushchenko and the forces of the Orange Revolution.

In a "Donbass-isation" of the government, members of the winning Regions of Ukraine party have more or less captured control over of Ukraine's fuel and energy complex, taken over the regulators and control the supervision of the financial system.

And the new finance minister, Mykola Azarov, a member of Regions, not only reversed a decision to nix the special economic zones but immediately paid out hundreds of millions in VAT rebates to companies in the Donbass.

Donetsk-based companies were the main beneficiaries of these tax breaks that were set up by the administration of former President Leonid Kuchma. During the Orange team's brief tenure last year they were one of the first things to go under the then finance minister, Viktor Pynzenyk (see accompanying interview).

Exporters in the Donbass region have been paid off early, while companies in other regions saw their VAT rebates slashed by up to 90% and many still haven't received their money.

Yushchenko is now fighting a rearguard action to fend off the invasion by the forces of the Donbass, but he is seeing power slip through his fingers and his party Our Ukraine is in danger of splitting under the strain.

Donbass' energetic team

The Donbass team is most visible in the fuel and energy sector. Viktor Yanukovych was voted prime minister on August 4 and two days later Yuriy Boyko, who hails from Donetsk where Akhmetov has his power base, was appointed energy minister.

Both Boyko's deputies are from the same region. Vadym Chuprun is a colleague of Yanukovych's from the Kuchma-days and was appointed deputy fuel and energy minister. He is from Rovnopil in the Dontesk region and was until recently the governor there. The other deputy is Oleksiy Sheberstov, who for a long time worked in DonbasEnergo.

Two weeks later Deputy Prime Minister Andriy Kluyev, a Regions loyalist, appointed his old friend from the Donetsk region Oleksandr Rogozin to the head of the National Electricity Regulating Commission (NERC), which regulates prices for gas and electricity. This is a key appointment because the commission is in charge of setting tariffs as well as overseeing the operations of the generating companies and "oblenergos," the regional power companies.

The other key job in the power sector has gone to a former employee of Akhmetov's: Ihor Hlushchenko used to be the director-general of Ukraine's only privately-owned thermal power station Vostokenergo, based in Donetsk and owned by Systems Capital Management, but is now president of the National Energy Company (NEC) of Ukraine.

"The NERC and NEC are the main authorities in Ukraine's energy sector. The NERC is responsible for regulating tariffs and licensing in the electricity and gas sectors, while the NEC controls all state-owned generation companies, regional distribution companies, and coal mines," says Troika Dialog's Ruslana Deykun. "In addition, the NEC determines which companies will be more or less profitable, depending on their prospects and investment needs, by factoring different profit margins into tariffs for generation companies."

The day after Kluyev's appointment on August 18, the wholesale energy market operator Energorynok, that controls the cash flows in the power sector, fell to Regions in the form of Antaoliy Lutsishyn who is a former CEO of Akhmetov's Servis-Invest, part of the Donbass Fuel Energy Company.

Kluyev was a key appointment and is a long-time ally of Akhmetov's; he has spearheaded appointment of a raft of Regions personnel throughout the rest of the sector and the campaign continued in September.

The heads of two important oblenergos, ZAON and DNON, were replaced by men loyal to Regions. Since the start of October, the manager of Centrenergo has been replaced, members of Akhmetov's Systems Capital Management have joined the board at Kyivenergo, and EGMs have been called at a raft of oblengos, which will take place in November and December.

By the start of next year, Regions and Akhmetov will have direct control over most of the key power assets in the country. Among the key state appointments in the regulatory bodies that supervise the power sector, only the boss of Ukrenergo, the transmission operator, has not changed since August.

"The main agenda items at the EGMs are to change the companies' supervisory boards and audit commissions, where people from the 'old Orange power' are present," says Alexander Paraschiy, an analyst with Concorde in Kyiv. "Soon after the EGMs, we also expect top management to be purged of people not supporting the interests of these Donetsk groups… The goal of the Donetsk businessmen is becoming clearer: to leverage their presence in the government to get control of state-owned energy companies."

Regions and Akhmetov are also taking over more or less unopposed other parts of the energy sector, having also captured the gas business.

Volodymyr Sheludchenko from Makiyivka in the Donetsk region has been made head of national gas company Naftogaz Ukrayiny. Sheludenko headed the Donetsk-based gas supply enterprise Donetskoblgaz between 1991 and 2003. And Serhiy Zubov from Kramatorsk in Donetsk heads the sister company Haz Ukrayiny.

source: bne

The world of finance

Akhmetov and Regions have done less well in capturing control over the financial sector, although they have a powerful hold on the sector in the form of the appointment of Mykola Azarov as finance minister and deputy prime minister, who is an old Donetsk hand. Azarov has been actively appointing his people to positions of power throughout the financial system.

Parliament's budget committee, headed by Azarov, voted on July 23 to restore tax privileges to the special economic zones, priority development areas and technology parks. The government of the previous prime minister, Yulia Tymoshenko, ended the widely abused exemptions in March 2005. Those in Donbass accounted for most of the tax reductions claimed.

One of the most blatant bits of the lever pushing by the Donbass cabal has been the paying out of VAT rebates this summer. Exporting companies from the Donetsk region received twice as much in VAT refunds for than were actually earmarked in the budget. Companies in the neighbouring Luhansk region also got 50% more than budgeted, while refunds to Ukrainian companies in other regions were cut significantly, according to reports in the pro-presidential newspaper Ukrayina Moloda .

Only a month earlier the then finance minister, Viktor Pynzenyk, had ordered an inspection of the VAT refund register and the government concluded that half of them were little more than scams.

Ukrayina Moloda reported it had seen documents that showed enterprises in the Donetsk region received UAH696m ($139m) instead of the UAH313m ($62m) earmarked for VAT rebates. Moreover, UAH153m of this was paid on the last workday of the month, which the paper suggested meant someone was trying to squeeze these payments into an accounting window.

On the other hand exporting companies in the Kyiv region, for example, got UAH60m ($12m) of the UAH376m ($74m) budgeted for VAT rebates. Companies in several other regions got a 10th of the money earmarked for refunds.

Yushchenko fights back

Yushchenko has attempted to fight back, but his position looks weak. In the second week of October he belatedly reacted to the obvious self-serving changes, complaining the "VAT refunds to exporters are very disproportionate."

VAT is by far the biggest earner for the government, making up 37% of its revenues. The president ordered an investigation by the head of the Security Service of Ukraine, Ihor Drizhchanyy, to be delivered in November, and ordered the Defence Council to take up the issue.

"We are talking about one of the fundamental taxes of the national budget," said Yushchenko. "And it is becoming murkier every week."

He also gave regional governors three days to establish investigative commissions that have to include representatives of the prosecutor's offices, law enforcers, tax authorities, businessmen and journalists.

"We are talking about the artificial withdrawal or immobilization of companies' working capital. In other words, the government is entering into relations with business that are not regulated by the law on the state budget and is borrowing billions of hryvnyas, on an unregulated basis and free of charge, for its own circulation," Yushchenko told the assembled ministers.

The president's main attack in an effort to weaken Regions' hold over the energy sector was ordering the dissolution of the NEC on October 9. A holding company that was set up in 2004 to own all the state's stakes in the oblenergos, the NEC was charged with improving efficiency in the 43 energy generation and distribution companies. It has been a fairly spectacular failure, as Ukraine remains the most wasteful consumer of power in Europe.

Yushchenko explained his decision by remarking that from the very outset he doubted the wisdom of the company's creation, and that its period of operations demonstrated the NEC had monopolized the energy sector. The State Property Fund was supposed to privatise the power sector, although this still seems to be on the cards.

However, a week later Yanukovych's cabinet refused to acknowledge the president's authority and excluded mention of the resolution in its own resolution on the creation of the NEC..

A row has now broken out about who has the power to order what, since the constitutional changes at the start of this year transferred more power to the parliament.

"The SPF's [recent] move to privatize minority stakes of GenCos and the Presidents' action to disband the National Energy Company are both aimed at decreasing the concentration of power in the hands of businessmen with ties to Donetsk and to somehow balance control of the energy sector," says Concorde's Paraschiy.

"If either the privatization was approved or the NEC disbanded, control over the energy companies would fall to the State Property Fund, which is controlled by the Socialists, and people close to the Donetsk business group would be prevented from seizing total control over the energy sector. Not surprisingly, the Yanukovych-led government has started to criticize these moves. The government, the key decision-maker in this case, wants to postpone the privatization process. At the moment, Donetsk businessmen close to the government already control most of the companies in the energy sector de facto," Paraschiy says.

The clock is ticking on the fight over the power sector, as a moratorium on the bankruptcy of energy assets is due to expire on January 1. The NEC failed in its task to reduce the debts of power companies and only managed to increase their financial transparency a little.

The cheapest way to privatise assets has always been to bankrupt them first and from the start of next year the process of debt-offsetting will stop. After January 1, any energy company that has not off-set its debt or restructured can be bankrupted.