Concentrating and Centralizing State-Owned Business in Ukraine

BY ANDRIAN PROKIP

Ukraine’s government recently announced a change in the approach to state-owned enterprises. It plans to privatize or liquidate about 3,500 of these, and others will be turned into joint-stock companies, or LLCs, owned by the state. The government should ultimately own about 100 companies, once these changes have been made.

But behind the scenes, another trend can be noticed: an attempt to establish big state-owned companies, which will become monopolies and likely will be governed in a centralized manner. And this trend is not just a response to the war, because some of these ideas have been discussed or implemented before.

Towards gas market monopoly?

Naftogaz unites many companies operating in different areas of the energy sector. The group is the largest of the state-owned companies in Ukraine and is an important contributor to the state budget. In 2021, Naftogaz’s contribution accounted for 10.7 percent of the state budget revenue.

Even before the war, Naftogaz was a significant presence in Ukraine’s energy market and the biggest in the gas market. Its subsidiaries were responsible for about three-quarters of gas production, operated all gas storage, and were significant players in gas trading and supply. Naftogaz’s subsidiaries also operated in oil production, oil and gas refining, renewables, heat supply, gas distribution, and fueling stations.

But government decisions during the war have made the company bigger, with more market power. Because of controlled gas prices far from Ukraine, Naftogaz has become a monopoly in gas supply to households, covering more than 98 percent of the market now. The government asked Naftogaz’s subsidiary to control 26 gas distribution companies, ownership which had previously been prevented by a court decision. Most of these had been owned by Ukrainian oligarch Dmytro Firtash. Later, the government gave Naftogaz ownership of several heat-power-producing plants.

In May, the government passed to Naftogaz control of a network of fueling stations previously thought to be owned by Viktor Medvedchuk, who has been arrested. This change was made to help with the fuel crisis, but the stations have not started operating yet.

The question is whether this vast state-owned company, covering the entire gas market and other areas in energy, will manage to be an effective owner, especially when the regulated gas and heat prices are subsidized. Naftogaz failed to increase gas production from 2014 to 2020 and demonstrated a slight drop instead, unlike privately owned companies. Now, during the gas crisis in Europe set off by Russia, this gas would be worth its weight in gold. The tricky thing is that since 2010, reforms were called to break Naftogaz’s monopoly and establish a competitive, transparent market.

A forestry company

In July, the government proposed establishing a single forestry company instead of the 157 small existing ones across Ukraine. Most of these were profitable and together generated $0.81 billion last year. This will establish a monopoly in forest planting, timber cutting, domestic wood trade, and exports.

Having a single company might really cut management costs and simplify forestry planning, relations with international organizations, and the process of obtaining grants and loans. But this may also create risks for organized rent-seeking by corrupt elites and non-transparent wood trading. Furthermore, the idea of a single monopoly contradicts the State Forest Management Strategy to 2035, adopted by the government last year. Representatives of civil society have raised concerns about the risks of this step.

A single electricity exporter

In June, the energy ministry proposed the establishment of a single state-owned company responsible for exporting electricity produced by other state-owned companies—Energoatom, operating nuclear power plants, and Ukrhidroenergo, hydropower plants. Neither of these have obstacles in trading and exporting electricity now.

During the war, it makes sense to amend economic policy to introduce more centralized planning and state procurement. But this should cover specific areas and fields. In other areas, government should introduce more liberalized conditions to promote business activity, which also means saving jobs and protecting companies’ ability to pay taxes—both activities essential during a war and for an economy after a war.

In Ukraine, big state-owned companies are not always effective or profitable. These have sometimes been used for rent-seeking by oligarchs and corrupt elites. They have been sometimes misused by the government, by being turned into donors for subsidizing or financing some state program far from the area where these operate. Besides, a concentrated market with a single monopoly or a few big companies means no competition, which is a fundamental precondition for efficiency and transparency.

It is too early to diagnose key governmental drivers for such a concentration in some markets. These reasons might include an attempt to govern these in a centralized mode. But the government should consider the lessons of Ukrainian big state-owned companies when planning its new policy for state-owned assets.

The opinions expressed in this article are those solely of the author and do not reflect the views of the Kennan Institute.