State railway monopoly Ukrzaliznytsia, or UZ, employs 250,000 people who were recently threatening to strike for better working conditions and higher wages. The labor stoppage would have paralyzed movement along 22,000 kilometers of rail track. While that crisis was averted, UZ is in big trouble. It has a bloated but poorly paid workforce, making an average of $410 a month.
Experts say UZ’s tariff structure makes no financial sense and favors several oligarchs, especially Rinat Akhmetov, Ukraine’s richest billionaire. His heavy cargo accounts for a third of UZ’s daily load and much of those shipments are subsidized — transported by the railway way at below-cost rates, according to reliable calculations.
Besides challenged by powerful vested interests, UZ is riddled with corruption and poor management.
It has had nine CEOs in five months and is looking for a new one to replace the recently fired Volodymyr Zhmak.
No wonder it lost $453 million last year.
A current UZ supervisory board member, a former infrastructure minister, two former UZ management board members, an investment banker, and an agricultural company executive were interviewed for this story on what ails the railway giant and how to fix the problems.
But nobody put it more succinctly than former supervisory board member Anders Aslund: “Everything is wrong there.”
Rebuilding system
For most of the three decades since Ukraine has been an independent country, the monopoly has lost money. Hard currency loans constitute the bulk of its debt burden. Much of its fleet is at least 40 years old due to inadequate capital expenditures.
At the management level, UZ’s Soviet-style company structure has 21 “directorates” at six regional branches, according to Irakli Ezugbaia, who resigned as the commercial and logistics director on March 11. While in charge of the only real profitable segment of UZ, Ezugbaia said the supervisory board had in February rejected his proposal to restructure the company into four business units under the umbrella of one legal entity.
One of the units would be cargo, the cash cow of UZ, which accounts for approximately 80% of revenue.
Two others would be the passenger and production units, both of which are losing money and cross-subsidized by the profitable cargo unit.
The fourth would be infrastructure.
The split would make it easier to manage UZ, streamline revenue and make costs and assets more visible than the current structure, according to him. After getting rejected and without receiving a reason for an identical proposal, Ezugbaia left UZ, citing “pressure, corruption, and slow reforms.”
Former CEO Wojciech Balczun, who ran UZ in 2016–2017, told the Kyiv Post that “it’s impossible to reform such a big company in a very short time without political support,” while adding that Poland and Germany have long reformed their railway companies into vertically managed business units.
The current architecture is like having “regional branch CEOs who are like local tsars and run the property they manage as a kingdom on their own,” said Volodymyr Omelyan, who served as infrastructure minister in 2016–2019. “There is a lot of internal resistance.”
In its current state, there is “substantial bureaucracy” at UZ and the “best way of surviving is doing as little as possible,” said Aslund, who was a supervisory board member from June 2018 until the end of September 2020. Aslund also blamed an unwillingness for change at UZ, among other reasons, for resigning.
UZ didn’t respond to a list of questions that were emailed for this article.
Cargo transportation
Five days before he was unexpectedly fired, Zhmak announced that he would in April propose to the supervisory board to have “a single logistical tariff for cargo transportation” instead of four different classes or freight. This aspect of operations has been holding back robust financial performance.
Prices for moving freight have been divided into four classes since Soviet times and the policy is considered to be economically unjustified, according to both Aslund and current supervisory board member Sergii Leshchenko, who is also a Kyiv Post columnist.
With little help from the government to upgrade its fleet and cover losses for passenger travel, UZ has had to rely on cargo and expensive loans to stay afloat, according to Dragon Capital’s head of research Andriy Bespyatov. Bespyatov said UZ’s total debt, excluding leasing agreements, is about $1.4 billion. The vast majority of it is in hard currency and includes outstanding Eurobonds. Its debt portfolio still has loans from Russian banks like state-owned Sberbank, which had lent $200 million at a 12% yearly rate.
The chronic cash shortage is mostly attributed to UZ’s opaque and unjustified pricing system for all sorts of services — but mostly cargo hauling. At the core is that UZ “cannot calculate the components that constitute the real tariff for moving one ton of cargo one kilometer — they cannot justify a single figure of tariff… that’s where the real mess starts,” Omelyan said.
Bureaucratic mess
To change tariffs and classification of freight is to get entangled in the web of the country’s bureaucracy. First the supervisory board must give approval. Then, according to Omelyan, UZ must submit its “proposals and justification,” usually based on inflation, electricity routing, and other causes to a special Infrastructure Ministry commission.
Next, the proposal would go to the Economy Ministry and the State Regulatory Service, which would send it to the finance and justice ministries “and relevant central government bodies for a final approval” before the new price change is set.
And business groups have their fingers in all or some of each stage in the process either directly or through industry and other lobbying groups, Leshchenko said.
Akhmetov benefits
The main beneficiary of this dysfunctionality is Akhmetov. His Metinvest and DTEK energy, mining and metals companies, provide one-third of UZ’s daily load, according to Ezugbaia.
Metinvest didn’t respond to emailed questions sent by the Kyiv Post.
About 40% of all loads get transported below cost. The cheapest of the four cargo classes transport iron and manganese ore, coal, fertilizer, timber and crushed stone for road construction.
Other beneficiaries include Kostyantin Zhevago, owner of Ferrexpo mining company, oligarch Dmytro Firtash who is heavily invested in fertilizer and billionaire Ihor Kolomoisky.
Ezugbaia, Aslund, Omelyan, Leshchenko and others have pushed for unifying cargo transport prices to meet the principle of “one ton is one ton, no matter what is transported.”
“Currently, there is no clear national model of tariff formation for rail freight,” the European Business Association stated in August. “The current tariff system is opaque and economically unreasonable, in addition, there is no reference to the type of costs which makes it impossible to clearly target the use of tariffs: traction, car, infrastructure, investment.” The other more expensive classes of freight within this sub-unit end up subsidizing for the first class of cargo. An aerial view of trains parked near Kyiv’s central railway station on April 5.
Grain haulers complain
In particular, the second class that moves grain and seed oils from fields and silos to ports for shipping get charged more. Oleksiy Lyssytsia, president of the Ukrainian Agribusiness Club and CEO of the Industrial Milk Company, said the farming industry avoids using UZ whenever it can.
“We tried many times to get the tariffs changed and put into one group but the agricultural lobby is not strong enough like Mr. Akhmetov is,” he said.
He added that businesses across all industries have the same complaint that there are transport delays when using UZ, “no guarantee of on on-time delivery, theft of products like grains, oilseeds and soybeans happen… and UZ doesn’t cover damages.”
Unfortunately, he said, big or small farmers “have no one to talk to about our problems” at UZ, Lyssytsia said.
Metinvest wins
Another observation that Leshchenko made was how a business unit of Metinvest won a huge tender as the sole bidder on the electronic ProZorro procurement system in mid-January to lease about half of UZ’s operational fleet of open wagons.
Three-year leases were issued for about 9,000 open wagons at the minimum bidding price of approximately $17.5 whereas the starting price was $29. Leshchenko noted that the huge auction lot “only suited” Metinvest, because no other player on the market needs that many open wagons.
Several days afterward, UZ conducted another auction for 85,000 railcar shipments, 47% of which Akhmetov’s DTEK won at the same daily price for leasing the open wagons, State-Owned Enterprises Weekly reported.
“Historically, there has been significant pressure from the business lobby on tariffs,” said Bespyatov.
Reforming state firms
Since the 2014 EuroMaidan Revolution, which ended the presidency of Kremlin-backed Viktor Yanukovych, Ukraine jumpstarted sweeping reforms to achieve macroeconomic stability and wean itself off money-sucking state-owned enterprises and banks.
Efforts were made to improve corporate governance and hiring practices that included installing supervisory boards with international experts and people with established business pedigrees.
Still, UZ continued to report losses in 2014–2016 and slowly began to climb uphill before finally achieving a semblance of boastful financial performance in 2019 with a profit of $116 million, according to the average currency rate of that year.
The previous year’s net income was only 7% of it in comparison.
Despite recording a decent profit in years, UZ’s problems still lingered as its audited report said it had $780 million worth of “fully depreciated property, plant, and equipment which remain in use.”
Approximately 50% of its operating expenses are personnel costs, Bespyatov of Dragon Capital said, adding to Aslund’s complaints of overstaffing.
Theft & corruption
Theft and corruption have led up to $700 million being lost yearly at UZ, Omelyan said. The company ends up paying up to double the market price at times when using the online ProZorro public procurement system.
Meanwhile, Prime Minister Denys Shmyhal recently instructed four ministries to assess the work performance of UZ since 2015, including how the management and supervisory boards performed in 2017–2020.
His move followed the creation in January for similar reasons of an ad hoc parliamentary committee to investigate improprieties for the same period.
As recent as March 26, the nation’s SBU domestic intelligence agency reported exposing the “heads of structural subdivisions of the Uzhhorod directorate of railway transportation for corruption during the transit transportation of foreign goods.” Losses to the company were estimated at more than $18,000.
Old fleet
Passengers still can expect to travel at an “average speed of 60 kilometers” per hour on the track, he said, “if the Ukrainian government would allocate $1 billion a year to upgrade (UZ’s fleet), it would dramatically change the picture and move Ukraine into the 21st century.”
Trains in some countries travel as fast as 250 kilometers per hour; trains must travel at least 200 kilometers per hour to be considered high-speed.
Summing up the situation at UZ, Aslund said that “there are so many vested interests that nobody wants to change anything.
