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Corruption Watch: February 10, 2005

10 February 2005, Volume 5, Number 1
By Roman Kupchinsky

An ongoing investigation by the Ukrainian Security Service (SBU) has revealed that in 2002, officials of the SBU, along with high-ranking members of the Ukrainian military and the state arms-sales company UkrSpetzExport, sold at least six cruise missiles each to Iran and China.

Such sales, outlined in a letter sent to newly elected Ukrainian President Viktor Yushchenko on 28 January by a member of the parliamentary committee investigating the case, would constitute a violation of international arms treaties to which Ukraine is a party. A copy of the letter was provided to RFE/RL by its author, parliament member Hryhoriy Omelchenko, a former officer of the SUB and past head of the parliament's committee on combating organized crime and corruption (for the full text of the letter, see

The investigation has already led to criminal charges against a number of individuals, including a Russian citizen presently being held in prison in the Czech Republic awaiting extradition to Ukraine.

Complementing the seriousness of the investigation's findings are claims that former President Leonid Kuchma was aware of the sales when they were carried out.

A former member of Kuchma's security staff, Mykola Melnychenko, addressed his claims in an interview with RFE/RL on 1 February. Melnychenko, who has been at the center of a scandal surrounding secret audio recordings he made of conversations that allegedly took place in Kuchma's office, although Kuchma has denied the veracity of the tapes.

Melnychenko said he provided the U.S. Federal Bureau of Investigation (FBI) with a recorded conversation purportedly between Kuchma and the then head of the SBU, Leonid Derkach, in which a voice alleged to be Derkach's is heard saying that the sale of the missiles to Iran was conducted with the help of the Russian Federal Security Service (FSB).

Cruising For A Scandal

The Soviet-made cruise missiles in question, the KH-55 (NATO classification AS-15 Kent) and KH-55SM (NATO classification AS-15B), are capable of delivering a 200-kiloton nuclear warhead, although Omelchenko told RFE/RL on 2 February that they were not equipped with nuclear warheads when exported to Iran. The KH-55 has a range of 2,400 kilometers, and the KH-55SM has range of 2,990 kilometers. Both are designed to be launched from heavy bombers.

The cruise missiles were part of the large arsenal of Soviet arms that remained in Ukraine after the collapse of the USSR. According to Omelchenko, 20 cruise missiles were falsely listed as having been destroyed by the leadership of the Ukrainian armed forces, and then 12 were covertly sold to Iran and China after end-user certificates falsely naming Russia as the end user were presented to the SBU. The SBU approved the sale of the missiles and allowed for their export through the state export control agency.

A series of shell companies and fake contracts were set up in Cyprus and other jurisdictions to facilitate payment for the missiles, according to Omelchenko's letter. The money was then withdrawn by the Ukrainian side and subsequently disappeared. After the missiles arrived in Iran, a group of Ukrainian specialists were sent there to help service the missiles. The cruise missiles were part of the large arsenal of Soviet arms that remained in Ukraine after the collapse of the USSR.

Omelchenko's letter went on to say that an Iranian company identified as SATAK Ltd. concluded a false contract with the Cypriot-registered company S.H. Heritage Holdings Ltd. to buy gas turbines for the Iranian oil industry. This contract served as a cover for payments for the cruise missiles and related equipment, according to the letter.

In April-May 2002, $12 million was transferred from SATAK to the Heritage Holdings account at the Arab Bank in Cyprus. Soon afterward, the Iranian Defense Ministry transferred another $1.5 million to this same account, the letter went on to say. From the total sum, $7 million was then transferred by Heritage Holdings to the Central European International Bank in Budapest to the account of a U.S. company, SP Trade Inc. which then sent $2.25 million to Aizkraukles Bank in Riga, Latvia, into the account of a U.S. company Interworks LLC. Interworks then transferred $750,000 to an account in an AKB Impeksbank bank in Odesa from where this money was withdrawn as cash in 2002.

Pattern Of Abuse?

In the summer of 2000, recordings made by Melnychenko and authenticated by the FBI had revealed that President Kuchma intended to sell the advanced Kolchuga radar system to Iraq. A subsequent U.S.-British commission of inquiry established that Kuchma did, in fact, have a conversation with UkrSpetzExport head Valeriy Malyev in his office about selling the Kolchuga to Iraq, but Kuchma and SBU officials at that time claimed that the sale never took place. The United States has not found any Kolchugas in Iraq.

In the case of the cruise missiles allegedly sold to Iran, the same officials from UkrSpetzExport who claimed that the Kolchugas were not sold and could never have left the country due to strict export controls, have now been implicated in the sale of the cruise missiles to Iran and criminal cases have been instituted against them.

According to Omelchenko's letter, on 22 October the SBU formally opened a criminal case and charged a number of high officials of UkrSpetzExport with embezzling $13 million from the sale of these cruise missiles.

Omelchenko and SBU investigators claim that Malyev, who headed UkrSpetzExport at the time of the alleged sales to Iran, knew that the sales were illegal and were destined for Iran. Malyev died in a suspicious car accident in March 2002.

Ukrainian citizens, acting on their own behalf, have been involved in illegal arms sales to Africa and Croatia since the fall of communism, but the alleged sale of cruise missiles to Iran in 2002 would be the first recorded instance in which Ukrainian governmental structures acted with the apparent knowledge of the president and the secret services of the country in carrying out such an operation.

Such a scenario would also make the purported sale of the Kolchuga radar system to Iraq seem more probable.

By Roman Kupchinsky

Reforming Ukraine's coal industry is one of the major problems facing President Viktor Yushchenko and the government of newly appointed Prime Minister Yuliya Tymoshenko. Tymoshenko knows the power of coal from personal experience. She tried to reform the industry while she was deputy prime minister from 1999 to 2001. She was abruptly removed from office in January 2001 by former President Leonid Kuchma, charged with fraud and money laundering, and jailed for several weeks. The charges against her were eventually dismissed.

The problems plaguing the coal industry in the heavily populated and economically depressed eastern Donbas Basin, which consists of the Donetsk and Luhansk oblasts, are severe and multifaceted.

A Long-Neglected Industry

Ukraine has huge coal reserves, estimated at some 37 billion tons. The industry employs 450,000 people and produced 90 million tons of coal in 2004. Poland, by way of comparison, had only 140,000 people employed in the coal industry in 2002 and produced 95 million tons that year, according to the World Bank.

According to the World Bank, approximately two-thirds of Ukraine's 193 existing mines are unprofitable and should be closed. Ukraine's coal industry has been in a critical state of health for decades and survives mainly due to subsidies from Kyiv, which amounted to some $2 billion in 2003 and 2004.

Such subsidies are not nearly enough, however, to maintain proper safety standards. In its August 2000 country brief on Ukraine, the U.S. Energy Information Administration found that "outdated equipment, a lack of spare parts, and poor safety procedures have resulted in safety problems and lost production, exacerbating the industry's inefficiency."

The industry's lack of productivity has also been calculated by the World Bank: "While a coal miner in Ukraine produced on average about 100 tons of (washed) coal in 1995, the comparable figures were 200 tons in Russia, 400 tons in Poland, 2,000 tons in the United Kingdom, and 4,000 tons in North America."

Most mines belong to state-owned coal enterprises run by managers appointed by the Ministry of Fuel and Energy, into which the Coal Ministry was incorporated in 2000. During the two Kuchma administrations, these two ministries were headed by people close to the so-called Donetsk clan, an informal grouping of business and political leaders in that region.

The Ukrainian Coal Ministry was described in a December 1998 World Bank report, "Restructuring the Coal Industry in Ukraine," as follows: "Arranging barter trades and bombarding the Finance Ministry and cabinet with requests for additional investment funds and production subsidies became the main occupation of the Coal Ministry."

The Human Cost Of Coal Mining

The high rate of fatal accidents in the Ukrainian coal industry is mainly due to criminal negligence, industry officials in Kyiv say. Four miners in Ukraine are killed for every 1 million tons of coal extracted. Ukraine's coal industry is considered the world's second deadliest, after China. More than 4,000 coal miners have died in accidents in Ukraine since 1991.

Timber, needed to construct mine shafts, is in short supply in Ukraine and is often reused until it rots, creating dangerous conditions.

Most mine fatalities in Ukraine are related to methane gas explosions, and most of these accidents take place in mines that produce coking coal used in the steel industry. These are also some of the most profitable mines in the industry.

A former deputy director of a coal enterprise in the city of Krasny Luch in Luhansk Oblast told RFE/RL that some fatal mine accidents in coking-coal pits are connected to management directives to extract up to three times the daily norm of coal, for which miners would receive double their monthly wages. The average monthly wage of a Ukrainian coal miner in January 2005 was 1,400 hryvnyas ($255). Coal enterprise managers, according to this former official, had signed profitable contracts with steel manufacturers to sell more coking coal in order to increase steel production.

However, existing ventilator systems that pump out the deadly methane gas that is a byproduct of mining are capable of removing only the amount of methane released during normal levels of coal extraction. The increased production results in an excess of methane gas that, when mixed with extra coal dust, often leads to fatal explosions. This former official also says that "rock dusting," a procedure of spreading limestone powder to make coal dust inert, is often not implemented by management, despite its low cost.

These facts, sources in the coal industry told RFE/RL, are often hidden from government commissions sent to investigate accidents. To date, no mine director or enterprise manager in Ukraine has been punished for allowing workers to mine coal in unsafe conditions. Only lower-level managers have so far been disciplined.

Inefficiency And Corruption

Coal-extracting machines widely used in Ukraine have drill bits fixed at drilling seams with widths of 1 meter and are incapable of being adjusted to dig narrower seams. This greatly increases the amount of waste rock mixed with the coal and decreases efficiency.

A former coal enterprise manager from Luhansk explained to RFE/RL how he had attempted to purchase a German-made extracting machine with an adjustable drill bit. He said he was ordered by a high official in the Ministry of Fuel and Energy to buy a fixed 1-meter drill made in Donetsk. This enterprise manager said he later learned that the ministry official had a vested interest in the drill-making factory in Donetsk.

Moreover, specialists in the Ukrainian coal industry told RFE/RL that some profitable mines are declared bankrupt and closed, then flooded to prevent their collapse. The closures are used as proof that the Fuel and Energy Ministry is attempting to reform the industry. After some time, however, these mines are bought by private companies at far below their real value; the new owners drain the water and resume profitable mining.

On 7 February, Mykhaylo Volynets, the head of the Ukrainian Confederation of Trade Unions and a member of the parliamentary Energy Committee, told Ukrainian television that there are presently 6,000 illegal coal mines operating in Ukraine that produce some 5 million tons of coal annually. He said these unregistered mines employ women and children, who work in unsafe conditions and receive no social benefits. Volynets added that local authorities and law enforcement agencies in the Donbas Basin are aware of the existence of these mines but are bribed to remain silent.

Coking Coal And Accusations Of Steel Dumping

For the past decade, successive Ukrainian governments have provided massive subsidies to the coking-coal industry. This policy has been, in fact, a subsidy to the metallurgical industry by providing it with low-cost coke. These subsidies, in turn, led to accusations of Ukrainian manufacturers dumping steel onto world markets.

On her website, U.S. Senator Debbie Stabenow says that "from 1997 through 2000, carbon steel slab imports [into the United States] from key producers have risen dramatically: Brazil up 25 percent; Mexico up 13 percent; Russia up 106 percent, and Ukraine up 542 percent."

The corruption-prone cycle of "coking coal-coke-steel" is illustrated by the 2004 tender terms for the privatization of the giant Kryvorizhstal mining and smelting enterprise, which the Yushchenko government is reviewing, saying that it serves as an example of corruption under Kuchma's regime.

The terms announced for the tender included provisions that any bidder must have a history of producing 1 million tons of coke and 2 million tons of steel in Ukraine annually in the past three years. This limited the sale to only two bidders: the Investment-Metallurgical Union (IMU) consortium and the Industrial Union of the Donbas. The IMU is co-owned by Viktor Pinchuk, the son-in-law of former President Kuchma, and Rinat Akhmetov, the widely acknowledged leader of the Donetsk clan and one of Ukraine's richest citizens. The IMU won the tender, paying almost $800 million for the enterprise, while others offering up to $3 billion were disqualified. On 28 January, a court in Kyiv blocked the IMU from taking possession of Kryvorizhstal, saying the bidding procedure discriminated against foreign bidders.

The coke industry in Ukraine is largely owned by Akhmetov. According to an article in "Invest Gazeta" on 13 January 2004, Akhmetov's ARS company developed into a firm "that coordinated the mining and sales of coking coal, as well as the production of coke. ARS now controls all the coal and coke chemical assets among Rinat Akhmetov's business interests."

Pinchuk owns Interpipe Trust, the largest Ukrainian enterprise producing wide-diameter pipes sold to Russia for use in its oil and gas pipelines. The second largest is Khartsyzk Tube and Pipe, owned by Akhmetov.

In March 2004, Ukrainian Fuel and Energy Minister Serhiy Yermilov was dismissed for, among other reasons, wanting to curtail state subsidies for coking coal. This subsidy, Yermilov said, was, in fact, a subsidy to the steel industries owned by a small circle of men close to former President Kuchma.

The Politics Of Coal

The troubles in Ukraine's coal industry far surpass those of other energy sectors.

-- Restructuring the coal industry would mean the loss of hundreds of thousands of jobs in a politically sensitive region.

-- Retraining programs for coal miners are not in place; the prospects for miners performing other jobs are bleak.

-- Entire municipalities in the Donbas Basin rely on the coal industry to pay for medical care, schools, public transportation, and other vital infrastructure.

How the new Ukrainian government intends to handle this problem is hard to forecast. Any coal reforms are sure to provoke angry reactions from vested interests in the Donbas Basin and from members of parliament involved in the metallurgical and energy-generation sectors of the economy.

The Donbas has shown itself willing to raise the specter of territorial separatism in order to maintain existing coal subsidy policies and schemes. The country's eastern regions had also threatened to secede as a possible response to the Orange Revolution demonstrations in Kyiv. How real the threat of separatism is remains questionable, but few have any doubts that the owners and managers of the coking coal-coke-metallurgical industries in Ukraine will lobby to prevent the implementation of far-reaching reforms and will continue to use coal as a political weapon.