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Put some vodka on a barrel

13.10.2014

chistaya pribylThe distilleries have been initiating the abolition of the state monopoly on the production of spirits. But, actually, the distilleries of the concern Ukrspirt are of little interest to investors. They are of interest only as sites for the construction of new enterprises or as producers of these products for the transition period.

The distilleries have been initiating the abolition of the state monopoly on the production of spirits. But, actually, the distilleries of the concern Ukrspirt are of little interest to investors. They are of interest only as sites for the construction of new enterprises or as producers of these products for the transition period.

Pet project of an American prisoner. Pavel Lazarenko, becoming a Prime Minister in 1996, faced a problem the current government has been struggling with: budgetary shortfall. Pavel Ivanovich decided that the state could have earned more on the sale of spirits, for this purpose it was necessary to prohibit the basic export scheme which is the give-and-take scheme. This mechanism as well as facilities, three times higher than domestic consumption, Ukraine inherited from the USSR. Therefore, for some time it remained the main producer and supplier of spirits to the post-Soviet states. Kazakhstan supplied grain to the domestic spirits distilleries in large volumes. The give-and-take schemes also used Russian enterprises, the main importers of Ukrainian spirits. They also bought grain and molasses for processing. That same year the Lazarenko government created the concern Ukrspirt which united spirits distilleries and some state alcoholic beverage enterprises. Since then, this structure is a state monopolist in the field of spirits production. In 1996, the domestic spirits distilleries produced a record 60.8 mln dal of spirits, 31.8 mln dal of which was sold to foreign markets. The profit of the industry was 272 mln UAH with the rate of cost efficiency 61.2%. In 1997, after the prohibition of the give-and-take schemes, the output of this product was reduced up to 23.8 mln dal, 5.6 mln dal of which was exported. "The production of spirits in Ukraine decreased primarily due to the fact that the same year Russia withdrew our spirits from the free trade, because it began to build its own capacities," Vitalii Sosnitskii, First Deputy Chairman of state concern Ukrspirt, says. "Since that time, the production of spirits in Ukraine has almost halved, and today the industry covers mainly the domestic market. The country consumes 22 mln dal. About 97% of this volume is used for the production of alcoholic beverages.

In spite of the changed conjuncture, both the structure of concern Ukrspirt and its facilities remained the same. They include 76 spirits distilleries, four alcoholic beverage factories, four trading houses, a food factory, a juice and fresh drink factory and seven regional associations. The facilities of the concern's enterprises are designed to produce almost 60 mln dal of spirits. Therefore, today every third enterprise does not work. And in 2007, 35 factories worked at a loss. About 70% of production facilities are worn out and run their course, because the equipment has not been updated for 20 years. Last year, Ukraine produced 31.3 mln dal of spirits, 9.2 mln dal of which was exported. Ukrspirt ended the year with a total profit of 9 mln UAH. 26 spirits distilleries, which are specialized in grain processing (grain spirits is used for the production of alcohol) and cooperate with vodka distilleries, produce more than half of the products. The enterprises processing molasses (a by-product of sugar production), the alcohol from which is mainly exported, are mostly idle. Last year the volume of its production was 10.3 mln dal.

Alcohol interests

The owners of vodka holdings, the main consumers of spirits, for several years have been actively lobbying the Verkhovna Rada for the privatization of spirits distilleries and the abolition of the state monopoly of Ukrspirt for the production of these products. In particular, last year such a bill was registered by Pavel Klimets, regional deputy, the owner of Olymp Company. Last time this question was raised on May, 15 at the meeting of the Parliamentary Committee on Agrarian Policy and Land Relations, the results of the concern's activity for the past year were considered at. It was about the fact that the spirits distilleries sell shadow spirits. Thus, according to Vladimir Demchak, Head of the Union of Wholesalers and Producers of Alcohol and Tobacco (SOPAT), up to 5 mln dal of shadow spirits is sold from the enterprises of the concern annually. It is used for the production of illegal vodka, the share of which at the market reaches 20% these days. "A candidate for the position of director of the spirits distillery is agreed with the local authorities and the governor. In spite of that, this position is occupied by people who sale spirits in an illegal way," Mr. Demchak says. Even tax posts at the spirits distilleries which are obliged to monitor accounting of products do not save the situation. Head of SOPAT is sure that: if the plant belonged to a vodka company, spirits would not retreat into the shadows, because none of the vodka producers are interested in selling raw materials to a competitor. Moreover, according to him, the prices on spirits, the vodka producers buy it at from the monopolist, are exorbitantly high. According to Mr. Demchak, Ukrspirt has to constantly raise the selling price in order to maintain its unprofitable and idle enterprises. "If unnecessary costs are excluded, 1 dal of spirits would be cheaper by 10‑15 UAH," he thinks.

"It would have been better if the excise duties have been paid as they should," – Boris Frantsishko, Deputy Chairman of concern Ukrspirt, says with an offence at such statements of the vodka producers. And he hints that the largest consumers of registered spirits and the processing companies of shadow spirits are the same companies.

The concern does not establish a single price for spirits at its enterprises. Last time it was done last year in October due to the rise in price of raw materials and energy resources. Then the price of 1 dal of spirits was increased from 46‑48 UAH to 62‑65 UAH. In response, the vodka producers threatened to import it from Russia, and the state monopolist promised not to follow the practice of a single price. And to avoid jumps in the prices on raw materials, the vodka companies began to purchase grain for spirits distilleries. So now they can negotiate a price with every spirits distillery separately. Meanwhile, Vitalii Sosnitskii considers that taking advantage of the situation the vodka producers seek to make money from grain, often selling it to the spirits distilleries at a price higher than the market price is. From his point of view, setting a single price was justified, because the observed excess of facilities at the market allows the vodka producers to dictate the price of spirits. And to keep a buyer, the spirits distilleries are forced to decrease it.

In principle, Ukrspirt and vodka companies have always struck a compromise. For example, Nemiroff helped the nearby Nemirovskiy Spirits Distillery to modernize its production facilities. "The company has invested tens of millions of dollars in the equipment for this state-owned enterprise," Tagir Imangulov, Head of Press of Nemiroff, says. And he adds that now the company buys about 95% of the required spirits from this spirits distillery. By the way, when the reconstruction was carried out, the director of the spirits distillery was Stepan Glus, co-owner of Nemiroff. According to Vitalii Sosnitskii, as a result of the modernization, the facilities of Nemirovskiy Spirits Distillery were increased two times and the neighboring enterprises, Nemiroff also bought spirits from before, had practically been stopped. According to him, the company gave the spirit distillery funds not for free. It was a loan for 40 mln UAH. And gradually, the company pays it.

It is obvious that the state is not able to finance the alcohol industry and control the movement of spirits at the market. So, it is not clear why it opposes the abolition of the monopoly. There are a lot of rumors in the market about this. They say that the amount of illegal spirits produced by the spirits distilleries of the concern is not much less than that registered one. The customers – vodka producers – pay the management of spirits distillery for unpaid excise duty in cash. Directors who are approved by the local authorities provide that money to structures close to a certain political force. There are rumours that at present all enterprises of the concern are divided between the different forces.

Moreover, Ukrspirt transferred the intellectual property rights for the spirits production (processing regulations, technical specifications) to private entities which were close to different political parties. So these days the state-owned enterprises have to pay royalties – payment for the use of technical specifications – to produce spirits. According to the source close to Ukrspirt entities, last year the spirits distilleries paid royalties in the amount of 25 mln UAH.

Bioethanol as a rescue

The management of Ukrspirt prepared a program of the industry development until 2011 to save its enterprises. It offers to change the speciality of the spirits distilleries from molasses processing to the production of bioethanol. For this purpose the concern wants to re-equip 11 enterprises which after reconstruction will be able to produce 218 ths. tons of bioethanol per year totally. Ukrspirt is also going to build the biogas units at 15 plants, including those which process grain. It is also going to produce biofuels in the amount of 59 ths. tons per year at six more plants. For the time being, only oil refineries have the right to produce and sell biofuels in Ukraine, so Ukrspirt has been lobbying for amendments to the legislation, offering to add spirits distilleries to the list of possible suppliers of these products. Previously, the state allocated the concern funds at the rate of 15 mln UAH for repurposing the enterprises. "These funds are apparently insufficient. That's why we refused to accept them," Vitalii Sosnitskii says. Now the management of the concern asks to allocate funds in the amount of 120 mln UAH from the state budget.

To finance the project, the concern has found two investors who cover the main costs for equipping the enterprises. Techinservice Group of Companies LLC re-equipped them for the production of bioethanol. The company specializes in the design, manufacture and installation of equipment for sugar mills and spirits distilleries. Techinservice has its own production site – Grebenky Machine Building Plant. It is assumed that the investor will install a technological unit at Ukrspirt enterprises which will process spirits into bioethanol by its dehydration (withdrawal of excess water). According to experts, this installation costs $ 600‑700 ths. According to Vitalii Sosnitskii, in general, Techinservice will invest 25 mln euro in the enterprises of the concern. According to Igor Shchutskiy, General Director and co-owner of Techinservice, some funds will be its own and some funds will be borrowed from a domestic commercial bank. He refused to give the name of the financial institution and credit conditions. The investor does not reveal the amount already invested in the conversion of the plants. He said that this information can be used by competitors. Ukrspirt and Techinservice are going to start production of bioethanol in October at six distilleries – Korostishivskiy Spirits Distillery, Zhovtneviy Spirits Distillery, Ivashkiy State Spirits Distillery, Khorostkiv Spirits Distillery, Naumovskiy Spirits Distillery and Triliskiy Spirits distillery. From October to December they are expected to produce 30 ths. tons of products. According to Vitalii Sosnitskii, the resulting bioethanol will be exported to the EU countries. The partners declare that they will be able to sell it on FOB terms in Rotterdam at a price of 412.5 euro/t.

At the enterprises the biogas production units will be installed which will not only process the dregs (byproducts in the production of spirits from grain), but also produce animal feed. The equipment will be installed by Biosystem Ukraine – the representative office of the Swedish company for the production of energy-saving technologies Biosystem AB. The concern reported that this company is ready to invest 60 mln euro in the distilleries of Ukrspirt. The parties do not give an answer to the question under what guarantees the companies invest funds in the idle state-owned enterprises. Valentin Makogon, Director of Biosystem Ukraine, told the newspaper PE about the plans of company regarding the production of biogas. According to him, the parent company Biosystem AB, through its partner, a European non-profit bank, took a loan for 30 years at small interest rates (perhaps, this is Nordic Investment Bank, which appears in the documents of Ukrspirt. – author's note). For construction of a biogas plant, the concern gives the company land for rent for 25 years. The cost of one plant is 6‑7 mln euro. Mr. Makogon is going to return the funds in four years. During this time, biogas is planned to be sold to the enterprises of Ukrspirt at a price equal to the market value of natural gas (!). Then, when the funds will be paid off, the price for enterprises will be significantly reduced. "Now I cannot say how high the price will be. But the cost of production of 1 ths. m3 of biogas is 1 USD. We have agreements with Ukrspirt which I cannot announce," Mr. Makogon said.

Ukrspirt is going to produce bioethanol and biogas on the basis of molasses. Techinservice expects to purchase it at 60.9 euro/t. Meanwhile, last year a ton of molasses costed 800 UAH on the market. This year, taking into account the decrease in sowing of sugar beet and the expected shortage of molasses on the market, it likely becomes more expensive. By the projections of the company AAA, this year the sugar beet harvest will not exceed 11.5 mln tons, whereas last year it was 17 mln tons.

According to estimates of Sergey Tsygankov, Deputy Director of the Institute of Food Chemistry, this year there is less than 600 ths. tons of molasses in Ukraine. In previous years it as a relatively cheap raw material for the production of bioethanol was exported to the EU countries in considerable amounts. Molasses is also used by domestic manufacturers of animal feed, citric acid and yeasts. Mr. Tsygankov said that to produce the specified amount of bioethanol and the subsequent production of biogas, at least 400 ths. tons of molasses for the enterprises of Ukrspirt will be necessary. It will be very difficult for one operator to collect such an amount at the best price.

Sergey Tsygankov challenged the efficiency of bioethanol production on the outdated equipment of the distilleries (for reference: in Europe, the minimum capacity of a bioethanol plant is 50 ths. tons per year). According to him, the enterprises of the concern consume three to four times more electricity than distilleries in Europe. According to the standard regulations of Ukrspirt, at our distilleries a release of steam per 1 l of spirit is 8‑11 kg, at the European distilleries a release of steam is no more than 3 kg.

New is always better than old

So, in the case of revocation of the state monopoly, it will be economically feasible to construct new distilleries than reconstruct the existing ones. This, however, does not apply to the company Nemiroff, which has already upgraded Nemirovskiy Spirits Distillery. It would be more interesting for the rest spirits manufacturers to build new modern enterprises. According to Yulia Samoilova, General Director of the company Olymp, the construction of such a plant requires from 30 mln USD to 50 mln USD. At the same time she noted that the industry should be reconstructed gradually. It will take two to three years to put a new enterprise into operation. So, at the first stage alcohol manufacturers will invest in the existing plants. And they will probably privatize the profitably located ones.

"We should move in two directions," Roman Vashkolup, General Director of the company National Alcohol Traditions said. – "It will be interesting for producers of alcoholic beverages both to buy existing distilleries and to build their own spirits production from scratch. Construction takes time. Therefore, it is reasonable to buy ready-to-use plants in order not to discontinue production. But it should be understood that technologies forge ahead. They should be implemented in Ukraine. And for this purpose it is necessary to build new plants."

Khortytsa Distillery has also said that it is more profitable to build new distilleries than to reconstruct morally and technically outdated distilleries. "Especially that their inconvenient location will cause additional logistic costs," Gennadii Vasiukov, Director of Legal Affairs of this distillery, said.

The current investors of the concern are not interested in the purchasing of the old distilleries.

"This is rubbish, they are not needed by anyone," Igor Shchutskiy said to the newspaper PE. And he added that now for his company it is profitable to cooperate with Ukrspirt under the existing agreements.

Meanwhile, Sergey Tsygankov considers that in the case of revocation of the state monopoly, the distilleries will be of interest to investors primarily with their sites. The construction of a plant at the new site will cost 25 mln euros.
While the dismantling of the old plant and the construction of a new one at that site using the existing infrastructure will cost half price.

According to Alexey Kunchenko, President of CJSC Severodonetsk Azot Association, if the distilleries will indeed be taken out of the state ownership, his company will consider the possibility of purchasing such an enterprise. "Many interesting projects can be created in this direction. But an investor should be ready for significant financial investments," he says. On the basis of a distillery it would be possible to organize the production of polyethylene, which today is fully imported from Russia. According to the calculations of Mr. Kunchenko, to create a full cycle production of: ethanol – ethylene – polyethylene, it is necessary to invest at least 150 mln euro.

Sergey Tsygankov considers that producers of bioethanol may potentially be interested in the sites of Ukrspirt. But he noted that taking into account the current prices for raw materials, it is unprofitable to produce it in Ukraine and export to Europe. And in Ukraine there is no legislative basis for the sale of these products. According to his estimates, the cost of bioethanol produced on modern equipment in Ukraine will be 0.65 euro/l. Therefore, it will not be able to compete with the Brazilian bioethanol made of cane, a liter of which costs 0.30 euro. "As of today, a half of the bioethanol plants in Europe, which cannot compete with Brazilian imports, have stopped," Sergey Tsygankov said.

Heinz Strubenhoff, Head of the project named German-Ukrainian Dialogue in Agriculture at the Institute for Economic Research and Policy consulting, agrees with him. According to him, the production of bioethanol in Ukraine may be beneficial only under the condition of state subsidies.

"About 80% of the net cost of bioethanol is accounted for raw materials. Profitability is also affected by the ratio of prices for oil and raw materials. As of today, this ratio is not in favor of the latter. During the year oil has increased in price two times and grain has increased in price three times. Now even sugar beets are too expensive raw materials for the production of bioethanol. It is economically feasible to produce bioethanol from cane," Heinz Strubenhoff says.

At the same time, according to Sergey Tsygankov, the production of bioethanol in Ukraine is today hindered, first of all, by the state monopoly. Three projects on the creation of bioethanol plants have already been organized, and only one of them has been brought to the construction phase. On the site of a former brick factory in Zolotonosha (Cherkasy region), the production is being built by the company KoronAgro by Oleg Oranov. For growing raw materials, he rents 30 ths. hectares in Poltava, Cherkasy and Kyiv regions. Initially it was supposed to produce bioethanol from corn. A year and a half ago, when the construction of the plant began, a ton of this raw material costed 80 USD. Now it costs 250 USD, which makes the production of bioethanol for export unprofitable. The investor has already invested 40 mln euro in the project. Therefore, now the only hope is change in legislation that would allow private companies to sell bioethanol or fuel additives in the domestic market.

Two other projects – the construction of a bioethanol plant on the basis of the former sugar mill in Chernivtsi by the company Assets Management Group as well as on the basis of a cannery in Kherson region by a local businessman – remained ink on paper.

Source: Net profit