By John Helmer, Moscow
It’s almost August, the month when everyone knows that serious coincidences can happen in Russia – and I’m not talking about the lunar cycle or Ramadan.
In election years, the prevention of coincidences has always been Kremlin Priority Number-One. This year that’s tempered by President Dmitry Medvedev’s concern that nothing coincidental happens to his re-election campaign. And in Prime Minister Vladimir Putin’s White House, it is plain that reassuring Russian workers of their job security and income against negative coincidence is also a priority effort.
Of course, in an economy divided between oligarch and state control, there can be occasions when the oligarch pursuit of maximum profit coincides with the government’s pursuit of wage growth and welfare stability. Then there are the times when they don’t coincide. The non-coincidence of those two can have unpleasant political consequences, especially at the ballot-box, which is one reason the Prime Minister engaged steelworkers at Magnitogorsk Metallurgical Combine (MMK) for this unusual session on July 15 .
The official transcript runs for 8,571 words; the question-and-answer conversation lasted for more than two hours. That makes one of the longest and most detailed analyses ever given by any European leader on steel sector policy and prospects. Read it as a political campaign speech, and you will understand who’s running in Russia (and who’s fellow-travelling).
At MMK for the commissioning of the new Mill-2000 production line for automobile steel sheet, Putin noted: “we would not be able to achieve our goal of increased domestic content in the auto industry to at least 60% or 65%, without the quality sheet metal the plant will now produce at this new mill. It is [now] economically inexpedient to import enough sheet metal to meet the production requirements we have set for our foreign partners, 300,000 vehicles a year. When you started producing sheet metal at this plant, it changed the economic prospects dramatically.”
The Prime Minister disclosed there is pressure from the European Union and American automakers to halt Russia’s domestic content rules. “We are in the middle of a difficult dialogue with the European Commission and our American partners on Russia’s accession to the World Trade Organisation (WTO). They insist that we change our position on this issue and rescind the requirements on 300,000 cars and 60% localisation. We said we want to join WTO but will not change our terms. This is a red line that we cannot cross because we cannot forego the interests of our domestic producers.”
That red flag of Putin’s drew a charge from the US auto bulls. Senator Debbie Stabenow, Democrat of Michigan, the auto-producing state, issued a public letter to the U.S. Trade Representative Ron Kirk. “This unfair trade practice”, the senator said, “reduces U.S. automobile exports to Russia by putting American-made vehicles at a distinct disadvantage,” Stabenow said. “Because Russia’s discriminatory production requirements would be illegal if Russia is bound by normal WTO rules, Russia should not be allowed to maintain this practice while negotiations continue or during any transition period should Russia join the WTO.” Ford and General Motors currently build cars in Russia, along with French, Italian, Korean and Japanese competitors, under the tax, tariff concessions and domestic content programme.
At his Magnitogorsk meeting, Putin was also asked to comment on signs Russia’s steel oligarchs have been shutting down steel output to hold up prices and profit margins. A despatcher at Sheet Rolling Line no. 9, Vadim Dorofeyev, told Putin that output at MMK has been “declining in the past few months. In particular, fewer contracts have been signed for the pipes made at Mill 5000, another of our major assets. The question is how can we resolve this problem? And does the government help stabilise the market?” Putin replied: “I am sure that as the global and Russian economies improve, this market will only expand, there is absolutely no doubt about it. No doubt about it.”
No doubt which way the swallows are flying then. But for how long?
A report this week by Renaissance Capital (RenCap) steel analysts predicts that growth in Russian consumption and sales of long steel products will stop by September. According to all-Russia data already published, long steel consumption reached 1.324 million tonnes, up 7% on the month of May, and up 20% on June of 2010. Long steel products include reinforcement bar (rebar) and wire-rod used in construction of buildings and bridges; girders; shapes pressed or punched for machine-building and hardware.
An itemized breakdown of this aggregate reveals that Russia’s construction and traders’ market takes the lion’s share of consumption — 951,300 tonnes, 72% — and this jumped 12% from May, 23% year on year. But the machine-building industries have reported a drop in consumption to 163,900 tonnes, down 6% month on month, but up 6% year on year. Railway car production remained flat from May at 44,400 tonnes, but automobile producers cut their long steel intake to 33,900 tonnes, down 14% from May, and also down 3% from June of 2010. (Flat steel sheet is the principal requirement for the automotive production line, and the Russian trend for flats appears to be the same as reported here for longs.)
According to estimates prepared by the Renaissance Capital analysts, Russian hardware plants reported last month’s consumption of long steel at 162,600 tonnes, down 1% month on month, up 15% year on year. Hardware is another indicator of which way, up or down, domestic consumer demand is moving.
Analysts Boris Krasnojenov and Vasily Kuligin say the improving signs in June “reflect a combination of factors, including (1) a traditional seasonal demand recovery; (2) lean inventories at metal traders, as they cut working capital requirements; and (3) reduced rebar supply from Evraz, NLMK, and Mechel, due to technological and sales contract-related factors. Accordingly, we expect only a short-term growth in the Russian long-steel segment, driven by one-off factors; and we think supply-demand balance is likely to be restored in September-October.”
That timing is awkward, for the parliamentary election is due on December 4; and the presidential election on March 4, 2012. Even at the best of times, Russian steelmakers don’t like to announce they are cutting production, but this year they are super-sensitive. “Technological factors” are often announced as “scheduled maintenance”, which sounds positive for the employment and payment prospects of steelworkers. “Sales contract-related factors” can mean many things in steel company reports; in Russia these days, it means that the oligarchs don’t want to cut their prices to make sales, so they produce less, deliver less, saving on costs, and conserve earnings and profit margins.
Domestic prices for rebar are also expected to continue their rise through August, the RenCap analysts claim, but then they are forecasting a correction of 4% to 5% forecast for deliveries in September and October. This trend, combined with the peaking of export prices for rebar ahead of the start of the August 1 Ramadan holiday in Turkey and the Middle East – traditional buyers of Russian steel — is widening the spread between domestic and export pricing of long steel, and delivering a short-term domestic price premium to the principal producers. These are Evraz (with a 23% domestic market share for rebar), Mechel (23% market share), and Novolipetsk Metallurgical Combine (20%).
The fastest growing of the Russian longs producers is Novolipetsk, through the plants it acquired from the Maxi group at the end of 2007 . As already reported, in the first half of this year Novolipetsk sold 643,000 tonnes of rebar, up 43% year on year. Novolipetsk says it will commission its new Kaluga minimill, with 750,000 tonnes per annum rebar capacity, in a year’s time, strengthening its dominance in the Russian market.
Just how profitable Russian steelmaking operations are, compared to other-country steelmakers, can be seen from this tabulation in the RenCap report. Read down the right-hand column, and you will see that earnings per tonne by the Russian steelmakers averages $208; that’s almost triple the European Union/US average; and 30% higher than the Asian steelmakers. Russian profitability is also significantly higher than that of most steelmills in Turkey and Latin America.
Make that Russian steel oligarch profitability – for that’s the rub at home right now. If they cut back on output so that steelworkers feel it, and complain loudly, the Prime Minister is certain to hear and bound to calculate whose pocket should feel the pinch before election time, so that the election result won’t turn out to be unpredictable for him.
Putin’s jawboning against imports of steel is also working with less than hoped-for effect. The RenCap report indicates that imported long steel products, intended for the automobile and pipe segments of the Russian market, are running at the 100,000 tonnes level, up on this year to date, but equal to the level last seen in August of 2010. Peak import volume of long steel products was 200,000 tonnes in May of 2007, and then 125,000 tonnes in July of 2008.
One outcome of this supply-demand balance for Russian steelmakers is no accident. Their share prices have been falling, with Mechel (Igor Zyuzin) and MMK (Victor Rashnikov) worst among the Russian performers.
What international investment bankers to the Russian oligarchs understand about this chart right now is that the collateral value of the oligarchs’ shares – pledged to secure repayment of their pre-2008 crash loans – is falling. And for the borrowers, that means the possibility of bank margin calls, renegotiation of their loan covenants, restrictions on their freedom of action, and, worst of all, increasing dependence on the goodwill and money supply of the Russian state.
Take a look at how Alexei Mordashov’s Severstal has just reported its second-quarter results, and you see that even before Putin gave his Magnitka pep talk on July 15, Mordashov was selling less steel but holding up price – and profit. Production of hot metal at the Russian mills was unchanged from the first quarter at 2.7 million tonnes; in the Severstal group, the Russian steelmills account for 83% of total production; Mordashov’s loss-making North American mills account for just 17%:
Sales volumes of the top two steel products, hot-rolled and cold-rolled flat steel, show the downward pressure of demand in the car and other machine-building sectors. The 7% decline in large-diameter pipes shows that Mordashov’s Izhstal mill, near St. Petersburg, isn’t getting the growth in orders from Gazprom, Rosneft, Transneft and the rest of the Russian energy sector which you might expect, given the rise of export prices for oil and gas.
But here’s the good news for Severstal’s profit-line and Mordashov’s dividend stream:
Average prices for every category of steel product went up as sales volumes came down. “Still highly cash-generative” reports RenCap.
Alfa Bank reports that Severstal’s sales result was also repeated by Novolipetsk and Evraz. “According to our estimates, the average realized price per tonne of steel product increased [at Severstal] by 9% q/q, between the 16% increase from NLMK and the 6% increase from Evraz. In terms of average realized prices, we note an 11% q/q increase in rolled steel and a 16% increase in semi-finished products prices, as well as a modest 3% increase in downstream products. Overall, we view the results as POSITIVE based on the recovery of steel production volumes and the 9% q/q increase in steel sales prices.”
MMK released its first-quarter operating results, including the sale prices for its main products, on April 21, three weeks after the close of the quarter. Release of the second-quarter figures is running late.
The steel oligarchs would like to save and keep their profitability, but if that costs jobs, pay, and steelworker votes in the coming elections…Well, you don’t have to take the auspices from the swallows on the Ides of August to figure out what that last coincidence can mean.