Yuri Adno

R

ussian Steel Summit held in Moscow in July, 2003 was a kind of peculiar sum-up of the reform period in the Russian metals industry.
In our opinion, two items out of a wide list of aspects, which determined the development of the metals industry in 1991–2002, must be singled out. First, the transformation of this industry into one of the major export sectors of the national economy. Second, a dynamic process of forming a new corporate structure of the industry.
Nowadays, metals industry, along with sectors of fuel-energy complex and a part of defense industry, is the most competitive industrial branch whose products are in demand in the world market. An entry of the Russian metals to the world market, regardless of its forced nature (it was caused by a dramatic reduction of home market) and a limited product range, can be considered one of the key achievements of the reforms. Aside from foreign exchange proceeds (an important source of investment reserves), export promotes a continuous increase of production standards and product quality. World competition becomes one of the main motivations of consolidating assets and concentrating facilities. Constant presence of Russian enterprises in the most important market niches favors an involvement of foreign partners in share capital and investment projects together with transnationalization of the Russian metals business.
The world market of metals is for the most part the market of big corporations, and to compete with them was problematic even for Russian metals-producing leaders. That is why during reforms the process of forming integrated corporations speeded up. Here, in opposition to world practice where large corporations developed in the conditions of stable market relations, Russian business was taking shape in the environment of economic and political instability, overcoming crises and gaining necessary experience by a cut-and-try method. Despite it, the newly formed companies managed to be integrated into the world economy comparatively rapidly and on the whole successfully and, in so doing, joined in the current globalization process.
For the first five years of the Russian reforms the metals industry stopped to be a state sector and virtually completely became a private sector. By 1996 about 80 % of metals-producing enterprises were privatized. As a whole, the transformation process in the metals sector can be traced in the scheme.

P  R  O  F  I  L  E
Yuri Adno Commentator of Eurasian Metals, head of sector of commodities markets and corporate structures study of Institute of World Economy and International Relations of Russian Academy of Sciences. Cand.Sc.(Eng.). He graduated from Moscow State Institute of Steel & Alloys and worked at steel plants and in research institutions for over 15 years. For thirty years he has been dealing with studies of economic problems of development of iron and steel complex of leading industrialized countries and Russia as well as resource-saving issues. Author of more than 150 scientific publications. More than once he participated in the preparation of comprehensive forecasts of technical and economic development of leading industrial branches and collective monographs on urgent problems of development of world economy. He has a wife, a daughter and two grandchildren. Hobby: tourism and sport.

At present the third stage is being completed – integrated business groups of a holding type are formed (to be more exact, their structure is nearing completion). They account for over 90 % of metals-producing facilities. The integration process drastically accelerated after the default and devaluation of the national currency in 1998. The privatized enterprises, trade companies and commercial banks started to accumulate assets and generate industrial holdings around themselves, thus trying to lower an effect of risk and uncertainty on their business. One cannot but note an importance of the factor of political stability that came after the 2000 election in this country. Among the important measures of the state policy one can point to an introduction of the new Tax Code, a reduction of credit rate and customs duties on metals export along with actions on protection of home market from unfair competition. On the whole, the federal authorities are interested in the formation of large integrated business groups, among it, through take-over and merging. Along with it, a whole number of legislative provisions still requires additional improvement – for example, laws on bankruptcy, holdings, joint-stock companies, anti-monopoly policy.
An expediency of integrating individual companies was defined by companies themselves, judging from the vertical structure of a process flowsheet that closed the entire production cycle. Of special value was an acquisition of suppliers of raw materials. Here such tools as take-over of stock in the exchange market or from physical bodies, small shareholders in the main (as a rule, personnel of the same enterprise), bankruptcy of enterprises and establishment of control over them through crisis management, accumulation of enterprises’ debts with the same aim were widely used.
Now the Russian metals-producing complex is comprised of, for the most part, large vertically-integrated companies. Horizontal integration is to a greater extent typical of tube and pipe industry.
The integration took different shapes. Some companies – EvrazHolding, United Metallurgical Company, Russian Aluminum – started as trade firms and only after that got down to accumulation of industrial enterprises. As often as not an intermediate step on the way to the formation of a vertically-integrated structure was a branch association of a cartel type set up as a rule during the period of economic instability for supporting products prices. Thus the prerequisites of establishing first financial and then administrative control by more powerful companies were formed and after that a transition to technical modernization became possible. In this way, for instance, Ural Mining & Metallurgical Company was set up. As was shown by practice, the most stable form of the integration process turned out to be the integration based on a large enterprise. It is connected with, above all, an optimal input of capital into investment projects or accumulation of assets in shortage. During the integration process big companies advanced to the field of mining raw materials as well as towards the business activities nearing end users.
The outpacing rates of integration in the non-ferrous metals industry as compared with the steel industry must be stressed. Most likely, it deals with a steadier and diversified demand for non-ferrous metals as well as an ordered world market based on goods flows and LME prices.

Scheme Main stages of reforming organizational structure of Russian metals industry Stage I – 1991-1994 Destabilization Privatization and transformation into joint-stock companies Liberalization of foreign trade and mass entry of Russian enterprises to world market Set-up of natural monopolies Set-up of first financial-and-industrial groups Appearance of foreign agents Introduction of tolling Stage II – 1994-1998 Survival Documentary pledge auctions Currency corridor Growth of prices and tariffs of natural monopolies Development of government short bonds market Mass bankruptcy of enterprises Start-up of integration processes in industry First antidumping sanctions against Russian exporters Stage III – 1998-2003 Economic stabilization Moderate growth Ruble devaluation in 1998 Growth of export profitability and accumulation of investment resources Introduction of Tax Code Control of customs tariffs Formation of vertically and horizontally-integrated companies Elaboration and implementation of medium-term investment programs Diversification of production and financial risks Intensification of antidumping sanctions against Russian companies First steps in transnationalization of metals business Russia gets market-economy country status

The process of corporate restructuring of the Russian metals industry is in line with the world tendency in general. It is enough to recollect the EU-initiated wave of mergers and take-overs which resulted in the set-up of Arcelor, Corus, ThyssenKrupp Stahl, LMM Group and other powerful corporations that enhanced the competitive positions of the European metals industry. In the US market International Steel Group (ISG) with a steelmaking capacity of about 16m tpy emerged. The integration processes were evident in the aluminum industry as well: Alcoa absorbed Alumax and Reynolds, with an increase in its share of the world production of up to 15 %. Alcan consolidated its position by means of merging with Algroup (Switzerland).
A certain impulse to the acceleration of integration process in the world metals industry was due to an entry to the world market of metals products from CIS and East-European enterprises. In Rumania, Poland, Slovakia, Croatia privatized metals producers are on sale owing to lack of investments aimed at their development.
When comparing Russian integrated business groups with foreign corporations, one can single out the following peculiarities:


1. Concentration of facilities incorporated into Russian holdings is still a long way from reaching the level inherent in the world metals industry. EvrazHolding occupies only the 11–12 place in the world rating of steel companies meanwhile three Russian steel giants – the Magnitogorsk Iron & Steel Works, Severstal and the Lipetsk Iron & Steel Works – are further below in the second or third ten. In the aluminum sector the positions of the Russian companies are more preferential: Russian Aluminum is on the second place, SUAL group, on the sixth.
2. For the time being securities market does not have a considerable effect on input of investments into the development of Russian integrated business groups because emission due to low liquidity is not yet a substantial tool of external financing. The majority of companies possesses stock related to the so-called "second echelon". Fairly high quotations in the "metals" securities market are a single phenomenon: in Russia only shares of Norilsk Nickel are attributed to "blue chips". It is connected with behavior of certain groups of shareholders. Fearing to lose control over companies, they use emission as a tool of redistribution of property in a limited effort, here an amount of dividend or market value is of secondary importance. As to attraction of capital, Russian companies prefer to use other tools (bonds, bills of exchnage) that do not imply changes in the list or structure of owners. Low liquidity of shares is also connected with inadequate transparency of holdings. Off-shore companies known to nobody often act as nominal holders of controlling blocks, here as often as not corporate property turns out to be fuzzy among several enterprises and physical bodies.

The Magnitogorsk integrated iron and steel works (MMK)

3. Even with comparatively high performance, capitalization of Russian companies is far behind world indicators. It can be explained by high risks in this country and industrial branch, relatively poor management, absence of experience in operation with securities. On the whole, the majority of integrated business groups, with a large potential of capitalization growth (Table 1), is underestimated. The last two years showed that Russian companies realized this problem. They are now trying to change the behavior pattern, in particular, to ensure the transparency of production and financial decisions, to strictly observe the rights of shareholders and generate a favorable image of their business.
4. Russian steel companies unite, apart from metals-producing facilities, iron-ore mining undertakings, coal mines, coke & by-products plants, refractories and fluxes plants, etc. Virtually all of them have own power-generating facilities and repair-and-mechanical shops. In the conditions of the Russian market such autonomy is considered a required guarantee of stable production though it undoubtedly raises production costs and prime cost of finished products.


5. The basis of the Russian steel industry is comprised of eight integrated iron & steel works accounting for over 85 % of steel and rolled products output. Meantime there are no specialized mini-mills in Russia. The preservation of such structure of the steel industry absolutely contradicts the world practice where enterprises differing in capacity and specialization provide for the possibility of manoeuvring in the period of economic depression, permit better response to the growing individualization of demand and lower risk in the introduction of technical innovations. It is not by chance that in the US the most successful and profitable company is Nucor which has only mini-mills in its structure.
6. In the Russian metals industry a trend to transnationalization is actively developing. Thus, Russian Aluminum meets its requirement for baixites through joint mining enterprises in Guinea, with more than 60 % of alumina made at the Ukrainian and Rumanian plants belonging to the company. In order to enter the world market, another aluminum producer – SUAL – formed an integrated industrial group with Fleming Family & Partners (UK). Norilsk Nickel purchased Stillwater Mining Company (US). Russian steel companies buy plants in Eastern and Central Europe (Table 2). Sure all these plants lack competitiveness and require large investments but in this way the Russian metals business creates a bridgehead to overcome import quotas and price limits and to further advance in the European market.

Mechel, Chelyabinsk region, one of Russia’s major producers of special grades of steel and alloys

7. It is still difficult from the viewpoint of cost efficiency to assess the tendency of an inter-branch expansion of capital and an aspiration of the Russian metals companies to diversify their business through participation in machinebuilding branches, for example, car industry. The activities of Russian Aluminum at the Gorky Automobile Plant (GAZ) and Severstal at the Ulyanovsk Automobile Plant (UAZ) have not brought any noticeable results so far. In the West similar processes took place on the frontier of the 1970s and 1980s when metals industry experienced a structural crisis and companies invested in higher rate-of-return production operations. Later on a majority of companies "dropped" their off-branch operations and retained only highly profitable ones, like, for instance, Marathon Oil & Gas in U.S. Steel. The practice proved that, for success in machinebuilding with faster capital turnover, products and technologies updating and developed production cooperation, radically different organizational forms and financial decisions are needed.
8. Cooperation trends among leaders were manifested as a set-up of strategic alliances, not-for-profit partnerships and consortiums. The biggest one is Russian Steel Consortium between the Lipetsk Iron & Steel Works and EvrazHolding established in 2001. The key directions of inter-company collaboration are elaboration of measures and rules of coordination in metals market, interaction in social policy, raw materials, relations with other market players, authorities, trade unions, etc. Similar declarations were made by other large companies. The matter in question is not ownership or merging however the corporate managers do not close out the chance of such a dialog in the future.
9. Russian metals-producing enterprises are city-forming. In the conditions of breaking the previous system of social protection and with the growth of economic influence of big business, the latter assumes a part of responsibility for social policy not only in a particular city but in the locality on the whole. Backed by general economic stabilization, the prerequisites of re-digesting the role of the social factor in the strategy of business groups and introducing respective corrections into corporate policy are being formed. If the positive dynamics of business development continues, the managers will better realize the necessity of long-term socially-oriented decisions and investments which payback will be evident to not only shareholders but the society at large. The regional aspect is of special importance. Leading companies, by forming, to a large extent, local budgets and ensuring employment, support stability in localities and dictate the dynamics of the regional economic development.


When coming back to the results of the June Summit, one can conclude that lately positive tendencies took shape in the Russian metals industry as a whole. The period of primary accumulation of capital and set-up of large integrated business groups as an organizational basis of production has been completed. An efficient management has been formed, a strong branch lobby is under action in the system of legislative and executive authorities. In a determinate sense, one can also speak about the completion of redistribution process and the traverse of consequences of privatization, which disrupted former branch and inter-branch process ties. It promoted the consolidation of positions in the world market, development of contacts with leading corporations, transnationalization of business and growth of investment attractiveness.