Yury Adno

T

he previous year excessive growth in prices for steel products has continued in the first quarter of 2005. There is a number of forces pushing steel product prices upward, including the world economy growth inertia, a significant demand for steel products on the part of China and other Asian countries and a low US dollar currency exchange rate. Moreover, partly we owe such high prices to mining companies, products of which play a key role in the steel production and cost formation processes.

In 2004 world prices for iron ore grew by 19% that was a record high increase over the previous twenty five years. However, this record did not last for long. In February CVRD, Rio Tinto and BHP Billiton, which together hold two thirds of the world ore mining market, announced their intention to increase prices for iron ore by as much as 71.5 %! Steel manufactures had to accept it sure intending in their turn to shift a major share of the higher cost burden to the customer.

Mining companies consider this increase objectively justified. Over the whole previous year they were working to their full capacity trying to meet demand for iron ore. Thus, for example, in 2004 CVRD produced and processed about 200 mln. tones of crude ore increasing its crude ore production volume by 12% within one year while BHP Billiton produced 25 mln. tones of iron ore just within the first quarter of 2004 that was 25% more compared to similar period of the previous year.

Today there are practically no iron ore production capacities left unused while the demand for iron ore has kept on growing. According to some data on the crest of the wave of the price boom the three iron ore mining majors are planning to invest at least US$5.3 billion into expanding their iron ore production capacities during the next several years. According to some estimation the Big Three may step up their iron ore production capacities by at least 1.5 times. While actively developing steel business co-jointly with steel companies of Brazil, Australia and the Republic of South African, the Big Three are now considering opportunities to acquire and mine iron ore bearing deposits in Russia.

Russian domestic market reacts adequately to the world trends: now the rate of increases in local prices for crude ore exceeding that for steel. Over 2004 in Russia prices for iron ore grew in 2.5 times closely approaching the world level and even exceeding it with regard to some items of steel products. This situation evoked a tough response of Russian steel companies. Heads of NLMK, ÌÌÊ and EvrazHolding forwarded the Russian Government a request to curb iron ore suppliers to prevent prices for steel and steel products from an excessive growth. This request worked: the Russian government imposed a duty on iron ore export and abolished previously applied 5% duty on import of raw materials.

To understand the essence of the dispute between iron ore mining companies and steel making companies one should consider more closely peculiarities of development of the Russian mining and metallurgical sector at the stage of market-oriented reforms.

With regard to crude ore production potential Russia ranks first in the world among Brasilia, Australia, India and China. Russian proven iron ore reserves exceed 100 billion tones that is about 30% of the world proven iron ore reserves, with approximately the same amount of iron ore available in probable reserves. However, iron ore mining operations and iron and steel works are located in different regions, which fact results in a complicated logistics scheme and high transportation costs.

Ciscaucasian Russia features a surplus of iron ore which is mostly exported mainly into the countries of the Central and Eastern Europe as well as into China while iron and steel works located in Ural and Siberia have to take crude ore from the Central Russia or to import it mainly from Kazakhstan. By the way, last year the increase in prices facilitated expansion of iron ore purchase geography: today it is supplied even from Australia so that on the whole now Russian crude ore export volumes have got practically equal to its import ones (see table 1).

Prior to the market oriented reforms Russian steel industry was a single vertically integrated supercorporation. Each mining and processing integrated works was assigned to a specific iron and steel works. In spite of the fact that in the course of the reforms pieces of property owned by mining and metallurgical companies were privatized separately there still remained some technological and processing links between them. When the process of establishment of new Russian steel companies was kicked off their shareholders actively started acquiring crude ore mining divisions as well so that today most major steel holdings have their own sources of crude ore incorporated into their structures. The one exception to them is MMK, a major steel making company, which has to buy significant volumes of iron ore from Kazakhstan and iron ore mining companies operating in the basin of the Kursk magnetic anomaly in the Central Russia.

Open casts of the Kursk magnetic anomaly, the largest iron ore basin, have reached their depth limit with a limited possibility to expand their area. High grade iron ore production keeps on declining with high share of poor ore containing detrimental impurities which call for application of expensive ore dressing flow sheets.

In the opinion of analysts the next few years will see a peak of Russian iron ore production to be followed by a decline due to exhaustion of the existing iron ore reserves. With slow progress in exploration works, one can not expect that some new significant iron ore deposits will be put into production in the near future. Moreover, while making high profits owing to exorbitant prices for steel (in 2004 profitability of major iron and steel works reached as much as 40%), steelmakers tried to prevent a proportional increase in prices for iron ore. All this significantly limited investment opportunities for mining and processing integrated works giving them no chance to develop and upgrade their production facilities on an adequate scale. According to data of ZAO Metalloinvest close joint stock company in 1998-2003 leading iron and steel works totally made about US$ 5.5 bln. in net profit while mining and processing integrated works, which supplied them with crude ore, suffered losses of approximately US$ 100 mln.

Assuming the world trends setting up of a new Russian integrated iron ore mining company unofficially named "the Alisher Usmanov&Basil Anisimov Group" looks pretty logically justified. Upon making a US$ 1.65 bln. deal, the largest one the history of the Russian steel business, a major iron ore mining alliance has been established based on the Mikhailovski and Lebedinski mining and processing integrated works which produce about 40 % of all the iron ore currently produced in Russia (see table 2.3).

Such an alliance has been unprecedented not only in terms of its scope but also in terms of its consequences. "The most surprising thing about it is that until now nobody has ever paid a serious attention to the fact that Russia has largest iron ore reserves, - says Alisher Usmanov, - Russia ranks first among other world countries not only in terms of its natural gas resources but also in terms of its iron ore reserves. We have a national gas production major i.e. GAZPROM. Why don` t we set up a similar major structure in the iron ore mining sector? For the present all Russian iron ore mining companies are real minors compared to CVRD, Rio Tinto or BHP Billiton. In the mean time we have got a good potential for growth."

Coupled with accepting the ongoing growth in world prices for iron crude ore, implementation of this idea could make things even more serious for the Russian steel makers with the Magnitogorsk Iron & Steel Works being most vulnerable to monopolization of the iron ore mining market. MMK management and shareholders` hopes for acquiring the Sokolovsko-Sarbaiskoi Mining and Processing Integrated Works in Kazakhstan have deceived for a while.

Viktor Rashnikov, the head of MMK, promises to «seek for an alternative option» saying that his experts have already taken to estimation of ore mining and processing potential of Ukrainian mining and processing integrated works for the purpose of acquisition. However, there has already been a serious competitor for MMK in this sector. With an intention to develop his group` s business in the same directions Alisher Usmanov has openly announced his plans "to unite in this or that form all the CIS iron ore mining and processing integrated works".

Among other enterprises which could be potentially integrated into the proposed new crude ore mining and processing corporation, Mr. Usmanov called Sokolovsko- Sarbaisky, Lebedinski and Mikhailovski mining and processing integrated works and a number of Ukrainian companies. "Such a united corporation will set prices for iron ore all around the world. I am ready to dedicate my life to reach this target," – says Mr. Usmanov.

For the present Mr. Usmanov himself and his representatives keep negotiations with the leadership of the Eurasian Industrial Association, the owner of the Sokolovsko- Sarbaisky mining and processing integrated works, on a possibility to acquire the controlling interest in the company. According to rumors filtered recently the Usmanov group intends to expand its business in Ukraine through buying assets of the former Ukrrudprom, whose ownership of the assets obtained in the course of the privatization will apparently be reclaimed.

Thus, having foreseen such an increase in prices for crude ore Alisher Usmanov apparently intends to establish a horizontally integrated ore mining and processing holding similar to that of CVRD, Rio Tinto or BÍP Billiton to become their peers in the world market of crude ore supplies.

There is only one thing which could interfere with Mr. Usmanov` s vast scheme i.e. a strong desire on the part of steel companies to prevent appearance of a too much strong supplier of crude ore on the market. To stop him they will have to make a pre-emptive strike i.e. to buy up his assets. In this case it may deal with several billion US dollars. Such significant funds may be raised only co-jointly by a pool of steel companies united within a single alliance. Though, it looks very unlikely that EvrazHolding, NLMK or Ìechel, which have their own sources of iron ore, could ever combine their efforts for this.

Besides, state agencies would hardly permit such course of events. Establishment of the Usmanov iron ore mining and processing intergated group was approved by the Federal Antimonopoly Service and secured with a credit facility granted by Vneshtorgbank. Independent analysts believe that by doing so the state expresses its interest in setting up an iron ore "GAZPROM" able to control "rules of the game" for the Russian metallurgical industry and to produce an influence on other world markets.

Reference:
ZAO Metalloinvest was incorporated in January 2005 as a managing company to control assets owned by Alisher Usmanov and Basil Anisimov. Their assets include a 100% stake in the Ural Steel, a 98% interest in the Mikhailovski Ore Mining and Processing Integrated Works (Mikhailovski GOK), a 30% interest in Tulachermet and a 30% stake in Moldovian Iron and Steel Works. The head of the company in Nazim Ephendov, the general director of OOO Ural Steel limited liability company.

Table 1. Dynamics of Iron Ore Production, Sales and Consumption Volumes in the Russian Federation, million tones

Indicator 1995 1998 2000 2001 2002 2003 2004
Iron Ore Production 81.2 85.8 83.2 82.8 84.2 91.8 94.1
Iron Ore Export 13.9 13.8 19.1 14.0 13.1 9.3 11.5
Iron Ore Import 4.3 6.6 3.3 9.2 8.8 9.4 9.7
Iron Ore Consumption 72,4 65,1 73,3 77,6 80,4 91,9 92,3
According to statistics offered by Chermet corporation

Table 2. Major Iron Ore Mining and Processing Integrated Works in Russia (iron ore production in million tones)
The Name Iron Ore Production the Known Owner
Lebedinski 19.5 Alisher Usmanov, Basil Anisimov
Mikhailovski 17.9 Alisher Usmanov, Basil Anisimov
Stoilenski 12.8 Vladimir Lisin
Katchkanarski 8.6 Alexander Abramov
Karelski Okatish 7.4 Alexei Mordashov
Source: data offered by the companies

Table 3. World Leading Iron Ore Mining Companies (the 2003 iron ore production in million tones)
Company Country Production
CVRD Brazil 150
Rio Tinto Brazil 102.6
BHP Billiton Australia 86
The Usmanov-Anisimov group Russia 37.4
KUMBA Republic of South Africa 30
Source: data offered by the companies
In the Picture:
Lebedinski Iron Ore Mining and Processing Integrated Works (Lebedinski GOK)
Mikhailovski Iron Ore Mining and Processing Integrated Works (Mikhailovski GOK)