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By John Helmer in Moscow

The collapse of Mechel’s share price (MTL:US), following a direct attack by Prime Minister Vladimir Putin on the company and its owner, Igor Zyuzin, for its coking coal price tactics, has generated a market-wide apprehension that strong, and stronger, measures are in store for mill profits and their proprietors’ health.

On Friday, the Russian index fell 5.6% on the day, but some steelmakers dropped further. According to the London Stock Exchange trading data, Novolipetsk fell 7.2%; Severstal, 6.7%; Evraz, 5.5%; and Magnitogorsk Metallurgical Combine, 4.4%.

As Moscow trading ended on Friday, and US trading opened, Mechel issued its first official statement; this followed a day of no comment from spokesman, Ilya Zhitomirsky. The statement said: “Mechel shares the concerns of the Government of the Russian Federation, steel plants and metallurgical industry in regard to the growth in prices for steel products and raw materials in the recent time. As was previously announced, Mechel has started the process of forming long-term commercial relationships with key partners and has signed a number of agreements for delivery of its products to the end of this year. Mechel is ready for cooperation with federal authorities of the Russian Federation and, if required, will provide complete information on any arising issues.”

There was a brief intra-day revival on the New York Stock Exchange, where Mechel is listed, but the stock price fell back to close at $26.20; that was 8% above the crash-point for the day. At the new level, Mechel’s share is 46% down on the month.

Industry and Trade Minister Victor Khristenko, who accompanied the prime minister to the meeting with steelmakers, told a local television channel that Putin’s charges are not political, and are limited to the pricing problem for coking coal and steel. “In my opinion, the situation will be settled when all members of this chain, suppliers and purchasers, build normal relationships based on long-term contracts.”

The emhpasis on normality was a gloss on Putin’s remarks the latter evidently did not intend.
In Putin’s attack on Zyuzin, he had threatened criminal investigation. Referring to Zyuzin’s illness and the company’s problems, Putin had said: “I ask also the Federal Antimonopoly Service [FAS] to pay special attention to this. Perhaps, even the Investigatory Committee of the Office of the Public Prosecutor. It is necessary to understand what is happening.”

The Russian market understood this as a threat of concession or ownership change. For one thing, the FAS investigation into price-rigging in the coking coal market had already been publicly announced, well before Putin’s initiative. For another, Putin’s reference to price increases and the spread between between export and domestic coking coal ignored the fact that the baseline for his comparison had been set more than a year ago, before Mechel acquired one of its coking coal suppliers.

The third spook factor was Putin’s hint of criminal proceedings. Targeted at individual executives like Zyuzin, and often initiated before civil proceedings have run their course, this is standard operating procedure for senior government officials, when a change of proprietorship is being engineered.

In the case of the Yukos oil company, the principal shareholders, Mikhail Khodorkovsky and Platon Lebedev, were arrested and imprisoned before they had time to flee the country. In the aluminium industry, criminal proceedings at the regional level were used in the takeover of the Novokuznetsk smelter, while the targeted shareholders were driven to asylum in France. Criminal proceedings were also used against the controlling shareholder of the Krasnoyarsk smelter, triggering his flight.

Last year, as the Russneft oil company was targeted for tax violations, its owner Mikhail Gutseriyev was forced to flee to London. In several recent takeovers of shipping companies, the threat of criminal proceedings has been used to drive senior executives to asylum, also in London.

A source, who knows both Zyuzin and his former co-partner in Mechel, Vladimir Iorikh, told Mineweb that Zyuzin has alienated many in the Russian steel community with his over-confidence. Iorikh, the source said, preferred to move to the safety of Switzerland with $1.5 billion in cash — a fraction of what his stake has grown to over the past year in Zyuzin’s hands. Until now, that is.

Zyuzin was reported in the Russian media to have been admitted to a cardiology clinic the day before Putin’s public rebuke. Hospitalization was a standard haven in the Soviet period for officials expecting, but unwilling to face, public censure. Whether Zyuzin knew what was going to happen and had sought haven, or whether he was suffering genuine symptoms, is unknown.

Putin’s spokesman, Dmitry Peskov, was reported as saying on Sunday that the attack was limited to Mechel’s anti-monopoly violations.”No Yukos parallels are relevant with Mechel,” Peskov said. “Yukos was charged with lots of criminal cases. … [The] measures against Mechel are taken not because it is Mechel as a concrete company, but just because the company committed violations.We are satisfied with Mechel’s intentions to cooperate with the state. But everything will depend on how this cooperation will develop in practice now.”

A source inside Mechel told Mineweb that Mechel has now signed long-term fixed-price coking coal contracts with Novolipetsk, Evraz and Magnitogorsk Metallurgical Combine, but not as yet with Severstal. The company had already done so before Thursday’s crisis.

Mechel says it does not know whether Novolipetsk will withdraw its complaint to the FAS, and Novolipetsk is not saying. But if Mechel is telling the truth, and Novolipetsk had signed for its coking coal before Putin’s attack on Thursday, why did Novolipetsk owner, Vladimir Lisin, go public with an endorsement of the apparent charges against Zyuzin?

According to Interfax, Lisin claimed: “if a company behaves properly on the market, it will be fine.” Lisin was reported as telling the news agency that Putin’s attack was focused on “a situation when someone falls out of mutually accepted norms of behaviour.” Was that wishful thinking, regarding his own concession? Or was Lisin trying to reassure the share market that Novolipetsk’s share price (NLMK:LI) should be spared?

In Monday trading, the London-listed share of Novolipetsk continued to move down in price, though it recovered in Moscow. Between the two markets, it is obvious that investment analysts do not agree on what is happening. If Zyuzin is in Lisin’s sights, then that is because of Lisin’s zero position in coking coal. For the moment, the Novolipetsk group has the lowest level of coking coal under vertically integrated management among all the major Russian steel groups — 0%.

In May, Novolipetsk announced it had drafted an agreement with European partner Duferco to improve on the shortfall of coal supplies under its control. An earlier attempt by Lisin’s group to draw its coal requirement from Prokopievskugol, in central Siberia, was a catastrophic failure. A spate of fatal accidents between August 2006 and March 2007 killed 34 miners.

Lisin then decided to abandon the asset, rather than invest in regulation-compliant safety measures. The mine company was turned over to the municipal authority of Prokopievsk, in the Kemeorovo region, for a nominal rouble. The terms were negotiated, but not fully disclosed, by Lisin, who worked them out with the Kemorovo governor, Aman Tuleyev.

Lisin’s latest plan calls for Steel Invest & Finance (SIF) to supply coal to Novolipetsk; SIF is the joint venture entity created on a 50/50 basis by Novolipetsk and Duferco, which already owns steel making and rolling facilities in the US and Europe. The proposed contract is estimated to be worth about $175 million, and would run through the end of 2008. A Moscow analyst reported this contract was “good news…the contract with Duferco should serve to provide the company with a reliable coal supply in a high demand market.”

In the longer term, Novolipetsk is holding a mine development licence for the Zhernovskoe-1 coal deposit in the Kemerovo region. First production and delivery from this mine is hoped for next year.
If a takeover of Mechel’s coal-mining assets might be on Lisin’s wish-list, Mineweb has also reported interest on the part of the state-owned specialty steelmaker, Russpetstal, in the stainless steel operations that were the original core of Mechel, before Zyuzin and Iorikh bought out the controlling shareholder at the time, Glencore.

If all Putin was doing was to add teeth to government jawboning against domestic price inflation, it remains to be seen what the price effects will be. As the steelmakers and their suppliers feel the pressure from the government to commit to long-term, six-month or year-long fixed pricing, Inprom CEO Igor Konovalov told Mineweb he believes there will be a downward correction in steel prices by the 4th quarter. Inprom is one of Russia’s leading steel service centre operators and domestic steel suppliers.

Russian producers, said Konovalov, “have been claiming they will boost their prices in August again, and they promise to hold them stable until the end of the year. We doubt this is realistic. We are expecting a 5% to 10% decline of prices in the market.”

A week ago, Lehman Brothers’ Moscow steel analyst, Vladimir Zhukov, reported an upgrade in his price forecasts for the Russian market. According to Zhukov’s analysis — which was completed before Putin’s intervention in the steel market last Thursday — the major domestic mills have been “looking for another 10-15% q-o-q price increase in 3Q 2008, while we expect a seasonal slowdown of construction activity from September onwards to take steel prices down 8-10% q-o-q in 4Q08.

Therefore, on an annualised basis, we expect steel prices in Russia to be up 45-50% y-o-y in 2008E, except for semi-finished and certain construction products that are expected to be up 60-70% y-o-y.”
Zhukov and other analysts believe that the 10% premium, which has recently prevailed for domestic steel prices over export prices, will shrink to zero by the year’s end, as the rate of growth in domestic demand for steel slows down. But a slowdown in domestic consumption of steel is not what Putin has in mind.

In his speech to the steelmakers, Putin said that steady growth in steel output should sustain in parallel steady growth in steel consumption, and the growth of the allied industries — housing construction, ship building, mechanical engineering, and the like. If today’s Russian output of 72 million tonnes of steel is to meet projected domestic requirements for 70 million tonnes in 2015, Putin said, then current export volume of 28 million tonnes will either shrink, or be met by newly added steelmaking capacity.

This was growth talk. But Putin failed to do what his Ministry of Industry and Trade officials had expected. He did not say what the government has decided to do about redirecting steel scrap exports to domestic mills, applying a penalty export tax, and perhaps a quota on export volumes. He failed to say whether he has accepted or rejected other ministry proposals for export duties on some types of steel products.

Instead, he referred to “the establishment of zero import customs duties on metallurgical raw materials, and also on some kinds of steel which we produce in insufficient quantity.” The first part of Putin’s proposal appears to refer, according to industry and customs sources, to steel alloy materials, such as chrome, manganese, silicon, titanium, molybdenum, and others. Eliminating duties on these would benefit most of the Russian steelmakers, especially Mechel.

Putin implied that he is also in favour of dropping import duties currently imposed on a variety of specialty alloyed steels. That too would boost Mechel’s position as the premier Russian specialty steelmaker.

Unless Putin is thinking of something else. “All of us still lack special steels and alloys,” he wound up his speech. “The organisation of such manufactures can be carried out, including with the application of the principles of private-state partnership.” If that last phrase is the cue for Russpetstal to reopen its bid for Mechel’s specialty steels, in a falling price market, it is little wonder that Zyuzin’s heart has skipped a beat.

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