By John Helmer in Moscow
As Russian villagers used to say in olden times, when the tsar is kind, the wait to see him is long; when he is cruel, there is no delay at all.
Prime Minister Vladimir Putin’s explicit attack on steel prices at the start of this week, and the commencement of a new antitrust investigation of price-rigging against the Evraz group, have opened the floodgates to a spate of complaints — by the state-owned car manufacturers against the flat-sheet mills, and by the oil companies against the pipemakers.
According to Russian industry reports and today’s Moscow business media, Sergei Chemezov, the head of the state conglomerate Rosteknologii, has delivered a complaint from the domestic automobile and truck makers, Kamaz, AvtoVAZ, GAZ and Sollers. In a formal letter to the prime ministry, they charge Severstal, Magnitogorsk (MMK) and Novolipetsk (NLMK) with demanding excessive increases in the prices of sheet required for the auto-body production lines. According to Chemezov’s public remarks after his meeting with Putin, the price increases recently demanded by the steel makers have ranged from 25% to 30%. Chemezov said the maximum the automakers should accept is 17%.
At the same time, the complaint appears already to have triggered preliminary investigation by the Federal Antimonopoly Service (FAS) of price movements for this range of products. A spokesman for the FAS has confirmed the agency has started a flat steel price examination, and hopes to complete a report for the government within two weeks. This allows time for the steel users and the steelmakers to lobby the government, the prime ministry, and the Kremlin for an outcome they can all live with.
The steel companies are not commenting officially. But they are suggesting to reporters and brokerage analysts that the measurement of the recent price increases is unfair exaggeration of the market position, because it fails to take into account the low base effect; this is the outcome of the collapse of international and domestic prices in the wake of the autumn 2008 crisis. The steelmakers also dispute that the rising cost of steel will cause a cost increase for new Russian cars of more than 5% on the sticker price. Russian demand for new cars has been stimulated by a government program comparable to the cash-for-clunker deals adopted to increase new car demand and sales in the US and UK.
Prime Minister Putin and President Medvedev are under pressure from state enterprises to limit the extent of profit-taking by the oligarch-owned, vertically integrated Russian steel groups; their direct ownership of coking coal, iron-ore and scrap supplies to the steel furnaces allows them to apply international pricing at the input stage, expanding their profit margins at the final product or export stage, and oblige domestic steel consumers to pay the higher price of the profit-taking chain. Precise calculation of these margins is also made difficult by oligarch trading and tax optimisation schemes on and offshore.
This is unpatriotic, Putin suggested on Monday, when discussing the price chain for steel production with the head of FAS, Igor Artemyev. “Everyone should feel responsible for their country”, Putin said, according to the official transcript. This is the first time the prime minister has hinted at the implications for domestic welfare of the high level of debt the oligarch-owned steel groups are now repaying for their premium-priced but lossmaking steel plants in the US and Europe, acquired before the crisis of 2008.
The immediate reaction of the UBS brokerage in Moscow was to report to clients today that a government investigation of the relationsahip between profit margins and pricing of steel “will not help investor sentiment, especially in the current volatile environment. However, we believe that the risk to the profits of the sector’s companies is relatively limited for several reasons: a) Any regulation in the sector will be highly complicated given that it should involve the whole production chain, not only pipe and steel prices, but also prices of coking coal, iron ore, scrap, and ferro-alloys; b) Lower profits of the sector’s companies, in case regulation decreases the prices of pipes, steel, etc, will likely reduce investments in capacity expansions in Russia, as risks to those investments will increase, while returns will decrease; c) Any regulation will also be hard to implement, given the relatively steep nature of cash cost curves in the sector (i.e. least efficient producers might be put out of business), while the ferrous metal related products and raw materials are not commodities and have different characteristics, making it hard to unify the potential regulation.”
At the same time as the FAS is investigating flat steel products, Russia’s oil companies have lodged a formal complaint, calling for a further FAS investigation of the pricing of steel pipes, which the oil companies use to drill for oil, and to transport it to domestic storage, refineries, and export terminals.
Five oil producers — Rosneft and Gazprom-Neft, which are state owned; LUKoil, Surgutneftegaz, and TNK-BP — charged price collusion by the three dominant domestic pipemaking groups — Pipe Metallurgical Company (TMK), United Metallurgical Company (UMC), and the Chelyabinsk Pipe Rolling Works (ChTPZ). TMK is the largest of the pipemakers, and is controlled by Dmitry Pumpyansky. The oil producers complain of “concerted action by leading manufacturers of pipes, from which in February [the oil companies] received notification of price increases of 15% or even 20%”.
Alexander Deineko, who heads the Russian Fund for Pipemaking Development, a lobby group funded by the three pipemakers, refused to respond to the collusion charge. Spokesmen for UMC and ChTPZ also refused to comment on the terms of the complaint.
The pipemakers’ fund publicly acknowledges that it depends on the federal government to regulate imports of pipes from competing sources in Ukraine, western Europe, China, and Japan; and to maintain a domestic sourcing priority for the biggest of the state-funded oil and gas pipelines now under construction in both western and eastern Russia.
Deineko is reported in a Moscow newspaper as claiming that in 2009 the oil companies recorded healthy profits, while the pipemakers struggled to keep their balance-sheets in black.
The pipemakers’ argument, according to brokerage analysts, is that they are hostages to the price of steel billet, the semi-fabricated form of steel which the pipemaking mills mostly buy from the large steel groups, and which they then convert into pipes of varying specifications and applications. If billet makes almost 80% of the cost of pipes, and billet prices rise, as they have been doing for the past half-year, the pipemakers are at risk of seeing their average profitability dwindle or become negative. According to a published calculation attributed to Deineko, if the current price increases sought by the pipe mills are not accepted by FAS, and the oil producers’ complaint not rejected, it will become difficult for the pipemakers to sustain output, maintain employment, and meet their debts.
A report by Alfa Bank steel analyst B arry Ehrlich says the latest round of price control moves “bring to mind the first half of 2008, when domestic price inflation, particularly for coal, steel and pipes, were a major concern for the government and industrial consumers. In 2009, TMK reduced prices by around 30%, less than the 45% drop in steel product prices. However, the company’s EBITDA margin fell to 9% in 2009 from 18% in 2008. TMK announced an increase in OCTG prices by 15% as of 2Q10. This increase appears justified, as metal scrap prices increased by 30% in 2H09-1Q10. We expect the company’s EBITDA margin to expand to 15% in 2010, which is still lower than the 2007-08 level.”
TMK’s shares are internationally listed through the London Stock Exchange, and they usually move in line with the price of oil. With a market capitalization of $3.3 billion, TMK is currently trading on stockmarkets at 6% below the price at the start of this year. This is better than the Evraz share price, which is currently down 19% in the year to date. In market response to today’s news, TMK is down 5.4%.
Ehrlich of Alfa Bank reported to clients this morning: “If the [oil producers’] letter triggers a successful FAS investigation, the impact could be considerable. However, it will be some time before we know the ultimate outcome.”