By John Helmer in Moscow
Brokers put fingers in the dyke, as Kremlin takes fresh bite out of profit
According to the tale of Hans Brinker, the brave little Dutch boy stuck his finger in the Haarlem dyke to save the Netherlands from being flooded.
In truth, the tale was a 19th century American invention. Until 1950 there was no dyke, no finger, and no little Hans. Then the Dutch Bureau of Tourism thought too many visiting Americans believed the story, so they erected a statue to Hans, and moved the non-existent exploit to Spaarndam, where the statue was.
Brokers and investment bankers are like that; and it’s at volatile times like these that you are bound to see a great many fictional fingers aiming to keep real floods at bay. Take, for example, the reaction of Renaissance Capital, a big Moscow house, to the disclosure last week that the Kremlin is thinking of intervening to hold steel prices down.
What is happening is that domestic steel prices have been going up so fast, traders say their quotes are obsolete within 24 hours. They joke that, after crossing the thousand-dollar level in April, hot-rolled coil (HRC) is now approaching the thousand-Euro mark, with no flattening or downturn in sight.
The Russian steel market is one of the largest producers in the world; one of the largest steel exporters in the world; and also one of the fastest growing steel markets for domestic consumption. Price inflation for steel products in the market is running at about 40% in the year to date. Estimated inflation in the price for coal is 200% year on year; up to 80% for iron-ore; and up to 45% for scrap. Additional inflationary pressure is building up for energy costs, labour, and transportation.
Naturally, people complain. Submissions to several government agencies from the oil industry and domestic pipemakers have charged that the steelmills are colluding in unreasonably high price demands. At a meeting last week, Industry and Trade Minister Victor Khristenko told a meeting of steelmill and pipemaking representatives that they should present their justification for current pricing, plus their case for and against export duties and other measures to regulate the price growth.
Khristenko’s intervention follows the opening by the trade division of his ministry — formerly at the Ministry of Economic Development and Trade, which was reorganized last month — of an anti-dumping and domestic injury investigation of pipe imports, principally from China. A parallel investigation is also underway at the Federal Antimonopoly Service (FAS) of the price Severstal, Novolipetsk and Magnitogorsk are charging for strip supplied to the pipemills.
The idea that government intervention is appropriate to bring down prices for domestic producers isn’t a novel one. High-level government officials, led by former prime minister Victor Zubkov — now first deputy prime minister — have backed export quotas and duties, as well as price controls, on domestic fertilizers, in order to assist farmers, and limit the growth of food prices. A windfall profit tax, previously imposed on oil producers and exporters, is also being consider for the steelmakers.
Naturally, the steelmakers don’t like it. But their bargaining position is undercut by their lobbying for an export duty imposed more than a decade ago on exports of steel scrap. That measure was intended to limit price growth for the scrap which domestic buyers require for their furnaces. A decade of counter-lobbying by the European Union to eliminate the tax as an obstacle to the flow of scrap to European consumers has totally failed.
Now, however, the export tax boot is on the other foot. The steelmakers argue that the increase in domestic prices is unstoppable, because it is following the international trend. The government and their domestic critics respond that this is a good reason to insulate the domestic market from the foreign one; tax the incentive to get more for the steel by exporting it; and dissuade the domestic price from rising towards, or past, the export level.
Steelmaker thinking in Russia also suffers from myopia and amnesia. The vertical integration of the Russian steel groups, which oligarchs like Alexei Mordashov (Severstal), Vladimir Lisin (Novolipetsk), and Victor Rashnikov (Magnitogorsk) took over from the Soviet model, comprise upstream coal, coke, iron-ore concentrate, and scrap sources, carefully consolidated with the mills, in order to protect the proprietors from hostile takeovers, either from commercial rivals or the state. Tax is what the steel oligarchs think of as a hostile state takeover.
Their structures have given the Russian steel proprietors unique access to their own coal and iron-ore supplies, and advantageous scope to avoid tax. Internal transfer pricing between the mines and the mills also enables higher profitability than seems warranted in today’s inflationary atmosphere. This, in turn, reminds everyone that enforcement of Russian laws on transfer pricing is non-existent. Thus, for the first time since the Russian government ordered a report on tax avoidance by the metal producers in 2004, and then did nothing about it, something serious is threatening Big Steel.
Russia currently imports from 25% to 30% of the domestic requirement for reinforcement bar and other long products. The domestic rebar price moved recently ahead of the export price by about 5%, after trading at a discount for the first months of the year. Flat steel product imports currently account for about 9% of domestic consumption.
One of the measures Khristenko suggested the government may adopt is to remove the duty on this imported steel, and reduce its price to domestic consumers. That, plus the spectre of an export duty of up to 20%, looks a serious threat indeed to the stock market.
On Friday then, several billion dollars of market capitalization were wiped off the listed value of the major Russian steelmakers, as their share prices crashed on sentiment that a government tax of up to 20% on the declared value of steel exports is likely — and soon.
Severstal led the losers with a 6.1% drop; that was compounded by scepticism towards owner Mordashov’s rush to spend several billion dollars to buy a safe haven in under-performing US steel assets. Magnitogorsk (MMK), which is exposed more than its peers to rising iron-ore and coal prices, dropped 5.7%. Novolipetsk (NLMK) fell 3.9%, Mechel 3.7%, and Evraz 2.9%.
Moscow investment bankers and brokers have reacted by trying to persuade the market that the impact of an export duty on steelmaker profits will be marginal.
According to a report by Renaissance Capital, which is especially close to Novolipetsk and Evraz, “we don’t believe that the reported figure of a 20% duty on exported steel was ever discussed and a figure of $100/tonne or 10% may be more realistic. This would affect NLMK and MMK the most. The probability of an earnings downgrade as a result is negligible as price hikes are still pending. We also see the results of the eradication of import duties into Russia as negligible if introduced. There is a global steel shortage underway and Russia’s markets are geographically isolated.”
Speaking for the steelmakers, Rob Edwards, a Renaissance Capital investment banker, claims “there is a strong possibility that any taxes will be limited to those materials with direct inputs into pipe making, which are HRC and hot strip. Russia imports plate, so those products will be exempt, and imports of longs which will also be exempt. We also understand that the rate at which duties will be levied will be 10% or not more than $100/tonne HRC.”
Edwards, who recently left Moscow for London, blamed “the politically powerful oil and gas sector in collusion with the pipe-making sector [for being] behind the current attempt to stem any further price hikes in flat steel in particular.” He claims the price control move is doomed to failure. “The Russian sector operates at one of the highest utilisation rates in the world today at over 98% and therefore hoping for more steel to be spirited out of idle capacity is futile. This also applies to imported steel. ”
During the election campaigns of the past six months the steelmakers have been publicly promising big investment in new steel capacity. However, most of Severstal’s free cash has been going into the acquisition of distressed US steelmills, where performance to date suggests a growing need for cash, and uncertain prospects for profit. Evraz has also been spending heavily outside Russia.
Rashnikov failed in his initial offshore move with Pakistan steel Mills, but he is building two steel plants in Turkey. Mechel, which has fended off an attempt at acquisition of its specialty steel division by the state-owned Russpetstal group, is now planning to spin off its coal and iron-ore assets, and list them separately in a London IPO by November.
If domestic pressures from the government on the steelmakers intensify, the steel proprietors suspect they may lead to a new round of consolidation. Alisher Usmanov, controlling shareholder of the Metalloinvest steel and iron-ore group, is currently trying to resist a state-sponsored takeover by the Norilsk Nickel group. Usmanov’s steelmills are Nosta and Oskol. He claims the terms of the consolidation undervalue his assets, and he has threatened to attempt a London IPO to fix a higher market price.
Government intervention to regulate the price of steel will put pressure on Usmanov to accept a lower valuation in the short term, or face the risk of a more drastic cut later on.