By John Helmer in Moscow
Coal mining in Russia is a dirty business, and mine company finances are a black box.
If the coal mines lose money, as they claim in recent financial reports, that could be because the coal is being priced for purchase by the steel company which consumes it, and also controls the capital of the mine, at a price which transfers profit downstream. The publicly available records make it impossible to know. What is now very well known, however, is that the imperative to produce more coal, at the lowest possible cost, has pressured mine managements and the miners themselves into creating unlawfully unsafe conditions in the mines. Diminishing wages, inadequate investment, and corrupt regulation combine to suppress the effectiveness of the mine safety systems that are in place, and would be protective — if they hadn’t been turned off.
This makes fatal accidents, especially methane gas explosions, inevitable. But what the proprietors of the Russian mines — the steel companies — do next is unusual.
In the past six months, when a chain of fatal mine accidents occurred at Prokopievskugol, one of the country’s leading steelmakers sold the mine for a nominal rouble to the state. In the second case, this past week, the steelmaker bought the 50% shareholding in the mine which it didn’t already own at a distress price. The first transaction saved the steelmaker at least $90 million. The second earned a discount of $250 million. The local stockmarket concluded that the fallout of the accidents would be upward, like methane.
Thus, the immediate result of the second fatal mine accident in as many months at Yuzhkuzbassugol, a Kemerovo-region coking coal supplier to Evraz, has been very lucrative for the shareholders of Evraz. It remains to be seen whether there will be any impact on mine safety conditions.
Evraz announced last Friday it is acquiring the 50% stake held in the Yuzhkuzbassugol (YKU) company from its management. No price was revealed. However, industry sources believe Evraz forced the management group to sell their shares at a substantial discount to current market value for the company, which has been considering an IPO valuation of between $1.5 and $2 billion.
In December 2005, Evraz paid $675 million for a 50% share in KYU, leaving operational control to senior managers, who held the other 50% stake. Last week’s deal is estimated to have cost Evraz between $500 and $750 million — a discount to market of between 25% and 50%, and a saving to Evraz shareholders of about $250 million.
The change in ownership was triggered by the Kemerovo region governor, Aman Tuleyev, after a methane blast at YKU’s Yubileinaya Mine on May 23, which killed 38 miners. Before, on March 19, a methane explosion at YKU’s Ulyanovskaya mine killed 110 miners — a record toll for a Russian mine disaster. The federal mine safety inspection agency then reported serious safety violations at YKU’s Ossinikovskaya mine.
The agency also announced the dismissal of five local inspectors for turning a blind eye to the problems. Agency director, former KGB general Konstantin Pulikovsky, accused the company of a “breach of safety rules in order to make a profit”. Two more local inspectors were fired after the latest explosion.
They are scapegoats for a policy pursued systematically by coalmine managements to tie miner pay to production targets, and reduce operating costs. Local press reports indicate that miners at KYU had suffered pay cuts before the accidents.
At the same time, to sustain shift output, miners, managers, and inspectors have all acknowledged that gas detection systems have been disabled.
According to an Evraz statement of condolences, issued after the accident, “Evraz will review its strategy regarding the equity investment in Yuzhkuzbassugol to ensure continuous value creation for Evraz shareholders. Evraz will also consider all possible steps and actions to decrease the level of technological and operational risks of Yuzhkuzbassugool. ” Within 24 hours, Evraz then announced it was buying out the YKU management.
The timing indicated that the move had been in discussion with Governor Tuleyev since March. Tuleyev is notorious for his manipulation of the metal producers in his region. Evidence submitted in a US federal court in connection with a well-known aluminium smelter case, made serious allegations against him and his associates. Tuleyev was directly involved in the disposal late last year, after a string of fatal accidents, of the Prokopievskugol mine, owned by the Novolipetsk Metallurgical Company of Vladimir Lisin. By selling when he did, Lisin not only issued a stop-loss for recurrent mining costs. He appears to have saved himself from having to pay the second instalment of the original purchase price of the mine.
No-one in the regional government, the mine company, the steel company, or Lisin’s circle will answer questions about the deal.
Tuleyev also made controversial interventions in a federal prosecution last year of the Evraz group for water pollution violations from two of its steel mills in the Novokuznetsk area, not far from YKU’s mine shafts. The outcome of that affair was a penalty of $92 million imposed on Evraz. The company has yet to report to shareholders on the findings, penalties and costs of that case.
Russian industry sources believe that Evraz’s latest move was part of a deal with Tuleyev to ward off more serious, and costly sanctions for YKU, including the shutdown of its mines, and the revocation of its mining licences. These had been publicly threatened, following the Ulyanovskaya disaster, as inspections of other coal mines exposed more problems.
Investment bankers and brokers, following Evraz’s financial performance and share price, note that, if the company is serious about mine safety, it is likely to change the compensation structure at YKU, and increase investment into safety. These should “result in deterioration of financial performance of the company and probably will further delay the IPO prospects [of YKU],” a broker told Mineweb.
An industry analyst believes that Evraz’s performance can be gauged from its environmental record in the water pollution dispute. By courting Tuleyev, it will endeavour to cut fresh outlays. In anticipation that its controlling shareholders Millhouse and Alexander Abramov will come under pressure to sell to a state consolidator, they will try to boost the share price for the final trade off, ahead of their exit.
Yury Vlasov, an analyst at Renaissance Capital, which promotes Evraz shares, claims that “buying Yuzhkuzbassugol would make Evraz the largest coking coal producer in Russia and secure its coking coal self-sufficiency. On the other hand Evraz will have to invest into mining technology and health and safety, bearing the risks of social responsibility.” He noted that the stock market reacted positively to acquisition report, adding 1% to Evraz’s GDR ($34.15).
Michael Kavanagh, steel analyst at Uralsib in Moscow, acknowledges “it is likely Evraz aims to capitalize on a YKU IPO sometime in the future, after an operational turnaround. They are opportunistic in buying the other 50% when the operation is in distress. We can also speculate that they may have been forced to step in to protect the mining licence. I have concerns with the rising costs of mining, inflation, and the strengthening ruble. If one starts to factor in the penalties and charges relating to the environment and safety, this would reinforce my concerns.”
In trading to date this week, Evraz’s share price is down 2.4% on the month, and up 33% on the year to date. “In the long term, we think the outcome of this transaction will depend on Evraz’s ability to produce a ‘turnaround story’; something Evraz management has delivered in the past,” Vlasov said.
YKU is the largest of Russia’s coking coal producers, lifting almost 11 million tonnes last year. It supplies 42% of Evraz’s requirement. Its reported financial performance last year indicates revenues of $595 million, and a net loss of $57 million.