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By John Helmer, Moscow

In the Russian system, oligarchs can pretend to be patriots, but noone believes it. Nor does anyone, least of all outgoing president Dmitry Medvedev, believe them to be committed to competitive business.

But if you sit in the Kremlin, trying to run the power vertical over the wall to the rest of the country, the oligarchs serve the purpose of doing what they are told. When the red telephone rings, the oligarchs can be made to click their heels, salute, and say Yessir! more swiftly than the directors of state-owned or nationalized concerns. At least that’s the theory. In practice, Russia’s governors don’t have enough time in the day to make all the required telephone-calls (if they knew what to say, and wanted to).

That is why it recently came to the attention of Deputy Prime Minister Igor Sechin that if the oligarchs who control the steel sector are allowed the slack, they will move the capital comprising their profit and dividend streams out of Russia. If they get a red telephone-call, their first move will be to borrow from a state bank and add to the debt of their Russian businesses. If they don’t get the call, they will reduce their investment at home, defer and postpone development plans; and increase investment offshore.

The rate at which this happens accelerates during cyclical downturns, when revenue and profit shrink, defeating thereby the counter-cyclical stimulus plans the government puts into place. Even corrupt stripping of the state spending and procurement process cannot compete with the secure, untaxed rates of return the oligarchs calculate they can enjoy for capital invested offshore.

That’s why the Russian power vertical doesn’t work properly in downturns, no matter how much state budget, state reserve, state bank and Gazprom money is allocated to stave off job losses and replace falling export demand with rising domestic demand. At election time, the friction this causes – the gap between what the Kremlin is saying and what is happening – makes the country’s rulers particularly nervous; their security men trigger-happy; and the country’s enemies extra-keen to take their shot at regime change.

This is so obvious, it’s difficult to spot when something genuinely new is happening. And I’m not talking about the “International Anti-corruption Committee”, whose London start-up was announced over the weekend by the Rupert Murdoch press in London. For months Russia’s capital outflow has been reported as a sign of loss of confidence in presidential candidate Vladimir Putin. So what to make of the attempt to arrest the flow and oblige the owners of Russia’s steelmills to invest larger amounts than they want in domestic revival?

Here’s how the story began. Then last Wednesday (January 25), the government’s intention became several degrees more operational, with a meeting in Moscow between government regulators and the owners of the steel companies. On Friday (January 27), Magnitogorsk Metallurgical Combine (MMK), owned by Victor Rashnikov, released production and shipment results for the fourth quarter and the full year; without Rashnikov meaning to, his own production report demonstrates the very problem the regulators are trying to solve. And Rashnikov wishes they won’t.

Let’s start with Rostekhnadzor (RTN), the Russian government’s work safety and technical inspection watchdog, which has tabled a set of regulations requiring the steelmakers to meet capital investment, modernization and environmental cleanup targets. The plan of regulation discussed at last week’s meeting also included the Federal Antimonopoly Service (FAS), and the Federal Environment Protection Agency (RPN).

A spokesman for RTN told CRU Steel News that his agency’s plan calls for an agreement with each steel company to identify a list of assets to be modernized and a time-frame for completion. Foreign assets are excluded.

The companies are to provide the necessary data, including their modernization plan and schedule, by March 15. The supervisory agencies will receive additional administrative powers to control these investment programmes, including direct access to the assets and the power to penalize companies or stop production at the assets if the agreed modernization programme is violated. During the programmes agreed with the regulators, the companies will not be able to sell, lease or pledge the assets under modernization. Their agreement to invest on the part of the steelmakers will not be rewarded or compensated by any incentive, tax offset or stimulus financing from the government.

The government move flies in the face of a statement by President Medvedev made at a meeting with his modernization committee on January 24. There he said the work of RTN has been “squeezing [businesses] even harder than tax inspectors did in the past. We should avoid excessive control while at the same time ensuring facilities’ safety, including those under construction and those that have already been commissioned.”

“The initiative itself appears strange,” according to Uralsib bank analysts Valentina Bogomolova and Dmitry Smolin. “If approved, we believe that the scheme will be definitely negative for the metals and mining segment, as there will be limited flexibility in investment strategy and companies will not be able to change or delay investment even in case of deteriorating markets and profits.”

Evgeniy Lukashevich, spokesman for Novolipetsk Metallurgical Combine (NLMK), and Tatyana Drachreva, the Evraz spokesman, told CRU Steel News they will not comment on the proposals. The spokesman for Mechel, Ekaterina Wideman, didn’t reply. Mikhail Ternovykh, speaking for Severstal, said his company has just received the RTN document and needs time to review it before responding.

MMK may be asked by bank and brokerage analysts what it thinks of the capital control rules when it presents its year-end results. In anticipation its share price is falling from this month’s hopeful peak:

After operating in the red in the third quarter, MMK disclosed on Friday that in the fourth quarter to December 31, the company’s steel output dropped for almost all categories of its products, as did steel prices. In aggregate, the company reports that crude steel output fell 2% from the third to fourth quarter and amounted to 3.18 million tonnes (mt); finished steel came to 2.95mt, down 3%.

For the full year, MMK reports the crude steel aggregate rose 7% over the 2010 level to 12.2mt, while finished steel totaled 11.16mt, up 7% year on year. But this result was half of that forecast by the company in October. At that time, the company announced that “MMK intends to increase finished steel output by 10-15% in 2011 compared to 2010. This growth will be driven by increased demand for MMK products from major steel-consuming sectors in Russia and by MMK Metalurji ramping up to full production capacity.”

The latest company report now admits that it is suffering from a contraction in Russian demand for thick plate from the oil and gas sector, which turned down 4% between the 3rd and 4th quarters to 171,000t, because of “a reduction in orders from pipe companies for rolled products for large-diameter pipes”. The contraction was even greater for long steel products in the construction sector, which fell 22% between the 3rd and 4th quarters to 372,000t, “due to the seasonal reduction in demand.” A year ago, production of longs in the 4th quarter came to 315,000t, but the seasonal decline from the 3rd quarter was just 6%. If it is almost four times worse, the weather isn’t to blame.

The steelmaker’s results would have been significantly more negative if not for the ramp-up of production and growth of shipments from MMK’s new units in Turkey, now known as MMK-Metallurji (formerly Atakash). In the 4th quarter, its production of finished steel grew on the quarter by 233,000t; for the year it grew 224% to 505,000t. Further expansion in Turkey is planned this year, with full capacity of 2.3mt per annum “planned for H1 12”, according to the company release.

Exports of MMK, including to Turkey, rose 12% on the quarter to 950,000t; 8% on the year to 3.47mt. The slide in domestic shipments was 14% in the final quarter, compared to the previous quarter, and amounted to 1.67mt. Growth in MMK’s shipments to the Russian market, on which it has depended in recent years, was just 2% for the year, totaling 7.11mt. That represents 67.5% of total, down 2 percentage points from the level posted earlier in the year.

Financial results for the quarter and for the year will follow in April. The price declines reported for the 4th quarter range from 4% for structural steel products, 7% for flat hot-rolled steel, 6% for longs, and 13% for thick-plate, produced at MMK’s Mill-5000.

The company maintains that it will recover in 2012, but it is no longer claiming to see the signs in the first half of the year. “It is expected that steel consumption in Russia will grow in 2012 faster than in the world at average. Steel consumption growth, realised investments in equipment modernisation and mastering of new products will help MMK to increase production of finished products in 2012 at its Russian facilities. General MMK Group output growth of finished steel products in 2012 may reach 15% among other [factors] due to ramp-up to full production capacity at the company’s facilities in Turkey.”

In short, MMK’s investment in Turkey is booming, while the position in Russia worsens. At the moment, just one tonne in 20 is produced by MMK in Turkey. If things go according to the company’s plan, in a year’s time the ratio will be one tonne in 5. It is this transfer of investment which last week’s proposed new investment regulations are aimed to slow down, or halt.

What does MMK think of the new scheme? Elena Evstigneyeva, the company spokesman, said: “Our representative attended the meeting, and we received the documents, but refuse to comment.”

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