The government catches Evraz Group with its hand in Uralvagonzavod’s pocket

31.05.2010 — Analysis

The Uralvagonzavod Research and Production Company initiated the antitrust investigation. According to Vasily Varenov, the company's Moscow representative, Evraz raised prices on mill products 7% in the second quarter of 2010 and warned of a further 20% increase in the third quarter. As a result, machinery manufacturers will owe the metallurgy industry an additional 400 million rubles in the first six months and 900 million rubles in the second. Since Uralvagonzavod primarily supplies state-run companies and thus cannot pass its higher expenses along to its consumers, it will have to absorb all of the additional costs.

Evraz justified its price increase for metals as the result of the rise in price for coking coal and iron ore. But Maksim Semenovy, an analyst for Alfa-Bank, has data showing how the foreign market, where the price of coal rose quickly from 130 to 200 dollars a ton, has had a significant influence on Russian manufacturers. The domestic market showed even greater momentum, since during the economic crisis the Russian mining and processing enterprises had significantly lowered their production and could not immediately respond to the rally in demand. In addition, a decision had been made to establish pricing parity with the international market. As a result, prices on the foreign and domestic markets became comparable.

V.Varenov suggests that the price increases for coal and raw materials might be due to market speculation by the large international firms BHP Billiton and Rio Tinto. Russian metallurgical holding companies, which provide 80-100% of their own raw materials, could not raise prices on their products because of the decrease in machinery manufacturing in Russia, a decline more drastic in Russia than abroad. A representative from Uralvagonzavod notes that their dealings with Evraz Group comprise but a tiny fraction of that company's overall sales, and thus the holding company could have created a special pricing policy for national defense contractors like Uralvagonzavod.

The metallurgical industry, however, was in no rush to sign long-term contracts with the machinery manufacturers. Evraz Group's vice president for PR, Aleksey Agureev, refused to discuss the holding company's exclusive relationship with Uralvagonzvod, but mentioned that the media had been in too much of a hurry when they broadcast the signing of the long-term contract between the businesses. It is clear that such a perspective is not to Evraz Group's liking, but the holding company's management does not want to discuss this openly, because prices have become such a hot-button topic.

Experts believe that the metallurgical industry is trying to raise prices in order to compensate for income lost when the world demand for metal declined due to the economic crisis. In 2009, Russian companies, trying to keep operating at full capacity, began dumping their mill products on the market, but production stoppages and layoffs still occurred. Trying to revive the market, the metallurgical industry suggested early in 2010 that the Russian government grant it some tax incentives and stimulate its sales by requiring manufacturers to buy metals from domestic suppliers.

Meanwhile, over the past few years the Russian government has regularly increased the rates of import duties on certain types of mill products as well as on iron and steel pipes, in order to protect the domestic raw materials market. It has also expanded the list of what imported equipment that would not be subject to VAT and has begun anti-dumping investigations against Brazilian, Chinese, Korean, and South African suppliers of flat-rolled stainless steel, as well as against Belgian, Kazakh, Chinese, Korean, and Finnish manufacturers of mill products with polymer coatings. The Russian minister of industry, Viktor Khristenko said in 2009 that the iron and steel industry had far outdistanced other industries in Russia because of lobbying for measures to protect its interests.

Experts believe that the metallurgical industry's recommendations were never fully enacted because it did not take into account the interests of other players in the market. But the massive governmental assistance to protect the Russian market from imports has allowed lobbyists to increase revenues by artificially inflating prices.

The investment company Troika Dialog made a prediction at the beginning of 2010 that coal prices would increase over the next three years but that the discount rates would decrease. It's a horrible thing to say, but the accident at the Raspadskaya mine (40% owned by Evraz Group), came just in time to halt the projected increase in the production of coking coal. The governor of the Kemerovo region, Aman Tuleev, claimed that now there will be some fuel shortages in the metallurgy industry.

Miners in the Kuzbass region were angered that leading mining companies were speculating on the coal market (and thus causing price increases) so closely on the heels of the mine explosion. Some of them recalled that several years ago there were explosions in the Ulyanovskaya and Yubileynaya mines, both belonging to Yuzhkuzbassugol. Coincidentally, this was at the exact same time that Evraz Group asked the owners of the coal company to sell some of its shares, allowing Evraz Group to control the corporation. The miners did not agree with the governor, Aman Tuleev's, decision, after the two accidents, to sell shares of Yuzhkuzbassugol at a reduced price to the Evraz holding company. In an interview with the Russian press, the miners entertained the idea that the tragedy at the Raspadskaya mine could have been part of a terrorist attack, since they could not recall any previous instance in which a methane explosion had caused such tremendous damage to mining operations.

Officials with the federal antitrust agency did not put forth any conspiracy theories of their own, but publicly proposed that Evraz openly jack up prices, thereby increasing operating expenses and poorly anticipating the future development of the international market. The holding company sells its end products through a number of intermediaries, which increases the cost by 30%. Officials believe that the output prices are out of sync with economic realities, since the production costs for mill products in Russia are lower than in most countries.

Machinery manufacturers confirm the officials' suspicions. According to the director of the Research and Development Enterprise Mashprom, Aleksandr Kotelnikov, now one is forced to buy metal from market traders, and this is how all machinery manufacturers are currently doing business. In addition, the metallurgical industry has been slow to pay for equipment purchases. Evraz negotiated for the right to have 30 days to pay for equipment after receiving it, but does not always adhere even to this timetable.

Experts believe that the metallurgical industry is taking advantage of its government support to try to solve its problems at the expense of other players in the market. Though it has won concessions on taxes and customs duties and has used overseas banks, the industry still demands exorbitant prices for its goods. According to A.Kotelnikov, some types of steel sheet cost almost 1000 Euros after VAT. These are crazy prices and so Russian machinery manufacturers are starting to think about buying their mill products from Europe. It'll get cheaper soon.

Vladimir Terletsky