MEMO FROM MOSCOW

Russia / Ukraine Steel News

STEEL INVESTMENT ACTIVITY IN RUSSIA, November 2008

The Russian Government last year adopted a new plan for the steel sector. According to this plan, entitled Strategy development - Russian metallurgical complex to 2015 total investment in the Russian steel industry for the period from 2008 till 2011 was envisagd at 700 billion Rubles (about $US 28 bln at an average exchange rate at 25 Rubles per 1 $US). In 2007 itself, total capital investment in the Russian steel sector was 128 bln Rubles (about $US 5.1 bln). The 2008 programme is for 160 bln Rubles of investment (about $US 6.4 bln). The recent figures are high (see Exhibit 1) in the context of modernisation over the period 2000–2003, when it amounted to only ~23-34 bln Rubles per year.

According to the Russian Ministry of Industry and Trade, the average coefficient of wear [the depreciation ratio] of Russian steel-making facilities in 2008 is about 44%. In 2000, this figure was 54%. After realization of the present strategy the figure will be around 40% in early 2012.

In 2007 Russian crude steel production reached ~72.4 mt (placing Russia at number four worldwide). However, about 16% of its crude steel was made by obsolete open hearth furnaces, which today only still operate in Russia, Ukraine and India. In 2007 the EAF share of Russian total crude steel production was about 27%, the remaining 57% crude steel being produced by BOF steelmaking. The Russian Government strategy recommended closing down all open hearth furnaces and obsolete rolling facilities over the medium term. According to this strategy, 2008 will see closure of OHF shops with a total capacity of 7 mt / year, with all remaining Russian OHFs closing by 2015.

For the last decade, Russia has more than doubled its production of EAF steel, and availability of scrap and low-priced electricity much facilitated this growth. In recent times around 15 new Russian mini-mills with total capacity of more than 20 mt/y have been proposed, and many of these are already under construction. According to medium-range forecasts prepared by the Ministry of Industry and Trade, total new EAF crude steelmaking capacity in Russia will expand a further 18 mt/year and the EAF share of total Russian crude steel production will reach about 35% on a total crude steel volume of ~90 mt. At the same time, the share of continuous cast steel will reach 78% in 2010 and 96% by 2015.

Observers of the Russian steel sector will know that steel exports play a very important role for Russian steelmakers, ever since the perestroika of the 1990s. Russian steel exports in 2007 reached 27.6 mt ($US 26.5 bln) and Russia is currently the number 3 steel exporter in the world. The modernisations mentioned above are seen as instrumental both in maintaining these export levels, and in satisfying fast-developing domestic steel demand.

The main Russian steel Holdings invested around $US 40-55/t of crude steel in 2007. The bigest investors included Severstal, MMK, NLMK, Evraz and Mechel (see Exhibit 2).

The investment focus of most Russian steel Holdings today relates to production of more competitive steel products (for export), and to investment in high added value products. For example, last year's growing demand in galvanized and polymer coated sheets was met by the construction of new modern coating facilities at Magnitogorsk, Lipetsk and at Cherepovets. In the beginning of 2007, total Russian steel coated sheet capacity was about 2.8 mt/y - in 2009, the figure will reach 4 mt/y. Several Russian flat rolled producers this year commenced production of special coated steel for auto applications. The share of coated flat rolled steel as a proportion of total cold rolled steel production in 2007 reached ~40% (in 2005 this figure was just 30%).

Some of the larger Russian integrated steel works invested in scrap processing last year, and in new EAF shops as well (MMK and Severstal). MMK in 2006 commissioned several new EAF shops and has now closed all its OHF steelmaking. Severstal Holding has announced plans to construct several new long product mini-mills, with start-up envisaged in 2010.

The Russian Government meanwhile has been very supportive for the large national steel projects. The big current projects include plate mills 5000 at MMK in Magnitogorsk and at OMK in Vyksa; and the DRI/HBI Midrex plants of the Metalloinvest Group. OMK Holding in late 2008 also started up the very first Russian thin slab complex which includes a scrap preparation shop, EAF steelmaking, ladle-furnaces and a strip rolling mill. TMK Holding - Russia’s largest pipe producer - is meanwhile planning to increase pipe production capacity from 4.1 mt/year in 2007 to 5.95 mt/yr up to 2010 (mainly by adding high and premium grade seamless pipe capacity). In 2007 TMK invested $US 734 mln to developing new production facilities; in 2008 the Company put on-stream other new facilities including a pipe mill at Taganrog.

In order to create a complete production chain, ChTPZ Group’s shareholders recently gave the go-ahead to build a new mini-mill with ~1 mt/yr EAF capacity at the Pervouralsk plant. This will provide in-house billet supply for all Pervouralsk seamless pipe production.

Metalloinvest Holding, the largest mining group in Russia, meanwhile have a $US 10 bln investment plan up to the year 2015. Urals Steel plans modernization of the current EAF shop, and introduction of a new BOF shop with closure of OHF steelmaking whilst increasing total crude steel-making capacity by up to 5 mt/year. Last year Metalloinvest put into operation a second HBI plant at Gubkin, using Midrex technology. The Company also announced plans to invest $US 1-1.5 billion per year to build four more HBI modules by 2013, to give it a total capacity of over 10 mt/year and make it the world’s largest supplier of HBI. There is actually a need for even more direct reduction capacity to feed growing EAF industry metallics demand in Russia and to supply local export markets. Several other companies in Russia are now actively considering building direct reduction plants. Russian steel traders are also making sizeable investments in developing the steel services centre network as also are a number of foreign firms (including ThyssenKrupp, Ruukki).

As the sector develops, so the market capitalisation of the Russian steel industry grows - increasing some 4.5-fold from 2004 till 2007. Russian steel companies have sought to increase raw material sourcing security as well as overall profitability by vertical integration. Backward integration has involved acquiring raw material assets [iron ore mines, coal mines, scrap processing facilities] and forward integration (a trend that is very much set to continue) includes downstream expansion in higher value-added products and grades.

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