Depreciating Russian Rouble Offsets Financial …...output was 667 million tonnes, down 1 percent on the same period in 2015. *Net financial result is defined based on accounting data

Depreciating Russian Rouble OffsetsFinancial Losses of Steel-MakersDeloitte CIS Research CentreMoscow, 2016

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Key findings 04

Overview of the global steel and iron market 05

Overview of the Russian steel and iron market 13

Key trend 06

Key trend 14

Production output trends 15

Production output trends 07

Steel consumption trends 17

Expert forecasts 11

Ferrous product exports in Russia 19

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Page 14

Global trade: facts and figures 12

Expert forecasts 21

Steel consumption trends 09

Industry specifics 18

Content

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01 Key findings

02 Overview of the global steel and iron market

03 Overview of the Russian steel and iron market

04 Steel and iron market

05 Appendix

06 Contacts

Content

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Steel and iron market 22

Appendix 28

Contacts 29

The current state of the steel-making industry 23

Top-20 M&A deals in the steel and iron market in 2015 and 2016 28

Challenges facing Russian steel-makers in 2016 24

Business growth strategy in 2016 26

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In 2016, political and economic events have continued to have a lasting effect on the global metals market. Instability and the resulting lack of confidence can be felt both locally and internationally.

The trends from 2015 have resulted in metal products oversupply and weaker demand that has triggered a further decrease in steel prices, with prices in the steel and iron market hitting a 10-year low:

• In 2015, the global output was down 2.8 percent to 1,613 million tonnes*

• In 2015, the global consumption of steel was down 3 percent to 1,500 million tonnes.*

During the first five months of 2016, global steel output was 667 million tonnes, down 1 percent on the same period in 2015.

*Net financial result is defined based on accounting data for all business operations of entities, representing a difference between profit (+) and loss (-) arising out of the sales of products (work or services), property, plant and equipment, other assets and non-operating income reduced by related expenses.**Based on the annual survey by Deloitte CIS.

Although the manufacturing geography has generally remained the same, the amount of steel produced by the top-10 leaders over the first five months of 2016 is down 2 percent.

The Indian steel-making industry has seen the highest growth rate in 2016. In May 2016, India produced over 8 million tonnes of steel, up 4.9 percent on the same period in 2015.

Despite a global decrease in steel consumption, some regions have seen an increase, with African countries taking the lead. In addition to Africa, ASEAN countries also witnessed an 8 to 9 percent growth in steel consumption from 1998 to 2015, second only to China. The construction industry is a major consumer of rolled metal products in ASEAN countries, accounting for 73.5 percent of the demand.

In 2015 steel output in Russia decreased by 1.5 percent to 69.4 million tonnes. In January-May 2016, the smelters produced 28.7 million tonnes of steel and 24.8 million tonnes of finished ferrous products, with an annual output down 2.4 percent and 2.2 percent, respectively.

In 2015 the demand for steel in Russia contracted by 10 percent to about 39 million tonnes. Specifically, the demand from the construction industry as the largest consumer of rolled products as well as from the car manufacturing industry dropped by 12 percent and 25 percent, respectively.

On the Russian market, decreasing demand resulted in rolled metal product imports dropping by 27.3 percent to account for 9.7 percent of the market.

Despite a decrease in demand, the smelting industry saw its net financial result* reach a historical high of RUB 572.4 billion in 2015, hitting an annual growth rate of 3.2 times. A weakening Russian rouble has boosted the competitiveness of Russian metal products, resulting in a sharp growth of exports and helping steel-makers offset losses caused by falling global prices.

Top-5** challenges facing steel-makers in 2016:

• Currency risk (40 percent)

• Shortcomings of government regulation of the industry (40 percent)

• Low foreign investment appeal (36 percent)

• Corruption (25 percent)

• Lack of qualified managing staff (25 percent)

Top-3** factors that could potentially drive development in steel-making companies:

• Lower labour costs (37 percent)

• Higher local demand in Russia (36 percent)

• Lower production costs (36 percent)

Top-5** priority growth strategies for steel-makers in 2016:

• Expansion into new markets (83 percent)

• More efficient production and technologies (77 percent)

• Business development through organic growth (73 percent)

• Higher prices for end products (67 percent)

• New product launches (67 percent)

Key findings

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05 Appendix

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Overview of the global steel and iron market


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Key trend

Production output trends

Expert forecasts

Global trade: facts and figures

Steel consumption trends

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Key trend

In many countries, metallurgy is one of the key manufacturing industries. It also has a significant impact on related manufacturing sectors. Production and consumption of rolled metal products are among the essential indicators reflecting the situation in the metallurgy market and the global manufacturing economy. The period from 1999 to 2014 saw global steel production grow more than double while the global population only grew by 21 percent. This trend shows just how important metal is; it is mined, smelted and traded.

In 2015, the growth in production and demand for steel that had been continuing for six years, reversed, resulting in:

• Steel production down 2.8 percent to 1,613 million tonnes*

• Demand for steel down 3 percent to 1,500 million tonnes*

The trends from 2015 have resulted in a situation of metal products oversupply and a weaker demand triggering a further decrease in steel prices that hit a 10-year low in the steel and iron market.

In 2016, political and economic affairs have continued affecting the global steel production market, with the resulting instability and lack of confidence felt both locally and internationally.

Metal products oversupply and a weaker demand triggering a further decrease in steel prices that hit a 10-year low in the steel and iron market.

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* ForecastSource: World Steel Association, EIU, Financial Times (forecast).

Global steel output reached 667 million tonnes during the first five months of 2016, down 1 percent on the same period in 2015 (Figure 1).

It is worth noting that the year-on-year gap is down to a minimum, with China as a major contributor. In May 2016, Chinese smelters produced 70.5 million tonnes of steel, up 1.8 percent on last year. At the same time, the analysis of the first five months of 2016 shows that China’s output is down 1.6 percent on the same period last year.

The forecast until 2017 has been adjusted to reflect recent developments on the market. According to the survey among analysts of the steel-making market, 2017 would see steel production grow by no more than 2 percent.

Steel-making geographies are generally unchanged, with the Top-10 steel-making countries remaining the same (Figure 2). It should also be noted that the output of the Top-10 countries suffered a decrease of 2 percent for the first five months of 2016.

Figure 1. Steel production dynamics for 2007-2016 (million tonnes)

Source: World Steel Association

Figure 2. Top-10 countries by percentage share in steel output for 2015


2016*2016 5M2014 20152013201220112010200920082007

Global production of steel, million tonnes

China

Japan

India

USA

Russia

South Korea

Germany

Brazil

Turkey

Taiwan

Growth rate

1 348

1.00 1.000.92

1.161.07 1.01 1.06 1.01

0.97 0.99 1.002

1 343 1 238 1 433 1 537 1 5591 649 1 670

667

1 6131 615

60%

8%

7%

6%

5%

5%3%

2%2% 2%

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Overview of the global steel and iron market \ Production output trends

As for steel production growth rates in 2016, India has significantly exceeded its output from last year. In May 2016, the country produced over 8 million tonnes of steel, up 4.9 percent on the same period in 2015, demonstrating the strongest growth for the current period. Indian smelters, thus, produced 38.6 million tonnes of steel for the first five months, up 2.4 percent on the same period last year.

In 2016, Ukraine produced more than 1.35 million tonnes for the first five months, demonstrating a record high growth of 14.6 percent on the same period in 2015, which is, however, explained by a low base effect.

In Iran, smelters have also benefited from the lifting of international sanctions. In May 2016, Iran produced almost 1.65 million tonnes of steel, up 13 percent on last year.

In 2016, Turkish smelters started using more metal scrap and less billets, achieving an output growth of 3.4 percent for the first five months.

However, it is the other way around with Egypt where local producers are struggling because of power and natural gas availability issues. As a result, Egyptian smelters are increasingly relying on semi-finished products. As a result, the country’s output for January-March 2016 decreased by 28.9 percent on the same period last year.

North America produced almost the same amount of steel as in the previous year. At the same time, the steel-making industry in Latin America has been seriously affected by the economic crisis in Brazil accounting for 53 percent of the regional steel-making market, and a decrease in domestic demand:

• In Brazil, steel production is down 13.9 percent for the first five months of 2016

• In Argentina and Mexico, output decreased by 15.3 percent and 5.9 percent, respectively

• In Venezuela, the output is down 77.3 percent

The EU saw steel production decrease by almost 4.7 million tonnes (6.4 percent) for the first five months (Table 1). More than one third of this decrease occurred in the UK. France, Spain, Hungary and Poland have also been affected significantly.

In January-March 2016, Russian steel-makers produced 28.7 million tonnes of steel and 24.8 million tonnes of finished ferrous products, with an annual production down 2.4 percent and 2.2 percent, respectively. In May 2016, steel production grew by 1.2 percent on the last month and was up 0.4 percent on the same month in 2015. Production of rolled metal products has grown by 1.6 percent in year-on-year terms and also up 0.2 percent in April 2016. (Please see the Overview of the Russian steel and iron market section for more details.)

As a preliminary conclusion, the utilisation of global steel-making capacities, which was 69.7 percent in 2015 (minus 3.8 pp), has hit its lowest since 2011; it is also at its minimum, according to observations by the World Steel Association for the entire period evaluated. China has also been affected by the continuing situation on the steel-making market since 2015, with a decrease in Chinese steel output down 2.3 percent in 2014. According to Thachat Viswanath Narendran,

Chairman of the Economic Committee at the World Steel Association, the steel-making industry continues to be affected by volatile financial markets, a slowdown in global trade, decreasing oil prices and other factors affecting consumption both directly and indirectly. Moreover, industry experts believe that one of the key issues facing the industry is continuing overcapacity.

Figure 3. Top-10 countries by share in steel output for 2007-2015 (thousands of tonnes)


2014 20152013201220112010200920082007

0

400

200

600

800

1 000

1 200

1 400

ChinaJapanIndiaUSARussiaSouth KoreaGermanyBrazilTurkeyTaiwan

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In 2015, steel consumption decreased by 3 percent from 2014 to 1,500 million tonnes. The positive forecast for 2015-2016 unveiled by experts in 2015 has fallen short of expectations. Moreover, the previous forecast

for 2016 has also been adjusted extending into 2017. The existing trend of falling global steel consumption has generally been decreasing, with some growth expected in 2017 (Figure 4).

Figure 4. Steel consumption dynamics for 2012-2017


2017*2016*2015201420132012

1.06

1 430

1 475

1 523

1 500

1 4881 494

1.00

0.990.98

1.031.03

* ForecastИсточник: Всемирная ассоциация производителей стали (WorldSteel Association)

Consumption, million tonnes Growth rate

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Steel consumption dynamics, as analysed by country/group of countries for 2012-2017 (Table 1), shows that growth in consumption is the strongest in African countries (30 percent), the EU (11 percent), ASEAN countries (9 percent) and other European countries (6 percent).

This statistically defined trend agrees with the conclusions made by the South East Asia Steel and Iron Institute (SEAISI) as part of a survey of the regional steel market. According to the survey findings, ASEAN countries enjoyed an 8 to 9 percent growth in steel consumption from 1998 to 2015, second only to China. However, most of the demand for rolled products in this region comes from the construction industry, which accounted for 73.5 percent of the demand in 2015. The car manufacturing industry follows at a distant second with 11 percent.

In Vietnam, the construction industry relies most heavily on the domestic steel market, with 90 percent of steel products consumed domestically in 2015. Vietnam also demonstrates a particularly high consumption rate for sheet metal (49 percent), which is comparable or even higher than the most developed ASEAN countries — Indonesia, Malaysia and Thailand. SEAISI experts’ reasoning for this is that Vietnam is in the process of extensive construction of plants and warehouses that broadly use galvanised steel for exterior finishing. Vietnam is also emerging as a relatively large exporter of cold-rolled products.

Meanwhile, experts from the European Steel Association (Eurofer) have a different view of consumption in the EU. Geert Van Poelvoorde, President of Eurofer, pointed out that overcapacity was also an issue for Europe

30-40 years ago as the industry underwent restructuring. “Forty years ago it was regional, today it is global and the root cause is overcapacity in China,” he stated. On the whole, the statistical data generally agrees with the

forecasts by Eurofer predicting zero growth for steel consumption in the EU in 2016. However, European steel experts see some potential for slight growth on the market in 2017.

Table 1. Global consumption of steel (million tonnes)

*Forecast


Consumption (million tonnes) YoY growth (%)

2012 2013 2014 2015 2016* 2017* 2012 2013 2014 2015 2016* 2017*

EU 140 135 138 153 155 158 1 0.96 1.02 1.11 1.01 1.02

Other European countries 35 37 38 40 41 43 1 1.06 1.03 1.06 1.03 1.03

CIS 57 59 61 50 46 48 1 1.04 1.03 0.82 0.93 1.05

NAFTA 132 132 136 135 139 142 1 1.00 1.03 0.99 1.03 1.03

Central and South America 47 49 51 45 43 44 1 1.04 1.04 0.89 0.94 1.03

Africa 27 28 30 39 41 43 1 1.04 1.07 1.30 1.04 1.06

Middle East 49 49 53 53 54 56 1 1.00 1.08 1.00 1.02 1.04

Asia and Oceania 943 986 1016 985 969 959 1 1.05 1.03 0.97 0.98 0.99

Total 1430 1475 1523 1500 1488 1494 1 1.03 1.03 0.98 0.99 1.00

Developed countries 390 384 390 399.1 406 410 1 0.98 1.02 1.02 1.02 1.01

Emerging countries 1040 1091 1133 1101 1082 1083 1 1.05 1.04 0.97 0.98 1.00

China 660 700 721 672.3 645 626 1 1.06 1.03 0.93 0.96 0.97

World (except for China) 770 775 803 827.7 842 868 1 1.01 1.04 1.03 1.02 1.03

Overview of the global steel and iron market \ Steel consumption trends

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Most experts generally expect a partial rebound in the steel-making market over the next two years. However, forecasts for global steel production and consumption feature a lack of certainty or dynamic change. Industry experts in various countries predict either a slight change of fortune or a further downward trend, although at a slower pace.

• According to a Financial Times survey of experts, steel production is expected to grow by a mere 0.15 percent in 2016.

• Experts at RIA Rating suggest that this global negative trend will continue in 2016. However, a potential stabilisation of domestic demand and an expected improvement in the pricing environment on the global market will not let the trend go beyond the recession of 2015.

• In the US, growth in steel production is expected to resume following a double-digit decline in 2015. This recovery will be driven by administrative barriers to imports and a stronger demand for steel from builders and

the car manufacturing industry. However, according to Platts, a limiting factor will exist in the form of a continuing decrease in demand from the oil and gas industry.

• In the EU, steel production is expected to grow, although at a rather slow pace. With continuing overcapacity, production will keep consolidating in the hands of the most efficient producers. A growing demand for steel, particularly from builders and car manufacturers who have been increasing their output at a fast pace, is a good sign for the industry. However, the local market may be threatened by cheap imports from China and Russia.

• The combination of low domestic coal and iron ore prices as well as a weakening rouble may put Russia in the most advantageous position in 2016. Platts has already recorded steel supplies coming from Russia to South East Asia, a region with steel imports traditionally coming from China, South Korea and Japan.

Expert opinions on global steel consumption are all but unanimous. While the World Steel Association expects a further decrease in steel consumption, Russian steel producer MMK predicts a positive global trend in its annual report for 2015.

• The World Steel Association has published a Short Range Outlook (SRO) for 2016-2017 predicting that global consumption of steel, which contracted by 3 percent in 2015, will continue to decline at a slower pace of 0.8 percent, with a contraction for 2016 and 2017 to make 1,488 million tonnes and 1,494 million tonnes (plus 0.4 percent), respectively.

• MMK expects that a year-on-year growth in global steel consumption will be 1.4 percent in 2016 and may also continue into 2017. The situation of falling prices has been fuelled by Chinese steel-makers ramping up exports by 20 percent following a contraction in the Chinese market in 2015, hitting a record of 112 million tonnes and posing a threat to almost all regional steel markets, particularly emerging South Asian markets. As a result, global prices for hot-rolled coil steel went down 32 percent last year.

Expert forecasts

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Global trade: facts and figuresTable 2. Major steel importers in 2015 Table 3. Top steel importers in 2015 Table 4. Matrix of trade relations in 2015 (million tonnes)

* Excluding intra-regional tradeSource: World Steel Association

Position Region Millions of tonnes

1 EU (28)* 37.7

2 United States 36.5

3 Germany 24.8

4 South Korea 21.7

5 Italy 19.9

6 Turkey 18.6

7 Vietnam 16.3

8 Thailand 14.6

9 France 13.7

10 India 13.3

11 China 13.2

12 Mexico 12.7

13 Belgium 12.1

14 Indonesia 11.4

15 Poland 9.2

16 Spain 8.9

17 Canada 8

18 Egypt 7.9

19 Taiwan. China 7.5

20 UK 7.2

Position Region Millions of tonnes

1 China 111.6

2 Japan 40.8

3 EU (28)* 33.8

4 South Korea 31.2

5 Russia 29.7

6 Germany 25.1

7 Ukraine 17.7

8 Italy 16.5

9 Belgium 15.2

10 Turkey 15

11 France 14

12 Brazil 13.7

13 Taiwan. China 11.2

14 Netherlands 10.6

15 USA 10

16 Spain 9.6

17 India 7.6

18 Austria 7.4

19 UK 7.3

20 Canada 6

Region EU Oth

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Euro

pean

co

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CIS

NA

FTA

Oth

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Am

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Afr

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Chin

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EU 106.4 5.5 14.5 0.4 2 1.4 8.5 0.3 4.9 0.1 144.1

Other European countries

10.3 0.7 8.8 0 1 0.1 3.2 0.4 1.3 0 25.8

CIS 1.3 0.4 8.7 0 0 0 1.6 0.1 0.3 0 12.5

NAFTA 7.3 2.5 3.1 17.4 6.4 0.6 4.4 4.3 9.1 0.4 55.5

Other American countries

1.4 1.1 0.6 1.3 2.9 0 8.4 1.4 1.3 0 18.3

Africa 7.3 3.2 6.8 0.2 0.4 1.6 9.2 1.3 1.4 0 31.3

Middle East 1.8 4.9 4.7 0.1 0.2 0 10.7 1.7 4.9 0.1 29.1

China 1.3 0.2 0 0.1 0.1 0 - 5.2 6.1 0 13.2

Japan 0.1 0 0 0 0 0 1.3 - 4.5 0 5.9

Other Asian countries 2.9 0.1 4.4 0.4 1.7 0.8 63.5 25.9 23 0.3 122.9

Oceania 0.2 0 0 0 0 0.1 0.8 0.2 2.2 0.3 3.8

Total exports 140.2 18.5 51.7 19.9 14.8 4.7 111.6 40.8 59 1.2 462.4

Including inter-regional exports

33.8 17.8 43 2.5 11.9 3.1 111.6 40.8 36 0.9 301.4

Net exports -3.9 -7.3 39.2 -35.6 -3.5 -55.7 98.4 34.9 -63.9 -2.6

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Overview of the Russian steel and iron market

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industry has been able to significantly reduce the physical deterioration of fixed assets, from 54 to 40 percent, so that today Russian companies offer almost a full range of metal products.

Despite the steel-making infrastructure having been developing dynamically over the last ten years, 2015 saw Russian steel-makers up against the deepest downturn in the previous five years. According to the Russian Federal Statistics Service (RosStat), the steel-making industry did quite well during 1H 2015 thanks to significant exports. However, the continuing decline in global prices for steel and other iron ore-based products changed the market situation in 2H 2015. In December, the production growth rate for steel and rolled products was down 13.3 percent, hitting the lowest point for 2015. In January-December 2015, the growth rate was down 6.5 percent.

In Russia, the steel-making industry remains second in importance to the oil and gas industry. According to the Russian Ministry of Industry and Trade, in 2015, the steel-making industry accounted for 4.7 percent of the country’s GDP, as well as for 12 percent in the manufacturing sector and 14 percent of exports, contributing a total of over 5 percent in taxes on all fiscal levels. As a consumer of products and services offered by natural monopolies, the steel-making industry consumes 2 percent of electric power generated for industrial purposes and 5.4 percent of total natural gas consumption. It also accounts for 18.8 percent of railway freight traffic. The steel-making industry also operates fairly mature assets developed as a result of active upgrading investments of about RUB 3.3 trillion made by companies over the last 15 years. With this upgrading, the steel and iron

According to the Russian government, the situation remains difficult in 2016, with a potential outlook for further decline in output due to three main reasons:01. Decreasing potential for growth, primarily due

to market constraints and additional foreign entry barriers for Russian steel-makers (please see the Production output trends section for more details)

02. Shrinking domestic demand (please see the Production output trends section for more details)

03. Unfavourable market conditions on the global markets

On the positive side, a significant decrease in metal product imports, which is driven among other things by sharp and unpredictable forex fluctuations, has enabled Russian steel-makers to enhance their role in supplying Russian customers with metal products. This kept prices fairly stable, if compared to quotes on the global market. According to Platts, 2015 saw Russian prices for hot-rolled products drop by 24 percent in US dollar terms, almost in line with the global market. Investments and production asset upgrades in recent years have enabled Russian steel-makers to keep domestic prices for flat-rolled products at a high enough level, compared to export prices, thanks to the level of quality and a growth in the sales of products with high added value.

In 2015 Russian steel-makers up against the deepest downturn in the previous five years, therefore the current year’s growth may be a result of a low base effect.

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According to RosStat, steel output in 2015 was down 1.5 percent to 69.4 million tonnes (Table 5). In January-May 2016, Russian steel-makers produced 28.7 million tonnes of steel and 24.8 million tonnes of finished ferrous products, with a year-on-year output down 2.4 percent and 2.2 percent, respectively.

In May 2016, steel production grew by 1.2 percent on the previous month and was up 0.4 percent on the same month in 2015. Rolled product output grew 1.6 percent year-on-year and was also up 0.2 percent on April.

In May, pig iron output rates entered negative territory (down 2.5 percent) for the first time in two years, as growth rates slowed down this April. At the same time, rolled ferrous products grew slightly on last year, up 1.6 percent. However, due to a significant drop in output, down 7.7 percent in May 2015, the current year’s growth may be a result of a low base effect (Table 5 and 6).

The drop in output is mainly due to sharp contraction in domestic demand, which is, in turn, the result of decreasing demand from the construction industry and several other active steel consumers.


Table 5. Output of key and finished products

Table 6. Year-on-year growth rates on the Russian steel and iron market

Source: RosStat

Source: RosStat, calculations by the Russian Ministry of Economic Development

Product

2010 2012 2013 2014 2015 Market share

Millions of tonnes

Pig iron (million tonnes) 48 50.5 49.9 51.5 53.7 27%

Steel (million tonnes) 66.8 70.4 68.9 70.5 69.4 34%

Finished ferrous products (million tonnes)

55 60 59.2 61.2 60.3 30%

Flat-rolled coated products (million tonnes)

3.6 4.7 5.4 5.6 5.6 3%

Steel tubes 9.2 9.7 10.1 11.3 11.4 6%

March 2016 on March 2015 April 2016 on April 2015 May 2016 on May 2015

Pig iron 9.4 3.5 -2.5

Finished rolled ferrous products 2.2 3.5 1.6

Steel tubes -9.2 -5.3 -14.2

Prefabricated steel structures -3.6 -14.7 -7.1

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Overview of the Russian steel and iron market \ Production output trends

Nevertheless, despite the slowing demand, the Russian steel-making industry had a net financial result of RUB 572.4 billion as reported by RosStat, up 3.2 times on 2014, reaching an historical high both in nominal terms and in terms of growth rates. The last time comparable growth occurred was in 2010 (up 2.1 times).

The stronger competitiveness of Russian metal products is above all explained by the weakening Russian rouble leading to a sharp growth in exports. The depreciating rouble acted to offset financial losses incurred by Russian steel-makers as a result of falling global prices, with most of the major steel producers showing profit by the end of 2015, in US dollar terms.

• Severstal reported a year-end profit of USD 552 million for 2015 against losses of USD 795 million in 2014. However, these losses were attributed to the sale of Severstal’s operations in North America in 2014;

• NMLK earned a profit of USD 967 million, up 25 percent;

• MMK’s profit was USD 421 million against a loss of USD 44 million in 2014;

• Metalloinvest’s profit went up 3.3 times to USD 218 million;

• Mechel increased its profit by 10.6 percent to RUB 101,807 million in 2015;

• Evraz reduced its net losses 1.8 times, with a net loss of USD 719 million in 2015 against a net loss of USD 1,278 million in 2014. These losses were mainly due to assets impaired by USD 441 million and foreign exchange losses of USD 367 million.

During the first five months, Russian tube makers produced 4.3 tonnes of tubes, down 7.3 percent on the same period in 2015. May 2016 saw steel tube output decrease by 14.2 percent in annual terms and 8.8 percent on the previous month. Rolled product output grew 1.6 percent year-on-year and was up 0.2 percent on April (Table 6).

These trends are primarily explained by a crisis in the construction industry, which is a major consumer of tubes, as well as by a decreasing demand from the oil and gas industry accounting for 40 percent of the demand for steel tubes.

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According to the data for 2015, domestic demand for Russian steel was down 10 percent to about 39 million tonnes. The demand from the construction industry, the biggest consumer of rolled products, and the car manufacturing industry dropped by 12 percent and 25 percent, respectively. On the Russian market, a decrease in demand for rolled products resulted in rolled metal product imports dropping by 27.3 percent to a market share of 9.7 percent in 2015.

It should be noted that this demand is to a significant extent met by importers supplying cheaper steel of lower quality, including China where producers have almost unlimited government support. Unlike the steel markets in Europe or America, the Russian market has almost no tariff barriers. As a result, some companies have to reduce output, sell auxiliary foreign operations and put investment projects on hold. For instance, Novolipetsk Steel had to shut down one of its blast furnaces in 2015 due to negative developments on the steel market.

In 2015 a growth in steel consumption in the energy sector was the only opposite trend in Russia, which is mainly explained by the sales of large-diameter tubes for large investment

projects. In particular, the first four months of 2016 saw metal imports to Russia grow 2 percent to 905 thousand tonnes. Foreign imports of steel tubes have demonstrated a much stronger growth, up 28 percent to 151 thousand tonnes. It is worth noting that this growth is driven by imports from CIS countries, with tube imports up 72 percent on the same period last year.

Given the differences identified between the segments within the market of interest, we recommend referring to the Industry-specific trends section for a discussion of the key steel-making sectors.

On the whole, according to experts, a slump in production could have been even deeper if it were not for an increase in exports offsetting a sharp decrease in domestic demand. According to the Russian Federal Customs Service, steel product exports grew 8.5 percent in 2015. Interestingly, the growth took place in the face of unfavourable conditions on the global market. On average, global prices for rolled steel products dropped by 25 percent in US dollar terms.


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Tube industryAccording to news agency Metall-Courier, Russia produced 8.1 million tonnes of welded tubes in 2015, down 1.3 percent on 2014 (8.2 million tonnes). The growth mainly came from increased metal consumption, which resulted in the production of 3.4 million tonnes of large diameter tubes (LDT). LDT production increased by 0.5 million tonnes, up 17.7 percent on 2014 (2.9 million tonnes). This increase was due to the demand from large trunk pipeline projects such as the Power of Siberia, the Bovanenkovo-Ukhta-Torzhok pipeline, the Sakhalin-Khabarovsk-Vladivostok and other initiatives.

In May 2016, steel tube production contracted at a double-digit pace. However, it is only welded large-diameter tubes, which account for 22.3 percent (in physical units) of total steel tube production, that had a negative growth rate of 53.8 percent in May. Production of steel structures also shows a negative growth of 7.1 percent on May 2015 (Table 6).

Automotive industryAccording to RosStat, the industry produced 1.37 million vehicles (trucks, passenger cars and buses) in 2015, down 27.5 percent from 2014.

According to preliminary estimates, in 2015 the sales of rolled metal products to major Russian automakers were 0.9 million tonnes, down 23 percent from 2014 (1.16 million tonnes).A squeeze in the consumption of rolled metal products is caused by vehicle production shrinking as a result of a weakening rouble and lower consumer activity.

Rolling stock manufacturingAccording to RosStat, 30,000 mainline cars were produced in 2015, down 45.6 percent from 2014. According to preliminary estimates, in 2015 sales of rolled metal products to major Russian rolling stock builders were 0.43 million tonnes, which is twice lower as in 2014 (0.86 million tonnes).Decreased consumption of rolled metal products occurred as a result of a squeeze in rolling stock production caused by an excessive fleet of gondola cars in Russia and railway cars remaining in service beyond their operating lifespan.

Shipbuilding industryAccording to the rolling-stock manufacturing statistics, a growth in shipbuilding orders resulted in sales of rolled steel plate products to

Russian shipbuilders reaching 114.8 thousand tonnes in 2015, up 23.8 percent from 2014.A growth in demand from Russian shipbuilders and ship repairers for hot-rolled steel plate products was boosted as a result of the initiative to renovate the Russian atomic-powered ice-breaker fleet for the needs of Rosatom and Gazpromneft.

Construction industryAccording to RosStat, 2015 saw 83.8 million square meters of housing stock put in service in Russia, down 0.5 percent from 2014 (84.2 million sq. m.). Non-residential stock put in service in 2015 was 29.4 million square meters, down 14 percent from 2014. Despite an economic downturn, the housing construction industry remains a major consumer of rolled metal products in Russia. There are several key reasons for this:

• Russia’s housing stock is smaller relative to Europe or even China;

• Russia has a significant amount of rundown housing stock;

• Several government programs (Housing for Russian Families, Incentive, Affordable and

Comfortable Housing and Utilities for Russian Citizens) have been launched;

• Infrastructure initiatives are underway to develop high-speed railway transportation and build roads, bridges, etc.

Additional commentsAs a result of a significant decrease in metal product imports in Russia due to sharp and unpredictable forex fluctuations, Russian steel-makers have ramped up sales to Russian customers. This has enabled fairly stable prices to be maintained relative to those on the global market. According to Platts, 2015 saw Russian prices for hot-rolled products drop by 24 percent in US dollar terms, almost in line with the global market. Investments and production asset upgrades in recent years have enabled Russian steel-makers to keep domestic prices for flat-rolled products at a fairly good level, compared to export prices, thanks to quality and growing sales of products with high added value.

Industry-specific trends

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Table 7. Russia’s ferrous product exports around the world

Source: Russian Federal Customs Service

Export items

In physical units (thousand tonnes)Growth rate

In monetary terms (USD millions)Growth rate

2014 2015 2014 2015

Ore and iron concentrate 22 997.4 21 254.5 -8% 1 951.1 1 013.8 -48%

Ferrous metals 39 258.6 42 191.7 7% 20 522.2 15 220.4 -26%

Ferrous metals other than pig iron. ferroalloy. waste products and scrap 26 089.5 28 312.2 9% 14 474.8 10 871.1 -25%

Pig iron 4 359.4 5 339.5 22% 1 692.8 1 381.1 -18%

Ferroalloy 912.5 752.4 -18% 1 965.2 1 276.2 -35%

Carbon steel semi-products 1 3511.8 14 641.8 8% 6 587.4 4 636.7 -30%

FRP of carbon steel 7 614.5 7 968 5% 4 436.5 3 321 -25%

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Table 8. Russia’s ferrous product exports to the CIS

Table 9. Russia’s ferrous product exports to non-CIS countries (thousands of tonnes)



Export items



2014 2015 2014 2015

Ore and iron concentrate 3 050 2 955.70 -3% 213.9 113.4 -47%

Ferrous metals 6 062.4 5 748.10 -5% 3 555.9 2 442.9 -31%

Ferrous metals other than pig iron. ferroalloy. waste products and scrap 4 524 4 336.80 -4% 2 973.6 2 071.8 -30%

Pig iron 142 100.80 -29% 63.6 31.6 -50%

Ferroalloy 53.1 31.30 -41% 95 48.3 -49%

Carbon steel semi-products 242.2 325.70 34% 107.4 91.8 -15%

FRP of carbon steel 1 691.5 1 446.50 -14% 1 160.9 791 -32%

Export items



2014 2015 2014 2015

Ore and iron concentrate 19 947.4 18 298.80 -8% 1 737.3 900.4 -48%

Ferrous metals 33 196.1 36 443.60 10% 16 966.3 12 777.5 -25%

Ferrous metals other than pig iron. ferroalloy. waste products and scrap 21 565.4 23 975.40 11% 11 501.2 8 799.3 -23%

Pig iron 4 217.4 5 238.70 24% 1 629.2 1 349.5 -17%

Ferroalloy 859.4 721.10 -16% 1 870.2 1 227.9 -34%

Carbon steel semi-products 13 269.7 14 316.10 8% 6 480 4 544.8 -30%

FRP of carbon steel 5 923 6 521.50 10% 3 275.6 2 530 -23%

Overview of the Russian steel and iron market \ Ferrous product exports in Russia

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Expert forecasts

Forecasts for the steel and iron market in Russia are in line with the global trends, with most experts agreeing that the market will be recovering within the next two years. In addition, a weakening rouble will help smelters strengthen their positions in global trade.

• Russian steel-makers will stay competitive on the global market in 2016, with their production capacities remaining loaded at more than 80 percent on average. According to a forecast by Moody’s, a decrease in prices in export markets will have a less serious impact on Russian steel-makers because Russia generally produces steel cheaper than its European competitors;

• According to experts from RIA Rating, the existing negative trend will remain in place for 2016. However, potential stabilisation of domestic demand and expected improvement in the global pricing environment will probably not let this trend worsen beyond what we had in 2015;

• In 2016, hot- and cold-rolled products will be the most exposed segments on the Russian market due to continuing depreciation of the Russian rouble, fluctuations in the effective demand for metal products in Russia and stabilisation of global prices for flat-rolled products, according to a forecast by MMK;

• The forecast of the socio-economic development of Russia for 2016, 2017 and 2018 suggests a lower demand in the steel market. According to Steel Market Research, year-on-year growth rates will be 1.95 percent, 2.3 percent and 5.4 percent for 2016, 2017 and 2018, respectively.

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Steel and iron market

In 1H 2016, Deloitte CIS carried out an integrated research project Current State and Outlook for the Manufacturing Sector in Russia — 2016. As part of the research objective, we surveyed experts from a number of steel- and tube-making companies. Conducting a detailed analysis of this survey allowed us to get a picture of the Russian steel-making industry and identify the sentiments and expectations of the market players, as well prospects they have for the future direction of their businesses and the industry as a whole.

04

22

The current state of the steel-making industry

Challenges facing Russian steel-makers in 2016

Business growth strategy in 2016

01 Key findings




05 Appendix

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The current state of the steel-making industryWe asked the survey participants several questions about the current situation as regards the market, the situation in their companies and the prospects of the industry as viewed from both the corporate and market perspectives.

TrendsSteel-making companies tend to have a less positive view of the current state of the industry. The number of respondents with a negative view of the situation for 1H 2016 is higher than the average by 17 pp.

Generally, opinions on the current condition of the manufacturing sector in Russia are divided equally.

TrendsLess positive views also prevail in answers to the question about the development prospects of the Russian manufacturing industry. While every fourth respondent (25 percent) from the manufacturing industry predicts worsening conditions, the number of respondents from steel-making companies expressing this view is higher by 15 pp.

TrendsBased on the replies, the steel-making companies appear to begin having more positive views of the situation in regard to their business. Ninety-three percent of respondents from companies producing metal products expressed a positive view of the situation of their company in 1H 2016, which is 5 pp higher than the average for the industry as a whole.

TrendsMost steel-makers (60 percent) do not expect any significant changes in the prospects for their business in 2016.

Given the optimistic views of the market’s current state, the perceptions expressed reflect an improving situation in the industry, which also agrees with the findings obtained based on the available statistical data.

What is your view of the current state of the Russian manufacturing industry?

What is your view of the development prospects of the Russian manufacturing industry?

What is your view of the current situation of your company?

What is your view of the development prospects for your company in 2016?

Manufacturing sector


Steel-makers

Steel-makers

Negative view Positive view

67%

33% 60% 7%

50%

28% 60% 12%

33%

50%



Steel-makers

Steel-makers

The situation will improve

The situation will improve

The situation will generally remain the same

The situation will generally remain the same

The situation will worsen

The situation will worsen

40%27%33%

25%37%38%

Negative view Positive view

93%7%

88%12%

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Currency risk (Weakening Russian rouble)

Shortcomings of government regulation (administrative, trading, economic and other barriers)

Low appeal of the Russian manufacturing industry for foreign investors

Corruption

Lack of qualified executive staff

Geopolitical risks (EU sanctions, Russia’s embargo, etc.)

Insufficient government support and financing

Insufficient production capacity and technological potential

Insufficient purchasing power of the population

Lack of qualified workers

Insufficiently optimised logistics

Expensive energy sources for production purposes


We asked the respondents to name the most significant challenges regarding support and growth of business. We performed an analysis to rank the challenges facing the market.

Top challenges

40%

40%

27%

25%

25%

23%

21%

9%

9%

8%

7%

5%

TrendsTop-5 challenges facing steel-makers in 2016:

• Currency risk (40 percent)

• Shortcomings of government regulation of the industry (40 percent)

• Lack of viability of the Russian manufacturing sector for external investors (36 percent)

• Corruption (25 percent)

• Lack of qualified executive staff (25 percent)

In spite of the depreciating rouble acting to offset losses incurred by Russian steel-makers in 2015 (please see the Overview of the Russian steel and iron market/Production output trends sections for more details), the weaker rouble and government regulation continue as top challenges for the steel-making industry. The primary reason is that a depreciating rouble only benefits industries with low to middle level of processing. Meanwhile, producers of metal products, equipment and related products have to deal with direct exposure to risks such as growth in production costs, lower demand and a loss of share on the global market, including, above all, risks expressed in monetary terms.

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A weakening rouble is the key factor significantly impacting steel-makers. Therefore, we asked the experts surveyed to tell us more about the consequences facing their companies as a result of the depreciating rouble.

TrendsOn the whole, the depreciating rouble was noted by 80 percent of the representatives from steel-making companies, including 58 percent of those who mentioned the positive impact of the depreciation.

As regards the individual business situation, almost every second respondent mentioned increased competitiveness on foreign markets (47 percent) and a growth in production costs (47 percent) as the key impacts of the depreciation, which also agrees with our findings.

At the same time, every third respondent saw a decrease in production costs (33 percent), which is by 5 pp higher than the average for the manufacturing industry as a whole.

In addition, every fifth respondent mentioned better competitiveness as a result of imports becoming more expensive (20 percent).

Only 7 percent of respondents pointed out a growth in interest from foreign investors.

The weakening rouble’s impact on steel-makers

Steel and iron market \ Challenges facing Russian steel-makers in 2016

Stronger competitiveness on foreign markets due to sales denominated in a foreign currency

Higher production costs

Lower production costs

The depreciating rouble has had no impact on the operations of a company

Stronger competitiveness of a company due to higher import prices

Improved business appeal for foreign investors

47%

47%

33%

20%

7%

20%

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Fundamental changes on the global steel-making market have led to notable transformations in how companies plan and manage their business. Uncertainty and higher operational risks have affected both the current situation of companies and their strategy for at least the next five years.

We asked respondents to share their views on what factors could help their companies become more competitive and what strategy they are planning to employ in a situation of greater uncertainty for 2016 and 2017.



TrendsTop-3* factors that could potentially drive the development of steel-making companies:

• Lower labour costs (37 percent)

• Higher local demand (36 percent)

• Lower production costs (36 percent).

37%

36%

36%

28%

16%

16%

13%

12%

12%

11%

8%

9%

5%

Competitive factors ranked for the steel-making industry in 2016 Lower labor costs

Higher domestic demand

Lower production costs, including energy costs

Lower administrative barriers, including trading barriers

Higher demand outside Russia

Availability of financing sources

Marketing

Government support for the manufacturing sector

Stronger technological and manufacturing potential (building new capacity)More efficient logistic processes

A broader range of products

Better trained staff

Limited imports, including “grey” imports

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Steel and iron market \ Business growth strategy in 2016

TrendsTop-5 priority growth strategies for steel-making companies in 2016:

• Expansion into new markets (83 percent)

• More efficient production and technologies (77 percent)

• Business development through organic growth (73 percent)

• Higher prices for end products (67 percent)

• New product launches (67 percent).

All of these strategies reflect the recovery taking place on the Russian steel and iron market.

Business development strategies in 2016

67%

83%

67%

77%

63%

73%

63%

60%

53%

43%

43%

40%

37%

37%

37%

33%

Expansion into new markets

Improvement of production and technological capacity

Business development through organic growth

Higher prices for end products

Launches of new products

Investments in personnel

Reduction of costs in Russia

Exports to countries in the Customs Union

Review of the procurement strategy

Separation and/or sale of non-core/low-priority operations

Construction of new plants in Russia

Reduction of procurements from foreign companies

Finding external financing sources

M&A strategy for the same market segment

Joint ventures with a Russian/foreign producer, including contract manufacturing

Currency risk hedges

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AppendixTop-20 M&A deals on the steel and iron market in 2015 and 2016

Date Deal target Buyer Seller Deal size (USD millions)

1 04.08.2015 Shougang Jingtang United Iron & Steel Co. Ltd (51% stake)

Beijing Shougang Co., Ltd. Shougang Group Corporation 7584

2 13.05.2016 Nisshin Steel Co., Ltd. (42.78% stake) Nippon Steel & Sumitomo Metal Corporation

2981

3 10.09.2015 Chongqing Iron & Steel Company Limited (22.47% stake)

An investor group led by Chongqing Yufu Assets Management Co Ltd

777

4 25.10.2015 North Star BlueScope Steel, LLC (50% акций) BlueScope Steel Limited Cargill, Incorporated 760

5 14.07.2015 Gerdau Acominas S.A. (3.5% stake); Gerdau Acos Especiais S.A. (2.39% stake); Gerdau America Latina Participacoes (4.9% stake); Gerdau Acos Longos S.A (4.77% stake)

Gerdau S.A. Itau Unibanco Holding S.A.; ArcelorMittal Netherlands B.V.

629

6 01.04.2016 Thyssenkrupp CSA Siderurgica do Atlantico (26.87% stake)

ThyssenKrupp AG Vale S.A. 500

7 21.08.2015 Fujian Sanan Steel Co Ltd Fujian Sansteel MinGuang Co Ltd

Fujian Sansteel (Group) Co Ltd; Fujian Sanan Group Co Ltd; Fujian Anxi Rongde Mining Co Ltd; Xiamen Xindaan Trading Co Ltd

431

8 19.10.2015 Shanghai Krupp Stainless Co Ltd (55% stake) Lujiazui International Trust Co Ltd

Outokumpu Oyj 420

9 20.06.2016 Vallourec Group SA (13.85% stake) Nippon Steel & Sumitomo Metal Corporation

390

10 26.04.2016 SKF (Kaydon velocity control business) Stabilus S.A. SKF AB 339

11 07.01.2016 Fame Risen Development Limited Intelligent Wealth Limited Kai Yuan Holdings Limited 307

12 10.09.2015 Taihan Electric Wire Co., Ltd. (74.66% stake) IMM Private Equity Inc 251

13 30.07.2015 Formosa Ha Tinh Steel Corp (5% stake) JFE Steel Corporation Formosa Plastics Group 225

14 13.08.2015 Shanxi Antai Section Steel Co Ltd Shanxi Antai Group Co Ltd Xintai Iron and Steel Co Ltd 218

15 18.05.2016 Cambridge International Inc. Rexnord Corporation Industrial Growth Partners 210

16 20.05.2016 Gerdau Sidenor Clerbil Sociedad Limitada Gerdau S.A. 174

17 21.12.2015 IPE Group Limited (95.16% stake) China Baoan Group Co., Ltd. 171

18 01.07.2016 SeAH Changwon Integrated Special Steel (19.94% stake)

SeAH Besteel Corporation POSCO 145

19 07.12.2015 Nga Chun Holdings Company Limited Zhejiang Jin Cheng Asset Management Company Limited

Vantage International (Holdings) Limited; Fung Chuen (Private Investor); Fung Chi Wing (Private Investor)

108

20 03.02.2016 Anhui Tianda Oil Pipe Company Limited (80,55% stake)

Vallourec Tubes S.A.S. Anhui Tianda Enterprise Group Co., Ltd; Anhui Tianda Investment Co. Ltd

91

28

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Contacts

Andrew Sedov

Leader of the Metals group in Deloitte, CIS

Partner, Head of Consumer and Industrial Products Audit department

+ 7 (495) 787 06 00, доб. 2260 [email protected]

Vladimir Perfiliev

Director, Consumer and Industrial Products Audit (Metals)

Deloitte CIS

+ 7 (495) 787 06 00, доб. 8060 [email protected]

Artyom Belyaev

Designer

Business Development Department

Deloitte CIS

[email protected]

Marina Elovskaya

Senior Manager

Business Development Department

Deloitte CIS

[email protected]

Lora Zemlyanskaya

Manager

Research Centre Leader Deloitte CIS

[email protected]

29

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06 Contacts

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Depreciating Russian Rouble Offsets Financial …...output was 667 million tonnes, down 1 percent on the same period in 2015. *Net financial result is defined based on accounting data