Annual report and accounts 2012

Market risks

Industry cyclicality and demand fluctuations

Steel demand depends on the economic situations of different regions and demand in steel-consuming industries. Severstal is highly sensitive to changes in the automotive, building and pipe industries as these are key steel-consuming industries.

In 2012, the Russian steel consumption grew by an estimated 5%, according to industry experts, and a similar 3% growth is forecast for 2013. Domestic steel production reached 71 million tonnes, 3.3% higher than in 2011.

Mitigating factors:

  • Domestic market growth allowed Severstal to increase sales to traditional consumers. Severstal is promoting its production in the automotive and pipe segments of the domestic market. Furthermore, we are pursuing cost and productivity improvements to improve our competitiveness and strengthen our ability to withstand general economic cyclicality.
  • We are monitoring the global market and are ready to increase export sales if necessary. In 2009, Severstal demonstrated its ability to redirect commodity flows from domestic to external markets, leveraging its cost efficient production methods.

Changes to sale prices

The steel and mining industries are highly susceptible to cyclical changes to steel prices.

Our operations depend heavily on changes to rolled steel and steel products prices on both the domestic and world markets.

In 2012, world steel prices continued to decline, starting in the second quarter 2011. Prices fell by 13.4% in comparison to average price of 2011. The primary reasons for the price drop were slack on key markets at the EU recession and crisis, and instability on the commodity markets. The average price of hot rolled coil in 2012 was US$645/ton.

Mitigating factors:

  • We were able to moderate the negative impact of the adverse economic situation, and to quickly overcome the consequences of the crisis.
  • We made major efforts to manage working capital effectively, increase operational effectiveness, use raw materials and energy effectively, increase labour productivity, closely control costs, focus on customers (quality of production and service), and increase our production of high-value-added goods whose prices are less sensitive to economic fluctuations.
  • We also strengthened our position in most prospective product niches, which have preferable competitive conditions and an attractive supply-demand balance. Our comparatively low production costs help us to mitigate the risk of steel price fluctuations.
  • To reduce the influence of sharp market fluctuations on our revenue, management initiated the Foresight project to improve employee understanding of our markets, and the Early Warning System to predict short-term price fluctuations three months in advance. We devote special attention to raw materials prices forecasting, as this helps us coordinate our purchasing strategy in line with market trends.
  • We closely consider the dynamics of leading indicators which signal possible future price changes. In certain markets we diversify our sales commitments between spot market and contract-based pricing to limit exposure to price volatility.

Fluctuations in raw materials, energy and services prices

Severstal requires substantial amounts of raw materials for steel production, in particular coal and iron ore, alloys and fluxes, natural gas, electric energy and industrial oxygen.

In 2012, decreased steel demand in the US and EU created slack in production. Prices fell in comparison to 2011. The low demand from steel producers negatively affected prices of coking coal, iron ore and scrap.

In 2012, the price for Australian coking coal decreased by 27% to US$210/tonne FOB. This was the result of a decreased world coking coal demand provoked by lower steel production levels. In 2013, coking coal prices are expected to continue to fall. In first quarter 2013, the contract price of Australian coking coal fell by another 14% to US$180/tonne FOB.

In 2012, the price of Australian average contract iron ore price fell to US$131/tonne FOB, a 16% drop compared to 2012. The drop was provoked by a slowdown in Chinese economy, and reduced global steel production levels. In first quarter 2013, the contracts for Australian iron ore were concluded with price of US$108/tonne FOB, the annual average price of Australian iron ore is expected to further reduce compared with 2012.

In 2012 scrap prices declined by 15-20% compared to the previous year, followed by lower steel prices which caused economic slowdown and steel overcapacity. The bullish trend will continue this year because of pressure from low raw materials prices. In 2013 scrap prices are expected to decrease by 5-7% year-on-year followed by lower steel and other raw materials (iron ore, coking coal) prices. Through the year: in the summer prices would slide due to comfortable weather conditions for collecting and delivering scrap with further recovery in autumn as a result of restocking at mills before the year end.

Supply volumes and the timeliness of their delivery can heavily impact operations; however, Severstal has little control over these factors. Severstal’s activities have been heavily affected by reduced steel production levels brought on by reduced demand and slight fluctuations in raw materials and energy prices and high transportation costs. In addition, among Severstal’s contractors are natural monopolies (electrical energy and natural gas providers and railroad companies), whose rates are set and adjusted by the federal government: this could lead to increased prices for gas and electricity and higher transportation costs where railroad services are limited.

Mitigating factors:

  • We manage sector risks related to the provision of raw materials and services by establishing long-term mutually advantageous contracts with key suppliers, optimising purchasing processes and conducting continuous inventory management. Most of our purchasing contracts for primary raw materials (pellets, iron ore and coking coal) are concluded for a period of at least one year.
  • High reliance on our own iron ore, coking coal and scrap supplies helps us to mitigate raw materials price rises.
  • Our heavier reliance on Russian suppliers helps us to gain on lower domestic prices.

Competition risks

During 2012, the global economy and steel market were in a very difficult position. Chinese economy slowdown, European sovereign debt problems, US fiscal cliff tensions, bleak performance of emerging countries (India, Brazil, Russia) resulted in a sharp fall of raw material prices, which pulls down steel prices, as well. Central banks tried to support the economy by liquidity injections in the form of monetary easing in the USA, Europe, Japan. Many countries decreased interest policy rates in order to stimulate economy, while inflation was under control.

Low-cost producers could reduce prices in order to gain market share, and competitors’ M&A deals could affect the competitive environment. The consolidation of niche-products manufacturers could create new entry barriers and complicate Severstal’s development in such markets. Artificial barriers set by local authorities could complicate entrance onto new markets and increase existing market shares.

The main peculiarity of the Russian market is its closed nature, which is the result of factors such as a weak logistics infrastructure and strict certification requirements.

Nevertheless, the Russian market is vulnerable to interventions by external producers of high added-value rolled stock (esp. China). 2008 and the first half of 2010 illustrate this fact: during these periods Chinese imports occupied more than half of the Russian high added-value rolled products market. In the second half of 2012, due to declining domestic steel demand, China began to export cheap steel products around the world, that stepped up the competition.

The development and appearance of new steel-consuming technologies potentially provides Severstal with more opportunities. However, competition on these markets has become increasingly fierce as markets mature.

Increased pressure comes from competition with substitute products (concrete, plastics, aluminium), which is currently growing. Mitigating factors:

  • We continue with our Clients Retention project which focuses on helping us to obtain a better understanding of clients needs, and improve our corporate image which will help us to more effectively compete domestically and globally.
  • We also continue to diversify our steel products capability in our major markets, as demonstrated by the recent modernisation program in North America.