Annual Report & Accounts 2013
Severstal Annual Report 2013 Home > Governance > Risk report > Market risks
 

Market risks

Industry cyclicality and demand fluctuations

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

In 2013, the Russian steel consumption grew by an estimated two per cent, according to industry experts, and a similar growth by 2-3 per cent is forecast for 2014. Domestic steel production reached 69.5 million tonnes in 2013, one per cent lower than in 2012.

Risks of poor performance are increasing in investment-driven sectors of the Russian economy. Investment activity decreased moderately by 0.3 per cent in 2013, prospects for 2014 are quite uncertain due to the impact of geopolitical tensions. Automotive production increased by 5.8 per cent year on year in 2013 due to the output of trolleybuses and trailers. At the same time, production of passenger cars and trucks diminished. Higher competition in the passenger car market led to a falling share of Russian brands. The cargo coaches market entered oversupply which resulted in lower production. The value of construction works decreased in 2013, however residential houses completion was up by 5.4 per cent year on year. Taking into account the fact that residential construction consumes about 80 per cent of construction steel volumes, the risks of slowdown in non-residential construction are more than compensated for by possible growth in the residential segment. The pipes and tubes sector demonstrated growth in 2013 on the back of oil drilling and tube shapes.

Mitigating factors:

  • Severstal has adopted a new strategy in 2013 focusing more on customer care and cost-cutting measures to increase the efficiency of its operations. That has allowed us to increase our market share in some segments.
  • In 2013, we redesigned our sales and distribution chain in Russia. We hope these initiatives will allow us to increase our market share in the domestic market in the future and increase profitability.
  • 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.
  • Severstal is focusing on supplying steel to foreign carmakers in Russia which represent the fastest-growing sector compared to domestic car production.

Changes to sale prices

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

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

In 2013, world steel prices continued to decline. Prices fell by 4-6 per cent in comparison with the average 2012 price. The primary reasons for the price drop were steel overcapacity, falling hard coking coal prices due to oversupply and the continued weakness of the global economy. The annual average price of hot rolled coil in 2013 was US$543 per tone (FOB Black Sea) and US$694 per tone (US domestic).

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.
  • Possible weakening of the Russian ruble might have a positive effect on our operations, as our cost structure is predominantly ruble-denominated. A weaker ruble also increases our strength as an exporter.
  • We also strengthened our position in most prospective product niches, which have 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 an Early Warning System to predict short-term price fluctuations three months in advance. We devote special attention to raw materials price 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

On the one hand, Severstal requires substantial amounts of raw materials for steel production, in particular coking coal and iron ore, alloys and fluxes, natural gas, electric energy and industrial oxygen. On the other hand, Severstal is a sizable seller of coking coal and iron ore pellets to third parties.

In 2013, coking coal and iron ore prices declined globally. That had a positive effect on the cost of production at our Russian steel assets. While on the other hand, our mining assets generated smaller earnings in 2013 than in 2012.

In 2013, the contract price for Australian coking coal decreased by 25 per cent to US$159/ a tonne FOB. This was the result of massive coal inventories accumulated in China because of strong domestic production. Other reasons included a depreciating Australian dollar, decreasing costs of Australian producers and growth of Australian coking coal supply. In 2014, coking coal prices are expected to continue to fall. In the first two months of 2014, the spot price of Australian coking coal fell by almost 10 per cent to US$120 per tonne FOB Australia.

In 2013, the iron ore market demonstrated significant strength on the back of growing steel production in China, increasing by 7.5 per cent year on year. The iron ore price increased by four per cent to US$135 per tonne CFR China compared to the drop of 23 per cent in 2012. However, in the first two months of 2014 iron ore prices declined to below US$120 a tonne due to weak steel production in China, negative steel market sentiments and increasing supply from Australia.

In 2013 scrap prices declined by eight per cent compared to the previous year due to lower steel prices which undermined demand for scrap. At the same time scrap supply was sufficient both in the USA and Russia. In 2014 scrap prices are expected to decrease by three per cent year-on-year followed by lower raw material (iron ore, coking coal) prices. Prices changed throughout 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 as well as slight fluctuations in raw materials and energy prices and high transportation costs. In addition, Severstal’s contractors include 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:

  • Our primary goal in mining is to decrease the cost of producing our assets. We have achieved good progress in 2013 via cost cutting initiatives and the redesign of business processes. In 2014-2015 we hope to see further cash cost reduction in mining as we will be completing our major investment projects.
  • Possible weakening of the Russian ruble might have a positive effect on our operations, as our cost structure is predominantly ruble-denominated. A weaker ruble also increases our strength as an exporter.
  • 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 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 material price rises.
  • Our heavier reliance on Russian suppliers helps us to gain lower domestic prices.

Competition risks

As mentioned above, during 2013, the global economy, steel and commodity markets were in a very challenging position. The weakness of some economies allowed their central banks to devalue national currencies. As a result, the competitiveness of some steel-makers and miners increased in 2013.

Our Competition risks are as follows: low-cost producers can potentially reduce prices in order to gain market share, and competitors’ M&A deals can affect the competitive environment. The consolidation of niche-product manufacturers can create new entry barriers and complicate Severstal’s development in some markets. Artificial barriers set by local authorities can complicate entrance into new markets and increase existing market share.

The main peculiarity of the Russian market is its isolated 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 value-added rolled stock (especially from China). The events of 2008 and the first half of 2010 illustrate this fact: during these periods Chinese imports occupied more than half of the Russian high value-added rolled products market. However, Russian domestic steel players are able to protect the local market from damping from time to time. In 2013, an import duty was imposed on Chinese color-coated steel.

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 from substitute products (concrete, plastics, aluminium), which is currently growing.

Mitigating factors:

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