ANNUAL REPORT 2016

Divisional Review

Severstal Resources Division

Severstal Resources comprises Severstal’s mining assets, which form the basis of Severstal’s vertically integrated business model. The division fulfils almost all the iron ore and approximately 70% of hard coking coal requirements of the Severstal Russian Steel division, while also selling iron ore pellets to third parties. Severstal Resources mines all its iron ore and coking coal in Russia.

Key assets

1. Karelsky Okatysh

Located in Karelia, north-western Russia, Karelsky Okatysh is one of the country’s leading and most modern iron ore mining complexes. It mines magnetite quartzite ores and produces high-quality iron ore pellets with an iron concentration of 64% to 66%. The two major deposits, Kostomuksha and Korpanga, have an estimated life of 30 years.

2. Olcon

Located in the Murmansk region, Olcon is Russia’s most northerly iron ore complex. Olcon mines magnetite-hematite quartzite ores from five open pits, and produces high-quality iron ore concentrate, crushed stones and ferrite strontium powder. Olcon’s deposits have an estimated life till 2026 year.

3. Vorkutaugol

Located in the Komi Republic (near Vorkuta), north-east European Russia. Vorkutaugol mines coking and steam coal, and is one of Russia’s largest producers of hard coking coal. Coking coal produces coke which is used for steel production. Steam coal is used in the energy and chemical industries. The two deposits we operate, Vorkutinskoye and Vorgashorskoye coal deposits, have an estimated life of 25 and 8 years, respectively. The business consists of five underground mines, one open-pit mine and three washing plants.

Performance overview

The market environment for steel-related commodities in 2016 remained challenging, both for coking coal and iron ore products.

In 2016 the average headcount at Severstal Resources was 12,914 employees, compared with 13,025 in the prior year.

Vorkutaugol

Coking coal concentrate

  • Average selling price increased 8% year-on-year driven by global benchmarks’ growth
  • The 25% cash cost per tonne rise year-on-year reflects the Severnaya mine incident in February 2016 and planned long-wall repositionings during 2016.

Olcon

Iron ore concentrate

  • Average selling price remained almost flat year-on-year
  • Due to operational efficiency developments Severstal managed to keep cash cost low
  • Sales volumes are expected to stay flat in 2017

Karelsky Okatysh

Iron ore pellets

  • Average selling price remained almost unchanged year-on-year, having increased 29% in Q4 q/q.
  • Decreasing cost dynamics reflect the operational efficiency programme and cost-saving initiatives.

Dynamics of revenue by products

Although most of our sales are intercompany, Severstal is a well-established commodity supplier both in Russia and beyond. Our principal third party sales products are pellets and coking coal concentrate. Russia is the principal market for our mining businesses, as our steelmaking assets are mostly located there. We also have a number of third party clients in Russia for our mining products including major domestic steelmakers. Sales and cost of sales figures in the charts below are presented in US dollars as a percent of the total sales or cost of sales of the Severstal Resources division.

Geographical diversification of sales

At Severstal Resources labour cost is one of the main contributors to the total cost of production. In 2016, labour costs accounted for 29% of the total cost base whilst materials and energy costs respectively accounted for 33% and 23% of the cost base. Cost reduction and efficiency improvements coupled with high safety standards are among the key priorities for our mining business. Global markets dynamics enabled the Company to partially offset the negative coking coal sales volumes drop with EBITDA declining only 4% year-on-year.

Cost of sales structure

EBITDA drivers in 2016 (US$ million)

Key developments in 2016:

Severstal Resources

In 2016, Severstal’s resource assets were focused on capacity development, ongoing maintenance and safety.

Karelsky Okatysh

  • Ore production commenced at a new open pit Severny-3. The pit’s capacity is 1.7 million tonnes of ore per year with a life of more than 15 years.
  • New DR-pellets were produced at Karelsky Okatysh, enabling the enterprise to access new niche markets. Operational testing of the new tailings thickening complex commenced. The new complex will enhance Karelsky Okatysh’s closed water cycle.

Olcon

  • A new rotary drier was installed in 2016. The new drier will help reduce environmental impact while also being more cost efficient.
  • Improvements were also made to the mining machinery fleet.

Vorkutaugol

  • A modern seismic environment is used at the mines to trace geological movements and prevent risk.
  • A new generation gas analytical system, Mikon-3, was installed at Vorkutinskaya mine.
  • Installation of a multifunction alerting and positioning system, Granch, began at the mines. This continuously monitors air quality in the mines.

Strategic priorities for 2017

In 2017 Severstal will continue to invest in production improvements, maintenance and safety.

Severstal Russian Steel Division

Severstal Russian Steel is a leading Russian steel producer, with a broad product mix, self-sufficiency in raw materials and an extensive distribution network. The division focuses on high value-added flat steel products and the production of long products for construction and downstream sales.

Our downstream assets include the production of large diameter pipes and metalware for machinery, as well as service centres and stamping facilities for exposed automotive parts. The division has the highest share of high value-added products among its domestic peers, while our flagship Cherepovets Steel Mill is one of the lowest-cost steel mills in the world.

Located in north-west Russia, the division’s steel operations enjoy convenient rail access to the Company’s mining operations and low-cost direct river access to the Baltic ports. It is also well positioned to serve the industrial hubs around Saint-Petersburg and Moscow.

In 2016 the average headcount at Severstal Russian Steel was 37,115 employees, compared with 37,543 in the prior year.

Key assets

1. Cherepovets Steel Mill

One of the world’s largest stand-alone integrated steelworks by capacity as well as an excellently located low-cost steel producer. It produces a wide range of flat and long-rolled products, including hot and cold-rolled flat products, galvanized and colour-coated products and long-steel applications. Rolling Mill 5000, located in Kolpino, near Saint-Petersburg, produces thick plate for large diameter pipes, ship and bridge building and other industries.

2. Izhora Pipe Mill

The mill in Kolpino specialises in manufacturing large diameter pipes from plate, which are produced at the nearby Kolpino Mill-5000. It has a production capacity of 600,000 tonnes of pipes per year, which is mainly used in oil and gas pipeline projects.

3. Mini-Mill Balakovo

A mini-mill focused on the production of long products for the construction industry. Annual production capacity is one million tonnes of rolled products.

4. Severstal-Metiz

Manufacturer of more than 55,000 product types, including low-carbon and high-carbon wire rods, nails, cold-drawn steel, steel ropes, netting and fastenings. Severstal-Metiz comprises several subsidiaries: the Cherepovets site in north-west Russia, the Orel site in central Russia, the Volgograd site in the Povolzhie region, as well as subsidiaries in Italy (Redaelli) and Ukraine (Dneprometiz).

In January 2017, the Group entered into a definitive agreement to sell to a third party 100% of the shares in Redaelli Tecna S.p.A., аn Italian steel company, included in the Severstal Russian Steel reporting segment.

5. Downstream production assets

  • Severstal-SMС-Kolpino applies the primer to shipbuilding plates, and produces semi-finished products for machinery and large fabricated sections for the construction industry. SMС-Kolpino has an automated steel product preservation line, distinguished by its shot blasting and protective prime coating, which are sheet metal processing methods designed to prevent corrosion. It also has an automated beam welding line, which produces welded structures such as T-bars and I-bars and automated plasma-beam cutting lines which carry out sheet metal cutting, including those used for manufacturing welded structures.
  • Severstal-Gonvarri-Kaluga Steel Centre is a Russian-Spanish joint venture of two global leaders in steel manufacture and processing. It has a design capacity of 170,000 tonnes of rolled metal products per year, produced for the automotive and electrical industries.
  • Gestamp-Severstal-Kaluga Stamping Facility is the joint venture of Severstal and Gestamp. It is equipped with a number of press lines and produces the full range of rolled steel products, from coils to car components for international car manufacturers. It has an annual output of 13 million stamped parts and has the potential to expand production.
  • Severstal-SMC-Vsevolozhsk service centre is a joint venture with the Japanese company Mitsui. This centre prepares high-quality CRC and galvanized steel, which will be further stamped at our joint venture with Gestamp in Vsevolozhsk. The service centre’s capacity is 150,000 tonnes.
  • Rutgers Severtar, a joint venture with Rutgers, based at the Cherepovets Steel Mill plant, produces vacuum pitch, technical oils and naphthalene.
  • TPZ-Sheksna was launched in 2010, and is designed to produce up to 250,000 tonnes of electric-welded pipes of various diameters, thicknesses and lengths for the construction industry, as well as square and rectangular sections with different cross-sections. The plant uses semi-finished steel products made at Cherepovets Steel Mill.

6. Trading companies

Severstal Russian Steel sells its products domestically to regional and national distributors, directly to end-users, and through AO Severstal Distribution. AO Severstal Distribution has a wide network of metal centres throughout the country. We conduct export sales principally through the subsidiary Severstal Export GmbH, as well as through SIA Severstal Distribution, Severstal Distribution LLC and ZAO Severstal Distribution.

Performance overview

Ongoing operational efficiency improvements accompanied by our well-planned maintenance and development investment programme enabled the Russian Steel division to further increase both hot metal and crude steel output. Specifically, increased usage of higher Fe content pellets (produced by Karelsky Okatysh), our upgraded coke battery and increased spread between pig iron and scrap improved coke hot strength back to historical levels (above 50%), which resulted in higher production and reduced coke consumption.

Production volumes (million tonnes)

Despite a 4.1% year-on-year decrease in Russian steel consumption, the Russian Steel division was able to respond to market headwinds and maintain relatively high sales volumes in 2016 at 10.7 million tonnes. The favourable location of the main producing asset supported the division’s sales strategy allowing prompt relocation of sales volumes between domestic and export markets.

Sales volumes (million tonnes)

Existing steel overcapacity issues and stagnating steel consumption globally put pressure on steel prices. This put pressure on Severstal average steel prices declining 2% for hot-rolled strip and plate and 1% for long products. At the same time Severstal’s average selling price for cold-rolled flat products increased 5%.

Average selling price (US$/t)

Our key domestic customers include construction companies and pipe mills, machinery and automotive clients. Therefore, our product mix covers a wide range of products of various specifications. Severstal Russian Steel benefits from its proximity to export routes. Our share of exports varies depending on the health of the Russian market and the alternative attractiveness of international sales options. In 2016 our export sales volumes comprise 38% of total sales. Sales and cost of sales figures in the charts below are presented in USD as a per cent of the total sales or cost of sales of the Severstal Russian Steel division.

Sales by regions 2016

Sales by industries 2016

Sales by industries 2015

We consistently work to maintain our leading cost position through labour and energy productivity and operational enhancements. In 2016 raw materials accounted for 69% of total costs. Labour and energy costs are ranked second and third with a share of 13% and 10%, respectively.

Cost of sales structure 2016

EBITDA drivers in 2016 (US$ million)

Key developments in 2016

  • Hydraulic pressing units installed at stands #5–8 at Mill 2000 to provide ½ EN thickness tolerance. CAPEX: US$22 million.
  • A new slitting machine for coils improved flatness and laser cutting. CAPEX: US$20 million.
  • Upgrade of the cut to length machine for sheets improved flatness and laser cutting. CAPEX: US$6 million.
  • Cooling tower #6 was reconstructed to further progress energy saving initiatives and improve water cooling for Cherepovets Steel Mill.
  • The reconstruction of hot-air units in blast furnaces #2 and #1 helped to reduce coke consumption and as a result iron production costs.
  • 4-stand SR Mill was brought back into commercial operation. The newly modernised mill will increase production of cold-rolled sheet by 200,000 tonnes per year, or 20% of annual volume. In addition, the operational commissioning of the new equipment will strengthen the product range and improve product quality. CAPEX: US$50 million.
  • 40% out of 276 issues were solved to improve operations.

Strategic priorities for 2017 and beyond

  • New HDG & coating line to increase capacity of HDG by 400,000 tonnes and coating steel by 200,000 tonnes. Estimated CAPEX is US$120 million. New lines will be completed during 2017.
  • A second ladle furnace to improve cost and quality is in development and is scheduled for completion in 2017. Estimated CAPEX is US$50 million.
  • Coking Battery #4 is scheduled for reconstruction to improve capacity. This is due for completion in 2017–2018. Estimated CAPEX is US$100 million.
  • An online trading platform will be opened in 2017. We plan to sell more than 3.5 million tonnes of rolled steel in 2018 using it.