Investment effectiveness

The world steel market is characterised by high and growing requirements for the quality and variety of steel products. Severstal continues to follow an investment programme aimed at reducing costs and increasing productivity, as well as improving quality and extending the variety. The programme is financed from both internal and external sources. Changes in the steel market or financial market situation may lead to an under-financing of the programme, which may negatively affect its schedule or scope, and Severstal’s financial statements.

Engineering, production, installation and commissioning of metallurgical equipment is a complex task involving the efforts and resources of the organisation, contractors, equipment producers, and spare parts suppliers. Mistakes may lead to delays in reaching planned production levels and use of full capacity, as well as increasing the total project costs and decreasing profitability. Introduction of new production equipment often requires employee training. The initial period of using new production equipment may be characterised by a relatively high level of unintended mistakes due to lack of familiarity with the new equipment. These may lead to breakdowns, idle time, and a higher rate of defective products, which together may affect financial results negatively.

Mitigation

To mitigate technical and technological risks, we choose contractors for construction and installation of equipment carefully. We regularly assess employees and provide necessary training, and have a Company-wide development programme in place. Because of the economic situation, we have reduced investment activity and have concentrated mainly on repair and modernisation processes, and on projects which are at the closing stages of implementation.

Risks related to production and equipment technical conditions

Our production activities may be affected by technical equipment problems which may lead to production stoppage (incidents), idle time, decreasing production volumes and breach of quality standards.

Mitigation

Mitigation actions include an investment programme and running a planned preliminary repair and maintenance programme.

We maintain a level of insurance covering property, plant and equipment, which is in line with that of other international and domestic steel companies. We have business interruption insurance cover ranging from fixed costs to full gross profits, depending on the plant, for interruption periods of up to 12 months’ indemnity. We also use insurance for third-party liability in respect of property or environmental damage.

Loss of key skills and knowledge through redundancy of key employees due to the economic situation

The slowdown of economic growth, decreasing foreign investments and liquidity, together with pessimistic forecasts and general uncertainty, seriously affected economic conditions. Deteriorating demand for steel caused by the economic downturn in major steel-consuming industries negatively affects the supply-demand balance and leads to decline in our production. This means we are over-manned. We implemented a programme to optimise our organisational structure and staffing, which means reducing expenses, increasing productivity and improving workforce effectiveness in general.

The necessity for staff reduction led to an increasing risk of losing valuable industry expertise, knowledge and skills, both technical and managerial, in research and development, market expertise and clients and supplier knowledge.

Mitigation

To mitigate these risks, we continue to implement personnel development and retention programmes and talent management, and emphasise our corporate values and ethics, and their role in different situations. Additional measures include establishing of competence centres for certain areas of knowledge and expertise, and placing qualified personnel in subsidiaries and other companies. We maintain constructive dialogue with local authorities and public organisations to address issues related to the economic crisis.

Health, safety and environmental risks

Mining and steel industries present potential hazards to the environment and to people because the production process includes high temperature, aggressive chemicals, and both hard and liquid industrial waste. This leads to strict requirements for occupational health and safety, fire protection and environmental safety. Occupational health, safety and environmental protection is one of our major priorities in all areas and stages of production, starting from coal and iron ore mining, coke production, and iron and steel making, through to the manufacture of finished high-tech steel products. We strive to eliminate any harm to the health and safety of people and the environment.

Mitigation

In 2008, we introduced a unified health, safety and environment protection policy including efficient HS&E management systems and standards, setting objectives and targets, identifying, assessing and managing HS&E hazards and risks. We also introduced into all parts of the Group responsibilities for senior and line management in implementing the HS&E policy and its performance, as well as improved practices, technology and equipment to prevent injuries, ill health and adverse environmental impacts, and employee training programmes. This comprises HS&E management systems at each entity which include risk management, contingency and recovery planning, information and communications, trainings and other relevant elements.

Legislation and regulatory risks

During the last decade the Russian legal system encountered frequent and significant changes in all spheres of regulation, which sometimes led to ambiguous and contradictory practice. This trend has been largely overcome in recent years. New laws became more pragmatic and well-balanced, striving to address the needs of both the private and public sector of the economy. For example, amendments to the Federal Law on Limited Liability Companies, in force from July 1, 2009 provided additional opportunities for joint-ventures. At the end of 2009, comprehensive amendments protecting creditors and increasing transparency of business entities were introduced.

Of course, certain spheres of Russian legislation, such as taxes and customs, are more vulnerable to continuous changes and regulation. And while some changes may have a negative effect, most of them are positive. For example, during 2009 corporate profit tax rates were lowered and consolidated social tax was abolished.

We anticipate regulations toughening in the areas of social security, environmental protection and technical regulations, but their influence on our activities is expected to be not significant. Current legislation of the Russian Federation provides enough instruments to secure Severstal’s rights and interests. Our international activities may be subject to the influence of changing laws and regulations in countries where we operate, but we expect such changes to have only a limited influence on our activities.

Mitigation

We base our activities, Russian and international, on strict adherence to all applicable laws and regulations – tax, customs, and currency control. We ensure monitoring and timely, appropriate reaction to changes, and strive to maintain constructive dialogue with regulators on issues of interpreting and implementing laws and regulations. In particular we work with Russian federal and local authorities, and participate in the Russian Union of Industrialists and Entrepreneurs and various ad hoc governmental committees. Our international activities are analysed both by in-house lawyers and respectable local or international law firms. We always hold negotiations with government bodies, such as anti-trust, financial and securities market authorities, in good faith and in strict compliance with their regulations, to maintain long-term constructive dialogue.