New Trends in Russia’s Coal Business, By Alexander A. Ignatov

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•Recent economic impact on Russian steel-makers
•Analysis of exports from Russia to the EU and Asia-Pacific, and a look at the recent shift of export quantities between the two regions
•The effect of transport infrastructure, including seaports and rail, and hydrocarbon pipelines on the Russian coal market
•Thermal coal consolidation among energy operators – what is the outlook?

By Alexander A. Ignatov, President / Senior Partner, IGNATOV & COMPANY GROUP, Russia

Published in: Business, Technology
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New Trends in Russia’s Coal Business, By Alexander A. Ignatov

  1. 1. BRAVE NEW WORLDFOR A SLEEPING GIANT > Russia on a threshold of APAC coal export
  2. 2. KNOCKIN’ ON HEAVEN’S DOOR > In 2009 Russia increased its coal export to Asia- Pacific (APAC) by 50% to 2008 > Russia’s coal export decreased in “traditional” markets – EU and CIS > Such change in export destinations may be either “accidental” event or a fundamental shift > Current presentation analyzes such shift and its2 background
  3. 3. Ad Astra Per AsperaRussia’s Coal Market in the Restless 2000s Loss of low- cost advantages Growth of Continuing surface mining business vs. concentration undergroundMove to Soviet- Trends Decline of time production 2000- lignite 2009 production volume In addition to several “basic” trends (that started at the beginning of the 2000s) years 2008-2009 have brought few new trends; “basic trends” to be analyzed in a context of their influence over APAC export 3
  4. 4. Great ExpectationsNew Trends That May Change the Industry Export Sales EU-APAC Growth Export Shift Coal Wars 2.0 Instable Equilibrium In a current presentation we pay our main attention to one of those new trends – EU-APAC shift in Russia’s coal export; and again – other new trends to be analyzed in a context of their impact over that export shift 4
  5. 5. Export as Survival KitExport Grew Absolutely & RelativelyHard period persuaded business participants to re-evaluate their salestrategies – paying extra attention to export; contrasting home sales theexport demonstrated 2.6% progress – from 95.6 mt in 2008 to 98.1 mtin 2009. But increasing their export Russia’s coalminers met anotherchallenge… 5
  6. 6. EU Moralists vs. APAC PragmatistsCoal Export Shift Has Occurred in 2009 Prior to 2009 Russia’s coal export was oriented mainly EU – with 73.4% share. But following market drop in Europe the western route of Russian coal export became less and less attractive. Export to CIS shrunk by 36% in 2009. Meanwhile the demand in APAC continued to grow – even in crisis period; 2009 became the time when several Russian coal tycoons began to shift export interests from EU to Asia- Pacific. In total Russia exported 50% more coal to Asia-Pacific in 10m2009 (14.8 mt) than in 10m2008 6
  7. 7. Brave New World?Fundamental Shift or Temporary Replacement? Scenarios for Russia’s Coal Export as Survival Kit Home, (export sales drive the mining) Sweet Home (domestic demand drives Friends Will Brave New the mining) Be Friends World (restoration of EU (fundamental shift & CIS export) to APAC) Russia’s coalmining may go one of two “strategic” ways – either to support growing domestic demand or to develop export trade; two options are possible in the export scenario – a fundamental shift from EU to APAC or restoration of the European focus 7
  8. 8. Doom for Domestic Boom?Shrinking in Domestic Sales Stimulates Export Global economic shrinking pressed down the Russian steel-makers – and their demand in coking coal respectively; in 10m2009 they used 30.7 mt of coking coal (fig. 3) vs. 35 mt in 10m2008 (12% drop). Thermal coal consumption felt by 7% - from 155 mt in 10m2008 to 132 mt in 10m2009. 8
  9. 9. Instable EquilibriumWho Will Ride – Domestic Demand or Export? In 1998-2008 export and domestic demand regularly replaced each other as main driver for coal production growth – with four-year periodicity 2009-2010 crisis has broken the harmony – causing instability and pushing the market to a “bifurcation point” The market may go one of three ways: -To continue “harmonic fluctuations”, maybe with another period -Domestic demand will push a production growth for next decade -Export will become constantly dominating driver for growth 9
  10. 10. TO AWAKEN A SLEEPING GIANT > APAC market provides excellent opportunities to Russia’s coal export – both in terms of volume and transportation routes > Russia’s current share in APAC coal export in 3% doesn’t correspond the country’s potential10
  11. 11. The House Of The Rising SunAPAC Coal Import Coal import (in mln MT) with APAC countries 11
  12. 12. The Sleeper Must AwakenRussia’s Share in APAC Coal Trade May GrowCurrently Russia holds about 3%in APAC coal export – far behindthe market leaders, Australia andIndonesia Intensive growth Extensive growth Russia may either follow APAC demand growth (extensive way) or increase it’s share in APAC market, competing with Australia and Indonesia in their “traditional” niches 12
  13. 13. For Club Members OnlyEastern Russia as a Coal Source for APAC 13
  14. 14. FIGHT CLUB > There are few large miners in Russia – comparable in size with the leaders in Australia and Indonesia – who may effectively provide coal export in APAC > Currently they have less export capabilities in coking coal, as it’s primarily used for supplying affiliated steel mills > The level of “self-supply” is much lower in thermal coal, and thus it’s possible to increase its export; however the mutual interest of energy operators and coalminers may lead to the same situation as in a coking segment – most of coal to be used for self-supply > Any case, the Russian miners need to launch new start-ups in the eastern part of the country to support APAC growing export14 > It’s hard to do without intensive foreign investments
  15. 15. On the Shoulders of GiantsWho Are the Potential ExportersCurrently 20 leaders provide 90% of Russia’s coal production – with SUEKproviding 38% in thermal coal production and Evraz Group 31% in coking coal.The main questions are a) do they have sufficient mines in Eastern Russia? b)do they have surplus of coal for export (over self-supply volumes)? 15
  16. 16. Oligopoly vs. Self-SupplyTwo Suppliers in Thermal vs. Self-Supply in CokingIn pre-crisis period the picture was quite clear in Russian coal market: leadingsteel-makers, such as Severstal or Evraz, owned big coking coal mines andbought most of their coal; 82% of coking coal was consumed internally whileonly 18% was exported. Russian energy operators utilized 66% of thermal coal– with SUEK and Kuzbassrazrezugol holding together 58% in supply; smallermines – not protected by long-term contracts with energy operators – preferredto export thermal coal by spot prices. 16
  17. 17. Coal Wars 1.0: The WinnersWhat Did Steel-Makers Fight For? The diagram shows the competitive positions of Russia’s leading steel makers in terms of their supply of coking coal. The x-axis shows the annual demand in coking coal by each of the major players (million t), and the y-axis shows the self-supply, defined as “coking coal supply with affiliated mines in % to coal demand with steel mill.” Evraz, Severstal and Mechel currently completely self-supply their steel mills with coking coal; MMK self-supplies about 50% of the required coal (deliveries with Belon), while 50% is being procured from non-affiliates; NLMK (after it sold Prokopyevskugol in 2007) and Metalloinvest currently have no affiliated mines. 17
  18. 18. Self-Supply is a MantraWho Has Free Volumes Over Self-Supply? Coal Market Miner with coal mining in Self- Large Whom “free” assets in Eastern supply, start- supplies volume, Eastern Russia Russia, mtpa ups mtpa mtpa Mechel Mechel Mining 25.9 3.8 22.1 Elga Yakutskenergo Evraz Evraz’s steel (Raspadskaya + 23.4 11.4 12.0 - mills Yuzhkuzbassugol MMK (Belon) 4.9 9.8 MMK Steel Mill - - TGK-12 SUEK 96.2 26.7 69.5 - TGK-13 Novosibirskene Kuzbassrazrezugol 50.0 6.5 43.5 - rgo Vostsibugol 13.5 12.0 Irkutskenergo 1.5 -Most of the rest coalminers (working in Eastern Russia) have no steel or energyaffiliates – and thus they may either sell their coal domestically or export it inany destination; of course such possibilities are limited with coal quality, minedistance to the Pacific seaports, and obligations to local authorities 18
  19. 19. Back in the USSRIs Coalmining Sufficient for Export Rise? In 2008 Russia celebrated 20 years since its coalmining record level – in 1988 a nation extracted 425 mt of total 467 mt produced in the USSR. Just in 10 years production shrunk twice to 232 mt in 1998 – however privatization became the turn out “magic wand” for the industry. As the result coal growth was reinstated and in 2008 the country manufactured 329 mt; nevertheless in 2009 it was a decline 19
  20. 20. Do We Need Another Hero?Foreign Investments for APAC Export Each +1% in +1 mtpa in projects Russia’s share in like Elga costs $70 APAC export equals mln of investments to +6-7 mtpa of coal Consolidated net So each +1% in profit of all Russia’s Russia’s share costs coalminers (w/o $450-500 mln of steel) was about investments $500 mln in 2008 I.e. Russian coalminers can Significant increase finance only +1% in APAC coal export per year in APAC is impossible w/o export with own foreign investments sources 20
  21. 21. WEAK LINK > Rail transportation is a good option at coal export in China and Korea > However rail route has few serious limitations, like insufficient number of border stations, lack of cars and state-run monopoly in locomotives > Marine transportation is more flexible and thus private miners actively invest start-ups in the Pacific > Rail-Seaport conjunction is still a “bottleneck”21
  22. 22. Orient ExpressIs the Rail Infrastructure Ready for Export? • Rail conjunction with China and Readiness North Korea • Rail conjunction with actual seaports in Pacific • Shortage of rail stations in Chinese border • Gondola cars shortage • No actual rail routes to new Bottlenecks coal start-ups • Limited capacity of paths to seaports • Limited capacity of BAM (due to a 749 km single-track segment)Existing rail infrastructure in Russia’s Far East allows to start the export sales –but it has few limitations that prevent fast increase of APAC export; to succeedin APAC endeavor the coalminers have to resolve the issues together with RZD 22
  23. 23. Come Sail AwaySeaport Start-Ups to Support APAC ExportAt Sept 2009 SUEK launched 12 mtpa Muchka bulk terminal in Vanino seaport; investing$300 mln to a venture SUEK opened the window of opportunity for Russia’s coal export boostto APAC up to 22-24 mtpa in the nearby future. Mechel Steel Group declared it would build acoal terminal in Vanino – to support upcoming export from Elga deposit; SibUgleMet plans toinvest $100 mln and construct 8-12 mtpa coal terminal in Vladivostok area 23
  24. 24. NOTHING PERSONAL, JUST BUSINESS > Few internal and external factors may become “limiters” for Russia’s APAC export; they can’t stop it at all – but may prevent its rapid growth > Cost issues (like faster growth of salaries to productivity or “cantering” rail tariffs) are the major “internal” factors > Probable coal wars in thermal segment may also negatively impact the export > If Ukraine renews coal import from Russia it’s hard to avoid “temptation” to sell there, not to distant APAC > New coal exporters (like Kazakhstan or Vietnam)24 become active in APAC – so Russia has to compete them too
  25. 25. Low-Cost Russia? ForgetMain Costs Grow Faster Than EfficiencyIn 2000-2008 salaries grew much faster than labor productivity and coalproduction; partially it was “compensated” with fast growth of coal prices– but any case, coalmining in Russia became more and more costly,eliminating low-cost advantages (to Western coalmining) 25
  26. 26. Coal Wars 2.0: On ThresholdBusiness Concentration in Thermal & CokingNow the country enters a phase when energy operators (EO) begin to create their ownempires in thermal coal – and they have good chance for this, as business concentrationlevel is much lower than in coking segment; energy companies hold only 6.3% inthermal coal production, SUEK and Kuzbassrazrezugol (due to their capitalization thesetwo will be hardly ever acquired with any energy operator) provide 58% of output, while36% of thermal coal output is controlled with private investors, usually ready to sellassets by good price. We may become the witnesses of new “Coal Wars”, no less violentthan at Oh-Oh decade dawn, when steel barons built their domains. 26
  27. 27. Brother’s AssistanceUkraine May Increase Coal ImportRussia is the key source for coal import in Ukraine – with 80% share in import; in 2009Russian coalmines delivered almost 6 mtpa of coal in Ukraine, while in 2008 this volumewas 10 mtpa (40% reducing was caused with demand shrinking in Ukraine).Kazakhstan was another active importer of coal in Ukraine – and in 2009 its share evengrew. In 2008 IUD began to import coal from Australia and the US; after SCM boughtUCC’s coalmines it began the coal import from the US. 27
  28. 28. New Kids On The BlockCompetition With New Exporters Kazakhstan •Rail import to China •Rail import to China Mongolia •Rail import to Korea • Rail and marine import to China Vietnam • Marine import to India • Marine import to Japan • Marine import to Chinese Taibei •Marine import to Japan Colombia •Marine import to China In addition to competition with APAC coal export Goliaths (Australia and Indonesia) Russia will inevitably meet new rivals with aggressive marketing strategy in the area 28
  29. 29. Long Way To ParadiseIt’s Not So Easy To Follow Export Shift Foreign investments Competition with Launch of new market-holders mines in Eastern and newcomers Russia Marketing Launch of new infrastructure in washing plants APAC Cost Resolving of rail management “bottlenecks” New seaport capacitiesTo live in a Brave New World, a world of fast-growing and huge coal demand with APACeconomies, Russia’s miners have to pass a long and hard way: from finding sources forthe endeavor and launching new mines and washing plants in eastern part of thecountry – to establishing of sale offices in major APAC countries and re-training salestaff for work with Oriental buyers 29

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