In December 2007, the Ukrainian steelmakers announced their steel production plans for 2008. According to these plans, the Ukrainian mills are aiming to produce about 35-38 million metric tons of pig iron and about 44-45 million metric tons of crude steel. However, the current situation in the raw materials market, where demand is way above supplies, and the growing costs of both basic raw materials and energy, may put the ambitious plans of the steelmakers in jeopardy while making their work less profitable and their final products more expensive. Of course, the degree according to which the different mills are affected by changes in the raw material and energy markets depends on the level of their self-sufficiency in particular raw materials and on the raw material requirements of different mills. Here, we give a brief estimation of how the developments in the Ukrainian raw material and energy markets could affect the production costs and profitability of local steel producers in 2008.
Scrap
Although scrap is an important raw material in steel production, due to the particular characteristics of steel production in Ukraine (currently there is only one mill in the country which has an EAF), scrap constitutes a rather small share in production costs. According to the estimates of the Ukrainian Association for Secondary Metals (UAMB), in order to produce the abovementioned volume of steel in 2008, steelmakers would need to buy about eight million metric tons of scrap in the open market, whereas scrap processing companies would be able to supply only about 7.29 million metric tons of scrap, leaving the balance unaccounted for.
However, the situation is not as bad as it might seem. First of all, the volumes announced by both steelmakers and scrap producers are estimated figures and, therefore, could change within the year. In addition, a clear trend - seen during recent years - of increasing self-sufficiency in scrap through accumulation of mills' own scrap resources, on the one hand, and of a change in metallurgical charges (lowering of scrap content) through modernization and new technological innovations by mills, may be expected to be continued next year as well. For instance, according to operational data, Ukrainian steel producers expect to register a five-to-six percent increase in steel production output in 2007. On the other hand, scrap consumption for the same period is estimated to show no more than a four percent increase, while the mill's scrap stocks are to increase by more than 20 percent. These data show that mills' self-sufficiency in scrap has increased considerably over the year. In addition, the use of scrap in the production of one metric ton of steel also shows a 1.1 percent decrease as compared to 2006. This means that even with the high-set goals for steel production in 2008, most Ukrainian steelmakers will not experience scrap shortages during the year regardless of the fact that scrap processing volumes in the country are trending downward (in 2007, the scrap processing volume in Ukraine is expected to decrease by 0.2 percent). Meanwhile, the scrap problem may surface in years to come as the use of EAFs increases in Ukraine with new production capacities being put into operation.
On the other hand, scrap prices in the Ukrainian domestic market are expected to rise in 2008 (some experts even predict a doubling of scrap prices in 2008), putting addition pressure on steelmakers' production costs. A decrease in the scrap processing capacity in Ukraine against the increasing use of this raw material inside the country can only lead to one thing - i.e. an even further reduction of exports deliveries, a trend which has been visible for a couple of years now. However, with considerable growth predicted for 2008 in international scrap prices, in addition to the proposed cancellation of the Ukraine scrap export duty, the Ukrainian steel producers will have to compete with exports by constantly hiking their procurement scrap prices in order to obtain the volumes they require. In addition, uncertainty on the issue of VAT on scrap operations (VAT on scrap was abolished in Ukraine at the beginning of 2007 for a period of one year), may cause an additional rise in scrap prices in 2008. Yet, since scrap constitutes only a minor part of production costs in Ukraine, the issue of rising scrap prices will not be as sharp as, let's say, the issue of price rises in other raw materials.
The only steelmaker which could face a major rise in its production costs due to increasing scrap prices in 2008 is ISTIL since the mill uses an EAF as its main means of crude steel production. However, the mill's production capacity is not so great as to make the problem with scrap a critical one, at least as regards 2008.
Iron Ore
Giving the increasing iron ore prices worldwide (for instance, the predicted iron ore price increase for 2008 for Australian and Brazilian material varies around 30 percent, while more radical predictions say 50 percent), and that iron ore is considered to be one of the main components in the steelmaking process in Ukraine, developments in the Ukrainian iron ore market are the ones which need to be followed closely in order to estimate how prices and iron ore availability will affect steelmakers' production costs and therefore their profitability in 2008.
The fact that Ukraine has its own substantial iron ore reserves will play a positive role, as Ukrainian steelmakers are estimated to pay less for their iron ore supplies than their foreign colleagues. According to the market estimates, Ukrainian iron ore producers plan to increase their iron ore prices for the domestic market by about 20-25 percent. Although, the latter increase margin is smaller than that expected in the international market, it will still substantially affect the production costs of Ukrainian steelmakers.
The effect of increasing iron ore prices on steelmakers' production costs is expected to be smaller for those companies which have their own iron ore reserves as they will be able to satisfy the iron ore needs of their steel production facilities (at least to some degree) without seeking to purchase in the open market. Meanwhile, the effect of rising iron ore prices is expected to be greater on steelmakers, such as ISD, Ilyich and Zaporizhstal, which do not have their own iron ore production facilities and are forced to buy iron ore from the open market.
In addition, the tension between steelmakers and iron ore producers in the market, which goes back some years now, will place even greater pressure on these mills. For instance, already by the second half of 2007, due to tensions between players in the iron ore market over prices, many steelmakers had considerably increased iron ore imports, mainly from Russia and overseas, thereby adding freight rates to their iron ore purchase price.
Moreover, due to the government announcements that the cost of railway transportation for iron ore is set to increase by 83.5 percent starting from January 1 while taxes on iron ore mining could be increased by 40 percent in 2008, Ukrainian iron ore producers may revise the abovementioned predicted increase in iron ore prices in an upward direction. This definitely will not make steel producers very happy.
As for domestic supplies of iron ore, with the latest acquisition of several iron ore assets by Russia's Evraz group, some decrease in the usual volume of iron ore available in the market can be expected in 2008 since Evraz is only 80 percent self-sufficient in iron ore.
The alternative to domestic iron ore supplies in 2008 may be imports. However, the increasing freight rates, railways charges and the scarcity of railway cars can make the final cost of iron ore even higher in 2008.
Coking Coal and Metallurgical Coke
The satisfaction of Ukrainian steelmakers'needs in coking coal and metallurgical coke in 2008 is currently one of the hottest issues for discussion. Domestic coking coal production is able to satisfy the Ukrainian steelmakers' needs in metallurgical coke only by about 55-60 percent, while the balance has usually been imported from Russia, mainly from the Altai region. However, due to the increasing needs of the Russian domestic steelmakers in this material as well as the accidents which occurred at Evraz's coking coal mines, supplies of coking coal to the Ukrainian market declined considerably starting from the second half of 2007, thus exacerbating the existing scarcity of coking coal in the market. Of course, the most affected by the problem were those mills which had no raw material reserves, such as Zaporishstal (although the situation with this mill's supplies of coking coal may improved in 2008 in the light of the mill's latest acquisition of Russia-based coking coal assets), ISD, Ilyich, and in some respects, Mittal Steel Kriviy Rih. While some mills (Mittal Steel Kriviy Rih and ISD primarily) tried to solve this problem by importing coking coal and metallurgical coke, others (Ilyich) decided to downgrade their capacities.
In 2008, the scarcity of coking coal in Ukraine is expected to continue. According to steelmakers' plans, the production of pig iron for the year is estimated at the level of 35-38 million metric tons. To produce this amount of pig iron, the country's needs in metallurgical coke will be about 20 million metric tons. Meanwhile, with the current coking coal production, the coking plans will be able to supply only about 17.5 million metric tons of metallurgical coke, leaving the balanced unaccounted for. In addition, the latest accidents at the Ukrainian coking coal mine Zasyadko in November and December, a mine which supplies about 1/3 of Ukraine's overall coking coal production, and uncertainty about its future will further worsen the scarcity of coking coal in the market in 2008.
The solution to the problem could be found in more systematic imports of coking coal and metallurgical coke from countries other than the CIS in 2008. However, the technical backwardness of Ukrainian ports and their maladjustment can raise a problem in a situation of large imports - i.e. late delivery of material which can lead to malfunctioning and even stoppage of production processes. As a result, the Ukrainian steel mills, especially those which have no coking coal facilities of their own, will try every possible means (price hikes being the first that come to mind) to attract the necessary volumes. The estimated rise in price for 2008 varies at around 30 percent. However, judging from Ukrainian coking coal and metallurgical coke market developments in 2007, the increase percentage will be higher. Rising metallurgical coke prices in the market will, no doubt, affect the steelmakers' production costs and their profitability. This statement is especially true for mills which lack their own coking coal resources.
Energy resources
Although natural gas is not a raw material used directly in steel production, its price does affect the primary costs of steel production to a large degree. The issue of gas prices is especially sensitive for the Ukrainian steelmakers as Ukraine depends on Russia for its gas supplies, the prices for which are revised on a yearly basis in an upward direction.
Currently the share of gas costs in overall production costs in Ukraine varies in the range of 7-12 percent depending on the mill. Although the share of gas prices in the overall production cost is smaller than that of the steelmaking raw materials, a consistent increase in gas prices may lead to a rise in the share of natural gas in the production cost, and thereby may affect the final cost of finished steel.
In 2008, the ceiling prices of natural gas for industrial consumers will increase by 30 percent according to Ukraine's government, intensifying pressure on Ukrainian steel producers. Meanwhile, the prices for natural gas are expected to rise further as Ukraine enters the World Trade Organization and therefore unifies its energy prices with those of other countries.
The alternative to natural gas in metallurgical production can be coal dust-injection technology, which uses steam coal instead of natural gas as a main energy source. The introduction of coal dust-injection would allow a 50 percent decrease in the use of natural gas. Currently, several Ukrainian steelmakers, such as ISD and Metinvest, are introducing this technology in their production facilities. However, until all Ukrainian steelmakers introduce this technology, the issue of rising natural gas prices will be sharply felt.
It may be said that cost of steel production will rise substantially in 2008 in Ukraine due to the increasing price of essential raw materials, energy resources, and other tariffs. As a result, an increase in prices for finished steel may be expected as well. Several Ukrainian steelmakers have already announced a possible price rise for their products in the order of 20-30 percent. These estimates, however, seem to be slightly optimistic, mostly depending on raw material cost increase estimate, and may be revised in an upward direction within the year.
As for the issue of the profitability of Ukrainian steelmakers, it may be said that although 2008 may be a tough year for steelmakers, the cost of production in Ukraine will still, at least in 2008, be lower than that in other countries. Along with the modernization and technical update programs directed at cost-saving, a positive growth in Ukrainian steelmakers' profitability can be expected in 2008. However, the rate of profitability increase can be expected to be smaller than in the last couple of years.