Russia’s Ferrous Metallurgy Industry Faces First Impacts of Economic Sanctions

On July 20, speaking at the annual assembly of manufacturers and entrepreneurs in Lipetsk Oblast, Vladimir Lisin, chairman of Novolipetsk Steel (NLMK)—first among Russia`s four steel-producing giants and one of the largest steel-producing companies in the world—remarked that the Russian ferrous metallurgy industry in general and the NLMK plant in particular are facing incredibly tough times. Specifically, Lisin argued that a combination of Western sanctions (which have resulted in Western markets de facto becoming closed to Russian steel producers), logistical challenges and increasing costs of freight services coupled with a large surplus of steel in the Asian markets have rendered “export from Russia virtually senseless.” He also warned that hopes of redirecting Russia`s exports to alternative markets—such as in the Indo-Pacific region—are, at least for now, an exceedingly low possibility, which stems from a number of factors. As a result, Lisin concluded, Russia is now exporting production of its ferrous metallurgy industry to its Asian customers at cost, which leaves the industry without any true profit margins (Rosbalt.ru, July 20).

Importantly, earlier, Denis Manturov—the Kremlin`s deputy prime minister, minister of trade and industry and a much hoped for crisis manager—admitted that, as of the end of June 2022, production output of Russia`s ferrous metallurgy industry had shrunk by 25 percent compared with April 2021. Expounding on reasons, Manturov (along with Lisin) underscored the rapidly decreasing domestic consumption of steel (and metals in general), which primarily owes to growing problems experienced by Russia`s economy in general and its construction sector in particular (Rosbalt.ru, July 20).

Beginning with this pessimistic outlook, the Russian business community has been waiting for official information from other actors of the domestic ferrous-producing industry. On July 21, Magnitogorsk Iron and Steel Works (MMK) and Severstal published official data on their performance, which demonstrated that both actors are facing similar problems and rates of sales are decreasing rapidly. Incidentally, the NLMK and Evraz, the other two industry leaders, have not published any official information at the time of writing. While the fundamental problems faced by MMK and Severstal have the same roots, their implementation strategies do differ. Moreover, while operational costs have increased by 29 percent, the rate of return has decreased by 5.9 percent (Kommersant.ru, July 21).

In analyzing the challenges Russia`s ferrous metallurgy industry is experiencing, experts identified  five major reasons (Forbes.ru, July 13).

First, analysts break down the actual impact of anti-Russian economic sanctions. As noted by leading analyst at KIT Finance Brokers, Dmitry Bozhenov, Russian metallurgist have not only lost their traditional export markets, but also economic sanctions have had an additional negative spillover effect on financial transaction mechanisms. As a result, these factors have had a severe impact on the industry as a whole.

Second, decreasing internal consumption of metals has severely hampered the industry. In addition to construction (both industrial and civilian), as mentioned by Manturov, two other industries should be mentioned: automobile production and railway construction. One anonymous subject expert stated that Russia`s annual production is currently projected to stand at 70 million tons. Yet, internal consumption is unlikely to go beyond 40 million tons. Since ferrous metallurgy is an export-oriented branch of the economy—and exports to traditional markets that normally yield the largest share of profits will be limited—the industry will suffer serious losses. Meanwhile, increased losses cannot be compensated for via an increase in domestic consumption due to the range of economic challenges faced by Russia`s steel-consuming industries.

Third, the appreciation rate of the ruble has destabilized the sector—which, in truth, is a serious problem for nearly every segment of Russia`s export-oriented economy.

Fourth, (archaic) taxation practices reflected in the remaining 2.7 percent excise tax on liquid steel—typically levied on the industry when profit margins are considerable—are now crippling the industry. While Russian businesses and some public figures have argued against existing regulations, some actors—notably, the Russian Ministry of Finance—are supporting the status quo, since potential elimination of the excise tax will mean finding alternative economic means in other sectors, which, under current circumstances, might spark discontent and increase tax burdens on other businesses.

Fifth, acute foreign competition is severely hurting the industry. This stems from the fact that—unlike precious metals or natural gas—the number of players in the ferrous metallurgy global industry is much larger, and Russia`s competitors are strong and largely unaffected by international sanctions.

Regarding Russia`s plans to mitigate the impact of challenges on its ferrous metallurgy industry, based on analysis of open sources, it appears that the Kremlin does not have a clear strategy. Nevertheless, two aspects need to be highlighted.

To begin with, as with other exported goods, Moscow hopes to find alternative buyers (mainly, in Asia, Africa and Latin America) for its metallurgy products. This scenario appears to be rather uncertain: While Asia already has large players in the industry, among which China holds primacy, consumption in other parts of the world, such as Africa and Latin America, is quite low and unlikely to provide an immediate solution for Russia. Indian sources have claimed that New Delhi has received its first cargo of ferrous metallurgy products at a quantity of 24,000 tons (Kallanish.com, July 25). Indian traders have also claimed that an additional 80,000 tons will be delivered sometime between August and September 2022 (Kommersant.ru, July 26).

Yet, in addition to being full of surface-level and hidden caveats, when trading in Asia, Russia is now compelled to sell its metallurgical products at a 30–40 percent discount, which—unlike oil, for which profit margins to Russian companies (even given the discount) are still substantial—makes exports economically counterproductive (Novaya gazeta, March 17). Critically, with its metallurgy, Russia cannot sell products at dumping rates—which might activate international anti-dumping investigations and protective duties.

Finally, Russia is hoping that the experience of RUSAL—in 2018 international sanctions had to be lifted due to the company`s dominant position in the global production of aluminum—could be repeated. Yet, as noted, the global ferrous metallurgy industry is extremely competitive, and Russia`s share is easily replaceable.