Risks 2020: what steelmakers expect from the coming year — Posts

GMK Center estimates the cost of next year’s risks for the mining & metals sector at $1.9 billion

The next year does not promise to be easy for Ukrainian mining & metals companies. Indeed, many factors setting trends in 2019 will continue to affect the situation in the global and domestic markets in the steel industry in the coming 2020.

According to GMK Center’s estimations, in 2019, Ukraine’s mining & metals sector lost profits worth $2.8 billion due to negative internal and external factors. At the same time, GMK Center analysts estimate the ‘cost’ of risks next year at $1.9 billion.

Top 10 risks of 2020 for Ukraine’s mining & metals sector

No.	Risk	Impact
1	Further deterioration in demand for steel outside of China, price drop	≈ –$800 million
2	Strengthening of protectionism in foreign markets	≈ –$370 million
3	Preservation or further strengthening of the UAH/USD exchange rate	≈ –$330 million
4	Increase in tax burden — rent for iron ore mining	≈ –$240 million
5	Growing environmental pressure, increased environmental tax	≈ –$130 million
6	Curtailment of incentives in China, reduction in steel consumption and possible increase in exports from China	n/a
7	Preserved imbalance in prices for iron ore and scrap	n/a
8	Increase in rail freight tariffs in Ukraine	n/a
9	Increase in marine transportation expenses as a result of the introduction of a new fuel standard, IMO-2020	n/a
10	Contraction of Ukraine’s steel market in Ukraine, growth in imports	n/a

Source: GMK Center

The situation in the global market

After a sharp drop in steel consumption in key regions for Ukraine (in the European Union by 3%, in MENA countries by 7%, in Turkey by 20%), expectations for the next year are moderately cautious. Specifically, EUROFER projects that in 2020, the apparent consumption of steel in the European Union may increase by 1.4% due to a moderate growth from Q2 2020. Arab Iron and Steel Union expects a 2.0% increase in demand in MENA countries following a 7% drop in 2019.

In general, Fitch gives a negative outlook for the global steel industry in 2020. At the same time, analysts do not exclude a moderate recovery of the industry next year. As a result of a temporary decrease in capacity and a decline in prices for raw materials, the margin in steel production may increase compared to the results of 2019.

The World Steel Association expects a 1.7% growth in the global demand for steel in 2020, up to 1.8 billion tons. Next year’s outlooks for steel production and consumption are however negative.

The situation in the domestic market

Analysts of Ukrainian investment companies*, interviewed by GMK Center, gave their assessments of performance figures in 2020. The assessments varied. Denys Sakva, Senior Analyst at Dragon Capital investment company, estimates the production of steel in 2020 at 22 million tons, whereas Oleksandr Martynenko, Head of the Corporate Analysis Department at ICU, expects a 3% drop, down to 19.4 million tons of steel.

In the opinion of Kostiantyn Fastovets, Head of Research at Adamant Capital, the steel production trends will not change next year. GMK Center analysts believe that steel production in 2020 may vary between 20.8 and 21.1 million tons, that is from minus 1% of this year’s level to plus 0.5%.

“I expect that in 2020, production volumes will decrease to the level of 2019 as follows: steel — 18.8 million tons (–8%), pig iron — 18.4 million tons (–7%), rolled products — 16.4 million tons (–9%). Even production of these volumes will require an improvement in the situation (prices, demand) in foreign markets compared to Q4 2019, which, I guess, could be counted on,” said Dmytro Khoroshun, analyst at Concorde Capital investment company.

Based on preliminary estimates of Ukrmetallurgprom, production of the main types of products will decrease as follows by the end of 2019: steel — to 20.5 million tons (–2.8% against 2018), pig iron — to 20 million tons (–2.7%), rolled products — to 18 million tons (–2%). In 2018, steel production amounted to 20.1 million tons (+0.3% against 2017), pig iron — 20.6 million tons (+4%), rolled products — 18.36 million tons (+3%).

As for domestic consumption, analysts, interviewed by GMK Center, expect a 2–3% increase in the demand for steel in the Ukrainian economy next year. GMK Center analysts give a similar forecast.

“Based on the data of Ukrmetallurgprom on the consumption of rolled products in Ukraine in 2018, 5.37 million tons (+6.4%), I think that this figure will reach 4.7 million tons (-13%) in 2019. In 2020, I expect stabilization and unchanged consumption of rolled products compared to this year, that is the same 4.7 million tons,” Dmytro Khoroshun added.

Overall assessments of the situation in Ukraine’s mining & metals sector next year (December 2019 to December 2020) provided by experts, interviewed by GMK Center, were different. Konstantin Fastovets, Dmytro Khoroshun and Denys Sakva expect the situation to improve, whereas Dmitry Churin, Head of Research at Eavex Capital, and Oleksandr Martynenko say that it is likely to get worse.

Steel quotations

The main question for Ukrainian steel producers is what prices for metal products to expect in 2020. A survey by GMK Center showed different assessments of the situation and trends. For instance, Konstantin Fastovets expects a 10% increase in the steel price (December to December). Denys Sakva is sure that it will drop by 5–6% on average over the year. In turn, Oleksandr Martynenko anticipates a 6–8% cut in steel prices in 2020 and a 15% cut in prices for iron ore. According GMK Center, steel prices will drop by an average of 10%.

Dmytro Khoroshun forecasts an increase in prices for metal products and a decrease in iron ore prices next year.

Forecast of trends in prices for products of Ukraine’s mining & metals sector from Dmytro Khoroshun, $/ton

Products	December 2019	December 2020	Changes, y-o-y
Slabs	395	440	11%
Rebar	400	490	23%
Hot rolled coils	448	490	9%
Iron ore 62% Fe, CFR China	93	73	-22%

“There are prospects for a rise in steel prices in 2020. A decrease in loan rates following a watering-down of the policy of the U.S. Federal Reserve has twice swept a wave around the globe. With low rates and a growth in construction, there will be no cheap metal. And iron ore prices rose again by the end of the year. $92/ton is just a good price, which was dreamed of a year ago. Yes, the price ceiling of $120/ton has been reached. I agree, there are problems with sales volumes. Yes, there is a factor of mysterious China, but it exists every year,” said Vitaliy Shapran, member of the NBU Council.

Earlier, Volodymyr Vlasiuk, Director of Ukrpromzovnishekspertyza SE, predicted that in 2020, prices for billets in global markets will decrease by 5% to $390/ton, FOB Black Sea; and prices for iron ore 62–63% Fe will fall by 9% to $85/ton, CFR China.

In the opinion of Volodymyr Vlasiuk, the main factors of falling steel prices in global markets are:

expected decline in steel consumption due to a slowdown in economic development in most regions of the planet;
decline in steel consumption in China amid a high level of production of rolled products;
increased competition amid deteriorating demand/supply balance, escalating trade wars, and tightened U.S. sanctions;
projected decline in iron ore prices in the course of recovery and increase in iron ore shipments from Brazil and Australia.

Impact factors

Analysts say that the further strengthening of the national currency is the main internal factor that could worsen the situation in Ukraine’s mining & metals sector in 2020. According to GMK Center, the revaluation of the hryvnia in 2019 cost the Ukrainian mining & metals sector around $400 million. Preserving or further strengthening the UAH/USD exchange rate in 2020 could cost another $330 million.

Interviewed analysts expect that by the end of 2020, the national currency rate will be at around ₴25–26/$1 (average annual exchange rate will be around ₴25–25.5/$1). According to Oleksandr Martynenko, the hryvnia’s depreciation will most likely occur in H2 next year. As reported earlier, an average annual exchange rate in the 2020 state budget is ₴27/$1 (projected rate at the end of 2020 is ₴27.5/$1).

Experts also list other factors of possible negative impact in 2020:

passage of the draft law No. 1210, which could significantly increase the rent for the use of subsoil by mining companies (according to GMK Center analysts, this could cost the domestic mining & metals sector $240 million);
considerable increase in rail freight tariffs;
rise in electricity and gas tariffs.

In addition, Denys Sakva mentioned the risks of increased labor outflows. In 2020, Germany will open its labor market for non-EU migrants, including Ukrainians. In his turn, Dmitry Churin believes the situation with Mariupol port to be risky.

“To date, Mariupol port is in a difficult situation. Due to hostilities in Donbas, the construction of the Crimean Bridge, and detentions of vessels in the Kerch Strait, the number of vessel calls has decreased almost threefold since 2014, from 1,417 in 2014 to 490 in 2018,” Dmitry Churin reminded.

Also, an increased environmental pressure on steelmaking companies cannot be disregarded. According to the estimates of GMK Center’s analysts, a possible 4-time increase in environmental tax rate could increase spending of mining & metals companies by $130 million.

According to analysts, the following impact factors will be likely positive for the mining & metals sector in 2020 (except for those opposite to the negative ones):

increased domestic demand for steel due to a growth in other sectors of the economy, including due to a decrease in the NBU rate and an increase in lending;
increase in the pace of construction, launch of new infrastructure projects;
better work of Ukrzaliznytsia;
decrease in prices for iron ore. This will help steel plants that are not vertically integrated with mining companies.

What the government needs to do

In the opinion of analysts of investment companies, the government should simply perform its direct functions and comply with the laws and guarantees provided, so that to promote the development of the mining & metals sector in the current conditions. According to Konstantin Fastovets, the parliament should not pass laws that could erode the competitiveness of Ukraine’s mining & metals sector in the global market. This refers to the draft law No. 1210 that provides for increasing fiscal pressure on the industry and does not ensure stability of the tax legislation.

“An increase in rent is an unreasonable measure amid a possible global cyclical decline in the steel industry,” Dmitry Churin explained.

In the viewpoint of Dmytro Khoroshun, it is important that the NBU continues to reduce the rate, as this could weaken the hryvnia and improve lending to the economy, which, in turn, could result in an increase in steel consumption. The mining & metals sector also needs a free electricity market where prices have recently declined. It would also be a good idea to avoid a rise in tariffs of Ukrzaliznytsia.

Optimization measures

In the difficult economic situation, mining & metals companies take various optimization measures, depending on the depth of the crisis. As a rule, the list of such measures provides for a reduction in spending.

At the first stage, one of these measures may be a temporary suspension of production (full/partial/under the pretense of repair works). As reported earlier, due to a weak steel demand, ArcelorMittal suspended some of its European assets. Similar measures were taken by Ukrainian steelmakers, Dniprovskyi Metals Plant (DCH), Dniprovskyi Iron and Steel Works (ISD), and Elektrostal (Kurakhovo).

Among optimization measures that steelmakers could take to improve their financial standing in 2020, analysts, interviewed by GMK Center, listed the following:

staff cuts or other forms of reducing employment (part-time, etc.);
freezing of investment projects and/or non-critical procurements and capital investments;
suspension of production (full/partial/under the pretense of repair works);
other optimization measures (freezing salaries, etc.).

In other words, this is a fairly standard set of measures to reduce spending, used by companies running into certain difficulties, regardless of industry.

*GMK Center gives thanks to the analysts of Ukrainian investment companies who participated in the survey:

Oleksandr Martynenko, Head of the Corporate Analysis Department at ICU;
Denys Sakva, Senior Analyst, Dragon Capital investment company;
Konstantin Fastovets, Head of Research at Adamant Capital;
Dmytro Khoroshun, analyst at Concorde Capital investment company;
Dmitry Churin, Head of Research at Eavex Capital.