Russia: Silent Mining Giant
Although Russia accounts for about 14% of global mining, most professionals in the industry know very little about Russian mining. Apart from a few large steel companies most large Russian mining firms are unknown in the market, and few people could name the most important Russian mines or mining districts. However, driven by the huge potential of its reserves and the modernization of its industry the country is slowly gaining a more prominent position on the international mining stage.
This article explores the current situation of the Russian mining industry and identifies two key trends that will shape it in the next decade: a struggle for competitiveness; and internationalization of the key players.
Russia’s Reserves & Production
Russia has been blessed with a large variety of mineral reserves across the country. The peninsulas in the northwest, the Ural mountains, Siberia, and the Far East all house important mining districts. Crucial inputs for economic development, like iron ore and coal, are abundant. The country holds 15-20% of the world’s reserves for these resources. The country’s position in reserves of gold and diamonds is very strong too. For a few minerals with only a small global market, like palladium and magnesium compounds, the country even has the potential of dominating the market. The most important observation when comparing the share of world reserves and the share of current global production is that for almost all key minerals the share of reserves exceeds the share of production (See Figure 1). In other words; it is likely that Russia will become more important in the global mining industry.
Current production in the country is more than sufficient to satisfy domestic demand, making Russia a net exporter of mineral goods. The country’s net export balance for ores, slag & ash was $1.3bln and for iron & steel over $14bln in 2010 (Source: ITC), with China being the largest trade partner for ores and Italy being the primary (initial) destination of Russian iron & steel.
Balancing domestic supply and demand
Russia is growing, and mining is needed to fuel this growth. Russian annual GDP growth varied from 4.7% to 8.1% in the period 2001-2008, outpacing growth in the western world (Figure 2). The economic crisis has hit Russia hard, making the economy shrink by almost 8% in 2009; recovering by 3.8% in 2010. However, growth is expected to outpace western growth in the coming years.
As a result of the high growth of the domestic economy, various industry development could take shape. If productivity increases, the potential of Russian reserves will enable a combination of exports and domestic sales, enabling rapid growth. However, if the Russian companies do not succeed in significantly increasing capacity, productivity will be too low to support both domestic and foreign growth. In this case export restrictions to protect the national growth could be instituted.
The structure of Russia’s current mining production is largely shaped in the Soviet period. Mining districts were set up to provide the country with mineral self-sufficiency decades ago. After privatization in the ‘90s most of the state owned assets have been combined in the current private companies. The privatization and the poor financial situation of the Russian government at the time has led to a typical characteristic of the Russian mining industry: the importance of tycoons. Many private companies are owned and controlled by one or a few founders. These founders were at the right place at the right time and knew the right people at the time of privatization. Their position has further been strengthened by the government’s desperate need for funds, resulting in large amounts of debt being issued to the tycoons.
Whereas company owners in the rest of the world typically try to gain control over companies via the stock market, the large ownership stakes held by the tycoons in Russia lead to frequent power struggles among major shareholders. The struggle for control over Norilsk Nickel is the most recent example: Interros, controlled by Vladimir Potanin, and Rusal, controlled by Deripaska,both try to gain the majority in the board of Norilsk Nickel, one of the world’s largest suppliers of nickel and copper. In the last years the power struggles have led to the emergence of clear domestic champions for most of the key commodities: Rusal for aluminium; Norilsk Nickel for nickel and copper; Suek and Mechel for coal; Alrosa for diamonds; TVEL for uranium, etc. For steel and gold the landscape is (and probably will stay) more fragmented.
The new class of Russian miners is increasingly looking across borders. Opening up to foreign influence is required for two reasons: to be able to undertake international projects, and to strengthen the balance sheets. The Russian industry faces a wall of investment requirements to replace outdated technology and develop new projects. A favorite means of raising these funds is by pursuing an Initial Public Offering (IPO), preferably in London. Various Russian and Kazakh companies have entered the English stock market recently. ENRC and Petropavlovsk (Peter Hambro) have already completed a listing, Severstal’s gold business, Nord Gold, Kazzinc (owned by Glencore), Polymetal and Highland Gold are working on the process.
As both the global resources business and the Russian economy are changing, the Russian mining industry will change. Two key trends will shape the development of the industry in the next decade: a struggle for competitiveness, increasing productivity and investing in new technology, and internationalization of the key players, with western companies entering Russia and the Russian champions focusing more on the west.
A. Struggle for competitiveness
Where miners around the world try to increase capacity, many Russian miners first have to focus on reaching the existing capacities of operations. Russian competitiveness stays behind because of a legacy of old assets with outdated equipment and a lack of solid institutions and skilled workforce. According to the World Economic Forum Russian productivity stays 72% behind OECD average. Although the overall education level is relatively high, skilled labor for many industrial tasks is lacking.
Probably the most important and challenging issue in increasing competitiveness of the Russian is the portfolio of old mining and processing assets with old, unreliable equipment. Much Russian-made equipment is still in use in operations, resulting in low efficiency. The key focus of the Russian mining industry and responsible government institutions in the next decade will be to modernize the operations and to build the infrastructure required to bring new projects on steam. Organizing investment to replace equipment and processing lines will be a difficult task.
Another part of the struggle for competitiveness is the workforce reduction challenge. Increasing efficiency typically means reduction of the workforce, leading to social tension in the mining regions. Alignment with government employment programs will be crucial to sustainably reduce the labor intensity of Russian mining.
The development of exchange rates will be important in the future of Russian competitiveness. Operating costs are incurred in rubles, while revenues are for a large part based on dollars. The Russian ruble slowly grew stronger between 2002 and 2008, increasing the relative cost of Russian production. The economic crisis made exchange rates jump to the level of 2002 again, helping the recovery of the Russian industry (Figure 3). However, when the Russian economy grows in strength and the USA continues to struggle with a government deficit the ruble is likely to appreciate again, hindering competitiveness of Russian mining.
The Russian mining industry sees Russian companies moving abroad and Western companies and investors trying to gain exposure to the Russian potential. ARMZ is gaining control over uranium deposits in Ukraine; Severstal is aiming for iron ore in Guinea; Rusal, Norilsk and Evraz are buying many assets abroad. At the same time Rio Tinto is looking for ways to mine diamonds in Russia; both BHP Billiton and Rio Tinto have set up exploration partnerships in the country; and several international gold mining firms are opening mines in Russia. However, a law regulating ownership structures of companies in strategic sectors, signed by mr. Putin in 2008 as a reaction to the economic crisis, restricts the voting rights of foreign owners of Russian operations, making it hard for western companies to control operations in Russia.
If not disturbed by the results of the 2012 presidential elections the current trend of internationalization of Russian mining giants will continue at a rapid pace. The search for foreign investment opportunities and investors will go hand in hand with a cultural change, the need for which is demonstrated by ENRC’s recent corporate governance issues. To attract foreign investment the government might loosen the regulation of foreign investment for development project of commodities for which no domestic shortage is foreseen. As a result, foreign investment in relatively scarce minerals nickel and aluminium projects is not likely to take off, but foreign investments in iron ore and especially precious metals and diamonds will grow rapidly.
Russia already is an important mining country, and based on the reserves in the country has the potential to grow even bigger. However, to realize this potential, challenges of productivity, infrastructure and international alignment have to be overcome. Whether foreign companies will get a chance to play a role in the new developments or not, the Russian mining industry will be present on the global mining stage. The new group of increasingly internationally active Russian mining companies are starting to compete with the western incumbents and Chinese to be the protagonists in the industry in the next decades.
©2011 | Wilfred Visser | thebusinessofmining.com