Russia's Metal and Minerals Growth Prospects Offset by Sluggish Domestic Markets and Scarce Capital

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Written by Richard Finlayson, Senior International Editor for Industrial Info Resources (Johannesburg, South Africa)--The average forecast for Russia's gross domestic product (GDP) growth in 2014 stands at about 3%; this is also the International Monetary Fund's (IMF) forecast. Earlier, the forecast for 2013 GDP growth had been reduced to 1.5%. Russia's government and companies are slightly more optimistic, predicting a gradual upward trend going into 2014. But the slow recovery of the EU market, which still takes a significant share of Russia's exports, continues to exert a negative influence on growth prospects.

Russia's manufacturing sector contracted for the third month in a row in September, and the headline purchasing managers' index (PMI) remained below the growth datum line of 50 for September and 49.4 in August. The composite PMI for the third quarter of 2013 at 49.3 was the lowest since the 49.2 recorded in the fourth quarter of 2009. Export orders declined for the first time in five months, and the manufacturing workforce experienced a sharp reduction.

A number of corporations and the government see a brighter light at the end of the tunnel than the IMF and international observers.

Pipe Innovation Technologies (PIT) forecast that demand for large-diameter pipe from energy companies such as Gazprom (OTC:OGZPY) (Moscow, Russia) could increase steeply by as much as 50% in 2014, after delayed projects are launched. Driving this would be the construction of the South Stream gas export pipeline to Europe and the Siberian link through to China--if the long-negotiated gas export deal is finalized. This "if" is the key to many deals globally, and it inhibits any categorically positive economic forecasts in current conditions.

If the pipe contract does not go through, pipe demand would be down 20% to 30% in 2013 compared to 2012, said Ivan Shabalov of PIT. It is expected that the South Stream pipe contract will be awarded in December or January.

The World Steel Association (WSA) forecast Russian steel demand growing at 3.8% in 2013 and 4.6% in 2014. But Alexey Mordashov, the chief executive officer of steel major Severstal (OTC:SVJTY) (Moscow), said that demand could exceed the WSA forecast as home construction and auto manufacturing pick up. Morgan Stanley estimates that construction will take about 60% of Russian steel usage in 2013, following record demand in July.

The country's Economy Ministry estimates that about 70.1 million square meters of newly built housing will be registered in Russia in 2013. This is the highest total since 2000. Set against the housing construction upturn is the fact that auto sales went down 5% in September, following a 10% drop in August.

The government is determined to keep a tight rein on inflation, which the IMF sees running at 6.2% in 2013 and the Bank of Russia targets at below 6%. Although companies would like to see easier monetary policy as they look to gather scarce capital for project development, it is unlikely that the bank will relent and cut interest rates.

The IMF has called on Russia to use resources more efficiently and make stronger investments, rather than increase oil prices and spare capacity. In order to boost growth, Russia needs decisive implementation of structural reforms, particularly supply-side reforms, said the IMF.

Norilsk Nickel (MCX:GMKN.ME) (Moscow), the world's largest producer of nickel and palladium, is cutting costs broadly and will "trim" spending to $2 billion a year. The cost-cutting and divestment in non-core assets is the current model for many Russian metal and mining companies. Norilsk will sell off assets in Finland, Australia, Botswana and South Africa. It will make the bulk of investments in developing its Arctic Polar Division, which holds large reserves of high-grade ore resources.

The company is planning an increase in nickel production of less that 3% over the next five years and could still face a surplus in the market this year. Vladimir Potanin, CEO, said that the nickel price was close to the bottom, but the company's loss-making competitors, with costs at $18,000 per ton and more and a market price of $14,000 per ton, could "survive for quarters, but not for years."

More than 50% of Norilsk's sales are in Europe, and the company expects the market for high-quality nickel to recover faster than demand for nickel pig iron, which also depends on low-cost input in places such as Indonesia, which is implementing measures against the export of mineral ores.

Involved in mining a wide range of mineral ores, Norilsk is developing a new model for the sale of refined nickel and other metals, as well as intermediate products. It is also looking to an improved recovery of precious metals to boost the bottom line.

Russia holds the world's largest reserves of iron ore, estimated at about 56 billion tons, and is fifth in the global production ranking. The country produces more than 100 million tons of ore annually and exports about 20%. The balance is used in the domestic market for the production of metalized raw materials and iron.

Vale (NYSE:VALE) (Rio de Janeiro, Brazil), the world's largest iron ore miner, says that increased global supplies could lead to some surplus capacity as early as 2015 and could amount to as much as 6% by 2018. But Russia is in a position to handle the surplus situation through domestic consumption. Vale also says the market could handle an average 5% excess capacity as global output could reach about 1.6 billion tons, with consumption at 1.5 billion tons by 2020.

Russia is looking to increase the production of commercial iron ore to 120 million to 125 million tons annually by 2017 with the development of new mining complexes in central Russia and the Far East.

The country has the second-largest coal reserves in the world, after the U.S., and in 2012 was the world's sixth-largest producer with 359 million tons (about 10% of China's production total) and was a net exporter, ranking third at 134 million tons. A coal production expansion drive is under way, looking at increased exports to Southeast Asia, thermal power projects in the country's Siberian region, and steel production. Production fell drastically after the end of the Soviet era, but it is now targeted as a high-growth industry.

Russia has a number of initiatives in the metals and minerals sector, including plans to invest $1 billion in rare earths production through 2018.

The raw resource reserves are there, the fuel is there, and the new "Look to the East" insures against slow recovery in Europe. But "resource-rich" coupled with "capital-stretched" means that the next 12 to 18 months have to be handled with firm strategies, if the medium-term potential of the sectors is to be realized. The country's regional and world markets either have strong competition or are awaiting opportunities to exploit.

Industrial Info Resources (IIR), with global headquarters in Sugar Land, Texas, three offices in North America and nine international offices, is the leading provider of global market intelligence specializing in the industrial process, heavy manufacturing and energy markets. Industrial Info's quality-assurance philosophy, the Living Forward Reporting Principle™, provides up-to-the-minute intelligence on what's happening now, while constantly keeping track of future opportunities.