Throughout 1990-1999 Ukraine’s iron & steel industry was subject to extensive structural adjustments relating to output of principal products, use of resources, internal and external exchange of commodities, pricing policies, finance and lending, ownershi

SLIGHT SIGNS OF RELIEF AFTER THE RAVAGING CRISIS

Anatoly SNIGIRYOV, Leonid SUPLIN, Scientific Research Institute for Economics under the Ministry of Economу

Throughout 1990-1999 Ukraine’s iron & steel industry was subject to extensive structural adjustments relating to output of principal products, use of resources, internal and external exchange of commodities, pricing policies, finance and lending, ownership reforms, business relations, and business management.

Quite frequently these adjustments were uncontrolled and produced sudden consequences for manufacturing and business relations. During this period output of iron, steel, rolled metal, and coke almost halved, production of manganese ore, tubes, pipes, and metal-based products lost some 72 to 82%, while output of commercial goods reduced by 51%. Simultaneously, cost per unit of products gained 15% and profitability rates plummeted to almost a naught (rates of return on production amounted to +0.1% in 1997, -0.4% in 1998, and -1% in the first half of 1999). Despite all these trends, the pattern of productive capacities suffered little or no change, while the number of workers, specialization of metallurgical mills, management approaches, and types of business relations remained about the same as ever before. However, the second half-year of 1999 saw recovery trends in output of principal products and improvement of financial performance of most metallurgical companies. Let’s try to find out whether these figures are good enough grounds for optimism.

To begin with, it is worth mentioning that metallurgical mills have clearly revealed the main trend of their business activities under the conditions of pending market transformations. It comes to re-orientation of business activities, i.e. less interest in domestic market and market of the Commonwealth of Independent States (CIS) and a steep turn towards the markets of EU member-states and non-CIS countries (see figure 1 for more details). Figure 1 shows that rolling output lowered 1.7 times and domestic consumption reduced almost sevenfold in Ukraine in 1990-1999. Though back in 1990 domestic market of Ukraine had consumed almost 70% of locally-made rolled metal, in 1999 more than 80% of Ukrainian-made rolled metal was exported beyond Ukraine, while imports of rolled products dropped to some 0.6% of domestic output.

It is a characteristic trait that structural adjustments in Ukrainian iron & steel industry went through four periods of market transformations. Main business performance figures were subject to fundamentally different adjustments and featured various behaviors during each one of these periods.

Period 1 (1991-1994) featured high pace of recession in manufacturing output (down by 57%), recession in domestic consumption (almost 3.7 times down), and plummeting export supplies (exports of rolled metal reduced by 43%), together with switching from the CIS markets to the EU and non-CIS markets (CIS-bound exports accounted for 85% of the total Ukrainian exports in 1990 and for 21.8% in 1994). At the same time, profitability of production was extremely volatile (ranging from 19.5% to 46.3%) spurred by galloping hyperinflation. This phenomenon was mainly brought about by the fact that back then executive authorities fixed and maintained low prices for power and fuel.

Figure 1. Production, export, import, and consumption of rolled ferrous products (preliminary estimate for 1999)

Period 2 (1995 – first half of 1998) saw stabilization and sometimes even recovery in output of major types of metal commodities, as well as a slowdown of recession in domestic consumption (30% down), growth in outbound export supplies (up by 42%) mainly in exports to non-CIS countries (up by 60%), and slackening of inflation rates (11.8% in 1996, 2.1% in 1997, and 4.5% in the first half of 1998).

However, pursuit of strict monetary policy worsened financial performance of manufacturing mills and drove rates of return almost to a zero. Meanwhile, enterprises were UAH 6.8 billion short on in-house current assets, whereas the unfavorable difference of payables less receivables grew fivefold and outran UAH 8 billion.

Period 3 (second half of 1998 – first quarter of 1999) featured a severe worsening of situation on the major world markets that consume Ukrainian-made metal products. The worsening was mainly called forth by the financial crisis in Southeast Asian countries and in Russia. The crisis foreordained recession in demand for Ukrainian metal and an average 30 to 40% drop in metal prices compared to the 1997 rates, while Ukrainian export prices were still lagging some 20% behind the global prices. Further diminishment of domestic metal consumption and temporary slackening of export activities aggravated the negative aftermath of the crisis. On the whole, these events caused a recession in manufacturing output.

Though in the first half-year of 1998 exports amounted to 103.5% compared to the first half of 1997, the second half of 1998 saw exports plummeting to 80.2% and steel output (an integrated indicator of metallurgical production) dropping from 101.2% to 89.5% respectively. Manufacturing output was in a truly headlong recession in September-October, when average daily output of steel came to only 76.6% compared to the figures of the second quarter of 1998.

Only the emergency devaluation of the national currency hryvnya (down by 63% in July-September) and restriction of price levels saved the situation somewhat.

Output and exports started moving up in December 1998, though supplies of most types of metal commodities turned out to be unprofitable for Ukraine that year.

Period 4 (second – fourth quarters of 1999) witnessed iron and steel industry slowly adapting to the new financial situation on the world metal markets. The new situation meant that competitive advantages were mainly attained by slashing production costs, limiting barter transactions, engaging in intensive and successful search for new markets (predominantly in non-CIS states).

This process was further fostered by improvement of the situation on metal markets. Verkhovna Rada of Ukraine (Supreme Council) was right on time passing the regulation "On measures to overcome the crisis in mining and metallurgical complex" and the law "On conduct of economic experience at mining and metallurgical enterprises", thus giving life to yet another favorable factor.

Lately, namely in 1997-1999, concurrent development of selected sectors, mills and types of business activities in Ukrainian ferrous metallurgy has practically stabilized.

Yet, making forecasts, one should keep in mind specific peculiarities of individual types of manufacturing activities. Let’s explore some of these specific features.

Figure 2. Steel output in Ukraine

Metalmaking

Quite often, foreign analysts concentrate on steel output when analyzing production trends and making forecasts for development of iron & steel industry.

There is another reason urging application of this analysis approach during transition to market economy. Back in 1998-1999 certain mills did not take into account semi-finished steel that was exported via intermediary companies, when reporting output of finished rolled metal. Comparative analysis and estimation of steel production per month in 1997-1999 point out that the 1999 steel production evolved very much alike to the 1997 scenario, the best in the past 5 years (see figure 2).

Notably, despite wintertime (November-December) limitations in supplies of natural gas and electric power, steel output climbed to 27,400,000 metric tons in 1999, 12% up compared to the 1998 performance figure. In fact, the 1999 steel output was the new 6-year record-high. Steel production is expected to gain some more 7 to 9% in the year 2000, though these figures are quite an optimistic forecast.

Tube MAKING

In 1999 Ukrainian mills manufactured 1,175,000 metric tons of steel tubes. This number corresponds to only 77% of the 1998 tube output and to 64% of the 1997 output. Figure 3 shows the behavior of average monthly production of steel tubes. Lowered export supplies, mainly to Russia, were the main reasons for plummeting production of tubes and pipes in Ukraine. For instance, Ukrainian tube exports to Russia dropped from 423,000 metric tons in the first half of 1998 to only 300,000 metric tons in the respective period of 1999 (29% down).

The main reason for such a sharp downswing was the greater devaluation of the Russian ruble against the US dollar than that of the Ukrainian hryvnya. This occasioned low competitiveness of Ukrainian-made tubes on the Russian market. The Russian government has heightened its protectionism practices, thus causing additional trouble.

There was another adverse factor pushing the tube output down, that is to say the threat of antidumping penalties against EU-bound supplies of Ukrainian-made seamless and other steel tubes, less than 406.4 mm in diameter. The point is that the European Commission figured that average price for imported Ukrainian tubes amounted to ECU 0.37-0.38 per kg, whereas average prices charged by European manufacturers were ECU/kg 0.62-0.67.

Yet, the European specialists neglected specific features of the range of Ukrainian tubes supplied, namely the poor quality of Ukrainian commodities, which predetermined low prices and enabled Ukrainian exporters more than doubling tube exports in 1998 (up to 133,400 metric tons, holding 11.2% of the overall European consumption).

To avoid antidumping retaliations, Ukrainian tube works had to limit tube exports to EU member-states in 1999. Sure thing, this was bad for domestic output of tubes and for export trade in these commodities. Moreover, average export prices for tubes lowered by some 20%. It is believed that tube output will gain only some 1-2% in 2000 considering larger exports to CIS countries and improved situation on the domestic market.

Ore mining

Following a 1.3-time downswing in output of commercial iron ore in September-December 1998 (see figure 4), the situation with Ukrainian ore mining somewhat changed for the better in January-May 1999. During the September-December 1998 recession, Ukrainian metallurgical mills lowered manufacturing output by 25% and Central European metallurgical mills by 28%.

Figure 3. Tube and pipe output in Ukraine

In April-May 1999 metalmaking mills of Ukraine boosted iron output by 110,000 metric tons per month against the first quarter of 1999. Unfortunately, this upturn in ironmaking activities was not followed by a corresponding growth in iron ore mining volumes. Quite the contrary, Severny Ore Mining and Concentrating Works was brought to a temporary shutdown in June 1999, while the state administration of Dnepropetrovsk region targeted its efforts at priority channeling of iron ore to its insider businesses.

During this period, the Central European market for iron ore indicated certain improvement of the situation. The market encountered shortage of iron ore, which stimulated competition among consumers. As a result, Ukrainian ore-mining companies obtained better cash settlements for their commodities. For instance, Krivorozhstal, Alchevsk Iron and Steel Works, Makeyevka Iron and Steel Works, Ilyich Iron and Steel Works of Mariupol, and Petrovsky Iron and Steel Works of Dnepropetrovsk paid more in cash. Yet, even greater cash settlements failed to liquidate shortage of iron ore on the market. In consequence, Ukrainian mills had to gradually step up imports of iron ore. This was especially true for metallurgical mills of Donbass region, which imported foreign iron ore worth USD 75,800,000 throughout the 10 months of 1999.

Production of iron ore commenced gradually increasing in June 1999 to meet the growing domestic consumption (output of pig iron gained more than 350,000 metric tons in the second quarter of 1999) and do more exports (2,500,000 metric tons in the first quarter, 3,400,000 metric tons in the second quarter, and some 4,000,000 metric tons in the third quarter of 1999). The seasonal factor, i.e. wintertime recession in mining activities in December, took its toll and altogether Ukrainian companies produced 47,800,000 metric tons of commercial iron ore, which corresponds to 93.5% of the 1998 output. Considering these trends, the 2000 output of commercial iron ore is estimated at 52.5-53.5 million mt, i.e. output is expected to gain some 10-12% and return back to the 6-year record-large performance of 1997.

Commercial products

For the sake of calculations, it seems expedient to find the correlation between output of commercial products and the total manufacturing output. For the year 1999, when steel output was volatile, analysis of correlation between output of commercial products and steel production reveals a clear linear dependence with a high correlation coefficient amounting to 0.979.

Speaking about the actual monthly outputs of commercial products in comparable prices in 1997-1999, there was one characteristic feature, namely supplies of natural gas and electric power were limited in the winter season (November-December) causing recession in output of most commodities, including commercial products.

In 1999 output of commercial ferrous products in comparable prices (January 1999 prices) amounted to UAH 23.3 billion, i.e. 106.2% compared to the 1998′ figures and 97.8% compared to the 6-year lows of 1997. It is expected that outputs of commercial ferrous products will increase by 5 to 7% in 2000, provided recovery of manufacturing output and the long-awaited growth in export prices.

Figure 4. Iron ore mining activities in Ukraine

Financial performance

It is a typical feature that structural adjustments in the real economy and in industry have lately been accompanied with continuous sad worsening of financial performance of ferrous metallurgical mills, predominantly due to growing prices for fuel and power and increasing freight rates.

The year 1998 saw the number of enterprises that suffer losses skyrocketing, e.g. 7 out of the 10 iron and steel works, 3 out of the 10 iron and manganese ore-mining companies, 2 out of the 6 steel tube works, and 4 out of the 10 metal product manufacturers encountered losses. Makeyevka Iron and Steel Works has been running at a loss throughout the past 4 years with accounts payable exceeding accounts receivable by UAH 600 million. Financial health of Severny Ore Mining and Concentrating Works is about as pathetic.

However, the economic experiment in ferrous metallurgy has called forth something of an improvement of financial performance since the second quarter of 1999. Growth tempos of the amount of payables have lowered significantly (see table 1 for more details). For the first time in the last half a year, the unfavorable balance of payables less receivables reduced by UAH 1.6 billion in the fourth quarter of 1999, though this change does not fully correspond to the obtained earnings and requires additional analysis and specification.

Better situation with gross profits is the second favorable factor. Our analysis has processed the data on the top 10 iron and steel works that have the largest sale turnovers (see table 2). These companies account for the bulk of what is called gross profit in metalmaking, thus it is quite possible to use their performance figures as an example illustrating the overall trends occurring in ferrous metallurgy.

Inauspicious outcomes of the Southeast Asian and Russian financial turmoil significantly spoilt the situation on foreign markets for Ukrainian metals, thus leading to large losses of ferrous metallurgical mills in the second quarter of 1998 and the first quarter of 1999. The fourth quarter of 1998 was the one to witness the largest aggregate losses (amounting to almost UAH 470 million). Back then, only Azovstal Iron and Steel Works managed to break even. The situation started improving gradually in the second quarter of 1999, when only 5 enterprises were still at a loss. Ukrainian iron and steel mills earned gross profits coming to UAH 96 million.

The third and the fourth quarters of 1999 retained the upward trend in gross profits. Zaporozhstal and Ilyich Iron and Steel Works scored high earning UAH 366.9 million and UAH 211 million worth of gross profits respectively. Unfortunately, Makeyevka Iron and Steel Works worsened its financial performance and suffered gross losses of UAH 371.5 million, including UAH 81.3 million in the fourth quarter. Poor performance of Makeyevka mill originated from delays in reconstruction works.

The third auspicious factor was a reduction in portion of barter settlements (down to 32% of the total sales compared to 40.8% back in 1998). It looks like enterprises are indeed interested in abandoning barter transactions, thus all the prerequisites are in place to forecast further reduction in the portion of barter settlements.

Figure 5. Output of commercial ferrous products

The first half-year of 1999 clearly revealed the fourth favorable factor, that is better dynamics of availability (or shortage) of in-house current assets. This behavior has been analyzed using the same approach as in case of gross profit analysis, i.e. there was considered a sample of the top 10 iron and steel works (see table 3). In-house current assets were gaining the most in the second and the fourth quarters of 1998 (20.9% up and 18.5% up respectively), thought in the first and the second quarters of 1999 growth tempos slowed down to +1.6% and +5.4% respectively. The leaders in replenishment of own current assets were Zaporozhstal Iron and Steel Works (+UAH 209 million) and Alchevsk Iron and Steel Works (+UAH 183 mln.).

Unfortunately, in 1999 Makeyevka Iron and Steel Works ran into shortage of current assets that was 1.8 times as big as the planned output of commercial products. This ratio is close to 80% at Yenakievo and Petrovsky Iron and Steel Works.

A rational mechanism of accumulation and replenishment of in-house and borrowed current assets is a significant factor for enhancement of financial performance of ferrous metallurgical mills in the new market environment. According to statistical financial statements, ferrous metallurgical enterprises had UAH 11 billion worth of current assets (both in-house and borrowed) as of the 1998 year-end. Keeping in mind metallurgical outputs in 1998, one can calculate that current assets made 1.73 turnovers in the course of the year. However, according to enterprises’ calculations, the standard amount of in-house current assets for ferrous metallurgical companies was fixed at UAH 3.4 billion. Although this standard was constantly going up in compliance with price growth tempos, this standard has not been subject to revision applicable to market conditions.

Hence, there is a need in valid revision of the standard of in-house current assets. The point is that this standard has been established a while ago under conditions of a different business environment.

Finally, arrangement of strategic partnership among banks and metallurgical enterprises is yet another propitious adjustment facilitating development of ironmaking and steelmaking activities. Good examples of such a partnership are the projects of joint-stock commercial innovation bank UkrSibbank as regards development of Severny Ore Mining and Concentrating Works and Dneprovsk Iron and Steel Works. Within the framework of these projects, it is provided to grant financial backup to run the manufacturing process, optimize financial and commercial flows, search for new business partners, enhance management approaches, and render consulting services to help these enterprises work cost-efficiently.

To make a summary, it is worth highlighting certain prominent trends of iron & steel industry in the short run. It is anticipated that acceleration of privatization processes will yield favorable results. As a matter of fact, privatization of iron and steel industry was launched back in 1995, while in 1996-1999 there were already quite a few non-state-owned metallurgical mills in Ukraine. The privatized metallurgical mills accounted for over 80% of the total output in iron and steel industry, though alteration of the type of ownership failed to stabilize financial performance.

Table 1. Accounts payable and accounts receivable of ironmaking and steelmaking mills (‘000,000 UAH)

Table 2. Gross profits of Ukraine’s metallurgical mills (‘000,000 UAH)

This situation stemmed from the fact that spontaneous privatization, launched on the initiative of the State Property Fund of Ukraine, has given birth to ineffective system of management over large-size industrial companies. Practically, each company had to find solution for new market challenges on its own. Besides, the privatization process did not take advantage of cross-ownership over shares in metallurgical mills that have adjacent technological processes or make similar commodities. As a result, the once-strong technological links deteriorated and Ukrainian manufacturers got into a more fierce competition on world metal markets.

At this point of time there has have been launched a new stage of ownership reforms, i.e. the property privatization certificate stage is over and the country is moving towards investment-oriented money privatization.

The list of 180 Ukrainian state-owned enterprises that are subject to sale in the year 2000 comprises 16 ferrous metallurgical mills, including 7 metallurgical plants and iron & steel works, 4 coke recovery plants, 3 ore mining and concentrating works, 1 tube mill, and 1 ferroalloy works.

It has been made public that the State Property Fund obtained an order to sell shares in companies, included in the list (in which the state owns at least 25% interests), in one piece (as an indivisible share block). Therefore, large stakes in metallurgical mills will be put up for sale at public tenders, competitions, and at stock exchanges.

For example, 50% + 1 share stake in Donetsk Metallurgical Mill has been offered for public tendering. A 45.5% interest in Azovstal Iron and Steel Works, a 50% + 1 share stake in Alchevsk Iron and Steel Works, a 25% + 1 share stake in Zaporozhye Ferroalloy Works, and a 25% + 1 share interest in Zaporozhstal Iron and Steel Works have been put up for sale via commercial competitions. Furthermore, stock exchanges will start trading in a 25% + 1 share stake in Zaporozhstal Iron and Steel Works and a 25% + 1 share interest in Zaporozhye Ferroalloy Works.

Consequently, large-scale privatization is becoming the strategic course of market reforms. Along with conducting privatization, Ukraine is working on resolution of the issues of promoting investments, on replenishment of current assets, repayment of outstanding taxes payable to the state budget and of outstanding accounts payable for consumed fuel and power. This privatization can bring to light the interested owners, who have previously been something of informal proprietors of metallurgical mills.

Therefore, all this proves that the Ukrainian iron and steel industry has taken a more definite turn towards market-type business relations, in which situation on the global metal market is the main signpost.

In this situation, metallurgical mills should sign a cartel agreement to pursue an agreed-upon pricing policy on foreign markets. This would prevent new antidumping inquiries against Ukrainian metalmakers and will facilitate cooperation between Ukrainian and foreign investors.

At the same time, it is important to stir the activities to make Ukraine acknowledged as a market economy, which will improve the environment for export business and will enhance the terms of export supplies, as well as will lower losses incurred via antidumping sanctions.

Table 3. Availability of in-house current assets at metallurgical mills at the end of period (‘000,000 UAH)

the Metal