In 1999 Ilyich Iron & Steel Works managed to overcome a negative tendency for decrease in manufacturing output, which was traced in the second half of 1998, and to lower negative returns on production.

TOO MANY COMPLICATED ‘MUST DO’S

Alexander CHAKO, Chief Financial Officer with Ilyich Iron & Steel Works of Mariupol

In 1999 Ilyich Iron & Steel Works managed to overcome a negative tendency for decrease in manufacturing output, which was traced in the second half of 1998, and to lower negative returns on production.

Positive changes became particularly clear in the second half of the fiscal 1999.

The favorable trends have resulted from a number of factors, the main of which are:

improvement of the situation on the world iron and steel market;

introduction (at the end of 1998) and execution (at the beginning of 1999) of state measures aimed at restraining domestic prices for resources and production-technical services;

introduction of complex measures to ensure more even operation performance of units under the present conditions of material and technical procurement;

strengthening of business contacts with suppliers, greater portion of settlements in cash and more direct supplies;

execution of an economic experiment at mining, iron & steel companies since July 1, 1999.

The Iron & Steel Works (ISW) raised production output compared to the 1998 performance figures:

Gains, 1999/1998 Same (%)

(‘000 tonnes)

Sintered ore +1,632.9 +19.8

Iron +441.5 +12.3

Total steel +542.4 +12.6

Commercial rolled metal +702.3 +19.8

Incl. finished rolled metal +92.5 +3.2

However, notwithstanding such an essential recovery, Ilyich ISW’s 1999 production plans for the principal types of metal commodities were not completed. The reasons are as follows:

irregular and insufficient supplies of iron ore, in particular ore concentrate, to Ilyich ISW. Even taking into consideration the lowest consumption estimate of 531.7 kg/tonne, the ISW suffered shortage of at least 600,000 tonnes of ore concentrate. This had its negative impact on the stable performance and on quality of production at sintering shops;

continuous interruptions in supplies of ferrous scrap and waste, though starting January 01, 1999, Ilyich ISW has paid for 100% of supplied ferrous scrap in cash, kept up about the same level of purchase prices as the other mills (since November, prices have jumped up and down virtually in every 10 days owing to large fluctuations of the UAH/USD exchange rate). On the whole, throughout 1999 Ilyich ISW experienced shortage of 260,000 tonnes of ferrous scrap, which resulted in 398,000 tonne losses in steel production and 328,000 tonne losses in output of commercial rolled metal.

Considering the current situation on the domestic markets for raw materials and fuel & power, Ilyich ISW did its best to single out the suitable and reliable procurement channels. Above all, the ISW gave proper heed to expansion of direct contracts with suppliers and to increase in the share of settlements in cash.

Starting April 1999, electric power has been supplied under a general agreement with the national joint-stock power company Energoatom. This allowed regaining the once stable power supplies and slashing the cost of purchased electric power by 26% against the first quarter of 1999 (as a result, in the 9 months of 1999 Ilyich ISW saved UAH 27,300,000 on power costs). Ilyich ISW has no outstanding accounts payable for electric power consumed in 1999. Starting the second half-year, our company has engaged in more active purchases of natural gas via auctions (by the year-end, natural gas acquired at auctions accounted for 49.2% of the total gas purchased). Nonetheless, the ISW has failed to ensure stable business transactions under the signed direct contracts. For instance, this statement relates to direct supplies of ore concentrate from Ingulets Ore Mining and Concentrating Works, though Ilyich ISW approved the proposed pricing scheme and settlements were made on timely basis and in cash. The ISW’s proposal to apply preferential railroad fares when a customer pays in cash was not supported by the Ukrainian railroad company Ukrzalizhnytsya, though intermediary transportation companies do grant similar discounts and incentives.

During the fiscal 1999 Ilyich ISW continued taking steps to lower material and power consumption in the manufacturing process. First of all, there were taken measures to reduce natural gas and electric power consumption. Shortage of these resources on the Ukrainian market is especially evident. In compliance with the end-to-end coefficient, consumption per tonne of commercial rolled metal lowered against 1998 by the following figures:

Natural gas -13.9 m3/tonne -5.9%

Power -79.7 kW*hour/tonne -13.4%.

Along with that, due to irregular supplies of selected raw materials (notably iron ore and ferrous scrap), Ilyich ISW had higher consumption rates in respect to certain feedstock against 1998. For instance, consumption of furnace charge per tonne of open-hearth steel gained 6.1 kg, with consumption of iron increasing by 25.4 kg per tonne. Owing to irregular procurement of raw materials and poor quality of certain feedstock materials including aluminum and ferroalloys, the ISW could not execute the measures planned as regards introduction of advanced technologies. As a result, Ilyich ISW failed to meet the stricter steel consumption standards at selected rolling shops. However, on the whole, introduction of novel technologies enabled lowering metal consumption in rolling by some 13.6 kg/tonne (according to the end-to-end consumption coefficient)

Along with general positive changes on the world iron & steel market, steps taken to improve production management approaches and to save resources significantly boosted production efficiency. These changes were most obvious in the second half of the year, after the company entered the sample selected for a national economic experiment. Therefore, the economic experiment shows that the state actually does something to help mining companies and metallurgical mills. However, the participating companies had to meet certain selection criteria via deploying additional internal reserves in order to boost rates of returns, lower the scope of barter transactions, make more complete and timely payments to the budget and suppliers. The aforementioned positive changes can be clearly traced on table 1.

Growth in production efficiency and tax incentives granted during the economic experiment enabled Ilyich ISW to raise investments in technical re-equipment and reconstruction of the tangible fixed assets from UAH 23,600,000 in 1998 to UAH 42,000,000 in 1999.

As production efficiency increased in the second half of the year, direct tax payments to the state budget grew significantly, thus counterbalancing the granted tax incentives on indirect taxes and duties. The actual payments to the state budget added UAH 4,700,000 or 6.9% compared to the first half of the year. This assessment does not even consider payments to the state budget, which had been transferred owing to increase in the portion of ISW’s cash payments for the resources and services consumed.

Ilyich ISW has no debts to the state budget. Quite the contrary, as of January 01, 2000 the state had an outstanding debt to our company on reimbursement of the VAT. These receivables have immobilized a considerable portion of our current assets (17.6% of the total), thus becoming one of the weightiest obstacles to improvement of the ISW’s financial performance.

The company has continued purposefully taking steps on pollution control. Implementation of the pollution control program lowered emission of noxious substances by 4,700 tonnes (2.1%) against 1998, even though growth tempos in output of sintered ore, iron and steel increased from 12% to 19%. The company allocated UAH 6,480,000 on measures aimed at ensuring environment safety. Pollution control activities got a new stimulus during the time of the economic experiment, when 70% of the accrued ecological charge was left for disposal of Ilyich ISW. These funds were purposefully allocated to finance the pollution control program.

Both in manufacturing and in the sphere of social issues, the ISW aimed its efforts at retaining the integrity of work teams. In 1999 Ilyich ISW founded two new structural divisions, namely a chemical-metallurgic factory (which currently owns the assets of the former chemical-metallurgic plant in Donskoye village) and Energoremont-2 specialized division. Besides, there have also been established new production sectors in the functioning shops. Average monthly wages made up UAH 337.7 per worker, 15.2% greater than in 1998.

The results of ISW’s work in 1999 (especially in the second half of the year) show that, in case the positive changes become more or less permanent, the process will keep on progressing, along with becoming irreversible. Nevertheless, the things do not depend on the company’s management only. The December 1999 situation has once again started showing since the very first days of 2000. There have appeared new obstacles on this way. In our opinion, the main problem is that state authorities virtually do nothing to counteract the negative trends, which have strengthened recently. First of all, this relates to the uncontrollably swelling prices for industrial and technical commodities, as well as for foodstuffs and essential goods. Once again, many enterprises practice using US dollars as the basic pricing units.

As a result, prices go up at about the same pace as back 1995-1996. For example, during the last month prices for iron ore gained over 20% and for coking coals – more than 15% (provided settlements in cash).

There is an impression that certain ministries and state agencies are not too willing to take efficient steps to bring recovery to domestic production. This negative feeling grows stronger as we take a look at business environments in other countries. For instance, Russia has imposed at least a EUR 15 export duty on ferrous scrap and a 6.5% duty on the customs value of iron ore exported, with transportation fares for exports of these resources twice as high as the domestic transportation tariff. Ukraine has failed to timely prevent large-scale metal scrap exports. Due to this, in the 9 months of 1999 scrap exports added 42% compared to 1998. As the new Tariff Book came in force on January 01, 2000, one should anticipate new complications. The new tariffs on transportation of export flows of iron ore and ore concentrate are extraordinarily low (at the minimal coefficient of 0.437). At the same time, fare on transportation of metallurgical and granular slag was increased by 18%. In consequence, output of iron & steel went down and Ukraine received less export revenues. During 19 days of January 2000, output of iron & steel at Ilyich ISW declined by USD 4,500,000 precisely owing to the reason outlined.

Ilyich ISW staff is also concerned with adoption of the law, which cancels a zero VAT rate on imports of electric power, coals and natural gas to Ukraine. Firstly, the government will have to reimburse greater amounts on VAT (about UAH 14,100,000 or 96% more per month), while the issue of timely reimbursement has not been finally settled yet. Secondly, mark-up of prices for fuel and power, including increase on account of the VAT rate, may annul all the efforts of enterprises to ensure timely payments for consumed resources with all the negative consequences stemming from that.

To retain the positive changes in activities of our enterprise (and of the industry on the whole), the Board of Ilyich ISW addressed the higher executive authorities with a number of proposals.

On our opinion, it is necessary to introduce state regulation of pricing activities of monopolies (e.g. prices of raw materials, fuel and power, railroad transportation fares). We believe that it is about time for the Ministry of Finance and the State Tax Administration to urge the Verkhovna Rada (Supreme Council) to prolong the effect of subclauses 6.2.5 and 6.2.7 (clause 6.2, article 6) of the law of Ukraine "On value added tax" until January 01, 2001. At the same time, it is necessary to consider introduction of accelerated reimbursement of VAT from the budget to enterprises. The accelerated mechanism may even envision issuance of treasury notes (or promissory notes) on the amount of state budget debts because enterprises need at least some kind of money equivalent to settle accounts with suppliers.

Table1. Financial performance of Ilyich ISW in 1998 and 1999

We also believe that the Ukraine’s Ministry of Transport should revise tariff rates charged for railroad freightage. This must be done to change the unreasonably low transportation fares on exports of iron ore concentrate and to lower tariff rates on conveyance of slag (tariff group 235; 271) down to the previous level, which was in force till January 1, 2000. Subsequently, the appropriate authorities with Ukrzaliznytsya (Ukrainian Railway) should acquire a right to grant various fare discounts if a client pays in cash. It is a little too odd when intermediary transportation companies do grant such discounts and the state monopoly does not.