29.01 Analytics

How Steel Cools: The war with Ukraine has destroyed Russian steel exports and will lead to a gradual degradation of the industry

Before the war, the Russian economy remained largely based on raw materials in terms of its export structure. Talks about the need for diversification were actively conducted in the first half of Putin's rule and gradually subsided in the second half of his tenure. However, from the perspective of its raw material profile, the Russian economy had a number of advantages: in particular, the strong position of its exporters of raw materials and semi-finished products in premium markets, primarily, due to its geographical location and long-standing ties, especially in Europe. This not only allowed for additional benefits from exports and additional budget revenues, but also to use the premium for the technological reequipment of associated industries and investments in their development.

Accordingly, the sanctions imposed against Russia, while not causing a collapse in its overall exports and even making them more profitable in the initial stages due to rising prices, have simultaneously led to Russian exporters losing premium markets. At the next stage, it becomes clear that redirecting the fallen volumes to Asian markets is not feasible due to increased costs, price discounts on 'toxic' Russian products and a lack of infrastructure. Finally, during the third stage, the weakening position of Russian exporters in international markets leads to their niches gradually being replaced by new players.

In other words, if it was previously believed that the raw material premium could serve as a lever for increasing investments in technology and allow for an increase in the added value of the Russian economy (including in raw materials), now the opposite is true: Russia has systematically destroyed all the advantages of its position even in the raw materials markets, depriving itself of long-term opportunities for development. Careful analysis shows that the common perception that Western sanctions are ineffective is a complete illusion. The effect of the sanctions is delayed and, at the same time, long-term, i.e. it leads to the loss of markets that will be almost impossible to regain even if the sanctions are lifted.

Russian steel exports: Chopping off the tail piece by piece

The Russian steel industry was one of the key sectors of Russian exports, which is now being gradually eroded by sanctions. As in the case of gas, the EU was the key and most premium market for major Russian companies: for example, Severstal's sales to Europe accounted for 31% of its revenue in 2021, while Metalloinvest's sales to Europe accounted for 29%. According to https://www.finam.ru/publications/item/rossiiyskie-syrevye-kompanii-prognozy-po-otkrytiyu-rynka-2022..., Europe accounted for 24% of the revenue of the Russian mining and metals sector, 14% came from North and South America, while the domestic market accounted for just 43%. European authorities predicted losses for Russian steelmakers from sanctions amounting to €3.3 billion annually. Shipments of ferrous metals to the US stopped in the summer of 2022, while in 2021 the US imported Russian metals worth $2.8 billion, as reported by RBC, citing the US Census Bureau.

Vladimir Lisin, the owner of Novolipetsk Steel (NLMK), complained back in the summer of 2022 that exports, which accounted for about 40% of production (28 out of 70 million tonnes of steel products), had become 'almost meaningless'. As a result of the reorientation of shipments to the east, primarily to China, the transport distance more than tripled from 2300 to 7900 kilometres. Discounts ranging from 15% to 40% had to be provided to new customers. However, according to Lisin, at that time, only 10–15% of the dropped volumes had been successfully ‘added’ to new markets.

However, by the end of 2022, according to estimates by the consulting company Yakov & Partners (formerly McKinsey in Russia), steel exports from Russia fell by only 10% to 26 million tonnes, the same level as the ‘Covid’ level of 2020. Despite Russian products being deemed ‘toxic’ for buyers sensitive to Western sanctions, discounts made them more attractive to countries that ignored the sanctions, particularly China and Turkey. Exports of semi-finished steel products to China tripled to 2.3 million tonnes and $1.34 billion in 2022. Although the Chinese market was never super-marginal, according to data from the industry agency Metals & Mining Intelligence as of December 2023, the prices of steel semi-finished products in China were $465–475 per tonne compared to $550–620 in Europe and $505–515 in Turkey. Due to the withdrawal from premium markets, Russian companies' revenues from ferrous metal exports in monetary terms fell more significantly than shipments in 2022, by 15% to $24.5 billion, according to data from the Federal Customs Service. 

In 2023, Russian steelmakers continued to reduce exports. According to the Ministry of Industry and Trade, the average reduction for the year was 10% (in tonnes). According to Eurostat, despite sanctions, Europeans continued to purchase steel semi-finished products from Russia within established quotas. In January–October 2023, deliveries to the EU decreased by almost 40% to 4.18 million tonnes, leading to a 46% reduction in the total revenue of exporters, from €3.87 billion to €2.1 billion.

Although Russian companies increased their shipments to some 'friendly' markets in 2023, including Africa, South America and the Middle East, this could not offset a new negative turnaround — a sharp decline in semi-finished steel exports to the new key market, China. Over 10 months, exports to China fell 3.4 times, to 658,000 tonnes, and in monetary terms this decrease was fourfold, down to $300 million, according to Chinese customs data cited by Kommersant.

Shipments of all types of steel products (not only semi-finished products) for the same period fell three times, to $576 million. According to Platts, steel imports to China dropped by 29% to 6.98 million tonnes from January to November. Moreover, now, amid low domestic demand, Chinese producers are competing with supplies from Russia in the Middle East and Turkish markets. 

The Ministry of Industry and Trade estimates that, historically, the share of exports in steel production was about 40-45%, but now it has dropped to 30-35%. According to the investment company BCS, Severstal and MMK have an even lower export share of 10-15%, and only NLMK, which has avoided European sanctions, has a share of 40-50%.

Thus, in 2022, Asian markets to some extent compensated for the reduction in supplies to the West (but more volume than in monetary terms), but in 2023 the trend reversed: now China is not only reducing imports of Russian products, but also squeezing them out of other Asian markets. However, metallurgists will have a small window in the near future. The eighth package of EU sanctions, adopted in October 2022, envisaged a ban on imports of not only Russian steel products, but also products from third countries if they were made of Russian steel. These restrictions were supposed to come into force in 2024, but at the very end of 2023, the EU extended the temporary exemption on imports of Russian slabs and billets for another four years, until October 2028. European companies need more time to substitute Russian raw materials.

Thus, as in other traditional Russian export markets, the effect of Western sanctions is growing over time as competing suppliers ramp up production and displace problematic Russian supplies in the face of tightening sanctions. Over the next few years, Russia will finally drop out of the league of global steel exporters, and will be replaced by other countries. This case demonstrates why the 'reorientation to the East' strategy does not work. Countries that have not joined the sanctions are using them to their advantage: first, they seek discounts and then capture the niches of toxic Russian exports.

The ‘Juche’ strategy for steelmakers

Export of steel and iron ore in the first year of the war in Ukraine, according to analysts at BCS Global Markets, became unprofitable for almost all Russian metallurgical companies due to Western sanctions, rising transportation costs, and the strengthening of the ruble. However, on the domestic market, they continued to have a profitability of over 30%.

The industry lobbying association Russian Steel warned the government back in May 2022 about industry losses and production cuts. For example, MMK cut production by more than 40%, and Severstal was forced to reduce capacity by 20-40%. NLMK predicted an overall decline in production by steelmakers of 15%, or a decrease of more than 11 million tonnes, and the World Steel Association (WSA) expected a 20% drop in steel consumption.

However, the final figures for 2022 turned out to be much better than forecast. Steel production in Russia declined by 7.2% over this period, to 71.5 million tonnes, according to the WSA report. First, Russian steelmakers began to replace significant volumes of steel that were previously imported into Russia by Ukrainian and Kazakh producers. For example, Ukraine's Metinvest annually exported about 0.8-1 million tonnes of rolled steel to Russia. According to Russian Railways, Russian imports of ferrous metals in 2022 decreased by 18%, and in monetary terms this was a decrease of 15%, to $5.1 billion (Federal Customs Service data). In other words, metallurgists used to sell their products on premium markets, replacing them on the domestic market with cheaper products from neighbouring countries, but now, having ceded premium markets, they have to settle for domestic ones. However, the companies' focus on domestic and 'friendly' markets has led to a decline in revenues. For example, Severstal's revenue for the first half of 2023 decreased by 10% and its net profit by 11%. MMK's revenue for the same period decreased by 12.5% and net profit by 9%. However, profitability decreased only slightly.

In addition, steel consumption in 2022 was driven by the growth in domestic demand and government support measures. As reported by Kommersant, the main driver in the rolled metal market in 2022 was the fuel and energy sector, where consumption grew by 28% due to the implementation of Gazprom's largest investment programme (which included the purchase of pipes and rolled steel for the construction of gas pipelines and repair programmes).

For 2023, WSA notes that steelmaking increased by 5.6% to 75.8 million tonnes. According to the Ministry of Industry and Trade's forecast, production will grow to 74 million tonnes by the end of the year, reaching pre-pandemic levels, although it will remain below the 2021 level. MK, which has already published operational results for the entire previous year, increased production by 11%, reaching nearly 13 million tonnes. Severstal increased production by 5% in the first nine months and expects a growth of 5.6% for the whole year.

Production grew thanks to a 15% increase in domestic demand for steel from January to September, according to Viktor Yevtukhov, Deputy Minister for Industry and Trade. An additional 5 million tonnes of demand was driven by government orders, including defence and construction. In its review for the first nine months of 2023, Severstal says that the demand growth was observed in sectors such as individual housing construction, logistics and transport infrastructure construction, and mechanical engineering. In addition, 2023 saw strong demand for lorries, light commercial vehicles (LCVs) and special vehicles, including as part of infrastructure projects. The production of freight cars (which increased by 46% in the third quarter) grew due to the resolution of component supply issues and an increase in freight volumes.

Moreover, in 2023, demand in the energy sector decreased primarily due to the reduction of Gazprom’s investment programme, which cut investments by 15% amid the loss of the European market. In 2024, the company's expenditures are further being reduced by 20%, down to 1.6 trillion rubles. The potential of Russia's domestic market has been almost exhausted. After the sharp increase in steel demand in 2023, the Ministry of Industry and Trade predicts an additional ‘minimum’ increase of 2-3%. And Severstal and Alfa Bank expect demand growth to slow down to 1-2%. According to the October forecast by WSA, steel consumption in Russia in 2023-2024 will amount to 43.8 million tonnes compared to 41.7 million tonnes in 2022.

The sharp increase in the Central Bank’s rate at the end of last year also worsens the outlook for domestic metal sales in 2024, primarily due to a possible slowdown in the construction sector amid rising mortgage rates, according to the Severstal report. The construction sector accounts for about 60% of steel demand in Russia or potentially more, so if the Russian authorities keep the Central Bank's key rate at such a high level or even raise it and curtail preferential mortgage programmes (they have been extended until 1 July, 2024), metal consumption may start to decline this year. However, demand from other industries, including automotive and engineering, is expected to largely offset this and allow for the overall positive dynamics of metal consumption in Russia to be maintained, as stated in MMK's forecast. Nevertheless, a potential slowdown in the recovery of engineering and other steel-consuming sectors due to high interest rates and cuts in some budget expenditures may lead to further reductions in metal consumption.

The Russian market will not become an alternative to exports for steelmakers. The redirection of part of the economy to the military may lead to a certain increase in domestic demand, but will not compensate for the losses, especially in monetary terms. However, there are no grounds for further expansion of the domestic market and for increasing its profitability.