Growth of expenditures is restraining the sector of steel and iron ore production on emerging markets - Fitch

/IRBIS, August 23, 2011/ - Rising costs constrain steel and iron ore sector in emerging markets, was indicated in the report released August 22 by Fitch Ratings. As indicated, Fitch notes that the rising costs in the domestic market in the CIS countries and South Africa could lead to a steady increase in cash costs per tonne of production. As a result, it may adversely impact on the medium-and long-term competitive position of producers of iron ore and steel in comparison with comparable companies in the world. "The average cash costs rose steadily in the past 12-18 months in countries with developing economies, driven by higher commodity prices and a substantial increase in energy costs and labor costs for the year. To a large extent this increase in cost due to current high prices for commodities, and the situation should improve after their decline. But at the same time, Fitch sees structural changes in the cost of electricity, gas and labor costs, which may not l adjust just as quickly when the weaker pricing environment - said Roelof Stenekamp, Director on Fitch's workgroup on European industrial companies. - The high prices in the current phase of the cycle conceal the lower efficiency in the smaller mining companies that do not have the same financial and operating flexibility to adjust the volume of production, as larger companies". It was stated that the financial impact of rising costs on the domestic market was also dependent on the exchange rate in the country. Thus, during the 2010 Russian ruble appreciated 4.2% against the U.S. dollar, and the first 8 months of 2011 the ruble rose by another 5.7%. Taking into account that the cost of mining companies (wages, electricity, and various consumables) is denominated mainly in domestic currency, it has a significant impact on the reporting of mining companies. It is noted that, historically, the CIS mining companies have access to electricity at one of the cheapest prices in Europe. The lowest costs for electricity are found in Ukraine, followed by Belarus, Kazakhstan, Armenia and Russia. At the same time in Ukraine is a rise in electricity prices against a background of significant investments in capacity expansion in generation and transmission of electricity, are aimed at improving long-term balance of supply and demand. In April 2011, there have been a large increase in electricity tariffs by 15%. Later, during 2011 and 2012 are expected to raise new about 15% -20%. As a rule, only part of the overall growth rate is shifted to large industrial customers, but a structural shift in the market determines the cost price increase even with a fully privatized market. Moreover, the expected negative impact on the overall cost per tonne as a result of inflation in Ukraine, which increased to 11.9% in July 2011, leading to double-digit increases in labor costs over the next year. At the same time, Russian and Ukrainian miners in general have competitive costs relative to comparable companies in the world, and conservative financial profile with moderate leverage, partially normalized in 2010 against a background of higher prices for steel and iron ore. Analogous to the situation in Ukraine, Russia is expected to increase electricity prices by around 15% in 2011 to provide funding for replacement of aging power plants and transmission infrastructure. Fitch expects that the price increase, expressed as a two-digit numbers, will continue in 2012, although as a result of political and regulatory pressure could increase prices slightly slower pace. In combination with high inflation (9.4% in June 2011), according to Fitch, in the medium to long term it could also have a negative impact on the whole low-cost position of Russian mining companies. As noted, moreover, the change of the Russian ruble is closely correlating with world oil prices, but for the price of oil, base metals and steel, in turn, is characterized by pro-cyclical dynamics. During the recession in 2009, the ruble fell by 27% against the U.S. dollar, and the rate of the Ukrainian hryvnia to the dollar has fallen by almost 47%. Such a sharp devaluation has allowed mining companies, because they are export-oriented, partly to smooth the negative impact of increased production costs on the domestic market and maintain profitability over the cycle. In South Africa, Fitch expects the average increase in electricity prices by 25% per year over the next three years as the country is in the process of construction and commissioning of new electricity generation capacity by almost 10 000 MW. In general, higher costs for energy and limited flexibility in managing the growing cost of labor in the domestic market will lead to higher cash costs for South African mining companies. The industry of minerals is to a high degree cyclical, and volatility increases toward the starting point of the value chain. Companies typically rely on low operating costs on its major mines in terms of maintaining long-term competitiveness. Producers with low costs, as a rule, it is possible to maintain production in periods of cyclical downturns, while producers with higher costs can be cut back production. As a result, cost control is a key factor, as assessed by Fitch ratings of these companies. [2011-08-23]