According to a report by international credit rating agency Moody's, iron ore operations will support the profitability of vertically integrated CIS-based steelmakers, despite growing price risks on slowing demand from China and a supply overhang. However, the profitability of the companies' steel operations will be constrained by lackluster demand in end-user markets in the CIS.
"As a result of continued, albeit slower, Chinese demand, we expect that the iron ore mining segments of low-cost vertically integrated CIS steel producers NLMK, Severstal and Metinvest will generate a significant share of 2014 operating profits," said Denis Perevezentsev, a Moody's Vice President-Senior Analyst and author of the report. "That said, we do not expect that the profitability of CIS steelmakers' steel operations will rally because we do not anticipate much improvement in demand in end-user markets in the CIS, where two-thirds of CIS-produced steel is consumed," continued Mr. Perevezentsev.
Moody's pointed out that downside risks remain as it expects that expansion projects could drive iron ore prices lower. The main downside risk to prices in the next 18-24 months is supply overhang as Australian and Brazilian miners ramp-up iron ore production at a raft of new projects, combined with an expected slowing pace of growth in Chinese iron ore imports.
Magnitogorsk Iron & Steel Works (MMK), which is the least integrated into iron ore and buys ore from third parties, will benefit the most if the iron ore market becomes oversupplied and iron ore prices contract during the next 12-18 months.
Furthermore, Moody's anticipates that there will be no benefit from steelmakers having their own coking coal operations as prices will remain low. The rating agency expects that hard coking coal sea-borne contract prices will continue to be under pressure during 2014, which means the coking coal sub-segments of Evraz Group, Severstal and Metinvest, which have large coking coal deposits or are self-sufficient in coking coal will not contribute meaningfully to consolidated results. MMK, which is only about 36 percent self-sufficient in coking coal, and NLMK, which does not own coking coal deposits, will continue to benefit from current low coking coal prices purchased for their steel operations from third parties.