The Renova & Evraz manganese scheme - The bell tolls for thee

Mineweb ^ | '21-SEP-05 | John Helmer

[Tailgunner Joe]

MOSCOW (Mineweb.com) -- Steelmaking requires manganese alloy to harden the product. It is thus natural that if the price of the steel is rocketing upwards, the price of manganese ore, and especially ferromanganese in its high-carbon form, will go ballistic.

During last year's steel boom, for example, the price of ferromanganese, landed in Hong Kong, nearly doubled from $580 per metric ton in January 2004 to a peak of $1,070 in October.

That was a lucrative opportunity for the world's largest holders of manganese ore reserves -- South Africa and Ukraine. Current estimates indicate that of the 5 million tons of manganese in mineable reserve worldwide, South Africa's Kalahari manganese field holds 4 million tons, or about 80%. The Ukrainian reserves are about 520,000 tons, or about 10%. Gabon trails well behind with 160,000 tons, followed by China, Brazil and Australia. Production is a slightly different story, with South Africa and Gabon leading, and the Ukraine producing much less than it could.

The reason for that is that it has proved to be much more profitable for the Ukrainian owner of Nikopol Ferroalloy Plant (NFP), the world's largest ferroalloy producer, to import manganese ore at a high price, and sell Nikopol's ferromanganese at a low price, before trading it on the international market at a premium. That owner, until very recently, was Victor Pinchuk, son-in-law of the former Ukrainian president, Leonid Kuchma.

In contract language, the scheme Pinchuk used at Nikopol is called tolling. The gainer is the trader of the ore who contracts for its processing, in return for paying the plant a processing fee, and taking the alloy out of the country without paying domestic taxes. In the two years, 2003-2005, that Pinchuk controlled Nikopol, it is estimated that the profits he accumulated offshore from this tolling scheme exceeded $500 million. Court litigation will shortly present detailed calculations, and the figure may top $700 million. For the plaintiffs, this is a case of alleged theft, fraud, and tax evasion. But for Pinchuk, it's a case of acquiring an asset legally, and exploiting it cost effectively, according to the law Dyadya Lyonya (Papa Leonid) was in charge of enacting.

For Victor Vekselberg and his Renova group, the opportunity that presented itself to acquire this profit-spinner was a familiar one. Vekselberg's Russian bauxite, aluminium and silicon group, SUAL, and its offshore trader, Access Industries, have had plenty of experience operating tolling schemes. Vekselberg, his SUAL chief executive Brian Gilbertson, and his global strategist Andrei Shtorkh knew that Pinchuk had to find a quick way out of holding the Nikopol asset, in case Kuchma's successors lost the Ukrainian elections to Victor Yushchenko and Yulia Timoshenko. For Yushchenko and Timoshenko were likely to reopen the dossier on Kuchma's privatizations, and cancel the two most profitable ones which Pinchuk had taken -- Nikopol, and the Krivorozhstal steel mill. And since the Orange Revolution of February, that was exactly what they did, going into the Ukrainian courts to rule that Pinchuk had come by his assets in violation of Ukrainian law.

The court rulings have now confirmed this, and returned the controlling shareholdings in both the manganese plant and the steelmill to the state. But not without a little disruption, as Timoshenko, the prime minister, accused President Yushchenko and his aides of corrupt dealing in the matter. Yushchenko has retaliated, dismissing Timoshenko and her ministers at the start of September, but failing this week, again on charges of corruption, of getting parliamentary approval for his candidate prime minister. A little manganese profiteering is currently going a long way in Kiev.

Just before the political collapse, it became clear that Vekselberg and his Russian partner, Alexander Abramov, who controls the Evraz steelmaking group, paid Pinchuk $25 million. The transaction appears to have been a security deposit; for it was far too much for minority shareholdings in the two Ukrainian manganese mines, Ordzhonikidze and Marganets; and far too little for the option to buy control of Nikopol, the price of which was negotiated with Pinchuk at about $380 million.

Ordzhonikidze and Marganets ore-processing combines (GOKs) were planned in the Soviet period to supply ore to Nikopol; Orzhonikidze has the capacity to supply 2.3 million tons per annum; Nikopol has the capacity to produce 1.2 million tons of alloys. Before the privatization of Nikopol in Pinchuk's favour, Ordzhonikidze was supplying Nikopol with 1.6 million tons of ore. After the takeover, this fell to zero.

In 2004, Pinchuk's second year as proprietor, Nikopol lifted its output of alloys to 1 million tons, up 18% on 2003. Ferromanganese was 314,000 tons, up 43%; silico-manganese was 708,000 tons, a gain of 9%.This production was done by processing 1.6 million tons of fully imported manganese ore -- from Gabon and elsewhere.

It is not known whether traders supplied any South African ore from either of the two major SA producers, Samancor or Assmang. Annually, Samancor mines about 3.4 million tons of ore, and turns out between 300,000 and 420,000 tons of alloys. Assmang -- a joint venture of African Rainbow Minerals and Assore -- mines just over 1.5 million tons of ore, and produces about 200,000 tons of metal.

In theory, Nikopol dwarfs the two South African producers. In practice, as soon as Pinchuk saw which way the political wind was blowing, ore imports to Nikopol were cut, and production of alloys fell dramatically. In the seven months to July 31, this year, Nikopol's aggregate production fell 19% to 496,000 tons -- 337,000 tons of silico-manganese, 153,000 tons of ferromanganese, and 6,000 tons of other products.

At the same time, a global over-supply of crude steel, and a cutback in Chinese steel demand, started steel prices moving downward. Manganese ore started the year at $3 per ton, and was down 23% to $2.30 by June 30. High-carbon ferromanganese was $880/ton on January 1, and $540 on June 30, a drop of 39%.

For Pinchuk, a down-payment of $25 million from Vekselberg and Abramov, with a commitment to pay another $350 million or so, was better than a gold-watch for his retirement from the manganese business. But what were Vekselberg and Abramov, Renova and Evraz, thinking while they threw their money into the dwindling market?

For the record, Evraz claims that the corporate group had nothing at all to do with the move to acquire Ukrainian manganese. "Any action," said a corporate statement on August 25, "including investigation of an opportunity to acquire a stake in NFP in the Ukraine is being made by a group of investors that includes Mr. Abramov, Evraz Group SA's Chairman and CEO, in their personal capacities only, and not by Evraz Group SA."

Shareholders -- including those western investors who had been persuaded to buy into the London-listed, Luxembourg-registered Evraz IPO in July -- may have needed some reassurance. For in June, Evraz had corporately lost about $20 million paid to secure its tender bid for the manganese mine in neighbouring Georgia. Six months before, Evraz had announced it would pay $132 million to the government in Tbilisi to acquire the Georgian manganese concentrate producer Chiaturmarganets, and its principal source of electricity, the Vartsikh hydroelectric power station. By June, however, Evraz claimed the deal would not be profitable enough. "Following detailed due diligence," an Evraz statement claimed, "Evraz concluded it would be unable to generate returns in line with its hurdle rate for acquisitions."

According to Shtorkh, the Renova strategist for the Ukrainian campaign, Abramov wanted "to act without public company funds and without Evraz authority... as a person." According to one disgruntled Evraz shareholder, the Belize-registered Flink SA, this was a sham. Evraz's statement followed only after the Ukrainian courts had ruled that Pinchuk's acquisition of Nikopol should be reversed, and the shares returned to the state. In paid advertisements that have been appearing this month in The Wall Street Journal, Flink claims "Evraz is concealing a lost investment in Nikopol through the purported acquisition of the [Ordzhonikidze and Marganets] GOKs from Pinchuk." So far, the Flink campaign hasn't targeted the loss of money in Georgia.

Shtorkh told Mineweb on July 22 -- just before the Ukrainian courts rang the curtain down on Pinchuk -- that "if the courts say the [Nikopol] shares belong to Pinchuk, then we offer to buy. If the shares go to the state, we are not ready to say if we will bid." Shtorkh identified the man he thought was the biggest rival for the Renova-Evraz plan -- Igor Kolomoisky, head of the Privat Bank group in the Ukraine. According to Shtorkh: "in the old days there were two GOKs [Ordzhonikidze and Marganets] supplying [Nikopol] plant. Pinchuk controlled the GOKs, Kolomoisky controlled the plant. They then started fighting. Kolomoisky diluted Pinchuk at the GOKs, Pinchuk did the reverse at the plant."

What is clear from Shtorkh's version of the plan is that Vekselberg and Abramov, Renova and Evraz, didn't expect to take over the GOKs. They also didn't need them to supply Nikopol, so long as they could continue Pinchuk's tolling scheme, and substitute imported manganese instead of domestic supplies. The evidence suggests that the pricing of their deal with Pinchuk assumed that tolling would continue, and profits stay offshore.

Evraz's vice president for investor relations Irina Kibina was asked to clarify where Evraz's three steelmills source their manganese alloy, and in what volumes. She has not responded. It is thus unclear what value Abramov placed on Nikopol for his Russian steelmaking operations. Much clearer, however, is the evidence that Abramov was confident of winning a bid to acquire the Krivorozhstal steelmill, the second of Pinchuk's Ukrainian assets to be renationalized by the Yushchenko-Timoshenko government. Abramov's confidence was boosted by a meeting he had in July with Yushchenko himself. Later events have caused Abramov to cast doubt on Yushchenko's capacity to deliver. But for weeks until August, Abramov seems to have thought that he and Vekselberg would first buy into the manganese mines; then buy the ferroalloy plant; and finally take the steel mill.

In the rivalry for Krivorozhstal -- the tendering is due to be decided on October 24 -- Abramov is again competing against Kolomoisky, the principal Ukrainian bidder, plus foreign rivals Arcelor, Mittal and Severstal. Perhaps in the Evraz strategy, Nikopol was a natural source of alloy for Krivorozhstal, and so long as the same owners controlled the chain of production through tolling, the profits could still be drawn offshore.

In Vekselberg's case, the move to take Nikopol off Pinchuk's hands was part of a different campaign. This is to diversify Renova and SUAL out of Russian-based bauxite and aluminium into other metals, preferably outside Russia altogether.

Vekselberg's methods of acquiring assets face charges of theft and fraud in federal court litigation in the United States, as well as in the Russian courts. If Vekselberg is to secure his fortune, he should therefore reinforce and redomicile the asset ownership through an IPO, like Abramov has done, although Abramov too is facing legal challenges to his asset claims in the US and Luxembourg, and an investigation by the US Securities and Exchange Commission.

In 2003 Vekselberg was fleet enough to cash out of the Tyumen Oil Company (TNK) by selling his stake to British Petroleum before the Kremlin hit him with back-tax claims, or the dispossessed asset owners could recover their losses in court. In South Africa, Vekselberg has been contemplating several metal and mineral ventures, none of them as expensive as they may appear, but all to prepare international investors for the opportunity to give Vekselberg their cash, in return for what they imagine is a stake in a global multi-mineral empire.

In this ambition, Vekselberg has recruited notable supporters, including Russian Minister of Natural Resources Yury Trutnev, and SA Deputy Minister of Minerals and Energy, Lulu Xingwana. The SA reception has been warmer fror Renova than the Ukrainian one. At about the same time, Renova and Evraz were losing their bid to acquire Nikopol, the Department of Minerals and Ernegy in Pretoria granted exploration and mining licences in the Kalahari Manganese Field to companies directly linked to, funded and advised by Renova.

To support the licence award, Renova has promised to spend $10 to $20 million on exploration and feasibility studies for a new manganese mine. If the results are mineable, Renova is promising to invest $50 to $70 million to open a mine with the capacity to produce 2 million tons of ore per year. If that materializes, Renova is promising its most expensive undertaking in a third stage -- to build a ferroalloy processing plant with capacity for 500,000 tons of metal per annum. There is a $200 million price-tag for that.

If Vekselberg were really intending to invest these three sums, then it would be natural for SA officials to celebrate a genuine inward investment of up to $300 million, producing jobs in the Northern and Eastern Cape regions, and generating taxable trading revenues of up to $500 million per annum. That's quite a gift horse; or possibly it's a Trojan one.

For Vekselberg's modus operandi has not so far encouraged a belief in substantial investment promises. Already there is speculation in the Ukrainian metallurgical industry that Vekselberg's SA venture is intended to supply ore, on tolling contract, to Nikopol, in order to generate the super-profits Pinchuk had managed from Gabon and other sources. If that were true, then the SA interest in seeing local beneficiation of the ore might be a long time in materializing. But what will become of the Kalahari venture if the Ukrainians stand firm, in the courts, the prime ministry, and the Rada, and reject the Renova-Evraz bid to take over Nikopol? Will Renova want to invest real cash of its own in a third major manganese production chain in SA, rivaling Samancor and Assmang, if tolling to Nikopol becomes impossible, and indeed, if Nikopol becomes a rival producer and exporter of the alloy? If Vekselberg gets cold feet about spending his own cash in the Kalahari, will SA banks be agreeable to making loans to substitute for incoming investment? Before these questions can be answered, there is another one that the South African government cannot have anticipated. Now that the Orange Revolution has started spitting out its pips in Kiev, South Africans in Pretoria might ask whether they should more credulous than the Ukrainians in assessing the promises on which the Renova-Evraz manganese plan has been based so far.

[sionnsar]

It is thus natural that if the price of the steel is rocketing upwards, the price of manganese ore, and especially ferromanganese in its high-carbon form, will go ballistic.

Huh?