Ukraine

Focus

Equity markets

Scope

Metals & Mining

Sector

Sector Primer

Iron ore 2010

Alexander Martynenko
Kiev, +38 044 2200120 alexander.martynenko@icu.ua

December

2010

READ FIRST THE DISCLOSURES SECTION FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION

December 2010

Sector Primer

Iron ore 2010

Contents
Executive summary Key drivers of profitability Key risks Supply chain and technology 4 5 7 9

Technology basics .........................................................................................................9 Key stages of iron ore processing ................................................................................ 10 Mining .................................................................................................................. 10 Beneficiation ........................................................................................................ 10 Agglomeration ...................................................................................................... 10 Supply chain ................................................................................................................ 10 Domestic iron ore market should further shrink.................................................... 10 Sales structure and key commercial products ..................................................... 12 Strong growth potential 15

Reserves: Underexploited and undistributed ............................................................... 15 The state controls ore reserves allocation ................................................................... 16 Industry players’ uneven control of reserves ................................................................ 16 Privatisation process nearly finalised ........................................................................... 17 Favourable geographical location and logistics ........................................................... 18 Favourable market environment 19

Iron ore and steel demand ........................................................................................... 19 China drives the global demand for iron ore ................................................................ 21 Pricing: oligopoly benefits ............................................................................................ 22 The Big Three ...................................................................................................... 22 Benchmark system .............................................................................................. 23 Pricing mechanism............................................................................................... 23 Transition of the benchmark system .................................................................... 24 Competitive environment ............................................................................................. 24 Production costs pose key concerns 26

Inferior quality of iron ore deposits implies costlier mining ................................... 27 Energy inefficiency creates the main risks for costs ............................................. 27 Labour structure needs further optimisation ......................................................... 30 Modernisation is time-consuming and capital-intensive ....................................... 31 Appendixes 32

Appendix 1. SWOT analysis ........................................................................................ 32 Appendix 2. Financial market exposure ....................................................................... 33 Appendix 3. Financial performance highlights ............................................................. 33 Glossary 34

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December 2010

Sector Primer

Iron ore 2010

Executive summary
Our formal coverage of the Ukrainian metals and mining industry begins with the publishing of this Iron Ore Sector Primer, which we plan to follow up by a similar primer on Ukrainian steel sector. We focus on the key factors driving profitability of Ukrainian iron ore producers, both short- and long-term. We also examine the iron-ore supply chain, key commercial products, and production technology prevailing in Ukraine. Finally, we provide a SWOT analysis of the sector and the sector’s significant risks.

Sector importance: The iron ore sector captures one of the main competitive advantages of Ukrainian steel mills on international steel markets by supplying the relatively cheap key steelmaking input, iron ore. At the same time, the sector itself plays an increasingly active role in the Ukrainian steel industry exports, having amounted to US$1.6bn in 9M10, or 13% of the total Ukrainian exports of ferrous metals & mining products and 2% of the corresponding Ukrainian GDP figure. One of the sector leaders, Ferrexpo, has its shares listed on the LSE, which are the most liquid among all the traded Ukrainian stocks. Also, the iron ore business segment accounted for 22% of US$6bn revenue and for 56% of US$1.4bn EBITDA of the leader of Ukraine’s metal-and-mining industry, Metinvest, in 2009. Strong growth potential: Having the third largest reserves of iron ore in the world based on iron ore content, Ukraine ranks just sixth in terms of the annual iron ore production. Privatization of the last state-owned iron ore company, KGOKOR, further development of reserves and introduction of additional processing capacities by private businesses have the potential to boost Ukrainian iron ore exports by at least 65% during 2011-15. Ukrainian iron ore companies are able to expand their market share in Europe and the Middle East, the regions where they have an edge over competitors in transportation costs and where they can supply the products with competitive quality. Ukrainian miners can also capitalize on the growing demand for iron ore in Southeast Asia, particularly China. Low production efficiency: On the back of volatile energy prices, energy-intensive production process is the main weakness of Ukrainian iron ore sector. High energy consumption is caused by significant mining depth and the low iron grade of local deposits, obsolete equipment, and cold winters. Producers also inherited an inefficient organisational structure and excessive headcount from the previous state ownership, which has led to low labour productivity. At the same time, modernisation and capacity increase are complex, time-consuming, and require substantial capex. Key drivers: In our view, the most significant factors affecting the profitability of Ukrainian iron ore producers are the world demand for steel, international benchmark iron ore prices, sales volumes, competitiveness in international markets, energy prices, transportation costs, the hryvnia’s exchange rate, and domestic inflation. Capex and the availability of financing are drivers affecting the sector in the longer term; however, they substantially influence Ukranian companies’ exposure to the other drivers mentioned above. Key risks: Highly volatile energy prices are the main threat to Ukrainian iron-ore companies’ profitability, as they face increasing competition on their way to foreign markets. At the same time, equipment upgrade aimed to improve energy efficiency and product quality, as well as production capacity increase may take longer than planned by companies due to possible scarcity of finance and technological complexity.

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the Middle East. significant depth of open/underground mining pits. At the same time. Ukrainian companies are at least able to retain their current market share. We believe the share of seaborne transportation costs is likely to grow. In particular. World prices for iron ore are influenced to a considerable degree by global economic growth. and product quality. while seaborne transportation services are provided by international carriers. With their current exposure to these factors. and are tightly regulated by the state. transportation costs are largely out of Ukrainian iron producers’ control. Traditionally. while seaborne transportation costs are driven by global demand. Ukrainian producers have been highly competitive in Eastern and Central Europe and Turkey. In pellets. Ukrainian iron ore prices closely trace international benchmark prices on both the domestic and international market. as the railway services in Ukraine are provided by the state monopolist. according to our estimates. While driven by demand as a result of world economy growth. International iron ore benchmark prices are currently the key indicator of both steel and iron ore demand in the world. which in turn is significantly affected by China. As a result. which have the highest added value. as Ukrainian companies plan to build up their iron ore exports to Southeast Asia. energy costs of Ukrainian producers account for nearly 45-55% of their total production costs. which minimise transportation costs. 5 . labour productivity. competition is increasing considerably. Ukrainian production of iron ore is energy-intensive compared to non-CIS competitors. However. and electricity. Sales volumes. and severe winters. as well as due to their products’ technical compatibility with steel mills of their long-standing customer base. Energy prices. supporting them during economic downturns. To become more cost-competitive in all targeted markets. Ukrainian mining companies have to improve their energy efficiency. the oligopolistic international market for iron ore has an additional significant effect on iron ore prices. and control over transportation costs. due to the proximity of these markets to Ukraine and good transportation infrastructure. Ukrzaliznytsia. obsolete equipment. Transportation costs. Ukrainian iron ore producers’ railway transportation costs are driven mostly by domestic inflation and the government’s policy. In order to further penetrate the markets of Western Europe and the Middle East. At the same time. and boosting them during growth phases. transportation costs. as Ukrainian companies are striving to expand their sales to Western Europe. which determines the world demand for steel and its inputs. Transportation costs add another 40-70% on top of the production costs of Ukrainian iron ore producers. Ukrainian iron-ore-making costs are driven substantially by prices for natural gas. Ukrainian companies will have to produce more products with higher iron content. Due to the low iron content of deposits. diesel fuel.December 2010 Sector Primer Iron ore 2010 Key drivers of profitability We believe that the following factors significantly influence the profitability of Ukrainian iron-ore producers: World demand for steel and iron ore. sales volumes also depend on Ukrainian companies’ ability to withstand competition on the international market. The key factors affecting competitiveness are production costs. according to our estimates. and Southeast Asia.

and raise the share of products with higher added value. and thus lowers their profit margins. Domestic iron ore investment projects are capital-intensive. the key capex projects at the moment are the development of new mines. Given the scope of capex required. technologically complex. Capex. hryvnia appreciation is directly related to growth in Ukrainian miners’ costs. Most of the Ukrainian iron ore producers’ revenues are either denominated in US dollars (related to exports) or pegged to the UAH/USD exchange rate (in relation to domestic sales). and introducing new ones. This makes domestic miners dependent on the stability and cycles of the financial markets.December 2010 Sector Primer Iron ore 2010 Hryvnia exchange rate and domestic inflation. Ukrainian iron ore producers are quite often unable to finance their investment projects exclusively from operating cash flows. As a result. 6 . At the same time. we estimate that 60-70% of the production costs of Ukrainian producers are denominated in and pegged to hryvnias. Availability of financing. the low credit ratings of Ukraine compared to developed markets and a significant portion of emerging markets result in attracting debt that is more expensive for Ukrainian companies compared to their foreign peers. The main purpose of these projects is to increase production capacity. For Ukrainian iron ore producers. and therefore need to raise additional funding through debt and/or equity. as they relate to the majority of labour costs. improve efficiency and productivity. translated into US dollars. upgrading existing ore-processing facilities. and time-consuming. improve product quality. Furthermore. electricity. and consumable materials.

particularly from Brazilian and Australian companies. the shortage of liquidity on the financial markets is likely to be mitigated by quantitative easing measures taken by developed countries. such threats as rising energy prices. the Middle East. has pursued in recent years the policy of bringing its gas prices for Ukraine close to prices charged to European countries. As a result. Ukrainian iron ore producers should introduce technologies to allow both raising the share of products with higher iron content and improving energy efficiency. Ukraine’s iron ore market may shrink considerably. and Southeast Asia. The growing demand for seaborne iron ore from China will be the key factor supporting the international benchmark prices. Probability: Medium Increasing reliance of Ukrainian steel mills on iron ore imports from Russia. they have nevertheless seen a converging trend. making them likely to rise in the next three-to-five years. World iron ore prices may decline due to the prospect of a double-dip recession and a resulting decline in steel demand. However. Russia’s monopolist natural gas company. Probability: Low 7 . In the cost competition area. inflation in Ukraine. This risk is pertinent mostly to Metinvest. and competitors’ optimisation of their transportation costs. they face stronger competition from international competitors. should prompt Ukrainian mining companies to improve their energy efficiency and labour productivity. Gazprom. Although energy prices for Ukrainian industry have been lower than energy prices in Europe and South and North America during the last four years. such as the prolongation of stationing the Russian Black Sea Fleet on Ukraine’s territory have so far allowed Ukraine to receive additional discounts on the natural gas price. which is the key supplier of iron ore to the IUD and Zaporizhstal and controls about 70% of the domestic iron ore market. which is likely to continue in the next four-to-five years. Probability: Medium to high Increasing competition. which are charged to Ukrainian iron ore producers. if international financial markets start tightening again. As Ukrainian producers are striving to expand their sales to the markets of Western Europe. and possible reorientation of Metinvest’s sales to the voracious Chinese market. Ukrainian iron ore producers may fail to raise sufficient funding for their capex. the industrialisation of developing countries mitigates the risk of the global demand for steel and steelmaking inputs falling again. are currently regulated by the state. Probability: Medium Decline in international benchmark prices for iron ore. The risk is mitigated by the uncertainty in transferring the control stakes to well-integrated steelmaking groups of Russia. these key Ukrainian consumers of domestic iron ore may reorient at least a part of their consumption towards imports of Russian iron ore. As Russia’s Vneshekonombank has acquired control stakes in the Industrial Union of Donbass (IUD) and Zaporizhstal for their further transferring to Russian businesses. In the product quality and product range area. However. the existence of framework agreements between Metinvest and the IUD on ore supplies until 2015. The Ukrainian government plans to liberalise electricity tariffs.December 2010 Sector Primer Iron ore 2010 Key risks Rising energy costs. We expect that the liberalisation mechanism will provide for a gradual increase in electricity tariffs. Ukraine’s political concessions to Russia. Probability: Medium to high Undermined ability to finance investment projects. Electricity tariffs.

Metinvest and Ferrexpo. the sector leaders. as Ukrainian iron ore is priced in USD. Probability: Low Possible shift of the global demand towards higher-grade iron ore products. Probability: Low 8 .December 2010 Sector Primer Iron ore 2010 Appreciation in the hryvnia may hurt competitiveness. however. are already planning to upgrade their equipment in order to increase the share of products with higher iron content. the negative impact from this appreciation will be mitigated by the dollar’s depreciation against other currencies. Ukrainian producers will have to raise energy consumption and thus inflate their production costs. and. Also. Although we believe that the hryvnia will appreciate against the dollar in the next two years. would lower their cost competitiveness. An appreciation in the hryvnia versus the US dollar would raise Ukrainian ore miners’ costs denominated in dollars. given the current scarce financing of the modernisation of both steelmaking and iron ore processing caused by the financial crisis. is most likely to be slow for another five years. including key competitor currencies the Australian dollar and Brazilian real. This shift in demand. with a likely decline of profit margins. To increase the iron content of their products.

Iron ore concentrate and pellets are the key commercial products sold by Ukrainian companies. Low integration of the domestic iron ore sector with Ukrainian steel mills has created the domestic market of iron ore. fines. Russian iron ore imports to Ukraine are likely to increase in the long term. which will cause the Ukrainian iron ore sector to reorient more towards exports.December 2010 Sector Primer Iron ore 2010 Supply chain and technology The relatively low grade of Ukrainian iron ore necessitates its further processing through the consequent stages of beneficiation and agglomeration before being consumed by steel mills. ICU estimates The main product of beneficiation. or pellets). cannot be charged in the BF directly. iron ore concentrate. Typically having a low iron content of 30-35% Fe. Ukrainian iron ore cannot be used in BFs directly. Chart 1. are focused on exports. and thus blocks the smelting process. Metinvest. each of which affects blast furnace (BF) productivity. sulphur. Hence. made in the sintering and pelletising processes. sinter ore (60-61% Fe) Concentrate (65-67% Fe) Pellets (58-67% Fe) Sinter (47-58% Fe) EXTERNAL STEEL MILLS Sources: Ferrexpo. since it blocks the passage for ascending gas inside the BF. etc. while a number of other producers. which is 60-70% controlled by one supplier. The process of iron ore upgrading used to obtain higher iron content and minimise chemical impurities is called beneficiation. including Ferrexpo. sinter ore (60-61% Fe) ORE MINING AND PROCESSING PLANTS Agglomeration Mining Drilling Blasting Excavating Iron ore (Fe<50%) Lump ore. Turkey. Two types of products commonly made in the agglomeration process are sinter and pellets. dolomite. phosphorus. concentrate is agglomerated in high temperatures into larger. and Southeast Asia. respectively. lumpy pieces with/without the mixing in of additives like limestone. etc) and by its structure of form (ore lump. with pellets playing an increasingly important role in exports. However. Supply chain of Ukrainian iron ore companies Lump ore. Ukrainian pellets are quality-competitive for the markets of Europe. Metinvest. as Russian steelmakers are gaining control over the main Ukrainian ore-deficient steelmakers. The behaviour of iron ore is determined by its chemical composition (content of iron. sinter ore (60-61% Fe) Sintering Sinter (47-58% Fe) Beneficiation Crushing and grinding Dry magnetic separation Flotation Concentrate (65-67% Fe) Combining sinter material Dewatering RELATED STEEL Concentrate (65-67% Fe) MILLS Concentrate (65-67% Fe) Pelletizing Combining pellet material Dewatering Pellets (58-67% Fe) Lump ore. and needs preliminary upgrading. 9 . Technology basics Iron ore extracted in Ukraine typically needs beneficiation and agglomeration before being fed to a steel mill’s blast furnaces Ukrainian iron ore mining companies represent a constituent part of the domestic blast furnace/base oxygen furnace (BF/BOF) process chain used to produce steel.

Central GOK and Northern GOK. the addition of Ingulets GOK to Metinvest’s existing assets. mixed with binding agents. apart from being directed to further processing stages. and coke breeze. and other iron-bearing materials. iron ore. and Zaporizzhia Iron Ore Combine are engaged in the underground mining of relatively rich iron ore with Fe content of over 50%. in a three-to-five-year term. screening. which were privatised by the Ukrainian government in 1999-2004. and is performed by the sector leaders Metinvest. 10 . making iron ore producers increase their exports The existence of the iron ore market in Ukraine is possible due to the low integration of the Ukrainian iron ore sector with the domestic steel mills. and flotation. As this privatisation was carried out in a non-transparent and corrupt fashion. and cooling. blasting. In pelletising. the role of exports in Ukrainian iron ore producers’ sales structures should substantially increase. iron ore is transported to the beneficiation stage. After extraction. Agglomeration Sintering and pelletising are two common types of iron-ore agglomeration Agglomeration of concentrate in Ukraine is made through either sintering or pelletising. when Metinvest Holding merged with the main iron ore-making and steel-making assets of Smart Holding. In the process of ownership concentration. jigging. Supply chain Domestic iron ore market should further shrink As Ukrainian steel mills will be becoming more upstream-integrated. such as washing. such as Kryviy Rih Iron Ore Combine. The resulting product. otherwise. the domestic iron ore market should considerably shrink. the domestic iron ore market will shrink. and is most commonly termed sintering ore. After crushing. advanced gravity separation. The Ukrainian iron ore sector remains poorly integrated with domestic steel mills All the Ukrainian iron ore companies evolved from formerly state-owned ore-mining and processing plants (OMEP. Correspondingly. and Southern GOK. In the sintering process. such ore is ready for the sintering stage. As a result. which is a more recent alternative to sintering. or merge with domestic iron ore suppliers. a number of Ukrainian miners.December 2010 Sector Primer Iron ore 2010 Key stages of iron ore processing Mining Open-pit mining of iron ore prevails in Ukraine Iron ore in Ukraine is extracted either from open-pit or underground mines. an abbreviation that is the equivalent of GOK in Russian). In both cases. concentrate is mixed with water and other additives. and the resulting slurry is dried. which followed privatisation. which does not require beneficiation. and baked. although we believe that this will mostly likely happen gradually. Additionally processed through crushing and heating. Sukha Balka. they are prepared for use in BF. the key event occurred in 2007. the sinter is ready for use in BF. with a Fe content of 65-67%. After the pellets have been screened and undersized material removed. the previous economic relations between domestic OMEPs and steel mills were mostly destroyed. However. and shoveling massive amounts of dislodged ore. The output material is ball-like granules with an 8-10mm diameter called pellets. dry magnetic separation. form the sinter burden. iron ore concentrate. non-integrated Ukrainian steel mills will either develop their own mines. However. acquisitions in the Ukrainian steel sector made by Russian companies are likely to reorient at least part of its iron ore consumption towards imports from Russia. increased the holding’s share in Ukraine’s production of merchant concentrate from 21% to 80%. Beneficiation Iron ore beneficiation is used to increase Fe content Upgrading iron ore to a higher iron content may involve several different techniques. flux (limestone). Open-pit mining is more common. is marketed by Ukrainian miners to external customers. Ferrexpo. which is then granulated and heated. concentrate. The open-pit mining process includes drilling blast holes.

99mln tonnes (excluding Mariupol Illich Steel. which includes Mariupol Illich Steel. Domestic external buyers of Ukrainian iron ore in 2009 (%) Note: The volume of sales by Ukrainian companies to external domestic steel mills in 2009 – 11.2 Donetskstal 17. Central GOK. Of the rest of Ukrainian OMEPs. The possible reorientation of Zaporizhstal and the IUD towards the iron ore imports from Russia will further squeeze the domestic iron ore market. however. Metinvest is 130% sufficient in iron ore (based on its current steelmaking capacity. Mainly due to this dependence on external iron ore. while Metinvest has a framework agreement on supplying iron ore to the IUD until 2015. Metinvest and ArcelorMittal Kryviy Rih. which are not self-sufficient in iron ore: IUD. Zaporizhstal. The whole process. in fact.0 IUD 60. some have to sell their products on the open market either in Ukraine or abroad (Poltava GOK-Ferrexpo. may take several years. 11 . Furthermore. as Russian steelmakers currently have deleveraging issues as their first priority.December 2010 Sector Primer Iron ore 2010 At the moment. and controls over 60-70% of the Ukrainian iron ore market. with Metinvest and other Ukrainian producers having to focus more on exports of iron ore.6 Metinvest 71. Sukha Balka). while others export to their parents’ countries (Zaporizhzhia Iron Ore Combine.4 Source: Metal-Courier Source: Metal-Courier The biggest domestic buyers of iron ore. is currently formed by three Ukrainian steelmaking groups. of which Metalloinvest looks to be the main candidate.69mln tonnes (excluding Mariupol Illich Steel.0 Imports 23. only ArcelorMittal Kryviy Rih’s OMEPs and Metinvest’s Northern GOK. may substantially reorient towards imports from Russia The domestic iron ore market.6 Chart 2. due to its significant excessive iron ore-making capacity. these control stakes may finally go to Russian steelmaking groups. Kryvyi Rih Iron Ore Combine). A high concentration of ownership in the iron ore sector has created an oligopoly in the Ukrainian iron ore market At the same time. acquired in 2010). the IUD and Zaporizhstal. which merged with Metinvest in 2010) Petrovsky Steel 3. only two steelmaking groups in Ukraine. having concentrated substantial ore-mining capacities with rich reserves. have upstream-integrated their steel mills to domestic OMEPs. which merged with Metinvest in 2010) Other domestic producers 5.1 Zaporizhstal 19. Chart 3. With the acquirers most likely acting as mediators. Southern GOK. Suppliers to the Ukrainian iron ore market in 2009 (%) Note: The volume of the Ukrainian iron ore market in 2009 – 15. and Donetskstal. control stakes in the IUD and Zaporizhstal were acquired by Russian companies through Russia’s state-owned Vneshekonombank in 2010. and Ingulets GOK are downstream-integrated to Ukrainian steel mills in one steelmaking holding.

Donetskstal). which is the only Ukrainian OMEP with a sinter plant on its premises. 12 . Ukrainian iron ore sales structure in 8M10 (%) Note: total amount of Ukraine’s iron ore sales in 8M10: 56. the secondlargest consumer without its own iron ore base. with Ferrexpo exporting 100% of its products in 2010. Sukha Balka. which specialises in the pellet segment only. accounting for 79% in total export volumes in 2009.9 External domestic sales 26. These products are even more significant in terms of exports. merged with Metinvest. while other sinter plants belong to domestic steel mills. mainly at the expense of sales to poorly integrated steelmakers. and technological specifics have caused Ukrainian iron ore producers to market all the products created along the iron ore production chain. Zaporizhstal.9 Internal domestic sales 33. and pellets are traded by Metinvest and Ferrexpo. At the same time. the domestic iron ore market accounts for only about 20% of Ukrainian iron ore producers’ total sales in 2010.2mln tonnes Chart 5. concentrate and pellets are the key commercial products of Ukrainian iron ore companies. Nevertheless. and other companies with deposits of iron ore with relatively high iron content (55-62% Fe).4mln tonnes External domestic sales 17. the share of OMEPs’ internal sales to related steel mills within one steelmaking group grew from 24% in 2009 to 34% in 8M10. Sinter is mostly traded by Southern GOK. Exports play an increasingly significant role in the iron ore sector operations: the share of iron ore exports in the sector’s total sales volumes grew from 34% in 2008 to 45% in 2009. after Mariupol Illich Steel.December 2010 Sector Primer Iron ore 2010 Sales structure and key commercial products During the recession. the Zaporizhzhia Iron Ore Combine. both for domestic sales and exports. Sintering ore is traded mostly by the Kryviy Rih Iron Ore Combine. Chart 4. jointly accounting for 72% in the total sales volumes in 2009. Metinvest and Ferrexpo have emerged as the leading iron ore exporters in Ukraine.7 Exports 39. which were hit the hardest by the global economic recession.7 Exports 39.7 Internal domestic sales 42.3 Source: Metal-Courier Source: Metal-Courier Concentrate and pellets are the key commercial products of Ukrainian iron ore producers Different mining conditions. Concentrate is traded by Metinvest only. the share of exports in iron ore sales of Ukrainian companies substantially increased Formed by steelmaking companies which are not self-sufficient in iron ore (the IUD. Ukrainian iron ore sales structure in 2009 (%) Note: total amount of Ukraine’s iron ore sales in 2009: 73. ore quality.

0 25. due to the following advantages: As opposed to sinter. thus causing serious transportation bottlenecks.0 20. pellets should gain an increasing share in demand for iron ore products in Ukraine and the rest of the world. which does not require agglomeration. while SCM owns a 75%-stake in Metinvest. 13 . Sales structure of key domestic iron-ore producers in 2009 Notes: (1) . while Metinvest plans to increase the pellet share in its total sales and decrease the share of concentrate. steel mills tend to switch to lower-quality iron ore products.Zaporizhzhia Iron Ore Combine (ZIOC) is 75%-controlled by Minerfin. and as such. steel mills are raising their shares of direct reduced iron production. which is more subject to spillage and tends to accumulate moisture and freeze during winters. strict penalties already allow deliveries of Ukrainian pellets only. as they focus instead on cost-cutting rather than productivity targets.0 internal domestic external domestic Chart 7. Nevertheless. pellets are also more transportable than concentrate. Further depletion of deposits of high-quality lump ore.Kryviy Rih Iron Ore Combine (KrIOC) is jointly controlled by SCM and Smart. (2) . which is being actively introduced in steel mills’ BFs in Ukraine and other countries.0 sintering ore pellets lump ore (mln tonnes) 20. KrIOC is not included in Metinvest’s assets and is deemed a separate business unit.Kryviy Rih Iron Ore Combine (KrIOC) is jointly controlled by SCM and Smart. (2) . By-product sales structure of key domestic iron-ore producers in 2009 Notes: (1) . KrIOC is not included in Metinvest’s assets and is deemed a separate business unit. which is largely pellet-based. Due to their hardness. their prices incorporate premiums related to other marketable products of iron ore.Southern GOK is jointly controlled by Evraz (50%) and Smart (50%) exports 30.0 Other Evraz ZIOC (1) KrIOC (2) Southern Ferrexpo Arcelor.0 10. while SCM owns a 75%-stake in Metinvest. pellets are considerably stronger.December 2010 Sector Primer Iron ore 2010 Chart 6.0 0.Southern GOK is jointly controlled by Evraz (50%) and Smart (50%) concentrate sinter 30.0 0.0 10. which makes them more transportable.0 15.0 (mln tonnes) 25. Pellets’ physical and chemical characteristics enable steel mills to achieve the highest BF productivity. (3). puts additional quality requirements on iron ore feed. The main disadvantage of pellets is that during steel demand downturns. Ferrexpo plans to keep pellets as its key merchandise product. (3).0 15.Metinvest GOK (3) Mittal KR Source: Metal-Courier Source: Metal-Courier The Ukrainian iron ore sector will further increase the share of pellets in its sales Pellets are the iron ore product with the highest added value. will increase demand for pellets.0 5. Sintering plants are likely to face increasing sanctions and limitations due to substantial pollution produced by the sintering process. The pulverised coal injection process.0 5. All over the world.Zaporizhzhia Iron Ore Combine (ZIOC) is 75%-controlled by Minerfin. thus increasing demand for pellets. while on the European market.Metinvest GOK (3) Mittal KR Other Evraz ZIOC (1) KrIOC (2) Southern Ferrexpo Arcelor.

9% Fe for Central GOK. while for the Middle East other than Turkey.5-63.4 Concentrate 46.0 Pellets 28. the companies should increase the share of 65% Fe pellets produced. Being long-standing customers of Ukrainian iron ore miners.3 Lump ore 0.0mln tonnes Sinter 1.3 Pellets 33.2mln tonnes Sinter 12.3 Lump ore 0. and Toyota) and electronics manufacturers (such as Panasonic Corporation). the low phosphorus content in Ferrexpo’s pellets make them particularly valuable for European and Asian flat steel producers delivering their products to automakers (such as BMW. which would require additional capex. Furthermore. and Southeast Asia. Product structure of Ukrainian iron ore sales in 2009 (%) Total amount of Ukraine’s iron ore sales in 2009: 73. To further penetrate the market of Western Europe. the steel mills of Central and Eastern Europe have good technical compatibility with Ukrainian pellets. Product structure of Ukrainian iron ore exports in 2009 (%) Total amount of Ukraine’s iron ore sales in 2009: 29. 14 .5 Sintering ore 18.December 2010 Sector Primer Iron ore 2010 Chart 8. Iron content of pellets produced by Metinvest is in the range of 60. Audi.8 Concentrate 43. while Ferrexpo produces pellets of 62% Fe and 65% Fe. Turkey and Southeast Asia Ukrainian pellets have the competitive quality necessary for the markets of Europe. they should introduce 68% Fe pellets.4 Source: Metal-Courier Source: Metal-Courier Ukrainian pellets have the competitive quality necessary for the markets of Europe.2 Chart 9.5% Fe for Northern GOK and an average of 63.9 Sintering ore 15. Turkey.

Ukraine ranks No. and introduction of additional processing capacities by private businesses have the potential to boost Ukrainian iron ore exports by at least 65% during 2010-15. Ukraine’s share in global iron ore output in 2009 was just 2%.S.2 12.0 8.0 6.09 0.0 4. 15 .26 0.6 (bln tonnes) 0.2 2.0 2.8 1.0 Brazil Australia India 0. Top 10 countries in the world in terms of iron ore reserves based on iron content Russia Australia Ukraine Brazil China India Kazakhstan Venezuela Sweden United States Other 0.0 16. Ferrexpo.0 8.S.1 in the world in terms of crude iron ore reserves.0 0.06 0. which plans to actively develop currently idle deposits in an attempt to more than double its output in the next five years. As the sole owner of Ukraine’s mineral resources. accounting for 19% of the world total.0 Other countries 0.December 2010 Sector Primer Iron ore 2010 Strong growth potential Having the third-largest reserves of iron ore in the world based on iron ore content.38 0.4 2.9 14. the regions where they also have an edge over competitors in transportation costs due to Ukraine’s favourable geographical location and well-developed transportation routes. KGOKOR.1 10. Being traditionally dominant in Central and Eastern Europe.0 10. This places Ukraine among the countries that underproduce the most in terms of their reserves. and where they can supply the products with competitive quality.0 13. this implies a No.2 0. The adjacent Kremenchuk Iron Ore region ranks second in terms of reserves accessed by just one business group.3 4. Ukraine ranks just sixth in terms of the annual iron ore production. In the case of recalculating the country’s reserves based on iron ore content. the state still plays a key role in distributing and regulating private businesses’ access to iron ore reserves.2 9. with the largest number of business groups involved in iron ore extraction. Chart 10. further development of reserves. including national steelmaking leaders Metinvest and ArcelorMittal Kryviy Rih.5 7. the Kryviy Rih Iron Ore basin is the largest (56% of the total national reserves) and the most actively exploited.0 2.37 Chart 11. Ukrainian iron ore companies are able to further penetrate the markets of Western Europe and the Middle East. At the same time.4 0. Reserves: Underexploited and undistributed Ukrainian iron ore reserves are substantially underdeveloped Substantial commercial underdevelopment of domestic iron ore reserves in Ukraine creates solid growth opportunities for Ukrainian mining businesses.90 Russia Ukraine South Africa 0.0 Source: U.05 (bln tonnes) 14.0 3.21 0. which accounts for nearly 56% of the total national reserves of iron ore in the region Among proven Ukrainian iron ore deposit sites. Privatisation of the last state-owned iron ore company.3 position in the global ranking and a 12% share of the global reserves. Top eight countries–producers of iron ore in 2009 China 0. Geological Survey Ukrainian companies most actively exploit the Kryviy Rih Iron Ore basin. Geological Survey Source: U.

At the same time. and other issues.0 1.4 Business group presence Metinvest. The state controls ore reserves allocation All mineral resources.8 27-70 28. including iron ore. Smart. and ArcelorMittal) to expand their mining and production.Donetskstal is in the process of obtaining a mining license.December 2010 Sector Primer Iron ore 2010 Other iron ore regions have a low presence of extraction activities.5 3. Business groups’ presence in the top five iron-ore basins and regions of Ukraine Iron ore basins/regions Kryviy Rih Basin Kremenchuk Region Bilozirka Region Pryazovya Region Kerch Basin Other Total Number of ore deposits (bln tonnes) Total 29 5 6 3 8 29 80 Exploited 21 2 1 6 30 Reserves bln tonnes 16.0 % of total 56% 14% 8% 10% 5% 6% 100% Fe content (%) 30-67 27. Correspondingly.4 1.5 55. Zaporizhzhia Iron Ore Combine. ArcelorMittal. Evraz Ferrexpo Zaporizhstal. are owned by the Ukrainian state. Metinvest. the country’s mineral resources cannot be privately owned. ICU estimates. with 69-72% iron content. Minerfin Donetskstal1 --- Notes:1. which plans to construct an OMEP with a 20mtpa iron ore capacity in the region. Privat. environment. which may be further extended for another five years. Ferrexpo. Currently.3 2. among which the Pryazovya region is the most prospective one. since its deposits have been prepared for further development since the 1970s.7-62. For the development of an unexplored deposit. the likeliest candidate for obtaining the license to exploit Pryazovya region’s reserves is Donetskstal. while ore-insufficient steelmakers have either to depend on outsourcing. miners should obtain an exploration license for an initial period of five years. and Zaporizhstal has just a minority control (25%) stake in one of its iron ore suppliers. including adherence to mining schedules. or seek mining licenses from the state to engage in costly greenfield projects. technology. A separate license is required for the extraction of minerals for an initial period of up to 20 years. Industry players’ uneven control of reserves Three companies currently control about 82% of the total iron ore reserves licensed by the Ukrainian state for exploitation Uneven access to iron ore reserves by the domestic industry players allows the ore-rich business groups (Metinvest. which gives out the rights for their exploitation to private businesses In order to obtain and sustain access to iron ore reserves in Ukraine. 16 .4-58. the IUD and Donetskstal are so far totally deprived of their own iron ore mines. According to the current Ukrainian legislation and regulations. companies in Ukraine may be authorised for mining activities by obtaining licenses and permits from relevant state authorities. Sources: Company data.8 30. businesses are critically dependent on the Ukrainian state’s licensing system. and may only be granted for the use of legal entities or individuals. Ferrexpo. and may contain special conditions relating to scope of work. or does not satisfy its license conditions. and can provide ore that is relatively easily beneficiated to concentrates.9 4. These licenses may be suspended or revoked if a company does not comply with existing regulations. and ArcelorMittal together account for 82% of the iron ore reserves to be exploited under the current licenses. Table 1.

433 3.169 900 300 300 266 266 300 300 n/d --- 33 58-66 58-67 59 59 35 35 56-59 --- 49. in October 2010.0 100.648 1. 17 . or a 34% increase in Ukrainian total export volumes of iron ore products.868 ----------GKZ5 reserves (mln Iron content (%) tonnes) --------n/a3 n/a3 n/a3 n/a 3 Metinvest Metinvest Metinvest Metinvest total Ferrexpo Ferrexpo Ferrexpo Ferrexpo Ferrexpo Ferrexpo Ferrexpo Ferrexpo Ferrexpo Ferrexpo total ArcelorMittal Minnerfin (Slovakia) Zaporizhstal SCM1 Privat 1 32 32 34 29-31 30 30 55 ------ n/a3 15. In order to privatise KGOKOR.807 937 7.192 1. which does not include Kryviy Rih Iron Ore Combine in its Iron Ore Division.there are no data available on GKZ reserves for separate deposits. 5 – GKZ standards .3 --Southern GOK Southern GOK Sukhaya Balka --- Smart2 Evraz2 Evraz Industrial Union of Donbass Donetskstal Notes: 1. as well as 724m tonnes of oxidized ore accumulated by neighbouring Southern GOK (jointly controlled by Smart and Evraz) and ArcelorMittal Kryviy Rih. Potential resources to be used by KGOKOR are the oxidized iron ore of Eastern Valiavkino deposit. SCM also controls 75% in Metinvest.3 82.866 97. based on their 2009 level of 29mt. About US$1. the German Democratic Republic.9 63.3 100.0 Poltava GOK Yeristovo GOK Belanovskoe deposit Galeshinskoe deposit Brovarkovskoe deposit Manuylivske deposit Kharchenkivske deposit Vasylyivske deposit Zarudnenske deposit 899 632 -------1. with an estimated 1bn tonne reserves.according to standards set by Australasian Joint Ore Reserves Committee (JORC).classification system and estimation methods for reserves and resources established by the Former Soviet Union . 4.9 Krivorizhsky Iron Ore Combine 49. Hungary. and Romania began construction of KGOKOR in 1985. The privatisation and the consequent completion of the construction of KGOKOR could potentially result in more than a 100% increase in Ukrainian pellet export volumes.702 326 -----6.December 2010 Sector Primer Iron ore 2010 Table 2.0 25. 2.689 3. Business groups’ control of iron ore reserves and production assets in Ukraine Group Control (%) Ore-mining and enriching JORC4 reserves JORC4 mineral resources plant/deposit (mln tonnes) (mln tonnes) 75.9 Krivorizhsky Iron Ore Combine 50. so it is now 70% complete.0 100.4bn has been invested in the construction so far.7mt. Czechoslovakia. KGOKOR alone will be able to add 34% to Ukraine’s total export volumes of iron ore based on the 2009 level KGOKOR has so far been the sole Ukrainian plant designed to process oxidized iron ore.65bn of the projected US$2.0 100.0 75.0 100. 3. the Ukrainian government announced its intentions to sell KGOKOR and initiated preparations for the plant’s privatisation.531 97. ICU estimates Privatisation process nearly finalised KGOKOR is the last nonprivatised large iron ore mining and processing plant in Ukraine Kryviy Rih Mining and Processing Plant of Oxidized Ore (KGOKOR) has so far remained the only non-privatised iron-ore-making company in Ukraine. The Soviet Union.Evraz and Smart jointly control Southern GOK.0 50.Privat and System Capital Management (SCM) jointly control Kryviy Rih Iron Ore Combine. based on their 2009 level of 9.0 101.0 102.0 99. but froze the project in the early 1990s.0 100.5 Central GOK Northern GOK Ingulets GOK 709 713 444 1. Sources: Company data. Once completed.0 ArcelorMittal Kryviy Rih ZaZhRK ZaZhRK -------82 --2. However.

5 (mln tonnes) 2. Germany for 9%. given their strong capabilities to finance M&A. ArcelorMittal.600 8.5 Metinvest Southern GOK Minerfin Kryviy Rih Iron Ore Combine Other (mln tonnes) 3.5 0.0 China Turkey Other Ferrexpo 4. well-developed rail links to its western border. and Bulgaria for 1%. where they are able to compete in transportation costs with more distant Brazilian and North American producers. Slovakia. proximity to the Black Sea also provides Ukrainian miners an opportunity for export to the fast-growing Chinese market. Ukrainian iron ore exports by key destinations Notes: CEE .5 0. but also compete for market share in the Middle East and China Favourable geographical location and logistics Ukraine’s geographical location. with the major shipments traditionally going to Austria. ICU estimates 18 . This predisposes Ukrainian iron ore exports towards these markets. the Czech Republic.0 0. and the tandem of Smart and Metinvest are the most likely candidates to acquire KGOKOR as result of privatisation. Chart 13.0 1.or higher self-sufficient in iron ore and will be followed by the rest of Ukrainian steelmakers by the end of KGOKOR’s construction. China’s share of the total exports of Ukrainian iron ore increased from 16% in 2007 to 38% in 9M10. Slovakia for 22%.5 3.5 2. KGOKOR will become 100%-oriented towards exports. heavy political weight.0 0.000 8.5 3.via the Panama Canal.Central and Eastern Europe CEE 4. Romania accounts for 68%. Poland. 2.0 2. and Turkey.0 Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Source: Metal-Courier Source: Metal-Courier However. Brazil.December 2010 Sector Primer Iron ore 2010 Ukraine has to pay off debt to other countries-participants of the project. Well-developed transportation infrastructure and access to the Black Sea allow Ukrainian companies not only to dominate in Central and Eastern Europe.0 1. Evraz.500 10 n/d 30 33 n/d Freight rate2 (US$/tonne) 10 n/d 28 25 36 Port Hedland Saldanha Yuzhny Tubarao Seven Islands 1 BHP Billiton Kumba Ferrexpo Vale Rio Tinto Australia S. Evraz. Shipping distance and freight rates to main China ports Sea port of departure Company Country Distance (nautical Sailing days miles) 3.000 11.5 1. as well as welldeveloped rail and river transportation links to the Black Sea ports.0 2.as of September 2010 Source: BHP.0 3. Table 3.0 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 1. Serbia. and interest in processing oxidized ore in the same location. We believe that. Central and Eastern Europe accounted for 60-76% of the total exports of Ukrainian iron ore from 2007-10. as these business groups are already 100%. Ferrexpo. and the tandem of Smart and Metinvest are the most likely candidates to acquire KGOKOR ArcelorMittal. Overall. provide Ukrainian mining businesses with a freight-cost advantage over their more distant competitors from Russia. Of US$517m debt. Ukrainian iron ore exports by key exporters Chart 12. and Australia in supplying merchant iron ore products to the markets of Europe and the Middle East.600 11. Africa Ukraine Brazil Canada Notes: 1 .

in 2008-10E. ICU estimates …however. world iron ore prices are substantially driven by the demand for steel. we use estimated days of seaborne transportation from Black Sea ports. Major trade flows of iron ore in 2009 CIS (149/32) Europe (28/-96) China (258/-629) JKT (0/-160) India (204/114) S. America (336/276) Australia (371/365) Notes: 1) Data in brackets – (“the region’s iron ore production”/”the region’s iron ore net exports/. S. Chart 14.December 2010 Sector Primer Iron ore 2010 Favourable market environment World demand for iron ore correlates closely with steel demand. iron ore However. 4) JKT – Japan. mln tonnes. respectively. Source: BHP Billiton. as well as steelmakers higher concentration of the iron ore industry compared to the steel industry.net imports”). CRU. Iron ore and steel demand The demand for steel and demand for iron ore have a common base… Similar to steel prices. which is concentrated around few regions. which have accounted for 15% and 50% of the world steel consumption. Consequently. Unlike steel demand. and real estate projects. Steel demand. 3) For CIS. both iron ore and steel prices are closely related to the availability of finance for governments and businesses to implement industry. China’s urbanisation and industrialisation is the key driver of the global iron ore demand and is also a good opportunity for the expansion of Ukrainian iron ore exports. 2) Data under trade flow arrows – “days of seaborne transportation”. the demand for iron ore is additionally affected by the oligopolistic nature of the global iron ore market. the global demand for iron ore is different from the demand for steel in that the companies have stronger bargaining power of iron ore companies is stronger than that of their steelmaking bargaining power than customers. mainly due to regional imbalances in iron ore supply and demand. however. driven by global economic growth. 5) Data over trade flow arrows – iron ore shipments in 2009. with China being the largest one. depends to a considerable degree on the heavy machinery and construction sectors.Korea and Taiwan. “average estimated freight rates per t of iron ore product as of September 2010”. in turn. infrastructure. The iron ore oligopoly enables Ukrainian iron ore producers to have the highest profit margins in the steelmaking industry. 19 .

0 BHP iron-ore fines (contract) CIS export billets US import rebar (%) 200.0 150. are in shortage of iron ore and depend on its imports from Australia.0 100. with 60% of the world steel trade volumes relating to extra-regional exports in 2008.0x. China. and the EU. Chart 16. and the CIS. which have an iron ore overcapacity.0 50. while the top three iron ore companies produced 33% of the world total output of iron ore and exported 73% of the world total seaborne trade volumes of iron ore. and. as steelmakers strive to pass on increasing costs to their consumers. Major extra-regional trade flows of iron ore versus steel in 2008 (mln tonnes) 50mln tonnes of iron ore 50mln tonnes of steel Source: World Steel Association The top ten steelmakers produce 23% of the world steel output.0 250. Chart 15. steel production is more oriented towards intraregional consumption.0 0. As a result of the higher bargaining power of iron ore companies. the top ten steelmakers’ share was 44% in China’s steel output. India.0 -50. South Korea. the growth in iron ore prices tended to be more prolonged and outpaced the growth in steel prices more often during demand hikes in 2007-10. iron ore prices have an additional inflationary effect on steel prices. As the world key steelmaking regions need to import high volumes of iron ore from overseas.December 2010 Sector Primer Iron ore 2010 Extra-regional exports of iron ore exceed steel exports by 2. while the top three iron ore companies control 73% of the seaborne trade of iron ore In 2009. which accounted for 79% of the world iron ore trade in 2008. and slightly less than 23% in the total world steel output. are highly concentrated in Southeast Asia and Europe Several key steelmaking regions. On the other hand. seaborne trade dominates in the global extra-regional exports of iron ore. Change in iron ore and steel prices to the basis at March 2006 China iron-ore fines (spot) 300.0 Mar-06 Source: Bloomberg Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 20 .7-3. Japan. Brazil. unlike steel exports. Furthermore.

4 145.3 86.9 7.5 168.1 47.3 5.486.8 25.4 0.3 37.3 72.8 2.7 -2.5 162.1 70.7 -6.7 145.1 131.9 257.0 149.6 23.5 10. World consumption of iron ore by country or region.526. World consumption of iron ore by country or region China 3.0 177.1 167.4 169.0 9.4 6.7 Notes: 1.0 9.9 294.2 87.9 -12. and of CIS.2 22.2 1.2 China Rest of Asia Europe CIS North America South America Middle East Africa Oceania1 Total 687.2 80.5 1. as the country’s industrialisation and urbanisation is underway.0 8.541.504.053.2 1.4 5.6 -7.2 1.579.1 175.248.6 88. driven by more than US$1trn worth of industry and infrastructure projects.2 20.0 -9.8 61. 2005-15 (mln tonnes) Country/region 2005 2006 2007 2008 2009 CAGR 2005-09 (%) 16.3 74.7 84.529.4 173.7 9. Source: CRU Chinese consumption of iron ore is estimated by the CRU to grow at 15% CAGR during 2010-15.350. America Middle East Africa Oceania* (bln tonnes) 2. The key region driving this increase will be China.3 392. led by Brazil.9 2.0 162.5 374.0 897.8 85.6 79.0 1.0 27.4 51.2 20. India.2 170.0 23.899.5bln tonnes.1 69.2 9.5 0.8 1.399.5 6. New Zealand and the Pacific Island nations.4 175.7 261.0 10.7 301.1 2010E 2011E 2012E 2013E 2014E 2015E CAGR 2010-15 (%) 1.3 2. requiring further growth in steelmaking capacity.5 9.9 354. The Middle Eastern countries are poised to demonstrate the fastest growth in iron ore consumption.5 Rest of Asia Europe CIS N.0 0. Table 4.8 6.6 1. America S.7 1.689. mainly responsible for iron ore consumption growth in the rest of Asia.8 6.5 83.8 2.1 1.5 1.3 75.7 121.171.7 7. Source: CRU 21 .6 72.261.6 -8.0 136.4 137.7 42.9 48.912.7 1.8 86.461. Rising iron ore demand will be further supported by the emerging-industry economies of South America.511.6 88. led by is estimated to account for 64% of the total world consumption in 2010.7 25.3 1.069.7 40.2 3.0 26.9 17.7 32. as the of iron ore will grow in Commodity Research Unit (CRU) expects world consumption of iron ore to grow strongly in 2010-13.9 9. is on the same track of economic development.3 21.7 148. which emerging markets.1 3.7 22. mainly due to 2010-13.9 23. to around 2.2 1.0 2.5 166.0 407.3 67.6 4.0 83.4 6.6 70.5 157. New Zealand and the Pacific Island nations.4 44.0 2.3 2.1 19.9 289.4 1.556.1 19. targeting a 35% growth in steelmaking capacity from 2010 to 2012.5 156.0 10.455.7 22.4 121.7 251. led by Russia.0 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E Note: Oceania consists of Australia.Oceania consists of Australia. BRIC and the Middle East Chart 17.9 2.5 1.December 2010 Sector Primer Iron ore 2010 China drives the global demand for iron ore The world consumption Ukrainian iron ore miners will capitalise on the buoyant global demand for iron ore.1 323.

5% CAGR in 2012-15.4 0. mainly due to the high fragmentation of the steel industry in China and China’s remaining high dependence on iron ore imports. the CIS. Metalytics expects China’s domestic iron ore production to level off in 2011-12. the CRU predicts that Chinese iron ore production will slip down at 2.4 0. will therefore play the key role in the region in building up sales volumes. since Chinese iron ore has a low iron content (20-30%) and is costly to mine and process. while iron ore imports will account for as high as two-thirds of the country’s total iron ore consumption. BHP Billiton. will be able to satisfy only 45% of its steel production needs in 2010 with its local iron ore supplies. S.Africa CIS Oth. which accounted for 73% of the seaborne ore trade volume and for 30% of the world iron ore production in 2009 and also dominate the world iron ore industry in capacity expansion projects. The region’s leader. in April 2010.0 1992 1997 2002 2007 2012 0. The Big Three In the foreseeable period of 2011-15.8 0. China.3 0. they capitalise on the oligopolistic nature of both the domestic and the international iron ore markets.0 2004 2005 2006 2007 2008 2009 2010E Source: Metalytics Source: Metalytics China’s dependence on imported iron ore will increase in the future The growing iron ore consumption in ore-sufficient South America. will add tension to the Southeast Asian iron ore market. where rising steelmaking capacities will become increasingly insufficient in iron ore resources. despite its remoteness. Hence. For Ukrainian iron ore miners. On the opposite side of negotiations. Pricing: oligopoly benefits Ukrainian iron ore producers benefit from the global iron ore oligopoly While Ukrainian iron ore companies do not play any role in setting global iron ore prices.2 0. and relative scarcity of high-quality ore.7 0. 22 .5 0. while Chinese steelmakers will increasingly rely on Australian and Brazilian iron ore. with the key one developing in the East Asia.December 2010 Sector Primer Iron ore 2010 High volumes of seaborne trade of iron ore are mainly supported by flows from Australia and Brazil to the EU and Southeast Asia The growing global consumption of iron ore will in turn further boost volumes of seaborne trade of iron ore due to inherent regional supply-demand imbalances. which puts additional pressure on iron ore prices. with its significant capacity. and Rio Tinto (the “Big Three”).0 0.8 (bln tonnes) 1. to $143-150 a tonne.6 0. the Southeast Asian market. and particularly India.America Others (bln tonnes) 0. which accounted for 20% of iron exports to China in 2009. growth potential.9 Domestic Chart 19.2 Australia Brazil India S. China’s consumption of iron ore Imports 0. Chart 18. Moreover. Asian steelmakers have so far failed to provide strong arguments in the negotiation process. The high bargaining power of the Big Three allowed them to raise global iron ore prices 100%.4bln tonnes).2 0. Despite being one of the countries with the highest iron ore reserves in the world (62.6 0. China’s sources of iron ore China 1. the world seaborne market for iron ore will continue to be controlled by the three largest international mining companies: Vale. China is still unable to effectively ramp up its domestic iron ore production.1 0. Asia Oth.

6 0. The rapid growth in this demand has caused international spot prices to be generally higher than benchmark prices in the last three years. Value-in-use is a term used to describe the adjustment made to benchmark prices to account for differences in chemical structure between a particular iron ore product and its relevant benchmark. Ukrainian iron ore producers also follow this mechanism in agreeing upon their prices for both domestic sales and exports. A smaller portion of the world seaborne iron ore trade is represented by the spot market. applies a premium over the Vale FOB Tubarao benchmark price for its European customers due to its ability to provide pellets on a just-intime basis in smaller continuous lot sizes.8 0. iron ore is priced in US cents per dry metric tonne unit. mainly due to the oligopoly similar to the one on the international market. To account for different Fe and free moisture content from different mines. iron-ore price movements flow to other markets. which is in fact the key driver for spot prices.Korea Taiwan Others (bln tonnes) (bln tonnes) 0.2 1. so. 23 . A price for fines is usually settled first.0 2004 2005 2006 2007 2008 2009 2010E 2004 2005 2006 2007 2008 2009 2010E Source: Metalytics Source: Metalytics Benchmark system Benchmark prices agreed upon among the Big Three have a critical influence on world prices for iron ore The majority of the world seaborne iron ore trade has traditionally been sold through longterm contracts. with a ~60-70% share. iron ore prices for Ukrainian customers are set much in accordance with the trends of the international benchmarks.0 Chart 21.0 0.8 0. also called framework agreements. to change a price in US¢/dmtu to US$/tonne. one can just multiply US¢/dmtu by the relevant Fe content fraction.December 2010 Sector Primer Iron ore 2010 Chart 20. On the domestic market. having replaced Japanese companies.0 China Japan EU-16 S. Key world seaborne trade off-taker countries/regions 1. hence they are called benchmark prices for the whole industry. In Southeast Asia. and then to less significant markets. depending on supply-demand balances. The latter have been dominated by the European and Southeast Asian steelmakers.2 0.4 0. Pricing mechanism Ukrainian iron ore producers closely follow international benchmark price trends in setting prices for both domestic sales and exports Iron ore producers other than the Big Three usually set their prices by adjusting the benchmarks for “value-in-use” and freight costs in a calculation process called a netback. as these differences lead to differing costs at steel mills. with tonnages and prices negotiated between the Big Three and their main steelmaking customers.4 0. for instance. Key world iron ore exporters Vale Rio Tinto BHP Billiton LKAB CSN Kumba FMG SNIM Indian Exporters Others 1. Chinese companies now lead the negotiations. or US¢/dmtu. The spot market is dominated by Indian and Australian sales to China. For export destinations. Ferrexpo. where sales are individually negotiated.2 0.6 0. and then premiums for lumps and pellets are negotiated. Once agreed upon by one market.2 1. and one-time contracts are made directly between a buyer and a seller. due to its significant demand for iron ore imports. as Metinvest dominates the Ukrainian market. the netback mechanism is also actively used by Ukrainian companies in applying their specific adjustments.

0 150. quality.0 Mar-05 Nov-05 Jul-06 Mar-07 Nov-07 Jul-08 Mar-09 Nov-09 Jul-10 Vale pellets (67% Fe) China Pellet (66% Fe) China concentrate (66% Fe) (US$c/dmtu) (US$c/dmtu) Source: Bloomberg Source: Bloomberg Transition of the benchmark system The financial crisis prompted the convergence of the benchmarking and the spot-price systems The gap between spot and benchmark prices for iron ore has ultimately led to changes in the benchmark system.0 0. such as price. Amounting nearly to an average of 20% in 2009 and 8M10. and reliance on spot prices increased dramatically. effective from April 2010. and used to rise during aggravating price disputes between Metinvest and the IUD. during the downturn of 2008-09. the IUD and Zaporizhstal.0 250. We believe. additional factors.0 200.5% Fe) Indian fines to China (63% Fe) 400.December 2010 Sector Primer Iron ore 2010 Chart 22. and fall after these disputes are settled.0 350. it may significantly increase in case some of Russian steelmaking groups takes over control stakes in key Ukrainian buyers of iron ore. Key global benchmark contract prices for iron ore Australian lump to Japan (64% Fe) BHP fines (63% Fe) 400. when spot prices collapsed by 55% and benchmark prices dropped by 33-45%.0 350.0 50. some miners led by BHP Billiton even insist on transitioning to the monthly basis. particularly Mikhailovsky GOK and Lebedinsky GOK. Competitive environment On their move to new markets. this system stopped functioning effectively. the market share of Russian iron ore miners is not stable in Ukraine. while. Ukrainian iron ore companies face increasing competition not only from the Big Three oremining companies. usually in April. range of products. after these stakes have been acquired by Russian state bank. Until the recent economic downturn. but also from other mid-tier companies located in Europe. the largest iron ore producers have agreed to use quarterly pricing. Vneshekonombank. on the other hand. 24 . which are controlled by Metalloinvest and are Russian plants located closest to the Ukrainian border.0 100.0 Mar-05 Dec-05 Sep-06 Jun-07 Mar-08 Dec-08 Sep-09 Jun-10 Chart 23.0 200.0 100. While long-standing relations with customers and technical compatibility with their steel mills provide little or no competition against Ukrainian companies in Central and Eastern Europe and Turkey. Ukrainian iron ore companies face increasing competition On their way to expanding sales to the markets of Western Europe and Southeast Asia. However. The market share of Russian miners in Ukraine may substantially increase due to a changing ownership structure in the IUD and Zaporizhstal Russian iron ore producers are also main competitors of Ukrainian companies on the Ukrainian market.0 50. As a result. and Australia.0 0.0 300. and transportation costs significantly affect the competitiveness of Ukrainian companies for other export destinations. The new methodology does not appear to have stabilised yet.0 300. However. reliability. as some steelmakers are calling for a return to the annual pricing method. that the return to the annual pricing is not likely in the nearest term. the CIS.0 250. however. Spot prices for iron ore products in China China fines (63. benchmark prices of iron ore were determined at four benchmark locations on an annual basis.0 150.

Christmas Creek Sishen.December 2010 Sector Primer Iron ore 2010 Table 5. South East Asia Western Europe Ukraine. Mikhailovsky GOK Notes: 1 . Carajas. Fabrica Samarco1 BHP Billiton Rio Tinto Fortescue Metal Group Kumba Luossavaara Kiirunavaara (LKAB) Metalloinvest NLMK Samarco1 Newman. South East Asia Western Europe. South East Asia Western Europe. Sources: Ferrexpo. Thabazimbi. Yarrie. Area C Iron Ore Company of Canada Hamersley.Samarco is jointly controlled by Vale and BHP Billiton. Malmberget Stoilensky GOK Markets of competition with Ukrainian producers Vale Western Europe. Central Europe. South East Asia Ukraine Russia Lebedinsky GOK. South East Asia South East Asia Western Europe South East Asia South East Asia Western Europe.key competitors with incorporation Ukrainian producers Brazil Australia Australia Australia South Africa Sweden Russia Tubarao. CRU. Metinvest. Yandi. ICU estimates 25 . Metalytics. Robe River Cloudbreak. Key international competitors of Ukrainian iron ore producers Company Share of iron ore export market in 2009 (%) 26 14 24 4 4 1 1 <1 Country of Affiliates . Kolomela Kiruna. Western Europe.

6 (US$/dry tonne) 43. as well as extremely low costs of labour. FOB cash costs1 for pellets in 2010 Ferrexpo 70. pellets. and the Middle East.3 54.December 2010 Sector Primer Iron ore 2010 Production costs pose key concerns For the most value-added iron ore products.0 50.6 56.0 59.0 0.Tubarao lovsky Poltava GOK Mont Wright Middleback Fabrica Carol Lake Central GOK Kiruna Northern MalmGOK berget Northshore Savage River Note: 1.6 53.0 20.9 52. Furthermore.0 20.0 57.0 Metinvest Metalloinvest Vale LKAB Other Rio Tinto 65. CFR China cash costs for pellets in 2010 FOB 160. Ukrainian miners have a clear cost advantage over their overseas competitors in the markets of Ukraine.4 54.0 80.0 10.0 0. Europe.8 50.0 40. especially as because energy prices in Ukraine are likely to grow.2 50.1 46.4 43.0 66.Including delivery costs to frontier/sea port.0 140. Ukrainian miners have an opportunity to improve their cost competitiveness and strengthen their market position by implementing efficiency improvement programs.5 30. In terms of cost competition. Ukrainian producers are positioned close to the middle of the global rating of production cash costs. Metalytics Chart 25. and are able to compete with their North and South American competitors on the markets of Southeast Asia.0 60.0 Lebedinsky GOK Carajas SSGPO Mikhai.0 60. the main weaknesses of Ukrainian mining companies─high energy consumption and low labour productivity compared to non-CIS competitors─are partly compensated for by lower prices for electricity and fuel. if one adds transportation costs to production costs. Chart 24. Metalytics 26 . getting closer to international averages in the next five years.0 40.5 50.0 Middleback Carajas LebeTubarao dinsky GOK Poltava GOK Fabrica Mikhailovsky Central GOK Savage River Northern GOK SSGPO Kiruna Mont Wright Malmberget Carol Lake Northshore Source: Ferrexpo.0 100.0 Sea Freight (US$/dry tonne) Ferrexpo (Ukraine) Metinvest (Ukraine) 120. Source: Ferrexpo.6 45.

0 Grinding media 10.0 0. as companies deepen and widen the pits in order to increase their useful lives. energy costs account for 45-55% in production costs of Ukrainian sinter and pellets. At currently exploited deposits.4 1.6 1. and Canada The 125-plus-year history of iron ore extraction in Ukraine has left today’s domestic miners with less economically profitable deposits.0 Natural gas 12. Stripping ratios on Ukrainian iron-ore mines are on average 3-4x higher than In Australia.8 0. Hence. Structure of Ferrexpo production costs of in 2009 (%) Note: 2009 cash costs of Ferrexpo were US$37.9 Spare parts 8.Canadian iron ore mining companies on average. 2007 usage ratios were taken.1 1.80 per t of pellets Chart 27. energy. Nevertheless. much more energy-intensive for Ukrainian companies compared to non-CIS competitors. Natural Resources Canada. which in many cases requires water drainage and gas offtake. Chart 26.0 (GJ/tonne) Labor 13. which refer to the amount of overburden removed per tonne of iron ore extracted.0 Ferrexpo Metalloinvest CNR (1) LKAB Canadian (2) BHP Source: Ferrexpo Source: Company data. Ministry of Industrial Policy of Ukraine. and Australian miners have deposits with around 60% of iron content.300 meters for underground mines. Ukrainian iron ore stripping ratios. require further iron concentration in order to make them usable for steelmaking. Brazil. (2) Canadian .0 Electricity 26. At the same time. Canada. are on average by 3-4x higher than corresponding stripping ratios in Australia. and the majority of reserves contain so-called “lean ores. thus implying a larger consumption of labour.” the iron content of which do not exceed 34%. and other resources. thus also rendering them more costly than open-pit mining in the leading ore-mining countries.0 0. and pose one of the biggest threats to producers’ competitiveness. and severe winters make mining and processing of iron ore.2 1. Energy use by mining companies in 2009 Notes: (1) . with mining depth often reaching 350 meters for open pits and 1. Ukrainian deposits containing ores with iron content over 50% require underground mining. particularly the production of sinter and pellets.2 Diesel fuel 10. Ukrainian lean ores.0 Royalties 2. obsolete equipment.4 0. therefore. Brazil.0 Other materials 10.Cliff Natural Resources. Energy inefficiency creates the main risks for costs Energy costs account for 45-55% of production costs of Ukrainian sinter and pellets The inferior quality of iron ore deposits. ICU estimates 27 . the stripping ratios should further increase.December 2010 Sector Primer Iron ore 2010 Inferior quality of iron ore deposits implies costlier mining The average iron content of Ukrainian iron ore deposits is 30% Ukrainian iron ore deposits are characterised by uneven quality distribution.6 0. energy prices are mostly non-controllable by Ukrainian iron ore producers. and the US. while Brazilian.CNR . North American. This relative energy inefficiency is partly compensated for by relatively cheap prices for electricity and fuel available to Ukrainian companies. 2008 usage ratios were taken Natural gas Purchased electricity Fuel oil Diesel & distillate Coal & coke Other Maintenance 8. On the other hand. South African.

0 5.0 50. Australian and Brazilian competitors.0 2006 2007 2008 20. Electricity tariffs charged to Ukrainian iron ore producers are currently regulated by the National Energy Regulation Commission.1 0. 28 .0 10. making them likely to rise in the next threeto-five years.Canadian iron ore mining companies on average. Ferrexpo and Metinvest.Cliff Natural Resources. However. the Big Three are able to consume part of needed electricity from inhouse power stations at cost. Chart 28.0 150. While natural gas prices for Ukrainian industrial consumers are set by the state-owned Naftogaz and regulated by the Ukrainian Cabinet of Ministers. which sets tariffs for both industrial and household consumers. Ukraine bargained for a 30% discount to the previous pricing scheme in exchange for allowing stationing the Russian Black Sea Fleet in the Crimea.0 16. According to the current pricing scheme. Ministry of Industrial Policy of Ukraine.0 0. Natural gas prices for industry Chart 29. Swedish and North American pellet-makers. pellets are produced at Samarco only (3) Canadian . Ferrexpo.0 0. as well as the state’s policy of industry support.0 350. in particular. A distinctive feature of agglomerated ore production at Ukrainian plants is the intensive consumption of natural gas. ICU estimates Electricity As a result of liberalisation.0 14.1 300.0 LKAB BHP (2) Canadian (3) Source: US Energy Information Administration.0 Metinvest Ferrexpo Vale Metallo. plans to cut its usage of natural gas by around 20% through installing a heat recovery system in its pelletising facilities. not needing to increase iron content of their ores. (2) – at BHP.0 100. Usage of natural gas by iron ore companies in 2009 Notes: (1) . We expect that the liberalisation mechanism will make for a gradual increase in electricity tariffs.0 3 (m3/t) 18. natural gas prices for Ukraine follow the trend in international oil prices.3 (US$/1000m3) 15. Natural Resources Canada. who are focused on using electricity and fuel. Furthermore.0 9. ABARE.CNR . their level is mainly affected by Gazprom.0 250. and Brazil. are able to save electricity at least at this stage. In the last five years. the Ukrainian government plans to liberalise electricity tariffs. Ukrainian pelletmakers. provides industrial consumers with electricity prices cheaper than those in Europe. Ukraine’s reliance on nuclear and hydro energy. the US. Ukrainian pellet-makers Ferrexpo and Metinvest are capable of substantially decreasing their natural gas consumption by modernising their equipment. ICU estimates Source: Company data.CNR (1) invest 0. 2007 usage ratios were taken. the Russian monopoly supplying natural gas to Ukraine. there is no guarantee that this discount will remain in the future. At the same time. Gazprom has been pursuing a policy of converging natural gas prices for Ukraine with prices for European countries.0 200. 2008 usage ratios were taken 2005 400. Though in 2010.3 13.0 Australia Russia Ukraine Canada United States Northern Europe 0. on average.December 2010 Sector Primer Iron ore 2010 Natural gas The consumption of natural gas in Ukrainian production of sinter and pellets is high compared to main competitors Natural gas is used by Ukrainian iron ore companies primarily in the agglomeration process for making sinter and pellets. electricity tariffs for Ukrainian industrial consumers should rise in the next three-to-five years The largest share of electricity is used by Ukrainian companies for grinding and crushing iron ore during the beneficiation. versus zero used by Australian. use 16-18m of natural gas per tonne of pellets.

6 166. prices charged to iron ore miners by affiliated gencos are subject to transfer-pricing policies of their parent companies and regulations of the state. ICU estimates Source: Company data.0 144. Supplied by Ukrainian private oil companies. Kostyantin Zhevago.14 0. and low excise taxes.2 (US$/kWh) 150.10 2006 2007 2008 200. Electricity prices for Industry Chart 31.4 100.9 0. 2008 usage ratios were taken 2005 0. these facilities may supply electricity to Ferrexpo upon the project completion. The regulations may change upon tariffs liberalisation.00 Russia Australia Canada Ukraine US North. More complex mining conditions reflected in higher stripping ratios force Ukrainian companies to consume more fuel than their Australian and Brazilian competitors. which sets the minimum tariffs for both industrial and household customers. Australia. Natural Resources Canada. Russia. Provisionally scheduled to be constructed in 2010-14.02 0. and follows trends in international oil prices.06 0. the proximity of a large oil supplier.0 Source: US Energy Information Administration.Cliff Natural Resources. Usage of purchased electricity by iron ore companies in 2009 Notes: (1) .08 0. 2007 usage ratios were taken. System Capital Management. Europe Brazil 0. The 75%-shareholder of Metinvest. (2) Canadian . and Europe. make fuel prices for Ukrainian companies 15-40% cheaper than in Brazil.CNR .Canadian iron ore mining companies on average. However. also controls DTEK. also has an ownership interest in Komsomolsk Cogeneration Company. However.12 0. ICU estimates Fuel Fuel prices for Ukrainian industrial consumers are 15-40% cheaper than for Brazilian. The majority shareholder of Ferrexpo.0 0. Ministry of Industrial Policy of Ukraine.04 50.0 (kWh/t) 184. and European companies Fuel is used by Ukrainian iron ore producers mainly to run mining equipment and transport iron ore and overburden. Australian. fuel is priced based on market factors.5 6.0 120.December 2010 Sector Primer Iron ore 2010 Ukrainian iron ore companies are also able to achieve savings on electricity by integrating up-stream into power generation companies. 29 . Chart 30.0 Ferrexpo Metalloinvest CNR (1) LKAB Canadian (2) BHP 26. which supplies to Metinvest approximately 68% of Metinvest’s electricity requirements. which has completed a definitive feasibility study for construction of electricity generation facilities near the Yeristovo deposit. ABARE.

3 Labor cost per tonne (US$) 2. there is still a cost advantage over North American.9 324. being 3-10x cheaper than for non-CIS competitors.6 9.56 4.2 1107.75 1. ICU estimates Notes: (1) CNR . As a result.2 86.00 Russia Ukraine US Brazil Canada Australia North.50 0. usage of fuel includes usage of diesel fuel. while Ukrainian miners’ per-tonne labour costs are higher than for Australian companies. (2) Canadian . and social constraints. political. however.4 1.53 5.25 0.48 2. 2008 usage ratios were taken.5 9.63 0.7 101.0 5.5 594. ICU estimates 30 .7 15. due to political and social issues One of the main reasons for such low labour productivity is the large number of support personnel inherited from the times of the state ownership. Brazilian. Ministry of Industrial Policy of Ukraine. Europe 1.25 1.5 77. The majority of Ukrainian iron ore companies plan to reduce their workforces through outsourcing ancillary services and changing their organisational structure. distillate and gasoline (4) for Ferrexpo.0 0. Source: Company data. Labour productivity and labour costs of iron ore producers for the financial year 2009 Company Net revenue per Production per Labour cost per employee (US$ 000) employee (000' tonnes) employee (US$ 000) 3087. partially compensates for that inefficiency. Diesel oil prices for commercial use 2005 1.1 10. and West European producers.7 87.0 4. ICU estimates Labour structure needs further optimisation Ukrainian iron ore producers generally have an excessive labour force. Natural Resources Canada. fuel oil.0 Ferrexpo Metalloinvest CNR (1) LKAB Canadian (2) BHP Source: US Energy Information Administration.0 3.0 2.61 3.75 2006 2007 2008 Chart 33.0 60.Cliff Natural Resources.7 88. 2007 usage ratios were taken. the extremely low cost of labour per employee of Ukrainian companies.72 6.2 1. they still have to introduce these changes gradually due to statutory.8 32.0 3. usage of fuel means usage of diesel fuel only. labour productivity is one of the areas where Ukrainian iron ore producers can achieve cost savings.03 4.3 10.88 18. but low labour costs per employee Ukrainian production of iron ore remains inefficient in terms of labour use compared to the world industry leaders and Western companies. However. ABARE.20 5.3 35. as domestic miners produce 5-20x less per employee than their non-CIS competitors.50 1.December 2010 Sector Primer Iron ore 2010 Chart 32.17 5. The optimisation of the labour structure may take a long time.35 3.00 0.Canadian iron ore mining companies on average. though more likely in the long term. Table 6.82 BHP LKAB Rio Tinto Vale Ferrexpo Metinvest Metalloinvest Sources: Company data. Therefore.2 4.13 (US$/litre) 4. Usage of fuel by iron ore companies in 2009 (liters/t) 6. (3) for non-CIS companies.0 1.

0 69. and commissioning requirements.0 End of 2014 1. procurement.3 100.8 166. enhance efficiency and improve quality of iron ore products.0 108.0 1Q13 212.1 2012 Extension of the current pit Extending the useful life of the pit to 2038.December 2010 Sector Primer Iron ore 2010 Modernisation is time-consuming and capital-intensive Development projects of the Ukrainian iron ore producers are complex.0 2017 Notes: 1. construction. and need to raise additional financing through debt or equity.1 125.0 Rio Tinto Source: Company data Fortesque BHP Vale Ferrexpo Metinvest Metalloinvest 31 .0 (US$/tonne) 209.0 200.5 81. As a consequence. Sources: Ferrexpo.5mtpa of pellets 168.7 2012 Project Project aim Capex required (US$m) Timeline Ingulets GOK FERREXPO Poltava GOK Poltava GOK Yeristovo GOK 105. and take a long time for implementation The leading Ukrainian iron ore miners are planning development projects that are aimed to increase production capacity. as well as due to the smaller scope of mining capacity expansion.0 2015 DONETSKSTAL1 Vasinovsky GOK Development of an underground mine Achieving new production capacity of 20mtpa of iron ore 1.500. investment projects of Ukrainian iron ore producers are more capital-intensive per tonne of output increase due to the larger portion of investments needed to upgrade/install processing equipment. Chart 34.Donetskstal is in process of obtaining the appropriate mining license. while the officially approved capex program is still pending. engineering. increasing the mining capacity by 25% to 35mtpa Upgrade of the existing concentrator facilities Increase of 65% Fe pellets share from 50% to 100% in the total sales Development of a new pit. 10mtpa of concentrate and 7.3mtpa. Highlights of the main Ukrainian iron ore development projects Parent group/operating asset METINVEST Northern GOK Construction of new beneficiation facilities and a new 21% increase in pellet-making capacity to 14.0 0.500. require substantial capex. Metinvest. Rusmet Cpml kj Compared to large Australian and Brazilian miners. technology. construction of new Achieving new production capacity of 28mtpa of iron beneficiation facilities and a pellet plant ore. Ukrainian companies in most cases find their operating cash flows insufficient to finance their capex.7 234. The complexity and lengthy time span of these projects also increases the likelihood of completion delays and cost overruns. Capex per tonne of iron ore on iron ore projects announced in 2009-10 250. modernisation of existing improved safety and environmental standards pellet plant OK 306-1 Construction of two flotation modules improved output quality 520.1 150. pellet plant Lurgi 278-B.1 50. capex figure is an approximate estimate. These projects are commonly complex in terms of their overall scope. Table 7.

growth in electricity tariffs as a result of tariff liberalization. rising prices for diesel fuel on the back of growing international prices for oil. SWOT analysis Table 8. complexity and long time span of development projects may cause completion delays and cost overruns. which should increase iron ore imports and boost overall demand for iron ore. Oligopoly on the domestic and international markets of iron ore: Allows for high bargaining power and provides domestic iron ore producers with the highest profit margins in the Ukrainian steel industry. obsolete processing equipment and severe winters in the region. Large underexploited reserves: Ukrainian companies have an access to mineral resources of at least 30bnt of iron ore. as well as developed railway and river transportation routes. Increasing demand for iron ore in Southeast Asia: Ukrainian iron ore producers may benefit from growing steel output in Southeast Asia. Low labour costs compared to non-CIS competitors.December 2010 Sector Primer Iron ore 2010 Appendixes Appendix 1. Increasing sales volumes through production capacity expansion. Australia. WEAKNESSES Inferior quality of iron-ore deposits: Lean ore deposits with less than 30% of iron content are dominating. European and Brazilian competitors. Relatively low electricity prices in Ukraine compared to US. and the US. as a result of implementing projects on introduction of new mining sites and ore processing facilities. social and political constraints. complicated mining conditions imply stripping ratios 3-4 times higher than in Brazil. Improving cost efficiency through introduction of new energy-saving technologies. OPPORTUNITIES Recovery of the global economy and the resulting growth in the world demand for steel and steelmaking inputs. Low bargaining power in purchasing transportation services: Dependence on the monopoly of state-owned Ukrzaliznytsia to provide railway transportation services in Ukraine and volatile international freight rates in the international seaborne trade. Low labour productivity due to inefficient organization structure is inherited from state ownership and is hard to change quickly due to statutory. Appreciation of hryvnia versus US dollar – may negatively impact Ukrainian companies’ cost competitiveness 32 . as Ukrainian companies may build up their own railway rolling stock and sea port facilities. Source: Investment Capital Ukraine LLC. Low bargaining power in purchasing energy: Ukrainian companies heavily depend on supply from oligopoly market of electricity and fuel in Ukraine. Increasing labour productivity through optimisation of organizational structure is achievable in the long term. This may be aggravated by the inability of Ukrainian companies to raise additional financing. including iron ore products of Ukrainian companies. Undermined ability to increase production capacity and upgrade equipment Large scope. SWOT analysis of Ukrainian iron-ore sector STRENGTHS Favourable geographical location and developed infrastructure: Proximity to the markets of Europe and the Middle East. Rising energy prices: Rising natural gas prices charged by Gazprom to Ukraine. Canada. being among the largest iron ore resources in the world. Energy inefficiency: Higher energy consumption compared to non-CIS competitors is caused by inferior quality of iron ore deposits. particularly China. Increasing presence on the markets of Western Europe and Southeast Asia. thus also hitting profitability of Ukrainian iron ore producers. provide Ukrainian producers with competitive advantage over its international rivals in freight cost component in these regions. Increasing competition against Ukrainian companies on their way to expanding sales to Western Europe and South east Asia. THREATS Possible recurring recession may adversely affect global iron ore prices. Optimisation of transportation costs. as well as the monopoly of Gazprom in supplying natural gas to Ukraine. Relatively low diesel fuel prices in Ukraine compared to non-CIS competitors.

4 Ferrexpo1 648. Sources: Bloomberg. PGOK UZ -----PGZK UK. Ukrainian iron ore sector exposure to debt and equity markets Parent group/Plant Parent control (%) -63.5 188. 4 .6 191.0) (9.0 --PFTS.0 -50. 33 . SGOK UZ CGOK UK.6 33% 39.1 25. RTS Ukraine -----PFTS.825.0 36% 78.3 -0.7 160.2 75. 3.8 EBITDA margin Operating profit Net income 44% n/d n/d 46% 211.3 33.6 146.December 2010 Sector Primer Iron ore 2010 Appendix 2.442.5 428.143.0 35% 47.7 40.304.Kryviy Rih Iron Ore Combine.1 119. Financial performance highlights Table 10. PGZK UZ EVR LI SUBA UZ -2.1 43% 331.621. RTS Ukraine LSE PFTS Ticker Shares outstanding (mln) -SGOK UK.According to Ukrainian national accounting standards.4 51.8 Net margin n/d 21% 21% 11% 11% n/a 18% 18% Notes: 1.7 24.2 30% 36.060.171.4 325.5 -24.0 -50.1 1.3 Securities listed Eurobonds Shares Shares -Shares Shares -----Shares GDRs Shares Eurobonds Security exchange (US$m) 500.another nearly 50% stake in Southern GOK controlled by Evraz.3 75.0 2% (8.0 837.6 KrIOC2 4 144.the remaining 50% stake in Kryviy Rih Iron Ore Combine is controlled by System Capital Management.0 Metinvest Northern GOK Central GOK Ingulets GOK Ferrexpo Poltava GOK Minnerfin (Slovakia)2 Zaporizhzhia Iron Ore Combine2 Privat Krivorizhsky Iron Ore Combine3 Smart Southern GOK4 Evraz Sukhaya Balka Notes: 1 . RTS Ukraine -LSE PFTS.8 286.2 Gross margin EBITDA n/d 811.1 307. 4. ICU estimates Appendix 3.6 21% 105.9 810. RTS Ukraine PFTS. 3 .According to IFRS.Zaporizhzhia Iron Ore Combine. Highlights of Ukrainian iron ore companies’ financial performance in 2009 US$m Revenues COGS Gross profit Metinvest1 5 1.0 Central GOK2 292. Financial market exposure Table 9.0 2.3 -75.2 ------15.7 341.Market capitalisation as of 8 December 2010.0 -----------650.2 198.5 0.9 82.9 47% 138.6 Market cap1 Free float (%) (US$m) -3. RTS Ukraine. 2.0 36% 105.0 51% 257. CGOK UZ -FXPO LN PGOK UK.5 -97.7 276.4 94.0 Northern GOK2 753.0 -99.6 South GOK2 273.7 -----0.Zaporizhzhia Iron Ore Combine is also 25%-controlled by Zaporizhstal.0 n/d n/d Ingulets GOK2 562.6 93.0 ZIOC2 3 135.8 44% 258.4) 27% 30.4 71. 5 – Metinvest’s financial performance highlights relate to the company’s Iron Ore Division only Sources: Company data. 2 .1 27% 5.8 -588.0 -----2.1 104.378 -0. Company data. PFTS.5 -3.0 1.

dolomite. ore mining and processing plant Grinding: Further reduction. Two types of products made as a result of agglomeration process are sinter and pellets Basin of iron ore: A general region with an overall history of subsidence and thick sedimentary accumulation of iron ore Benchmark price: International seaborne traded iron ore benchmark price agreed between the major iron ore producers and specific West European or Asian steel producers for a given year Beneficiation: a process adopted for upgrading iron ore to increase its iron content and reduce gangue content BF: blast furnace BOF: basic oxygen furnace Cash costs: production costs ex-works. the term is given to naturally occurring high-grade iron ore mtpa: million tonnes per annum 34 . Agglomeration: a process used to turn iron ore fines/concentrate into larger. administrative and distribution costs CFR: Delivery including cost and freight Fe: Iron Flotation: A means of separating one type of mineral from another using reagents after milling. which has issued the Australasian Code for Reporting of Exploration Results. commonly separating sulphide minerals from silicate minerals FOB: free on board GKZ standards . after crushing. etc.g. whose physical properties are well suited for transportation and downstream processing in a blast furnace IUD – the Industrial Union of Donbass JORC .classification system and estimation methods for reserves and resources established by the Former Soviet Union and last revised in 1981 GOK: Russian abbreviation standing for OMEP..Australasian Joint Ore Reserves Committee. lumpy pieces with/without additives such as limestone. phrases and abbreviations that are frequently used in this report. of size of mined rocks by mechanical action Iron ore concentrate: product of the flotation process with an enriched iron content Iron ore fines: Fine ground iron ore Iron ore pellet: Dried and hardened agglomerate of iron ore concentrate.December 2010 Sector Primer Iron ore 2010 Glossary The following is the list of terms. depreciation and amortization). Mineral Resources and Ore Reserves used by international mining companies LKAB: Luossavaara Kiirunavaara AB Lump iron ore: In mining. excluding non-cash items (e.

Proved reserves are the economically mineable part of measured resources Pulverized coal injection (PCI) technology: involves injecting pulverized coal directly into a blast furnace through tuyeres. in some circumstances. measured resources of iron ore. estimated or interpreted from specific geological evidence and knowledge. quantity. in order of increasing geological confidence. Mineral resources are further divided. consolidated or unconsolidated. Probable reserves are the economically mineable part of indicated and.December 2010 Sector Primer Iron ore 2010 Netback: A calculation process used for adjusting the benchmark prices of iron ore for value-in-use and freight costs OMEP: Ore mining and processing plant. which reduces the consumption of coke and increases blast furnace productivity Mineral resources: A mineral resource is a concentration or occurrence of material of intrinsic economic interest in or on the earth’s crust (a “deposit”) in such a form. as these differences lead to differing costs at steel mills 35 . a common legal entity/business unit engaged in iron ore production in Ukraine Open pit: Surface mining in which the ore is extracted from a pit or quarry Overburden: Material of any nature. The location. an indicated mineral resource (whose geological characteristics can be estimated with a reasonable level of confidence) and a measured mineral resource (whose geological characteristics can be estimated with a high level of confidence) Pellet plants: Processing facility that takes as its input iron concentrate and produces ironore pellets Pig iron: Crude iron obtained directly from the blast furnace and cast in molds Sinter: An aggregate which is normally produced from relatively coarser fine iron ore and other metallurgical return wastes used as an input/raw material in blast furnaces Spot price: The current price of a metal for immediate delivery Stripping ratio: The unit amount of overburden/waste that must be removed to gain access to a unit amount of ore or mineral material Value-in-use: A term used to describe the adjustment made to benchmark prices to account for differences in chemical structure between a particular iron ore product and its relevant benchmark. that overlies a deposit of useful materials Ore reserves: Ore reserves are sub-divided in order of increasing confidence into probable ore reserves and proved reserves. quality and quantity that there are reasonable prospects for eventual economic extraction. into three categories: an inferred mineral resource (whose geological characteristics can be estimated with a low level of confidence). grade. geological characteristics and continuity of a mineral resource are known.

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December 2010 Sector Primer Iron ore 2010 38 .

The analyst(s) hereby certifies that the views expressed within this publication accurately reflect her/his own views about the subject financial instruments or issuers and no part of her/his compensation was. whose name(s) appear on the front page of this publication.December 2010 Sector Primer Iron ore 2010 Disclosures ANALYST CERTIFICATION This research publication has been prepared by the analyst(s). is. 39 . or will be directly or indirectly related to the inclusion of specific recommendations or views within this research publication.

The value of.ua CORPORATE FINANCE TEL.ua Lee Daniels. The information contained herein is subject to change without notice. International Equity Sales javier.valchyshen@icu.icu.ua Konstantin Stetsenko. It does not constitute an investment advice or an offer or solicitation for the purchase of sale of any financial instrument.stetsenko@icu.ua Maksym Nikulyak Equity analyst (Electric Utilities) maksym. Head of Research alexander. Copyright and database rights protection exists in this report and it may not be reproduced.ua Alexander Martynenko Equity analyst (Metals & Mining) alexander.gontareva@icu. Additional information is available upon request.sinani@icu.ua Investment Capital Ukraine is regulated by Securities and Stock Market State Commission of Ukraine (licence numbers: dealer activity AB 440399. Only investors with sufficient knowledge and experience in financial matters to evaluate the merits and risks should consider an investment in any issuer or market discussed herein and other persons should not take any action on the basis of this report. Managing Director makar. Equity Trading svetlana.demchyshyn@icu.ua EQUITY SALES AND TRADING TEL.ua Svetlana Shevchun. broker activity AB 440398.ua FIXED-INCOME SALES AND TRADING TEL.ua RESEARCH DEPARTMENT TEL.LEONARDO Business Centre 19-21 Bogdan Khmelnytsky Street Kiev. +38 044 2200120 Makar Paseniuk. +38 044 2201621 Sergiy Byelyayev. Director.ua CHAIRMAN OF THE BOARD OF DIRECTORS Valeria Gontareva valeria. Investors should make their own investigations and investment decisions without relying on this report.reyes@icu. or income from. International Equity Sales julia. Editor lee.martynenko@icu. are not necessarily available in all jurisdictions.shevchun@icu. .ua Vlad Sinani. distributed or published by any person for any purpose without the prior express consent of Investment Capital Ukraine.ua Olga Nosova. All rights are reserved. may be illiquid and may not be suitable for all investors. Managing Director konstantin.byelyayev@icu. Analyst (Economy) olga.nikulyak@icu. +38 044 2200120 Javier Reyes. While reasonable care has been taken to ensure that the information contained herein is not untrue or misleading at the time of publication. any investments referred to herein may fluctuate and/or be affected by changes in exchange rates.ua Andriy Tovstopyat Equity analyst (Food & Agribusiness) andriy. 01030 Ukraine Tel. underwriting activity AB 440400.ua Alexander Valchyshen. Investment Capital Ukraine makes no representation that it is accurate or complete. Any investments referred to herein may involve significant risk.tovstopyat@icu. Past performance is not indicative of future results.pecheritsa@icu. Director.paseniuk@icu. Fixed-Income Trading sergiy.nosova@icu.ua Julia Pecheritsa. +38 044 2201621 Volodymyr Demchyshyn./fax +38 044 2200120 www. DISCLAIMER This research publication has been prepared by Investment Capital Ukraine solely for information purposes for its clients.daniels@icu. Director volodymyr. securities management activity AB 440401 dated 17 November 2008). Equities vlad.

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