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The crisis may affect the ownership structure of MMC of Kazakhstan

18 August 2016
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The next few years will be a good test for the hardness of MMC of Kazakhstan

This is the opinion of the Association of Mining and Metallurgical Enterprises (AMME). Current crisis can strongly pull the industry, said a member of the Presidium of the National Chamber of Entrepreneurs "Atameken" and CEO of AMME Nickolai RADOSTOVETS. According to him, in such a "storm" the only solution can be cost control and optimization of business costs. The head of the association told about the state and prospects of the industry to the reporters of the website www.palata.kz

- Nikolay Vladimirovich, what is now in crisis worries the industry, what chances does it have to remain afloat in a period of stagnant prices?

- The main thing for the industry now - is state regulation and financial burden. At the beginning of spring the Association calculated the taxes we pay to the budget. For the base we took EBIT benchmark, or earnings before interest and taxes. As a result, we found that the financial burden on the industry is approaching 60%. The Finance Ministry, however, believe that the tax burden on the MMC is somewhere 12-13%, since their calculations are based on the gross annual income. This shows a difference of views on the economic effect of the industry.

On the basis of such fiscal reality, it is difficult to build a sound regulation. Now the introduction of the new Tax Code postponed to 2018, but the debate over it remains active. We see in the media the turmoil with the introduction of sales tax. Our position remains unchanged. We are in favor of improving the administration of VAT, but not multiplication of costs in the production chain with a cascade of sales tax. I think that this autumn and winter will show, that a further increase of tax burden after abolition of VAT may be simply dangerous. By the way, the group of companies "Kazzinc" has already stated that they are thinking of the restructuring of its structure and liquidation of its subsidiaries as internal services from the possible transition to a sales tax would increase their costs by 40-50 million USD per year. So that the risk of the introduction of the indirect tax has to be rethought.

The entry into force of the New Subsoil Use Code is also scheduled for 2018. We hope that this important document for the sector will be synchronized with the new Tax Code, because the main thing is the question of tax stability for new investors and strategic fields. In general, we have developed a package of proposals on the basis of the recommendations of the enterprises.

If to look in general, the draft Code on subsoil use is progressive. Taking at least a provision on placement of deposits for reclamation of mines in advance, which has to commensurate with the scale of production. However, there are concerns that such a freezing of funds on bank accounts of stakeholders can significantly deplete the working capital of enterprises. Moreover, many mines are operating from the Soviet era, such deposits are at an advanced stage of depletion. Why only the companies must pay the full restoration of the entire cycle of subsoil? Maybe it is worth more than the elimination of mines to study the international experience of regulation and determine the transitional provisions under the Code on mineral resources to companies and government funds could share the load, where the initial stage of development of mineral resources has been initiated in Soviet times? This will help stabilize the financial flows of enterprises to ensure timely investment and recruitment.

The Code offers tax rate by the Australian method. It is difficult to say whether it will meet Kazakh realities, but in general the spirit of a liberal regulatory regime is suggested for investors. If it is adopted in the tax system, in coordination with the Tax Code, commercial discovery bonus and excess profits tax will be eliminated with the possible transition to the MET. In any case, in an era of low price the increase in tax rates would not necessarily mean a large amount of their collection. At the same time, the Code does not regulate precisely some areas of MMC. For example, there is no clear relation of the regulator to the processing of techno mineral formations and use of groundwater. Such significant omission has to be discussed with the companies.

Now that the Code is not accepted, the enterprises suggest that it is necessary to change the law on subsoil use in terms of the possibility of replenishment of the authorized capital. Such rules are already laid down in the draft of the new Code. But now investment funding of subsoil users is hampered by bureaucratic hurdles. Therefore, companies ask to expand the list of reasons that do not foresee obtaining of a permission to increase the authorized capital, additional placement of shares among existing shareholders. They also propose to exclude from the regulatory requirements on agreeing with government agencies putting of the subsoil use rights as a collateral and the associated use of the loan, received under it. In addition, at the recent meeting of the committee of basic industries of NCE, mining companies have offered to cancel the economic expertise of draft contracts and amendments thereto. Moreover, the recommendations were announced by the mining business to shift R & D deductions from gross annual income to the taxable income. On top of that, in a difficult time when environmental payments are an additional burden, companies need get a time out during pre-trial appeal of environmental penalties in environmental control committee, the appeal commission at the Ministry of Energy. We hope that the state with the understanding will react to these issues.

- In recent years we have seen a slight price increase for copper, iron, zinc and gold. Did it help businesses?

- Yes, the recent rebound in prices has allowed some companies to recover. It is a consequence of coordinated deterrence of USD, Brexit, speculators actions in commodity markets and new attempts of central banks to revive the economic growth. Most likely, in the fall the market correction will be over, and we will face again a new price bottom. Therefore, companies need to look for sources of cost control and expenditures of enterprises, auditing of administrative superstructure, as the prices will remain low for three to four years. It is possible that not all corporations will emerge from this storm without losses. And there is only one way out of the crisis - thrift in costs, optimization of production processes, fiscal austerity without a bloated administrative apparatus. On the other hand, it is necessary to look for new niches, to develop a new regulation of commercial products. Here is an example of a recent transition to blooms of SSGPO. Or take the plans to build a steel plant with the release of raw materials for the rail and structural steel plant in Aktobe. Some companies even master the related industries to prevent excessive dominance of suppliers of goods and services, which sometimes overstate their margins. To do this, mining companies began to communicate more with each other, learn from the experience, intensified intra-cooperation.

- About which sectors do you speak?

- Now the largest mining and metallurgical company in Kazakhstan plan to create an electronic trading platform for its suppliers. This will greatly enhance the market power of companies; it will reduce the monopoly of individual contractors and the prices of purchased products due to the scale and transparency. In addition, we are now planning to appeal to the Government to provide an opportunity for companies themselves to insure their employees against industrial accidents. People need to receive full, timely compensation in case of an injury. Now the insurance market poorly manages the task that threatens the social security of people affected in the workplace. Therefore, we believe that the foundations for insurance of employees should be created inside the companies.

- Do you think that the suppliers of equipment and services develop monopoly pricing and  they do not always fulfill their obligations?

- Yes, take, for example, the recent investigation of the Eurasian Economic Commission against Caterpillar dealers on the territory of the EAEU countries. It showed a big difference in their prices in Russia and in Kazakhstan. Now dealers harmonized their pricing policy. As a result, the Kazakh mining companies can choose among distributors of the supplier countries in Eurasia in terms of acquisition of equipment, parts and service. Their prices are more in sync and no additional surcharges are required from the mining companies by Caterpillar. We hope that this policy will extend to most suppliers of mining equipment across the EAEU through best practice, initiated by EEC.

We also expect the support of the Government in matters of equal access for Kazakhstani MMC products to the Russian ports. Federal Antimonopoly Service of Russia now works to unify the rules of access to the ports, where the terminals are often owned by mining groups. Meanwhile, Kazakh exporters face higher tariffs for transshipment or barriers that force them to sell goods to local traders at reduced prices.

According to insurance companies, there are delays of payments as a result of lawsuits due to the reluctance to pay for risks. Therefore, it is justified that companies want to transfer most of the risk on payments for themselves, in their own internal funds, so that workers do not suffer from the tyranny of insurers.

- Some important projects of MMC develop in Kazakhstan, despite of the crisis?

- Although prices are not at the highest level, we see that new projects are launched. It Boschekul, Aktogay, Koktaszhal, Kyzyl, Syrymbet, Masalskoe, Shalkiya. Despite the steady contraction of demand in China, raw materials from these projects are in demand. Moreover, Chinese investors activate in the sector, such as the Silk Road Foundation of China and other investors, focused on gold and base metals. Recent transactions in the industry show interest in Russian companies. Therefore, in general, we believe that the crisis may affect the ownership structure of MMC Kazakhstan until 2019. There may be mergers and acquisitions. Some companies decide to sell non-core assets, transfer them to more focused players. On the whole, more effective foreign and Kazakh corporations will benefit, which have already begun to modernize its business model and capacity a few years ago.

Recently was announced the deal on the gold deposit Komarovskoe, "Tau-Ken Samruk” began to sell its small gold deposits, the Russian media speculated on synergy of ERG with Russian companies. The western media stated that Vasilkovsky gold deposit will be put up for sale. You should not believe everything, since the latter's assets generate stable income to their shareholders and the crisis can be underestimated.

- How will prices affect the volume of production? We can see that the operating parameters for copper, coal, zinc change lately.

- Indeed, the production figures for zinc have declined slightly. But it is a reasonable signal to the market and finding the right proportion of prices and volumes. As a result, Goldman Sachs has announced the upcoming zinc deficiency in the near future, so that this decline is the only benefit. In general, this year is planned a much greater reduction in zinc production in Kazakhstan. But the prices went a bit up, and as a result the production decline was approximately three times less than expected. Autumn will be a benchmark for prices, where will go parameters of zinc production. In general, it should be expected in 5-10% of the corridor from the past year indicators. Zinc will remain a strategic raw material for many innovative products and sectors in the medium term, therefore, there are no big worries.

As for copper, of course, production rates remain behind the intended results. But growth projects of Bozshakol and Aktogay gradually increase their power against the backdrop of a small rise and stabilize prices in the first half. Therefore, we predict that copper production will increase significantly by the end of the year, especially given the increasing rates of "Kazakhmys".

With regard to coal, the situation develops in the other way. In the first half of the year, coal production decreased by 6%. Unfortunately, we see the market decline for Ekibastuz coal in Russia. Import substitution and switching to non-dollar settlements have reduced the margin for key coal enterprises in Kazakhstan. However, climate change is playing a role in reducing the consumption of coal at heating station of Kazakhstan. Recently we received a statement that it is necessary to shift to gas powered heating in the capitals, instead of high-ash coal. But I believe that, before making such statements, it is necessary to carry out calculations of transition and its social costs for the regions. In Almaty, for example,  there is a gas thermal power station-1, in Astana, this issue has not been resolved. As far as I know, "Gazprom" may be interested in the gasification of capitals, which now calculates the return on such investments.

You may need to seek some kind of compromise, and actively engage in a decrease in ash content and enrichment. In our country we have a successful project of coal chemistry Saryadyr deposit, which was implemented with the support of the State Fund "Parasat", and may be a special government program is required for deep processing. However, it is very expensive, but promising with very high oil prices.

To some extent reduction of the national consumption of Ekibastuz coal was offset by the observed increase exports of Shubarkol coal. This we have achieved by reducing the transit tariffs within the EAEU. But since August, were suddenly raised railway tariffs for internal transportation of coal from the previous 4% to 7.5%. There appeared a number of barriers in Russian ports, where access was difficult, there is shortage of wagons. It reduces the potential for Shubarkol coal exports.

It is proposed to transfer part of the tax burden of the rent tax on coal exports to MET. This transition requires a jeweler's approach to the application of the severance tax on coal in Kazakhstan, so it is counted at the price of diamonds. There are differences with the fiscal authorities on how to consider transfer pricing. The detailed and specific methodology is required on how to calculate the market price of coal exported abroad. Especially because the State Revenue Committee makes steps towards the development of special pricing methods for metal concentrate, natural gas and cotton fiber, and automates their accounting.

Recently in Pavlodar was held a meeting of coal producers with the Prime Minister of Kazakhstan. There coal miners said that prices are constrained by regulation that significantly affects the investment ability of the industry. At the same time, the media reported a sharp rise in coal prices in retail during the summer. But an investigation conducted by KREMZK did not reveal any market abuse. According to forecasts of the Ministry of Energy, coal exports to Russia will fall to 20 million tonnes in 2017 from the current 22-23 million tons. Most likely, it will continue to fall until 2020, with a gradual import substitution by Siberian plants. Now under the Government will be formed a working group on the problems of the coal industry. We will work on solving immediate problems and adaptation under the long-term trends.

If you look at chromium, iron-containing raw materials, steel production, the production of gold, aluminum, and they show relatively good indicators. In some fields for chromium, of course, there is depletion of the ore. But "Kazchrome" and "Voskhod-Oriel", as a whole, demonstrate good levels. SSGPO slowly recovers its volume, "ArcelorMittal Temirtau" increases shipments of rolled metal products, Kazakhstan Electrolysis Plant plans to increase the production of primary aluminum this year. "EvrazKaspian Steel" had a stagnation period in winter, but with the beginning of the season, the plant resumed production at full capacity. Manufacturers of gold increased production of unprocessed gold by more than 20% in the first half. Last year, the sub-sector produced 31 tonnes of refined gold. This year we expect an increase of more than 5%.

We suggested the Government among other things to set up funds for the annual procurement of 50 thousand tons of zinc, copper, aluminum for stabilization of production and financial flows of mining companies, in order to avoid the negative impact of low prices. However, a decision on the establishment of a uranium fund only was adopted.

- The industry is tightly interrelated with electric power industry. Changes in the last somehow impact the enterprises?

- Of course, the mining and metallurgical complex consumes up to 50% of electricity in Kazakhstan. Now, by the way, the consumption falls in the whole country, to some extent, this was due to the fall of the production of iron-containing raw materials and an increase in energy saving measures in companies. Recently, for example, the Eurasian Energy Corporation reported a decrease in steam losses and electricity on its own needs. Other division of ERG “Kazchrome" conducted energy audit and for subsequent five-year plans to invest almost 10 billion tenge in energy efficiency measures. In total, according to our rough estimates, the industry has reduced energy consumption due to energy saving up to 100 million  kilowatt/ hours over the past five years.

At the same time, if you look at the energy sector as a whole, we are concerned about the rampant growth of monopoly tariffs. For example, in some regions, where operate the mining and metallurgical enterprises, raise gas prices, from which is produced heat and electricity. This tariff increase will increase the production costs of mining companies in these regions by 1-2%, which is critical for survival in times of crisis. We understand that the state-owned companies have large debt load, but still it should not be solved at the expense of the whole industry stagnation. Take, for example, KTZ or KEGOC's, the tariff rates of which will increase this year and the next few years, according to their commitments, which, of course, may vary due to the different needs that shows the recent increase in railway tariffs for coal transportation. These infrastructure companies have taken over some of the industry costs and thus received funding of a pension fund to service its debt. In our opinion, this is a practical solution to not slow down the turbine of the economy in the face of the MMC, which is indispensable when the oil, services and finance sector contract.

Another burden for our industry become binding of tariffs for renewable energy to tenge and other major currencies. We believe that it is leaning toward dollarization, we have in the country a surplus of electricity to 3000 megawatts, and we continue to subsidize the expense of electric power companies, unstable power sources. This results in a more expensive production costs for steel companies and retail electricity. This year KEGOC will increase the purchase of renewable electricity, which greatly worries us, because soon will be calculated indexation of "green" tariff, and not with an eye on inflation, but on the dollar exchange rate. Such a mechanism of tariff formation is dangerous in the long term, given the free flow rate of the national currency. I understand that renewable energy investors are afraid of currency risk, but they have to calculate with purchase of foreign equipment. If the situation in the industry will continue to deteriorate, the electricity consumption will fall. This will mean even greater proportional burden on producers of 'traditional' electricity. I'm afraid that the RES indexed rates may lie more on the shoulders of ordinary people in the retail, of course metals and mining companies can adapt to energy saving to some extent. But one deposit of funds in settlement and financial center at KEGOC will withdraw from their turnover considerable funds, which means that cash flows will be even more expensive for them.

In addition to all this, the industry is preparing for the deregulation of prices for diesel fuel and increase the excise tax on it from the previous level of 540 tenge to 9,300 tenge per ton. This will inevitably affect the cost to industry transport equipment, locomotive traction. We felt that in the season from April to October, MMC will further spend 2 billion tenge for the increase in excise duties, or to pay more than about 7.5 tenge per liter. Of course, the purchase price of diesel fuel mining and metallurgical enterprises is slightly different from the retail price at the pump because of the volumes, but the excess of the level of 110 tenge per liter will be critical for the industry.

Generally, it develops mixed picture for the power industry. We have idle capacity, a large surplus of several thousand megawatts, while still continuing the discussion of "Samruk-Energo" for the construction of the Balkhash thermal power plant. This is despite the fact that frozen reconstruction of the third block of Ekibastuz GRES-2 Power Plant due to lack of demand. We have to export the electricity to Russia and Kyrgyzstan at different prices. Recently it was decided to cancel the construction of thermal power plants at Torgay on kushmurunskih coals. It was decided to construct a nuclear power plant. I think this is a good example of a prudent attitude.

Daniyar Serikov

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