Keys to survival: production efficiency and premium-quality products | Volga, Materials, extraction

Materials, extraction

Keys to survival: production efficiency and premium-quality products

6 Mar '09
This story is from our just-published Year-End Review - download it here!

Just like metallurgy, the mining sector is suffering painful problems stemming from its internal systemic limitations and exacerbated by the current crisis. We asked Evgeniy Gaisler, an experienced manager, deputy CEO for strategic development of metallurgic and mining company Belon, about his views.

Prior to all the political and economic mayhem of the summer and fall of 2008 when Russia’s WTO accession was put on hold, many experts felt Russia’s WTO membership would hit domestic producers, with steelmakers and non-ferrous producers most seriously affected.

Sooner or later this country will join the WTO. What needs to be done to help metallurgy and mining sectors benefit from the process?

There is a real problem. I believe the root cause lies with the peculiarities and priorities of steelmaking and metalworking in the Russian Federation, which began in the Soviet Union with its Council for Mutual Economic Assistance.

Here’s an example: in 2007, Russian metal makers produced about 73 million tons of steel; 37 million were shipped to domestic customers and 36 million were exported. It is hard for me to estimate how much of steel exports later returned in the form of deeper-processed products like automotive sheets, stainless steels, etc. But I’m sure it is a sizable amount.

Russia’s metallurgy continues to produce semi-finished items, not end products. Therefore, one of Russian companies’ effective pre-WTO strategies is the extension of their production chains by purchasing end producers abroad (EvrAz, Severstal or NLMK already do that, for example).

Another strategy that Magnitogorsk Steel suggests is the extension of the domestic production chain by buying and constructing Russian facilities to manufacture auto components, metal ware parts, etc.

Both strategies are perfectly viable, with the former being fast but yielding lower returns for a number of reasons, and the latter being implemented only step-by-step but more promising financially.

Let’s talk about mining. Market analysts and observers say that the main problems of the coal mining sector are:

1) transportation costs, which account for up to 40% of the per ton price, making Russian coal less competitive;

2) declining export markets due to the increasing number of countries with lower production costs, like Australia, Indonesia, Columbia, South Africa or China;

3) lack of hard coking coals, which cause a deficit of high-quality furnace feed coal, resulting in lower-quality steel; and

4) downgrading of coking coals as existing coal mines are getting depleted (some even forecast that furnace coal reserves in Russia will be completely depleted in just 10 to 13 years).

What are your views?

Let’s remember one thing first, Russia’s mining sector is 100 % private and it’s only been private since 2002. Also, this sector in Russia is perhaps unique in the world as it has no assistance from the state whatsoever. Even the most advanced coal-mining countries like Australia, the U. S. and China subsidize some of the sector’s needs in some ways.

Yes, indeed, transportation costs are high because coal must be delivered to ocean ports which are very far from the source of excavation. Furthermore, we have a labor force deficit which is getting more and more pressing and finally, geological conditions in operating mines are deteriorating.

All of these negative factors unavoidably drive the cost of production up, pushing profitability down and trimming capex programs as a result.

There’s only one way to meet these challenges head on: a sharp increase in labor efficiency. Today, the average labor efficiency in the Kuzbass mining area is 150 tons per person per month, while in Australia it is three times as much.

However, I need to say that since 2002 when the sector was privatized a lot has been done to improve things. Companies buy efficient equipment abroad, breakage face load is being boosted and efficiency is rising, but slowly, though.

The downside is that all of this change inevitably results in some negatives, such as a higher accident rate because mine infrastructure has not been designed to handle such loads. Consequently, the way to achieve more efficient production is a major upgrade of all components of the production chain to eliminate low-skill and manual labor.

This will require automation and mechanization of the current mining process. Our estimates show that there is enormous room for vastly increasing production efficiency – more than enough to offset the adverse effects of high transportation costs.

Speaking of quality… These days, all coking coal extracted is treated. Coal for energy purposes is 20 % concentrated. The alleged low quality of Russia’s coal is a myth.

For example, in 2007 Belon launched Eastern Europe’s first cannel coal (a very dense and hard coal), treatment factory and began exporting this very high calorie (6,000 kcal/kg calorie), low-sulfur product. And our firm took almost no time to find customers who greatly preferred this coal to that of Australian, Columbian or South-African suppliers.

In fact, this coal contains only 0.2 % of sulfur – five times lower than the EU standards within 1 % requirement! It is attractive beyond all doubt.

But to make coal a market gem, it must meet ALL the standard requirements for calorie content, ash percentage, moisture, etc. This can only be achieved by treating 100 % of coal – there’s no alternative to that.

Over the past few years the government has been pushing a policy of increasing the share of coal in the country’s entire energy balance. Have all pros and cons been taken into account? Is this policy difficult to pursue?

The history of industrial production development cannot be reversed. In the 1970s this country chose a gas-oriented strategy for its energy development. It is impossible to simply get up one day and decide, “let’s change to more coal.”

In some countries, coal accounts for 40% or more of energy generation. In Russia, it is less than 20%. How to achieve a 40% share? Pretty simple. All new power-generating facilities should be coal-based, and this must become a government priority.

But the capital expenditure for coal-fueled electric power stations is 25 to 30% higher than that for gas-based ones. Therefore, the state needs to provide investment incentives for the construction of coal-based electric power stations that use cutting-edge “pure coal” technologies. When utilizing such technologies, a coal station’s efficiency is as much as with a gas-fueled one.

For these new generating plants, new coals are required: high-calorie, low-ash and low-sulfur. This is the only way of including coal in the energy balance. Until that time Russia will not need our high-quality coal because there are no places to use it.

What was your sector’s most significant event of 2008?

This might sound immodest but to me, the sector’s most significant event that occurred was the commissioning of Belon’s Kostromovskaya mine. It’s what we call “green fielding” at its best.

For the first time since 1991 private capital brought about, from scratch, a mine that meets most up-to-date safety and efficiency requirements, all without any government investment whatsoever. Capital investment in the mine has topped $200m over a five-year period.

It really marks a seminal event for the mining sector. It shows that, notwithstanding the infancy of Russia’s private coal industry, and in spite of little or no government support for Russian miners unlike abroad, and despite the fact that private owners have had to honor even old commitments of the long-deceased USSR with regard to coal workers’ social benefits, the coal sector is developing dynamically and in the right direction, becoming competitive internationally and attractive for investment.

If you had a crystal ball, how does the mining business shape up in 2009?

The year 2009 will be very difficult for the entire country, not only for the coal industry. In the face of the global economic crisis all the inherent deficiencies of Russian industry will crystallize into acute and hard-to-solve problems.

As Russia continues to be a commodity-based, export-reliant economy with feeble and unstable domestic demand, which is likely to be exacerbated by growing dependence on imports in a number of key goods of both industrial and consumer categories in combination with a slump in global commodity prices and lower demand for commodities, the Russian ruble will continue to fall.

This will affect finances of Russian businesses very badly, especially the investment potential. This means that our economy will continue lagging behind in labor and energy efficiency.

As domestic demand for coal in steelmaking drops; chronic imbalance in favor of gas as fuel for energy generation fuels will persists; rail transportation and electrical energy costs will continue to rise – in the face of this, mining companies’ RoA will plunge. The key challenge for the management of each specific coal company, rather than industrial officials, is how to ensure sustainable operation of each production area in such a cash-strapped environment.

I think a decisive factor for success will be a product portfolio that has enough premium-quality products that are in strong demand internationally to weather overall lower global coal consumption.