Key Points Downstream Beneficiation Case Study: Ukraineccsi.columbia.edu/files/2013/10/Ukraine__Iron-ore... · Downstream Beneficiation Case Study: Ukraine 2 This map depicts the

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JaredTalkin1,2March2016

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TableofContentsKeyPoints.......................................................1Introduction..................................................1IndustrializationofTsaristRussia...2CentralizedPlanningintheUSSR....6UkrainianSteelIndustryinTransition.......................................................6UkrainianSteelIndustry:AdvantagesandChallenges...............10KeyConclusions.......................................11Appendix......................................................12 Bibliography..............................................13

While favorably located toexport into regional markets,competing at an internationallevel is significantly moredifficult than relying on thedomestic market for growth, asdemonstrated by Ukraine's ironandsteelsectortoday.

KeyPoints

1 Jared Talkin is a research fellow at the Columbia Center on Sustainable Investment.

2 The author would like to thank Perrine Toledano and Nicolas Maennling for their insight and guidance during the course of this project. Also, the author would like to thank Ruslan Rudnitsky for his review of this case study.

CCSIPolicyPaper

DownstreamBeneficiationCaseStudy:Ukraine

IntroductionUkrainewasselectedasabeneficiationcasestudyduetothepresenceof longstanding interconnected coking coal and steel industries withdocumented iron ore beneficiation beginning as early as 1869 in theDonets Basin and continuing to the present.. While other regions inUkraine have historically beneficiated iron ore, such as the Urals, forthe purpose of this examination only the conditions related to thedevelopmentandmaintenanceofthesteelindustryoftheDonetsBasinwillbeanalyzed.

TheDonetsBasinisinterestingbecausenotonlyhastheDonetsBasinhistorically possessed all the necessary raw inputs to foster resilientdomesticironorebeneficiation,theregionhasalsoexperiencedvariedpolitical, economic, and socialoutlooks thathavehadbothdirect andindirect effectson thedevelopmentof integrated steel industries.Forthe purpose of this case study, the periods to be examined will bedefinedas the industrializationofTsaristRussia(1869-1917)andthepost-Soviet Period in Ukraine (1991-2013). While the steel industryalsoexpandedduringtheSovietera, thisperiodwasmarkedbystrictprice controls and central planning policies, which createdinefficienciesandultimatelycontributedtothefalloftheSovietUnion.The steel industry during the latter half of this period wascharacterizedbymanagerial inefficiency, inadequatepricedesignandresponse,aswellas incorrect incentivestructures.Theresultof thesefactorswas thatby themid-1980’s theSoviet ironandSteel industrylaggedfarbehindWesternEurope,Japan,andtheUnitedStatesinthedevelopmentandimplementationofnewtechnologiesthatshapedthewaysteelwastobeproducedinthe1990’s. Giventhatthisresearchproject assesses the economic factors that incentivize the steelindustry,thisperiodisnotanalyzedingreaterdepth.

Thelocationofthecoalandiron-ore deposits were keydeterminants for theestablishment of the iron andsteel industry in the DonetsBasin. Also, domesticinfrastructureprojectsledtothegrowth of the iron and steelsectorinTsaristRussia.

The private sector played a keyroleinUkraine’searlysuccesses,through their provision offoreign direct investment andadvancedtechnologies.

The Ukrainian steel industryexperiment and the regionalpolicy investment incentivesapplied from 1999-2003 weresuccessful, in that they resultedin an increase in fixed capitalinvestmentandmodernizationofproduction capacities thatresultedinefficiencygains.


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This map depicts the Southern Russian region’s industrial centers and rail roads in 1914

Map1.SouthernRussia,1914

IndustrializationofTsaristRussia

TheindustrializationoftheDonetsBasinandtheestablishmentof ironorebeneficiationindustries intheregionwere initiallymade possible due to the development associatedwith agricultural production andgrainexports.ThenineteenthcenturyRussianEmpirewasmarkedbyprofoundchanges inbothpoliticalandeconomicgeography.Serfdomwasabolishedin1861,whichmadeavailabletotheindustrialistsahugeamount unskilled human capital. Ukraine developed rapidly as an exporting agricultural region,which isexemplifiedbythefactthatthroughouttheperiod1860-1913overthree-quartersofRussia'sexportswereagriculturalproducts.iItwasduring thisperiod thatRussiawasnicknamed 'thegranaryofEurope'.iiThisdevelopment as an agricultural exporter of grains resulted in the expansion of railways, thusmaking itpossible todevelop theDonets’ andKrivoiRog’s coal and ironore.While the railroadwas extended andcompleted to support theexportof agriculturalproducts suchasgrain, industrialists recognized thenewopportunitiesthatitpresentedforthedevelopmentofanintegratedironandsteelindustryandseizeduponthem.Themajor turningpoint inRussian industrialhistorycame in1884with thecompletionof therailroadproject thatmade it possible to join the coal of theDonetsBasin and the ironoreofKrivoiRog, asdepicted inMap1, with themore developed central regions of Russia.iiiWhile coal extraction had beengoing on in theDonRegion andEkaterinoslavProvince since the late 18th century, the greatest boom inDonbascoalproductionwasfueledbyforeigninvestmentbeginninginthelate19thcentury.iv

Foreign investorsconnected the coalproduction to steelmaking, drawing oniron reserves of KrivoiRog twohundredmileswest of the coalfields.vThe first foreigncompany to enter themarket was the NewRussian Company forthe production of Coal,Iron and Rails in 1869,led by John Hughes, aWelsh engineer-entrepreneur. Hughesand his successorsdeveloped the heavyindustry of SouthRussia in the 1880’sand1890‘s – profitingfrom the symbioticrelationshipamongcoalsteel and railroads. viThis was characterizedbyagreatinfluxofforeigncapitalattheturnofthecenturythatfurtherspeededrailroadconstruction,andalsothedevelopmentofexportindustries,specificallygrainandcoalinUkraine.viiTheFrenchandBelgians


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Table1.PigIronProduction

were the most heavily invested in Donbas, having spent 550 million Francs and 275 million Francsrespectivelyby1900,whichisequivalenttoapproximately$US3.4billionintoday’smarket(Insee,2015).This foreign investment resulted in the Donets Basin surpassing older regions, such as the Urals, in theproduction of coal, pig iron, and steel by themid-1890’s.viiiThe great increase in demand for materials,resulting from the boom in railroad construction, stimulated the growthof heavy industry in theDonetsBasin. The region had access to superb resources of iron ore, coal, limestone and refractories, waswelllocatedwithrespecttofoodsupplies,andhadarapidlydevelopingsystemoftransportation.ix

With this rise of the coking coal and steel industries came the establishment of an extremely importanttrade groupwith regard to the development of iron ore beneficiation in the Donets Basin. In 1874, TheAssociation of Southern Coal and Steel Producers was established; this organization's establishmentcorresponded with the birth of the Donbas coal and steel industry.xThis is significant because theAssociationacted tocatalyze theboomwith theprovisionof foreigndirect investment,management,andengineering expertise, education in the form of schools, and acted as a government liaison/lobby.Furthermore,theactivitiesoftheAssociation’smemberssetthestageforrapidSovietindustrialization.

Freeaccesstodomesticmarketsandprotectionfrom foreign competition were crucialcomponents of the Association’s position withregard to government intervention. In the1880’s the government began promoting thesubstitution of foreign pig iron with domesticpig iron from South Russia (Donets Basin).xiLobbying efforts by the Association yieldedresults in 1887, with the governmentimplementing duties on imported iron ore of8.54 $US/metric ton (~212 $US/MT 2014prices) and 10.37 $US/metric ton (~260$US/MT 2014 prices) via ports and overlandtransport respectively.Dutieswere also leviedon other imported iron and steel products,most significantly iron rails used for rail-roadconstruction. The impact of this was drastic,withimportsofpigirondroppingfrom229,329metric tons in 1886 to 73,713 metric tons in1888.xiiAt the same time, this tariff protectionfacilitatedthegrowthofdomesticpigironproductionintheDonbasregion,seeinganincreasefrom49,142metric tons in 1887 to 720,750metric tons in 1898.xiiiThese trade policies enacted by the governmenthelped the steel producers capture the domestic market and facilitated significant grown during theformativeyearsoftheindustry.Thisguaranteeddomesticmarketcreatedbytheprotectionisttradepoliciesactedtocatalyzeengagementbyforeigninvestorswhosawthisasanopportunitytocapitalize.Withtheirsuperior technologies and abundant financial resources, this resulted in the establishment of a vastintegratedsteelindustryinsouthernRussia.xiv

Table1showsthegrowthofpigironproductioninSouthRussiafrom1887to1897inrelationtooverallRussianproduction.Thegrowthpatternpointstoapositivecorrelationbetweentheimplementationofthe

This table was created by the author from data originally published in the Journal of Iron and Steel v.55 1899 no. 1 page 566


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Table2.PigIronProductionvs.Consumption

1882 12,482 573,214 498,400 1,023,2771884 9,796 599,227 509,525 1,098,9571887 14,006 309,581 602,803 908,0381891 11,876 326,584 988,940 1,319,4921893 NA 409,517 1,117,887 1,679,0001895 NA 779,760 1,400,274 2,234,0001897 NA 835,415 1,838,129 2,727,000

AmountofPigIron(IncludingIronandSteel)MetricTon

Year Exported Imported ConsumptionProduction

import tariffs in 1887 and thegrowth of the domestic iron orebeneficiation industry in SouthRussia. Table 2, below, depictsRussian production vs.consumption of pig iron from1893 to 1897. Annual productionwas consistently lower thanannual demand making it likelythat exports during this periodwereminimal.Infact,Table2alsoshows that from 1882 to 1895,exports of pig iron were verysmall with regard to totalproduction. In 1887, exportsrepresented ~ 2.3% of totalproductionforthatyearand,in1891,exportsrepresentedonly1.9%oftotalproductionforthatyear.Whatthis translates to is that all new ironworks being built during the period of early 1880’s to 1900werefocusedonmeetingdemandinthedomesticmarkets.ThissupportsthenotionthattheforeigncompanieswereinvestingintheDonbasregionwiththegoalofbuildingironorebeneficiationindustriesinordertosupply thedomesticmarketwhile avoiding importduties on their products.However,while therewas alarge increase indomesticproduction, there are still significant levels of importsdespite thepresenceofimporttariffs.

Foreigncapitalaccountedforroughlyone-halfofallnewinvestmentinindustrialcorporationsduringthisperiod.xvAlong with this foreign capital came engineer-managers, industry expertise, and advancedtechnologies.Allof theseelementscontributed to theestablishmentofa successful ironorebeneficiationindustry. The early industrial pioneers, who came to invest in the Donbas Basin, were confronted withsignificantobstaclestoindustrializationthatincludedforeigncontrolofcapital,thetotalabsenceofhousing,health facilities, and other vital amenities to workers.xvi Beyond the lack of any substantial physicalinfrastructure,therewerealsoanumberofinstitutionalblockstotheindustrializationeffortsthatincludeddiverging sectorial interests, state taxes, tariffs, and railroad policies that pitted agricultural producersagainst industrialists.xviiYet, despite the challenging climate that these physical conditions created, theindustrial pioneers, led by foreign interests, were able to surmount them and forge the foundation of astrongindustrythatisstillproductivetoday.Table1(seepreviouspage)illustratestheconsistentincreaseinoutputofpigironinRussiafrom1887to1914.Whatistrulyinstructionalfromthetableisthateachyearthe production from South Russia represented a greater percentage of overall Russian production,accountingforonly~9.3%ofproductionin1887andrisingto~57%oftotalproductionby1910.

This table was created from data originally published in the Journal of Iron and Steel v.54 1898 no. 1 page 586 and from data originally published in the Journal of Iron and Steel v.51 1897 no. 1 page 608


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Table3.IncreasesinProductionEngineerswho represented foreign firmswere themostpredominant in the leadership of the SouthernAssociation.Thisis illustratedbythefactthat,outofthe24councilmemberssittingontheboardoftheSouthernAssociation in 1905, 16 were engineers, 14 worked forforeign forms, and ten of those fit both categories.xviiiTheseengineermanagersembracedthefreemarket/freelabormarket,butfavoredgovernmentinterventionintheformof tariffs,preferential freightrates.andsupport forrailroad building. xix Furthermore, members of theAssociation understood that making steel requirededucationandtheypromotedtechnicalenlightenmentbyfounding and supporting mining schools. xx Mostmanagers that represented foreign interests were ofRussian and Ukrainian descent, which helped them tobalance the interests of their employers with theinterestedoftheircountryandlocallaborers.

Beyonditssuccessesatestablishingadvancedproductiontechnologieswhileprovidingeducationalresourcesalongwith other basic amenities to their workers, theAssociationwasalsosuccessfulingettingthegovernmentin St. Petersburg to pressure the local state government(zemstvos)toequalizetaxesonagriculturalandindustrialproperties.xxiTraditionally,thelocalgovernmentwaspopulatedbylandownersandthusdecisionssuchashow toappraisepropertyand levy taxeson incomeandcapital assets fell in favorof theagriculturalists,resultinginaninequitableburdenfallingupontheindustrialsector,especiallywithregardtoproportionoftaxescollected.

Through its organization, the Association helped to drive government policies that that facilitated theestablishmentandgrowthof ironorebeneficiation inSouthRussia.Thesepoliciescanbesummarizedasfollows:

First, the government provided high tariff protection for industry. This resulted in guaranteeing anadvantage todomesticproducers over foreignproducers, thus encouraging thedevelopmentof domesticproductioncapacity.Whilethegovernmentwasfosteringdomesticindustrythroughtheimplementationofthese tactics, it was equally interested in the revenue that was generated though the establishment ofimport duties. Second, the government accounted for the greater part of new railroad construction,withrailroad construction being the receipt of the heaviest financial support from the government. Theapproximation for expenses in direct railroad construction and for the subsidization of private railroadconstructionwas1billionrubles(approximately$US550million in1890)over theperiodof the1880’s-1890’s.xxiiTheRussian railway systemalmost doubled from1889 (18,600miles) to 1901 (35,000miles).Thegovernmentalsopracticedapolicyofplacingordersforrailsatafixedpricethatwasguaranteedforseveral years, helping to stabilize the industry. Furthermore, the government simultaneously boughtnumerousprivatecompaniesfortopprices,sothatby1901governmentrailroadsconstitutedtwo-thirdsofthe total railnetwork.This largeexpenditureandexpansionof the railroadsguaranteeda soliddomesticdemandthatcatalyzedthegrowthofproductioncapacity inSouthernRussiaandalsoencouragedforeign

This table was created from data originally published in the Journal of Iron and Steel v.51 1897 thru v.90 1914


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direct investment in the country; these two movements went hand in hand. Finally, the governmentengagedinapublicrelationscampaigntoenlistsupportforindustrializationathomeandabroad.Examplesof the tactics employed through this campaign included the release of propaganda at the national level,which supported the economic policies for industrialization and through the solicitation of FDI from theprivatesectorincountriessuchasBelgiumandFrance.xxiii

CentralizedPlanningintheUSSR(1928-1991)

While the Soviet Union experienced a huge industrial expansion and relative economic stability during the series of 5-year plans that guided the course of the economy in the Soviet Union (1928-1990), the centralized planning during this period was characterized by many inefficiencies, due to a lack of both market signals and incentives for innovation. Furthermore, the structure of the iron and steel industry in communist Russia was uncompetitive and by the mid-1980’s the Soviet iron and Steel industry lagged far behind Western Europe, Japan, and the United States in the development and implementation of new technologies that shaped the way steel was to be produced in the 1990’s. This is evidenced by the huge drop in production during the economic transition that ensued after the collapse of the USSR. This is another reason why the iron and steel industry of the Soviet Russia is not examined in more detail in this case study.

UkrainianSteelIndustryinTransition(1991-2013)

After the breakdown of the Soviet Union in 1991, Ukraine inherited a large complex of mining andmetallurgicalenterprisesequaltoabout35%ofthewholeUSSRindustry.xxivThepost-SoviettransformationhadanenormousimpactontheUkrainianironandsteelindustry.WhileproductioninUkrainereacheditspeak of 56.5million tons per year in 1985, production of steel in Ukraine dropped dramatically to 15.9milliontonsby1995.xxvFurthermore,withinthefirstfiveyearsofUkraine’snewlygainedindependence,theproductionofferrousmetalsplummetedbyalmost60%.From1990to2002Ukraine’sshareintheworldsteelproductionhalvedto4%.

ThecollapseofUkraine’sdomesticmarketforferrousmetalswasthemajorcauseoftheindustry’scrisisinthe first half of the 1990s. With the breakup of the Soviet Union, Russia and the Commonwealth ofIndependent States (CIS’s)were in economic turmoilwhich resulted in a greatlydiminisheddemand for,andthusoutputof,capitalgoods,militaryarmaments,andconstruction,withtheseaccountingforthemajordomestic consumption of steel.xxviAll in all, from1993 to 2002 the domestic consumption of crude steelshrankby80%.Despitethesestarkrealities,bythelate1990’sUkrainehadbecomethethirdlargeststeel-exportingcountry.By2013,upwardsof80%ofUkraine’soutput from themetalsandminingsectorwasdestined for export.xxviiThis represents a shift from producing for the domesticmarket to being heavilyreliant on export markets, leaving the Ukrainian industry at the mercy of the highly competitive worldmarket. The post-Soviet transformation positioned steel products to become the single largestUkrainianexportcommodity,accountingin2002for30%ofthecountry’stotalmerchandiseexportsandworth$US5.3billion.Thistrendhascontinued.Asof2013thesteelindustryofUkrainecontinuedtoprovideover30%of goods exported and accounted for over 20% of foreign exchange earnings.xxviiiIn addition to its steelexports,Ukraineisalsotheworld’s4thbiggestexporterofironore.In2013asmuchas37.98millionmetrictons-almosthalfoftheironoreproduced-wasexported,mainlytoChina(46.3%),CzechRepublic(12.2%),andPoland(10.4%).

OneofthemostsignificantchallengesthattheUkrainianironandsteelindustryhasfacedduringthepost-Soviet period, and continues to face today, is its obsolete production facilities and outdated technology.


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Thesefactorshavecontributedtothelowlevelsofefficiency,productivity,andprofitabilityandafocusonlow value-added products. The pervasiveness of the low value-added products is illustrated by fact thatsteelproductionispredominantlyingots,themostelementarycrudesteelproduct.Intermsofthestiflinginefficiencythatpermeatestheindustry,notonlyhastheaverageUkrainiansteelworkerbecomeoneoftheleast productive in theworld, but also the average production perworker is less during the post-Sovietperiodthanunderlatestatesocialisminthe1980’s.xxix

To add insult to injury, theUkrainian iron and steel industry has faced restricted access or been barredaltogetherfromexportmarketsforitsproducts.Since1992,theUkrainianironandsteelindustryhasbeensubjecttonumerousanti-dumpinginvestigationsandexternalmarketrestrictions(IMF,2003).Asaresult,theexportopportunitiesoftheUkrainianironandsteelproducerswerebadlydamagedbyawaveofanti-dumping sanctions, import tariffs, quantitative restrictions, andotherprotectionistmeasures imposedbytheEuropeanUnion,theUnitedStates,andanumberofothersteel-producingcountries.xxxRecently,on27June 2014, the EU andUkraine signed theDeep and Comprehensive Free TradeArea(DCFTA) as part oftheirbroaderAssociationAgreement(AA).InApril2014,inresponsetothesecurity,politicalandeconomicchallengesfacedbyUkrainetheEUunilaterallygrantedUkrainepreferentialaccesstotheEUmarketuntil31December2015.Toavoidfurtherdestabilizationofthecountry,andinparticulartoguaranteeUkraine'saccesstotheCISmarketundertheUkraine-Russiabilateralpreferentialregime,inSeptember2014theEUpostponedimplementingtheDCFTAuntilJanuary2016(EuropeanCommission,2015).

Thefirstgovernmentalinitiativeduringthepost-Sovietperiodintendedtodirectlytargetreformintheironand steel industry was ‘TheConceptionof theDevelopmentofUkraine’sMiningandMetallurgicalComplexuntil2010’, approved by Ukraine’s parliament on 17 October 1995 (Vidomosti Verkhovnoï Rady No. 39,1995).This legislation emphasized the leading regulatory roleof the state tobeplayed in theprocessofessentialindustrialrestructuring,privatization,andadjustmentofUkraine’smetalssectortotherealitiesofpost-communismandglobalization.ThisinitiativealsorecognizedtheUkrainiansteelindustry’sproblemsin terms of production technology, product diversification, international marketing, and provided for anumber of activities aimed at the transformation of the Ukrainian metals sector into a more balanced,competitive,efficient,andenvironmentallyconsciousindustry.xxxi

The ‘Conception of the Development of Ukraine’s Mining and Metallurgical Complex’ was followed by anumber of legislative initiatives and executive orders concerning the operation and restructuring of theUkrainian iron and steel industry (See Appendix 1).xxxii Additionally, the initiative titled ‘On SpecialEconomicZonesandaSpecialRegimeofInvestmentActivitiesinDonetskoblast’(SeeAppendix1)waspassedon14January1999.ThislawestablishedaspecialregimeofinvestmentactivitieswithinDonetskoblast’sterritories for prioritized development, which covered almost the entire provincial area. Corporateeligibilityisdelineatedbyaminimumproposedinvestmentofatleast$US1million($US250,000forsmallfirms). Commercial entities that meet the requirements and operate within the priority developmentterritoryareprovidedwithalargenumberoftaxbreaksandallowances,customsduty,andotherincentivesfortheperiodof30years(seeTable5.Seenextpage).WhiletheinitiativeappliedtoallindustriesintheDonetskoblast,theindustryoftheregionispredominantlyengagedinminingandmetallurgicalactivities.As a result, the Donbas ferrous metals companies have been able to make additional fixed capitalinvestmentswithin this special regulatoryregime.xxxiiiTheUkrainiansteel industrystateassistancepolicyandtheregionalpolicyinvestmentincentiveshaveledtoasubstantialincreaseinfixedcapitalinvestmentintotheferrousmetalssector.Inaddition,modernizationofproductioncapacitiesundertakenbyanumberofUkrainiansteelcompaniesduringthecourseofthesectorialexperimentresultedinsubstantialefficiencygains. While,somesignificantmodernizationprojectshavebeenexecuted,ingeneraltheferrousindustry


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Graph1.CrudeSteelProduction,PigironProductionandIronOreExports

This graph was created from data sourced from UN COMTrade and the World Steel Association

Table5.TaxIncentivesintheDonetskPriorityDevelopmentTerritories

remainslargelyobsolete,lackinginanysubstantialinvestmentandneedingtosignificantlyimproveenergyefficiency.xxxiv

Morerecentpressures,associatedwith highercosts imposed byGazprom, have actedto catalyze themodernization of theindustry throughimprovements inenergy efficiency, steelquality, and output.Interpipe Steel builtthe first completelynew rolling mill inUkraine in 40 years,with the plant beingcommissionedin2012.The company claims ithas reduced gasconsumptionper ton ofsteel produced byupwards of 90%.ArcelorMittal, Ukraine’slargest investor, haspumpedmore than$US1billion into improvingefficiency at thecountry’s largest mill,Kryvyi Rih, with gasconsumption rates atthis factory being cutfrom 43 to 35 cubicmeters per ton of steelproduced.xxxv

A brief resurgence wasenjoyed by steel theindustryinearly2000s,which correlated withthe governmental “stateassistance policy”. However, in 2008 the steel sector was severely hit again, this time by the globalrecession.Withinthelastfewyearsitsoutputofcrudesteelfluctuatesintherangeof30to35millionmetrictons, following the demand of the internationalmarkets. After ranking 7th in world steel production in2006,Ukrainewasovertakenbyrapidlydevelopingcountries,specificallyIndia,Turkey,andBrazil.Ukraine


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This graph was created from data sourced from the WSA Statistics Yearbook 2014

This graph was created from data sourced from the State Statistics Service of Ukraine

nowonlyoccupiesthetenthpositionintheworld,forcrudesteelproduction,producing32.8millionmetrictonsin2013.xxxviIntermsorsteelexports,asof2013Ukraineranked5thintheworldwithexportstotaling24.7MMT.TrendsintheUkrainianironandsteelindustryaredepictedinGraphs1and2.

Graph2.SteelExportsbyCategory

Graph3.RegionalStructureofSteelExports


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UkrainianSteelIndustry:AdvantagesandChallengesUkrainehasanumberofadvantageswhenitcomestoitsdomesticironandsteelindustry.Ithasoneofthelargestironorereservesintheworldandhasabundantavailabilityofotherresourcessuchascokingcoal,manganese ore, and limestone. These conditions contribute to its ability to support a large domesticallyintegratedsteelindustry.Inaddition,Ukrainehasinfrastructureinplaceandanabundanceofwell-educatedhuman capital. Furthermore, the steel producing centers arewell locatedwith respect to sources of rawinputs,suchasironoreandcoaldeposits.Additionally,Ukraine’ssteelproducersareincloseproximitytoimportant markets such as Europe, CIS, the Middle East, and North Africa, with the proximity to thesemarketplacesshowingapositivecorrelationbyshareoftotalsteelexportsasdepictedinGraph3above.While the industry is suffering from technological obsolesce, it has a high potential for technologicalimprovements that will increase its competitiveness in the global market. More recently, a devaluedcurrency has made Ukraine one of the cheapest places in the world to produce steel. On top of all theadvantageslistedabove,Ukrainehasahugepotentialtogrowitsdomesticsteelmarket.

DespitetheoverwhelmingnumberofadvantagesUkraineholds, itssteel industry isstill facingsignificantchallenges.ProbablythemostsignificantdisadvantagethatUkrainefacesisitsweakdomesticconsumptionanddependencyuponexportmarkets.Thisrelianceuponexportmarketsleavestheindustryatthemercyofworldpricesand facing competition fromproducers,whouseonaverage30% less energy toproducesimilar products and have higher rates of productivity per worker.xxxviiLow productivity per worker inUkraineismainlyasymptomassociatedwithobsoletetechnologiesandtheuseofopenhearthfurnacestoproducesteel.AstheUkrainiansteelindustrycontinuestomodernizeanddecommissionolderproductionfacilities,productivitywillbecomeonparwithitsEUneighbors.

AnotherchallengethattheUkrainianindustryfaceshastodowiththequalityofdomesticironoreandcoalbeing extracted. A large percentage of the iron ore requires significant beneficiation because the ferrouscontentfromopenpitsinUkraineisonaverageonlyaround26-33%.Therearealsoissuesassociatedwiththedomesticcoalsupply;thecoalsaredeep-mined(makingminingmoredangerousandexpensive),theyare high in sulfur contentwhich results in lower quality steel products, and domestic coking grades arescarce requiring coke imports or the implementation of costly capital improvements tomake up for thedeficit. Furthermore, the assets used in production are highly depreciated and need to bereplaced/upgraded. Finally, the quality of the finished steel produced needs to be improved, as a largeproportion of production is semi-finished and other products with low added value. The production oflowerqualitysteel isassociatedwiththequalityofthedomesticinputswhiletheproductionof lowvalueaddedproductsmainlystemsfromtheobsoleteproductionfacilities.

KeyConclusionsTheUkrainianironandsteel industryservesasaninstructivecasestudybothintermsofthefactorsthatcontributedto itsearlysuccessesandits transformationduringthepost-Sovietperiodbeginning in1991.Whilenotallofthefactorsthatwerekeyingredientsintheestablishmentandgrowthoftheindustryareasrelevanttodayastheywereduringtheinfancystagesofdevelopment,allareworthexaminingwhentryingto develop policy mechanisms that aim to foster the development of downstream beneficiation.Furthermore,manyof thechallengesthatthe industry facestoday, intermsofcompetitiveness,efficiencyandaccesstomarketsareubiquitousamongplayersintheironandsteelindustry.

Thereareanumberoffactorsthatcontributedtotheearlysuccessesrealizedduringtheestablishmentand


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formationoftheironandsteelindustryinUkraine.Intermsoftradepolicy,thegovernmentprovidedhightariff protection for the industry, which resulted in a guaranteed advantage to domestic producers overforeign producers, thus encouraging the development of domestic production capacity. These types ofpoliciesonlyyieldedmeasureableresultsbecauseUkrainealsohadarobustdomesticdemandforironandsteel, of which a significant portion was attributed to government contracts. The Russian governmentaccounted for the greater part of new railroad construction, with railroad construction receiving heavyfinancialsupportfromthegovernment.Thiscreatedaclimateofsteadydemandandstablepricesforsteel,whichallowedfortheindustrytoflourishbutwasnotsustainableoverthelongtermaswasevidencedfromgreat fluctuations in production numbers and employment that accompanied increases or decreases ingovernmentspendingontherailwayexpansion.

Theprivatesectorplayedakeyrole inUkraine’searlysuccessesthroughtheirprovisionof foreigndirectinvestment and advanced technologies. The early foreign pioneers brought highly skilled engineers andmanagers thatbalanced thedemandsof their foreignemployers,whileunderstanding the social,politicaland economic needs of the regionwhere they operated, which contributed to the overall success of theindustry. The private sector was also responsible for the creation of an industry association thatcommunicatedtheneedsoftheindustrytothenationalgovernment,whichcontributedtofavorabletaxandtradepoliciesbeingimplemented.Whileearlygovernmentinterventionwasaimedatprotectingdomesticproducers and stimulatingdomesticdemand, contemporary interventionshavebeenmore complex,withthegoalsofanindustryoverhaulandweatheringrecession.

TheUkrainiansteel industrystateassistancepolicyandtheregionalpolicy investment incentivesappliedfrom 1999-2003 were successful in that they resulted in an increase in fixed capital investment andmodernization of production capacities that resulted in efficiency gains. This state assistance policy alsohelped to alleviate strains associated with the European recession of the early 2000’s. Despite themovement by theUkrainian government to implement exemptions and investment incentives in the late1990’sandearly2000’s,theseshavenotaddressedtheissuesassociatedwithalackofdemandforsteelinthedomesticmarket.Theimportanceofhavingarobustdomesticorregionallyintegratedmarketdemandforsteel isreinforcedbytherecentexperiencesofUkraine’scontemporarysteel industry,wherealackofdomesticdemandandlossofRussiaasanexportmarket,duetotheseparatistconflictthere,haveleftthesteel industry solely at themercy of the international market, where price fluctuations, oversupply andworldeconomicdownturnshavebeenshowntohavedisastrouseffects.

Likeitshumblebeginnings,foreigninvestment/ownershipandadvancedtechnologiesstillplayakeyroleinUkraine’ssteelindustrytoday.Thepost-Sovietsteelindustry’sprivatizationandconsolidationwasexecutedinalargepartbymulti-nationalsteelmanufacturingcorporationslikeAcelorMittal.Alongwiththesenewpartners/owners has come workforce reductions and capital improvements aimed at addressing issuesassociatedwithproductioncost,quality, andenergyconsumptionperunitof steelproduced,whichhaveincreased the industry’s competitiveness in the world market. In order for Ukraine to improve itscompetivenessintheworldsteelmarketsitwillbenecessaryforthesteelindustrytocontinuetoupgradeits production capacities to includemore continuous casting facilities and to decommission its outdatedopenhearthfurnaces.Itisalsonecessarytoaddressissuesassociatedwithqualityandavailabilityofcokingcoal.Appendix

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Name Date DescriptionTheConceptionoftheDevelopmentofUkraine’sMiningandMetallurgicalComplexuntil2010’(VidomostiVerkhovnoïRadyNo.39,1995).

1995

Thislegislationemphasizedtheleadingregulatoryroleofthestatetobeplayedintheprocessofessentialindustrialrestructuring,privatization,andadjustmentofUkraine’smetalssectortotherealitiesofpost-communismandglobalization.ThisinitiativealsorecognizedtheUkrainiansteelindustry’sproblemsintermsofproductiontechnology,productdiversification,internationalmarketing,andprovidedforanumberofactivitiesaimedatthetransformationoftheUkrainianmetalssectorintoamorebalanced,competitive,efficient,andenvironmentallyconsciousindustry.

VidomostiVerkhovnoïRadyNo.38,1999andVidomostiVerkhovnoïRadyNo.17,2002

1999&2002

TheLawsofUkraine‘OnEconomicExperimentatEnterprisesofUkraine’sMiningandMetallurgicalComplex’(validfrom14August1999until1January2002),and‘OntheFurtherDevelopmentofUkraine’sMiningandMetallurgicalComplex’(validfrom1January2002until1January2003),providedthemajorityofdomesticsteelproducerswithanumberofstateassistancemeasures:(a)penaltiesandfineschargedforuntimelypaidtaxes,duties,andothermandatorypaymentswerewrittenoff;(b)ferrousandnon-ferrousmetalsenterpriseswereprovidedwithtaxallowancesforfixedassetsdepreciation;(c)someshareofthemandatorypaymentbymetalscompaniesofthe‘stateinnovationfund’tax,the‘enterpriseprofit’tax,the‘value-added’tax,andthe‘environmentalpollution’dutyweretoremainattherespectivecompaniesanduseddirectlyfortechnologyimprovementsandenvironmentalsafetymeasures;and(d)ferrousandnon-ferrousmetalscompaniescoveredbythetwolawsconcernedwerereleasedfrompayingthe‘generalusagemotor-waymaintenance’duty.

OnSpecialEconomicZonesandaSpecialRegimeofInvestmentActivitiesinDonetskoblastVidomostiVerkhovnoïRadyNo.7,1999

1999

ThislawestablishedaspecialregimeofinvestmentactivitieswithinDonetskoblast’sterritoriesforprioritizeddevelopment,whichcoveredalmosttheentireprovincialarea.CorporateeligibilityisdelineatedbyaminimumproposedinvestmentofatleastUS$1million(US$250,000forsmallfirms).Commercialentitiesthatmeettherequirementsandoperatewithintheprioritydevelopmentterritory,areprovidedwithalargenumberoftaxbreaksandallowances,customsdutyandotherincentivesfortheperiodof30years.


13

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