This is our tenth overview of investment activity in the country. Expert has been publishing it every quarter for two years and a half. Based on the results of our previous studies, we revealed and empirically proved an intuitively obvious fact: real investment activity increases in spring and summer but falls in winter (cold makes construction of new plants and factories, pig complexes and pipelines difficult). In 2010 and 2011, this thesis was brightly proved, but this year we have recorded no anticipated growth. In fact, it means that we have been witnessing a decline in investment activity. This conclusion is directly proved by information on the number of announced or launched projects. For example, in February, March, and April, we identified 27, 13, and 8 projects, respectively (including those being implemented, government-launched, and infrastructure-related ones). In addition, this decline that started in February was recorded in April by Rosstat (Federal State Statistics Service) as well (taking into account the seasonal factor, it was 1.4%).
Earlier, we pointed out to a decline in investments in the private sector; however, government inflows throughout last year succeeded in compensating them. And now we have reached the breaking point, when the investment decline trend became obvious and absolute.
According to our observations, the investment activity of companies with foreign capital (see Figure 1) that accounted for about 15%-20% of the total amount of investments in the country has considerably declined for the last six month. Apparently, they are preparing themselves for the notorious second wave of the global economic crisis that is on the point of breaking out and they have no time for investments in new markets. It is very likely that this is a mid-term trend and, accordingly, we should not anticipate any particular inflow of investments from foreigners for the years to come.
When foreigners leave, it becomes obvious that the country’s economy will have to be developed by national businesses. The long-term future of the country depends on how our businesses will perceive their role in its economic development. It is high time we focused on obstacles they have to cope with and what should be done to make businessmen think not only about the current profits but also about the country their children and grandchildren will live and work in.
It is important to understand that Russia is a country of large and very large businesses. Their impact is overwhelming when it comes to investments. However, we have no feeling that the size of investments made by such businesses corresponds to their role in the country’s economy.
In our opinion, we can identify at least three large typological groups with clearly expressed features and particular investment specifics among large businesses. Each of them gives an idea of idle resources in the investment area.
We included large businesses that were formed in the 1990s in the first group; these are businesses controlling the country’s basic production assets, primarily raw material ones: oil industry, iron and steel industry, nonferrous metal industry, fertilizer production, and coal mining. These businesses are strongly dependent on the world’s market situation, are oriented toward exports and some of their representatives nurture or implement plans of expanding abroad. They slowly modernize their Russian assets without any fanaticism. But their main competitive advantage consists in the low net cost of production and they are ready to sweat at this topic 24 hours a day. With few exceptions, these businessmen are unlikely to move to more advanced technological sectors, for example, the engineering industry (let alone electronic and computer devices) due to their years long rooted mentality. From the government perspective, they need no special measures to be taken (forcing or attractive). The only thing that could be done is improvement of Russian legal, accounting, and fiscal specifics to facilitate the procedure for creation of a corporate center of profit and capitalization in Russia. Several such companies (for example, Evraz plc, Polyus Gold International, UC Rusal) that control large portions of the Soviet-era industries are incorporated abroad and do not show the best example to follow. Of course, they have their own reasons relating to exporting activities and their wish to go trading on foreign stock markets as fast and as cheaply as possible, as well as many other reasons; however, those that look up to them, primarily medium-sized companies, believe that having a holding superstructure abroad is the best way of doing business in Russia. This approach is strictly pragmatic, but patriotism is what it clearly lacks. Patriotism, in its turn, is voluntary. And a good will can appear only when the legal framework, judicial practices, etc. will start to improve in Russia. Public officials should think how to improve the investment climate in Russia.
The second group includes companies developed during the 2000s. Their owners are the so called new wave tycoons. They became rich as a result of their relations with today’s political elite economic activity of which needed conduits, i.e. companies oriented toward implementation of various economic megaprojects. They successfully trade with public companies, are involved in construction under government procurement projects, and have recently started to control a considerable portion of the export infrastructure. However, they have a problem: they rarely build something new at their own initiative. It is possible, of course, to make them invest in any plant or pipeline, but their lobby resource is so powerful that this will result in any free government credit for one hundred years or so or tax holidays for the same period. We believe that this problem solution should be found in the economic area. For example, it is possible to make these companies find themselves in a competitive environment by forcing them to disclose their consolidated statements at the initial phase. Only then will economic efficiency of their operations be clear and will they think how to transform their companies from conduits of the political will into real economic players.
The third group includes companies in the orbit of direct government management, for example, Gazprom, RZD, Transneft, FSK EES, Rosatom, and Inter RAO EES. Each of them has huge investment programs, which is a good sign. However, the scale of their efforts corresponds to the degree of their inefficiency. In other words, they use trillions of rubles, one third or even half of these amounts (nobody knows exactly) being wasted on super profits of officials of these public monopolies of all levels starting from entry managers. The cost of services provided by these monopolies is close to the level of developed countries. Therefore, they serve as a global channel of profit redistribution in the economy: from large and medium-sized businesses that were previously subsidized by low tariffs of gas, energy, and transportation for the benefit of public entities. No one disputes the fact that the size of these subsidies should be reduced. But global capital redistribution from efficient owners for the benefit of inefficient ones is nonsense, and this is where the giant reserve worth hundreds of billions or even trillions of rubles lies, which, under the best scenario, could be invested in other sectors. In other words, the government should announce a program of improving efficiency of public monopolies in order to increase investment activity in the country.
The oil refining sector has experienced a real investment boom for the last few years: according to the 2011 results, it even surpassed the ultra-capital intensive metallurgy sector in terms of capital investments (see Figure 2). In total, the Rosstat estimates that approximately USD 9 billion was invested in this industry in 2011. And it should be emphasized that the explosive growth of investments started in 2008 – 2009, when vertically integrated oil companies (VIOC) earning surplus profits in the high pricing environment morally matured for higher investments in modernization. The Government performed efficiently at that moment by adopting new technical regulations with respect to the main range of oil refinery products: diesel, car gasoline, aviation kerosene and fuel oil (world environmental standards Euro-3, Euro-4, and Euro-5 were introduced). VIOCs had to invest billions of US dollars in modernization of oil refineries and construction of new plants annually. These are indeed large amounts of money.
Four projects are described in this project, but their total value amounts to nearly USD 7 billion, i.e. approximately 35% of the total nominal amount of investments.
The project implemented by Surgutneftegaz, which has been building an advanced oil processing center at its unique oil refinery, Kirishinefteorgsintez, for eight years, is a separate project. The project is worth USD 3 billion. Once the center is put into operation in 2012 – 2013, the oil refinery will process almost half of currently produced fuel oil (4.9 million tons) into fuel, mainly Euro-5 class diesel. Located in the town of Kirishi, Leningrad Region, the plant is likely to export almost the entire amount of its high-class fuel, because it is not demanded in Russia yet.
Gazprom Neft soon plans to launch a complex of diesel fuel hydro-treating and catalytically cracked gasoline at Omsk oil refinery. The complex is designed to produce Euro-4 and Euro-5 standard diesel fuel. LUKoil invests USD 1.8 billion in construction of a vacuum gasoil hydrocracking plant at Volgograd oil refinery. It will increase the output of light oil products: diesel fuel – by 1.8 million tons annually and gasoline – by 600 thousand tons.
It should be emphasized once again: the oil refinery is modernized as a result of direct participation of the Government following its decision to adopt new technical regulations. This is one of rare examples of efficient performance in the area of the industrial policy.
While Russian VIOCs modernize their old oil refineries, a new Antipinskiy oil refinery is being built in Tyumen Region. Its investor is New Stream Group that is controlled by businessman Dmitriy Mazurov. New construction is quite expensive. The amount of planned investments in construction of only the third phase of the oil refinery reaches USD 1.8 billion (they are planned to be made over the period from 2012 to 2015). As a result, the refinery’s production capacity will double to reach 7 million tons.
The history of origin and development of Antipinskiy oil refinery is quite instructive and shows how a simple and clear business idea can help set up a business worth billions of US dollars. Until the middle 2000s, Tyumen Region, the main oil extraction area of Russia, had had no oil refineries and, as a result, gasoline and diesel had had to be transported from Ufa, Omsk, or Perm, i.e. covering more than five hundred kilometers. In the early 2000s, there appeared investors that conceived a business idea and invested in construction of a regional mini oil refinery. Having changed its owners several times, the first production complex of Antipinskiy oil refinery with the processing capacity of 400 thousand tons of oil annually was completed and put into operation in 2006. Fuel was highly demanded in the area and the refinery’s capacity was increased to 800 thousand tons in 2006 – 2007. Having accumulated funds, New Stream Group launched the second phase of the plant with the capacity of 2.8 million tons of oil products annually in May 2010. New investments are made and the refinery continues to extend at present.
Our traditional leaders from the electric power industry slightly lag behind the oil refining industry. They have seven projects worth USD 6.6 billion, i.e. 34% of the total nominal amount of investments: new power units and power transmission lines are built in various places of the country. On the whole, money to modernize the electric power energy has been found (see Figure 3). Perhaps, this is the only positive aspect in the entire reform of the electric power energy (see more details in Manmade and not market marvel in Expert No. 50, 2011).
The new 880 MW power unit at Beloyarka NPP in Sverdlovsk Region has been built for almost 30 years. The planned amount of investments is huge: USD 4.5 billion. According to the representatives of Rosenergoatom Concern, about USD 2.5 billion were used as of May 2012. Works to build BN-800 power units (a fast neutron reactor) were started at Beloyarka NPP in 1984 (then the BN-800 launch was scheduled for 1992). However, following the 1986 incident at Chernobyl NPP, construction of all new nuclear plants in Russia was frozen and projects were to be corrected. No works were actually performed in the 1990s due to lack of money. Large-scale financing started only after the power unit with the BN-800 reactor was included in the Federal Target Program “Development of Russian nuclear energy industrial complex in 2007 – 2010 and through 2015” in 2006.
We could be happy that the Soviet long-delayed construction project is finally close to be completed. But at what cost was this goal achieved? We are presenting an excerpt dedicated to construction of a new power unit at Beloyarka NPP from one of the latest articles by Bulat Nigmatullin, former deputy minister for Russia’s nuclear power sector, and an expert in this field: “The main advantage of fast neutron reactors in the nuclear sector consists in the possibility to quickly reproduce fuel and save natural uranium. But at what cost of natural uranium will it be economically reasonable to build and operate fast reactors? The answer to this question should be given by each country individually taking into account its own fuel and energy balance and availability of energy resources. For Russia with its huge reserves of gas, coal and oil, construction of the BN in the country is absolutely irrelevant and, in my opinion, the BN export potential is low. In addition, comparison of the cost of 1 kV generated by the BN-800 power unit capacity with the non-serial active zone and the new VVER-1200 project reveals that it is more expensive by 1.6 – 1.7 times.
Today, by employing our efforts and resources to develop fast reactor projects, we started to considerably lag behind in creation of a modern and competitive power unit with a water-cooled reactor. Russia’s nuclear energy sector will have to prove its competitiveness both on the international market as compared to improved NPP projects with PWR and BWR reactors made in South Correa, China, the USA, France, and Japan, and on the domestic market as compared to reconstruction and new construction of steam gas plants and coal power units at the supercritical and over supercritical thermal power parameters. Instead of building BN-800, we should reconstruct 6 GW steam turbine units into steam gas ones and reduce gas consumption in the electric power industry by 3 billion cubic meters annually. And we could save USD 360 million annually, if the gas cost is counted at domestic prices (USD 120 per one thousand cubic meters), and over USD 720 million annually if the export prices are taken into account (in 2011 prices). However, consumers are not asked whether they need such expensive toys”.
Government investments into the electric power sector are now prevailing (see, for example, “The reform has a beginning, but no end” in Expert No. 20, 2012). It is not surprising as more than half of generation is controlled by public companies, let alone networks gradually receiving investments through tariffs from consumers. From this perspective, we should emphasize a project of FSK EES worth USD 400 million: a 500 kV Aluminiyevaya-Abakanskaya-Itatskaya PTL is being built to improve reliability of electricity supply to Khakasia-Minusinsk energy district (Sayanogorsk and Khakassia aluminum plants of UC Rusal are located in the area). The 336 km PTL will be laid along the operating high voltage line in the territory of Khakasia and the Krasnoyarsk Territory. Construction of a new PTL became even more relevant after the accident at the Sayano-Shushenskaya HPP. The first power transmission line was built thirty years ago to maintain the Sayano-Shushenskaya HPP capacity to supply power to Khakasia and the southern part of the Krasnoyarsk Territory. The project stipulated construction of the second line, but it was not completed due to lack of financing. It is only now that it is being implemented.
If the investment boom in the oil processing sector and energy power sector is an incontestable fact, the word boom in the agricultural sector should be used with reserve. The fact is that private capital has been replaced by government funds for the last few years, mainly in the form of credits extended by public banks and subsidy of the interest rate on them from the budget sources.
This process is accompanied by a large number of announced agricultural investment projects in the information field, which we closely follow (see Figure 4). Numerous declarations of intent and a small number of implemented investment projects in the agricultural sector can be explained by the fact that every businessman in this field believes that it is their duty to try obtaining money from the government. This is why they announce their plans, both feasible and non-feasible ones, hoping to draw attention of high-ranking official and secure their protection. However, it is a known fact that public banks do not have enough money for all. Therefore, our heroes have to always promise something, but fail to actually implement their projects. For example, this time we gathered 11 investment projects in the agricultural sector and the food processing industry worth USD 1.8 billion; however, six projects worth USD 1.5 billion are just declarations of intent.
The iron and steel industry continues to fill gaps on the domestic market. Their contribution to the common money-box consists of two projects worth USD 1.18 billion. Both projects are quite remarkable.
The universal structural mill is scheduled to be launched this summer at Chelyabinsk ironworks owned by Mechel. The mill has been built for five years, and the amount of investments reached about USD 850 million. The capacity of the actually new plant will total 1.1 million of steel products annually. It will be used to produce high quality rail tracks 100 m long (about 40% of its load) and shaped products (U-section, beam, h-corner: 60% of the load). In 2008, RZD and Mechel signed an agreement for supply of rail products until 2030 totaling 400 thousand tons of rails annually. The first supplies were anticipated in 2011, but Mechel failed to launch its mill in due time, RZD had to urgently purchase 100-meter rails in Japan, and the monopoly is very unhappy about this fact.
The south of Russia is in the thick of metallurgy industrialization. Until recently, this was the only macro district having no ironworks. And metal is highly demanded here as the area is full of construction sites: Olympic Sochi, Grozny with its skyscrapers, and resorts in the Caucasus. Abinsk electrometallurgical plant with the capacity of 500 thousand tons of reinforcement materials has been the brightest projects implemented for the last few years; it was launched in 2010 by local businessmen Ivan Demchenko and Shalva Gibradze, owners of Novorosmetal.
In the 1990s, they were the largest scrap procurers and exporters in the south of Russia. In 2001, they built an electric steel smelting complex with the capacity of 120 thousand tons of blanks; in 2005-2006, they invested again and started to process up to 500 thousand tons of metal scrap, managing to considerably reduce its exports. In 2010, they erected a new plant for production of reinforcement materials in the town of Abinsk, Krasnodar Territory, investing USD 160 million. Reinforcement materials and other rolled steel products are mainly supplied to Sochi construction sites; their exports are low. At present, Novorosmetall Holding is building an electric steel smelting complex with the capacity of 1.3 million tons of steel blanks on the site in Abinsk. Therefore, Abinsk ironworks will have its own steel and it will not have to bring it from Novorossiysk covering 60 kilometers, which will considerably reduce the net cost of reinforcement materials. Novorosmetall will sell and export steel blanks produced by it, as they are not demanded for its own facilities manufacturing rolled products.
This industry yielded three projects worth USD 1 billion.
We are going to describe one of them. Evraz plc (a new holding superstructure incorporated in London) started to build the Yerunakovskaya-8 mine in Kuzbass, worth USD 590 million. This has been the second-largest coal mine greenfield project since the collapse of the USSR. Unlike the first one implemented by Colmar in Yakutia since 2003, its implementation will raise no doubts. The new coal is planned to be launched in early 2013; its capacity will amount to 2 million tons of coking coal. Therefore, Evraz plc ironworks in Russia will be supplied with their own coal despite the possible sale of its 40% interest in the Raspadskaya coal company.
As compared to other economic sectors, high-tech sectors such as electronics and pharmaceutics can rarely boast of any investment projects. Even if investment projects do appear in the information field, they are usually at the zero phase of implementation, which could not always be seriously taken. But this time, the situation is different.
Citronix (part of AFK Sistema) invests in the electronics project. In February 2012, Citronix and Rosnano launched production of microchips according to 90 nm technology at Micron plant in Zelenograd. The capacity totals 3 thousand plates per month; a full production chain has been actually set up at Micron: from design to assembly and testing of microchips. Microchips produced according to 90 nm technology are planned to be used in production automation systems, passports, the universal electronic map, smart-cards, etc. Important consumers of chips made by Citronix include MTS, Megaphone, Vympelcom (SIM-cards), Sberbank and VTB-24 (banking cards), Moscow subway and Aeroexpress (RFID-tickets). Microchips produced according to 90 nm technology will help Citronix promote its products on more advanced high-tech markets: digital television, satellite navigation, avionics, and car electronics. “Production of the full cycle and the R&D center will help us enter the world’s market by using our own know-how and technologies. The project provides conditions for renaissance of the Russian Silicon Valley and training of human resources able to perform at the world’s level”, - says Citronix President Sergey Aslanian at the facility opening ceremony.
As regards pharmaceutics, we should mention an investment project initiated by Novo Nordisk, a Dane company that is the world’s leader in production of diabetes medicines. The Danes started to build a plant that will produce insulin cartridges in the technological park of Grabtsevo, Kaluga Region, of which foreign investors are so fond. By the way, the Danes selected a place for their plant for two years and considered Tver Region, Yaroslavl Region, and Kaluga Region. The amount of investments to be made into the new project will total USD 100 million; the plant launch is scheduled for early 2014. Packaging of cartridges and prefilled syringes by using original raw materials from Novo Nordisk plants located in Europe will be launched at the first phase. Upon reaching its full capacity, the plant will be able supply modern insulin preparations to over 200 thousand Russian citizens. It should be noted that, just like several other similar projects implemented for the last couple of years, Novo Nordisk plant is actually an assembly plant and will not produce any insulin.