Russian Steel

Russian Steel and Metalware is the second largest producer of flat steel products in Russia. With a market share of 16.7 percent in domestic crude steel production in 2005, Russian Steel and Metalware is one of the five largest steelmakers on a crude steel production basis. Russian Steel and Metalware consists of four sub-segments: its steel production facilities in Cherepovets, Izhorsky Pipe Mill and Severgal, and its wire drawing and metalware manufacturing business, Severstal-Metiz. Russian Steel and Metalware’s steelmaking capacity is 11.6 million tonnes per year. In 2005, Russian Steel and Metalware’s total steel production was approximately 10.8 million tonnes of crude steel and 9.8 million tonnes of finished steel. With a metalware capacity of 1.2 million tonnes, Severstal-Metiz has a market share of more than one-third of domestic Russian metalware production.

Russian Steel and Metalware’s primary steel production facilities are located in Cherepovets, in northwest Russia, approximately 600 kilometres from Moscow and approximately 450 kilometres from St. Petersburg. It also operates a heavy plate mill, Mill 5000, in Kolpino, which is approximately 26 kilometres from St. Petersburg. These locations give Russian Steel and Metalware strategic proximity to river ports and railways, providing logistically favourable access to raw material sources and customers.

Russian Steel and Metalware is focused on high-margin, high value-added products, such as cold-rolled and galvanised sheet, including automotive grades and heavy plate, tubular and drawn products, which represent 26 percent of Russian Steel and Metalware’s total production. Severgal, Russian Steel and Metalware’s joint venture with Arcelor, is the largest producer of galvanised steel in Russia and the only producer of automotive grade galvanised steel in Russia.

Strategy

Russian Steel and Metalware’s strategies include the following:

• focus on Russia as a high-growth market;
• focus on highest growth key markets: automotive and large diameter pipes;
• leverage existing leading market shares; and
• increase profitability through cost structure advantages.

Facilities

Russian Steel and Metalware’s steel production facilities are the second largest in the CIS in terms of revenue and output and the fifth largest in the world, with a production or installed capacity of 11.6 million tonnes of crude steel per year as at 31 December 2005. The facilities are fully integrated, occupying approximately 30 square kilometres, with coking, sintering, blast furnaces, steel making, casting, hot and cold rolling and downstream operations for galvanising and pipe production.

The hot phase at Russian Steel and Metalware’s steel production facilities consists of two vacuum degassers; a coke plant; a sintering plant; five blast furnaces, one of which is the largest in Europe; three oxygen converters; two electric arc furnaces, or EAFs; three open-hearth furnaces; seven continuous casting lines; a cogging mill; a continuous billet mill; two hot-strip mills and a heavy plate mill. The cold phase consists of three continuous picking lines, two cold rolling mills and annealing facilities, two tempering mills, two lines for dynamo steel, two galvanising lines, automotive grade galvanising facilities at Severgal, four cold-roll forming lines, one colour coating line and six pipe rolling mills.

Steel Production Facilities, Russian Steel and Metalware – Output and Utilisation Rate by Unit

	Actual output						Equipment		Capacity		Utilisation
	(million tonnes per year)						(as at 31 December 2005)				(year ended 31 December 2005)
	2003		2004		2005
Coking plant	4.146		4.200		4.204		7 batteries		4.250		4.204
Sintering plant	7.828		8.188		8.342		8 machines		8.350		8.342
Blast furnaces	7.641		7.922		7.976		5 furnaces		8.134		7.976
Basic oxygen converters	7.962		8.168		8.479		3 furnaces		8.500		8.479
EAFs	0.997		1.092		1.429		2 furnaces		1.467		1.429
Open-hearth furnaces	0.929		1.180		0.895		3 furnaces		1.600		0.895
Continuous casting	8.766		9.234		9.926		7 casters		9.930		9.926
Hot-rolling mills	4.417		4.302		4.898		3 mills		5.000		4.898
Cold-rolling mills	2.329		2.619		2.418		2 mills		2.800		2.418
Section rolling mills	1.690		1.576		1.594		4 mills		2.350		1.594
Cold roll-forming lines	0.148		0.166		0.154		4 lines		0.200		0.154
Continuous pickling lines	2.734		3.009		2.788		3 lines		2.800		2.788
Pipe rolling mills	0.166		0.164		0.189		6 mills		0.200		0.189
Hot-dip galvanising lines	0.484		0.585		0.600		2 lines		0.600		0.600

Cherepovets steel plant. Cherepovets has state-of-the-art facilities with a focus on high value-added flat steel products. The facilities’ total production capacity is 11.6 million tonnes per year.

Coking facilities. The coking plant at the Cherepovets facilities comprises seven coke batteries, with a combined capacity of 4.2 million tonnes per year. Five of these coking batteries are equipped with dry quenching units. Dry quenching technology is used to regenerate a portion of the heat, improve coke quality and reduce pollution. Gas produced by the coke oven is captured and recycled to generate heat in the Cherepovets facilities.

Sinter produced at the Cherepovets facilities has an iron content of 58 percent and low levels of non-metallics and impurities, such as sulphur and phosphorous.

Blast furnace facilities. There are five blast furnaces at the Cherepovets facilities. Blast Furnace 5 is the second largest in the world, with a capacity of 3.5 million tonnes per year, and is expected to be fully refurbished in 2006, after which capacity is expected to reach 3.6 million tonnes in the second half of 2006. Blast Furnace 4, which recommenced operation in December 2005 after refurbishment and recommissioning, has an installed capacity of 2.2 million tonnes per year. Blast Furnaces 1 and 2, the oldest furnaces, have an installed capacity of 1.2 million tonnes each per year. Blast Furnace 3 has a capacity of 1.7 million tonnes per year.

Following the temporary closure of Blast Furnace 5 for relining in 2006, Russian Steel and Metalware estimates that its output of pig iron from its blast furnaces at the Cherepovets facilities will not be sufficient to supply the full capacity of the basic oxygen converters, EAFs and open-hearth furnaces at the Cherepovets facilities. Russian Steel and Metalware intends to reduce this deficit by purchasing pig iron from other steel producers and using 320,000 tonnes of surplus slabs accumulated during the first half of 2006, which is expected to substantially cover any shortfall until the recommissioning of Blast Furnace 5 scheduled for late 2006.

Steel-melting facilities. Crude steel is produced at the Cherepovets facilities in three oxygen converters, each with a capacity of 350 tonnes, two EAFs and three open-hearth furnaces.
There are also seven continuous casters at the Cherepovets facilities. The converter shop is equipped with five radial-curved slab continuous casting machines, and the electric arc shop is equipped with one vertical billet continuous casting machine and one slab continuous casting machine.

As part of its capital programme to improve the quality of the steel, reduce the loss of metal and effect long-term cost reductions, Russian Steel and Metalware began to modernise its steel-melting facilities in 2000. In 2005, Russian Steel and Metalware installed a second EAF and a continuous square billet casting machine in the electric arc shop at the Cherepovets facilities. The second EAF and the additional billet casting machine are capable of producing 1.2 million tonnes of steel per year. The continuation of this programme will involve the decommissioning of the remaining three open-hearth furnaces, the ingot casting lines and cogging facilities. The programme is expected to be completed in 2007.

Flat products rolling facilities. Russian Steel and Metalware’s rolling facilities at Cherepovets consist of three hot-rolling and a cold-rolling shops for flat products.

Hot-rolling Shop 1 is equipped with two combined semi-continuous mills. Mill 2800, which has a capacity of 400,000 tonnes per year, produces thick plates with a thickness of 6.35 to 50 millimetres, which serve as feedstock for Mill 1700, which has a capacity of 800,000 tonnes per year. Mill 1700 produces sheet with a thickness of 0.8 to 8 millimetres and is equipped with four coilers, with a capacity of 2 million tonnes per year.

Hot-rolling Shop 2 is equipped with Mill 2000, a continuous wide-sheet mill with a capacity of 6 million tonnes per year, making it one of the largest hot strip mills in the world, and includes four reheating furnaces and length and width-cutting machines. Mill 2000 is operated on a fully-automated basis and produces sheet with a thickness of 1.2 to 16 millimetres.

Hot-rolling Shop 3 is equipped with Mill 5000, a heavy plate mill located in Kolpino. Mill 5000 produces wide quarto plate for shipbuilding, and strips for pipe manufacturing. Mill 5000 has a capacity of 450,000 tonnes per year, expected to be increased to 850,000 tonnes per year by the end of the year.  Of this increased volume, Russian Steel and Metalware plans to send 500,000 tonnes per year to the Izhorsky Pipe Mill, which was commissioned in July 2006.

The cold-rolling shop, with a capacity of 2.8 million tonnes per year including pickled hot-rolled steel, is equipped with a four-stand continuous rolling Mill 1700 and a five-stand continuous rolling Mill 1700. The shop has three pickling lines, two galvanising lines with zinc and alumozinc coating, two tempering mills, a set of belltype annealing furnaces as well as slitting and cutting lines, and produces cold-rolled sheet with a thickness of 0.25 to 3.2 millimetres.

Long products rolling facilities. Russian Steel and Metalware’s long products rolling facilities at Cherepovets consist of a section shop and a cold-formed shapes shop.

The section shop is equipped with a medium-section Mill 350, with a capacity of 1 million tonnes per year; a small-section Mill 250, with a capacity of 750,000 tonnes per year; thermo-strengthening equipment; two wire rod Mill 150, each with a capacity of 600,000 tonnes per year; and Mill 280, which is currently not operational. The section shop is able to produce wire rod with a diameter of 5.5 to 11.0 millimetres, round-shape profile with a diameter of 12 to 100 millimetres, angles with a flange width of 20.0 to 75.0 millimetres and a thickness of 4.0 to 9.0 millimetres, reinforcement bars with a diameter of 6.0 to 40.0 millimetres, hexagonal bars of grades 12.0 to 48.0 and channels of grades 6.5 to 10. Wire rods are produced in coils. The section shop has an aggregate capacity of 2.35 million tonnes, but the maximum output that can be produced by the section shop with the existing product mix is 1.7 million tonnes.

The cold-formed profiles shop produces a range of different shaped profiles: closed profile, S-shape profile, E-shape profile, trough-shape profile, angle profile and others. It also has six pipe mills that can produce pipes with circular, oblong and semi-oblong, square and rectangular cross sections of a wide range of sizes.

Severgal. Severgal is Severstal’s 75 percent joint venture with Arcelor since 2001 and has a focus on high-quality galvanised auto body sheet products.
In commercial operation since December 2005, Severgal is a galvanising plant with a projected galvanising capacity of 400,000 tonnes per year. Russian Steel and Metalware’s total investment related to this plant was approximately US$210 million. Severgal can produce galvanised-steel sheet with a thickness of 0.4 to 2.0 millimetres and a width of 900 to 1,850 millimetres. Russian Steel and Metalware currently uses this plant to produce ExtragalTM steel sheet product coated with zinc-iron alloy and intends to begin production of Galvallia steel. Severgal’s production for the first half of 2006 was approximately 87,600 tonnes.

Severgal is strategically located close to several major domestic automotive greenfields, including Nissan and Toyota in St. Petersburg, with estimated project units of 50,000 each in 2008, and Volkswagen in Kaluga, with estimated project units of 115,000 in 2007.

Izhorsky Pipe Mill. The Izhorsky Pipe Mill is Russian Steel and Metalware’s large diameter pipe project for the oil and gas industry. The project is designed to produce pipes meeting the requirements of domestic and international customers, including Gazprom and OAO Transneft as well as a number of Russian oil companies.

The construction of the Izhorsky Pipe Mill in Kolpino, next to Mill 5000, included three-layered anti-corrosion coating technology and was completed in July 2006. Mill 5000 was modified to produce strips manufactured by its steel segment to feed the project. When fully utilised, the Izhorsky Pipe Mill is expected to have a capacity of 600,000 tonnes per year of large diameter pipes with three-layered anti-corrosion coating, diameters ranging from 610 millimeters to 1420 millimeters and 18 meters in length. Pipes of this length are not currently produced in Russia.
The project was financed through a mixture of internal and external financing, including EBRD financing, at a total estimated construction cost of approximately US$300 million.

Severstal-Metiz. Severstal-Metiz is a subsidiary of Severstal and forms part of Russian Steel and Metalware. Severstal-Metiz is the leading downstream wire drawing and metal processing business in Russia, with a market share of more than one-third of total domestic metalware production, approximately 53 percent of Russia’s metalware exports and 6 percent of metalware manufacturing in Europe.

Severstal-Metiz operates large wire drawing and metal processing operations in Cherepovets, Orel and Volgograd, as well as the recently acquired Carrington plant in the UK and the Dneprometiz plant in Ukraine, and produces more than 26,000 products, including rod, nails, cold-drawn steel, steel rope, netting and fastenings. Including these recent acquisitions, Severstal-Metiz now has a total maximum annual production of approximately 1.2 million tonnes.

Production Process

The steelmaking process at Russian Steel and Metalware begins with coal, iron ore, both in concentrate and pellet form, limestone and dolomite, non-ferrous metals, ferro-alloys and scrap metal being fed into the coking plant to produce sinter, pellets and coke.

The mix of sinter, pellets and coke is then fed into the blast furnaces, which operate continuously. During the blast furnace process, the charge is converted into pig iron. Liquid slag, which remains after smelting, is also removed from the blast furnaces. When cooled, the slag is crushed at the slag-processing facilities and is then sold domestically by Russian Steel and Metalware as road-construction material. Gas produced by the blast furnaces is captured and recycled to produce heat.

The molten pig iron is transported to the basic oxygen converter shop and to the remaining open-hearth furnaces and EAFs in 100-tonne railway ladle cars for EAFS and 600-tonne for converter shop. The basic oxygen steel-making process is autogenous, or self-sufficient in terms of energy.

The two EAFs at Cherepovets, each with a capacity of 150 tonnes per heat, do not need to be charged with molten pig iron, and can be charged with “cold’’ material, normally steel scrap, recycled goods made from steel which have reached the end of their useful life and solid pig iron. The current proportion of scrap metal used in the EAFs is approximately 79 percent. Other forms of raw materials may be used, including pig iron from the blast furnaces that has been cast and allowed to go cold. Molten steel produced by the EAFs can either undergo secondary steel-making or be transported to the continuous caster.

Approximately 89 percent of the liquid steel is fed from the furnaces into the continuous casting machines to produce slabs and billets. Continuous casting is the most effective casting process with the lowest metal consumption per tonne of rolled products and saves approximately 70 kilograms of steel per tonne compared to ingot casting. The slabs are further rolled at the hot-rolling mills into sheet and coils.

The remaining 11 percent of the liquid steel is poured into bloom ingots. The ingots are then treated in the cogging mill to produce rolled billets for hot-rolled section steel of various types. Some of this steel is then fed into the profile-bending machines and pipe rolling mills. As noted above, Russian Steel and Metalware has begun the process of closing the open-hearth facilities located in Cherepovets, due to cost, environmental and efficiency considerations, to facilitate the transition from ingot casting to full continuous casting. This process is expected to be finalised in 2007.

Additional processing methods related to cold-rolling further improve the surface characteristics of the steel. These additional processing methods include pickling, hydrogen annealing and tempering. Some cold-rolled sheet is galvanised, which involves applying a coat of zinc and aluminium, and some is polymer coated.

Quality control. Russian Steel and Metalware has established comprehensive quality-control systems at each stage of its production cycle. Russian Steel and Metalware currently operates a total quality management, or TQM, system at each of its steel production facilities, which involves organising employees in quality teams. Established in the converter shop at Cherepovets in 2000, these teams are now in place at all of Russian Steel and Metalware’s shops. Russian Steel and Metalware uses the European Foundation for Quality Management model for TQM and also employs techniques of benchmarking performance to best practice and statistical process control, which Russian Steel and Metalware began in 2001. The main objective of these techniques is to improve the quality of steel by improving technological process parameters. The current quality-control systems are carried out by an internal quality control division with further support provided by SGS Vostok Limited, a French-based quality surveyor, during transportation and loading.

Lloyd’s Register has completed several audits of a number of the production facilities within Russian Steel and Metalware and has extended its quality-management certificate of compliance with standard ISO 9001:2000 to 31 December 2008. In May 2005, Russian Steel and Metalware was certificated according to the ISO TS 16949-2002 automobile standard until 31 December 2008.
The quality-control measures employed by Russian Steel and Metalware have enabled it to maintain a range of products that meet the high standards required in the United States, Germany, the United Kingdom, Japan and other markets in addition to the modernised Russian oil and pipeline industries. A range of products produced by Russian Steel and Metalware have been certified by the Marine Register of the Russian Federation, Lloyd’s Register, the American Bureau of Shipping, Norske Veritas, Germanischer Lloyd, Bureau Veritas and the Russian River Register. In 2001, Russian Steel and Metalware received several certificates attesting to the quality of the production output at Mill 5000. Russian Steel and Metalware’s steel products are supplied to various development projects in the “North Sea” shelves and for the “Sakhalin-2’’ oil and gas pipeline programmes in far eastern Russia.

Products

Crude steel products. Russian Steel and Metalware produced 10.8 million tonnes of crude steel in 2005. Its current crude capacity is 11.6 million tonnes, corresponding to a utilisation rate of approximately 93 percent during 2005.

Year		Russian Steel and Metalware		Total Russian production		Russian Steel and Metalware/ Russia
		(million tonnes)				(percent)
2001		9.32		57.45		16.2
2002		9.63		58.50		16.5
2003		9.89		61.47		16.1
2004		10.44		65.58		16.2
2005		10.80		66.19		16.7
Source: Chermet Corporation.

Finished steel products. Most of Russian Steel and Metalware’s crude steel production is further processed into finished steel products, which include flat and long products. Flat products include hot-and cold-rolled sheet, plates and coils. Long products include hot-rolled sections, cold-formed shapes and pipes.

			Year ended 31 December
Product			2003		2004		2005
			(thousand tonnes)
Rolled steel products, including			8,810		9,294		9,834
Hot-rolled sheet			4,417		4,302		4,898
Cold-rolled sheet			2,329		2,619		2,418
Hot-rolled sections			1,690		1,576		1,594
Semi-finished products, including			375		796		925
Export slabs			362		793		922
Cold-formed shapes and pipes			314		330		343
Coated/galvanised products			482		585		600
Severstal-Metiz (Total of all products)(1)			578		804		826
Note:
Severstal-Metiz was established in its current form in 2005. Figures for 2003 are for ChSPZ only.

Hot-rolled sheet. Hot-rolled flat products include heavy-gauge plate and light-gauge hot-rolled sheet produced from ordinary and high-quality carbon steel, low-alloy strengthened steel and clad steel. Clad steel includes two and three-ply steel combined with a corrosion-resistant or wear-resistant ply.

Russian Steel and Metalware produces hot-rolled plate with a maximum thickness of 60.0 millimetres, up to 4,800 millimetres in width and 20,000 millimetres in length, as well as coils for rerolling of up to 36 tonnes. Heavy-gauge plate is used to manufacture pipes, oil and gas tanks, ships, bridge structures and railway cars. Light-gauge hot-rolled sheet has a minimum thickness of 0.8 millimetres and is used for welded pipe and tubing, automotive parts, small-size shapes, channels and profiles.

Cold-rolled sheet. Cold-rolled flats consist of cold-rolled sheet and coils with a thickness of 0.25 to 3.2 millimetres and are up to 1,620 millimetres in width. Cold-rolled sheet, which has a greater plasticity and a better surface quality than hot-rolled sheet, has various uses, including the manufacture of automotive body-panels and home appliances. In addition, cold-rolled products serve as feedstock for Russian Steel and Metalware’s galvanised and roll-formed products.

Hot-rolled sections. Hot-rolled steel sections are produced from ordinary carbon steel, high carbon steel, low-alloy steel, structural alloy steel and include equal and unequal angles, hexagonal shapes, round bars, steel strips, wire rods and reinforcement bars.

Semi-finished products. Semi-finished products are intermediary products from the production process and represent generic steel products that have not yet been rolled for a specific application. Severstal classifies the following products as “semi-finished”, which are normally not classified as “saleable goods”: (i) steel ingots or steel slabs from continuous casting; and (ii) billets from the continuous billet mill prior to treatment in the rolling mills.

Cold-formed shapes and pipes. Russian Steel and Metalware produces over 250 types of carbon and low-carbon steel roll-formed shapes, including perforated, close-welded square and rectangular sections. Profiles with rectangular and square cross sections are widely used in the agricultural machine-building, civil construction and automotive industries. Cold-formed sections also include a wide range of pipes and construction and furniture materials.

Coated/galvanised products. Russian Steel and Metalware produces aluminium-coated and galvanised products, including those produced for the automotive industries. Severgal, Russian Steel and Metalware’s joint venture with Arcelor, produces galvanised sheet steel with a high-quality surface for the automotive industry. Russian Steel and Metalware believes that demand from international automotive manufacturers will increase demand for galvanised products.  In December 2005, a new facility for the production of polymere-coated steel products began operations on the Cherepovets site. Due to the strict requirements of automotive plants outside Russia, Russian Steel and Metalware has focused on improving the quality of its products significantly and has developed new grades of products (for example, products with an alumino-silicon coating and high-strength steels) to meet the demands of automotive customers.

Other steel products. Russian Steel and Metalware is able to produce sophisticated steel grades for pipe manufacturing as well as high-quality steel with a very low level of impurities (sulphur content of less than 0.025 percent and a phosphorus content of less than 0.05 percent). Russian Steel and Metalware is also the only producer in Russia of “K-54’’ grade steel, which has enhanced corrosion-resistant and cold-resistant properties and can be exploited in temperatures as low as minus 60 degrees Celsius. The Izhorsky Pipe Mill is expected to produce large diameter pipes of a type not currently produced in Russia. Other goods manufactured by Russian Steel and Metalware include civil construction goods and associated products.

Civil construction goods include a wide range of products such as door hinges, window butts, steel tiles and others. Associated products include a wide range of by-products, e.g. chemical products including benzol and green vitriol, blast furnace and converter slag and other by-products of the metallurgical process. Consumers of these products are the agricultural, chemical and construction industries. Russian Steel and Metalware also provides various ancillary services to customers, primarily rolling services.

Metalware. Severstal-Metiz’s factories in Russia focus on the manufacture long products, such as low carbon and high carbon wire rods, nails, cold-drawn steel, steel rope, netting and fastenings. Severstal-Metiz comprises three sites: the Cherepovets site, the Orel site and the Volgograd site, located in northwest Russia, central Russia and the Povolzhie region of Russia, respectively. Each of these are dynamically developing regions with a high concentration of industrial and consumer-type customers. In addition to enjoying significant geographic coverage, Severstal-Metiz operates in all of the basic segments of the Russian metalware product market as the products manufactured at the respective plants complement each other. Dneprometiz produces wire and certain other processed products at its production facilities located in Ukraine. In 2005 Dneprometiz had a total production of 123,000 tonnes. Severstal-Metiz expects the Dneprometiz acquisition to further strengthen its position in the fast growing Ukrainian metalware market. CWL supplied more than 50 countries worldwide in 2005 and has a production capacity of more than 200,000 tonnes of wire a year at its CWL plant.

Supply Chain

The principal raw materials used by Russian Steel and Metalware to produce steel include iron ore concentrate and pellets, coking coal, limestone and dolomite, non-ferrous metal and ferro-alloys and metal scrap. Russian Steel and Metalware maintains a minimum two-week reserve of all the main raw materials used in their production process. This reserve is normally increased to approximately three weeks during the winter to compensate for any potential break in supply due to bad weather and for increased consumption rates experienced during the colder weather. In addition, during the winter the stocks of ferro-alloys and scrap are increased to one and three months, respectively.

Russian Steel and Metalware’s steel production energy requirements include water, gas, electricity and steam.

Raw materials. Severstal Mining has the capacity to provide nearly 100 percent of the iron ore requirements and coal requirements of Russian Steel and Metalware’s steel operations.

Iron ore and pellets. The smelting process at Russian Steel and Metalware’s blast-furnace facilities requires 30 percent of the feedstock to be in the form of iron ore pellets, the majority of which are sourced from Severstal Mining.

Iron ore concentrate and pellets are supplied to Russian Steel and Metalware’s steel operations on the basis of contracts that are reviewed and renegotiated on an annual basis. Russian Steel and Metalware has sought to ensure the security and reliability of its iron ore supplies through diversification as well as by sourcing iron ore from Severstal Mining.

All of Russian Steel and Metalware’s steel operations contracts with its iron ore suppliers, including those with Severstal Mining, are concluded on an arm’s-length basis and can be re-negotiated if suitable raw materials can be purchased from alternative suppliers at lower prices. Russian Steel and Metalware’s quality control of the iron ore supplies involves verifying suppliers’ quality certificates and monitoring the moisture content, iron content and weight of the ore concentrate at laboratories located at each of the production facilities located within its Russian steel operations. On a case by case basis, contract arrangements provide for price adjustments depending on the quality of the concentrate.

Coal. Russian Steel and Metalware meets all of its coke supply requirements from its own coke batteries, using coal purchased from Severstal Mining, in particular Vorkutaugol and Kuzbassugol.
Russian Steel and Metalware has long-standing relationships with its key coal suppliers, which consist primarily of companies in Severstal Mining, in particular Vorkutaugol and Kuzbassugol. Vorkutaugol has been supplying coal to Russian Steel and Metalware and its predecessors for over 40 years. Geographically, the Cherepovets facilities are closer to Vorkutaugol than Vorkutaugol’s other customers.

All contracts with Russian Steel and Metalware’s coal suppliers, including those with Severstal Mining, are concluded on an arm’s-length basis and may be suspended if suitable coal can be purchased from alternative suppliers at lower prices. Contracts are generally concluded for a term of one year, with the intention of ensuring continuity, security and reliability of supplies. Payment under these contracts is made on delivery.

Scrap. Russian Steel and Metalware believes that it is the largest consumer of scrap in Russia.  Russian Steel and Metalware sources its scrap on a spot basis from smaller suppliers and on a contract basis for larger volumes.

Russian Steel and Metalware has its own scrap-processing facilities that allow it to utilise a wide range of sizes of steel scrap. These facilities include special cutting and packaging lines for processing the scrap so that it is ready for use in the smelting process. Scrap is sourced both externally, from companies that collect scrap metal, and internally, by using amortisation scrap and production waste. Scrap is used in all steel-melting processes; the average proportion of scrap metal in the metal charge used in the smelting process ranges from approximately 30 percent in the oxygen converter and open-hearth furnace shops to close to 80 percent in the electric arc shop.

Other raw materials. Russian Steel and Metalware sources limestone from it’s own mine located in the northern part of the Vologda Region, approximately 250 kilometres from Cherepovets.
A wide range of ferro-alloys is also used in the steel-making process. Non-ferrous metals, such as zinc, manganese and aluminium, are primarily employed in the production of higher value-added steel products, such as galvanised sheet. Russian Steel and Metalware sources most of its ferro-alloy requirements from third-party suppliers under annual contracts.

Russian Steel and Metalware also imports certain raw materials, such as ferro-alloys and refractory materials, from France, Austria, China and Ukraine. Prices for non-ferrous metals are generally linked to the London Metal Exchange.

Energy. Russian Steel and Metalware’s electricity requirements total approximately 6.3 million megawatt-hours per year. More than 50 percent of these electricity requirements are satisfied by two on-site power stations owned by Russian Steel and Metalware. The two power stations have a total installed capacity of approximately 446 megawatts. The power stations generate electricity by burning natural gas and waste by-products from the steel mill’s production process, such as coke breeze, blast-furnace gas and coke-oven gas. Recycling waste by-products creates significant cost savings.  As a result, Russian Steel and Metalware uses a relatively low amount of energy coal to generate electricity at its facilities.

Russian Steel and Metalware covers its electricity deficit through direct contracts to buy electricity in the Russian wholesale electricity market.

To generate heat, the steel-making facilities within Russian Steel and Metalware use blast-furnace gas. The gas used is sufficient to meet all of the heat requirements of Russian Steel and Metalware. Any surplus is sold to local household utilities.

Natural gas and fuel oil also form part of Russian Steel and Metalware’s energy requirements. Natural gas is used as a heat source in the open-hearth furnaces, blast furnaces, reheating lines and power plants.

The power plants within Russian Steel and Metalware operate a combined cycle.  These plants burn gases, including natural gas, to generate steam for electricity and burn by-product coal breeze from the coking plants to supplement hot water and industrial steam output. Russian Steel and Metalware’s power plants use fuel oil only in emergencies.

Russian Steel and Metalware purchases its natural gas from Gazprom, the national gas supplier, at prices established by the Russian Federal Tariff Agency.

Capital Improvement Programme

Russian Steel and Metalware has invested almost US$1.7 billion in modernising its steel operations since the beginning of 2003.  This capital improvement programme was designed to replace and refurbish major equipment, increase productivity and efficiency, effect environmental upgrades and develop its product mix further to produce higher-quality, value-added products, including galvanised steel and cold-rolled products. New products under development include tube-making strips, such as X-70 and X-100 API-class strength for large diameter pipelines; heavy plates for a shipbuilding project to be rolled by 2800 and 5000 rolling mills; hot-dip galvanised sheets for automotive exposed parts and IF-steels; new-class carbon and low-alloyed steels with increase corrosion-resistant and low-temperature-resistant properties; long products of A 500C class for construction applications.

As a result of this capital improvement programme, modern processing technology and equipment from leading companies in the steel industry, including Fuchs, LOI and Siemens, have been installed at Russian Steel and Metalware’s facilities.

It is also planned that three blast furnaces and three coke batteries will be refurbished in the next two years and that the last open-hearth furnaces (which currently have a production capacity of 900,000 tonnes per year) will be closed by 2007. The basic oxygen furnace complex, or BOF complex, is expected to be modernised and expanded to increase production to 9.5 million tonnes per year. In 2005, a second 1 million tonne capacity EAF entered commercial operations. It is expected that the continuous casters will be modernised and one machine fully revamped to eliminate the last remaining ingot casting and cogging complex, which currently accounts for 11 percent of production.

Research and Development

Russian Steel and Metalware has pursued research and development initiatives with Russian universities and research institutes. Such initiatives include a research and development centre for cokemaking and ironmaking and studies for oil and gas pipe and shipbuilding steel applications.

Sales and Marketing

Russian Steel and Metalware sells its products in both the international and Russian domestic markets. While export sales have increased over the last three years, Russian Steel and Metalware continues to view the Russian domestic market as strategically important and has implemented a long-term programme designed to broaden its customer base and develop its relationship with various key customers. In the export markets, Russian Steel and Metalware aims to sell products for which there is low demand in Russia, and sales are made predominantly on a spot-market basis.

Russian domestic sales. Russian Steel and Metalware continues to regard Russia as its most important market, which is characterised by lower transportation costs for delivery to customers. This market offers various competitive advantages, including the ability to realise higher profit margins, high demand from domestic industries that rely on a stable supply of steel products and the ability to develop long-term strategic alliances with customers. As domestic sales have higher profit margins than export sales, Russian Steel and Metalware aims to increase its share of domestic sales in the future.  In the first half of 2006, Severstal’s share of domestic sales was increasing progressively.

Customers. Russian Steel and Metalware’s most important customers are the pipe-manufacturing and automotive industries. Russian Steel and Metalware also attaches increasing importance to the growing construction and construction materials sectors, which include a number of important customers located in the St. Petersburg region, as well as to the large customers emerging in the developing economies of several CIS countries.

The pipe manufacturing sector accounted for approximately 24 percent of Russian Steel and Metalware’s total domestic sales in 2005 and approximately 18,1 percent in 2004. Russian Steel and Metalware’s principal customers in the pipe manufacturing sector are the Vyksa and Cheliybinsk pipe plants.

Russian Steel and Metalware is the only producer in Russia of “K-54’’ grade steel which has enhanced corrosion-resistant and cold-resistant properties and can be exploited in temperatures as low as minus 60 degrees Celsius. Russian Steel and Metalware’s principal customers in this sector are the Vyksa and Cheliybinsk pipe plants.

To increase its sales in the shipbuilding sector, Russian Steel and Metalware has developed new grades of steel with improved weldability. Russian Steel and Metalware estimates that sales to this sector constituted 2.8 percent and 2.5 percent of domestic sales for 2004 and 2005, respectively.

The Russian automotive sector accounted for approximately 12,3 percent of Russian Steel and Metalware’s total domestic sales in 2005 and approximately 14 percent in 2004.  This sector is characterised by an increasing demand for a wide range of high-quality products, including IF-steel and zinc-coated products. Russian Steel and Metalware’s key customers in the domestic automotive sector are GAZ, AutoVAZ and UAZ. Russian Steel and Metalware’s sales to AutoVAZ and UAZ together accounted for more than 50 percent of Russian Steel and Metalware’s total sales to the Russian automotive industry in 2005. The main products supplied to the automotive sector in 2005 were cold-rolled sheet (63 percent of total supplies to the industry) and pickled and oiled hot-rolled sheet (17 percent of total supplies to the industry). Due to the strict requirements of automotive plants, especially those outside Russia, Russian Steel and Metalware has focused on improving the quality of its products significantly and has developed new grades of products (for example, products with an alumino-silicon coating and high-strength steels) to meet the demands of customers.

As at 31 December 2005, Severstal-Metiz was the largest company in the metalware industry in Russia. Approximately 95 percent of Severstal-Metiz’s steel feedstock is supplied by Russian Steel and Metalware. In 2005, Severstal-Metiz had a total production output of 826,356 tonnes of metalware, as compared to 803,689 tonnes in 2004. Severstal-Metiz was also able to strengthen its position in the high-profit segments of the Russian metalware market, for example ropes, and to maintain strong relationships with key clients, such as Russian Railways. ChSPZ is the core plant within Severstal-Metiz, with 2005 annual production of 560,863 tonnes of metalware, as compared to 571,794 tonnes in 2004. All the numbers are based on managerial estimations.

Key account management.  Russian Steel and Metalware has identified 11 key domestic customers as part of a project to work in close co-ordination with customers in strategically important industries, including such large accounts as Severstal-Metiz, OAO Volzhsky Pipe Plant, ChTPZ, AutoVAZ, UAZ, GAZ and Caterpillar. Russian Steel and Metalware works with these customers as part of its “key account management” process, which includes the development of new products and leads to further innovations both for the customer and Russian Steel and Metalware. Services for such customers include the construction of consignment warehouses and rolled-steel warehouses in different regions and quarterly product-quality co-ordination (overseen by co ordinating boards).

The regional distribution of Russian Steel and Metalware’s products involves the delivery of steel products to large warehouses, regional supply agencies, traders and industries from which they are distributed to a wide range of consumers (including small businesses and the public). In 2004, Russian Steel and Metalware sold approximately 1.8 million tonnes of steel products to this group of consumers. Russian Steel and Metalware estimates that this amount increased in 2005 to more than 2 million tonnes.

Export sales are conducted entirely through Russian Steel and Metalware’s export trading subsidiaries.

Products. Russian Steel and Metalware’s domestic sales are dominated by hot-rolled sheet and sections. Higher value-added products such as cold-rolled and galvanised sheet are also very significant. Russian Steel and Metalware also sells some non-steel “associated products”, which include a wide range of chemical products, benzol, green vitriol, blast furnace and converter slag and other by-products of the metallurgical process. These products are used in the agricultural, chemical and construction industries. Russian Steel and Metalware’s Cherepovets facility has a 20 percent market share of special niche product sales and a 26 percent market share of value-added product sales. Its joint venture Severgal has a 43 percent market share of special niche product sales and a 57 percent market share of value-added product sales.

Contracts. Russian Steel and Metalware has developed an approach to contractual relations with its Russian domestic customers that is relatively new in Russia. Contracts are concluded on a quarterly, semi-annual, annual or 15-month basis depending on the customer (for example, relationship history, industry and significance). Contracts also include a flexible system of discounts and rebates that provides for adjustments to the contract price on the basis of product tonnage, timing of payment and other contractual terms.

Sales to key customers are made at long-term prices and on customised terms, allowing Russian Steel and Metalware to fully reflect the higher degree of sales complexity in each case. Long-term contracts usually have a duration of approximately six months or more and ensure more stable operating conditions for Russian Steel and Metalware.

Russian Steel and Metalware seeks prepayments from certain customers, including new customers and those companies who are considered to be at risk financially. In 2005, prepayments accounted for approximately 18 percent of Russian Steel and Metalware’s sales, compared to 21 percent in 2004. The remainder of contracts require settlement within a range of five to thirty days from delivery and combined settlements. Russian Steel and Metalware offers credit to a number of key customers of up to thirty days under bank guarantees. This flexibility of contract and credit terms has generated a significant competitive advantage for Russian Steel and Metalware, allowing it to forge closer ties with customers and to react more effectively to changes in market conditions.

International sales. In line with its strategy of focusing on the Russian domestic market, Russian Steel and Metalware’s international sales strategy is, on the whole, oriented towards identifying spot markets of steel products.

Customers. Russian Steel and Metalware also focuses on a number of international customers irrespective of the fact that sales to such customers do not represent a substantial proportion of total international sales. These customers are often targeted for other strategic reasons, for example, to establish relationships with the customer, particularly where the customer is likely to establish or has recently established operations in Russia or where Russian Steel and Metalware aims to gain further exposure to sophisticated customers with complex specification requirements.

Severgal Russia’s primary international customers are companies in the automotive industry, such as Fiat, Ford Motor Company, General Motors Corporation, Renault, Greif (formerly Van Leer), Philips, Merloni and Electrolux, for which it produces galvanised sheet steel with a high-quality surface and other high-quality products.

Distribution. Russian Steel and Metalware conducts its export sales primarily through two export-trading subsidiaries, Severstal Export GmbH and AS Severstallat.  This system has enabled Russian Steel and Metalware to increase the efficiency of its export operations by minimising its reliance on intermediaries in the sales process and, therefore, reducing its distribution costs. The two export-trading subsidiaries referred to above are owned by Severstal’s wholly owned Austrian subsidiary, Severstal Trade, which holds 99.8 percent of Severstal Export GmbH and 50.5 percent of AS Severstallat.

Severstal Export GmbH is the management centre for Russian Steel and Metalware’s sales operations in the export markets, excluding the Baltic States, which are covered by AS Severstallat. Managing export operations through one centre has allowed Russian Steel and Metalware to achieve cost savings through lower administrative expenses, to benefit from large volumes and to eliminate intermediaries from the distribution chain.

AS Severstallat has been Russian Steel and Metalware’s export agent in the Baltic region since its formation in 1992. Although Russian Steel and Metalware has direct contracts with certain customers in the Baltic market, the majority of sales contracts, primarily with shipbuilding companies, are entered into through AS Severstallat. AS Severstallat is currently a joint venture between Severstal and local partners, not affiliated with Russian Steel and Metalware, and was originally established in 1992. AS Severstallat now operates as an export agent, a customer-oriented regional service centre and a producer of metal products for Baltic countries and elsewhere in Northern and Eastern Europe. It conducts a variety of businesses, including direct metal sales, a cutting service for coils and the production of long products and pipes.

Products. Russian Steel and Metalware’s export sales are dominated by hot and cold-rolled sheet, which accounted for more than three-quarters of sales in 2005.