Tough times ahead for miner that has seen it all — Huge Noril’sk nickel complex weathers the storm of Russian privatization

For Russia, the road to privatization is strewn with anxieties and uncertainties — a situation amply illustrated by recent developments at the Noril’sk Mining and Metallurgical Kombinat in Siberia.

Situated at the margin of the northwestern part of the Siberian plate, where it adjoins the West Siberian and Karsky plates, the Noril’sk region is famous for its copper-nickel mineralization and for a variety of other mineral deposits. The Noril’sk Kombinat includes mining, refining and metallurgical operations, and is the largest complex of industrial enterprises in all of Russia.

It is also among the least stable.

The Kombinat’s troubles can be traced to 1992, when the Russian government introduced the Mass Privatization Program, a controversial shares-for-loans scheme aimed at fostering an open market by unloading some of Russia’s biggest state-owned companies.

Under the terms of the deal, the government would loan its shares in a company for cash. With the shares as collateral, an outside investor would operate a particular company until such time as the government could repay the loan and recoup its interest.

In July 1995, the country’s second-largest commercial bank, Oneximbank, picked up the Russian government’s 38% interest in Noril’sk for the bargain-basement price of US$170 million. The workers and management of the company, which includes subsidiaries Severonickel in Siberia and Pechenganickel on the Kola Peninsula, control 50%, while the remaining 12% belongs to the Russian public. Shares in the company were bid at US$6.50 at the beginning of March, with 126 million common shares outstanding.

Detractors of the deal, including Russia’s parliament and workers at Noril’sk, denounced the transaction as the plunder of one of Russia’s greatest resources; supporters saw it as a small step toward a brighter future.

To understand the problems facing Noril’sk, which supplies 20% of the world’s nickel, 62% of it palladium and huge amounts of platinum, nickel and cobalt, is to glimpse an economy in transition.

Michael Newbury, whose company, Endeavor Financial, has helped broker joint-venture deals in Russia’s gold sector, knows how difficult such a transition can be. “I’ve seen fair-sized companies whose planning and budget are all on one page,” he says. “Before, when they needed something, these companies wrote to Moscow and said, `Send us $10 million for new tractors.’ You just had to justify it by meeting your quota; economics had nothing to do with business. Now there’s no Moscow to get the money from, and you have to figure whether you’re making money or losing it, never having done that before.”

Noril’sk’s post-privatization problems are legion, and each is as complex as the last. In the past three months, the Kombinat’s woes have sent the prices of platinum group metals (PGM), particularly platinum, soaring, and has nudged the prices of gold and silver as well.

The most immediate hurdle facing the company is the threatened walkout by 130,000 employees who have not been paid in months. Back wages owed by the company stand at $200 million, which is also how much Noril’sk owes the Russian government in back taxes.

Situated 320 km north of the Arctic Circle, Noril’sk is a seminal company town. More than a third of its 300,000 inhabitants are employed in some capacity by the Noril’sk Kombinat, which, thanks to communism, is financially responsible for everything from power generation to housing to pig farming.

Oneximbank wants the region of Krasnoyarsk, where the town is situated, to shoulder the financial burden of its infrastructure. Noril’sk estimates that it spent 42% of 1996 revenues on the upkeep of the town. The only way workers can expect to be paid on time, says the company, is if the regional government agrees to foot the town’s bill.

The beleaguered conglomerate must also wait out the heel-dragging of the Russian government in passing the latest budget, which includes provisions for supply contract negotiations with Japan, the world’s leading consumer of platinum. Fears of a shortage of the metal led Japanese fabricators to turn to the spot market for their supply, a move that drove prices in February to a high of US$392 per oz., compared with US$360 at the beginning of the year.

“The market has been on a runabout,” says Bernard Penner, a bullion trader with New York-based brokerage house Rudolph Wolfe. “The problems [at Noril’sk] do affect the price.”

Labor unrest

Prices have also been boosted by the saber-rattling of Noril’sk’s union.

Fears that Russian supply would drop if workers were to walk off the job led speculators and funds to scoop up whatever platinum and palladium they could find.

The resulting spot market activity and short covering led to an increase in the price not only of PGMs, but of gold and silver as well. The PGMs are credited with helping prop up the price of gold when it bottomed at US$337 per oz. in the middle of February.

But, according to many market watchers, a work stoppage at Noril’sk is unlikely. “Nobody believes there’s going to be a long-term strike,” says Penner. “They’re working for nothing anyway. What they have is basically state aid. They have a job and a lot of people in that country don’t have jobs, or houses or food. They can make all the noise they want, but they’ve got nowhere to go. It’s hard to walk out of Siberia.”

The Russian conglomerate has so far experienced frustration in its struggle to set itself back on an even keel. Its year-old restructuring plan was recently shelved as a result of pressure from employees. Even the Russian government, which was once supportive of the miner, seems to be distancing itself. Although it pledged a credit of US$200 million for retooling and tax credit considerations to Noril’sk in August 1996, that support was recently withdrawn. Noril’sk is also concerned over the deal it has with state export agency Almazjuvelirexport, which buys the company’s output at 30% below average world prices. The licences that would allow Noril’sk to sell straight to the consumer at a higher price are difficult to obtain.

Bright side

Nonetheless, Noril’sk is determined to weather the transitional storm. It has been operating since 1935 and still has another 40 years of reserves. The company’s various deposits contain up to 3.4% nickel, 3% copper, 1.3% cobalt and 53 grams PGM per tonne.

The restructuring plan, which is expected to be re-implemented, calls for a balanced budget, the closure of unprofitable plants, shunting of infrastructure costs to the regional government, and production increases of 20% for nickel, 9% for copper and 27% for cobalt. According to the company, February production figures are expected to rise 10% to 21% over figures recorded the same period in 1996.

Newbury believes Noril’sk’s salvation lies in a thinner, trimmer operation.

“Noril’sk should spin off the non-core activities — the farms, the hospital, the grocery store, the school,” he explains. “The company cafeteria needs food, so spin off the pig and cow farms and let the farmers sell their produce to the company. That would get rid of a lot of peripheral stuff. The town would become more efficient and the payments for that sort of thing would be more realistic.”

However, the cost of modernizing operations will not come cheap. “The requirements for improving efficiency are staggering,” says Newbury. The proposed refurbishment of the Pechenganickel plant in Murmansk, for example, was estimated at US$84 million. The project, which was to be funded jointly by the Russian and Norwegian governments, was shelved because the facility was deemed too old. “What you really need to do is recapitalize the company and perhaps list it on a world stock exchange,” Newbury continues. “Also, an American Depository Receipt exchange might help raise dollars that could be used to upgrade operations.”

Investment desirable

Foreign investment would certainly help lift Noril’sk out of the doldrums, according to Boris Yatskevich, the deputy minister of Russia’s ministry of natural resources. “We have already begun attracting investment, and we have the full support of regional and federal governments,” he says. “The Russian government believes society should be kept open and [that] shares of many companies [should be sold] to whomever wants them.” The country’s gold sector was thrown wide open in 1996 following the reform of mining and tax regulations and reductions in government royalty payments. Currently, seven Canadian companies, including Ursa Major Resources, High River Gold, Armada Gold and Kinross , are evaluating 15 deposits in the country. According to Yatskevich, there is nothing preventing other foreign companies from investing in Noril’sk.

“Mining is undoubtedly important to a healthy Russian economy,” he says. “Its importance is less than that of oil and gas, but it is still significant.” Newbury concedes that while there is money to be made in Russia and that the government has made an effort to attract foreign investment, investors would be well-advised to adopt a long-term approach. “The bang for the buck in Russia is good, but you have to sit on the side of the pool with your toes in the water. It takes a lot of time to find out what’s good and what isn’t.”