The Verkhovna Rada may soon sharply increase rent rates for the extraction of iron ore, one of Ukraine's main export commodities.
Parliament is already drafting a corresponding bill, as Danil Getmantsev, head of the relevant parliamentary committee, confirmed to Strana.
The project aims not only to increase rent, but also to completely change the tax base.
A 5% tax is planned to be levied on the market price of ore (on Platts China).
Currently, rent is calculated based on the cost price of the ore (rate - 11-12%).
On the one hand, the price of ore is currently at a record ($168 per tonne, compared to $88 in March last year), which allows exporters to make excess profits and makes the authorities eager to confiscate them.
On the other hand, metallurgists complain that the second rent increase since the quarantine (in 2020, rates were raised by 50%) will have a negative impact on the industry and exports.
There's another nuance. As Strana has learned, the Verkhovna Rada is currently negotiating with Rinat Akhmetov, whose companies control the lion's share of iron ore production and who will be hit hardest by the rent increase. He is counting on substantial compensation from the state, which will cover the costs of the rent increase.
"The country" I figured out how parliament plans to rewrite the ore royalty rates.
6 billion from ore
It's worth noting that last summer, the ore rent was already increased by almost 50%—to 11-12% of the cost of production (12% is taken if the market price of ore exceeds $70 per ton, that is, it is now calculated at the highest rate).
This norm is contained in the scandalous law “on tax terror” (No. 1210).
Moreover, a more significant rate increase was initially planned, as well as a transition to a new tax base (based on the sales price). However, the metallurgical lobby in the Rada ultimately succeeded in defeating these regulations. Even the "soft" rent increase was criticized by metallurgists, who claimed that the increased tax burden during the quarantine would hit the industry hard.
However, as it turns out, the agreements proved temporary. Record-breaking global ore prices (in March, $167 per ton, compared to around $60 two years ago) didn't go unnoticed by our legislators, who decided they hadn't asked for enough last time.
Now the "servants" and tax authorities are drafting a new bill that would require iron ore miners to pay 5% of the Platts China price (i.e., the market price). The Chinese price was chosen for a reason—the lion's share of Ukrainian ore exports goes to China.
Danylo Hetmantsev, head of the Verkhovna Rada Committee on Finance, Tax, and Customs Policy, confirmed the information about the upcoming changes.
"We already raised the tax rate by 50% in 2020. We plan to increase taxes further, but the specific bill will soon be submitted to the Verkhovna Rada; it's currently in the development stage," Getmantsev said.
"Resource prices are high. And since the budget is empty, the Verkhovna Rada is actively seeking additional sources of income, so they've returned to the issue of ore rent," explained Mykhailo Volynets, MP and head of the Independent Miners' Trade Union.
It's worth noting that, based on the results of last year (during which the price of ore on the global market almost doubled), most exporters significantly improved their financial performance.
For example, Rinat Akhmetov and Vadim Novinsky's Metinvest increased its net profit by 54% compared to 2019, reaching $526 million, while EBITDA increased by 82%, reaching $2,204 billion, with margins growing by 10 percentage points, from 11% to 21%.
Ferrexpo Group Constantine Zhevago (controls Poltava Mining and Processing Plant) increased its net profit by 58% to $635,3 million in 2020.
Ferrexpo's revenue for the year increased by 12,8%, to 1,7 billion, EBITDA by 46%, to 859 million. Net cash flow from financial operations increased by 45%, to 687 million dollars.
At the same time, as Danil Getmantsev noted in an interview, the effective (real) tax rate for iron ore companies is significantly lower than the rent.
"The law currently specifies two methods for calculating the tax base: the expenditure method and the actual method. Using the actual method, our producers don't calculate the tax base for ore. They calculate it based on the expenditure indicator. Using the expenditure method, the effective rate, at the current rate of 8%, is slightly over 2%. At the rate we've specified in the law (No. 1210 – Ed.), it's around 3,7%," Getmantsev noted.
Proponents of increasing the ore rent also cite the following argument: mining and processing plants receive approximately 40 billion hryvnias in net profit per year, but only pay 3 billion hryvnias in rent for the extraction of iron and manganese ores.
"On the one hand, increasing the rent is the right thing to do. The state only receives about 40 billion hryvnias per year in rent payments, 95% of which comes from gas, oil, and gas condensate. The situation with ore is a complete nonsense. Its price on global markets has skyrocketed in recent years—from $55 to almost $170. Meanwhile, the budget receives mere peanuts. Rent can be increased significantly. And linking it to global prices makes it justified—more earned on exports means more paid into the budget. If global prices fall, then we'll have to pay less. On the other hand, it's possible that increasing the rent on ore will weaken the competitive advantage of our metallurgists in foreign markets. A better approach would be to introduce an expert duty on ore and keep the rent low for domestic processing, which would allow the authorities to both fill the budget and support the metallurgists," says economist Oleksiy Kushch.
What will happen to metallurgy and exports?
But it is unclear what will happen to ore prices and exports this year.
Iron ore prices in China, where most of our exports go, have now dropped.
As of March 19, the price of ore fell by $160,16 per ton.
Iron ore futures on the Dalian Commodity Exchange fell 3,5%. The price of the raw material fell 2,8% over the week.
The decline comes amid concerns among traders about a reduction in steel production in the city of Tangshan due to high levels of pollution.
Tangshan authorities have issued a notice to local steelmakers (which account for 14% of China's total steel production) about possible production cuts for the year. The reduction could be 30-50%.
Fitch also predicts a decline in average iron ore prices in 2021. Prices could fall to $125 per tonne, and even to $70 in the long term.
As for the volume of Ukrainian ore exports, according to the industry association Ukrmetallurgprom, they fell by 2% in the first two months of this year, compared to the same period in 2020 (to 7,09 million tons).
But the main blow could fall on the metallurgy industry, which uses iron ore. When speaking out against high ore rents last time, metallurgists argued that the income from ore exports subsidizes metallurgy production. Therefore, raising the rent could, in theory, worsen the situation in the metallurgy industry.
For example, Yuriy Ryzhenkov, CEO of Metinvest Group, commenting on the increase in ore rent under Project 1210, noted that in 2019, Ukrainian metallurgical companies suffered losses exceeding UAH 30 billion. They had to be subsidized from revenues from iron ore sales.
In 2020, Ukrainian metallurgical exports were not performing well.
Over the course of the year, 18,5 million tons of ferrous metals were exported, worth $7,69 billion. In physical terms, this is a 0,7% increase over 2019, but in monetary terms, it represents a decrease of 11,9%.
It's worth noting that steelmakers are so far refraining from commenting on the new proposal to increase ore royalties. Rinat Akhmetov's Metinvest and Ukrmetallurgprom, contacted by Strana for comment on the proposed changes, have yet to state their position.
Although at the stage of last year's rent increase, Metinvest required amendments to the new law.
"We, as a company, along with many associations, call for a postponement of the initiatives in Law No. 466-IX regarding increasing the iron ore mining rent. We call for the development of transparent and understandable, market-based methods for setting the rent," Ryzhenkov said at the time.
"Increasing rents will lead to the loss of sales markets and sources of foreign exchange earnings, job losses, a significant reduction in payments to the state and local budgets, and a deterioration in the state of the economy and national security of Ukraine," Ukrmetallurgprom stated.
Bargaining with Akhmetov?
However, there is a nuance that explains why the metallurgists, who desperately defended the recoupment of every "extra" percent of rent last year, are now silent.
Rinat Akhmetov's companies control the lion's share of iron ore production. And as Strana has learned, active negotiations over rent are currently underway with him. As our source in the metallurgy industry explained, "They want to raise rates temporarily; the term is currently being discussed—for 5 or 10 years. During this time, Akhmetov will pay rent, even at the maximum, of around 50 billion hryvnias (approximately $1,8 billion), and that's if prices don't fall. But in exchange, he's negotiating a budget subsidy for the modernization of thermal power plants, which amounts to around 4 billion euros. So he'll still get more from the budget than he pays."
In reality, the bidding process could be much broader, especially in light of Zelensky's intention to "redivide" the subsoil.
"Last time, they also said that rent needed to be raised, but then at KZRK (controlled by Rinat Akhmetov and Igor Kolomoisky), they refused to raise workers' wages and allowed a large-scale protest. Basic occupational safety standards are not being observed. The State Labor Inspectorate found 650 violations at KZRK, which would require the mines to be shut down altogether. So, in parallel with the rent issue, we also need to address issues of wages, occupational safety, and investment," says Mykhailo Volynets.
"The rent issue is debatable. We need to consider the potential rise in raw material prices for metallurgists, how this will impact the cost of finished products, and whether it will reduce their competitiveness in the global market," noted Yuri Korolchuk, an analyst at the Institute for Strategic Studies.
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