Overview of the cement industry in the countries of the Customs Union

Contents
Introduction 1 State of the cement industry in Russia, Belarus and Kazakhstan in 2012 2

The cement industry in Russia 3 The cement industry in Kazakhstan 6 The cement industry in Belarus 8 Analysis of the key features of the cement industry in the countries of the Customs Union 10 Cement production involves high energy costs 12

Survey results: development of the industry in the medium term

13

Russias accession to the WTO 13 Expansion of imported cement 16 Certication system and state control over cement quality 17 Industry-specic issues 18 Sources of nancing 21 Industry prospects 22

Contact details

25

Introduction
The cement industry is one of the most promising in the economy in the countries of the Customs Union. In 2012, Russia reached a record-high level of cement consumption. Analysts expect demand to grow signicantly by 2020 amid the modernization of the Russian and Kazakh transport systems, the implementation of the federal housing programs in Russia and Kazakhstan, and the preparation for the 2014 Winter Olympics in Sochi and the 2018 FIFA World Cup. At the same time, manufacturers bear additional expenses as energy and transportation tariffs rise, coupled with high borrowing costs. The industrys attractiveness led to tougher competition, resulting in the evolvement of modern energy-efcient production in all countries of the Customs Union, Russias accession to the WTO in 2012 and a signicant increase of imported cement in total consumption. Facing tougher competition, cement manufacturers are forced to review their long- and short-term development plans. They need to streamline their operating structure and learn how to manage the cost of goods. Consideration should be given to the adoption of energy-efcient technologies, modernization of the existing capacities and borrowing in the nancial markets. In 2013, the executives of cement manufacturers are cautiously optimistic about the future. How do they view the future? And how do they assess the current state of the market and its development prospects? To get answers to these and other questions, we conducted a survey among cement manufacturers of Russia, Kazakhstan and Belarus. We would like to thank all the survey participants for their contribution and hope that the companies who took part in the survey will become our respondents on a regular basis.

Vasily Potapov Partner EY

Overview of the cement industry in the countries of the Customs Union Introduction |

State of the cement industry in Russia, Belarus and Kazakhstan in 2012

| Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012

The cement industry in Russia

In 2012, Russia reached a record-high level of cement output and consumption. Consumption increased by 7.6 million tonnes (13.2%) as compared with last year. An increase in consumption by 2.3 million tonnes (30%) was met by growing imports, in particular from Turkey, Belarus and Iran. Table 1. Russian cement imports by exporting countries (thousands of tonnes)
Country Turkey Belarus Iran Latvia Romania Sweden Lithuania South Korea China Poland Other Total
Source: CMPRO.

The percentage of export in the total output remained stable: 2.1% and 2.3% in 2011 and 2012, respectively, with Kazakhstan, Azerbaan and Belarus accounting for most of Russian exports (over 96%). The Russian cement market is represented by 10 big manufacturers and the same number of smaller local players. The ve leading industrial groups account for 61.4% of the market. They are followed by manufacturers owned by foreign cement holdings, whose aggregate share is 18.7%. The rest of the market goes to local players, including RATM Holding, Vostoktsement, LSR Group and others. In 2012, the major players had the following shares in the market (Figure 1).

Figure 1. Major cement manufacturers share of the Russian market in 2012 (%)
13.1 3.2 5.3 3.6 4.6 5.0 3.8 5.5 7.7 6.5
Holcim Dyckerhoff RATM Heidelberg Cement Vostoktsement Other

33.7

2011 986 282 310 141 197 141 253 84 422 2,816

2012 1,882 967 458 305 153 203 203 102 203 610 5,087

8.0

EUROCEMENT Group Novoroscement Sibirskiy Tsement Mordovcement Sebryakovcement Lafarge Source: CMPRO.

Table 3. Main parameters of the Russian cement market, 2005-2012

2005 Output, thousands of tonnes Imports, thousands of tonnes Exports, thousands of tonnes Consumption, thousands of tonnes Purchase price, RUB per tonne, incl. VAT and delivery charges Market capacity, RUB billion Imports, % of consumption Exports, % of output Increase in output, % Increase in consumption, % Increase in purchase price, RUB per tonne, incl. VAT and delivery charges, %
Source: CMPRO.

2006

2007

2008

2009

2010

2011

2012

48,534 54,731 59,933 53,548 44,266 50,371 55,936 61,516 400 3,100 790 3,207 2,757 1,869 8,130 804 1,300 1,600 1,133 1,748 2,816 1,188 5,087 1,428

Imports went up from 2.3% of total consumption in 2010 to 7.8% in 2012. The increase in imports from Turkey and Iran, which accounted for 46% of total imports in 2012, is due to the attractive sale prices and geographical proximity to major construction sites in Southern Russia. Table 2. Russian cement exports by importing countries (thousands of tonnes)
Country Kazakhstan Azerbaan Belarus Other Total
Source: CMPRO.

45,834 52,314 60,821 60,874 43,966 49,756 57,564 65,175 3,088 3,577 4,041

153.6 0.9% 6.4% 1.5% 5.9% 12.8% 14.1% 4.5% 3.1% 9.5% 16.3% 13.4% 1.5% -10.7% 0.1% 3.0% 3.6% -17.3% -27.8% 2.3% 3.5% 13.8% 13.2%

205.9 4.9% 2.1% 11.0% 15.7% 15.8%

263.3 7.8% 2.3% 10.0% 13.2% 13.0%

2011 647 344 153 44 1,188

2012 771 357 271 29 1,428

Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012 |

According to some Russian analysts, demand for cement in the Russian market will reach 97.6 million tonnes by 2020, while major international players and EY analysts are more conservative in their estimates of the Russian market, expecting 89 million tonnes by 2020 with an average annual growth of about 3%.

Demand for cement is likely to grow in Russia

Stagnation and the subsequent drop in consumption due to the global economic crisis in 2008-2010 were followed by growth in 2011. The Russian construction market is expected to retain a high demand after 2012, underpinned by the need for housing and infrastructure construction and for nalizing several large projects in the run up to the 2014 Sochi Olympics and the 2018 FIFA World Cup. In its preparation for the FIFA World Cup, Russia announced a RUB580 billion budget for the development of the necessary infrastructure1. The long-term development of the Russian housing market will be promoted by the Presidents initiative to implement a large-scale affordable housing program that, among other objectives, is designed to reduce the mortgage rates from 11.9% in 2011 to 2.2% in 2018. The program is also designed to cut the average housing price by 20% by increasing the supply of
1

Figure 2. Cement consumption per capita, 2010

China Luxembourg Turkey Switzerland Austria Italy Portugal Belgium Spain Slovenia Croatia the Netherlands Russia Czech republic Norway Finland Roumania Ireland Bulgaria France Germany Brazil Hungary Sweden Estonia Lithuania India The UK Latvia 0 200

352

 Russia to spend nearly $20 billion on 2018 World Cup, Reuters, 30 September 2012.

400

600

800

1,000

1,200

Source: Cembureau, FLSmidth&Co.

| Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012

affordable housing. The Government plans to allocate land for the construction of affordable housing at low regulated prices. According to the Russian Presidents Edict, 60% of the families in Russia will be provided with affordable housing by 20202.

Figure 3. Volume of housing construction in Russia (actual data for 2012)

160 140 120 100 mln sq. m 80 60 40 20 0 -10% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013F 2014F 2015F 2016F 2017F 2018F 2019F 2020F
215 Urals FD 1 -570 Siberian FD 30.7 32.0 30.3 31.7 33.8 36.4 41.0 43.6 61.2 64.1 50.6 59.9 58.4 76.0 67.0 62.3 65.7 90.0 110.0 100.0 142.0 132.0 121.0

30%

20%

Russian market is inuenced by geographic factors

The uneven distribution of cement production capacities across Russia and the CIS countries increases the share of the transportation component in cement pricing. As a result, the biggest cement supplier controls over 50% of the market in ve out of eight federal districts. EUROCEMENT Group operates in almost every federal district, and in 3 of them its market share exceeds 50%. Some of the federal districts of Russia have a cement production decit, while others produce too much. In general, the cement production decit in Russia was 1.5 million tonnes in 2011 and 2012. According to professionals, the main reasons for the overall decit are that the raw materials for cement are insufciently developed and production capacities are not fully used. There was a shortage of cement in the Central Federal District, the Northwestern Federal District and the North Caucasian Federal District (24%, 15% and 28% of consumption, respectively) in 2012, while in the Volga Federal District and the Siberian Federal District, oversupplies reached 19% and 10% of production, respectively, that year.

10%

0%

Housing commenced (total volume built) Source: Amicron Consulting, Federal State Statistics Service.

Dynamics against the previous year

Figure 4. Production and consumption of cement by federal districts of Russia from 2010 to 2012 (thousands of tonnes)
Regions with a consumption decit
2,807

4,000
2,240

3,000 2,000 1,000 0 -1,000 Central Northwestern North Far East FD FD Caucasian FD FD
-291 -367 -257

2,716 1,551

885

978

820

-850

-697

Regions with a production decit

-1,148

-1,019

-962

-4,000 -5,000

-2,968

-3,000

-2,072

-2,000

2010

-4,557

2011

-1,365

Volga FD

Southern FD

2012

Sources: CMPRO and the Federal State Statistics Service.

 Russias affordable housing plans ambitious JP Morgan, Property Investor Europe News, 15 May 2012.

Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012 |

102

469

The cement industry in Kazakhstan

The 2007 national banking crisis and the 2008 global nancial crisis slowed down the development of the national economy and the construction industry. In 2011, the construction industry still did not reach the record level of 2008.

The growing demand for cement in Kazakhstan in the 2000s increased prices and imports (to 3.5 million tonnes) in 2007 and attracted more investment in the industry. In 2007-2008, intentions to build 10 large production enterprises were disclosed, with each enterprise adding at least 1 million tonnes annually to the existing production capacities. The rst wave of construction increased the aggregate project capacity of Kazakh enterprises to 13 million tonnes by 2012. This indicator may reach 18 million tonnes if enterprises of the second wave are launched by 2014 (this likelihood is low).

The 2010-2014 Development Program for the Construction Industry and the Production of Construction Materials in Kazakhstan, adopted in 2010, was designed to play an important role in this respect. The cement market is characterized by the oligopoly of ve manufacturers (12 plants). The investigation conducted by the Competition Agency revealed anticompetitive concerted actions resulting in nes of KZT1.7 billion (US$11.5 million) in 20093.

3  CMPRO, Cement Industry of Central Asia.

Table 4. Main parameters of the Kazakhstan cement market in 2005-2014

2005 Output, thousands of tonnes Imports, thousands of tonnes Exports, thousands of tonnes Consumption, thousands of tonnes
Source: CMPRO.

2006 4,880 2,631 1 7,510

2007 5,699 3,506 9,205

2008 5,837 1,826 131 7,532

2009 5,694 782 25 6,451

2010 6,683 1,010 199 7,494

2011 5,500 900 200 6,200

2012 6,300 1,000 200 7,100

4,181 1,890 4 6,067

| Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012

Kazakh cement market development prospects

Company directors in the Kazakh construction materials market point out the fast growing prices, a trend that is likely to stay in 2013. The fast growth of construction is promoted by the Kazakh Governments infrastructural improvement policies designed to create a favorable environment for diversifying the national economy and developing sectors which are unrelated to oil production and rening. Rail and motor roads have been rapidly modernized since 2010. By 2014, Kazakhstan plans to invest approximately US$19 billion for developing the transport infrastructure, particularly in routes connecting China and Europe that will promote international trade4. The national company Kazakhstan Temir Zholy (railroads) plans to invest over US$40 billion in developing the railroad system by 20205. In October 2012, the World Bank provided a US$1.1 billion loan to Kazakhstan to build a new motor road between Almaty and the border crossing point Khorgos on the Chinese border6. Kazakhstan plans to allocate US$14.6 billion for housing construction as part of the Affordable Housing 2020 program launched in 2013. The program promotes rented housing that may subsequently be bought out, and also envisages measures to improve the housing infrastructure
4  Kazakhstan rolls out new roads, CNN, 13

Figure 5. Volume of housing construction in Kazakhstan (actual data for 2012)

12 10
9.0 10.0

100% 90% 80% 70% 60% 50% 40% 30%

2.6

8 Million sq. m 6 4 2 0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013F 2014F
2.1 6.2 5.0 6.7 6.8 6.4 6.4 6.5 6.7 6.6 6.9

7.2

7.6

7.7

8.0

20% 10% 0% -10%

2015F 2016F 2017F 2018F 2019F 2020F

Housing commenced (total volume built)

Dynamics against the previous year

Source: Affordable Housing 2020 program, Agency of Statistics of the Republic of Kazakhstan.

(car and pedestrian access, electricity and water supply, etc.). Besides, nancial assets are placed with banks to reduce the mortgage interest rates. The Kazakh Government plans to support manufacturers of domestic construction materials within the framework of the Affordable Housing 2020 program7.
7  Affordable Housing state programme, Kazakh TV,

September 2012.

16 December 2012; Affordable housing 2020 is the rst document providing comprehensive housing solutions: Kazakhstan Deputy Prime Minister www.bnews.kz, 7 December 2012; Industry Forecast - Residential & Non-Residential Kazakhstan - Q1 2013, Business Monitor International, 7 January 2013.

5  Kazakh state rail rm adds $300 million to 30-yr

bond, Reuters, 2 November 2012.

6  World Bank Approves US$1.07bn Highway Loan -

Road Trafc-Technology report, Business Monitor International, 17 Oct 2012.

Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012 |

The cement industry in Belarus

Industry modernization is expected to be completed by the end of 2013. As a result, the aggregate annual capacity of cement plants in Belarus will increase from 4.9 million tonnes today to 7.3 million tonnes in 2013 and 9.6 million tonnes in 2014. In March 2013, the Belarusian Government decided that the state will partially compensate cement manufacturers for the interest on bank loans in the amount of 50% of the National Bank renancing rate on loans in BYR or in the amount of 50% of the contractual rates on loans in foreign currency. At the same time, the state will increase its interest in the equity capital of cement manufacturers by the compensated amount8. These measures are necessary to ensure that nancing is available and to more effectively implement investment projects on the construction of cement production lines and coal preparation sections coupled with the transfer of the existing clinker production lines from natural gas to coal, and on the development of the engineering and transport infrastructure9.
8 www.belta.by 9 www.belta.by

Table 5. Main parameters of the Belarusian cement market in 2005-2013

2005 Output, thousands of tonnes Increase in output, % 3,131 2006 3,495 2007 3,821 2008 4,219 2009 4,350 2010 4,531 2011 4,604 2012 4,906 2013F* 7,000

11.6%

9.3%

10.4%

3.1%

4.2%

1.6%

6.6%

42.7%

Source: State Committee on Statistics of the Republic of Belarus. * F forecast.

In January 2013, the President of the Republic of Belarus announced that cement exports must exceed domestic consumption in 2013, reaching approximately 5 million tonnes, which is more than half of all the cement produced. Russia is the primary market for Belarusian cement. The Belarusian cement market is represented by three manufacturers: OJSC Belarusian Cement Plant, OJSC Krasnoselskstroimaterialy and OJSC Krichevcementnoshifer. In the future, the Government plans to create a vertically integrated construction holding, embracing

10 branches (OJSC Mogilevzhelezobeton, OJSC Orshanstroimaterialy, OJSC Lyuban Construction Materials Plant, OJSC Grodno Construction Materials Plant, OJSC Smorgonsilikatbeton, OJSC Reinforced Concrete Structures Factory No. 13, and others) in addition to those cement manufacturers.

| Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012

In 2009, Belarus started to modernize its cement industry by engaging Chinese state company CITIC Construction in the construction of new facilities. Construction was nanced primarily with loans of roughly US$530 million from China Exim Bank to cement manufacturers.

Figure 6. Volume of housing construction in Belarus

7 6
5.1 5.7 4.7 3.8 4.1 6.6

20%

5.5

5 Million sq. m 4 3 2 1 0

10%
4.5

3.5 3.0 2.8 3.0

3.5

0%

-10%

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Housing commenced (total volume built) Source: State Committee on Statistics of the Republic of Belarus.

Dynamics against the previous year

Movements of housing construction

Overall, 36.2 million sq. m of residential space were built in Belarus in 2006-2012. As a result, over 1 million people improved their housing conditions. Around 60% of housing (21.7 million sq. m) was built with the governments help. In 2010, Belarus commissioned more housing than any other CIS member (699 sq. m per thousand inhabitants) and was second in housing occupancy (24.6 sq. m per capita). One of the objectives of the government housing policy in Belarus is to increase housing occupancy to 27-28 sq. m per capita in 2015.

In 2013-2015, the volume of all housing commenced in the country will come to 24.5 million sq. m, including 9 million sq. m for citizens entitled to benets, with housing construction reaching 9.5 million sq. m in 2015. The volume of housing to be built will be determined each year by the Belarusian Governments decisions. Since 2013, measures have been taken to reduce the interest rate on loans for the construction of social and commercial housing10.

10  Decree No. 267 of the Council of Ministers of the

Republic of Belarus of 5 April 2013 On the Concept of State Housing Policy before 2016.

Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012 |

2012

-20%

Analysis of the key features of the cement industry in the countries of the Customs Union
Russia has the biggest share of wet production among the Customs Union members
According to our survey, nearly 72% of Russian manufacturers use the more expensive wet method today. In 2012, the share of wet production in Kazakhstan and Belarus was 47% (with plans to reduce it to 39% by the end of 2013) and 59% (with plans to reduce it to 44% by the end of 2013), respectively. Moreover, the survey shows that the Russian capacities based on the wet method, kilning and the semi-dry method are used better (72%-88.5%) than the capacities of enterprises applying the dry method. This is additional proof that the dry method is still new and offers good opportunities. Russias state strategy of developing the cement industry until 2015 is designed to increase the share of dry production to 40%. This strategy is supported by 32% of the respondents who think that in the next 5 years the market will encourage local manufacturers to commission new production facilities that use mainly the dry method. This is due to the fact that the main targets of many manufacturers in the next 3-5 years are technology modernization, lower production costs and greater protability, all of which are impossible when the old method is used. Figure 7. Production methods by country in 2010
Japan India Spain EU US Mexico Kazakhstan China Belarus Russia 0 Dry production Sources: CMPRO and EY. 19% 20 40 Wet method 41% 72% 60 Semi-dry method 80 Kilning 53% 50% 3% 59% 3% 6% 100 67% 93% 91% 90% 82% 23% 47% 47% 100% 7% 4% 5% 3% 7% 18% 9% 1%

Figure 8. Use of current production capacities in Russia in 2012 by the production method
95 90 85 80 % of respondents 75 70 65 60 55 50 54.0% Dry production Wet method Semi-dry method Kilning 76.9% 72.0% 88.5%

Sources: CMPRO and EY.

10

| Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012

Cost of cement production by using the production method The cost of goods is, as mentioned above, the main difference between the wet and dry production methods. The cost of goods is structured below: The cement industry consumes a lot of energy, with gas and electricity accounting for over 40% of all the expenses. Producer prices obviously depend on the energy tariffs set by the government. The liberalization of domestic gas prices and the growth of energy tariffs (which may be subject to an average annual increase of 6.2% and 12.7% in 2010-2015, respectively) may have an adverse impact on the operating margin if the actual demand growth ratio is lower than expected. If this is the case, the likely scenario is higher cement prices for customers or the intensive shifting to import from factories with the lowest production costs.

Low amortization in the case of wet production is due to the extreme depreciation of xed assets (over 80% of the assets require replacement or repair). Moreover, repair and maintenance are quite costly (16% of all costs). Where the dry method is used, amortization accounts for 25% and repair for 6%. The selling price for customers also includes transportation costs. The uneven distribution of cement manufacturers across Russia and other CIS countries results in a higher share of transportation costs in cement pricing.

An important fact is that 75% of the respondents competed with foreign cement manufacturers in the low-price segment in 2012. Foreign competitors have already gone through the period of transition to the new production method and had time to recover modernization costs, allowing them to keep their selling prices relatively low. Thus, the dry production of cement is competitive. A transition to dry production, however, tends to drive prices up in the mid-term period due to the high cost of the loans raised for modernization and the long payback period.

Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012 |

11

Cement production involves high energy costs

EY Insight The development of an energy strategy is a structured approach that allows a company to identify and introduce effective technological solutions and processes (e.g., the dry process, vertical rotary kilns, recuperation of heat, energy efcient fans, etc.), analyze opportunities for using alternative fuel (including coal, petroleum coke and biomass) and take measures to automate process control (e.g., automated kiln operation and robot-aided laboratories). The strategy allows technical limitations and nancing opportunities to be taken into account in order to choose the most appropriate measures for driving down the energy expenses. Besides, an energy strategy allows companies to respond in time to various risks stemming from new limitations or rules in the energy markets, greenhouse gas emission requirements, etc. and use the opportunities which arise.

The heavy dependence of economic effectiveness of cement production in the Customs Union countries on energy consumption is due to the following key factors: Outstripping growth of gas and energy prices High (as compared to the average industry indicator) per-unit energy consumption indicators (mainly because of the less effective technologies and processes)

The level of energy efciency of the industry is directly linked to protability, growth and development opportunities of companies. International experience shows that the development of a detailed energy strategy enables cement enterprises to choose the most effective solutions to the problem of energy dependence with regard to the market, technical and economic conditions.

12

| Overview of the cement industry in the countries of the Customs Union State of the cement industry in Russia, Belarus and Kazakhstan in 2012

Survey results: development of the industry in the medium term

Russias accession to the WTO

Russias major WTO commitments
L ower import tariffs. In line with Russias WTO commitments, customs duties for certain types of cement may be reduced from 5% to 3% as early as in 2013. Removal of the existing and a ban on new import restrictions that contradict WTO rules, including quotas, bans and import permits. Figure 9. Which of the following consequences of the Customs Union formation had or will have the greatest impact on your companys operations?
Simplied customs procedures and lower customs costs Toughening competition on the part of the suppliers of the Customs Union members Expanded market for domestic products Lower administrative barriers following harmonized industry legislation Reduced market for domestic products No impact or other 0%

34% 28% 14% 17% 3% 3%

5% 10% 15% 20% 25% 30% 35% 40%

Overview of the cement industry in the countries of the Customs Union Survey results: development of the industry in the medium term |

13

Quote from a respondent: "We need to learn how to use the WTO tools to stimulate the industry in every way, i.e., not to let in a wild import without taking any supportive measures."

Application of the Customs Union Single Tariff Preferences System to the developing and least developed countries. Under this scheme, cement imported from the developing countries is subject to 75% of the current import duty. The list of the developing countries includes major cement exporters to Russia (including Turkey, Iran and China). Join the WTO government procurement agreement within four years of accession to the WTO. The agreement contains a whole set of rules and procedures for government procurement tenders and requires equal conditions for Russian and foreign vendors. Restructure subsidies in industry with a view to abolishing subsidies banned by the WTO or to changing them in a way that granting is not dependent on whether the products are exported or whether Russian products are privileged over the imported ones. Gas pricing. Gas suppliers will set prices based on the commercial principles. However, the Government will continue to regulate prices for citizens and noncommercial consumers.

Cement producers perspective of Russias accession to the WTO and the possibility of WTO member states taking additional protectionist measures
Answering the question of how Russias accession to the WTO will inuence the Russian cement market, 70% of the respondents expressed their concern that the cement selling price will drop as a result of toughening competition on the part of foreign cement producers. Indeed, the WTO adheres to the principles of reciprocity and non-discrimination. At the same time, the WTO rules envisage a number of exceptions to the nondiscrimination rule, e.g., justied protectionist measures. These measures may be introduced under certain circumstances to discourage import while envisaging tariff regulation. These justied protectionist measures include: Anti-dumping measures Compensatory duties Protectionist measures

Figure 11. What was the overall effect of Russias accession to the WTO on the cement industry?
Generally negative No effect Generally positive

63% 31% 6%
0% 10% 20% 30% 40% 50% 60% 70%

The rst two types are resorted to in respect of a specic trade partner. The WTO permits them under certain circumstances, for instance, when unfair competition is detected as a result of a scrupulous investigation. Examples of such circumstances are export subsidies or dumping by partners. Between 200 and 300 anti-dumping investigations are initiated annually, with 2-3 of them leading to the introduction of anti-dumping measures. Investigations are most common in India, the USA and the EU states. Many anti-dumping investigations are initiated in relation to China, since the recognition of China as a non-market economy makes it considerably easier to prove an anti-dumping case. There are currently 11 anti-dumping measures in place in the Customs Union, including 3 that were introduced or extended in 2012 and 2 in early 2013. These measures are primarily directed against the import of metal products and automotive goods.

Figure 10. In your opinion, which of the following consequences of the accession to the WTO had or will have the greatest impact on your companys operations?
Toughening competition on the part of foreign cement producers Selling price drop as a result of the imported cement inow Lower administrative barriers following harmonized industry legislation Proper industry protectionist measures focused on the consumers' long-term interests Joining the WTO had no signicant inuence on the company's operations, as the SFD market is located far from the borders of other participants

45% 39% 10% 3% 3%

10

20

30

40

50

14

| Overview of the cement industry in the countries of the Customs Union Survey results: development of the industry in the medium term

Figure 12. In your opinion, is an anti-dumping investigation into cement imports necessary?

No 33% Yes 67%

Quote The ofcial GATT brochure Aider la croissance mondiale, published in 1989, stresses that GATT is "not a free trade charter but a mechanism to hold back protectionism". This description seems to be quite appropriate.

Figure 13. What was the country of your direct competitor in 2012 (%)?
2 20 2 2 3

5 5 5

15 10 13
Ukraine, Russia France, The UK Romania Sweden South Korea Belarus

10

Recently, analysts have pointed out the growth of protectionism around the world
How often do the leading world economies resort to protectionist measures? It seems to be very often, especially lately. The new wave of protectionism was triggered by the slowing growth and stagnation of the world economies and is primarily directed at the revival of business activity. According to the Debacle Protectionism Report published by Global Trade Alert in June 2012, the actual number of protectionist measures in 2010 and 2011 exceeded the forecast by 36%. The traditional protectionist measures, like higher tariffs or trade protection tools, account for merely 38.9% of all measures in 2011. The rest are measures of concealed protectionism that lie outside the scope of the existing WTO agreements and are often unnoticed by outside observers (e.g., recommendations to state-owned companies to purchase goods and services from local vendors).

Kazakhstan Lithuania Poland Latvia China Iran Turkey

The WTO report published in April 2012 also shows that between October 2011 and April 2012, the G20 countries introduced 124 new protectionist measures covering 1% of all world trade. Representatives of the Russian cement industry are concerned about how their products will compete with cheap cement from Turkey and Iran. According to the Federal State Statistics Service, the share of these countries in imports in 2012 was 37% and 9%, respectively (an increase of over 90% as compared with the previous year). Respondents also named Turkey and Iran as their main competitors. Besides, 75% of the respondents noted that imported cement is traded in the low-price segment. According to the survey, 67% of the respondents supported the initiative of starting an anti-dumping investigation into imported cement.

Compensatory measures (in response to exporters being subsidized by their respective governments) are usually taken by the developed countries, with the US, EU countries, Canada and Australia at the top of the list. They are usually directed against China and India. Up to 15 cases of introduction of compensatory measures are registered annually. Protectionist measures are far less common. They are taken primarily by the developing countries, mostly by India, Turkey, Jordan and Chile.

Overview of the cement industry in the countries of the Customs Union Survey results: development of the industry in the medium term |

15

Expansion of imported cement

Rising price competition from manufacturers of imported cement
In 2012, cement consumption in Russia increased by 7.6 million tonnes, or 13.2% as compared to 2011, with 30% of the growth accounted for by import from Turkey and Iran. A trend towards a greater share of imported cement in overall consumption continued in early 2013. According to CMPRO, in January consumption grew by 5.2% as compared with the same period of the previous year. Production increased by 4.7%, and import, by 20%. An interesting fact is that imported cement accounted for a signicant market share in particular regions. For example, Turkish cement accounted for 30% of the Murmansk Region market and over 50% of the Rostov Region and the Krasnodar Territory markets. According to our overview, in 2012, 20% of the respondents competed with Turkish, 15% with Iranian, 13% with Latvian and 10% with Chinese cement manufacturers. The Russian market participants are concerned about the situation, because the growing demand does not make the Russian cement industry more attractive. Today, most of the prot from market growth goes to importers and intermediaries. They are more mobile and free from the pressure of capital outlays and borrowing. As a result, 81% of our survey participants are negative about the increase in the imports of cement into the Customs Union. Figure 14. Does your company feel the growing impact of the increased share of imported cement on the market?
No 13%

Figure 15. In your opinion, what are the factors contributing to the growth of cement imports?
Geographic proximity of foreign manufacturers to cement consumption areas Attractive prices in the national market Low production costs of foreign cement Russias accession to the WTO and planned lowering of import duties on cement High quality of imported cement 0%

26% 24% 22% 13% 4%

5% 10% 15% 20% 25% 30%

Reasons for growing cement imports into Russia

Our survey participants named the geographic proximity of foreign producers to areas with high cement consumption, attractive prices in the national market and low production costs of imported cement as the main reasons for growing cement imports. Besides, some respondents pointed out the following important factors: Over 70% of the Russian capacities are wet production. Fixed assets are heavily depreciated and capital spending is high, making the complete cost of Russian cement signicantly higher and undermining its competitiveness. Low price for imported cement. A simpler cement certication procedure in Russia than in other countries.

Figure 16. In your opinion, what will be the market share of imported cement in 2013-2014?
From 10% to 15% From 8% to 10% From 6% to 8% From 4% to 6%

13% 33% 27% 20%

0% 5% 10% 15% 20% 25% 30% 35% 40%

EY Insight If the share of imported cement continues to grow in the Russian market, competition will toughen and local manufacturers will experience still greater pressure. This will lead to a smaller share of Russian manufacturers and the curtailing of long-term investment programs aimed at industry modernization.

Yes 87%

16

Certication system and state control over cement quality

Today, the certication of cement is not obligatory in Russia; there is no approved list of certifying bodies
Today, the certication of cement is voluntary in Russia. Federal Law No. 184-FZ On Technical Regulation, adopted by the State Duma on 15 December 2002, provides for obligatory certication only if the Technical Regulations on Cement are in place and are yet to be adopted in Russia. The Technical Regulations of the Customs Union become effective only on 1 October 2015, while the compliance documents previously issued will be effective by 2017. As for importers, the survey shows that only some of them will get a quality compliance certicate. Some importers may get a compliance certicate for all products based on merely one test, or they operate without any certicate at all, as a result of which raw materials of a low quality may be supplied for construction. Another important quality indicator of cement is its compliance to the climate and construction norms in each region of Russia. This includes such indicators as the percentage of alkalis (the inadequate content of which worsens concrete quality, promotes cracks and corrosion, and makes structures less durable) or the percentage of tricalcium aluminate (the high concentration of which leads to lower freeze-thaw resistance). Quality control is performed and compliance certicates are issued by over 100 independent accredited certication centers in Russia. Moreover, according to the Internet and other sources, the certicate can be obtained within a day, while the standard cement quality control procedure takes at least two months. According to analysts, the absence of mandatory certication and regional quality compliance norms affects the parameters and durability of construction materials and the facilities built by using them. The large number of accredited certication organizations and the insufcient regulation of their activities mean lower quality control. As a result, such a situation has an impact on the environment and the health and safety of Russian citizens. Thus, according to manufacturers, certication control iof the cement sold in the Customs Union markets should be enhanced in order to develop the cement industry and improve the new facilities. Figure 17. Was your competitors cement certied?

23%

77%

Imported cement was certied Imported cement was not certied

Cooperation between the manufacturers of cement, concrete and ready-mix concrete and the developers is not subject to regulation
The existing legal framework neither provides clear quality standards nor delimits the responsibility of construction material suppliers and developers when construction materials are of a low quality. For insgtance, the requirements for the quality and safety of construction materials, contained in the Technical Regulations Concerning the Safety of Buildings and Structures, are inadequate. Moreover, the new international GOST 7473-2010 of 1 January 2012, which determines the technical requirements for ready-mix concrete in the Customs Union, does not clearly indicate the time when the developer assumes responsibility for the low-quality construction materials. As a result, conicts between developers and construction material manufacturers are common. One of the ways of resolving this problem is to create self-regulating organizations (SRO) and develop SRO regional standards binding on their members.

Figure 18. What was the quality of your competitors cement?

33% 67%

High

Low

The St. Petersburg Builders Union, the pioneer SRO, was registered on 22 February 2012. Among its main activities was to draft a new standard called Ready-Mix Concrete Production and Acceptance Rules designed to regulate cooperation between the suppliers and buyers of construction materials. The SRO members themselves think that the standard should be nalized and tested further. Besides, a system of control over adherence to the standard should be created and introduced.

Overview of the cement industry in the countries of the Customs Union Survey results: development of the industry in the medium term |

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Industry-specic issues

In the latter half of 2012, the non-prot organization Soyuzcement proposed including cement in the Unied List of Products subject to mandatory conformity evaluation (verication) in the Customs Union, carried out by adopting a compliance declaration. According to the Soyuzcement proposal, certication will be administered by bodies included in the list of accredited organizations. It is noteworthy that 93% of our respondents supported the mandatory quality compliance certication of cement sold in the Customs Union. They also supported the idea that cement should be included in the Unied List of Products Whose Compliance Must Be Evaluated (Veried) in the Customs Union and for Which Unied Documents Are to Be Issued.

Another issue is the level of the product quality evaluation services provided by the certication centers. Many respondents mentioned state control over the certication centers as a necessary measure; it includes stricter accreditation criteria, the restriction of the number of these organizations, and the mandatory availability of own laboratory. According to the survey participants, the most signicant problems of the cement industry pertain to growing production costs, rail transportation (incl. the availability of trains and the railroad capacity during the season), stiffer competition on the part of the imported cement manufacturers, and the depreciation of xed assets. All these issues show that the industry is becoming less attractive for investment.

Figure 19. What is your evaluation of the present cement certication quality control in the Customs Union?
7%

40% 53%

High

Medium

Low

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| Overview of the cement industry in the countries of the Customs Union Survey results: development of the industry in the medium term

Respondents opinion Taking these measures will help to improve the quality of the cement produced and imported, raise the level of quality control and, accordingly, increase the safety of buildings and structures.
Figure 20. Please specify measures necessary to improve the quality control of cement sold in the Customs Union

Inclusion of cement into the Unied List of Products Whose Compliance Must Be Evaluated (Veried) Production evaluation, testing of samples and inspection control as accreditation criteria for certication centers Availability of own laboratory as an accreditation criterion for certication centers Speedy adoption of Technical Regulations on cement in the Customs Union Stricter accreditation criteria for certication organizations Approval of an exhaustive list of certication organizations Minimum length of quality control as an accreditation criterion for certication organizations 0 2 4 6 8 10 12

20% 14% 16% 13% 13% 11%

There is a long-standing need for upgrading the Russian cement industry. Fixed assets are depreciated by more than 80%, and over 70% of the capacities are accounted for by costly wet production. This has an adverse impact on the competitiveness of Russian cement even in the national market, as can be seen by an increase in imported cement in overall consumption to 7.8% in 2012. Cement manufacturers have long realized that the industry needs modernization and that any delay may have an adverse impact on the ability of Russian companies to survive. Therefore, in 2007, when the markets were high, roughly 100 projects were announced with a view to building new and modernizing the existing production enterprises. According to manufacturers, however, only 11 of them were implemented. The main reasons for the slowdown of modernization were the drop in demand and the prices during the crisis. The forecast demand to be met by 2020 will require a larger production capacity and an upgrade of the industry. The average period of construction of a new plant ranges from three to ve years; the average payback period for a new plant is up to eight years.

13%
14 16 18 20

Figure 21. What are the most pressing issues for your business currently?
Rising transportation tariffs Rising energy tariffs Need for technical upgrade of production facilities Competition with foreign cement High cost of borrowing Insufcient capacity of railroads Deciency of rail transport Plans to cut import duties in connection with the WTO accession Unavailability of nancial resources Insufcient production capacities Sale price doesnt cover production costs of 1 tonne of cement 0

18% 17% 13% 14% 11% 8% 7% 5% 4% 2% 1%

2 4 6 8 10 12 14 16 18 20

Overview of the cement industry in the countries of the Customs Union Survey results: development of the industry in the medium term |

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Respondents opinion The current cement price is attractive for both Russian manufacturers and importers. However, Russian cement is far more expensive than imported cement due the industrys structural drawbacks, which undermine the manufacturers modernization plans. Consequently, the whole industry may no longer be competitive.
Figure 22. Under what circumstances will your company approve the rapid construction of new production capacities?
Initiation of an anti-dumping investigation and introduction of anti-dumping import duties Government support for nancing the cement industry Introduction of tariffs and quotas to compensate losses from import which harms the cement industry Introduction of government subsidies and compensatory duties in respect of cement Mandatory certication of cement quality Tax benets for new and upgraded capacities Government encouragement of direct foreign investments Positive pricing structure Growth of demand in excess of available production capacities 0%

25% 25% 16% 16% 6% 3% 3% 3% 3%

5% 10% 15% 20% 25%

Respondents indicated the following motivating factors that would, if available, encourage the faster construction of production facilities: The upward trend in supply and demand, as well as the establishment of a fair market price for cement that would cover production costs and at the same time remain competitive with cheaper imports Measures against growing imports of cheap cement (initiation of an anti-dumping investigation and the introduction of compensatory duties) State support for nancing the cement industry (support at the local level and low-interest lending)

20

| Overview of the cement industry in the countries of the Customs Union Survey results: development of the industry in the medium term

Sources of nancing

Respondents opinion
Over 50% of the respondents point out the increasing cost of borrowing and the problems of credit availability. Large Russian producers and companies with foreign capital felt no changes in the loan markets. Although many respondents mentioned the deteriorating bank lending terms, 20% of them continue to regard loans as a possible source of nancing production and modernization. Twenty percent of the respondents believe that bank nancing and the lease of equipment are of certain interest to manufacturers.

The availability of affordable long-term bank loans is a major factor to be considered by cement producers in investment decision-making today.

Figure 23. How do you evaluate credit availability in 2012-2013 as compared with the previous period?

14% 36% 9%

Figure 24. What sources of nancing is your company considering for expansion purposes?
Equity

37% 20% 20% 7% 7% 5% 2%

0% 5% 10% 15% 20% 25% 30% 35% 40%

18% 23%
Credit receipt procedures have been simplied Cost of borrowings has decreased Nothing has changed Credit receipt procedures have become more complicated Cost of borrowing has increased

Bank nancing Equipment leasing Borrowing from shareholders Closed share offering/involvement of a strategic investor Bond issuance Tied loans from equipment manufacturers

Overview of the cement industry in the countries of the Customs Union Survey results: development of the industry in the medium term |

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Industry prospects
Industry consolidation
Experts say industry consolidation is probable in all the Customs Union countries, as there are several interesting and independent players. According to the cement companies, the most attractive areas for business development are the Central, Northwestern, Southern, Volga and Urals Federal Districts and Kazakhstan. Figure 25. What changes do you expect in your market in the near term (within 1-3 years)?
Tougher competition Larger import Increased demand for the products Increase of product prices Introduction of mandatory certication Decrease of product prices Less import of products% Less demand for products 0%

28% 25% 20% 10% 7% 5% 3% 2%

5% 10% 15% 20% 25% 30%

Investments and description of investment projects

How do cement manufacturers plan to spend their own and raised resources? Most respondents mention reconstruction, modernization and more efcient use of production capacities, followed in terms of importance by the construction of new facilities for dry production and the purchase of new equipment.

Figure 26. In your opinion, what trends will the cement market follow in the next ve years?
The market will encourage local manufacturers to introduce new production capacities The market will encourage local manufacturers to purchase other players and consolidate the industry The market will encourage foreign cement manufacturers to establish production enterprises in Russia, Belarus and Kazakhstan The market will encourage foreign manufacturers to purchase local cement manufacturers The market will encourage local and foreign cement manufacturers to Modernize the existing production facilities 0%

32% 26% 21% 18% 3%

5% 10% 15% 20% 25% 30% 35%

Answering the question "In your opinion, how will the cement industry develop in 2013-2014?", respondents said they expected a growth of 2.5%-11%. Average growth is expected to remain below 10% in Russia.

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Corporate social responsibility a topic for the coming years

All our respondents from the cement industry said that the more efcient use of resources, particularly energy, will be their main corporate social responsibility (CSR) task in the coming years. This choice of priority is clear, given the share that the resources account for in the total cost of goods. The absolute majority of respondents plan to concentrate on cooperation with the external stakeholders, both consumers and suppliers. Environmental issues are important for the industry, including emission reduction, the recultivation of pits and the use of industry capacities for the purpose of waste disposal. Much has to be done to improve the security and the health and safety standards at production facilities. Most respondents believe that the areas of social security, charity and transparency for external stakeholders have been attended to. However, some respondents still see opportunities here. Figure 27. If your company plans to expand into other regions/countries, indicate the priority targets.
CFD FEFD Belarus
6 5 4 3 2 1 0

Figure 28. Most players plan to launch new or modernize the existing production capacities
Is your company planning to build new production facilities in 20132014? 12% 12% 44% 44% 19% 15% 23% What are the strategic objectives of your company for the next 15 years? 4% 4% 23%

Plans to modernize the existing facilities No plans Plans to build new production facilities

NWFD SFD

Modernization Reduction of costs, holding back cost of goods Increasing output Increasing capacity Increasing sales, expansion into new markets Maintaining market share In-house delivery service

Figure 29. What are the priority growth areas for your company?
VFD Reconstruction and upgrading of the existing production facilities More efcient use of the existing production capacities Building new production facilities (dry method) Purchasing new equipment Purchasing other manufacturers New products, services and solutions Building new production facilities (semi-dry method) Building new production facilities (wet method)

Kazakhstan

31% 26% 21% 12% 5% 2% 2% 0%

0% 5% 10% 15% 20% 25% 30% 35%

NCFD No expansion SFD

UFD

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Tax factors
The taxation of new and upgraded facilities is a topical issue, given the expected growth of investment in renovation and production expansion. Amendments to tax legislation may open up new opportunities in the optimization of tax expenses for businesses. The entry into force of the amendments to property tax regulations on 1 January 2013, whereby real estate is excluded from the tax base, is one of the factors that allows the tax burden to be reduced. There is concern about the Governments intention to amend land taxin 2014-2015. Hence, the CEOs are increasingly focusing their attention on the market value of land. Besides, the respondents attach importance to transfer pricing, the opportunities to purchase equipment at favorable prices, and government measures to combat offshore schemes.

Figure 30. What are the lines your company will pursue in corporate responsibility / sustainable development in 2013-2014 or has already pursued successfully?
Human rights Transparency Personnel social security (social package) Sponsorship and charity Biodiversity protection Corporate volunteering Labor safety and industrial security Land restoration Lower air pollution Cooperation with customers on product quality Waste utilization Cooperation with vendors on corporate responsibility More efcient use of resources (including energy) 0% 2% 4% 3% 3% 1% 6% 5% 5% 5% 8% 7% 9% 9% 9% 10% 13% 6% 8% 10% 12% 14% 2% 1% 1% 1% 1% 2% 3% 8% 7% 7% 6% 4% 3% 4% 3% 3% 2% 2% 2%

Plan to develop Do not plan to develop We believe that we have already developed this issue

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| Overview of the cement industry in the countries of the Customs Union Survey results: development of the industry in the medium term

Contact details
Vasily Potapov
Partner, Transaction Advisory Services Tel.: + 7 495 755 9678 Vasiliy.Potapov@ru.ey.com

Oxana Yashina
Director, Transaction Advisory Services Tel.: + 7 495 755 9831 Oxana.Yashina@ru.ey.com

Denis Borodenok
Director, Marketing and Business Development Tel.: + 7 495 648 9605 Denis.Borodenok@ru.ey.com

The survey covered the largest cement producers, including the industry leaders, in Russia, Kazakhstan and Belarus. We have interviewed more than 70%, 40% and 60% of the cement producers in Russia, Kazakhstan and Belarus, respectively (the selection was made on the basis of performance indicators for 2012). Both Russian and international companies participated in the survey.

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