Market Know-How: Anti-Trust Body Declares War on Cement Maker

Eurocement Group became Russia’s leading cement producer after it took control over the production facilities of Inteko Group and the Su-155 construction company. When the government okayed the deal with Inteko in the spring of 2005 the Federal Anti-Monopoly Service put Eurocement Group’s share at 34%.

Immediately afterwards the group pushed up the price of cement by nearly 70% and refused to supply it without prepayment, ordering its debtors to pay off their outstanding debts by late April.

The company explained those moves by the need to modernize production. President of Eurocement Group Mikhail Skorokhod said wear and tear of production capacities stood at 80%, while the dollar-nominated price of cement had dropped below the level of 1997. Moreover, the amount owed to the group by construction companies exceeded 1 billion rubles.

Eurocement Group laid down a plan worth $560 million to overhaul its production facilities. If it had been implemented, the group could have increased output by 5.2 million tons by the year 2008, with two new factories accounting for the lion’s share of that growth.

Those explanations, however, proved unconvincing and some of the construction firms suspended cooperation with the group, while the DSK-1 company severed ties with Eurocement completely.

Construction companies explained that because they are paid after their finished projects are commissioned they are unable to pay for cement in advance and are forced to raise loans. Andrei Pankovsky, DSK-1’s deputy general director, says that other producers supply cement to companies whose debts stands at 7-8 million rubles.

“While working in a low-profit branch we in fact credit one of the highest-profit sectors,” Eurocement Group’s executives retort.

Eurocement Group is breaking the procedure established on the construction market. Following its example concrete-mixing plants, too, have started to demand advance payment, the Moszarubezhstroi company reports.

“Take DSK-1, the oldest construction works that has carried the bulk of the burden of rebuilding Moscow since the years of Soviet rule. Over the 44 years of its existence the company has squeezed out everything it could from its equipment and some of its plants are literally hanging by a thread. Still, none of them has pushed up prices by 70%,” head of the Moscow city construction industry department, Vladimir Resin, said recently.

Because of the actions of Filaret Galchev’s company the city’s construction sector has been forced to radically re-adjust its budget plans by pushing up expenses, Resin said. The city officials have calculated that “after the price of cement grew by 800 rubles” the city’s construction industry’s direct losses amounted to 1 billion rubles

According to Resin, the first to suffer the consequences will be the city’s social programs, Resin said. Last year’s tenders were held without taking into account the price increase, builders complain. Yevgeny Sklyarov, president of Mospromstroimaterialy, reports that the construction budget for one square meter of municipally-owned housing facilities has grown 4.5%.

“Nowadays, the contractors’ minimum returns stand at 6% cent while the 4.5% increase results in direct losses for us,” Pankovsky says. The increase is even higher for commercial residential development, where the final price includes encumbrances and the city government’s share, as well as the higher price of construction materials.

“The cost of commercial housing has grown by some 10%; to survive we will have to push up prices even higher,” Pankovsky says.

First deputy head of the company Mosstroimekhanizatsiya-5, Sergei Kachalin, says that construction of municipally-owned housing is pushing the company into the red: “By increasing the cost of cement we will have to cut costs of other materials. And this means [poorer] quality. For our company the situation is critical because municipal orders make up 75% of all our contracts.”

Other cement works supply their products at prices that are also high, but still lower by 100-150 rubles per ton, says Andrei Pankovsky.

City hall has already adjusted its plans for social housing construction. The city’s economic policy department has reported that while the cost of municipal housing construction this year stood at 23,000 per sqm the projected figure for next year is 28,000 rubles.

Moreover, next year city hall plans to select a cement supplier for its municipal housing projects through a tender.

The Federal Anti-Monopoly Service (FAS) launched an inquiry into Eurocement Group’s pricing policy in May. Five months later the agency agreed that the group had a monopoly. Earlier, when approving its deal with Inteko, the agency had said the company’s share on the market did not make it a monopolist.

Andrei Tsyganov, deputy chairman of FAS, told Vedomosti that Eurocement Group’s share stood at 55% in five of seven federal districts of Russia. FAS ordered the group to lower the price of cement to a competitive level and transfer the income derived as a result of the violation of anti-trust laws to the federal budget by Nov. 1.

“The price increase was not entirely caused by external factors which allow them to push up prices by 60% at a time,” Tsyganov said. If the group fails to comply, FAS has threatened it with severe measures – it may consider splitting the group up.

According to Tsyganov, such a measure is applied if a violation cannot be eliminated in any other way. At the same time, the agency’s officials refuse to comment on what has brought about their change of heart towards the group.

“FAS has sided with the lobbyists for the construction sector who pursue their selfish ends,” a spokesman for Eurocement Group, Sergei Meshcheryakov, said.

Cement makers were shocked. “The FAS ruling will result in Russia importing cement. We will feel the implications in 3 to 5 years when production begins to fall apart,” a senior manager at Novorocement told Vedomsti. Rosstroi expects the shortage of cement to reach 10 million tons by 2010. If prices drop, the shortage will be felt much sooner as producers will have to reduce their investment projects.

But the ruling issued by the anti-trust agency on Oct. 25 proved to differ greatly from what the construction companies had expected. Eurocement was not satisfied either.

The company was ordered to pay a fine of 2 billion rubles and to lower the selling price to 1,361 rubles per ton. The admissible maximum price was set at 1,497.1 rubles per ton of construction cement (VAT and railway tariffs excluded).

Moreover, the agency ordered Eurocement Group not to increase prices without notifying FAS in advance and explaining the reasons for the move. “If the anti-monopoly body decides that the increase is unjustified, Eurocement Group will not be allowed to change the price,” the agency said in a statement.

Eurocement Group responded by asking the Moscow Arbitration Court to invalidate the ruling. The company has also threatened to freeze its investment programs and to allocate funds only for emergency repair works and maintenance of production facilities.

General director of Tsemprominvestholding, Pavel Bystrov, fears that the FAS ruling could be detrimental to the entire industry: “In five years we will be purchasing cement abroad.” The price of 1,361 rubles per ton is nearing the prime cost, as it is, Bystrov says. If FAS wins the case, other cement makers, too, will have to lower their prices. If this happens, further development of the sector will be out of the question.

Mikhail Bogush, general director at Alfa Cement, agrees. “I doubt that investors will take an interest in the sector, with prices like that. Eurocement so far is the only company that has tangible development plans. Others have not risked investing,” he says.

Earlier, Mikhail Skorokhod told Vedomosti he set the competitive price at 2,050 rubles per ton. Construction firms say that FAS has effectively legalized the price close to that figure. The price of cement is made of its initial cost, VAT (18%) and cost of delivery to Moscow (approx. 300 rubles per ton).

“Today, the prime cost of cement stands at 850 rubles, the selling price is 1,800 rubles. Even by taking into account seasonal and investment costs, as early as today one ton of cement by Galchev is sold at 1,476 rubles. In other words, FAS has asked the Group to lower the price by less than 10%,” a manager at a cement-making company says.

A high-placed source in the city construction industry department says the FAS ruling is “extremely advantageous for Eurocement.” “With this decision the agency has practically approved 100% profitability. A further increase will result in inflation, and this will not be the problem for Eurocement. Construction companies have received moral compensation; now they have to realize that the situation has not changed and their next complaint will get them nowhere,” the source said.

A top executive at a major construction firm says that the cement price will not drop by more than 7%, following the ruling. “Thus, the city will lose 930 million rubles instead of 1 billion,” he says. Experts believe that means the loss of approximately 50,000sqm of housing. The deputy head of Capital Group, Alexei Belousov, says that “the builders are happy with the decision, as such, because it will naturally result in lower prime cost of one square meter.”

If the court upholds the FAS ruling, consumers may ask Galchev’s company to pay them back the price difference, anti-monopoly officials say. Admittedly, the general director of the concern Krost, Alexei Dobashin, doubts that any of them will be able to get back the difference between the price set by FAS and the price set by Eurocement in May.

“There is no established procedure set for enforcing the payment,” he says. Yevgeny Sklyarov adds that the builders voluntarily signed agreements where the higher price was stated. Market players also doubt that the government will succeed in collecting the fine from Eurocement Group. For example, the United Trading Company was earlier fined 20 million rubles by the service. It is highly likely that the latest ruling – on Eurocement – will be cancelled, considering that the size of the fine is unprecedented in Russia.

Besides, the anti-trust body loses cases in court more often than it wins them, says Denis Balakin, general director at the law firm Corpus Juris. Even if worst comes to worst, Eurocement Group will be able to delay the reduction of prices for at least six months.

Interestingly, both parties explained their stance by the need to fulfill the affordable housing program adopted by the government.

“The state of affairs in the cement making industry makes it impossible to fulfill the task set by the president of Russia to boost housing construction by 2010 to 80 million square meters,” the cement producers claim. Their opponents insist that resulting from the price increase Moscow will fail to develop over 50,000sqm of municipal housing provided to low-income households on a free-of-charge basis.

Analysts assume that in the long run the parties will have to come to terms. “The cement-making plants that are not part of the Galchev empire are unable to produce more than 7 million tons per year, while demand is much higher. On the other hand, Moscow builders are the main consumers of Eurocement’s production,” analysts at AG Capital investment firm note. As regards the justification of further price increases, experts do not think it is a problem. “As the tariffs charged by the natural monopoly grow, the producer will automatically push up the price of cement,” they are convinced.