The Severstal company said on August 6 that it had concluded long-term contracts for metal product supplies with machinery and metal makers, including United Metallurgical Company (UMK), Avtovaz and the GAZ group. This is the latest example of the tendency whereby metal producers increasingly seek long-term contracts with customers, as required by the government. The goal pursued is to stem the rise in the steelmaker’s expenses, thereby reducing the inflationary pressure on the economy.
Severstal has been applying long-term contracts with customers since 2003. The company began by fixing prices for 18 to 24 months ahead under priority national projects, such as Sakhalin-1 and Sakhalin-2. The company’s quarterly contracts with pipe-makers for round billet shipments are another example of the trend. The company’s latest contract with UMC stands out for the length of its term and for the adoption of a price correcting system intended to even out prices on the metal market. Severstal also has long-term deals with numerous automakers, both within and outside Russia. The contracts stipulate fixed prices and terms of delivery ranging from a quarter to two years.
We believe that the move will allow the company to build its image and avoid claims from the government, which has recently been waging a war against companies reluctant to provide industries with raw materials under long-term deals. More predictable operating results of both raw material suppliers and consumers are another advantage of long-term contracts. However, we believe that the move will have a limited impact on the company’s fundamental value. As the company switches to long-term contracts with customers, it may lose the opportunity to tap into the more lucrative spot market. We currently have no official recommendation on Severstal shares.
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