Rada approves new iron ore royalty calculation mechanism

Ukraine’s parliament on Nov. 30 approved the new
mechanism for calculating mineral resource royalty payments for iron ore mining
companies.

 

The new mechanism changes both the base and the rate
that will be used for the royalty payment calculation, and will enter force
once it is signed by the Ukrainian president.

 

The new base will be the Platts IODEX 62% Fe CFR China
index without any adjustment for logistics costs, according to media reports.

 

The new rate will depend on the value of the Platts
index. A 10% rate will apply if the index averages above USD 200/t for the
payment month. If the index average is between USD 100/t and USD 200/t, a 5%
rate will apply. For index monthly averages below USD 100/t, a 3.5% rate will
apply.

 

In the current mechanism, the base is the cost of iron
ore mined before enrichment and pelletizing, and amounts to USD 20-30 per ton
of the final product, according to Concorde Capital estimates. The current rate
is 12% for a price index for 58% iron fines CFR China above USD 70/t and 11%
otherwise.

 

Dmytro Khoroshun: The new
mechanism will not impact the creditworthiness of either Metinvest (METINV) or
Ferrexpo (FXPO LN).

 

This is because during periods of prices around and
below the expected long-term average, the royalty payments will be similar to
what the Ukrainian producers of concentrate and pellets pay under the current
royalty calculation mechanism.

 

Admittedly, the changes will increase the royalty
payments by up to 3.3x when prices are elevated, and by 6.7x and more for
periods of exceptionally high prices. However, both Metinvest and Ferrexpo will
earn elevated and exceptionally high profits during such periods, and will be
able to afford higher royalty payments.

 

Namely, when the 62% iron index is close to but below
USD 200/t (the 5% rate applies), the royalty would increase by up to 3.3x, to
around USD 10 per ton of final product. Metinvest’s annual royalty payments
(including 46% of royalties paid by its Southern Iron Ore joint venture) will
increase by up to USD 250 mln (11% of its EBITDA in 2020, during which year the
index average was about USD 110/t) to up to USD 350 mln (16% of 2020 EBITDA),
we estimate. Ferrexpo’s annual payments will increase by up to USD 83 mln (10%
of 2020 EBITDA) to up to USD 119 mln (14% of 2020 EBITDA).

 

However, when the prices exceed USD 200/t (the 10%
rate applies), the royalty payment would increase by at least 6.7x to USD 20/t
or more.

 

On the other hand, for a reasonable long-term average
of USD 75/t for the 62% CFR China index (the 3.5% rate applies) the royalty
payment would drop about 13% to USD 2.6/t.

 

We assume that both Metinvest and Ferrexpo pay USD 3
per ton of final product in royalty under the current royalty calculation
mechanism, without any dependence on the market prices for their products.

 

We maintain our neutral view on METINV bonds.