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Metinvest under investigation for alleged royalty underpayment

Metinvest under investigation for alleged royalty underpayment

2 February 2022


Ukraine’s authorities have been conducting
investigative activities at the Kryvyi Rih miners of the country’s largest steelmaker
and iron ore producer Metinvest (METINV), according to the company’s Feb. 1
press release.


The investigations are related to alleged tax
violations, Metinvest said, adding that the actions have been accompanied by numerous
violations. Searches have been carried out unlawfully, computer equipment has
been confiscated without any legal grounds, pressure is exerted on the
employees of the enterprise, and economic activity has been partially
paralyzed, according to the release.


Ukrainian law enforcement agencies, including
representatives of the Security Service of Ukraine, the Economic Security
Bureau of Ukraine and the Prosecutor’s Office are thus exerting unprecedented
and unjustified pressure on its business, Metinvest said.


Through their actions, Ukraine’s authorities have
appropriated the function of the tax service and have attempted to circumvent
Ukrainian tax legislation by imposing additional tax obligations on businesses.


The Economic Security Bureau of Ukraine is conducting
investigative activities at four enterprises related to the alleged
underpayment of mining royalty, the Bureau said in its Feb. 1 press release.
The amount of the alleged underpayment during 2018-20 is around UAH 18 bln,
according to the Bureau, which added that criminal proceedings for tax evasion
against employees of the four enterprises have been initiated.


Dmytro Khoroshun: The
potential tax liabilities of Metinvest – as well as other iron ore miners like
ArcelorMittal Kryvyi Rih (AMKR) and Ferrexpo (FXPO LN) – are rooted in the
different treatment by the miners and the tax authorities of the iron ore tax
legislation. Although liabilities are substantial, the companies have good
chances of winning the main battle being conducted in Ukrainian courts.


Our estimates for alleged iron ore royalty
underpayment (from the Ukraine’s authorities’ point of view) by the three
miners consolidated by Metinvest are USD 448 mln for 2018-20 and USD 417 mln
for 2021. Underpayments for Southern Iron Ore (a Metinvest joint venture) are
estimated at USD 227 mln for 2018-20 and USD 196 mln for 2021.


Possible underpayments by Ferrexpo (FXPO LN) are
estimated at USD 214 mln for 2018-20 and USD 201 mln for 2021.


State pressure: a sign of weakness in the ongoing
legal battles

Most importantly, we agree with Metinvest that whether
the underpayment claims are legal or not should be decided in courts between
the company and Ukraine’s tax service. Such court proceedings are currently in
progress, we understand, and it has not yet been finally established that
Metinvest, or any other Ukrainian company, underpaid royalty for iron ore


Metinvest and other Ukrainian iron ore miners,
including AMKR and Ferrexpo, have good chances of winning the court battle
because of their substantial intellectual and financial resources, we think.


The investigative actions by Ukraine’s authorities are
unlikely to improve the chances of Ukraine’s tax service winning the court
battle with Metinvest, we think. This is because the company should have been
prepared for such actions after similar pressure was applied recently to
ArcelorMittal Kryvyi Rih.


Ukraine’s tax service lost several cases related to
iron ore mining royalty in courts during the last several years, and the public
and substantial pressure expressed via such investigative actions is a sign of
the state’s legal weakness, we think.


Estimates for potential Metinvest liabilities

Regarding the estimates, the three mining companies
consolidated by Metinvest (Central Iron Ore, Northern Iron Ore and Inhulets
Iron Ore) produced 86.9 mmt of concentrate with 62% of iron during 2018-20.
These three miners paid USD 175 mln in royalty during 2018-20 (data from
Extractive Industries Transparency Initiative and the censor.net news site).
This comes down to about USD 2.0 per ton of concentrate with 62% of iron. We
think that these payments were based on the royalty payment base being the
“calculated value” of raw ore (mined and crushed, but not enriched), which is
the production cost plus a markup for imputed profitability.


Ukraine’s authorities possibly applied a different
approach: using as the base for the royalty payments the “value” of the miners’
final products (concentrate and pellets), which should be their FCA price. We
estimate the royalty payments under this approach as follows: the average index
values for fines with 62% of iron in China were USD 70/t for 2018, USD 94/t for
2019, and USD 109/t for 2020. The royalty rates were 8% for 2018, 8.8% for
2019, and 10.4% for 2020 (in the middle of that year, the rate switched from
8.8% to 12%). Therefore, the value per ton that the miners should have paid, in
the opinion of Ukraine’s authorities, should have been USD 5.6/t in 2018, USD
8.3/t in 2019, and USD 11.3/t in 2020. The total royalty that Metinvest’s three
miners should have paid under this approach during 2018-20 is USD 738 mln, we
calculate. Therefore, the three miners underpaid royalty by USD 563 mln.


Regarding Southern Iron Ore, a Metinvest joint
venture, during 2018-20 it produced 37.3 mmt of concentrate, paid USD 30 mln in
royalty, should have (under our estimate for the assumed approach by Ukraine’s
authorities) paid USD 315 mln, and underpaid USD 284 mln.


The total royalty underpayment by the four miners (the
three consolidated by Metinvest plus its JV) during 2018-20 therefore amounts
to USD 847 mln, we estimate. The underpayment mentioned in the news, UAH 18
bln, or USD 675 mln using the average 2018-20 exchange rate, is 80% of our
estimate. Of these USD 675 mln the three miners consolidated by Metinvest
underpaid USD 448 mln, and Southern Iron Ore underpaid USD 227 mln, we
calculate using the same 80% factor.


We also estimate that Ukraine’s authorities might
conclude that during 2021, the three consolidated by Metinvest underpaid USD
417 mln in royalty. We calculate this value using the yearly average 62% fines
in China index of USD 161/t, the royalty rate of 12%, the per ton value of USD
19.3/t, and the 31.3 mmt as the production value for 2021. We also assumed that
Metinvest’s three miners actually paid about USD 82 mln in royalty using the
approach with “calculated value of raw ore” as the base.


The 2021 underpayment (from Ukraine’s authorities’ point
of view) by Southern Iron Ore is estimated at USD 196 mln.


Estimates for potential Ferrexpo liabilities

We also note a risk of Ukraine’s authorities raising
similar claims against Ferrexpo, Ukraine’s largest iron ore pellet producer and
exporter. We calculate that Ferrexpo produced 40 mmt of concentrate during
2018-20, paid USD 71 mln in royalty, and that Ukraine’s authorities might
conclude its underpayment was USD 214 mln (again, using the “price of
concentrate” approach and the 80% factor for the underpayment). For 2021,
Ferrexpo likely paid around USD 33 mln in royalty and its underpayment, from
Ukraine’s authorities’ point of view, might be USD 201 mln.


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