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 mining.


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 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.