Investing in Kuzbass (Kemerovo region): Trends and Opportunities

February 2006

Prepared by Mark Shulgov, BISNIS representative in Tomsk

Foreign companies are currently showing growing interest in investment in Siberia. Kuzbass, a compact territory situated in southwestern Siberia, is one of the most economically developed regions in Russia, second in Siberia by the number of industrial output and first by volume of investments. With three million inhabitants, 20 cities, and a highly developed transportation network, the region is also notable for having the highest retail trade turnover in Siberia.

The basis of powerful industrial complex of Kemerovo region (coal mining, metallurgy, chemistry, machine building) was laid in 1930s-1950s. The economy of Kuzbass successfully overcame the complications of 1990s, and since the early 2000s has demonstrated slow but steady development. Most large enterprises currently belong to private owners who already proved their management effectiveness and understand the importance of accelerated modernization and technical reconstruction of production facilities. Spending for reconstruction in different branches of the regional economy reached 21 billion rubles ($730 million) in 2004 and 28 billion rubles (about $1 billion) in 2005; total investments in Kemerovo region were 59 billion rubles ($2 billion) in 2005.

A number of factors, such as favorable foreign trade picture, general improvement of social and economic situation, positive indices of business finance and industrial activity, and reduction of tax burden have combined to make a relatively favorable investment climate in Kuzbass. Regional legislation “On State Support of Investment and Industrial Activities in Kemerovo region” and “On Tax Exemptions for Investors and Industrial Producers in Kemerovo region” outline the main mechanisms of state support to investors and have spurred an inflow of funds in the regional economy. In particular, this legislation reduces regional taxes for companies investing in priority sectors of economy and officially guarantees the inviolability of foreign investments and protection from illegal interference of the state.

Sustainable economic development of Kuzbass, political stability, and unique competitive edges of the region attract foreign investors to this territory, and foreign investments already occupy an important place in the economy of Kuzbass. Some $52.7 million (34 percent increase compared to 2003) was invested into the local economy from abroad in 2004. There are several ventures with foreign capital in Kuzbass, working in mining (Raspadskaya-Joy, UK), telecommunications (RIKT, Italy, and Kemerovo Cell Communication, Austria), trade ( Sibita, Italy and U.S.-Russian venture New-York Motors Sibir), food production (Zirve, Turkey), and others.

Active technical reconstruction in Kuzbass industry provides broad opportunities to foreign investors and manufacturers. Sophisticated industrial equipment and machinery applied in mining, metallurgy, construction, and food processing dominate the region’s imports. Despite the fact that the machinery is for the most part delivered from Europe and in particular, from Germany, the United States already became one of the main suppliers of such products to the region, occupying almost 16 percent share in total imports of equipment.

According to the forecasts of local investment authorities, the industrial structure of investments in Kuzbass will generally remain the same over the next few years. Fast modernization in the key sectors and transition to production of competitive chemical, metallurgical and mechanical engineering products are declared the main task of Kuzbass industry, and local manufacturers and authorities specially emphasize implementation of innovation-intensive technologies and introduction of high-tech equipment.

Coal mining

More than a half of 240 Russian coal-mining enterprises are situated in Kuzbass. Starting from 1999, the owners of Kuzbass coal companies invested more than $3 billion into development of the main branch of regional economy; more than a third of this sum was spent for construction of new facilities. Kuzbass coal industry became most stable coal-producing complex in Russia, supplying 55.8 percent of coal and 83.3 percent of coking coal. In 2005, this industry produced a record 167 million tons of coal. The seven largest private companies—KuzbassRazdezUgol (40 million tons), SUEK (Siberian Coal Power Company, 24 million tons), UzhKuzbassUgol (17 million), Uzhnyi Kuzbass (15.6 million), SibUgleMet (11 million), Raspadskaya Coal Company (9.7 million) and Sibirskiy Delovoy Soyuz (9.1 million tons) together account for 70 percent of total output.

The current situation in Kuzbass coal mining is somewhat controversial. The amount of coal produced in 2005 is actually sufficient to satisfy all domestic demand in Russia, and export the surplus quantity. Several Kuzbass companies were going to construct high-capacity coal trans-shipping terminals in the Russian Far East to increase supplies to Pacific Rim countries, but world prices fell by 30 percent in 2005, and so management will probably be revising such plans. Although the investments in development of new fields is a profitable undertaking and several tens of coal field auctions were held in 2005, regional authorities recommend that Kuzbass coal mining should not further expand production, and limit itself to 160-170 million tons per year. Kemerovo Governor Aman Tuleev recently proposed that the Russian Federal Government develop a target “Program of Russian coal industry development till 2020,” oriented toward wide-scale utilization of coal to replace natural gas in domestic power generation. This concept would be realized by means of design and construction of modern new facilities in Kuzbass and other regions, as well as by conversion of 27 combined gas/coal power plants from 56 present in Russia to sole use of coal. Realization of these proposals would require around $1 billion of investments, and development of appropriate schemes for obtaining credits and subsidizing the credit payments.

Large amounts of money are presently spent for technical re-equipment and accident prevention in coal mining; in 2004, 8.4 billion rubles were invested in construction of new facilities and 14.1 billion in technical re-equipment and modernization. In 2005, total investments in coal industry reached 30 billion rubles (more than $1 billion). Kuzbass coal mining companies expect to make the same scale of investments in 2006 (about 30 billion rubles). Also, coal companies of Kuzbass region are planning to spend 12 billion rubles ($400 million) for accident prevention until 2010.

Construction of new coal mining facilities in Kuzbass is in many cases accompanied by simultaneous construction of coal cleaning (enriching) factories. They provide at least 1.5 to 2 times increase of coal companies’ profit without increase of mine productivity, as well as helping ameliorate ecological problems. Such facilities provide up to 40 percent profitability and the investments are usually recompensed within 5 years. Two large coal cleaning factories were the main investment projects of Kuzbass coal industry in 2005, and authorities predict that at least seven other cleaning factories will be built by 2010.

Metallurgy

Currently, highly developed metallurgical complex becomes a primary industry in Kuzbass by total volume of production. It comprises both ferrous (Novokuznetsk Metallurgical and West-Siberian Metallurgical Combines belonging to Evrazholding and Gurievsk Metallurgical Combine, considered most stable company in local metallurgy, affiliated with Moscow Craft Group,) and non-ferrous metallurgy (Novokuznetsk Aluminum Plant belonging to Rusal; Kuznetsk Ferroalloys and Yurga Ferroalloys enterprises of Ural-Siberian Mining and Metallurgical Company).

Large-scale tender programs and modernization of main and auxiliary facilities was launched in Kuzbass metallurgy in 2000s. Following figures illustrate the trend: about 1.7 billion rubles were invested in Kuzbass metallurgy in 2002, 5.8 billion – in 2003, 13.8 billion in 2004, and 19.3 billion rubles (approx. $670 million) in 2005. In particular, West-Siberian Metallurgical Combine installed and launched a unique slab machine for continuous metal casting (only few of such kind are present in the world), and state-of-the-art German calibrating equipment was earlier introduced at Novokuznetsk Metallurgical Combine. Altogether, 43 large production units were modernized at Kuzbass metallurgical enterprises during 2005.

Chemical industry

Some 1.3 billion rubles was invested in chemical industry in 2005; this was a maximum figure for the last 15 years, exceeding at least by 30 percent the sum of investments made in 2004. Management of Kuzbass chemical companies, which number around 80, is also confident that the upgrading of facilities is an essential factor for economic stability, so those funds were spent on modernization and introduction of new technologies. Azot JSC, affiliate of SIBUR-holding and one of the leading chemical manufacturers in Russia, consumed the bulk of this money—more than 900 million rubles were spent in 2005 for modernization of caprolactam production and construction of new facilities, and at least one billion rubles (around $35 million) to be invested for further reconstruction in 2006.

Machine building

About a billion rubles was invested in machine building and mechanical engineering in Kuzbass in 2004 (800 million in 2005). As a result, the output of Kuzbass machine building companies in 2005 grew by 30 percent compared to 2004. The enterprises also report that the volume of orders for the mining equipment they produced exceeded 5 billion rubles ($175 million), which was 25 percent higher than in 2004.

Managers of Kuzbass machine building companies suppose that transition to manufacturing of competitive mining and transportation (railroad freight cars) equipment and machinery is the main goal of Kuzbass machine building industry for 2006, and at least 1.5 billion rubles will be spent for this purpose. Consequently, local machine building companies like Yurmash intend to upgrade production lines. However, some of the experts warn that as machine building in Kuzbass is so closely interrelated with the coal industry, it can be seriously affected by the global coal market fluctuations.

Transportation and Communications

Kemerovo region occupies the first place in Russia by volume of cargo transportation, and is characterized by high development of road and railroad networks. Regional business and authorities pay special attention to maintenance and development of railroads, vitally important to the key industries, and in particular to coal mining. Approx. $220 million was invested in regional railroad transportation in 2005, under the Program of Kuzbass Railroad Transportation Development. Apart from construction of new stations, spans, switches and bridges, electrification and modernization of facilities, such projects as construction of fiber-optical communication lines are realized also. New “Program of Kuzbass Railroad Transportation Development for 2006-2008” and “Collaboration Agreement for 2006” signed between the Russian Railroads, JSC, and Governor Aman Tuleev, imply serious further steps to improve the transportation infrastructure. Out of 17.7 billion rubles of investments in railroad transportation scheduled for the next few years, 10.8 billion rubles will be contributed by the Russian Railroads and the rest by Kuzbass coal mining and industrial enterprises.

IT and communications technologies began rapid development in Kuzbass in 2003; the process was initiated by increasing activity of investors, who spent $15 million for communications development in 2003 and about $100 million in 2004. Further introduction of up-to-date IT and communication services has been accompanied by steadily growing number of Internet and cell phone users.

SibirTelecom, the main provider of communications services in Siberia, in 2005 invested about $40 million into construction and development of networks in Kuzbass. According to collaboration agreement signed between SibirTelecom and the regional administration, the investments of 2006 will be mostly related to improving the communication quality and developing the existing telecom objects. The range of provided services in the future will be extended mostly through diversification of Internet related services. It should be mentioned as an example of recent advancements, that a project of equipping the city public transportation with global positioning system was realized in 2004-2005 in Kemerovo City; the only other one of this kind in Russia is located in Moscow. Taking into account that the economic growth outpaces the telecom development of the region, the unmet demand makes Kuzbass a promising market and place to invest in telecom.

Construction

Annual growth of house building in Kuzbass constituted around 10 percent in previous years. Owing to abundance of tumbledown buildings and sharp problem of lack of new housing, regional authorities decided to increase the volume of residential construction by 30 percent per annum since 2006, when the national program in construction started.

In 2005, about 3 billion rubles were invested in construction in Kuzbass, and 642,000 sq. meters of dwellings were constructed; about a half of this figure was attributed to individual (private) construction. The authorities, being aware that at least 1 million sq. meters of housing should be annually constructed to satisfy the demand in Kuzbass, took a number of steps to develop regional construction till 2010. Not less than 6 billion rubles, including 2 billion from federal and regional budget, will be invested each year to develop construction. Among the priorities, such measures as modernization of existing construction industry enterprises and manufacturing of components for cottage building are mentioned. The main emphasis will be made on complex site development in the residential areas, construction of engineering networks and social infrastructure. Lack of proper social infrastructure is attributed to the large cities like Kemerovo and Novokuznetsk, and realization of this concept will start in 2006 from construction of a satellite city near Kemerovo. Engineering infrastructure, schools, hospitals and other social objects will be erected before residential construction. Residential buildings will include cottages, condominiums and apartment buildings, providing variety of accommodation choices for population with different incomes.

According to the estimates of regional authorities, the capacity of local construction companies is insufficient to realize these plans, and at present the region considers proposals from several foreign construction companies interested in investing in Kuzbass. In addition, to completely fulfill the 2006 program, Kuzbass is interested in attracting extra $70 million.

There are several construction materials factories in Kuzbass, and although their capacity is generally sufficient to realize the plans of large-scale construction, each of them requires modernization. Siberian Cement, the leading construction materials producer in Siberia, issued a bonded debt in 2005, and allocated the raised funds to repair and reconstruct the facilities of its affiliate Topki Cement. Both production lines and high-tech automatic control systems are developed at the site; new packaging line will be imported from Germany in 2006.

It is often mentioned that being one of the economy centers in Siberia, Kemerovo City seriously lacks sufficient number of comfortable and properly equipped hotel rooms, as only a few mostly old-style hotels are present in the city. Private investors who constructed a number of comfortable modern hotels successfully resolved such problem observed in neighboring Tomsk region just a few years ago. This sphere may provide good opportunities for investments.

Leasing operations

The market of leasing in Siberia is still relatively small (the volume of leasing operations in Siberia reached approx. $200 million in various industries, or about 7 percent of the Russian leasing market), but was characterized by a high growth rate. Especially high popularity of leasing in Kuzbass in stipulated by necessity of renewal of production facilities (most of large factories were constructed in mid 20^th century, so at present deterioration of production facilities in the region on average reaches 60 to 80 percent). Raising large amounts is usually difficult to local companies, and leasing in such conditions is regarded as most simple and effective ways to perform modernization, allowing fast at cost-effective renewal of technological equipment and installations.

Small business is steadily developing in Kuzbass, ranked 6^th in Russia by level of entrepreneurship development - around 180,000 inhabitants of the region (every 7^th employed) are engaged in small entrepreneurship, almost 2,000 new jobs were created and more than 3.7 billion rubles invested in the sphere of small business in 2005. Leasing is on high demand by small businesses. SMEs usually receive on leasing such items as PCs, printing equipment, devices for medicine and cosmetology. Trading and refrigeration equipment constitute around 30 percent of all equipment supplied on leasing, the share of means of transport reaches 40 percent in some of local leasing companies' turnover.

There are three types of companies on local leasing market. First category includes companies incorporated into the large industrial holdings and serving the affiliate enterprises only. Second is represented by companies established by banks and specializing both in leasing and banking operations. Most numerous group includes independent leasing companies, serving various orders, though some companies prefer working with specific types of equipment, e.g., solely for road construction.

Local leasing companies are mainly oriented toward small-scale operations ($10,000 to 100,000), while large Moscow leasing companies working in Kuzbass prefer larger ($0.5 to 1 million) leasing deals; hence they generally do not compete with each other. To attract more clients, most leasing companies are presently trying to reduce annual increase in cost of equipment supplied on leasing, keeping it within 12 to 15 percent, which is affordable to clients. Assuming ongoing technical reconstruction in local industry and favorable market conditions, the experts predict considerable further growth of demand on leasing services in Kuzbass.

Agriculture

Concerning the main projects of 2006 in agricultural complex of Kemerovo region, regional agriculture related authorities indicate that apart from the priorities recommended by the Federal Government—development of cattle farming and individual private farming activities, in Kuzbass the emphasis will be made on cereals cultivation. The authorities also point to the fact that high competitiveness of Kuzbass agriculture was reached due to ongoing investing into its technical re-equipment.

Along with the process of establishing powerful vertically integrated agricultural companies, observed in most Siberian regions, individual farming in Kuzbass provides about 70 percent of locally produced vegetables, 90 percent of potato, 50 percent of meat and milk. Introduction of up-to-date technologies in large agricultural enterprises inevitably influences employment, encouraging people to start production of demanded products at individual small farms. Regional authorities undertake serious efforts to support farming and entrepreneurship in agriculture. 3,000 farmers received preferential loans. About 5 of 219 grain combines purchased in Kuzbass in 2005 were granted for free to stimulate the farms that actively expanded their cultivation areas.

According to preliminary estimates, at least 7 billion rubles (approx. $250 million) will be invested in agriculture development in 2006; 1.3 billion rubles will be contributed by the regional budget and all the rest by private investors and special purpose federal budget funds allocated to realization of national projects in agriculture. Agricultural companies need at least 3.2 billion rubles of credits to develop large livestock farms.

The companies interested in investing in agriculture may consider following investment proposal. A large green-house complex in Kuzbass, one of the few in Siberia engaged in “industrial scale” flower-growing, is interested in application of advanced technologies and modernization of existing facilities and presently searches for investors ($1.5 million) to complete the reconstruction; taking into account the market conditions, the company expects that the investments will be paid back in 15 months.

Tourism

Kuzbass is a promising place for investments in tourism and recreation. Tourism is officially considered one of the priorities in the regional economy development. Five districts of Kemerovo region – Gornaya Shoriya, Gurievsk, Mezhdurechensk, Mariinsk and Tisul, where unique nature, picturesque sights and relatively developed sports and tourism infrastructure are present, will serve the pivots for tourism related projects realized in Kuzbass. The region is already known as one of the main centers of mountain skiing in Russia. Apart from several winter-sports resorts already present in Kuzbass, holding company Siberian Business Union recently started construction of western-standard mountain skiing complex, which will take about 6 years and at least $40 million of investments.

* * * * * * * * * * * * * * *

2006 calendars of largest industrial fairs and exhibitions in Kuzbass:

· Kemerovo City - http://www.bisnis.doc.gov/bisnis/bisdoc/0512fairskemer.htm

· Novokuznetsk City - http://www.bisnis.doc.gov/bisnis/bisdoc/0512fairsnovokuz.htm

For more information, please contact Mark Shulgov, BISNIS representative in Tomsk, Kemerovo and Irkutsk regions, at email: bisnis-tomsk@mail.ru

For more information on Siberia, visit BISNIS online at www.bisnis.doc.gov