Fertilizer investment — keep it in the family?
Fertilizer International; 9/1/2001
Too many of those companies which took the plunge and endeavoured to invest in the Former Soviet Union’s fertilizer sector were chastened by their experiences. “Throwing money into a black hole,” was how one executive characterised his company’s experience after it abandoned a joint-venture operation with a Russian fertilizer partner. Kemira Agro, however, is undaunted and has reached an accord with JSC Acron to market NPK fertilizers. Meanwhile, Gazprom has been a major indigenous investor in the Russian nitrogen sector. What is the reality today of investing in Russia’s fertilizer markets?
Western companies have been conspicuous in their almost complete absence from investing in the FSU’s fertilizer and agricultural sectors since the demise of the Soviet Union a decade ago. This period has, of course, been marked by extended periods of poor profitability for the western fertilizer industry, and few North American or Western Europe companies had the funds to spare to take what was for them a proverbial leap in the dark. Even though many FSU fertilizer producers were financially weakened in the face of collapsing demand in the home market, the prevailing belief among their western counterparts was that there was more than sufficient fertilizer capacity globally, and that the ailing Russian companies deserved to wither on the vine.
One company, with ample experience of operating in overseas countries, was emboldened to take the plunge of investing in the FSU fertilizer sector: this was Norsk Hydro. Its subsequent experience provides a textbook example of the pitfalls facing western companies in the first decade after the end of the old regime. Norsk Hydro was due to become a majority partner in the Ukrainian stevedoring company, Transinvestservice (TIS), which was set up in 1995 to develop an integrated fertilizer terminal at the port of Yuzhny, Ukraine. In the original project, Hydro Agri International (HAI) took a 24.5% equity stake at a cost of some $15 million, in partnership with the Ukrainian government’s State Property Fund (SPFU) to renovate and expand an unfinished phosphate fertilizer terminal at the port of Yuzhny. Also involved in the joint venture were the European Bank for Reconstruction and Development (EBRD) and private local investors.
HAI planned to use the facilities both to export fertilizers sourced in the FSU and import phosphate rock to supply Ukrainian factories. HAl’s then Vice President, Odd Gronlie, described the project as “a tool for increased activity in Ukraine and Russia.” When finished, the terminal would have a capacity of up to 3 million t/a of fertilizers and associated products, and the ability to load Panamax vessels. Hydro would be responsible for the management of the terminal and its restructuring. In addition to the prospect of speedy loading for N fertilizer bulk exports, HAI envisaged its participation at the terminal as a means of boosting its presence in phosphate fertilizer production and marketing. The HAI plan foresaw the berth taking imports of phosphate rock for Ukrainian factories.
The TIS project formed just one part of Hydro’s ambitions to develop a stake in the FSU, as the company had also expressed an interest in the privatisation of Ukrainian fertilizer producer PO Azot Cherkassy. In the event, the company lost out to other bidders.
Worse was to follow. In March 1997, to Hydro’s utmost dismay, TIS declared all previous agreements invalid and presented HAI with a demand to pay more money to Ukrainian interests or else be ejected from the project. Hydro regarded such a demand as “totally unacceptable” and pledged to “defend its position through all available legal and political channels.” Having signed several binding contracts, HAI was committed to investing $15.2 million in the project and had actually spent some $5 million ordering 80% of the mechanical equipment for the terminal, which was ready for shipment from Denmark. The company emphasised that it had been invited to join the TIS venture by the SPFU after the trading company, Transammonia, had dropped out. SPFU and local partners had not put up any money, but were supposed to help obtain permits and negotiate the venture through Ukrainian political waters.
According to reports at the time, the reasons offered for the Ukrainian change of heart were somewhat arcane:
* The JV was no longer valid, because “the legal documents were written in Russian, not Ukrainian.”
* “The Ukrainian partners put only one signature on the documents, not two.
* The Ukrainians feared that “Hydro would gain a monopoly position through control of the terminal.”
A veritable cuckoo had appeared in the TIS nest, prompting the SPFU’s change of heart. This was Fedcominvest (FCI), the Monaco-based trading company, which had bought a 10% stake in TIS, and was wanting to push Norsk Hydro out altogether. FCI offered to pay SPFU $4 million to acquire the handling equipment ordered by HAI. FCI meanwhile moved ahead to obtain permits from local authorities in Ukraine to install a pilot plant to export sulphur from Yuzhny and revealed plans to build a full-scale sulphur terminal at a later date. By proceeding with its own investment in the project and embarking on its own construction at the site, FIC provided clear-cut evidence of Hydro’s exclusion as a JV partner.
The moves by FCI did not win universal approval within Ukraine. The head of the Ukrainian agency for reconstruction and development was reported to have said, “The decision by SPFU to exclude Norsk Hydro from TIS was not correct, and the agency will offer a political back-up to the Norwegian producer.” Faced with increasingly difficult working conditions, Hydro withdrew its project management team from Odessa in March 1997 and turned to the courts in Stockholm for redress. The Stockholm court was stipulated in the original contract as the one to which any contractual disputes would be referred.
The Stockholm court is believed to have ruled in favour of Norsk Hydro, and a very unhappy chapter for the company was duly closed. Meanwhile, what of the TIS terminal? The integrated terminal was completed at the end of 2000, consisting of a twin-berth terminal on the opposite side of the Yuzhny sea channel from Odessa Port Plant (OPZ). The terminal uses the common water area with the OPZ terminal, facilitating co-operation in loading combined cargoes. The TIS project as completed consists of a 570 m common feeder system serving existing Berths 16/17 at Yuzhny. The loading capacity of the terminal was stepped up from 12,000 t/d to 32,000 t/d. The TIS terminal facilities were completed by the provision of conveyor galleries and two portal shiploaders, enabling the terminal to achieve a turnover of 2 million t/a. TIS has provided a third 75,000-tonnes covered mechanised warehouse at Berth 16, allowing simultaneous storage of eight kinds of dry goods.
None of this provides much consolation to Norsk Hydro, which found that contracts with the Ukrainian authorities proved mere scraps of paper. At top governmental levels, relations between the Ukrainians and Russians can be fractious, but at the basic commercial level, FCI was able to exert enough muscle to eject Norsk Hydro from the joint venture. It is scarcely surprising that no other western fertilizer producer has risked the same degree of exposure in the FSU.
Gazprom – the white knight?
Keeping the FSU fertilizer industry in the family appears to be the prevailing motto elsewhere in the region. As noted, many FSU fertilizer producers soon began to struggle in the new economic environment, and they inevitably began to accumulate debts – notably for the supply of natural gas feedstock. This was provided by Gazprom, which responded to non-or delayed payments by offering the distressed companies lifelines in the form of tolling agreements and other special terms, or even outright purchase. Other producers, notably in Siberia, were able to benefit from concessionary rates on rail transportation to Far Eastern Russian ports.
Despite the collapse in domestic demand, the Russian fertilizer industry appears to have survived surprisingly intact, against all odds. One might suggest that this survival is positive proof of the merits of keeping ownership – and control – within the Russian “family”. Indeed, the past two years have been marked by a definite recovery. Production is now running at around 67% of its peak in the late 1980s and is 50% higher than the nadir of 1994. (Table 1).
However, there is an ultimate limit to raising production, and even if domestic demand rose dramatically in the short-to medium term, the effects of years of chronic under-investment in Russia’s fertilizer capacity would become all too clear.
How effective a white knight is Gazprom likely to prove over the longer term? At least six or seven plants are known to be dependent on Gazprom or its subsidiary, Mezhregiongaz, including Berezniki, Kemerovo, Novomoskovsk, Cherepovets Azotand Kirovchepetsk. Gazprom has also recently acquired shares in Agrocherepovets. Recently, Mezhregiongaz has joined forces with JSC Interchimprom (in which Mezhregiongaz already has a 30% shareholding) to form the JSC Agrochimpromholding joint venture. The JV will consolidate the assets of five Russian nitrogen plants with a combined capacity of around 4 million t/a of ammonia, 4 million t/a of AN, 1.9 million t/a of urea and 1.7 million t/a of NPKs. The joint venture will guarantee gas supplies to the plants.
Solvalub will market the product for the new joint venture to cover the costs of the gas supplies. The new organisation has pledged the necessary investment to modernise the plants and improve energy efficiency – an area in which the FSU fertilizer has notably lagged behind its Western European and North American counterparts. The new consortium has also pledged to promote domestic fertilizer consumption and assist the Russian agriculture by providing credits to farmers.
These measures do at first sight suggest that Russian enterprise is finding solutions to Russian problems. The agreement clearly strengthens Gazprom’s hand, ensuring that it will receive payment from a customer base that is tightly bound to it as a supplier. This is Gazprom’s own chosen agenda, and its longer-term interests could readily diverge from those of the Russian fertilizer industry as a whole.
Many developments in the Russian fertilizer sector over the past decade have flown in the face of orthodox opinion, and have been out of step with developments elsewhere in the world. For example, there have been few moves to privatise the Russian fertilizer industry, least of all by inviting foreign investors to rake a stake. There is a back-log of investment in the Russian fertilizer industry, over and above rehabilitating elderly, energy-inefficient and polluting plants. The Gazprom lifeline may not prove sufficient to take care of this, even in those plants which are now embraced by the gas supplier.
Gaxprom’s primary concern is its own cash flow and return on its very heavy investments in the gas supply sector. Up to now, it has helped stimulate the revival in Russian fertilizer production, but the short-term outlook is set to change. This year, Gazprom has announced that the supply of natural gas to the fertilizer industry will be cut by between 2-4%, due to supply shortages. How this cut will be implemented remains subject to speculation, but is expected to target companies with large gas debts, while more gas could be made available to customers who pay their bills promptly.
The primary need for investment within the Russian fertilizer industry is for reduced energy consumption and pollution control. This is recognised by the newly-established Agrochimpromholding joint venture, which has declared a goal of reducing gas consumption by some 30% as well as debottlenecking some plants. However, the achievement of this goal inevitably requires foreign partners to supply a significant share of the finance and technological expertise. The reluctance and institutional difficulties confronting potential overseas participants may thus prove the crucial limiting factor in the ultimate modernisation of the Russian fertilizer industry.
Interchimprom and Mezregiongaz acknowledge this as they prepare a schedule for revamping the plants under their control, which provide up to 40% of all nitrogen fertilizers produced in Russia. Capacity utilisation at these plants has been haphazard. Talks have thus been held with leading contractors, including Krupp Uhde and Lurgi Oel Gas Chemie, Monsanto and Ammonia Casale, with the goal of involving them as investors in the revamp projects. Interchimprom has devised a separate budget to form the basis of a financial package intended to attract further domestic and overseas investment. The Interchimprom contribution is understood to be 50:5 0 funded by its own revenue and profits from the plants. Agrochimpromholding is also hoping to secure some state participation in the project, principally from the Ministry of Agriculture.
Laying ghosts to rest
The Russian authorities are also keen to promote the development of enhanced distribution facilities, including export terminals. Several projects are currently under way, but western partners have so far avoided participating in them. These projects include the Ust Luga terminal project on the Russian Baltic, which is being promoted by RosKhim Terminal at an estimated cost of $35 million.
Not all companies see the FSU as a proverbial black hole for unwary western investors. For example, Kemira Agro has reached an accord with the privatised and independent JSC Acron company to cover the marketing of NPK fertilizers. The agreement rakes effect in the fourth quartet this year, and will cover some 250,000 t/a of Acron’s products, which Kemira Agro will market mainly in South East Asia. This agreement extends the existing market arrangement between the two companies, which covers the Baltic countries. Kemira Agro is evaluating the possibility of increasing its marketing of Acron NPKs and other commodity fertilizers produced by the Russian company-notably urea and AN.
Russia has had an atrocious press in the past decade, with much attention being paid to the emergence of a cadre of unscrupulously rich individuals, the “Oligarchs” – a handful of ruthless individuals who exploited the economic and social chaos into which Russia descended after the break-up of the Soviet Union. The oligarchs have been described as indulging in “a live-hard, scam-hard, die- early mentality”. They have certainly exerted some influence in fertilizer markets in the past ten years.
However, while such people are still easy to identify in many walks of Russian business life, thievery and thuggery are no longer the sole criteria for conducting business. “A contract, a handshake and even a court of law have all at last gained some validity.” (The Independent, 30 June 2001) “The result is a widespread sense of belief that things one day might work.” Already, within official circles, the view is beginning to prevail that business in Russia should follow more universally accepted business precepts, and the economy should be put on to a more sane basis. “People have starred to understand that you can’t get everything with guns – you need to use your brains,” one observer commented. As certain senior Russian policy-makers acknowledge the need to transform Russia into a European country – “to bring Russia back into Europe,” according to one – the climate for investment will surely improve.
Perhaps such a change in approach will be reflected before long in the fertilizer industry, as bridges are finally built between erstwhile rival groups of producers.
Table I
Russia — Fertilizer
Production 000 Tonnes Nutrient
1997 1998 1999 2000 (E)
N 4,292 4,082 5,132 5,800
P 1,777 1,689 2,122 2,400
K 3,444 3,475 4,070 3,750
Total 9,513 9,246 11,324 11,950
Source: IFA
Euro banks back Togliatti
Two European investment banks have advanced working capital loans totalling $55 million, which will enable TogliattiAzot – Russia’s largest ammonia producer – to fund an ambitious export programme over the next five years. The European Bank for Reconstruction and Development (EBRD) has provided $40 million, while another $15 million has come from the Black Sea Trade Development Bank of Greece. Some three-quarters of the total funds are earmarked to cover input costs, including raw materials, energy, labour and the retirement of existing debt. In return, TogliattiAzot will be required to provide accounts that meet International Accounting Standards from 2001, and retrospectively to 1999.
While neither loan covers project finance, the injection of new capital is expected to spur TogliattiAzot to complete two projects which are intended to enhance the company’s marketing and distribution network. The most important of these is an ammonia export terminal at Zhelezny Rog, on the Russian Black Seacoast, north west of Novosrossiysk. This terminal will have offshore mooring with two loading berths, each capable of handling a 35,000-tonnes ammonia vessel. Four 20,000-tonnes storage ranks will be provided, in two stages. A subsea pipeline will transfer ammonia from a railcar receiving point and storage tank location out to the loading berths. A second ammonia terminal is close to completion at the southern Chinese porn of Zhangjiang. The Black Sea terminal is budgeted to cost around $150 million, while the Chinese terminal will cost an estimated $50 billion.
The Black Sea terminal will enable TogliattiAzot to reduce its dependence on shipments via the Ukrainian port of Yuzhny. The Ukrainian authorities have limited Togliatti’s ammonia exports to around 1.2 million t/a, compelling the company to operate at just two-thirds of capacity.
