Biden Targeting Ukrainian Oligarch May Help ArcelorMittal

The Biden Administration has taken less than two months after assuming office to declare sanctions against one of Ukraine’s most powerful and notorious oligarchs.

The message from Washington is clear: epic corruption, which has plagued the country for most of the past three decades, will no longer be tolerated.

This is good news for ArcelorMittal (MT), the largest foreign investor in Ukraine, as the company has been recently facing increasing pressure from oligarchs, regulators, and even security service officials.

The security service raided ArcelorMittal’s Ukrainian subsidiary six times over the past 20 months, at one point bringing in a special radiological team and shutting down a $150 million steel casting project.

An attempt by the prime minister to stop the security service from deploying the intimidation tactic may have cost him the job - a secret recording of a high-level meeting was used to topple the Cabinet. This allowed the oligarchs to reestablish control over the government, and to resume the pressure on ArcelorMittal.

These developments underscore grave challenges faced by ArcelorMittal at one of its most important steel and mining operations worldwide. This also shows why the Biden Administration’s steps to rein in the oligarchs and to reestablish the rule of law in Ukraine are so important.

‘Significant Corruption’

Antony Blinken, the Secretary of State, on March 5 issued a statement designating Ihor Kolomoisky, the oligarch, as ineligible to enter the United States for his involvement in "significant corruption." Blinken also expressed concern about Kolomoisky’s “current and ongoing efforts to undermine Ukraine’s democratic processes and institutions, which pose a serious threat to its future.”

Kolomoisky is widely regarded as one of the strongest backers of Ukrainian President Volodymyr Zelensky, a former comedian whose show has been running on a television channel controlled by the oligarch.

Not a single investor was laughing though in August 2019 when Kolomoisky had openly called on the government to nationalize ArcelorMittal’s Ukrainian operation, known as ArcelorMittal Kryviy Rih.

A forceful nationalization of a successful private business in any country would send a negative signal to global investors, but in Ukraine such move would be even more sinister.

Here is why: Ukrainian oligarchs gained their wealth and power not via private enterprise, but rather through exploiting state-owned assets. They use political connections to appoint loyal managers at state-owned companies, make company books opaque, and channel earnings to a myriad of anonymous offshore accounts.

Kolomoisky, via his loyal managers, for decades controlled the country’s largest oil producer, Ukrnafta, which is majority owned by the state. In the same way, he controlled for years Ukrtransnafta, the 100% state-owned oil shipping monopoly among other assets.

Any potential nationalization of ArcelorMittal’s lucrative Ukrainian subsidiary would make even the wealthiest Ukrainian oligarchs salivate in anticipation of future profits.

This would also be a huge red flag for investors as the subsidiary is ArcelorMittal’s second-largest mining operation in the world and is simply too important for the company, contributing strongly to its impressive performance over the past six months.

Raiding Operation

Ukraine, which accounts for about a fifth of ArcelorMittal’s annual iron ore production, harbors the company’s second-largest mining operation after Canada. ArcelorMittal has invested $10 billion in its Ukrainian business over the past 15 years.

ArcelorMittal Kryviy Rih increased production of iron ore, mostly concentrate, to 10.7 million metric tons in 2020, up from 9.8 million mt in 2019. Its steel output dropped to 4.7 million mt from 5.3 million mt due to the pandemic, while rolled steel production fell to 4.3 million mt from 4.7 million mt.

A watershed moment for the company occurred on July 20, 2019, when 18 security service agents, armed with radiation measuring devices, had entered its facilities. After the 14-hour raid, the agents concluded that radiation levels were too high and ordered managers to immediately shut down work on its brand new $150 million billet continuous casting machine.

Eighteen days later, after realizing the agents may have made a measuring mistake, the security service allowed the managers to resume the work.

The calm lasted less than two months. On September 3, 2019, a squad of 11 security agents raided the company again, this time inspecting its coke-producing facilities for as long as 19 hours.

The next day, in what appears to be a concerted effort, the authorities had slapped ArcelorMittal Kryviy Rih with a bill for additional tax assessment worth $300 million. This basically equals the amount the operation pays in taxes annually. The authorities admitted the bill was prepared after an input from the security service.

ArcelorMittal is currently fighting the tax bill in court.

The scope of the security service investigation ranges from the company’s alleged impact on the environment to ‘financing of terrorism,’ a charge that even Ukrainian authorities themselves struggle to explain. By law, such accusation is the only way for the security service specifically to get involved in an active investigation of a company.

The raids, investigations, and regulatory pressure have been a serious distraction for ArcelorMittal Kryviy Rih, draining company resources and putting exhausting pressure on its personnel.

The new tax bill would have a direct financial impact on ArcelorMittal and force the company to scale back its capital investments, reduce production and exports, and may potentially trigger massive layoffs.

Wiretapping Scandal

The attacks on ArcelorMittal began three months after Zelensky’s election to office, perhaps offering some clues to the sudden change of hearts now affecting the company in Ukraine.

Ivan Bakanov, Zelensky’s childhood friend, is now head of the security service that leads the investigation. Before his appointment, Bakanov was head of Zelensky’s comedy show.

Investors are concerned to see Zelensky’s two closest allies, Bakanov and Kolomoisky, spearheading the attacks against ArcelorMittal. This raises questions about Zelensky’s own commitment to reforms.

At times, the level of hypocrisy toward investors was simply amusing.

As security agents have relentlessly put pressure on the largest foreign investor in the country, Zelensky has been courting other investors in Davos in January 2020 with a promise to create “investment nannies,” or special bureaucrats to help investors overcome the web of bureaucracy.

A handful of pro-Western government officials tried to stop the intimidation tactic used against ArcelorMittal.

Prime Minister Oleksiy Honcharuk, less than a month after his appointment to lead the government, has voiced his concerns. “I do not like this signal, and I have shared my impression with the head of the relevant agency,” Honcharuk in televised remarks in September 2019.

What followed, however, was a pushback that involved the wiretapping of a high-level government meeting and a leak of sensitive recording that had shaken the Cabinet and had eventually led to its collapse in March 2020.

The recording, which was anonymously posted on YouTube on January 15, 2020, featured Honcharuk apparently telling other Cabinet members that Zelensky’s understanding of the economy was “primitive.”

Within hours of the posting, two lawmakers, known allies of Kolomoisky, called for dismissal of Honcharuk and the entire Cabinet. As a result of the reshuffle, oligarchs reestablished control over the government, opening doors for new attacks against ArcelorMittal.

Ironically, the only time when ArcelorMittal Kryviy Rih did not face the raids was during the COVID-19 pandemic lockdown. With the lockdown order lifted, the raids had resumed. On October 15, 2020, the agents inspected the facilities in support of the new tax assessment claims.

The most recent raid has taken place on February 8 with the security agents inspecting the mining operation, checking samples of iron ore and other raw materials.

The raid was followed by Bakanov’s comments on March 17 accusing ArcelorMittal of not paying enough taxes, an allegation that had been vehemently rejected by the company.

The regulatory pressure kept building. Days after Bakanov’s comments, the State Environmental Inspectorate ordered ArcelorMittal to construct a new tailings facility and get – for the third time – an environmental assessment.

The problem is that unless the new tailings facility is put in operation soon, ArcelorMittal may be forced to stop its mining in Ukraine as two existing tailings facilities are running out of room.

‘A Lot of Good News’

This is why the Biden Administration’s sanctions imposed against Kolomoisky and its calls for Ukraine to restart reforms are so important. The action seeks to break an Oligarch-Government bond, which has essentially defined Ukraine’s political and economic system over the past 30 years.

The message is aimed not only at oligarchs but also at those government officials and public servants who have supported massive corruption and enabled unfair treatment of honest investors.

To make sure the message has been received, President Biden called Zelensky on April 2 and urged him to “tackle corruption and implement a reform agenda based on our shared democratic values that deliver justice, security, and prosperity to the people.”

At last, there are signs the Ukrainian authorities may have been taking the message seriously, and perhaps are preparing to ease the pressure on the largest foreign investor.

Zelensky agreed to meet Lakshmi Mittal, executive chairman of ArcelorMittal, on April 14 to discuss the company’s plans to invest $1 billion into cleaner steelmaking in Ukraine. Both, Zelensky's office and ArcelorMittal issued upbeat statements after the meeting.

“There seems to be a lot of good news awaiting us all,” ArcelorMittal Kryviy Rih said in its statement posted on Facebook.

Investors will be eagerly watching for signs of progress.

Once the investigations and regulatory pressure go away, it would remove a cloud of uncertainty that has been hanging over ArcelorMittal’s second-largest mining operation in the world and would be a reason for investors to cheer.

Outlook

Prospects for steel companies around the world have been improving as economies reopen following coronavirus pandemic lockdowns.

Most steel companies, including ArcelorMittal, U.S. Steel (X), Cleveland-Cliffs (CLF), Nucor (NUE), and Steel Dynamics (STLD), enjoyed an upward trend since September 2020 due to recovering global demand.

President Biden’s $2 trillion infrastructure proposal, which aims to revamp U.S. roads, bridges, airports, housing, and utilities, once approved by Congress would further support steel prices and help steel companies improve margins.

ArcelorMittal’s share price rose steeply since September 2020, reflecting strong global demand and pricing in expected earnings gains. This, coupled with the remaining uncertainty surrounding the company’s operation in Ukraine, suggests the company is probably fairly valued.