Unlike the majority of Russia's industries, the aluminium industry is performing quite well. In late February, the Krasnoyarsk Aluminium Plant (KrAZ) opened a modernised electrolysis facility that should increase annual output by 20,000 tonnes. The Sayanii Aluminium Plant (SaAZ) increased its capacity by more than 10 percent during the autumn of 1998 by adding two new facilities, and the third colossus of Russia's aluminium industry, the Bratsk Aluminium Plant (BrAZ), produced a record 852,000 tonnes of aluminium in 1998.

In 1998, Russia's aluminium output increased 3 percent to 3 million tonnes, the industry operated at 98 to 99 percent of capacity, and Russia ranked second in the world in aluminium exports. Twenty-five percent of aluminium consumed in the world in 1998 was smelted in Russia.

In the early 1990s, Russia's aluminium industry was on the verge of catastrophe. The collapse of the Soviet system and the start of free-market reforms deprived the industry of nearly 80 percent of its main markets, the military industrial complex, civilian aircraft manufacturing and machine building. It was precisely these sectors which had suffered most from reforms. Despite a massive decline in production (50 percent on average and 70 to 100 percent in the aluminium-consuming sector), the aluminium industry managed to emerge almost unscathed. The explanation is simple - Russian aluminium producers re-oriented in favour of exports.

Tolling Became Music to Their Ears

Tolling is a system in which the producer and supplier of raw materials is also owner of the final product. In Russia, tolling was tolerated as a necessary evil. Prominent businessman Lev Chernii and President of Trans World Metals Ltd. David Rubin deftly took advantage of the grave situation of Russian aluminium producers who had found themselves without markets and working capital. Initially, foreigners took a high risk, but later the risk was minimised by making Russian smelters entirely dependent on foreign alumina supplies. Under the tolling scheme, Russian enterprises received approximately 40 percent of the sale price of aluminium at the London Metals Exchange. In the meantime, foreign partners attempted to acquire control of Russia's major aluminium industries. Trans World Metals bought stakes in BrAZ and SaAZ. To the credit of the Russian managers, they not only used tolling as a means of survival but also as a way to preserve control of the enterprises. According to estimates made by the Russian Centre of Industrial Restructuring, tolling accounted for 88 percent of Russia's 1998 aluminium output. Last year, Russia exported 91 percent of its aluminium production volume, primarily to Boeing, Rolls Royce, Aerospatiale and Pratt & Whitney.

Although tolling helps domestic aluminium producers, it does have its drawbacks. Defenders of the budget have tirelessly condemned the scheme because the sector is exempt from VAT and other taxes. In late 1997, experts from the State Tax Inspectorate calculated that the repeal of tolling would help raise an additional $400 million to $500 million for the state budget. These experts forgot, however, that Russian alumina suppliers could provide only 35 to 40 percent of the amount required. The only way to increase domestic production of alumina is to develop the Sredne-Timanskoe bauxite deposit, which would require some $1.5 billion in investments. Furthermore, the repeal of tolling would deprive Russia's aluminium producers of about $2 billion in working capital. Given the present situation, the country's economy cannot afford to pay this price. In all likelihood, tolling will remain in effect through next year, and in December 1998, the government decided to maintain existing customs terms for tolling operations. That decision was made because the Central Bank's benchmark interest rate soared to 60 percent, making it almost impossible to attract any sizeable credits. Russia will not be able to end tolling in its non-ferrous metallurgy sector unless the Central Bank's benchmark interest rate is reduced to 15 percent per annum.

Two Ways

Tolling has been widely condemned. "Tolling is the cheap sale of our labour and the result is an aluminium glut on the market that presents serious problems for our country," said Oleg Deripaska, CEO of the Siberian Aluminium Group, in late January. The Siberian Aluminium Group comprises the Samara Metallurgical Plant (SaAZ), Sayanii Foil, Abakanwagonmash, Resal and a number of other companies. Deripaska argued that instead of unprocessed metals, Russia should sell partly refined metal products. But tolling hinders that. "How can we stand up to competition on the markets when millions of tonnes of cheap aluminium are flooding the United States, enabling the Americans to manufacture cheap products and parts," Deripaska said.

Deripaska advocated a "patriotic" approach to developing the aluminium industry in Russia. Assertively - at times aggressively - he has succeeded in bringing together a supplier of alumina (Nikolayev alumina plant in Ukraine), producer of primary aluminium (SaAZ), manufacturer of aluminium articles (Sameko in Samara) and several distributor companies. Currently, the Siberian Aluminium Group sells more than 50 percent of its output on the domestic market. Its products range from aluminium foil to beverage cans.

In the meantime, Deripaska's opponents have formed another group, centred around the Bratsk Aluminium Plant. Their tactic is to export unprocessed aluminium with maximum profit. BrAZ managers believe that instead of investing in the development of processing facilities at home, it is better to find a good foreign partner to provide facilities or investments.

But the competition is not limited to ideology. Siberian Aluminium has outpaced BrAZ in taking control of the Nikolayev Alumina Plant in Ukraine. Recently, the two groups crossed swords over the Novosibirsk Electrode Plant. The enterprise was declared bankrupt and placed under external management, and rumour has it that a Deripaska appointee has become external manager.

In the next three years, Siberian Aluminium plans to double its aluminium output and bring it up to 613,000 tonnes per year. Comparatively, BrAZ currently produces more than 800,000 tonnes of aluminium per year. But SaAZ has the advantage of modern facilities. It was built in 1985, while BrAZ was built 30 years ago. SaAZ plans to spend $600 million on modernisation and expansion of production. New smelters will supply nearly all output to Sameko (a member of the Siberian Aluminium Group) for re-processing. "We are consistent in our strategy to replace the export of [raw] metals with domestic re-processing of metals into sophisticated items for both domestic consumption and export," says German Tkachenko, spokesman for Siberian Aluminium.

Sameko plans to increase output from 85,000 tonnes to 150,000 tonnes per annum. This will require $100 million in investments. While counting on domestic demand, Sameko is conducting negotiations with potential customers in the West, specifically Volkswagen, Boeing and Air Industries. As attractive as it is, the patriotic approach in the aluminium industry may bring huge losses. Russia's crisis-ridden market promises no certainty. "Deripaska is taking a big risk," says one metallurgy analyst. "It is extremely difficult to export re-processed aluminium, and good sales on the domestic market would require at least a 30 percent increase in demand. In this respect, Siberian Aluminium needs assistance from the government: first of all a sweeping revision of industrial policy, i.e. a decision to sponsor the manufacture of aeroplanes, automobiles, etc."

The manufacture of household foil and beverage cans is not enough to ensure adequate sales and profits. Theoretically, the loss of the aviation industry (which used to be the main consumer of aluminium in the Soviet Union) could be offset by demand from the automotive industry and construction. In the United States, automobile manufacturers consume 25 percent of aluminium, a similar proportion goes to the manufacturers of various containers and packaging materials and 15 percent is consumed by the construction industry. In Russia, the situation is different. In recent years, there has been little demand from automotive plants and packaging and building enterprises. Russia's technological backwardness is a big reason for this. The manufacture of one car in Russia requires 40 kilograms of aluminium; in the West, the corresponding figure is 150 kilograms. And the construction industry still uses more reinforced concrete and wood than metal.

Mr. Deripaska, it seems, has a flair for reading the future, for his current plans fit nicely into the economic strategy put forward by Prime Minister Evgennii Primakov's government. Unlike Deripaska's opponents, whose co-operation plans are limited to large Western companies interested in purchasing cheap aluminium, the chief of Siberian Aluminium is still cherishing hopes of a possible alliance with the state.

Looking for a Match

Two other Russian aluminium giants - BrAZ and KrAZ - prefer not to rely upon the domestic market. They are busy looking for a foreign business partner who can offer them investment, modernisation, and access to the global metal market's big players club. "The practice of establishing global alliances is widespread," the head of one metallurgy complex told the Russia Journal recently. "We cannot ignore this feature of international business when shaping our strategic plans. Whatever market we try to penetrate, be it international or domestic, we will not be able to compete successfully against such alliances. That is why our present objective is either to join an already existing alliance or to create a new one."

Last fall, KrAZ approached several large foreign companies with co-operation proposals. Representatives of the PECHINEY company (France), one of the world's aluminium leaders, visited the plant late in November. The French appear to be interested in the Krasnoyarsk plant's proposal.

There is an opinion that attracting a foreign partner will become a lot easier if the potential partners are not only offered the use of manufacturing facilities, but also a specific project involving these facilities. In other words, the emphasis is put on establishing new markets. Given that the Russian aluminium plants' are all located in Siberia, China would be a logical choice for the development of new markets. The recent progress in Russian-Chinese relations, as witnessed by China's intention to develop its Northern provinces by using Russian oil, gas, power and metals, has given aluminium plants a chance to prove that they have potential access to the vast Chinese market, as well as other markets in the region.

Dangerous Costs

Growing domestic prices and the industry's lagging technological development (most of the aluminium plants were built in the 1940s through 1960s) presuppose another serious problem - the rapid increase of costs. Some three years ago, CRU International Co. concluded its three-year survey of Russian aluminium plants by saying that Russians are already losing the advantages they had in the early 1990s. Back then, the prime cost of one tonne of metal was $1,006. The cost of production grew to $1,460 per tonne by 1995 and stayed at that level up to the middle of last year, when the falling rouble made life a bit easier for exporters (the plants themselves claim, however, that production costs range from $1,000 to $1,200 at BrAZ and SaAZ, and $1,180 to $1,250 at KrAZ). The price of aluminium on the London Metals Exchange fell throughout last year, sinking to its lowest point in 5 1/2 years in February 1999, when it posted below $1,200 per tonne, down from $2,560 per tonne in 1988.

The global financial and economic crisis leaves little hope for the situation to improve any time soon, and the forecast made by Anthony Bird Associates two years ago that the price of aluminium would reach $2,698 per tonne in 1999 has failed to come true.

The threat of sliding into debt has prompted SaAZ and KrAZ to launch extensive modernisation projects. Aluminium enterprise managers admit they are taking high risks: They can raise loans; but can they pay them back amid instability on domestic and foreign markets? "Nobody can guarantee for us the stability of electricity and railroad tariffs," BrAZ CEO Yuri Shlyafshtein says. "So long as the government gives us no guarantees it is difficult to invest. Currently, we have no debts and enjoy some freedom to manoeuvre. For example, we can cut production volume or reduce costs at some stages. With the burden of debt on our backs, however, we will lose this room to manoeuvre."