Rusal Forges Ahead With Investment‎

From a distance the Irkutsk aluminum smelter, located near Lake Baikal in Eastern Siberia, looks almost derelict. The 50-year-old Soviet-era plant, built at the height of the Cold War with little regard toward cost efficiency, is made up of grey concrete buildings with rusty beams and shattered windows. It houses a production facility that was closed down in 2009. But behind the abandoned industrial shell are two renovated blocks – freshly painted in blue and white – home to UC Rusal's newest production line, which was opened in April and has the capacity to produce 166,000 metric tons.

Rusal, the world's largest aluminum producer by output, is extremely proud of the new systems. It takes just a couple of workers, dressed in clean coveralls emblazoned with the company's logo, to man the almost fully-automatic smelting line.

The new potline – a row of electrolytic cells used to refine aluminum from bauxite – is the first large investment that has been made at the smelter since the collapse of the Soviet Union in 1991. Rusal is one of the only companies in the Russian metals sector to have spent the billions needed to replace legacy equipment dating back decades. The company's Khakass plant, which was opened in 2006, was the first new aluminum smelter to be built in Russia for 20 years.

The company's capital expenditure and research and development spending may be low by international standards but they are among the highest in Russia. The question now is: Can the company keep investing to remain competitive or will it be hamstrung by provisions forced on it during the credit crisis and the resulting restructuring of its corporate.

Oleg Deripaska, Rusal's chief executive and principal shareholder, says that his company's renovation projects have not been an answer to the government's call to modernize the country's economy. Instead they were triggered by business necessity. "If I start talking modernization at Rusal's management meeting, people would think I had gone insane," he says. "The main thing is to be competitive and to be able to win contracts. We need to be competitive to survive."

Mr. Deripaska – one of the main winners of the infamous "aluminum wars" that took place in Russia during the 1990s, when exporting the metal was one of the most lucrative businesses in the country – adds that the global economic crisis will not keep him from spending money on the reconstruction of his company's smelters.

Investment Required

During the privatization of the aluminum industry, Rusal inherited assets of varying ages and in varying states of disrepair – from the mid-sized Sayanogorsk smelter built in 1985, to plants dating back to when Joseph Stalin ruled the country. While the price of aluminum was high and electricity – which makes up by far the largest proportion of production costs – was cheap, Rusal could turn a profit even when using this ancient equipment.

But following the recent economic crisis, demand for aluminum – which is used in cyclical industries like automotives and construction – slumped. The price of the metal hit a seven-year low of $1,300 a ton in February 2009. In response, Rusal turned off some of its least effective smelters. In total, 11% of the company's capacity was made idle.

The company, which had been expanding for the best part of the previous decade, had to hold talks with more than 70 domestic and international banks about restructuring its $16.8 billion debt. These negotiations ultimately resulted in the company going public on the Hong Kong Stock Exchange in January. The majority of the proceeds from the listing were used to pay off creditors. As part of the restructuring agreement, Rusal agreed to limit its capital expenditure to $481 million this year.

Keeping Creditors Happy

More than a half of that money has been earmarked for the ambitious Boguchansk project, where both a new smelter and a power station will be built in partnership with RusHydro, a state-controlled hydropower company. Mr. Deripaska says that his company explained to its creditors that this capital expenditure was "a must", a view to which the banks were, he insists, in agreement.

However, Mikhail Stiskin an analyst at Moscow-based Troika-Dialog believes that the debt restructuring will apply the brakes to Rusal's ambitions. He says: "The company's capital expenditure is capped by the lenders. And I doubt that it is enough, given that many of the smelters are rather old."

Rusal's capped capital expenditure for 2010 is about a third what its international rival Alcoa is planning to spend and a quarter of what Chalco has earmarked for investment. The proportion of profit that Rusal spends on research and development is much lower than at Alcoa, although analysts point out that direct comparisons are not entirely fair as the two companies are structured differently.

Mr. Stiskin says: "Rusal differs positively from other similar Russian companies, but what the company is allowed to spend may be too little." He added that Rusal is "squeezing what it can from its current technologies".

Rusal admits that, were it not be for the limit on capital expenditure, it would have moved faster with its key growth projects, including the giant Boguchansk smelter. Mr. Deripaska, however, remains positive. "I'm sure we invest where we need to and as much as we need to," he says.

It costs Rusal much less than almost all its rivals to produce aluminum. But this is at least partly because of the falling value of the ruble and the company's access to cheap electricity. The Irkutsk and Khakas smelters have been supplied with cutting-edge technology. But, together with the large and modernized Krasnoyarsk smelter, they only represent about third of Rusal's total output.

New Technology

The company has been developing proprietary technology to make its plants more efficient. Mr. Deripaska says: "If you want to be competitive, you need to develop your own technological process, as what can be found on the market is old already. In the past seven years we have developed our own technology and found how to modernize the process."

Andrey Torgashev, a director at the Canadian engineering consultancy Hatch, says: "Rusal's progress was not bad at all in the past years, as its new 'pre-baked' technology is very close in productivity to that of Alcoa and Rio Tinto Alcan".

Mr. Deripaska plans to continue spending on research and development. He says: "A couple of hundred engineers don't cost too much to the company."

Those engineers are currently researching the possibility of developing a so-called "inert anode", the holy grail of the aluminum industry. This technology, were it to be developed and installed, would revolutionize aluminum production.

From 2007 to the middle of last year, Rusal reduced its workforce by 19% to 78,892 people. But Mr. Deripaska says he hopes to be able to re-employ the majority of those ex-workers as production picks up. Although modernization of production may lead to fewer workers servicing smelters, he said, the company would need them to perform other functions.

Mr. Deripaska, who says be will remain in his position as chief executive of Rusal until the company's market capitalization has doubled, is also keeping a close eye on how the government manages its own modernization program.

"Oil will not last forever, we must understand that," he says, adding that the government could help kick-start modernization by cutting taxes on processing and IT industries to attract capital and companies to Russia.

Mr. Deripaska says he had hope the government would have taken more steps to stimulate domestic consumption before now. This, he reasons, "would have prevented a GDP drop and unemployment" in Russia.