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«SIBUR» LLC is the managing organization of PJSC «SIBUR Holding».

117218, Moscow, Krzhizhanovsky st., 16/1

The crunch is still biting in Russia

Sibur saw its net income for the financial year 2008 fall 29.2% to Rb16 billion ($478 million) versus a year ago.

However, despite the challenges faced, Sibur is slowly moving ahead in its quest to become a major player in the petrochemicals arena. Already, Sibur Holding is the largest petrochemical business in Central and Eastern Europe and the CIS, and includes 34 operations ranging from the processing of gas to the manufacture of consumer products Platts spoke to Sibur president Dmitry Konov.

What is your perspective on 2009, from the experiences of your own company and the industry as a  у whole in the Central and Eastern Europe and in Russia? H ow do you think the industry has managed through the downturn over the course of the year?

I would say it has been pretty mixed. Looking at our company first, we started very poorly, in line with how we finished last year. With a significant de-stocking process taking place, we in some cases had our capacity utilization rate at about 50-60%, especially in our rubbers business. The rubber business had taken a significant hit (was blown) due to the weakness caused in the in the tyre manufacturing and the automotive industry, affecting the whole value chain. The business has shown a good recovery since the beginning of the year.

In other part of the business, we basically had a 100% capacity utilization in our polymers and synthesis businesses. This was achieved mainly due to the availability of cheaper gas based feedstock, which is part of our vertical integration.

Meanwhile the rubbers business was down by 50%, though it has also since recovered.

What are the main drivers behind that recovery? Is it due to the recovery in the underlying demand and in volumes, or has your company made internal efficiency changes?

It is also important to note the good performance sustained in our feedstock business. It is a significant portion of our profitability today. On the other hand, the devaluation of the local currency, the rouble, has also helped allot. At once we had good feedstock availability, which was universal for the whole industry, not only exclusively to us and this feedstock, especially in Q1 and Q2 this year was cheap. Complementing the devaluation, we saw very little or no imports at all coming into the Russian domestic market. The devaluation also allowed most of the Russian producers to export with a profit. Basically the cost base, while around 30% lower than the last year due to the devaluation, stayed stable for some time. Despite the lower prices in Europe on most of the products, it was still profitable to export out of Russia.

Sustainable exports to Asia have been an added bonus for the European petrochemical industry. Have exports to Asia also helped you?

We export rubbers and it is a reasonable portion of our production. We witnessed a huge drop in volumes in Q4 2008 and in Q1 2009, but they have since recovered. Plastics, however, is a marginal market for us as we are mostly selling in Russia and in most cases we export to Europe.

If we look at an average bio polypropylene film producer in Russia, last year, he had 100% capacity utilization and was selling 100% of his production in Russia, while his supplies were 70% local and 30% imported.

Today what we see is that there is a drop in the local end demand. The Russian   polypropylene film producer today sources 100% of his PP locally and sells about 30% of his finished product in Europe.

So the change in the market structure, together with the devaluation has helped the Russian market?

An additional element that has benefitted the industry but not us specifically is the drop in the LPG demand. The domestic Russian market was basically flooded with LPG, which became extremely cheap and this has significantly supported the profitability at some petrochemical companies. This was somewhat reversed by the Russian government, as it abandoned the export duties on LPG , so the market imbalance did not last long. From Q2 onwards it was not that good for the petrochemical industry although it was still good for us, as we were still long on LPG, as we do not process all of our LPG in our downstream operations.

As the LPG prices have since risen you can now offload it into the  i market, instead of using it in your own system?

Yes, we actually expect that the LPG export duties will be back in October-November, although as we understand it, the new structure of the duty will be more favourable to us under the new regime than during the previous one, abandoned by the government at the beginning of the year.

As for the export demand, we can see that in the basic polymers the domestic demand was significantly hit in the traditional automotive and construction industries. The basic polymer which was mostly hit is PVC. In both emulsion and suspension there has been about 40-45% drop in demand, year on year. We see the polypropylene market mainly flat, only marginally lower. However the domestic polyethylene demand is in yearly comparisons lower by 15-20%.

With the recent discussions centred around the recovery in demand, what is your assessment it? Do you see a genuine recovery in the underlying demand or do you see the recent boost in volumes as merely an improvement in stock positions through the value chain?

There is some difference between Europe and Russia. In Russia the de-stocking was as huge as elsewhere, but it occurred with a 3-4  month lag to the global destocking trend. In Russia, it was not only the demand-led weakness. The weakness of the Russian financial system also played a part. I believe that what we saw in Russia was actually on the bigger scale to what was witnessed in Europe. For many parts of the value chain, from the final consumer to the resin producer, it has been almost impossible to get any credit to support the working capital. And this problem led to, especially in the converter industry, to a complete halt in buying. So the scale of the de-stocking in Russia has been much stronger than anywhere in the world.

What we are now seeing in Europe, and more so in Asia is that in some parts of the production chain, there is a re-stocking effect. Some buying has resumed in certain parts of the value chain. However this has not yet happened in Russia. We only see a marginal restocking in Russia. It is not a major factor here.

When talking about a recovery, we should distinguish between the GDP and the industrial production. Unlike Europe, Russia witnessed a double digit drop in its GDP (during the current downturn) So for us now, what can be called a recovery or viewed in a positive light is that the GDP drop now comes back to a single digit.  We expect that the overall GDP drop comes back to 5-10% fall on yearly basis and by Q4 we will probably see it a minus 3-4% level. So there is no really significant recovery uin Russia.

Do you think the Russian recovery is around 6 month behind Europe?

I think that the 6-9 month lag is this there. The recovery rate in Europe is also much steeper to what we expect in Russia. The Russian economy is pretty much driven by the commodity pricing of metals and oil. Therefore if we see a significant uptick in the prices of oil, it will significantly accelerated the recovery rate in Russia. It will also restore the consumer confidence in Russia.

If we take a look at the major industries with respect to the polymer demand, construction industry is officially down by 20%. Visibly, it could be down by 50%. Some of the old projects that were in the pipeline are now being finished and some of them are not, but there are very few new projects in the pipeline. If we look at the automotive industry it is down by 60% year on year.

Are there opportunities present in the current downturn and if there are what are they? Is there an opportunity to be aggressive? Or do you say “lets ride this storm out until the good times come?”

We have improved the efficiency in cooperation between our headquarters and the production cites. In terms of the consolidation attempts…we have not been historically interested in acquiring any but one of our competitors.

Would you say that the credit crunch effect has been more prolonged in the Russian value chain than in the Western Europe?

The impact of the credit crunch is still felt in Russia. It is still ongoing. There is also a different in the governmental stimulus packages in Europe and in Russia. European governments are more interested in the demand aspect. While the government in Russia has a general policy in helping the producers, so the government in Russia is more likely to bail out a producer.

There seems to be a preference in Russia to have big national champions in commodity markets?

If the Russian government had a strong interest in a big national petrochemical champion, it would promote the consolidation of industry.

We still feel governmental support in parts of our business though. We are just structurally finalizing our deal with VEB*, which is a state owned   ' bank, on the financial package for our Tobolsk project. It is our largest investment project to date. If we take a closer look at the deal it will be $1.4 billion loan, which is mostly financed by a syndication of Western banks, however some portion of the indirect payment will come from the VEB bank, it will be around 15-20% of the total package.  This deal shows that there is governmental support but it is still limited, so we use opportunities.

*Subsequent to this interview Sibur finalized an agreement with VEB.

With a growing fear of new lower-cost capacities coming to Europe, could Russia potentially take market share from someone in Europe?

To some extend I would say yes, but it actually depend on the product. If we take a look at a reasonably typical European producer, he operates a naphtha cracker, with its ethylene and propylene derivatives adjacent to the cracker. If we take a look at the Middle Eastern producers, they have very cheap ethylene derivatives and relatively market-value prices propylene derivatives. Both of these products will be coming to Europe. So these producers have a fixed low cost of ethane feedstock, but they have typical market discounts for propane, so this leads to a much higher cost for propylene derivatives in contrast to ethylene derivatives. So Europe will be faced with cheap ethylene derivatives and relatively market prices propylene derivatives.

So in contrast to that, you have a European integrated cracker, which now becomes completely uncompetitive on the ethylene derivatives side, which consequently leads to low capacity utilization and then a potential shutdown. The closures would happen at smaller crackers in Italy and France. Eventually when the polyethylene and polypropylene units come out of the market, there will be a different balance between the ethylene and propylene derivatives in Europe. So I think this will give a window of opportunities for the Russian producers, mainly in the propylene chain.

The next stage after the improvements in demand is the recovery of profitability. If Russian demand has around 9 month to recover, when is the expected return to profitability? A year? 18 month?

The improvement in the European petrochemical industry is capped by the competitive Middle Eastern cost position. With any potential uptick in the energy prices, the European industry will be hit more than ever before because of this cap. There will be a struggle for a market share in Europe. There will be a need to take out several million tons of the global capacity in the ethylene derivatives in the next couple of years globally, with the Middle East entering the global market, while the demand growth is not as previously expected. With any potential increase in the energy markets, European producers will not be able to push their margins higher and pass the costs further down the production chain.

Looking at Russian profitability there are cases of improving profitability and there are cases when the profitability has not improved. For .Sibur, our non-traditional structure of the assets and business segments helped us through the downturn, not only the vertical integration aspect but the feedstock itself, as we can sell

it into the rising markets. Our polymer business in the Q2 and Q3 operates with an EBITDA margin of 15-22%, while the feedstock business operates with a higher margin. But for many producers who operate in polymers only have a much lower EBITDA margin. This structure differenmtiates us from other Russian producers and allows us to grow in some segments.

What are your expectations of Q4 2009?

The coming quarter will not be anything like the Q4 of 2008. The volatility in commodity pricing made people lose all forms of visibility. I expect that during this Q4 the activity will slow down slightly and maybe it is better to be less stocked. There will not be a significant collapse in prices; also there will not be much volatility in prices and volumes.

With the Chinese markets looking increasingly unlikely to import as much as they have, will Europe be the primary location for all exports from the Middle East?

The European producers will be at a significant risk; also in terms of the demand, I don’t think China will bail Europe out again. Europeans will not be competitive again. Maybe some set back in the energy prices will allow the prices to be more competitive in Europe.

If we sum up 2009: costs have been cut; companies have restructured, so what is the next wave of challenges for the industry to overcome?

I believe that three factors will pose challenges. Firstly the recovery will be much slower than we are made to believe. Secondly, high energy prices will pose a challenge and thirdly, more Middle Eastern capacity will be another hurdle to overcome. There is a discipline in the market now, which today allows the market digest the current Middle Eastern product coming to Europe. However, there will be more products coming in 2010 and 2011. So there will be a need to re­establish the balance.

Contacts for Media

Press Office

Anna Lebed

International Media Relations

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