russian forest sector overview...2020/01/01 · market. the share of e-commerce parcels in all...

Russian Forest Sector Overview2018-19

With assistance from

ContentsIntroduction 1

Key drivers of the forest sector in Russia and globally 2

Growth of forest industries in Russia and globally 6

Outlook for exports 10

Fast-growing forest industries 12

Investment attractiveness of the forest sector 24

Government support 34

Taxation 36

Forest resources 41

Conclusion 43

Contacts 44

1Russian Forest Sector Overview 2018-19 |

IntroductionRussia is home to one of the world’s largest wood reserves, making the growth of its forest sector an important priority. 2018 was a landmark year for the domestic forest sector, as the Russian Government approved in September the Forest Sector Strategy to 2030 to improve the sector’s global competitiveness, while exports of forest products reached their all-time high of US$13.4 billion. Positive trends continued in 2019, with Russia’s forest sector progressing toward targets set under the Strategy.

Despite marked improvements, considerable potential remains to be tapped to increase the supply of forest resources and the share of value added in manufacturing. Government support of the forest sector is big1. However, investment inflows mostly come from private companies, while it is crucial to improve the investment appeal of the forest sector to enable exponential growth.

To prepare this report, EY, with assistance from the Association of Specialists of the Pulp and Paper Industry (ASPPI), conducted its annual survey among forest sector companies to capture perceived trends and identify sector industries that have the greatest growth potential. We studied historical and forecast performance data across industries such as financial and operational metrics, investment inflows, promising investment projects and the scope of government support.

Sales managers of more than 20 leading Russian companies in the forest sector participated in the survey. Our report consists of the following sections:

• Key drivers of the forest sector in Russia and globally

• Outlook for exports

• Fast-growing forest industries in Russia and globally

• Investment attractiveness of the forest sector

• Risks

• Government support and taxes

• Forest resources

Our report is intended for industry players, investors, government bodies, financial institutions and other stakeholders. We would like to thank all survey participants for their contribution, and hope that you will find our report insightful.

Igor PrutovPartner, CIS Forest Sector Leader

+7 (916) 825 2309 [email protected]

Sergei Malkov Management Board Member of the Association of Specialists of the Pulp and Paper Industry

+7 (925) 000 1011 [email protected]

1 Priority Investment Projects, Special Investment Contracts, tariffs designed to protect domestic manufacturers, incentives for some forest industries and other support

2 | Russian Forest Sector Overview 2018-19

Key drivers of the forest sector in Russia and globally

Global economy and populationConsistent growth in individual earnings and, hence, consumption are driving demand for goods and services.

International tradeSteady growth in international trade is a key driver for the manufacturing sector.

Economic growth in Russia and globally, CAGR

Indicator 2008-18 2019-28

Per capita GDP growth*

World 1.5% 1.8%

Russia 0.8% 1.6%

Population growthWorld 1.2% 0.9%

0.1% (0.2%)

* In real terms

Source: Oxford Economics

International trade growth, CAGR

Indicator 2008-18 2019-28

Exports growthWorld 1.8% 5.7%

Russia (0.2%) 4.3%

Growth in forest product exports*

World 1.4% 4.2%

3.3% 4.7%

* Wood and cork products, pulp, waste paper, paper and paperboard.


The forest sector makes an important contribution to the global economy and is subject to increased regulatory scrutiny:

• The imposition by the US of import duty on sawnwood from Canada

• The imposition by Russia of export duty on roundwood to boost the output of forest products

• China’s ban on imports of recyclable materials and untreated waste paper

• The provisional* entry into force of the Comprehensive Economic and Trade Agreement (CETA) between Canada and the EU that is aimed to lift trade

* The agreement has not yet been fully implemented


Renewable energyRenewable energy is a fast-growing energy source globally. Biofuel, made from plants, is an important alternative fuel source, accounting for 50% of all renewable energy produced in 2017.

Share of renewables in total energy consumption

Sources: US Energy Information Administration’s International Energy Outlook 2018, International Energy Agency’s Renewables 2018

Building construction and furniture manufacturingBuilding construction and furniture manufacturing, CAGR

Indicator* 2008-18 2019-28

Growth of the building construction industry

World 2.7% 3.2%

Russia (1.3%) 1.0%

Growth of the furniture manufacturing industry

World 2.8% 3.6%

(3.4%) 1.3%

* Real growth rates in US dollars (value-added output)


While projects in Russia are still confined to low-rise buildings, the use of timber in high-rise structures is gaining ground globally.

Under Russia’s Forest Sector Strategy, domestic construction of wooden housing is projected to reach 13.6 million square meters in 2030. To stimulate demand, the Russian Ministry of Industry and Trade has launched a program to provide subsidized loans for purchases of wooden homes.

World:

• Mjøstårnet, Norway, 85 meters, 2017–19

• Brock Commons, Canada, 53 meters, 2015–17

• HOHO VIENNA, Austria, 84 meters, 2016–19

Russia:

• Wood–city, Moscow

• Sokol Town, Moscow Region

• Good Wood Plaza, Zelenograd

Renewable energy

2008 2018 2028

10%

CAGR = 4.3%

CAGR = 3.0%

13%16%

https://www.skyscrapercenter.com/building/mjostarnet/26866

https://www.skyscrapercenter.com/building/tallwood-house-at-brock-commons/22424

http://www.hoho-wien.at

https://archi.ru/projects/russia/13846/zhk-wood-city

http://totan.ru/portfolio/sokol-town

http://goodwoodplaza.ru


Internet growthGlobal Internet growth has significantly changed the structure of consumption of goods and services, transforming the entire economy. Rapid technology advances have also had an impact on the forest sector. For instance, the consumption of print publications is declining globally amid the digital explosion.

Rise of e-commerceIncreased Internet penetration has driven the e-commerce market. The share of e-commerce parcels in all packages in Russia jumped by 32% in 2018 compared with 2017. The e-commerce market is expected to grow by up to 20% on average annually in 2018 through 2021. Data Insight forecasts its annual growth in Russia at 18%.

Share of Internet users in the total population Share of e-commerce in total retail sales


Sources: Oxford Economics, Statista, Data Insight

23%

49%56%

75%85%

89%

27%

76%79%

World Germany Russia

2008 2018 2028

5.9%

3.7% 4.2% 5.0% 5.5% 5.8% 6.4%

7.4%8.4%

9.8%11.4%

13.1%

2016 2017 2018 2019 2020 2021

World Russia


Global production of fabrics and clothesThe production of cotton and linen is strongly conditional on the weather, the size of available arable land and other natural factors. The ongoing growth in the consumption of clothes and footwear is projected to push demand for artificial fabrics, including viscose that is derived from dissoluble cellulose, as the market changes to remain balanced in terms of supply and demand and, hence, prices.

Environment and sustainabilityThe production of recycled products is on the rise as public environmental awareness has increased worldwide. Restrictions on plastic use are driving the production of wood-based packaging. The share of packaging paper jumped from 50% in 2008 to 58% in the total production of paper products in 2018.

Growth in fabric production, CAGR

Indicator 2008-18 2019-28

Growth in fabric and clothes production* World 3.1% 2.4%

Growth in viscose fiber production** World 3.4% 4.3%

* Real growth rates in US dollars (value-added output)

** CAGR in 2016–18 and 2019–24, million tons

Sources: Oxford Economics, Mordor Intelligence

Growth in plastic production, CAGR

Indicator 2008-18 2019-28

Growth in plastic production*

World 2.9% 2.9%

Russia 4.1% 2.6%

Growth in recyclable packaging paper** World 4.7% 5.4%

* Real growth rates in monetary terms (value-added output)

** CAGR in 2017-19 and 2019-23, USD

Sources: Oxford Economics, Mordor Intelligence

As many as 53 countries banned single-use plastic in 2018, and five countries more are projected to follow suit by 2020. In addition, 127 countries have limited by law the production and consumption of single-use plastic. Single-use plastic products such as tableware will be banned in the EU in 2021.


!"#$% &

9.2%3.1% 3.8% 5.8%3.0%2.8%2.4%2.1%1.9%1.6%1.5%0.9%0.5%0.3%-0.8%-1.3%-1.5%-6.7%-8.8%

CAGR in 2013–18 (nonlinear scale)

4.86.9

94.4

38.1

134.8

20.0

208.6

35.0

48.753.6

7.8

87.7

44.0

262.6

134.2

25.024.4

11.6

11.1

4.5

11.4

Fast-growing industries

Russia’s share of the global

market

Fiberboard

Commercial roundwood

Wood fuel

Charcoal

Wood chips

Wood pellets

Sawnwood

Veneer sheets

Plywood

Particleboard

OSB

MDF/HDF

Mechanical wood pulp

Semi-chemical wood pulp

Chemical wood pulp

Recovered fiber pulp

Recovered paper

Newsprint

Household and sanitary paper

Packaging materials

Wrapping paper

4.7%

11.2%

0.9%

7.5%0.1%

7.1%

3.6%

2.5%

1.5%

3.2%

9.1%

5.9%

8.7%

4.3%

8.7%

9.9%

1.6%0.1%

2.5%

3.1%

4.3%

Growth of forest industries in Russia and globally

Source: EY

Global production in 2018, USD million


!"#$% &

9.2%3.1% 3.8% 5.8%3.0%2.8%2.4%2.1%1.9%1.6%1.5%0.9%0.5%0.3%-0.8%-1.3%-1.5%-6.7%-8.8%

CAGR in 2013–18 (nonlinear scale)

4.86.9

94.4

38.1

134.8

20.0

208.6

35.0

48.753.6

7.8

87.7

44.0

262.6

134.2

25.024.4

11.6

11.1

4.5

11.4

Fast-growing industries

Russia’s share of the global

market

Fiberboard

Commercial roundwood

Wood fuel

Charcoal

Wood chips

Wood pellets

Sawnwood

Veneer sheets

Plywood

Particleboard

OSB

MDF/HDF



Chemical wood pulp

Recovered fiber pulp

Recovered paper

Newsprint


Packaging materials

Wrapping paper

4.7%

11.2%

0.9%

7.5%0.1%

7.1%

3.6%

2.5%

1.5%

3.2%

9.1%

5.9%

8.7%

4.3%

8.7%

9.9%

1.6%0.1%

2.5%

3.1%

4.3%


Survey findings We conducted a survey among forest sector companies to look at their expectations for the future of sector industries. After that, we ranked the industries based on their production growth expectations (see Table 1 below). According to our findings, the following forest industries have the biggest growth potential:

• Packaging paperboard

• Household and sanitary paper

• Corrugated board

• Plywood

• OSB

• Wood pellets

• Particleboard

• MDF / HDF

• Chemical pulp

Below is an overview of current trends across forest industries and their prospects.

Packaging paperboard, corrugated board, household and sanitary paper, plywood, OSB and wood pellets topped the 2019 ranking. Overall, the 2019 survey findings correlate with historical data on sector growth (see the previous two pages).

Chemical pulp, wood pellets and sawnwood ranked lower in terms of future growth compared with the 2018 survey (the lower expectations for the future growth of the chemical pulp industry were due to a drop in world prices in 2019 and subdued demand for unbleached pulp dominating in Russia).

Respondents’ outlook on the output of the Russian forest sector in the next three or five years, 2019 survey

Actual and forecast production growth across forest industries

Change, 2018/2019

Decline ~ 0%/ p.a.

Growth

>3%/p.a. 1-3%/p.a. 1-3%/p.a. >3%/p.a.

Packaging paperboard


Corrugated board n/a

Plywood

OSB

Wood pellets

Particleboard

MDF / HDF

Bleached pulp

Unbleached pulp

Wrapping paper n/a

Sawnwood

Wood chips n/a

Charcoal n/a

Roundwood

Printing and writing paper

Newsprint

Product

World Russia

CAGR in 2013–18

CAGR in 2013–18

CAGR in 3–5 years, 2018 respondents’ expectations

CAGR in 3–5 years, 2019 respondents’ expectations

Growth rate2,

2017/2018

Packaging paperboard 2.3% 3.8% 1-3% >3% 2.3%


2.8% 11.7% >1% >3% 15.8%

Plywood 3.8% 4.0% 0% >1% 7.6%

Wood pellets 10.8% 21.4% >3% >1% 7.1%

Sawnwood 3.0% 5.0% >3% 1-3% 5.2%

Chemical pulp 1.7% 4.9% >3% 0-3% 1.6%

Source: EY and ASPPI Survey


2019 leaders 2018 leaders

2 Data from FAOSTAT may differ from Russian official statistics due to different calculation methods used to determine some indicators


Actual and forecast output of Russia’s fast-growing forest industries3

To achieve targets set under the Russian Forest Sector Strategy, most industries should demonstrate annual growth higher than 3%, while the production of wood pellets, OSB, MDF and HDF should grow by 6% to 7% a year.

* CAGR in 2012-18 ** EY estimates based on a strategic scenario

CAGR in 2008-18 5.5% 11.7% 4.5% 88.7% 14.7% 3.9% 10.4% 2.4%

CAGR in 2018-30 n/a n/a 2.7% 7.2% 6.8% 1.0% 5.9% 3.6%

2008

2018

2030

Source: FAOSTAT, Russia’s Forest Sector Strategy to 2030

Packaging paperboard,

thousand tons

Household and sanitary paper,

million tons

Plywood, million m3

OSB, million m3

Wood pellets, million tons

Particleboard, million m3

MDF/HDF, million m3

Chemical pulp, million m3

3.1

n/a

5.2

0.0

3.1

1.4 1.2

6.2

3.1

n/a0.6

4.0

5.5

2.6

4.0

1.8

8.4

9.5

5.8

14.0

9.1

0.20.8

7.2



Outlook for exports

Russia has seen steady growth in USD-denominated exports of forest products since 2015, with exports soaring by 20% in 2017-18. However, exports dropped by 6% year-on-year to US$6.2 billion in the first half of 2019. The drop was largely due to lower prices putting the brakes on production growth as the chemical pulp and plywood industries demonstrated a significantly worse performance. However, exports, especially processed timber and newsprint, have been on a steady increase in physical terms.

According to the Russian Export Center,

forest sector exports are projected to increase most to China, CIS countries (Kazakhstan, Azerbaijan, Uzbekistan and Belarus), Germany, Italy, Saudi Arabia and India. The map to the right4 shows top destinations for the Russian forest sector’s fastest-growing exports in the near term. The woodworking industry ranks first with forecast exports of up to US$4.5 billion, followed by the paper industry with US$1.1 billion to USD$3.6 billion and the chemical pulp industry with US$0.6 billion to US$1.7 billion, which can be largely attributed to strong demand from China. The map is followed by a ranking of countries based on their share in Russia’s fastest-growing exports.

10,5179,308

11,149

13,395

11,287

9,522

Russia’s forest product exports* in 2013-18, USD million

4 The map is based on an expert analysis of trends in international trade, commodity markets and country markets

2013 2014 2015 2016 2017 2018

Source: Russia’s Federal Customs Service

* Including commercial roundwood.


CountryTotal potential export growth,

USD million

Potential export growth by industry, USD million

Processed timber Chemical pulp Paper

China 1,050-1,900 450-600 450-850 150-450

Kazakhstan 305-920 150-450 5-20 150-450

Germany 225-620 150-450 5-20 70-150

Azerbaijan 220-605 150-450 0-5 70-150

Uzbekistan 175-540 150-450 5-20 20-70

Belarus 170-525 20-70 0-5 150-450

Italy 145-320 70-150 5-20 70-150

Saudi Arabia 90-225 70-150 0-5 20-70

India 60-210 20-70 20-70 20-70

South Korea 80-190 70-150 5-20 5-20

Spain 45-160 20-70 5-20 20-70

Poland 45-160 20-70 5-20 20-70

France 45-160 20-70 5-20 20-70

Iran 45-160 20-70 5-20 20-70

Turkey 45-160 5-20 20-70 20-70

Indonesia 45-160 5-20 20-70 20-70

Armenia 40-145 20-70 0-5 20-70

Moldova 40-145 20-70 0-5 20-70

UAE 40-145 20-70 0-5 20-70

Morocco 40-145 20-70 0-5 20-70

Israel 30-110 20-70 5-20 5-20

Map of top destinations for the Russian forest sector’s fastest-growing exports in the next two or three years

Source: Russian Export Center, online news platform Exporter’s Navigator


Fast-growing forest industries

Wood pulp production in Russia and globally in 2018

We performed our analysis of fast-growing forest industries primarily based on data from FAOSTAT5 and Russia’s Federal Customs Service.

Chemical pulpGlobal demand for chemical pulp rose at a CAGR of 1.8% from 2013 to 2017. Uruguay reported the highest increase in chemical pulp production, 15.5%, followed by Belarus with 14.6%, Bulgaria with 11.4%, Brazil with 7.0% and Indonesia with 5.4%. Russia’s CAGR was 3.5%.

Packaging consumption is a key driver of the pulp and paper industry globally. In Russia, its drivers include the production of newsprint for domestic consumption and exports, which continue to grow despite industry players’ expectations and rapid digitalization worldwide, as well as demand from the packaging and household and sanitary paper industries.

Russia is among the top ten pulp producers globally. Pulp production in Russia is dominated by unbleached pulp, which is in lower demand in the global market compared with other more

Exports, USD’000

Share of global

exports

Canada 7,049,138 17%

Brazil 6,453,808 16%

US 5,929,219 14%

Finland 3,099,108 8%

Sweden 2,747,445 7%

…

Russia 1,555,545 4%

Source: FAOSTAT

Top five exporters of chemical pulp in 2018

Imports, USD’000

Share of global

exports

China 15,817,584 36%

Germany 3,583,018 8%

US 3,542,838 8%

Italy 2,054,833 5%

France 1,517,257 3%

…

Russia 124,608 0.3%

Source: FAOSTAT

Top five importers of chemical pulp in 2018

value-added products. According to Russia’s Federal State Statistics Service Rosstat, the country’s chemical pulp production totaled 8.6 million tons in 2018, remaining at approximately the same level as a year earlier.

Russia’s exports of chemical pulp also remained approximately at the 2017 level, 2.1 million tons, but they jumped by 36%, or US$400 million, in monetary terms on the back of higher prices. Exports in physical terms increased slightly in 2019. Large-scale upgrade programs are needed to enable any substantial increase in exports and meet targets under the Russian Forest Sector Strategy.

However, the construction of pulp mills requires significant investments. The most recent wave of investments in the industry began in 2008-9 and was stable since 2014. Capital expenditures soared by 68.5% to RUB 52.9 billion in 2018. Projects are underway to


Source: FAOSTAT

Source: FAOSTAT

World Russia

Bleached sulphite pulp

Unbleached sulphite pulp

Bleached sulphate pulp

Unbleached sulphate pulp

Chemical pulp


Dissolving pulp


upgrade facilities in the pulp industry, and more pulp mill projects are being considered, including in Krasnoyarsk Krai, Irkutsk Region, Vologda Region and Khabarovsk Krai. In 2019, a number of large companies, including the Ilim Group, the Segezha Group, the Mondi Syktyvkar Pulp Mill and the Arkhangelsk Pulp Mill, continued activities under their Priority Investment Projects. However, the sector needs far more investment to deliver the Strategy, including finance for the construction of facilities from scratch.

78% 68%

0%

4%

7%

13%25%

4%

World Russia

0% 0%

56%

19%

20%

45%

1% 4%


Russia’s production, imports and exports of chemical pulp in 2008-18

Source: FAOSTAT, Russia’s Federal Statistics Service, Russia’s Federal Customs Service

Note: Data on the production and exports of mechanical and semi-chemical wood pulp comes from Rosstat and the Russian Federal Customs Service, since FAOSTAT uses only estimates.

China

US$1,030 million 69% of total exports, 33% year-on-year increase

The US

US$62.6 million 50% of total imports

Russia’s exports and imports of chemical pulp in 2018

Source: Russia’s Federal Customs Service, Russian Export Center

Japan

US$55 million 4% of total exports, 15% year-on-year increase

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

7,179

2,035

65

1,715

43

1,870

61

2,035

94

2,258

120

1,976

141

2,061

157

2,227

147

2,300 2,259 2,266

151 147

Output, thousand tons Exports, thousand tons Imports, thousand tons

6,750

7,510 7,661 7,6587,211

7,5377,875

8,2088,587 8,5789,000

8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000

0147

South Korea


Poland


Germany


Sweden


Finland



Packaging materialsIncreasing packaging consumption is a key driver of the pulp and paper industry globally. Greater demand for packaging paper and paperboard can be attributed to the rise of e-commerce and stronger demand for packaging based on biodegradable materials.

Global demand for packaging materials rose by a 1.9% CAGR in 2013-18. Belarus reported the highest growth, 10.7%, followed by Uzbekistan with 9.2%, Argentina with 8.9%, Slovakia with 8.6% and Costa Rica with 6.1%. In Russia, production grew by a 4.0% CAGR in 2013 through 2018.

Demand for packaging materials in Russia is mainly driven by the food industry. Import substitution efforts also play a crucial role. The production of packaging materials in Russia, although not increasing in physical terms in some segments, increased overall by 12.5%, with the production of kraft paper, and paper for corrugated board and wrapping paper, rising by 29.3% and 9.0%, respectively. Exports increased considerably, driven by exports of kraft paper/paperboard and testliner/fluting that rose by 9.5% and 5.9% in physical terms, respectively, and by around 30% in monetary terms.

A big number of capacity upgrade and expansion projects were started in Russia in 2018 and 2019:

• The Kama Pulp and Paper Mill announced its intention in 2018 to build a coated board line (planned investments: up to RUB 10 billion)

• A board machine upgrade6 at the Arkhangelsk Pulp and Paper Mill to increase container board production capacity by 20% (planned investments: RUB 6.8 billion)

• The construction of the Europack LLC plant (Arkhbum LLC) to make corrugated board and corrugated board containers (board of three and five layers and four-flap boxes)

• The construction of a plant with annual capacity of 600,000 tons of paperboard and other packaging materials in Ust-Ilimsk and kraftliner capacity additions in Bratsk to bring annual capacity to 100,000 tons

• An upgrade of the Segezha Pulp and Paper Mill to increase annual bag paper capacity from 320,000 to 400,000 tons

• A board machine upgrade at the Aleksin Paper and Board Mill to increase annual capacity to 118,000 tons of flat-layer board and paper for corrugated board (planned investments: RUB 2.3 billion).

• The launch of Board Machine 1 with annual capacity of 60,000 tons under the Perm Pulp and Paper Mill’s Strength of Board Project at Mayak JSC

• Capacity additions at the Pavlovo Posad Corrugated Board Plant

• Capacity additions at Yaroslavky Karton LLC

• A board machine upgrade at the Naberezhnye Chelny Paper and Board Mill

Packaging prices have been on a steady rise in Russia and elsewhere in the world in the last couple of years, driven by

Exports, USD’000

Share of global

exports

US 8,137,169 15%

Germany 6,844,621 13%

Sweden 5,382,360 10%

Finland 4,062,188 8%

China 3,853,758 7%

….

Russia 1,126,540 2%

Source: FAOSTAT

Top five exporters of packaging materials in 2018

Exports, USD’000

Share of global

exports

Germany 4,910,571 10%

US 3,576,104 7%

China 3,121,092 6%

Italy 2,369,145 5%

Mexico 2,281,912 4%

….

Russia 957,350 2%

Source: FAOSTAT

Top five importers of packaging materials in 2018

higher chemical pulp prices that have tightened competition in the market. No new big players have emerged in the market. However, existing companies are focused on expanding production capacity and their geographical footprint. Many experts expect increased market consolidation in the near future.

Russia’s production, imports and exports of packaging materials in 2008-18

Source: FAOSTAT

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

3,628

925

730

916 777 800

745

971

798

1,083

870

1,103

814

1,265

771

1,268 1,344 1,452

764 833

3,425

2,622

4,3454,665 4,846 4,867

5,154

5,679 5,7925,896

6,000

5,000

4,000

3,000

2,000

1,000

0748

483704

6 A similar project was implemented at the Aleksin Paper and Board Mill in 2017 and 2018 to launch new board products



Russian exports and imports of kraft paper and paperboard in 2018

Russian exports and imports of corrugated paper and board in 2018

Russian exports and imports of paper and paperboard containers and packaging in 2018

China

US$132.3 million 18.3% of total exports, 73.6% year-on-year increase

Kazakhstan


Kazakhstan


Italy

US$63,9 million 8.8% of total exports, 9.1% year-on-year increase

Estonia


Belarus


Germany


Belarus

US$23 million 80.4% of total exports, 1.0% year-on-year increase

Ukraine


Sweden

US$15 million 34.3% of total imports

Italy


Germany

US$55.4 million 19.8% of total imports

Finland


Lithuania


China

US$56 million 20.1% of total imports





Source: BFC Marketing Source: BFC Marketing

Forecast production of container board in Russia in 2019-23, thousand tons

Forecast production of corrugated board in Russia, million square meters

32

5,600

1,039180

5,800

1,061

644

6,200

1,107

1,406

2017 2018 2019 2020-23 2018 2019 2020 2021 2022 2023

Production of corrugated packaging Production of corrugated board

6,000

1,086

6,400

1,127

6,600

1,148


Household and sanitary paperThe household and sanitary paper market has been steadily growing in recent years. Contributing factors are its low sensitivity to economic shocks and volatility. Demand for household and sanitary paper increased by a 2.7% CAGR in 2013-18, with the biggest growth, 33.8%, observed in Indonesia, followed by Myanmar with 30.4%, Madagascar with 30.0%, Belarus with 25.1% and Norway with 23.6%. Household and sanitary paper production in Russia rose by 11.7% in the period.

Per capita consumption of household and sanitary paper in Russia totaled 3.8 kilograms in 2018, with Russia lagging behind not only developed markets such as the US and Western Europe with annual per capita consumption exceeding 15 kilograms, but also emerging economies such as China. Per capita consumption of household and sanitary paper in Russia is expected to grow and reach an average European level.

Per capita consumption of household and sanitary paper in 2008-18, kilograms

Russia China USPoland

Source: FAOSTAT, Oxford Economics, EY analysis

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

22.0

4.2

8.4

1.5

21.8

4.4

9.4

1.4

21.8

4.7

9.5

1.6

21.8

5.5

9.8

2.3

21.4

5.8

10.4

2.5

22.1

5.8

11.1

2.5

21.6

6.0

11.9

3.1

21.7

6.4

13.0

3.0

22.0

6.6

15.6

3.2

21.9

6.9

15.8

3.2

21.8

6.9

15.4

3.8

There were only four big players in the Russian market of household and sanitary paper in the early 2000s. Currently, 60% of the market is held by the top five industry players, while one more big player is expected to emerge in the next three years7. Strong demand for household and sanitary paper has increased competition, with small companies starting to enter the market. Imports have been virtually driven out of the Russian market by domestic producers. Russia imported 6,700 tons of household and sanitary paper in 2018 while producing 580,000 tons8.

Low consumption of household and sanitary paper in Russia creates the potential for local producers to ramp up production. The price, quality and variety are becoming increasingly important to consumers as the consumption of household and sanitary paper is growing. Smaller players can find it difficult in the longer run to retain customers and their market shares, which can provide impetus to market consolidation.

Exports, USD’000

Share of global

exports

Germany 1,549,510 30%

Indonesia 528,745 10%

Turkey 362,646 7%

Italy 360,797 7%

China 301,864 6%

….

Russia 36,182 1%

Source: FAOSTAT

Top five exporters of household and sanitary paper in 2018

Imports, USD’000

Share of global

imports

Germany 1,128,729 23%

US 534,574 11%

UK 419,465 8%

Australia and New Zealand 196,936 4%

Italy 160,758 3%

….

Russia 10,949 0,2%

Source: FAOSTAT

Top five importers of household and sanitary paper in 2018


Household and sanitary paper and other materials (EAEU Classifier Code 4803)

Toilet paper (EAEU Classifier Code 481810)

Other household and sanitary products (EAEU Classifier Code 481890)

Handkerchiefs, facial tissues and towels (EAEU Classifier Code 481820)

Tablecloths and napkins (EAEU Classifier Code 481830)

Clothes and accessories (EAEU Classifier Code 481850)

Russia's exports of household and sanitary paper in 2018

34%

32%

17%

13%

3% 1%

US$108 million

7 The construction by the Arkhbum Tissue Group, affiliated with the Arkhangelsk Pulp and Paper Mill, of a plant in Kaluga Region; the start of a new paper machine is scheduled for 2020



Switzerland


Source: Euromonitor International

70,05171,516

73,27575,180

77,377

79,867

2018 2019 2020 2021 2022 2023

CAGR = 2.7%

Forecast retail trade in household and sanitary products in Russia, RUB million

Russia’s production, imports and exports of household and sanitary paper in 2008-18

Source: FAOSTAT

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

600

500

400

300

200

100

0

191

2

20

3

19

185

4

24

213

2

28

310

4

28

330

7

30

333

6

31

420

14

6

445

32

5

491

51

6

501

38

7

580

China


China


Finland


Russian exports and imports of household and sanitary paper and other materials in 2018 (EAEU Classifier Code 4803)

Russian exports and imports of toilet paper, tissues and handkerchiefs in 2018 (EAEU Classifier Code 4818)

Germany


Germany


Poland


Belarus


Belarus


Kazakhstan


Kazakhstan





PlywoodOwing to its geographical location and an abundance of birch veneer, Russia is the leading producer and exporter of birch plywood globally, ranking among the top three exporters of plywood. Birch plywood has unique properties and is highly valued compared with other types of plywood.

Plywood is used for building construction and furniture manufacturing. Global demand for plywood totaled 160 million cubic meters in 2018, with its global exports rising by 6.7% year-on-year in monetary terms. Russia’s exports of plywood rose by 8.6% in physical terms as Russia accounted for 9% of global plywood exports, supplying more than 60% of domestic output abroad. CIS, European and East Asian markets are top destinations for Russian plywood exporters. The weakening of the Russian ruble in the last couple of years has driven Russian plywood exports, with the industry seeing increased investment inflows and the emergence of new players.

There has been a shortage of plywood feedstock in Russia due to timber and veneer exports to China. This shortage has prompted big plywood producers to start their own logging operations to reduce dependence on external suppliers. As part of measures to support the woodworking industry, Russia introduced quotas on exports of plywood feedstock for the period from 1 January 2019 through 30 June 2019.

Experts expect steady growth in demand for plywood, citing ongoing tensions in US-China trade relations that can drive exports to the US. Russian industry is prepared to ramp up production, with the completion of four major investment projects in 2018, including Sveza Novator, CFMK, Novatorksoye Woodworking Plant and Belozerskles. In 2019, UPM Chudovo started to sell plywood made at its newly commissioned line. The Sveza Group is planning to implement projects in Vologda Region and Tyumen Region, while the Segezha Group is planning to complete a project in Kostroma Region.

Exports, USD’000

Share of global

exports

China 5,446,924 34%

Indonesia 1,694,381 11%

Russia 1,353,029 9%

Malaysia 1,217,856 8%

Finland 660,397 4%

Source: FAOSTAT

Top five exporters of plywood in 2018

Imports, USD’000

Share of global

imports

US 2,907,002 19%

Japan 1,507,011 10%

Germany 979,469 6%

South Korea 888,765 6%

UK 763,951 5%

….

Russia 41,857 0,3%

Source: FAOSTAT

Top five importers of plywood in 2018

Russia’s production, imports and exports of plywood in 2008-18

Source: FAOSTAT

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

4,500

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

0

2,592

1,326

115

1,334

53

2,107

1,512

35

2,689

1,600

43

3,040

1,717

252

3,150

1,758

244

3,303

1,969

222

3,540

2,206

75

3,607

2,458

58

3,759

2,483

67

3,729

2,696

74

4,013



OSBOriented strand board (OSB) is used as a substitute for plywood but it is cheaper while being similar in durability. North America and Europe are the major OSB consuming regions.

The global consumption of OSB increased at a 5.7% CAGR from 24 million cubic meters in 2013 to 31 million cubic meters in 2018. The greatest growth, 35.8%, was observed in Georgia. Trailing behind were China with 34.7%, Finland with 34.1%, Belarus with 29.3% and Iceland with 28.5%. Experts expect global OSB production to grow by 6.2% annually, with the greatest increase, 6% to 7%, to come from the construction and furniture industry. The production of OSB-based packaging is to grow steadily, at no more than 5% a year.

OSB production in Russia jumped by an impressive 68%9 in 2013-18, resulting in a considerable decline in imports in the last couple of years. OSB production is highly dependent on activity in the construction and furniture industries, as well as new demand for it from

industries such as building repairs in Russia. Wooden housing construction is also a potential driver of demand for OSB. Currently, measures are taken at a government level in Russia to stimulate investors and developers to use wood-based boards in housing and industrial building construction.

Russia’s OSB production capacity is expected to increase in 2019 following the launch of new large OSB plants, Kronospan and Talion Arbor, pushing

down imports further. There are a dozen projects in the OSB industry’s pipeline to build new plants in 2019-21. Planned capacity additions will enable Russian producers to fully satisfy domestic demand.

Experts note similar trends in OSB consumption in Russia and abroad, warning that it may never return to its peak level observed in 2011-18. Growth will continue at a moderate pace, but it is unlikely to accelerate.

Exports, USD’000

Share of global

exports

Canada 1,738,002 54%

Romania 217,449 7%

Germany 161,027 5%

Latvia 144,778 5%

Belarus 137,104 4%

….

Russia 67,205 2%

Source: FAOSTAT

Top five exporters of OSB in 2018

Imports, USD’000

Share of global

imports

US 1,630,201 51%

Germany 260,418 8%

Russia 89,033 3%

Japan 84,864 3%

UK 80,557 2%

Source: FAOSTAT

Top five importers of OSB in 2018

Finland


The US


Russia’s exports and imports of plywood in 2018


China


Latvia


Poland


The Netherlands


Belarus


Egypt


Germany





Kyrgyzstan


Furniture Construction Packaging

Source: Mordor Intelligence

6,618 7,025

14,015

11,3949,783

19,634

14,41113,187

10,934

2018 2019 2020

Forecast global OSB production, million square meters

ParticleboardGlobal particleboard consumption grew by a 2.9% CAGR to 96 million cubic meters in 2013-18. China and Europe are the biggest consumers of particleboard, accounting for a third and 44% of total global consumption, respectively.

Demand from the construction and furniture industries is a key driver of particleboard production, as is the case with OSB. However, Russia’s particleboard market has long been saturated, unlike

the OSB market. Particleboard is the most popular board in the furniture industry.

Particleboard production in Russia increased by 13% to 8.4 million cubic meters10 in 2018, which can partly be attributed to the completion of the Swiss Krono Priority Investment Project to start a new particleboard line, and production increases at the Kronospan and Tomlesdrev plants. As more capacity additions should be expected in the next couple of years, annual growth in particleboard production can exceed 1.68 million cubic meters following the

completion of all projects in the current pipeline.

Russia was among the world’s top five exporters of particleboard in 2018. Particleboard exports, excluding OSB, rose by 4.4% year-on-year to 21% of total output in 2018. CIS countries are major destinations for Russia’s particleboard exports. The depreciation of the Russian ruble in 2014-15 led to rapid growth in exports. In 2017-18, Russia started to supply particleboard to China, Chile and Columbia.

Russia’s production, imports and exports of OSB in 2008-18

Source: FAOSTAT

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

1,400

1,200

1,000

800

600

400

200

0

297

20

298

643730 9

710

10115

360

40

618

68

367

797

114

393

1,013

257

388

197

390

571 547

372

1,356

Kazakhstan

US$20.5 million 30.4% of total exports, 65,3% year-on-year increase

Romania


Russia’s exports and imports of OSB in 2018


China


Ukraine


Latvia


Chile

US$5.1 million 7.7% of total exports

Poland


Belarus


Finland





Exports, USD’000

Share of global

exports

Austria 757,452 13%

Germany 594,900 10%

France 402,400 7%

Thailand 387,569 7%

Russia 306,535 5%

Source: FAOSTAT

Top five exporters of particleboard in 2018

Imports, USD’000

Share of global

imports

Germany 610,137 11%

Poland 398,404 7%

US 310,040 5%

UK 267,945 5%

China 256,699 5%

….

Russia 62,299 1%

Source: FAOSTAT

Top five importers of particleboard in 2018


Kazakhstan

Uzbekistan

Azerbaijan

Belarus

Tajikistan

Kyrgyzstan

Lithuania

Poland

Ukraine

Armenia

Other countries

Russia’s particleboard exports in 2018

5%

6%

7%

8%24%

28%

7%2%

3%

4%

5%

US$307 million

Russia’s production, imports and exports of particleboard in 2008-18

Source: FAOSTAT

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

9,000

8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000

0

5,751

411

472

575

248

4,562

562

231

5,429

377

229

6,634

764

324

6,723

784

430

6,555

1,016

6,183

1,257

253

6,591

1,544

233

6,573

1,703

254

7,460

1,778

275

8,400

423

Tight competition from other board segments forces particleboard producers to introduce product improvements on a regular basis. For instance, many are focused on lowering board density without a radical reduction in strength properties. A new technology to make composite panels of particleboard, MDF and HDG has recently come into widespread usage. This technology gives durable board that is able to compete with OSB.

MDF/HDFGlobal demand for MDF/HDF rose at a CAGR of 2.4% from 2013 to 2017. Hungary saw the greatest growth, 56.0%, followed by Iceland with 29.8%, Ghana with 25.3%, Georgia with 20.8% and Canada with 18.2%. MDF and HDF are made of wood fiber using the dry process. MDF and HDF are both highly durable but highly priced. Demand for MDF/HDF in Russia mostly comes from laminated flooring and door producers. Unlike other countries, Russia is not seeing the replacement of particleboard with MDF/HDF in the market, and MDF/HDF and laminated flooring based on MDF/HDF are mostly exported.

Russia’s MDF/HDF imports have dropped to the minimum since 2014 following capacity additions in the domestic industry. However, their imports picked up by 2.4% in physical terms in 2018.

Russia’s MDF/HDF exports rose by 18% year-on-year to 1.1 million cubic meters, or 34% of total output, in 2018. CIS countries, including Uzbekistan, Kazakhstan and Belarus, are the top consuming countries of Russian-made MDF/HDF, with MDF supplied partly to China and marginally to the European market. The weakening of the Russian ruble has made Russian exporters more competitive in international markets.

Imports, USD’000

Share of global

imports

US 998,538 14%

Iran 344,843 5%

UK 335,156 5%

Canada 307,117 4%

Germany 267,173 4%

….

Russia 137,754 2%

Source: FAOSTAT

Top five importers of MDF/HDF in 2018



Exports, USD’000

Share of global

exports

China 1,017,581 14%

Germany 852,633 12%

Belgium 602,475 9%

Thailand 454,513 6%

Austria 316,758 5%

….

Russia 308,718 4%

Source: FAOSTAT

Top five exporters of MDF/HDF in 2018 Forecast global MDF/HDF production, million cubic meters

Source: Mordor Intelligence

6 6 8 5 5 6

20 21 25

63 6481

4 4 5

CAGR = 4.2%

CAGR = 3.3%

CAGR = 3.5%

CAGR = 1.6%

CAGR = 3.3%

20192018 2024

Russia’s production, imports and exports of MDF/HDF in 2008-18

Source: FAOSTAT

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

3,500

3,000

2,500

2,000

1,500

1,000

500

0

1,171

193

171

177

193

1,003

100

344

1,078

75

548

1,197

184

702

1,316

246

689

1,110

255

1,885

336435

2,230

618292

2,595

903

297

2,970

1,066

304

3,147

628

Russia’s MDF/HFD production is now on the rise. Projects launched before the 2014 crisis, including Kastamonu and Egger, have made a significant contribution to its growth. In 2019, Altailes started a new MDF/HDF plant. There are plans to commission more plants in Russia in 2020-21, including the MDF Asino Plant (a subsidiary of Roskitinvest CJSC), the Igoresvkaya Woodworking Plant (part of the Russky Laminat group) and Kronospan’s plants near Kaluga and in Primorye. Thus, Russia’s MDF/HDF production is expected to increase further, to up to 1.15 million cubic meters a year, in the mid run.

Uzbekistan


Romania


Russian exports and imports of MDF/HDF in 2018


Belgium


Belarus

US$23.2 million 7.5% of total exports, 6.7% year-on-year increas

Germany


Poland


China


Azerbaijan


Kazakhstan



North America South AmericaEuropeAsia-Pacific Middle East and Africa



Wood pelletsThe production of wood pellets is on the rise. Global consumption grew by a 9.1% CAGR in 2013-18. Government initiatives to stimulate the consumption of environmentally friendly fuels are a key driver of demand for wood pellets. However, the growth of the wood pellet market may slow down amid increasing competition from other alternative energy sources.

The annual production of wood pellets in Russia has grown by more than 7% since 2015, seeing a record growth rate of 21% in 2017. However, growth slowed down to 7.1%11 in 2017. The contributing factors were low utilization rates of newly commissioned plants and a shortage of feedstock as wood residues were mostly used to produce particleboard and fiberboard.

Russia exports almost all of its output of wood pellets. Denmark, Italy, Sweden and other EU countries were top destinations for Russian-made wood pellets in 2018. Experts also expect increased demand for Russian wood pellets from Asian countries that have not yet introduced tight certification requirements.

Exports, USD’000

Share of global

exports

US 809,855 22%

Canada 377,759 10%

Vietnam 354,000 10%

Latvia 255,140 7%

Austria 199,009 5%

….

Russia 186,166 5%

Source: FAOSTAT

Top five exporters of wood pellets in 2018

Imports, USD’000

Share of global

imports

UK 1,317,163 34%

Denmark 605,297 15%

South Korea 521,771 13%

Italy 474,179 12%

Belgium 179,638 5%

….

Russia 1,834 0,05%

Source: FAOSTAT

Top five importers of wood pellets in 2018

The fuel pellet market in Russia is yet at its nascent stage as companies are not rushing to shift from coal to wood-based biofuels. There are no government incentives to stimulate the consumption of renewable energy. Currently, Russia does not have any large consumers that could offer wood pellet producers a price comparable to their export prices to support their profit margins, adjusted for transportation costs.

Despite slowing production growth, the Russian wood pellets market is attractive to investors. There are big and smaller players in the Russian market, with many domestic producers certifying their

products for compliance with European standards, although this is not always possible for smaller companies.

Russia’s production capacity for wood pellets continued to increase in 2018-19. The Segezha Group started a wood pellet plant in Krasnoyarsk Krai in late 2018. Two more new plants, Kharovsklesprom in Vologda Region and Solnechny Krug in Khabarovsk Krai, were commissioned in early 2019. The wood pellet industry has more than 10 projects in the pipeline, including two large-scale projects that ULK LLC plans to implement in Ustyany and the Pinega district.

Russia’s production, imports and exports of wood pellets in 2008-18

Forecast global demand for wood pellets, thousand tons

Source: FAOSTAT

Source: FutureMetrics

2012 2013 2014 2015 2016 2017 2018

2,000

1,500

1,000

500

0

729

791

22,556

27,31329,825

33,03237,361

41,263

47,03551,205

744

1.47

684879

913

935

974

1,073

2.80

1,2901,439

4.89

1,680 1,800

1,511

2.09 1.11 1.34 2.18


Denmark

Italy

Sweden

UK

Netherlands

South Korea

Latvia

Lithuania

Finland

France

Other countries

UK

Japan

US

South Korea

Denmark

Belgium

Other

Russia’s exports of wood pellets in 2018

5%

5%

6%

9%11%

44%

6%2%

4%

4%

4%

US$186 million

2018 2019 2020 2021 2022 2023 2024 2025

40%

9%13%12%14%12%

14%16%

12%10%15%

13% 15%

17%

9%11%

17%

17%

9%8%

17%

5%

15% 16%

8%

18%

8%8%

16%

14%

7%7%

17%

14%

17% 18%

18%

16%

6%7%

15%

13%11%13%11%

38% 35% 32% 28% 25% 22% 21%




Investment attractiveness of the forest sector

Forest sector multiples globallyThe forest M&A market did not see any fundamental shifts in 2018. According to Capital IQ, 313 M&A deals were announced or completed in the forest sector in 2018, one deal more than a year earlier. M&A activity in the forest sector slightly increased in 2017-18 compared with 2016. The top forest M&A deal in 2018-19 was a merger of two Brazilian pulp and paper giants Suzano Papel e Celulose S.A. and Fibria Cellulose S.A., announced in March 2018 and closed in January 2019. The deal exceeded US$14 billion, resulting in the creation of the world’s biggest pulp producer holding around 17% of the global market. Other top deals in 2017-18, worth US$2 billion to US$7 billion, were struck in the US, China and Brazil.

M&A activity in the forest sector is concentrated in the paper, pulp and packaging industries, which are

demonstrating robust growth. The largest 2017-18 deals in value terms were also concluded in these industries.

M&A deal multiples12 in the global forest sector

Multiples13 by industry and M&A deals in the global forest sector since 2014

12 Median, excluding discounts and premiums. Extreme multiples (EV/EBITDA > 50 or EV/Revenue > 20) were not used13 Median, excluding discounts and premiums. Extreme multiples (EV/EBITDA > 50 or EV/Revenue > 20) were not used

Source: Capital IQ

Source: Capital IQ

12.2 x

8.8 x

5.7 x

0.9 x

8.3 x

0.8 x

8.6 x

1.4 x

7.7 x

1.6 x1.2 x 1.3 x

2014 2015 2016 2017 2018 2019

EV/EBITDA

EV/EBITDA

EV/Revenue

EV/Revenue

7.5 x

1.0 xTimber industry

7.9 x

1.2 xPulp and paper industry

8.9 x

1.2 xBoard production

9.1 x

1.0 xPackaging industry

8.2 x

1.1 xAll industries


Operational performanceIn 2018, median EBITDA margins of sample international public companies remained at the same level as a year earlier, approximately 13%. The highest EBITDA margin reported totaled 50%, a record high for the last five years. Median profit margins vary from 12% to 15% depending on the industry, with companies in the paper and pulp industry reporting the highest margins.

Russia’s forest sector companies mostly do not disclose their financial statements to the public. As Russia's forest sector companies mostly do not disclose their financial statements to the public, it is difficult to evaluate overall performance in the sector based on financial results disclosed by some players (including the Ilim Group, the Segezha Group and the Kommunar Paper Mill). However, margin increases of 6% to 12% reported by the three companies in 2018 may indicate growth in profits across most Russian companies.

Respondents asked in our most recent survey offered a more conservative outlook for 2019 compared with a year earlier. Only 43% of companies expected EBIDTA margins to increase in 2019, which was 4% less than earlier. As many as twenty-seven percent projected that they would decline. Respondents cited the worsening of the market environment due to higher feedstock prices, lower prices of finished products and increased competition.


2018 2019

0%11%

Decrease by over 5%

0%16%

Decrease by 3-5%

29%32%

Increase by 3-5%

53%32%

Will not change (+/- 3%)

18%11%

Increase by over 5%

Source: Capital IQ, companies’ financial statements

2014 2015 2016 2017 2018

Ilim Kommunar Paper Mill MedianSegezhaMaximum

36%

44% 46%

50%

46%

EBITDA margins of Russian producers and international public companies

How will EBITDA margins change in 2019?

12% 12% 13% 13%13%

37%

21%

45%

37%

19%17%

23%20%

8%

9%

17%

8%

33%


Investment appeal of Russia’s forest sectorM&A activity in Russia has been steadily declining since 2018 due to geopolitical and trade tensions. The forest sector is no exception, with M&A activity remaining subdued. No big deals have been reported in Russia in the last couple of years, while details about deals struck are mostly unavailable.

Target company Buyer Deal date Deal value, USD million Interest acquired

SFT Group14 Prinzhorn Group 19 April 2019 n/a 50%

Solomenskiy Lesozavod PJSC Bravarus Limited 20 March 2019 n/a 100%

Solomenskiy Lesozavod PJSC Nemplast Limited 26 February 2019 n/a 8.4% (an increase to 100%)

Porosozero LLC Solomenskiy Lesozavod PJSC 31 January 2019 n/a 99% (an increase to 100%)

Shujales JSC Solomenskiy Lesozavod PJSC 30 January 2019 n/a 63.1%

Zelenodolsk Plywood Plant OJSC S. Kogogin 29 January 2019 n/a 1.04% (an increase to 100%)

Kommunar Paper Mill JSC Promservice LLC 27 December 2018 3.6 0.8%

Kondopoga OJSC Vera Preiz 18 December 2018 n/a 9.17%

Kommunar Paper Mill JSC n/a 17 December 2018 n/a n/a

Kondopoga OJSC n/a 6 December 2018 n/a 19.97%

Onegales LLC Segezha Group 15 November 2018 n/a n/a

Volga JSC Brentli Investments Limited 18 October 2018 n/a 98.98%

Kondopoga OJSC n/a 3 October 2018 n/a 26.08%

Kondopoga OJSC Maksim Smirnov 3 October 2018 n/a 7.56%

Kama Pulp and Paper Mill (announced deal) OTKRITIE Bank 3 October 2018 n/a n/a

Source: Capital IQ

M&A deals in Russia’s forest sector in Q4 2018 - Q1 2019

14 www.prinzhorn-holding.com

https://www.prinzhorn-holding.com/news-press/detail-view-holding/news/austrian-prinzhorn-group-signed-an-agreement-to-enter-into-a-joint-venture-with-russian-sft-group/?tx_news_pi1%5Bcontroller%5D=News&tx_news_pi1%5Baction%5D=detail&cHash=a4e527871fc8937b1a95fe000b6d8c53


According to respondents, M&A deals in Russia are mostly driven by the diverse structure of the market, which has a big number of small players and only a few big companies. The current economic situation in Russia makes it increasingly difficult for smaller players to compete, while big players are interested in buying small businesses to obtain access to feedstock and expand capacity.

Only 10% of respondents in our survey indicated plans to acquire existing businesses as part of their investing and financing activities. Investment programs in the industry are mostly focused on expanding market footprints. Among their top priorities, respondents cited better productivity, lower costs, capacity additions, entry into new markets and a shift to value-added products.

With respect to financing sources, it is important to note the limited access to capital, as almost none of the respondents indicated plans to raise funds in highly liquid capital markets. Currently, Russian players can count only on earnings reinvestment, with the finance raising potential being limited, or debt, which debt that is quite expensive in Russia. Thus, subsidized interest rates play a crucial role in the competitiveness of investment projects in the forest sector. More than half of respondents, 55%, noted no changes in access to debt in 2018, while 36% said that access had become easier.

71%73%

71%

Productivity enhancement and cost management at existing facilities

24%41%

33%

Debt reduction and financial flexibility

53%

59%67%

Capacity additions at existing facilities

76%36%

38%

Replacement of worn-out equipment

0%14%

0%Disposal of non-core assets/business

59%41%

48%Entry into new markets

0%27%

38%

Autonomous power generation systems

0%5%

5%

Search for investors and partners to build a plywood plant

29%59%

43%

Production shift to value-added products

18%27%

33%

Better access to resources through forest land leases

0%5%5%

Product quality improvement

0%41%

33%

Disposal of low-grade timber and waste from main production processes

12%14%

10%

Acquisition of companies in the forest sector

0%

0%0%

Disposal of core business in the forest sector

What were your investment priorities in the last couple of years and what are they this year?

20182017 2019



How has access to debt changed this year compared with a year earlier?

It has worsened

What sources of financing does your company plan to use this year to expand /support current operations?

How has the investment appeal of the forest sector changed this year?

How will your company’s investments in current operations and capacity expansion change this year from the year before?





6%

9%

50%55%

44%36%

2018

2018

2018

2018

2019

2019

2019

2019

72%77%

Bank financing

78%68%

Equity

6%9%

Private share placement/funds from a strategic investor

22%18%

Shareholder loans

0%0%

Public offering (IPO)/ ICO

28%45%

Equipment leasing

0%5%

Bond issue

11%14%

Proceeds from the sale of assets

0%0%

ICO

It has remained unchanged

Loans have become easier to obtain (more

affordable)

The investment attractiveness of the forest sector, as perceived by respondents, did not change significantly compared with a year earlier. However, there were some improvements, with the number of respondents ranking the sector’s investment appeal higher increasing and the number of respondents noting negative trends dropping.

According to respondents, the key trend that will shape Russia’s forest sector in the next three or five years will be the commissioning of new production capacity, as there are plans to implement a big number of investment projects and close inefficient facilities.

Other possible trends include an increase in transportation costs, advanced wood processing and integration between logging and woodworking companies. M&A activity is low, but companies believe that there is a potential to give it a spur.

0%

11%

72%

0%

73%

5%6%

0% 0%5%

31%

38%

25%29%

25%

14%13%

10%

17%23%

5% 0%

Can’t say Significantly worsened

No significant changes

Significantly improved

Decrease by over 70%

Decrease by 40-70%

Decrease by 10-40%

Will not change (+/- 10%)

Increase by 10-40%

Increase by 40-70%

Increase by over 70%


What were your priorities as part of investing and financing activities?

In your opinion, what areas offer your company the biggest opportunities to cut costs and increase margins?



2018

2018

2019

2019

Capacity additions

Electricity

Spare parts and materials

Third-party transportation services

Diesel fuel or natural gas

Other energy sources

Repairs of fixed assets by external providers

Labor costs, including payroll and social contributions

Other

Self-sustaining wood burning power stations

Withdrawal of inefficient capacity

Deployment of innovative equipment and robots

Expansion of Russian players into new markets

Production shift to more promising segments

Higher transportation costs

Forest infrastructure development and construction of forest roads

Lower credit burden

Advanced wood processing

Production diversification

Integration between logging and woodworking companies

(vertical integration)

Other

Industry digitalization

Introduction of intensive forest management practices

Increase in the collection of waste paper

Cost efficiency

Increased presence of foreign players in the Russian forest sector

Market consolidation (horizontal integration)

Increased production from recovered materials

Innovative wood products

65%77%

65%45%

12%41%

0%41%

47%36%

47%36%

0%36%

29%

50%47%

50%47%

37%0%

0%32%

19%26%

0%26%

19%5%

13%16%

32%

0%27%

0%

0%

0%

0%

23%

18%

29%14%

29%14%

12%14%

0%

0%

0%

0%9%

14%

14%

14%

29%5%

27%

23%

Areas that offer considerable savings opportunities include electricity, spare parts and materials, as well as transportation costs. According to the survey, 41% of companies believe that increasing transportation costs will affect growth, with 37% saying that they have the potential to cut such costs. Transportation costs are higher when wood is procured from remote logging operations, affecting the competitiveness of forest products. Companies in the forest sector have repeatedly highlighted the need to develop adequate infrastructure to satisfy the needs of the sector.


Priority Investment ProjectsThe list of Priority Investment Projects (PIP) included 149 projects in mid-2019. In 2018 and 2019, the Russian Government raised the minimum investment requirement for PIP status, prompting some investors to revise their planned budgets. Investments expected under all PIPs amounted to RUB 709 billion as of 1 July 2019.

Investor Region Project Investment, RUB million Status

Kraslesinvest JSC Krasnoyarsk Krai Boguchany. A timber facility (including a pulp mill) 131,600 In progress

Ilim Group JSC Irkutsk Region Upgrade of production facilities in Irkutsk Region 53,200 In progress

Pomorskaya Sawmilling Company LLC Arkhangelsk Region Full-cycle woodworking production facility 28,346 In progress

Kronoshpan Kaluga LLC Kaluga Region Wood-based panel production facility 22,463 In progress

Ilim Group JSC Irkutsk Region and Krasnoyarsk Krai Forest utilization in Irkutsk Region and Krasnoyarsk Krai 18,700 Completed

Итого 254,309

Source: Russia’s Ministry of Industry and Trade

Top five Priority Investment Projects by value

As many as 73 projects worth a total of RUB 200 billion have been completed. Eighteen projects worth a total of RUB 55 billion were completed in 2018 and the first half of 2019.

As many as 131 investment projects worth more than RUB 958 billion, including PIPs, are expected to be implemented in the forest sector in 2019-23. Most of them, 84, will be implemented in woodworking, accounting for less than 10% of total investment. Despite low margins, investments in sawmilling operations are on the rise, driven by increasing demand from the Chinese market as the industry is highly export-oriented.

More than RUB 500 billion is to be spent on the development of the pulp and paper industry in Russia. Most of this sum will go toward packaging paper and paperboard production projects focusing on the construction and upgrade of facilities. This industry is rapidly developing around the world and Russia is striving not to lag behind. Another driver is stronger global demand for coniferous pulp and products made from such pulp.

The investment appeal of Russia’s wood-based board industry remains high due to an increase in exports and the growth of the domestic market. However, demand varies depending on the type of such boards. Feedstock shortages and high transportation costs hinder investment projects in this industry in Russia.

Completed Priority Investment Projects in forest utilization Investment projects started or planned in 2019-23, including PIPs

12.56

29.60

101.35

43.74

11.57

2015 2016 2017 2018 H1 2019

Investments in completed projects, RUB billion

Number of completed projects

11

2419

14

4


Pulp and paper

Wood-based boards

Woodworking Pellets/ biofuel

Investment, RUB billion Number of projects

518

339

8416

17

66

Source: Lesnaya Industria magazine

33

15


Completed investment projects Region Project Investment, RUB million

Ustyanskaya Timber Processing Company LLC Arkhangelsk Region Low-grade timber processing and pellet production 16,684

Arkhangelsk Pulp and Paper Plant JSC Arkhangelsk Region Paperboard mill upgrade 12,996

Sibles Project LLC Krasnoyarsk Krai Construction and upgrade of advanced timber processing plants 5,752

Rimbunan Khidzhau MDF LLC Khabarovsk Krai MDF/HDF plant 5,533

Uvadrev-Holding LLC Udmurt Republic Advanced particleboard production process 4,244

Novaya Vyatka Ski Plant JSC Kirov Region Plant upgrade 1,802

Belozerskles LLC Vologda Region Value-added woodworking process 1,418

State Agency Vologdaselles Vologda Region Logging, sawmilling and woodworking 998

Lestekhsnab Plyus LLC Kirov Region Timber processing operations 794

Kholbit LLC Vologda Region Logging operations and a woodworking plant upgrade 793

Cherepovtsy Plywood and Furniture Plant JSC Vologda Region Plywood production capacity expansion 696

Sveza Novator Vologda Region Plywood plant upgrade 687

Ufa Plywood and Board Plant Republic of Bashkortostan Upgrade of board lines at the large-size plywood plant 633

LESTECH LLC Sverdlovsk Region High-tech woodworking processes 575

Solomenskiy Lesozavod LLC Republic of Karelia Logging operations and timber processing 541

Vologda Waste-free Technologies LLC Vologda Region Pellet production and value-added woodworking processes 469

StroiLes LLC Kirov Region Logging operations and integrated timber processing: the launch of a plant to build houses from laminated veneer lumber 369

Novatorksoye Woodworking Plant LLC Vologda Region The construction of houses from profiled laminated veneer lumber 324

Total 18 projects 55,306


Completed Priority Investment Projects in 2018 and the first half of 2019


RisksRespondents asked in the EY and ASPPI 2019 Survey cited access to capital/investment liquidity, regulatory uncertainty, the scarcity of forest resources and external volatility among the key risks affecting Russia’s forest sector.

1. Capital access/liquidity risks

Overall, access to credit remains a challenge for Russian companies compared with international financial markets despite some improvements cited by respondents. Loans bear high interest rates, while security requirements are extensive. Russian producers can compete with other players in international markets but they are often beaten out because of high credit costs in Russia. Apart from high interest rates, access is complicated by elaborate lending procedures and difficulties with obtaining long-term loans. As there are a big number of requirements that must be satisfied to qualify for reduced interest rates, soft loans are usually granted only to holding companies.

Forest sector projects have long payback periods, especially capital-intensive projects in the pulp and paper industry. Increases in debt costs after the start of a project may force investors to mothball it. According to respondents, it is extremely difficult to obtain bank finance for a project with a payback period of seven to eight years. It is easier to borrow funds for financing working capital, but high interest rates may strip the company of free cash to expand and upgrade its production facilities. Thus, forest sector companies are left with little choice but to focus on investment projects with quicker returns.

The Russian authorities are taking steps to improve the investment attractiveness of the forest sector. For instance, subsidies are available to partly compensate companies for loan interest. Like other exporters of non-commodity goods, forest sector companies are also entitled to transportation cost subsidies.

Key risks to the investment appeal of Russia’s forest sector


Access to capital/investment liquidity

Regulatory uncertainty

Scarcity of forest resources

External volatility

Feedstock exports and shortages

Environmental standards

Poor protection of ownership rights

Inflation and foreign exchange risks

Lack of skills

Energy costs

Tight competition in Russia

Transportation costs

Increased costs associated with felling fees and forest land leases

Drop in the purchasing power of consumers

Geopolitical risk

Innovation shortage

45%

41%

36%

32%

27%

27%

27%

27%

27%

23%

23%

23%

18%

18%

18%

5%

2. Regulatory uncertainty

Respondents ranked regulatory uncertainty as the second most significant risk for the forest sector. Despite the government’s efforts to protect local businesses, boost value-added exports and improve the overall investment attractiveness of the forest sector, domestic players are concerned about the current legislative framework and its rapid changes that extend beyond the forest sector.

The logging business is dependent on a long period of forest reproduction as forest areas may take 50 to 100 years to recover after logging. At the same time, it takes two to 10 years to build and commission a woodworking plant under an investment project that will start to pay in four to eight years. This means that companies need a stable regulatory environment to run investment projects. However, the legislative framework regulating the forest sector is revised annually. A national forest sector policy is needed, along with amendments to the Forestry Code, to improve regulatory certainty in the longer term and reduce regulatory risk.

3. Forest resource scarcity

Competition for forest resources increased in 2018, pushing up their prices. Upgrades and the commissioning of new plants are the key factors driving domestic demand for forest resources. Russia holds 20% of the world’s forest land and one-quarter of the world’s wood reserves, but, paradoxically, local companies are experiencing shortages of forest resources. Extensive forest exploitation, wildfires and illegal logging pose the biggest threats to forests in Russia. The increasing scarcity of forest resources makes forest sector companies turn to operations in less economically attractive areas that are associated with higher transportation costs resulting in higher prices of finished products.

Inefficient re-forestation practices and unsustainable logging observed in Russia for many years have led to a decline in commercial forest resources. Currently, more commercially valuable conifers are being replaced with broadleaved species, birch and aspen. The authorities are looking for solutions, introducing a temporary ban on veneer exports in 2019 and considering a complete ban on raw


timber exports. However, more efficient measures to mitigate shortages of forest resources could be the promotion of intensive15 forest exploitation practices, robust control to prevent illegal logging and a transparent system to track wood reserves.

4. External volatility

The Russian forest sector is highly oriented toward exports, which contributes to its exposure to the changing external environment. Investors’ risks associated with external volatility can be measured using the beta coefficient that determines the degree of systematic risk as opposed to asset-specific risk and shows how changes in an asset’s returns correlate with changes in the market’s returns. If an asset has a beta of more than 1.0, this indicates that market risk is above average.

15 Intensive forest exploitation practices focus on the planting and sustainable management of forests that are commercially valuable and conveniently located to plants and sales markets

Higher industry risks increase returns required by investors, as evidenced by an analysis of expected and actual returns across economic sectors against beta.

The beta value in the oil & gas and metals sectors ranges from 1.3 to 1.5, according to Aswath Damodaran. These sectors are highly cyclical. The beta value for power and utilities companies stands between 0.6 and 0.8 (Aswath Damodaran's data) as the sectors are more stable and less dependent on economic cycles.

The beta value for companies in the forest sector exceeds 1.0. This means that returns can dramatically decline during economic recession. Investments in the forest sector are risky even in developed economies. However, the degree of market risk can obviously depend on the industry. For instance, the biofuel industry that produces feedstock for electricity is

less sensitive to macroeconomic volatility as opposed to boards that are used in construction.

It is rather difficult to predict how global trends might impact the forest sector, but there are ways of mitigating risks, including changes in the global market environment. For instance, it is possible to account for some trends using various indicators. At the same time, the diversification of investment portfolios remains the most common approach to mitigating risks.


Government support

Respondents participating in the EY and ASPPI 2019 Survey were asked to evaluate how the current regulatory framework and government support programs impact their business in particular and the industry as a whole.

Respondents cited tax benefits and changes in customs regulations among the initiatives that are stimulating forest sector projects most in 2019. At the same time, the percentage of companies applying tax benefits dropped in 2019 despite the recognition of their important role for project activities. This is probably due to the complicated process of applying for tax benefits as well as business concerns about possible disputes with the tax authorities.

Forest sector companies need to study available tax benefits to apply them on a larger scale and rule out any disputes with the tax authorities.

Priority Investment Projects and Special Investment Contracts are the most popular government initiatives among investors. However, a big number of companies use none of the available instruments. Possible reasons may include non-compliance with eligibility criteria, which is unlikely given the abundance of tax benefits and the eligibility scope, as well as low awareness and a poor understanding of how the company can apply available tax benefits. It is feasible to study all available tax benefits and potential reform areas, including the development of a regulatory

Restrictions on exports of roundwood and other raw materials

Tax benefits for projects in the forest sector

Financial support of projects in the forest sector

Financing of construction of forest roads

Increased spending on forestry education and scientific research

Special Investment Contracts, incentives for projects in advanced development zones and other designated

support mechanisms

State procurement contracts for forest products, including incentives for construction projects using innovative

materials based on timber

Import substitution regulations for the forest sector

Financial support for the seed plantation industry

Simplification of lease procedures for forest land

Amendments to customs regulations

Government support mechanisms that may have the greatest impact on the forest sector in the next five to seven years

78%77%

72%77%

61%59%

56%68%

50%41%

33%32%

28%32%

22%27%

22%36%

22%18%

17%18%


20182019


framework for Special Investment Contract 2.0, to determine how they can be best applied to a specific company or project.

According to the survey, tax regulations are not at the top of the agenda of the Russian forest sector. Companies are more worried about the distribution of forest resources and environmental laws.

Government support mechanisms used by the forest sector in 2018-19

Government incentives that forest sector companies currently use or plan to use to reduce their tax burden (as of 2019)

Key regulatory challenges for Russia’s forest sector in 2019

Availability of opportunities to improve tax efficiency in 2019

67%74%

67%42%

20%32%

33%16%

Federal and regional subsidies

Special tax regimes

Support of development institutions

Other



Source: EY and ASPPI Survey Source: EY and ASPPI Survey

20182019

Priority Investment Project Allocation of forest resources

Yes

Special Investment Contract Environmental regulations

No

None, because we cannot obtain access to any

Construction standards and operational principles

We don’t know, we have never thought about it

Advanced development zone Import/export duty

Regional Investment Contract Tax legislation

None, because we do not understand what mechanisms are

efficientOther

37% 55%

62%

37% 55%

19%

32% 36%

19%

26% 36%

11% 14%

11% 5%

Given the recent proposal by the Russian Ministry of Finance to introduce an environmental tax by amending the Tax Code (for details see below), steps are being taken to harmonize environmental regulations with tax laws. An overwhelming majority of respondents surveyed in 2019 said that they had opportunities to improve their tax efficiency.

A shortage of internal resources that are needed to technically address the issue is usually a key barrier.

However, it is feasible to consider such initiatives as they can deliver significant value and give the company leverage in negotiations with the tax authorities.


Taxation

Constantly changing tax laws and practices both in Russia and globally require agility from business to navigate tax risks. As part of our report, we have prepared a summary of the most pressing tax issues for Russia’s forest sector.

Russian tax laws

Reform of non-tax payments

In January 2019, Russia’s Ministry of Finance published for public discussion a draft of amendments to Parts 1 and 2 of the Tax Code introducing the following federal payments:

• Environmental tax

• Recycling fee

• Federal road fee

• Tax on public communication network operators

plus one local tax:

• Hotel fee

The finance ministry proposes replacing charges for negative environmental impact with an environmental tax to be imposed on legal entities and sole entrepreneurs for environmental damage caused by their operations in Russia, including on its continental shelf, in the exclusive economic zone or in the Russian part of the seabed of the Caspian Sea.

This tax will be charged on emissions of air and water pollutants from stationary sources, discharges of pollutants into water sources and the disposal of production and consumption waste. Fixed rates will apply to different types of negative impact, depending on the type of pollutant.

Environmental fees currently paid by companies that produce or import consumer products, including packaging, but do not recycle waste from their use,

and recycling fees paid by producers and importers of vehicles, including trailers and self-propelled vehicles, will be incorporated into a single recycling fee applicable to an extended list of taxpayers and taxable items. Different recycling fee rates will apply to goods and packaging subject to recycling after the loss of their consumer properties, and to trailers and self-propelled vehicles.

Following a discussion on the draft amendments to the Tax Code with the business community, the authors added a provision allowing companies to recycle waste using their own resources, as they are currently allowed to do. Companies that recycle goods and packaging on their own will be eligible for a tax deduction of no more than the product of all sales in the 12-month fee period and the applicable recycling quota in this period.


The entry into force date is still under consideration. The draft law, if adopted in 2019, will enter into force on 1 January 2020.16 Taxpayers failing to pay new taxes fully or partly will be subject to a fine equal to 10% of the unpaid amount from 1 January 2020 through 31 December 2029.

We recommend keeping a close eye on the evolution of the regulatory framework pertaining to charges for negative environmental impact and environmental tax. It is important to note that new articles of Russia’s Administrative Offenses Code applying to producers and importers of goods and packaging took effect on 17 June 2019, including Article 8.5.1 on violations of the procedure for submitting reports and Article 8.41.1 on the failure by producers and importers of goods using external providers of recycling services to pay the required fee in a timely manner. Thus, the failure to pay the environmental fee is currently punished by a fine of RUB 5,000 to RUB 7,000 for officials and a fine equal to triple the amount of the unpaid fee, but no less than RUB 500,000, for legal entities.

Court practice on the classification of movable property as immovable

Pursuant to amendments to the Russian Tax Code made by Federal Law No. 302-FZ of 3 August 2018, movable property ceased to be taxable as of 1 January 2019. Currently, taxpayers face an increased risk of their movable property being reclassified as immovable.

When seeking to prove their case in disputes over the classification of property, the tax authorities cite attributes of immovable property and indivisible items as set out in civil laws such an inseparability of an item from land, the impossibility to move an item without causing disproportionate damage to its designated use17 or the impossibility of dividing an item in kind without destroying or damaging it or modifying its designated use18, and as established through court practice, including attributes such as technological connection.

One of the most illustrative cases considered in the last two years was a case against Timber Mill No. 2519 CJSC that was denied tax benefits for movable property20 and ordered to pay additional tax amounts with respect to this property (a wood pellet line, cross transfers and automated anti-fire system) reclassified by the tax authorities as immovable.

The lower court, based on an expert opinion, took sides with the tax authorities that maintained that the fixed assets in question should be subject to tax as they are not intended to function separately from the primary asset (the shop) and cannot be removed or replaced without prejudice to the building’s designated use. The appeals court upheld the lower court, adding the following:

• The argument that equipment can be dismantled and sold does not negate the lower court’s conclusion.

• The taxpayer’s argument that there is no registered title to the fixed assets is rejected. The absence of registration does not disprove the fact that the assets in question constitute an integrated indivisible item.

• The accounting method used for the fixed asset does not automatically classify this asset as movable or immovable property. A fixed asset recognized in accounting as several inventory items may constitute a single immovable item.

The Federal Arbitration Court of the Northwest District supported the above findings and rejected the taxpayer’s claims.

The case was subsequently heard by the Supreme Court.

16 Excluding the hotel fee that will be introduced on 1 January 202217 Article 130 of Russia’s Civil Code 18 Article 133 of Russia’s Civil Code19 Determination of the Supreme Court of the Russian Federation of 12 July 2019 No. 307-ES19-5241 in Case No. А05-879/2018. The case has not yet been closed but

referred to the lower court for a new hearing20 Article 381.25 of the Russian Tax Code


21 As of the date of this Report, the date of a new hearing was not yet known22 Resolution of the Federal Arbitration Court of Volga-Vyatka District of 18 February 2013 in Case No. А29-4831/201223 Determination of the Supreme Court of the Russian Federation No. 304-KG18-11694 of 10 August 2018 in Case No. А67-4196/201724 Determination of the Supreme Court of the Russian Federation No. 304-KG17-14299 of 13 October 2017 in Case No. А27-26491/201525 Federal Law No. 269-FZ “On Amendments to Parts One and Two of the Tax Code of the Russian Federation” of 2 August 2019

The Supreme Court ruled the following:

• Tax laws must contain clear and precise criteria for movable property items that have attributes allowing their reclassification for property tax purposes. Tax rules must be formally well-defined, meaning that they must be sufficiently precise to be properly understood and applied.

• The taxation of corporate assets is made definite by means of formal accounting criteria for treating a taxpayer’s property (movable and immovable) as fixed assets

• The Russian Classifier of Fixed Assets (OKOF) is the principal classification applied to fixed assets for accounting purposes.

• In accordance with the OKOF, as it was when the fixed assets were recognized in accounting, the assets in question were intended to support the production of finished products, rather than building operations, and should thus be treated like fixed assets such as machines and equipment.

• The fact that equipment is installed in a specially constructed building, including the fact that subsequent dismantling and moving the equipment would entail additional costs and partial liquidation of the building, does not in itself mean that the equipment is a building accessory.

• The expert opinions are essentially an assessment of the economic feasibility of dismantling the equipment if it is subsequently decided to move the facility.

• In other words, these conclusions concern matters that are not relevant to the case and are inadmissible as evidence, since they do not prove that the assets acquired by the taxpayer were wrongly classified as equipment that can be accounted for as separate inventory items.

• An analysis of individual cases should not depend on expert opinions or specific requirements for item installation and operation – for example, on climate conditions requiring that the equipment be housed in a building to ensure its normal operation.

• Nevertheless, the court upheld the tax authorities’ right during a tax audit to check for signs that an item of immovable property (a building or structure) can be treated in accounting separately to avoid assets tax.

Based on these arguments and conclusions, the Supreme Court reversed the appealed part of the court decisions and sent the case back to the lower court for a new hearing.21

Despite the positive outcome of this case for the taxpayer, it is yet early to speak of any fundamental change in the tax authorities’ approach to the classification of property as movable. In particular, the Supreme Court’s ruling has introduced the ‘designated use of an item’ as a new tax criterion, suggesting that a decision should be made whether the designated use of an immovable property item in question (e.g., a building) is a use that supports its normal operations or a manufacturing process. Since this criterion requires judgment, taxpayers and tax authorities may take diametrically opposite positions.

Property uses are also often an issue in disputes with the tax authorities over the useful life of fixed assets as well as codes under OKOF and the Classification of Fixed Assets by Amortization Group. Such disputes also arise in connection with a functional analysis performed by the tax authorities to revise the OKOF code, classification or useful life of a fixed asset. Both courts and tax authorities build their cases on designated uses of fixed assets,22 industry regulations,23 specifications or the manufacturer’s recommendations regarding the asset in question.24

To avoid the assessment of additional tax amounts due to the above and minimize overall tax risks, we recommend the following:

• Using a uniform documented approach to accounting for such fixed assets so that they are recognized according to the same standards or classifications

• Adopting uniform rules for the assignment of available groups or types of fixed assets to OKOF codes, depreciation groups and useful lives to perform a comprehensive functional analysis of available fixed assets

• Using OKOF codes in assigning a fixed asset to movable or immovable property

• Preparing a defense case for assets that may lead to a dispute with the tax authorities so that the company could effectively support its position based on specifications, accounting policies and expert opinions.

EY can provide comprehensive support to taxpayers in the matters described above.

Special Investment Contract 2.0

In August 2019, Russia published a federal law25 that is part of a package of laws introducing significant amendments to the regulatory framework for Special Investment Contracts. This law outlines changes in tax benefits available to investors under such contracts.

New eligibility criteria for profits tax benefits are the following:

• Investors must account separately for income/expenses attributable to the investment project that is implemented under the Special Investment Contract and income/expenses attributable to other activities.

Previously, Special Investment Contracts entitled investors to a reduced profits tax rate only when revenue from contract-related activities exceeded 90% of their total revenue.


26 Status card of the draft law on ratification: http://sozd.duma.gov.ru/bill/643148-7

This threshold was lifted under the new rules, with investors only required to account for financial results under the Special Investment Contract separately to apply a reduced rate to income from related activities.

• Reduced profits tax rates under Special Investment Contracts will now be granted for the entire project duration.

Previously, they were available to any investor only until 2025. Under the new rules, tax benefits will be granted until the reporting/tax period in which the Special Investment Contract terminates, but not beyond the reporting period in which total income and tax benefits granted under the Contract exceed 50% of capital expenditures for the investment project.

International tax laws

MLI ratification

In April 2019, the Federation Council, the upper house of the Federal Assembly of Russia, approved a law ratifying the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, known internationally as the Multilateral Instrument (MLI).26

The objective of the MLI is to allow governments to modify existing tax treaties in an efficient manner to address the intentional transfer of income to jurisdictions where it is exempt from tax or subject to reduced tax rates, causing significant tax revenue losses.

MLI signatories are required to adopt a list of tax treaties that the MLI will cover and determine exceptions for optional provisions and how they will comply with agreed minimum standards.

The MLI will apply simultaneously with existing tax treaties, meaning that taxpayers will be required to compare the contents of the applicable tax treaty with the contents of the MLI and positions taken by both jurisdictions that are parties to this tax treaty.

The MLI will considerably tighten eligibility requirements for benefits under tax treaties, introducing the principal purpose test, a requirement that a taxpayer should hold a minimum amount of shares or interest in a Russian company to apply a reduced tax rate to dividends, and other limitations.

The MLI will take effect on the first day of the month following the three calendar months from the date the instrument of ratification is deposited. Russia deposited its instrument of ratification for the Multilateral BEPS Convention on 18 June 2019. Thus, the MLI will take effect for Russia on 1 October 2019.

http://sozd.duma.gov.ru/bill/643148-7


27 Draft Law No. 687103-7 “On Amendments to the Federal Law ‘On the Voluntary Declaration by Individuals of Assets and Accounts/Deposits with Banks, and on Amendments to Certain Laws of the Russian Federation’ (on the extension of the amnesty period),” https://sozd.duma.gov.ru/bill/687103-7; Draft Law No. 687102-7 “On Amendments to Articles 45 and 217 of the Tax Code of the Russian Federation (in connection with the adoption of the federal law on amnesty extension)”, https://sozd.duma.gov.ru/bill/687102-7; Draft Law No 687101-7 “On Amendments to Article 76-1 of the Criminal Code of the Russian Federation (on the extension of exemption from criminal liability for economic crimes)”, https://sozd.duma.gov.ru/bill/687101-7

28 Article 4.1 of Law No. 140-FZ, the newly introduced clause 3 of Article 45.2.1 of the Russian Tax Code

The effective date of the MLI differs from its entry-into-force date. For withholding tax, the new rules will start to apply from 1 January 2020, covering the tax treaties that have been ratified by the other state. For other taxes, the new rules will start to apply no earlier than 1 January 2021.

The coming implementation of the MLI suggests that companies with international presence should take a close look at their operational policies, including:

• Checking their international transactions for compliance with the principal purpose test to ensure that their principal purpose is not treaty abuse, and with other criteria set out in the MLI

• Introducing controls to monitor compliance with the MLI

EY has developed a proprietary tool to assess the impact of the MLI on tax treaty provisions. This tool is freely available at https://mli.ey.com/match.

Mandatory disclosures Europe

In May 2018, the Council of the European Union formally adopted Council Directive (EU) 2018/822 introducing a new mandatory disclosure regime. The new regime provides for mandatory automatic exchange of information in the field of taxation in relation to reportable cross-border arrangements. These rules require intermediaries such as tax advisors, banks, lawyers and other providers of similar services and, as the case may be, taxpayers to report potentially aggressive tax arrangements to the tax authorities in the EU member countries.

We recommend companies with operations in the EU to adopt procedures for monitoring compliance with the new rules that are aimed at deterring aggressive tax planning practices.

Third stage in Russia’s capital amnesty program

The State Duma, the lower chamber of the Federal Assembly of Russia, has passed a package of laws27 launching a third stage for the voluntary declaration of assets under the capital amnesty program. The stage will last until 29 February 2020.

Under the capital amnesty program, Russian citizens are invited to voluntarily declare their assets abroad such as accounts, real estate, securities or controlled foreign companies (hereinafter, the “CFC”). As previously, taxpayers submitting such “special returns” will be exempt from certain criminal, administrative or tax sanctions, provided that certain conditions are met, but controlling persons will no longer be exempt from tax on the CFC’s profits.28

The list of assets that should be reported has remained the same.

Key changes under the capital amnesty program are the following:

• Taxpayers may declare foreign accounts opened before 1 January 2019. Accounts closed as of the special return date are also covered by the program, provided that they were closed no earlier than 1 January 2019. Exemptions are provided only if the taxpayer has transferred all cash from such foreign accounts to Russian banks.

• Exemptions will apply if the tax liability arose before 1 January 2019 and the respective asset (property) is reported in the return, with the exception of a CFC’s profits.

• Taxpayers filing notifications of participation in a foreign company or a CFC notification, along with a special tax return, will not be deemed to be in violation of the deadlines.

Exemptions may apply to a CFC only if it is registered as a Russian legal entity after its redomiciliation and simultaneous status conversion to international company.

Changes in Switzerland’s tax laws

In a referendum held on 19 May 2019, Swiss voters adopted the Federal Act on Tax Reform and AHV Financing (TRAF). The amendments will take effect at the federal level on 1 January 2020. In most cantons, they will also take effect in 2020.

The new rules will terminate tax privileges on 1 January 2020 for holding companies, trading companies, principal companies and Swiss-based finance branches of foreign companies.

This means that companies with operations in Switzerland need to consider other opportunities for the optimization of their tax burden if they want to continue operations in Switzerland.

https://sozd.duma.gov.ru/bill/687103-7

http://sozd.duma.gov.ru/bill/687102-7

https://sozd.duma.gov.ru/bill/687101-7

https://mli.ey.com/match


Forest resources

Russia is home to one of the world’s largest wood reserves. Its forest land totaled around 1,185 million hectares in 2017, with 67% of it covered with growing stock. Despite its vast reserves, Russia ranks only fifth globally in timber harvesting. Factors behind low timber harvesting volumes include extensive forest exploitation practices that result in the depletion of forest resources.

Currently, Russia is seeing a gradual shift to intensive forest exploitation practices as resource scarcity has become an industry-wide concern.29 Artificial reforestation programs were implemented in a total area of 172,000 hectares in 2018 compared with natural reforestation in a total area of 751,000 hectares. The area under artificial reforestation declined by 2.3% in 2018 compared with a year before.

According to the LesPromInform magazine, forest users planted trees on 120,000 hectares of land, or 70% of all land covered by artificial reforestation programs, in 2018.

Countries with the largest wood reserves in 2018, % of the world’s wood reserves

Countries with the highest timber harvesting volumes in 2018, million cubic meters

Russia US

Brazil India

Canada China

US Brazil

China Russia

DR Congo Canada

Australia Indonesia

Indonesia Ethiopia

Sudan DR Congo

India Nigeria

Other

21% 439

13% 354

8% 329

8% 257

5% 236

4% 152

4% 118

2% 114

2% 89

2% 76

32%

Source: Lesonline Source: FAOSTAT

29 The Segezha Group introduced new forest management methods in the Republic of Karelia under a pilot project in mid-2019 as part of its shift to intensive forest utilization practices. The project cost is estimated at RUB 365 million. Source: www.segezha-group.com

https://segezha-group.com/press-center/news/segezha-group-realizovala-investitsionnyy-proekt-po-priobreteniyu-novoy-tekhniki-dlya-vedeniya-inten/


Wildfires also make a substantial contribution to forest depletion, damaging 7.4 million hectares of Russia’s forest land in 2018, double the 2017 level. The hot and dry weather was a key cause of the 2018 wildfires.30

At the same time, the wildland fire management service Avialesokhrana has been allowed to conduct artificial rain operations, which helped prevent massive wildfires in Yakutia. There is also a debate about the possibility of transferring

wildfire management responsibilities to a federal-level agency. If it happens, considerable public funds may be earmarked for such operations.

30 Many countries worldwide have to tackle similar problems, including the consequences of climate change. Large wildfires also erupted in the US (California), Portugal and Greece in 2018

Wildfires in Russia Reforestation programs in Russia, thousand hectares

3,1912,749 2,508

3,282

7,408

2014 2015 2016 2017 2018

Forest land covered by wildfires, ‘000 ha Number of wildfires, thousand

17

1112

1112

Source: Statistical Book: Russia in Figures, 2019 Source: Statistical Book: Russia in Figures, 2019

Indicator Far East Federal District

Siberian Federal District

Northwestern Federal District Ural Federal District

Forest land, thousand hectares 505,864 373,061 118,323 115,242

Land covered by forest vegetation, thousand hectares 294,941 276,625 88,546 69,425

Total wood reserves, million cubic meters 20,619 33,163 10,425 8,106

Wood harvesting*, million cubic meters 16.4 75.8 52.7 15.5

Annual allowable cut, million cubic meters 91.5 267.5 119.7 98.6

% of wood harvesting volumes in the annual allowable cut 18% 28% 44% 16%

* 2017 data

Source: Russia’s Forest Sector Strategy to 2030, 2018 Social and Economic Indicators

Indicator Volga Federal District Central Federal District Southern Federal District

Northwestern Federal District

Forest land, thousand hectares 41,290 24,665 3,793 2,212

Land covered by forest vegetation, thousand hectares 37,857 22,637 2,955 1,701

Total wood reserves, million cubic meters 5,706 3,976 494 278

Wood harvesting*, million cubic meters 29.6 21.5 0.6 0.2

Annual allowable cut, million cubic meters 70.4 56.3 7.0 0.7

% of wood harvesting volumes in the annual allowable cut 42% 38% 9% 34%

* 2017 data

Source: Russia’s Forest Sector Strategy to 2030, 2018 Social and Economic Indicators

Russia’s wood reserves by region

2013 2014 2015 2016 2017 2018

872

77%

2%

21%

863

2%

22%

76%

8032%

23%

75%

8402%

21%

77%

9622%

18%

80%

940

2%

18%

80%

Artificial Natural Combined


31 Program relaunch, see the section on Special Investment Contract 2.0

Russia’s forest sector demonstrated record-high performance levels in 2018, with considerable growth observed in most sector industries. Companies are also optimistic about growth prospects, counting on key growth enablers. Domestic and international demand for Russian forest products is strong, which is attributable to their superior consumer properties, environmental sustainability and relatively low costs.

Priorities for forest sector companies in 2019 include capacity additions, the expansion of geographical presence and operational excellence that will also be driven by the closure of inefficient plants. Limited access to capital and low liquidity of investments are key risks to capacity expansion projects. According to the survey, access to debt has worsened compared with a year earlier, while debt is a key source of financing for new projects, along with equity.

Improved financial results in 2018, the development of strategic initiatives and government support have increased the forest sector’s investment appeal. This is evidenced by our survey findings, with more than 50% of respondents expecting increased investment inflows into the forest sector in 2019 and 25% noting “considerable” improvements in the investment climate.

Government support for the forest sector is significant and includes restrictions on raw timber exports, investment incentives under Priority Investment Projects, Regional Investment Contracts and Special Investment Contracts, and the development of Russia’s Export Center, with more than half of respondents using government support, especially Priority Investment Project and Special Investment Contract benefits31 (37% of respondents). Restrictions on raw timber exports, tax benefits, financial

support for specific projects and the construction of forest roads are the most efficient support mechanisms, according to the survey. At the same time, forest infrastructure development, including the construction of forest roads, will be a low priority in 2019, as expected by respondents.

To achieve targets set under Russia’s Forest Sector Strategy to 2030 and the sustainable growth of the forest sector, it is crucial to take further steps to increase resources available to companies, stimulate value-added production, improve the investment appeal of the sector and enhance the regulatory framework and government support mechanisms.

Conclusion


Igor Prutov Partner, CIS Forest Sector LeaderTel.: +7 (916) 825 [email protected]

Denis MekhedovSenior Manager, Russian Forest Sector Advisory ServicesTel.: +7 (903) 784 [email protected]

Yelena Smirnova Russian Export Center, Leader of the Forest Sector Exports ProjectTel.: +7 (965) 196 [email protected]

Contacts

Ksenia Baginian Partner, CIS Industrial Products Leader Tel.: +7 (495) 755 9884 [email protected]

Andrei Sulin Partner, CIS Metals & Mining and Industrial Products Tax & Law Leader Tel.: +7 (495) 755 9743 [email protected]

Sergei Malkov Management Board Member of the Association of Specialists of the Pulp and Paper IndustryTel.: +7 (925) 000 [email protected]

About the Association of Specialists of the Pulp and Paper Industry The Association of Specialists of Pulp and Paper Industry is a union of industry experts with voluntary membership created to represent and protect professional interests involving the promotion of the pulp and paper industry and the forest sector in the Russian Federation.

The association currently has around 300 members working in the Russian forest sector and pulp and paper industry.

The association’s mission is to unite professionals and enhance the image of the sector. The Association of Specialists of the Pulp and Paper Industry is a nonprofit organization.

The chief objectives of the Association of Specialists of the Pulp and Paper Industry are to support and develop the domestic forest sector, including the wood-processing, pulp-and-paper and forest chemical industries, promote important industry initiatives and projects, make the sector more competitive, facilitate the exchange of information and experience between industry professionals, represent the sector’s interests in interaction with state and other agencies, promote cooperation between companies in the sector, and organize and participate in industry exhibitions, seminars and conferences in Russia and abroad.

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