Tim Gosling in Moscow -

Mid-February saw the announcement of merger talks between Gazmetall - one of the largest Russian steelmakers and the country’s top producer of iron ore - and Ukraine’s Industrial Union of Donbass (IUD). Should it go ahead, the union will form a metals giant worth as much as $20bn, yet it’s far from a done deal, with opinion on either side of the border quickly diverging following the news.

Fifty-percent owned by Alisher Usmanov, Gazmetall currently produces 6m tonnes of steel annually; IUD turns out 9m tonnes. It’s thought that the new conglomerate will aim to increase output to overtake Severstal – producing 17.6m tonnes - as Russia’s largest steelmaker. Kommersant, also owned by Usmanov, reported that a letter of intent was signed February 17.

According to the Russian press, Gazmetall would control the new company, with IUD’s principal holders – Vitaly Hayduk and Sergey Taruta – likely to receive 40% at the very most in return for the Ukranian company’s assets. IUD is estimated to be worth $5bn-7bn; Gazmetall $10bn-12bn.

That balance of control is disputed in Ukraine however, while IUD officials have been at pains to point out there’s a long way to go before the first large cross-border deal between Russia and Ukraine in the metals and mining sectors goes through.

Usmanov has long advocated forming a metals giant from amongst the scattered pieces of the former Soviet Union’s steel industry, and although officials from both sides are reported to have confirmed talks, it’s not the first time that the Gazmetall chief has spoken of plans to join forces with one or another company.

If it does go ahead, the key to the tie-up lies upstream. Given Gazmetall’s excess of iron ore – the company turns out around 40m metric tonnes each year - the merger would provide a solution to IUD’s difficulties in sourcing raw materials. System Capital Management (SCM) heads a list of antagonistic relationships in Ukraine for the Donetsk-based corporation, which in recent months has been forced to look as far afield as Brazil for supplies.

The Russian company has stated it will begin shipping iron ore to IUD this quarter. Meanwhile, the merger will expand Gazmetall’s steel production dramatically - increasing the benefits to be had from vertical integration, as well as getting their foot in the door of EU markets. Usmanov claims an IPO will launch within a year of the merger.

Alexander Pukhaev of Deutsche UFG says the plan represents a "pure business deal," and that since transportation costs define iron ore as a "regional business," it makes perfect sense for the two to come together.

On the other hand, without more transparency over the ownership of a variety of assets, it’s impossible to rule out the suggestion that Gazmetall may have been stirring things. Ukrainian concerns Smart Group and Privat Group have been at the forefront of IUD’s difficulties recently. October even saw 300 workers from an IUD plant picketing a neighbouring Smart Group facility over the price of iron ore coming out of Inguletsk GOK.

Smart Group and Privat Group are bedfellows of Gazmetall. Perhaps most significant in this context is the convergence of ownership in iron-ore assets in Kryvyi Rih, including Inguletsk GOK, although Andrei Gorsik of Concorde Capital in Kiev suggests “the relationship with Gazmetall is not 100% clear.” The media has described Smart Group chief Vadim Novinsky as Usmanov’s junior partner in the past, while Privat Group controls the Ukrainian edition of Kommersant.

"The trigger to these talks is the rise of domestic iron-ore prices," says one analyst. "It has a lot more to do with Smart Group then SCM."

Although IUD’s three small assets in Central Europe would give Gazmetall a footing in the EU, and the partnership with Duferco provides a worldwide distribution network, few expect a merger to have significant impact on the steel markets. Gorsik suggests that the Ukrainian iron-ore market may well feel the effects however.

"It could weaken the players," he suggests. "They may have to find new markets, lower their prices; or even integrate with Gazmetall, given that some of their customers are now part of this company."

Battles in Ukraine’s metals and mining industries are often far from purely business affairs. IUD’s lack of iron-ore assets has its roots in SCM’s advantages in privatisation deals - thanks to its ties with Prime Minister Viktor Yanukovych and the ruling Party of Regions.

In late 2006, IUD cemented a growing relationship with President Viktor Yushchenko, Hayduk gaining an appointment to the National Security and Defence Council. One of Yushchenko’s first moves when he took power was to force the resale of the Kryvorizhstal steel and mining company. Originally bought by a consortium including SCM for just $800m in June 2004, Mittal paid $4.8bn the following year

With Usmanov heading Gazprominvest-Holding, and Gazmetall said to have gained assets such as Ribnita steelworks in Moldova via the state-controlled energy giant, the Russian side of the deal is hardly without political influence either.

Certainly, attitudes differ in the statements coming out of the two countries. While discussion in Russia is of synergy, new conglomerates to take on the world, and control by Gazmetall, across the border there’s less optimism.

"IUD's owners are open to a merger, but not according to the parameters suggested by the press in Moscow," Oleksandr Pylypenko of IUD told Interfax.

There is a chance that Kyiv could prevent Ukraine’s second-largest corporation coming under Russian control at the joint venture stage.

"It really makes no difference that this is a Ukrainian asset," says Pukhaev. "Russian companies are buying assets all over the world. In the steel industry, that’s the only way to play the different regions and make a company more stable."

This is why Pukhaev doesn’t expect to see more large deals across this border - firms want to expand outside the CIS region.

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