Czech Steel Sector Restructuring Programme Implementation Report

1. IX. Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" March 2007

2. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" For strengthening competitive ability of the Czech steel industry and achievement of permanent viability was accepted (see the Government Resolution of the Czech Republic No. 840 dated 29 August 2001) the document "Czech Steel Sector Restructuring Programme" (hereinafter "Programme"), which included after discussion with the EC the following definition of the targeted position of the Czech steel sector: • possibility of the steel production to achieve after permanent dismantling of 1.9 million tonnes of redundant capacities (within the entire metallurgical cycle) about 6 million tonnes of liquid steel per year; • production with increasing share of flat rolled products, and particularly with the growth of finalization of the production by means of creation of product chains, proceeds from apparent domestic consumption; • rationalization of all activities shall bring about a significant reduction of number of jobs in steel sector and, as to the number of employees in primary metallurgical operations of the entire Czech steel sector, it shall reach the targeted state of affair of 8500 employees, which corresponds to an illustrative productivity of about 700 tonnes of liquid steel per employee of primary metallurgy. At the same time, as a way out for achievement and maintenance of permanent viability, it has been accepted to proceed by means of creation of "product chains", valorization and finalization of processing of primary metallurgical products with higher value added in terms of finalization of long rolled products, flat rolled products and welded tubes.

3. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" Macro-economic prediction for the Czech Republic a) Basic economic indicators in the Czech Republic Growth of the GDP in the Czech economy has been exceeding the 5% level for the last three years; wealth differentials with the advanced countries are gradually disappearing, which is an effect resulting from the CZ accession to the EU.

4. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" b) Overall position of the Czech steel sector in 2006 • The volume of finished steel production increased by 7.9% inter-annually and primary production (pig iron and steel) by 9.5%. The production of long products increased by 11.4%, flat products by 10.8% and steel tubes by 9%. Deliveries grew both on foreign markets (by 11.8%) and on the domestic market (by 5.2%). The last results are signalling recovery of economic growth in the groups processing the decisive part of steel production, which contributed to growth of the real consumption of steel products in Europe. It should henceforth gradually enhance and stimulate accordingly the growing demand for steel products. • Year-on-year growth of material productions of steel products in the CZ was in this comparison simultaneously accompanied by price decline, when compared with high base of 2005. It significantly influenced the fact that the prices in the entire branch of basic metals, metallurgical and fabricated metal products had dropped by 2.6%. Year-on-year price decline was taking place in majority of the important commodity groups. Price development of the finished steel products was also influenced by the continuous growth of prices of iron ore (approx. +19%) and steel scrap (approx. +15%) and on the other side by price decline of coal. The prices of steel tubes dropped inter-annually by 2.3% only. The prices of other steel products declined by 4%. • Because of ongoing restructuring of the steel sector, further decline in the number of employees by 3.6% was reported. Nominal average earnings went up by 5.6%. • Whereas profitability of revenues within the entire branch amounted to 10.1%, return on owner´s equity achieved 23.3%.

5. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" • strengthening of negotiating position with the suppliers and major customers; • implementation of production discipline and production flexibility consisting inutilization of available capacities, which strengthens the ability to meetrequirements of the final consumers; • financial strength and possibility to stimulate interest in steel sector withininvestors´ community and to get resources for modernization. Traditional path to manufacture as much as possible from the available capacities and to realize sales for achievable prices is being, and will be, substituted by profit maximization from synergy effects both from integration and production finalization into product chains, which are focused on more sophisticated products in compliance with the market requirements. Particularly the following development factors can be specified for the nearest period: • internal consolidation of steel companies; • strategy of procurement of raw materials and energies; • necessity to resolve environmental issues. In addition to cyclical development in demand, the branch vulnerability is further enhanced by the "fragmentation" of the manufacturers. The major advantages of mergers - globalisation are as follows:

6. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" Financial situation Total (of orientation) data for the entire branch of steel industry(including price cost-squeeze) Operating profit/loss increased, when compared with 2005, labour productivity went up by 10.4%. The profit/loss accordingly was to decisive extent influenced by the results, which were reported in dominant steel companies in the Ostrava region. From the view of "internal rationalization" the reduction of material and energy intensity of the production by 11.6% took place; turn of inventory accelerated by 14%. The overall profitability from revenues reached 10.1%, which can be considered good position for steel sector.

7. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" Labour productivity Development in employment is showing a trend of ongoing reduction of jobs in metallurgy, namely rationalisation of production processes in particular, by means of outsourcing of servicing activities. For illustration, there were 38549 employees in the Czech steel sector in 2001 (beginning of the implementation of the "Programme"). Labour productivity assessed by the level of steel production per employee (in tonnes per year)

8. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" Trading with greenhouse gases Implementation of EU environmental legislation The total emission factor for the branch the period 1999 - 2005, including enterprise heating plants, was ranging between 1.98 – 2.14 tonnes of CO2 per tonne of liquid steel and it completely corresponds to the achieved factors within the EU (professional literature states for integrated metallurgical plant with heating plants production only for ensuring of metallurgical production its value 2.14 tonnes of CO2 per tonne of liquid steel). It is in compliance with the fact that all monitored equipment are being operated on the level of BAT. After considering factors, which influence reduction as well as enhancement of specific emissions we may say that also for the period 2008 - 2012 the value of composed total emission factor for the branch of the production and metal processing will be ranging between 2.03 – 2.14 tonnes of CO2 per tonne of liquid steel, i.e., it is not expected more significant change in comparison with the period 2005 - 2007.

9. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" IPPC – Integrated Prevention Pollution and Control • steel companies joined in "Steel Association" have submitted an application for IPPC for more than 95% of the facilities, which are liable to the Act No. 76/2002 Coll., in wording of the later regulations; • average time to process respective application is 4 - 8 months, average time of ratification process is about 1 year; • steel companies joined in the above-mentioned association should not face to any problem to get IPPC until stipulated deadline - 30 October 2007; • on the basis of the assessment, which was performed by independent organizations, it may be said that all steel companies are being operated in compliance with BAT; • revision of European BREF´s Regulation, which is applied for manufacture of pig iron and steel, is being performed.

10. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" REACH – Legislative aspects (registration, evaluation and permitting of chemical substances) European legislation, related to this issues, was accepted on 18 December 2006 (Directive No. 1907/2006/EC) being effective from 1 July 2007. REACH impact calculation on metallurgy is as follows: • total costs could achieve CZK 1.8 billion in the course of next 5 years; • the costs per one registration in the amount of CZK 20 - 30 million determine that one-off costs during three years shall achieve CZK 400 - 600 million, which is approximately 0.35% of the receipts of steel enterprises; • effect of the procured chemical substances could present CZK 200 - 300 million per year (as steady impact of implementation of REACH); • impact on decreasing of costs (in the area of workforce) by 250 - 480 jobs (until 2012).

11. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" • production was concentrated on more heavy-duty and efficient units; • adaptation of production capacities by means of cessation of non-efficient obsolete units (4 sintering belts, 10 coking batteries, 6 blast furnaces, 43 steel-making furnaces (largely with open hearth), 4 blooming mills and 21 rolling mills were closed down); • modernization and construction of new units improving technological as well as economic parameters of the branch level (improvement of secondary metallurgy, construction of continuous casting, modernization of rolling mills, construction of new minimill - ladle metallurgy, continuous casting and hot strip mill of Steckel type). Targeted position of Czech steel sector Permanent dismantling of 590 thousand tonnes of finished rolling capacity has been realized in the entire range of Protocol 2 of the Czech Republic´s EU Treaty of Accession. In 2005 VPFM´s Hot Mill No. 1 and VPFM´s Hot Mill No. 2 were closed down (altogether 70 thousand tonnes capacity), and in 2006 Duo Mill at VS was closed down (altogether 130 thousand tonnes capacity). At the same time in 2006 technical and technological reduction of HCC Heavy Section Mill was carried out with capacity reduction by 270 thousand tonnes. The important technological changes in steel industry had already commenced in 1985. During the entire time period a number of important trends in capacity changes were manifested:

12. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" Annual production of about 6 million tonnes of steel a) In 2004 7.0 million tonnes of steel was produced. In 2005 this figure was 6.2 million tonnes and in 2006 it was about 6.9 million tonnes. b) The volume of continuously cast steel has already achieved (1997) the level of technologically possible maximum and it is ranging on the level of 90% approximately. Some characteristics of steel production (development connecting with implementation of the "Programme") in comparison with 1975: • the share of continuously cast steel - growth by 77 %; • consumption of crude steel per 1 tonne of rolled material - decline by 223 kg/t; • consumption of pig iron per 1 tonne of crude steel - decline by 40 kg/t; • energy intensity (per 1 tonne of steel production) - reduced by 12 GJ/t. Apparent domestic consumption

13. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" In order to resolve social and employment consequences of the Czech steel sector restructuring, the government approved a "Comprehensive project of associated social programme for resolving steel sector restructuring" in 2000 (hereinafter ASP), which was helping to eliminate social problems of redundant employees. Number of employees Associated Social Programme for resolving steel sector restructuring For implementation of ASP in the period from 2000 to the end of 2006 were provided financial means of the state budget in the amount of CZK 1,093 million, which covered in a full extent the requirements of steel companies for providing contributions to dismissed employees. Within the framework of ASP 7.8% of the employees found their other job. The average period of continuous employment of the dismissed workers in metallurgy presented 31 years. A great part of the dismissed workers (61 %) was laid off at a claim for pension from one to five years.

14. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" Spent funds from state budget for implementation of ASP There are other instruments for resolving social and employment consequences of the Czech steel sector restructuring, which are included in: • utilization of the "Programme START" to support business undertaking. In 2006 there were provided 290 interest-free loans in total volume of CZK 109 million across all industrial business undertakings. More than two-thirds of these loans, which were being provided by the Czech-Moravian Guarantee and Development Bank, focused on business support of redundancies within the framework of restructuring of steel companies; • "Programme of regional development", which stimulates a creation of new jobs in the regions touched by the restructuring.

15. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" Utilization of state aid In the determined period there was not granted to the Czech steel sector after accession of the CZ to the EU in 2003 any further restructuring aid. The commitments, which relate to granting of maximum legal amount of State Aid to the beneficiary companies listed in Attachment 1 of Protocol 2, were fulfilled.

16. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" Cessation, reduction of finished production capacities The targeted project of cessation and permanent capacity dismantling by 590,000 tonnes was fulfilled by the end of restructuring period, i.e., until 31 December 2006.

17. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" In compliance with Protocol 2, state aid could be granted only to beneficiary companies listed in Attachment 1 of this protocol, namely for period from 1997 to 2003. Summary of the fulfilment of the obligations of Protocol 2 of the Czech Republic´s EU Treaty of Accession In the course of the monitored process the NPF of the CZ completed the sale of NH and VPO to the company LNM Holding in 2003. In 2005 OSINEK, a.s. in the form of public bidding sold VÍTKOVICE STEEL, a.s. to the company Mastercroft Ltd. (from Russian group EVRAZ), while the acquirers are meeting the conditions and principles, which were determined by Protocol 2. At the same time, on the basis of permanent dismantling of the production capacities, net reduction of level of capacities in accordance with time table determined in Attachment 2 of the protocol was met and verified. The CZ, in compliance with Protocol 2, has removed trade barrier on the market with coal and enabled to the Czech steel companies to have an access to coal for international market prices.

18. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" Modernization and restructuring processes resulted in enhancement of labour productivity of the employees in the branch. At the beginning of restructuring the labour productivity in the Czech Republic, in tonnes of annual steel production per employee, amounted to 100 - 120 tonnes per year, while in the EU these values at the given enterprises were ranging within the limits of 400 - 500 tonnes per year.

19. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" • aid focused on research and development; • aid focused on environment protection; • aid focused on training and employment; • aid associated with enterprise closure. At present time we may identify within the framework of the support to the branch of steel industry the following valid legal regulations dealing with the said issue: • instructions for regional aid, which specify steel sector itself reglementing providing of state aid in the years 2007 - 2013, resp. specifying prohibition of providing of regional aid; • other regulations, reglementing specific cases of a possibility to provide the aid in steel sector area, which deal namely with:

20. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" The results reported by the Czech steel sector from the beginning of implementation of "National Restructuring Programme", which was approved by the EC, indicate that especially economic results and growth of productivity are associated with intensification measures in restructuring of the Czech steel sector as recommended by the EC. Also the process of transformation and privatisation of steel companies has also contributed to a transparent implementation of the restructuring programme and essentially to enhancement of competitiveness of the final steel production, mainly in the three State Aid beneficiary steel companies. Conclusions The programme of the Czech steel sector restructuring has been completed. We consider the commitments of the Czech Republic resulting from Protocol 2, which concern restructuring of steel sector, as fulfilled. Traditionally strong steel industry of the Czech Republic, similarly like an access on the EU market, are substantial advantages, which should guarantee success in the upcoming years. The measures, determined in restructuring programmes and business plans, will enable to focus on needed improvement and strengthening of operation output so that the companies may gain a larger resistance against possible economic decline.

21. IXth Report on results of the implementation of the "Czech Steel Sector Restructuring Programme" Meaningful and favourable aspect in meeting objectives of the "Programme" was application and implementation of more than 40 project of research and development, which contributed to growth of production quality, effectiveness and to achievement and maintaining of viability. Based on knowledge of procedures and positions of EC it is necessary to stress that any further state aid for steel industry would be in contradiction with "Treaty of Accession". Attainment of permanent viability of steel companies must be realized without any state aid. Development in steel market and a pressure on implementation of investments focused on increasing receipts from sales of products with higher value added and on meeting requirements of ecological legislation will be a decisive factor governing business effectiveness for the next period.