Russian Forest Sector Overview

2018-19

With assistance from Contents

Introduction 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 Introduction

Russia 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. Igor Prutov Partner, CIS Forest To prepare this report, EY, with assistance from the Association of Specialists of the Sector Leader Pulp and Paper Industry (ASPPI), conducted its annual survey among forest sector companies to capture perceived trends and identify sector industries that have the +7 (916) 825 2309 [email protected] 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 Sergei Malkov Our report is intended for industry players, investors, government bodies, financial Management Board Member institutions and other stakeholders. We would like to thank all survey participants for of the Association of Specialists of the Pulp and Paper Industry their contribution, and hope that you will find our report insightful.

+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

Russian Forest Sector Overview 2018-19 | 1 Key drivers of the forest sector in Russia and globally

Global economy International and population trade

Consistent growth in individual earnings and, hence, Steady growth in international trade is a key driver for the consumption are driving demand for goods and services. manufacturing sector.

Economic growth in Russia and globally, CAGR International trade growth, CAGR

Indicator 2008-18 2019-28 Indicator 2008-18 2019-28 Per capita GDP World 1.5% 1.8% World 1.8% 5.7% growth* Exports growth Russia 0.8% 1.6% Russia (0.2%) 4.3% World 1.2% 0.9% World 1.4% 4.2% Population growth Growth in forest 0.1% (0.2%) product exports* 3.3% 4.7%

* In real terms * Wood and cork products, pulp, waste paper, paper and paperboard.

Source: Oxford Economics Source: Oxford Economics

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

2 | Russian Forest Sector Overview 2018-19 Building construction Renewable and furniture energy manufacturing Renewable 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 Building construction and furniture manufacturing, produced in 2017. CAGR

Indicator* 2008-18 2019-28 Share of renewables in total energy consumption

Growth of the building World 2.7% 3.2% CAGR = construction industry Russia (1.3%) 1.0% 3.0% CAGR = Growth of the furniture World 2.8% 3.6% 4.3% 16% manufacturing 13% industry (3.4%) 1.3% 10%

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

Source: Oxford Economics

2008 2018 2028

Renewable energy

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

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

World: Russia: • Mjøstårnet, Norway, • Wood–city, Moscow 85 meters, 2017–19 • Sokol Town, • Brock Commons, Canada, Moscow Region 53 meters, 2015–17 • Good Wood Plaza, • HOHO VIENNA, Austria, Zelenograd 84 meters, 2016–19

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.

Russian Forest Sector Overview 2018-19 | 3 Internet Rise of growth e-commerce

Global Internet growth has significantly changed Increased Internet penetration has driven the e-commerce the structure of consumption of goods and services, market. The share of e-commerce parcels in all packages transforming the entire economy. Rapid technology in Russia jumped by 32% in 2018 compared with 2017. advances have also had an impact on the forest sector. For The e-commerce market is expected to grow by up to 20% instance, the consumption of print publications is declining on average annually in 2018 through 2021. Data Insight globally amid the digital explosion. forecasts its annual growth in Russia at 18%.

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

89% 13.1% 85% 11.4% 9.8% 75% 79% 8.4% 76% 7.4% 5.9%

6.4% 56% 5.0% 5.5% 5.8% 3.7% 4.2% 49%

2016 2017 2018 2019 2020 2021 23% 27% World Russia

Sources: Oxford Economics, Statista, Data Insight

World Germany Russia

2008 2018 2028

Source: Oxford Economics

4 | Russian Forest Sector Overview 2018-19 Global production of Environment and fabrics and clothes sustainability

The production of cotton and linen is strongly conditional The production of recycled products is on the rise as on the weather, the size of available arable land and other public environmental awareness has increased worldwide. natural factors. The ongoing growth in the consumption Restrictions on plastic use are driving the production of of clothes and footwear is projected to push demand for wood-based packaging. The share of packaging paper artificial fabrics, including viscose that is derived from jumped from 50% in 2008 to 58% in the total production dissoluble cellulose, as the market changes to remain of paper products in 2018. balanced in terms of supply and demand and, hence, prices. Growth in plastic production, CAGR Growth in fabric production, CAGR Indicator 2008-18 2019-28 Indicator 2008-18 2019-28 Growth in plastic World 2.9% 2.9% Growth in fabric and production* World 3.1% 2.4% Russia 4.1% 2.6% clothes production* Growth in recyclable Growth in viscose fiber World 4.7% 5.4% World 3.4% 4.3% packaging paper** production** * Real growth rates in monetary terms (value-added output) *  Real growth rates in US dollars (value-added output) ** CAGR in 2017-19 and 2019-23, USD ** CAGR in 2016–18 and 2019–24, million tons Sources: Oxford Economics, Mordor Intelligence 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.

Russian Forest Sector Overview 2018-19 | 5 Growth of forest industries in Russia and globally

Commercial Global production roundwood Packaging Fast-growing in 2018, USD million materials 262.6 11.2% industries 208.6 2.5% Sawnwood Wood fuel 134.8 8.7% 134.2 0.9% Chemical wood pulp

4.3% Plywood 94.4 87.7 Recovered 2.5% fiber pulp Russia’s share Household and of the global Recovered paper sanitary paper market 53.6 0.1% MDF/HDF 48.7 1.5% 1.6% 44.0 Particleboard 38.1 3.1% Wrapping paper 35.0 3.6% Charcoal 25.0 8.7% Newsprint 3.2% 24.4 Mechanical 0.1% Wood chips wood pulp 20.0 Veneer sheets 7.5% 11.6 OSB 9.1% 11.4 Wood 11.1 9.9% pellets Fiberboard Semi-chemical 4.3% wood pulp 7.8 6.9 5.9% 4.7% 7.1% 4.8 4.5

-8.8% -6.7% -1.5% -1.3% -0.8% 0.3% 0.5% 0.9% 1.5% 1.6% 1.9% 2.1% 2.4% 2.8% 3.0% 3.1% 3.8% 5.8% 9.2% CAGR in 2013–18 (nonlinear scale)

Source: EY

!"#$% & 6 | Russian Forest Sector Overview 2018-19 Commercial roundwood Packaging materials Fast-growing 262.6 11.2% industries 208.6 2.5% Sawnwood Wood fuel 134.8 8.7% 134.2 0.9% Chemical wood pulp

4.3% Plywood 94.4 87.7 Recovered 2.5% fiber pulp Russia’s share Household and of the global Recovered paper sanitary paper market 53.6 0.1% MDF/HDF 48.7 1.5% 1.6% 44.0 Particleboard 38.1 3.1% Wrapping paper 35.0 3.6% Charcoal 25.0 8.7% Newsprint 3.2% 24.4 Mechanical 0.1% Wood chips wood pulp 20.0 Veneer sheets 7.5% 11.6 OSB 9.1% 11.4 Wood 11.1 9.9% pellets Fiberboard Semi-chemical 4.3% wood pulp 7.8 6.9 5.9% 4.7% 7.1% 4.8 4.5

-8.8% -6.7% -1.5% -1.3% -0.8% 0.3% 0.5% 0.9% 1.5% 1.6% 1.9% 2.1% 2.4% 2.8% 3.0% 3.1% 3.8% 5.8% 9.2% CAGR in 2013–18 (nonlinear scale)

!"#$% & Russian Forest Sector Overview 2018-19 | 7 Survey findings Respondents’ outlook on the output of the Russian forest sector in the next three or five years, 2019 survey We conducted a survey among forest Change, Decline ~ 0%/ Growth sector companies to look at their 2018/2019 >3%/p.a. 1-3%/p.a. p.a. 1-3%/p.a. >3%/p.a. expectations for the future of sector industries. After that, we ranked the Packaging paperboard industries based on their production Household and sanitary growth expectations (see Table 1 below). paper According to our findings, the following Corrugated board n/a forest industries have the biggest growth potential: Plywood

• Packaging paperboard OSB

• Household and sanitary paper Wood pellets • Corrugated board Particleboard • Plywood MDF / HDF • OSB Bleached pulp • Wood pellets Unbleached pulp • Particleboard Wrapping paper n/a • MDF / HDF Sawnwood • Chemical pulp Wood chips n/a Below is an overview of current trends across forest industries and their Charcoal n/a prospects. Roundwood Packaging paperboard, corrugated Printing and writing board, household and sanitary paper, paper plywood, OSB and wood pellets topped Newsprint the 2019 ranking. Overall, the 2019 survey findings correlate with historical Source: EY and ASPPI Survey data on sector growth (see the previous two pages). Actual and forecast production growth across forest industries Chemical pulp, wood pellets and sawnwood ranked lower in terms of future World Russia growth compared with the 2018 survey CAGR in 3–5 CAGR in 3–5 Growth (the lower expectations for the future Product CAGR in CAGR in years, 2018 years, 2019 rate2, growth of the chemical pulp industry were 2013–18 2013–18 respondents’ respondents’ 2017/2018 due to a drop in world prices in 2019 and expectations expectations subdued demand for unbleached pulp Packaging paperboard 2.3% 3.8% 1-3% >3% 2.3% dominating in Russia). Household and 2.8% 11.7% >1% >3% 15.8% sanitary paper 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%

2019 leaders 2018 leaders

Source: EY and ASPPI Survey

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

8 | Russian Forest Sector Overview 2018-19 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.

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

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%

14.0

9.5 9.1 8.4 n/a 7.2 6.2 5.5 5.8 5.2

2008 4.0 4.0

2018 3.1 3.1 3.1 2.6 2030 1.8 1.4 n/a 1.2 0.6 0.8 0.2 0.0

Packaging Household and Plywood, OSB, Wood pellets, Particleboard, MDF/HDF, Chemical pulp, paperboard, sanitary paper, million m3 million m3 million tons million m3 million m3 million m3 thousand tons million tons

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

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

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

Russian Forest Sector Overview 2018-19 | 9 Outlook for exports

Russia has seen steady growth in USD-denominated exports of forest products since According to the Russian Export Center, 2015, with exports soaring by 20% in 2017-18. However, exports dropped by 6% forest sector exports are projected to year-on-year to US$6.2 billion in the first half of 2019. The drop was largely due increase most to China, CIS countries to lower prices putting the brakes on production growth as the chemical pulp and (Kazakhstan, Azerbaijan, Uzbekistan and plywood industries demonstrated a significantly worse performance. However, exports, Belarus), Germany, Italy, Saudi Arabia especially processed timber and newsprint, have been on a steady increase in physical and India. The map to the right4 shows terms. top destinations for the Russian forest sector’s fastest-growing exports in the near term. The woodworking industry Russia’s forest product exports* in 2013-18, USD million ranks first with forecast exports of up to US$4.5 billion, followed by the paper 13,395 industry with US$1.1 billion to USD$3.6 11,149 11,287 10,517 billion and the chemical pulp industry 9,308 9,522 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.

2013 2014 2015 2016 2017 2018

* Including commercial roundwood.

Source: Russia’s Federal Customs Service

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

10 | Russian Forest Sector Overview 2018-19 Map of top destinations for the Russian forest sector’s fastest-growing exports in the next two or three years

Total potential Potential export growth by industry, USD million Country export growth, 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

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

Russian Forest Sector Overview 2018-19 | 11 Fast-growing forest industries

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

Chemical pulp value-added products. According to upgrade facilities in the pulp industry, Russia’s Federal State Statistics Service and more pulp mill projects are being Rosstat, the country’s chemical pulp considered, including in Krasnoyarsk Global demand for chemical pulp rose production totaled 8.6 million tons in Krai, Irkutsk Region, Vologda Region and at a CAGR of 1.8% from 2013 to 2017. 2018, remaining at approximately the Khabarovsk Krai. In 2019, a number of Uruguay reported the highest increase same level as a year earlier. large companies, including the Ilim Group, in chemical pulp production, 15.5%, the Segezha Group, the Mondi Syktyvkar followed by Belarus with 14.6%, Bulgaria Russia’s exports of chemical pulp also Pulp Mill and the Arkhangelsk Pulp Mill, with 11.4%, Brazil with 7.0% and remained approximately at the 2017 continued activities under their Priority Indonesia with 5.4%. Russia’s CAGR was level, 2.1 million tons, but they jumped Investment Projects. However, the sector 3.5%. by 36%, or US$400 million, in monetary needs far more investment to deliver terms on the back of higher prices. Packaging consumption is a key driver of the Strategy, including finance for the Exports in physical terms increased the pulp and paper industry globally. In construction of facilities from scratch. slightly in 2019. Large-scale upgrade Russia, its drivers include the production programs are needed to enable any of newsprint for domestic consumption substantial increase in exports and meet Top five exporters of chemical pulp and exports, which continue to grow targets under the Russian Forest Sector in 2018 despite industry players’ expectations Strategy. Share of and rapid digitalization worldwide, as Exports, global well as demand from the packaging and However, the construction of pulp mills USD’000 exports household and sanitary paper industries. requires significant investments. The Canada 7,049,138 17% most recent wave of investments in Russia is among the top ten pulp the industry began in 2008-9 and was Brazil 6,453,808 16% producers globally. Pulp production in stable since 2014. Capital expenditures Russia is dominated by unbleached pulp, US 5,929,219 14% soared by 68.5% to RUB 52.9 billion which is in lower demand in the global Finland 3,099,108 8% in 2018. Projects are underway to market compared with other more Sweden 2,747,445 7% … Wood pulp production in Russia and globally in 2018 Russia 1,555,545 4%

Source: FAOSTAT 0% 0% 1% 4% Top five importers of chemical pulp 19% in 2018 68% 78% 56% Share of Bleached sulphite pulp Imports, global Unbleached sulphite pulp USD’000 Bleached sulphate pulp exports 0% Unbleached sulphate pulp 7% 45% China 15,817,584 36% 4% 4% 25% Germany 3,583,018 8% 13% 20% US 3,542,838 8% World Russia World Russia Italy 2,054,833 5% Chemical pulp Dissolving pulp Source: FAOSTAT France 1,517,257 3% Semi-chemical wood pulp Mechanical wood pulp … Source: FAOSTAT Russia 124,608 0.3%

Source: FAOSTAT

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

12 | Russian Forest Sector Overview 2018-19 Russia’s exports and imports of chemical pulp in 2018

The US China

US$62.6 million US$1,030 million 50% of total imports 69% of total exports, 33% year-on-year increase

Germany South Korea

US$39 million US$100 million 3% of total exports, 7% of total exports, 68% year-on-year increase 65% year-on-year increase

Poland Sweden Finland Japan

US$40 million US$22.9 US$19.3 US$55 million 3% of total exports, million million 4% of total exports, 49% year-on-year increase 18% of total imports 13% of total imports 15% year-on-year increase

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

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

9,000 8,587 8,578 8,208 7, 875 8,000 7,661 7,510 7, 658 7, 537 7,1 79 7,211 7,000 6,750

6,000

5,000

4,000

3,000 2,300 2,259 2,035 2,258 2,227 2,266 1,870 2,035 1,976 2,061 2,000 1,715

1,000 65 43 61 94 120 141 157 147 147 151 147 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

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

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.

Russian Forest Sector Overview 2018-19 | 13 Packaging • A board machine upgrade6 at the higher chemical pulp prices that have Arkhangelsk Pulp and Paper Mill to tightened competition in the market. materials increase container board production No new big players have emerged in the capacity by 20% (planned investments: market. However, existing companies Increasing packaging consumption RUB 6.8 billion) are focused on expanding production is a key driver of the pulp and paper capacity and their geographical footprint. • The construction of the Europack industry globally. Greater demand for Many experts expect increased market LLC plant (Arkhbum LLC) to make packaging paper and paperboard can be consolidation in the near future. corrugated board and corrugated board attributed to the rise of e-commerce and containers (board of three and five stronger demand for packaging based on layers and four-flap boxes) Top five exporters of packaging materials biodegradable materials. in 2018 • The construction of a plant with annual Global demand for packaging materials Share of capacity of 600,000 tons of paperboard Exports, rose by a 1.9% CAGR in 2013-18. global and other packaging materials in Ust- USD’000 Belarus reported the highest growth, exports Ilimsk and kraftliner capacity additions 10.7%, followed by Uzbekistan with 9.2%, in Bratsk to bring annual capacity to US 8,137,169 15% Argentina with 8.9%, Slovakia with 8.6% 100,000 tons Germany 6,844,621 13% and Costa Rica with 6.1%. In Russia, production grew by a 4.0% CAGR in 2013 • An upgrade of the Segezha Pulp and Sweden 5,382,360 10% through 2018. Paper Mill to increase annual bag paper Finland 4,062,188 8% capacity from 320,000 to 400,000 tons Demand for packaging materials in China 3,853,758 7% Russia is mainly driven by the food • A board machine upgrade at the Aleksin …. industry. Import substitution efforts also Paper and Board Mill to increase annual Russia 1,126,540 2% play a crucial role. The production of capacity to 118,000 tons of flat-layer Source: FAOSTAT packaging materials in Russia, although board and paper for corrugated board not increasing in physical terms in some (planned investments: RUB 2.3 billion). segments, increased overall by 12.5%, with Top five importers of packaging materials • The launch of Board Machine 1 with the production of kraft paper, and paper in 2018 annual capacity of 60,000 tons under for corrugated board and wrapping paper, Share of the Perm Pulp and Paper Mill’s Strength Exports, rising by 29.3% and 9.0%, respectively. global of Board Project at Mayak JSC USD’000 Exports increased considerably, driven exports by exports of kraft paper/paperboard and • Capacity additions at the Pavlovo Posad Germany 4,910,571 10% testliner/fluting that rose by 9.5% and 5.9% Corrugated Board Plant US 3,576,104 7% in physical terms, respectively, and by • Capacity additions at Yaroslavky Karton around 30% in monetary terms. China 3,121,092 6% LLC Italy 2,369,145 5% A big number of capacity upgrade and • A board machine upgrade at the expansion projects were started in Russia Mexico 2,281,912 4% Naberezhnye Chelny Paper and Board in 2018 and 2019: …. Mill Russia 957, 35 0 2% • The Kama Pulp and Paper Mill Packaging prices have been on a steady announced its intention in 2018 to rise in Russia and elsewhere in the world Source: FAOSTAT build a coated board line (planned in the last couple of years, driven by investments: up to RUB 10 billion)

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

5,896 6,000 5,679 5,792 5,154 4,846 4,867 5,000 4,665 4,345 4,000 3,628 3,425

3,000 2,622

2,000 1,265 1,268 1,344 1,452 971 1,083 1,103 925 916 777 800 1,000

730 704 745 798 870 814 771 748 764 833 0 483 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Output, thousand tons Exports, thousand tons Imports, thousand tons

Source: FAOSTAT

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

14 | Russian Forest Sector Overview 2018-19 Russian exports and imports of kraft paper and paperboard in 2018

Italy China

US$63,9 million US$132.3 million 8.8% of total exports, 18.3% of total exports, 9.1% year-on-year increase 73.6% year-on-year increase

Sweden Germany Finland

US$15 US$63.1 million US$4.6 US$14.4 million 8.7% of total exports, million million 34.3% of total imports 24.1% year-on-year increase 10.5% of total imports 32.8% of total imports

Russian exports and imports of corrugated paper and board in 2018

Estonia Kazakhstan

US$3.1 million US$0.9 million 10.9% of total exports, 3.2% of total exports, 100.0% year-on-year increase 79.0% year-on-year increase

Italy Belarus Lithuania

US$1.9 US$23 million US$1.4 US$1.5 million 80.4% of total exports, million million 21% of total imports 1.0% year-on-year increase 16.7% of total imports 16.9% of total imports

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

Belarus Kazakhstan

US$51.9 million US$47.5 million 29.9% of total exports, 27.3% of total exports, 17.4% year-on-year increase 7.2% year-on-year increase

Germany Ukraine China

US$55.4 US$21.1 million US$34.9 US$56 million 12.1% of total exports, million million 19.8% of total imports 16.9% year-on-year increase 12.5% of total imports 20.1% of total imports

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

Forecast production of container board in Russia in 2019-23, Forecast production of corrugated board in Russia, million thousand tons square meters 6,600 6,200 6,400 1,406 5,800 6,000 5,600

644

180 1,039 1,061 1,086 1,107 1,127 1,148 32

2017 2018 2019 2020-23 2018 2019 2020 2021 2022 2023 Production of corrugated packaging Production of corrugated board

Source: BFC Marketing Source: BFC Marketing

Russian Forest Sector Overview 2018-19 | 15 Household and Per capita consumption of household and sanitary paper in 2008-18, kilograms

22.0 22.1 22.0 sanitary paper 21.8 21.8 21.8 21.4 21.6 21.7 21.9 21.8

The household and sanitary paper market has been steadily growing in recent years. 15.6 15.8 Contributing factors are its low sensitivity 15.4 to economic shocks and volatility. 13.0 Demand for household and sanitary paper 11.9 11.1 10.4 9.8 increased by a 2.7% CAGR in 2013-18, 9.4 9.5 with the biggest growth, 33.8%, observed 8.4 6.9 6.9 in Indonesia, followed by Myanmar with 6.4 6.6 5.5 5.8 5.8 6.0 4.7 30.4%, Madagascar with 30.0%, Belarus 4.2 4.4 3.8 with 25.1% and Norway with 23.6%. 3.1 3.0 3.2 3.2 2.3 2.5 2.5 Household and sanitary paper production 1.5 1.4 1.6 in Russia rose by 11.7% in the period. Per capita consumption of household 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 and sanitary paper in Russia totaled Russia China Poland US 3.8 kilograms in 2018, with Russia lagging behind not only developed Source: FAOSTAT, Oxford Economics, EY analysis markets such as the US and Western Europe with annual per capita consumption exceeding 15 kilograms, Top five exporters of household and Top five importers of household and but also emerging economies such sanitary paper in 2018 sanitary paper in 2018 as China. Per capita consumption of Share of Share of Exports, Imports, household and sanitary paper in Russia global global USD’000 USD’000 is expected to grow and reach an average exports imports European level. Germany 1,549,510 30% Germany 1,128,729 23% Indonesia 528,745 10% US 534,574 11% Russia's exports of household and Turkey 362,646 7% UK 419,465 8% sanitary paper in 2018 Australia and New Italy 360,797 7% 196,936 4% Zealand 3% 1% 13% China 301,864 6% Italy 160,758 3% …. …. 34% Russia 36,182 1% Russia 10,949 0,2%

Source: FAOSTAT Source: FAOSTAT

17% US$108 million There were only four big players in Low consumption of household and the Russian market of household and sanitary paper in Russia creates the sanitary paper in the early 2000s. potential for local producers to ramp up Currently, 60% of the market is held by production. The price, quality and variety 32% the top five industry players, while one are becoming increasingly important more big player is expected to emerge to consumers as the consumption of Household and sanitary paper and other materials 7 (EAEU Classifier Code 4803) in the next three years . Strong demand household and sanitary paper is growing. Toilet paper (EAEU Classifier Code 481810) for household and sanitary paper has Smaller players can find it difficult in the Other household and sanitary products (EAEU increased competition, with small longer run to retain customers and their Classifier Code 481890) companies starting to enter the market. market shares, which can provide impetus Handkerchiefs, facial tissues and towels (EAEU Classifier Code 481820) Imports have been virtually driven out to market consolidation. Tablecloths and napkins (EAEU Classifier Code of the Russian market by domestic 481830) producers. Russia imported 6,700 tons Clothes and accessories (EAEU Classifier Code 481850) of household and sanitary paper in 2018 while producing 580,000 tons8. Source: Russia’s Federal Customs Service, Russian Export Center

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

16 | Russian Forest Sector Overview 2018-19 Russia’s production, imports and exports of household and sanitary paper Forecast retail trade in household and in 2008-18 sanitary products in Russia, RUB million 600 580

491 501 CAGR = 2.7% 500 445 79,867 420 400 77,377 330 333 310 75,180 300 73,275 213 71,516 200 191 185 70,051 51 2 3 4 2 4 7 6 14 32 38 100 6 20 19 24 28 28 30 31 6 5 7 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2018 2019 2020 2021 2022 2023 Output, thousand tons Exports, thousand tons Imports, thousand tons

Source: FAOSTAT Source: Euromonitor International

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

Poland Kazakhstan

US$10.4 million US$11.4 million 28.7% of total exports, 31.5% of total exports, 6.0% year-on-year increase 1.5% year-on-year increase

Belarus Switzerland Germany China

US$3.3 million US$0.9 million US$0.8 million US$1.5 million 9.0% of total exports, 8.9% of total imports 7.8% of total imports 13.7% of total imports 19.7% year-on-year increase

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

Belarus Kazakhstan

US$8.5 million US$20.9 million 11.8% of total exports, 29.2% of total exports, 30.7% year-on-year increase 2.1% year-on-year increase

Finland Germany China

US$8.5 million US$15.9 million US$10.6 million 11.4% of total imports 21.5% of total imports 14.3% of total imports

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

Russian Forest Sector Overview 2018-19 | 17 Plywood

Owing 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. Russia’s production, imports and exports of plywood in 2008-18 There has been a shortage of plywood 4,500 feedstock in Russia due to timber and 4,013 4,000 3,729 veneer exports to China. This shortage 3,607 3,759 3,540 has prompted big plywood producers 3,500 3,303 3,150 3,040 to start their own logging operations to 3,000 2,689 2,696 2,592 2,458 2,483 reduce dependence on external suppliers. 2,500 2,206 2,107 1,969 As part of measures to support the 1,758 2,000 1,717 1,512 1,600 woodworking industry, Russia introduced 1,326 1,334 quotas on exports of plywood feedstock 1,500 for the period from 1 January 2019 1,000 222 through 30 June 2019. 500 252 244 74 115 53 35 43 75 58 67 0 Experts expect steady growth in demand 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 for plywood, citing ongoing tensions in Output, thousand tons Exports, thousand tons Imports, thousand tons US-China trade relations that can drive Source: FAOSTAT exports to the US. Russian industry is prepared to ramp up production, with the completion of four major Top five exporters of plywood in 2018 Top five importers of plywood in 2018 investment projects in 2018, including Share of Share of Sveza Novator, CFMK, Novatorksoye Exports, Imports, global global USD’000 USD’000 Woodworking Plant and Belozerskles. exports imports In 2019, UPM Chudovo started to sell China 5,446,924 34% US 2,907,002 19% plywood made at its newly commissioned line. The Sveza Group is planning to Indonesia 1,694,381 11% Japan 1,507,011 10% implement projects in Vologda Region Russia 1,353,029 9% Germany 979,469 6% and Tyumen Region, while the Segezha Malaysia 1,217,856 8% South Korea 888,765 6% Group is planning to complete a project in Finland 660,397 4% UK 763,951 5% Kostroma Region. Source: FAOSTAT …. Russia 41,857 0,3%

Source: FAOSTAT

18 | Russian Forest Sector Overview 2018-19 Russia’s exports and imports of plywood in 2018

The US Finland

US$199.5 million US$59.4 million 14.8% of total exports, 4.4% of total exports, 37.7% year-on-year increase 0.8% year-on-year increase

Poland China

US$2.3 million US$14.6 million 5.3% of total imports 33.9% of total imports

The Netherlands Belarus

US$1.7 million US$13.7 million 4.0% of total imports 31.8% of total imports

Latvia Egypt Germany

US$56.9 million US$2.7 US$150.8 million US$113.4 million 4.2% of total exports, million 11.1% of total exports, 9.9% of total exports, 15.4% year-on-year increase 6.3% of total imports 56.8% year-on-year increase 29.9% year-on-year increase

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

OSB industries such as building repairs in down imports further. There are a dozen Russia. Wooden housing construction projects in the OSB industry’s pipeline is also a potential driver of demand for to build new plants in 2019-21. Planned Oriented strand board (OSB) is used as a OSB. Currently, measures are taken at a capacity additions will enable Russian substitute for plywood but it is cheaper government level in Russia to stimulate producers to fully satisfy domestic while being similar in durability. North investors and developers to use wood- demand. America and Europe are the major OSB based boards in housing and industrial consuming regions. Experts note similar trends in OSB building construction. consumption in Russia and abroad, The global consumption of OSB increased Russia’s OSB production capacity is warning that it may never return to its at a 5.7% CAGR from 24 million cubic expected to increase in 2019 following peak level observed in 2011-18. Growth meters in 2013 to 31 million cubic the launch of new large OSB plants, will continue at a moderate pace, but it is meters in 2018. The greatest growth, Kronospan and Talion Arbor, pushing unlikely to accelerate. 35.8%, was observed in Georgia. Trailing behind were China with 34.7%, Finland with 34.1%, Belarus with 29.3% and Top five exporters of OSB in 2018 Top five importers of OSB in 2018 Iceland with 28.5%. Experts expect global Share of Share of OSB production to grow by 6.2% annually, Exports, Imports, global global with the greatest increase, 6% to 7%, to USD’000 USD’000 exports imports come from the construction and furniture industry. The production of OSB-based Canada 1,738,002 54% US 1,630,201 51% packaging is to grow steadily, at no more Romania 217,449 7% Germany 260,418 8% than 5% a year. Germany 161,027 5% Russia 89,033 3% OSB production in Russia jumped by an Latvia 144,778 5% Japan 84,864 3% 9 impressive 68% in 2013-18, resulting Belarus 137,104 4% UK 80,557 2% in a considerable decline in imports in …. Source: FAOSTAT the last couple of years. OSB production is highly dependent on activity in the Russia 67,205 2% construction and furniture industries, Source: FAOSTAT as well as new demand for it from

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

Russian Forest Sector Overview 2018-19 | 19 Russia’s production, imports and exports of OSB in 2008-18 Forecast global OSB production, million square meters 1,400 1,356 19,634 1,200

1,013 1,000 14,015 14,411 797 13,187 800 710 10,934 11,394 618 571 9,783 600 547 390 7,025 372 367 393 388 6,618 360 400 297 298 257 197 200 37 101 114 64 40 68 20 30 9 15 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2018 2019 2020

Output, thousand tons Exports, thousand tons Imports, thousand tons Furniture Construction Packaging

Source: FAOSTAT Source: Mordor Intelligence

Russia’s exports and imports of OSB in 2018

Romania Kazakhstan

US$2.1 million US$20.5 million 2.3% of total imports 30.4% of total exports, 65,3% year-on-year increase Latvia China US$0.8 million 0.9% of total imports US$1.5 million 1.6% of total imports Chile Belarus US$5.1 million 7.7% of total exports US$84.1 million 92.6% of total imports

Ukraine Poland Finland Kyrgyzstan US$2.5 million US$1.9 US$4.4 million US$11.5 million 3.7% of total exports, million 6.6% of total exports, 17.0% of total exports, 63.6% year-on-year increase 2.1% of total imports 382.3% year-on-year increase 282.0% year-on-year increase

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

Particleboard the OSB market. Particleboard is the most completion of all projects in the current popular board in the furniture industry. pipeline. Global particleboard consumption grew Particleboard production in Russia Russia was among the world’s top five by a 2.9% CAGR to 96 million cubic increased by 13% to 8.4 million cubic exporters of particleboard in 2018. meters in 2013-18. China and Europe are meters10 in 2018, which can partly Particleboard exports, excluding OSB, the biggest consumers of particleboard, be attributed to the completion of the rose by 4.4% year-on-year to 21% of total accounting for a third and 44% of total Swiss Krono Priority Investment Project output in 2018. CIS countries are major global consumption, respectively. to start a new particleboard line, and destinations for Russia’s particleboard production increases at the Kronospan exports. The depreciation of the Russian Demand from the construction and and Tomlesdrev plants. As more capacity ruble in 2014-15 led to rapid growth in furniture industries is a key driver of additions should be expected in the exports. In 2017-18, Russia started to particleboard production, as is the case next couple of years, annual growth in supply particleboard to China, Chile and with OSB. However, Russia’s particleboard particleboard production can exceed Columbia. market has long been saturated, unlike 1.68 million cubic meters following the

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

20 | Russian Forest Sector Overview 2018-19 Tight competition from other board Russia’s production, imports and exports of particleboard in 2008-18 segments forces particleboard producers to introduce product improvements 9,000 8,400 on a regular basis. For instance, many 8,000 are focused on lowering board density 7,460 6,723 without a radical reduction in strength 7,000 6,634 6,555 6,591 6,573 6,183 properties. A new technology to make 6,000 5,751 composite panels of particleboard, 5,429 MDF and HDG has recently come into 5,000 4,562 widespread usage. This technology gives 4,000 durable board that is able to compete 3,000 with OSB. 1,703 1,778 2,000 764 784 1,544 575 562 1,257 411 377 1,016 324 430 1,000 472 248 231 423 Russia’s particleboard exports in 2018 229 253 233 254 275 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 7% 2% Output, thousand tons Exports, thousand tons Imports, thousand tons 3% 28% 4% Source: FAOSTAT

5% Top five exporters of particleboard Top five importers of particleboard 5% US$307 in 2018 in 2018

million Share of Share of Exports, Imports, 6% global global USD’000 USD’000 exports imports 7% Austria 757,452 13% Germany 610,137 11% 24% 8% Germany 594,900 10% Poland 398,404 7%

Kazakhstan Lithuania France 402,400 7% US 310,040 5% Uzbekistan Poland Thailand 387,569 7% UK 267,945 5% Azerbaijan Ukraine Belarus Armenia Russia 306,535 5% China 256,699 5% Tajikistan Other countries Source: FAOSTAT …. Kyrgyzstan Russia 62,299 1% Source: Russia’s Federal Customs Service, Russian Export Source: FAOSTAT Center

MDF/HDF Russia’s MDF/HDF imports have dropped Top five importers of MDF/HDF in 2018 to the minimum since 2014 following Share of capacity additions in the domestic Imports, Global demand for MDF/HDF rose at global industry. However, their imports picked USD’000 a CAGR of 2.4% from 2013 to 2017. imports up by 2.4% in physical terms in 2018. Hungary saw the greatest growth, 56.0%, US 998,538 14% followed by Iceland with 29.8%, Ghana Russia’s MDF/HDF exports rose by Iran 344,843 5% with 25.3%, Georgia with 20.8% and 18% year-on-year to 1.1 million cubic Canada with 18.2%. MDF and HDF are meters, or 34% of total output, in 2018. UK 335,156 5% made of wood fiber using the dry process. CIS countries, including Uzbekistan, Canada 307,117 4% Kazakhstan and Belarus, are the top MDF and HDF are both highly durable Germany 267,173 4% but highly priced. Demand for MDF/HDF consuming countries of Russian-made …. in Russia mostly comes from laminated MDF/HDF, with MDF supplied partly to flooring and door producers. Unlike China and marginally to the European Russia 137,754 2% other countries, Russia is not seeing the market. The weakening of the Russian Source: FAOSTAT replacement of particleboard with MDF/ ruble has made Russian exporters more HDF in the market, and MDF/HDF and competitive in international markets. laminated flooring based on MDF/HDF are mostly exported.

Russian Forest Sector Overview 2018-19 | 21 Russia’s MDF/HFD production is now Russia’s production, imports and exports of MDF/HDF in 2008-18 on the rise. Projects launched before 3,500 the 2014 crisis, including Kastamonu 3,147 2,970 and Egger, have made a significant 3,000 contribution to its growth. In 2019, 2,595 2,500 Altailes started a new MDF/HDF plant. 2,230 There are plans to commission more 2,000 1,885 plants in Russia in 2020-21, including 1,500 1,316 1,171 1,197 the MDF Asino Plant (a subsidiary of 1,078 1,003 1,110 1,066 618 903 Roskitinvest CJSC), the Igoresvkaya 1,000 435 702 689 628 344 548 292 Woodworking Plant (part of the Russky 171 193 336 500 100 297 304 193 177 184 246 255 Laminat group) and Kronospan’s plants 75 near Kaluga and in Primorye. Thus, 0 Russia’s MDF/HDF production is expected 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 to increase further, to up to 1.15 million Output, thousand tons Exports, thousand tons Imports, thousand tons cubic meters a year, in the mid run. Source: FAOSTAT

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

Share of CAGR = Exports, 4.2% global USD’000 exports 81 64 China 1,017,581 14% 63 CAGR = Germany 852,633 12% 3.5% CAGR = CAGR = CAGR = 3.3% 25 1.6% 3.3% Belgium 602,475 9% 20 21 8 Thailand 454,513 6% 6 6 5 5 6 4 4 5 Austria 316,758 5% Asia-Pacific North America Europe South America Middle East and …. Africa Russia 308,718 4% 2018 2019 2024

Source: FAOSTAT Source: Mordor Intelligence

Russian exports and imports of MDF/HDF in 2018

Romania Uzbekistan

US$27.1 million US$79.5 million 8.8% of total exports, 25.7% of total exports, 10.4% year-on-year increase 54.7% year-on-year increase

Germany Belgium

US$45.6 million US$9.9 million 33.0% of total imports 7.2% of total imports

Poland China

US$7.9 million US$21.4 million 5.7% of total imports 15.5% of total imports

Belarus Azerbaijan Kazakhstan

US$23.2 million US$30.5 US$15.2 million US$48.5 million 7.5% of total exports, million 4.9% of total exports, 15.7% of total exports, 6.7% year-on-year increas 22.1% of total imports 52.5% year-on-year increase 67.3% year-on-year increase

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

22 | Russian Forest Sector Overview 2018-19 Wood pellets The fuel pellet market in Russia is yet products for compliance with European at its nascent stage as companies are standards, although this is not always not rushing to shift from coal to wood- possible for smaller companies. The production of wood pellets is on based biofuels. There are no government the rise. Global consumption grew by Russia’s production capacity for wood incentives to stimulate the consumption a 9.1% CAGR in 2013-18. Government pellets continued to increase in 2018-19. of renewable energy. Currently, Russia initiatives to stimulate the consumption The Segezha Group started a wood pellet does not have any large consumers that of environmentally friendly fuels are a plant in Krasnoyarsk Krai in late 2018. could offer wood pellet producers a price key driver of demand for wood pellets. Two more new plants, Kharovsklesprom comparable to their export prices to However, the growth of the wood pellet in Vologda Region and Solnechny Krug support their profit margins, adjusted for market may slow down amid increasing in Khabarovsk Krai, were commissioned transportation costs. competition from other alternative in early 2019. The wood pellet industry energy sources. Despite slowing production growth, the has more than 10 projects in the pipeline, Russian wood pellets market is attractive including two large-scale projects that The annual production of wood pellets to investors. There are big and smaller ULK LLC plans to implement in Ustyany in Russia has grown by more than 7% players in the Russian market, with many and the Pinega district. since 2015, seeing a record growth rate domestic producers certifying their of 21% in 2017. However, growth slowed down to 7.1%11 in 2017. The contributing factors were low utilization rates of newly Top five exporters of wood pellets Top five importers of wood pellets commissioned plants and a shortage of in 2018 in 2018 feedstock as wood residues were mostly Share of Share of Exports, Imports, used to produce particleboard and global global USD’000 USD’000 fiberboard. exports imports Russia exports almost all of its output of US 809,855 22% UK 1,317,163 34% wood pellets. Denmark, Italy, Sweden and Canada 377,759 10% Denmark 605,297 15% other EU countries were top destinations Vietnam 354,000 10% South Korea 521,771 13% for Russian-made wood pellets in 2018. Experts also expect increased demand Latvia 255,140 7% Italy 474,179 12% for Russian wood pellets from Asian Austria 199,009 5% Belgium 179,638 5% countries that have not yet introduced …. …. tight certification requirements. Russia 186,166 5% Russia 1,834 0,05%

Source: FAOSTAT Source: FAOSTAT Russia’s exports of wood pellets in 2018

6% Russia’s production, imports and exports of wood pellets in 2008-18 2% 4% 1,800 4% 2,000 1,680 4% 44% 1,500 1,290 1,511 974 1,439 913 5% 1,000 US$186 791 684 1,073 879 935 5% million 500 729 744 1.11 1.47 1.34 2.18 2.80 4.89 2.09 0 6% 2012 2013 2014 2015 2016 2017 2018

Output, thousand tons Exports, thousand tons Imports, thousand tons 9% Source: FAOSTAT 11%

Denmark Latvia Italy Lithuania Forecast global demand for wood pellets, thousand tons Sweden Finland UK France 51,205 47,035 Netherlands Other countries 15% South Korea 41,263 14% 7% 37, 361 UK 16% 7% 6% Source: Russia’s Federal Customs Service, Russian Export 33,032 7% Japan 17% 8% Center 29,825 16% US 27, 31 3 17% 9% 8% 17% 16% South Korea 22,556 14% 11% 8% 12% 18% 18% 13% 9% 14% Denmark 12% 10% 17% 11% 8% 14% 17% 5% Belgium 13% 15% 12% 16% 17% 18% 13% 11% 13% 15% 15% Other 9% 38% 28% 40% 35% 32% 25% 22% 21% 11 Data from FAOSTAT may differ from Russian official 2018 2019 2020 2021 2022 2023 2024 2025 statistics due to different calculation methods used to determine some indicators Source: FutureMetrics

Russian Forest Sector Overview 2018-19 | 23 Investment attractiveness of the forest sector

Forest sector M&A deal multiples12 in the global forest sector multiples globally 12.2 x

8.8 x 8.3 x 8.6 x The forest M&A market did not see any 7.7 x fundamental shifts in 2018. According 5.7 x to Capital IQ, 313 M&A deals were announced or completed in the forest 1.3 x 1.4 x 1.6 x sector in 2018, one deal more than a 1.2 x 0.9 x 0.8 x year earlier. M&A activity in the forest 2014 2015 2016 2017 2018 2019 sector slightly increased in 2017-18 EV/EBITDA EV/Revenue compared with 2016. The top forest M&A deal in 2018-19 was a merger Source: Capital IQ of two Brazilian pulp and paper giants Suzano Papel e Celulose S.A. and Fibria M&A activity in the forest sector demonstrating robust growth. The largest Cellulose S.A., announced in March 2018 is concentrated in the paper, pulp 2017-18 deals in value terms were also and closed in January 2019. The deal and packaging industries, which are concluded in these industries. exceeded US$14 billion, resulting in the creation of the world’s biggest pulp producer holding around 17% of Multiples13 by industry and M&A deals in the global forest sector since 2014 the global market. Other top deals in

2017-18, worth US$2 billion to US$7 7.5 x Timber industry billion, were struck in the US, China 1.0 x and Brazil. 7.9 x Pulp and paper industry 1.2 x

9.1 x Packaging industry EV/EBITDA 1.0 x EV/Revenue

8.9 x Board production 1.2 x

8.2 x All industries 1.1 x

Source: Capital IQ

12 Median, excluding discounts and premiums. Extreme multiples (EV/EBITDA > 50 or EV/Revenue > 20) were not used 13 Median, excluding discounts and premiums. Extreme multiples (EV/EBITDA > 50 or EV/Revenue > 20) were not used

24 | Russian Forest Sector Overview 2018-19 Operational EBITDA margins of Russian producers and international public companies performance 50% 46% 46% 44% 45% In 2018, median EBITDA margins of sample international public companies 37% 37% remained at the same level as a year earlier, approximately 13%. The highest 36% EBITDA margin reported totaled 50%, 33% a record high for the last five years. Median profit margins vary from 12% 23% 20% to 15% depending on the industry, with 19% companies in the paper and pulp industry 21% 17% 17% reporting the highest margins. 12% 12% 13% 13% 13%

Russia’s forest sector companies mostly 8% 8% do not disclose their financial statements 9% to the public. As Russia's forest sector companies mostly do not disclose their financial statements to the public, it is 2014 2015 2016 2017 2018 difficult to evaluate overall performance Maximum Ilim Segezha Kommunar Paper Mill Median in the sector based on financial results disclosed by some players (including the Source: Capital IQ, companies’ financial statements Ilim Group, the Segezha Group and the Kommunar Paper Mill). However, margin increases of 6% to 12% reported by the How will EBITDA margins change in 2019? three companies in 2018 may indicate growth in profits across most Russian 0% Decrease by over 5% companies. 11%

Respondents asked in our most recent 0% Decrease by 3-5% survey offered a more conservative 16% outlook for 2019 compared with a year 53% earlier. Only 43% of companies expected Will not change (+/- 3%) EBIDTA margins to increase in 2019, 32% which was 4% less than earlier. As many 29% Increase by 3-5% as twenty-seven percent projected that 32% they would decline. Respondents cited the worsening of the market environment 18% Increase by over 5% due to higher feedstock prices, lower 11% prices of finished products and increased competition. 2018 2019

Source: EY and ASPPI Survey

Russian Forest Sector Overview 2018-19 | 25 Investment appeal of Russia’s forest sector

M&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.

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

Deal value, Target company Buyer Deal date Interest acquired USD million SFT Group14 Prinzhorn Group 19 April 2019 n/a 50% Solomenskiy Lesozavod PJSC Bravarus Limited 20 March 2019 n/a 100% 8.4% (an increase Solomenskiy Lesozavod PJSC Nemplast Limited 26 February 2019 n/a to 100%) 99% (an increase Porosozero LLC Solomenskiy Lesozavod PJSC 31 January 2019 n/a to 100%) Shujales JSC Solomenskiy Lesozavod PJSC 30 January 2019 n/a 63.1% 1.04% (an increase Zelenodolsk Plywood Plant OJSC S. Kogogin 29 January 2019 n/a 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

14 www.prinzhorn-holding.com

26 | Russian Forest Sector Overview 2018-19 According to respondents, M&A deals in What were your investment priorities in the last couple of years and what are Russia are mostly driven by the diverse they this year? structure of the market, which has a big number of small players and only a few 71% Productivity enhancement and cost big companies. The current economic 73% management at existing facilities situation in Russia makes it increasingly 71% difficult for smaller players to compete, while big players are interested in buying 53% small businesses to obtain access to Capacity additions at existing facilities 59% feedstock and expand capacity. 67% Only 10% of respondents in our survey 29% Production shift to value-added 59% indicated plans to acquire existing products businesses as part of their investing and 43% financing activities. Investment programs 59% in the industry are mostly focused on Entry into new markets 41% expanding market footprints. Among 48% their top priorities, respondents cited better productivity, lower costs, capacity 0% Disposal of low-grade timber and waste 41% additions, entry into new markets and a from main production processes shift to value-added products. 33%

With respect to financing sources, it is 24% Debt reduction and financial 41% important to note the limited access flexibility to capital, as almost none of the 33% respondents indicated plans to raise 76% funds in highly liquid capital markets. Replacement of worn-out 36% Currently, Russian players can count equipment 38% only on earnings reinvestment, with the finance raising potential being limited, or 18% Better access to resources through debt, which debt that is quite expensive 27% forest land leases in Russia. Thus, subsidized interest rates 33% play a crucial role in the competitiveness 0% of investment projects in the forest Autonomous power generation 27% sector. More than half of respondents, systems 38% 55%, noted no changes in access to debt in 2018, while 36% said that access had 12% Acquisition of companies in the become easier. 14% forest sector 10%

0% Disposal of non-core assets/business 14% 0%

0% Product quality improvement 5% 5%

0% Search for investors and partners 5% to build a plywood plant 5%

0% Disposal of core business in the 0% forest sector 0%

2017 2018 2019

Source: EY and ASPPI Survey

Russian Forest Sector Overview 2018-19 | 27 What sources of financing does your company plan to use this year to expand /support current operations?

72% Bank financing How has access to debt changed this year 77% compared with a year earlier?

78% Equity 68% 6% It has worsened 28% 9% Equipment leasing 45% It has remained 50% 22% unchanged 55% Shareholder loans 18% Loans have become 44% easier to obtain (more 11% Proceeds from the sale of affordable) 36% assets 14%

Private share placement/funds 6% 2018 2019 from a strategic investor 9% Source: EY and ASPPI Survey

0% Bond issue 5% 2018 0% 2019 Public offering (IPO)/ ICO 0%

0% ICO 0%

Source: EY and ASPPI Survey

The investment attractiveness of How has the investment appeal of the forest sector changed this year? the forest sector, as perceived by respondents, did not change significantly 72% 73% 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 23% respondents noting negative trends 17% 11% dropping. 5% 0% 0% According to respondents, the key trend Can’t say Significantly No significant Significantly that will shape Russia’s forest sector worsened changes improved in the next three or five years will be the commissioning of new production 2018 2019 capacity, as there are plans to implement Source: EY and ASPPI Survey a big number of investment projects and close inefficient facilities. How will your company’s investments in current operations and capacity expansion Other possible trends include an increase change this year from the year before? in transportation costs, advanced wood processing and integration between 38% logging and woodworking companies. 31% 29% M&A activity is low, but companies 25% 25% believe that there is a potential to give it a spur. 14% 13% 10% 6% 5% 5% 0% 0% 0%

Decrease by Decrease by Decrease by Will not change Increase by Increase by Increase by over 70% 40-70% 10-40% (+/- 10%) 10-40% 40-70% over 70%

2018 2019

Source: EY and ASPPI Survey

28 | Russian Forest Sector Overview 2018-19 What were your priorities as part of investing and financing activities? Areas that offer considerable savings opportunities include electricity, spare parts and materials, as well as 65% Capacity additions transportation costs. According to the 77% survey, 41% of companies believe that 65% increasing transportation costs will Withdrawal of inefficient capacity 45% affect growth, with 37% saying that they have the potential to cut such costs. Expansion of Russian players 12% Transportation costs are higher when into new markets 41% wood is procured from remote logging

0% operations, affecting the competitiveness Higher transportation costs 41% of forest products. Companies in the forest sector have repeatedly 47% highlighted the need to develop adequate Advanced wood processing 36% infrastructure to satisfy the needs of the sector. Integration between logging and 47% woodworking companies 36% (vertical integration)

0% Industry digitalization In your opinion, what areas offer your 36% company the biggest opportunities to cut costs and increase margins? Introduction of intensive forest 29% management practices 32% Electricity 0% Increase in the collection of 50% waste paper 27% 47%

0% Cost efficiency Spare parts and materials 27% 50% 47% Increased presence of foreign players in the 0% Russian forest sector 23% Third-party transportation services Market consolidation (horizontal 0% 0% integration) 23% 37%

Increased production from recovered 0% Diesel fuel or natural gas materials 18% 0% 32% 29% Innovative wood products 14% Other energy sources 19% Self-sustaining wood burning 29% 26% power stations 14%

Deployment of innovative equipment 12% Repairs of fixed assets by external providers and robots 14% 0% 26% Production shift to more promising 0% segments 14% Labor costs, including payroll and social contributions Forest infrastructure development and 0% 19% construction of forest roads 14% 5%

0% Other Lower credit burden 14% 13% 16% 0% Production diversification 9% 2018 2019 29% Other Source: EY and ASPPI Survey 5%

2018 2019

Source: EY and ASPPI Survey

Russian Forest Sector Overview 2018-19 | 29 Priority Investment Projects

The 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.

Top five Priority Investment Projects by value

Investment, Investor Region Project Status RUB million

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

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

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

Итого 254,309

Source: Russia’s Ministry of Industry and Trade

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.

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

24 19 14 66 11 4 101.35 518 33 15 339 17 4 3.74 29.60 12.56 11.57 84 16

2015 2016 2017 2018 H1 2019 Pulp and Wood-based Woodworking Pellets/ paper boards biofuel

Investments in completed projects, Number of completed projects Investment, RUB billion Number of projects RUB billion

Source: Russia’s Ministry of Industry and Trade Source: Lesnaya Industria magazine

As many as 131 investment projects More than RUB 500 billion is to be spent The investment appeal of Russia’s wood- worth more than RUB 958 billion, on the development of the pulp and based board industry remains high due to including PIPs, are expected to be paper industry in Russia. Most of this an increase in exports and the growth of implemented in the forest sector in sum will go toward packaging paper the domestic market. However, demand 2019-23. Most of them, 84, will be and paperboard production projects varies depending on the type of such implemented in woodworking, accounting focusing on the construction and upgrade boards. Feedstock shortages and high for less than 10% of total investment. of facilities. This industry is rapidly transportation costs hinder investment Despite low margins, investments in developing around the world and Russia is projects in this industry in Russia. sawmilling operations are on the rise, striving not to lag behind. Another driver driven by increasing demand from the is stronger global demand for coniferous Chinese market as the industry is highly pulp and products made from such pulp. export-oriented.

30 | Russian Forest Sector Overview 2018-19 Completed Priority Investment Projects in 2018 and the first half of 2019

Investment, Completed investment projects Region Project RUB million

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

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

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 Vologda Region Plywood production capacity expansion 696 Plant JSC

Sveza Novator Vologda Region Plywood plant upgrade 687

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

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

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

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

Total 18 projects 55,306

Source: Russia’s Ministry of Industry and Trade

Russian Forest Sector Overview 2018-19 | 31 Risks Key risks to the investment appeal of Russia’s forest sector

Respondents asked in the EY and Access to capital/investment liquidity 45%

ASPPI 2019 Survey cited access to Regulatory uncertainty 41% capital/investment liquidity, regulatory uncertainty, the scarcity of forest Scarcity of forest resources 36% resources and external volatility among External volatility 32% the key risks affecting Russia’s forest sector. Feedstock exports and shortages 27%

Environmental standards 27% 1. Capital access/liquidity risks Poor protection of ownership rights 27% Overall, access to credit remains a challenge for Russian companies Inflation and foreign exchange risks 27% compared with international financial markets despite some improvements Lack of skills 27% cited by respondents. Loans bear Energy costs 23% high interest rates, while security requirements are extensive. Russian Tight competition in Russia 23% producers can compete with other players Transportation costs 23% in international markets but they are often beaten out because of high credit Increased costs associated with felling fees 18% and forest land leases costs in Russia. Apart from high interest rates, access is complicated by elaborate Drop in the purchasing power of consumers 18% lending procedures and difficulties with Geopolitical risk 18% obtaining long-term loans. As there are a big number of requirements that must Innovation shortage 5% be satisfied to qualify for reduced interest rates, soft loans are usually granted only Source: EY and ASPPI Survey to holding companies.

Forest sector projects have long payback 2. Regulatory uncertainty 3. Forest resource scarcity periods, especially capital-intensive Respondents ranked regulatory Competition for forest resources projects in the pulp and paper industry. uncertainty as the second most increased in 2018, pushing up their Increases in debt costs after the start of a significant risk for the forest sector. prices. Upgrades and the commissioning project may force investors to mothball it. Despite the government’s efforts to of new plants are the key factors driving According to respondents, it is extremely protect local businesses, boost value- domestic demand for forest resources. difficult to obtain bank finance for a added exports and improve the overall Russia holds 20% of the world’s forest project with a payback period of seven to investment attractiveness of the forest land and one-quarter of the world’s eight years. It is easier to borrow funds sector, domestic players are concerned wood reserves, but, paradoxically, local for financing working capital, but high about the current legislative framework companies are experiencing shortages interest rates may strip the company and its rapid changes that extend beyond of forest resources. Extensive forest of free cash to expand and upgrade its the forest sector. exploitation, wildfires and illegal logging production facilities. Thus, forest sector pose the biggest threats to forests in companies are left with little choice but to The logging business is dependent on Russia. The increasing scarcity of forest focus on investment projects with quicker a long period of forest reproduction as resources makes forest sector companies returns. forest areas may take 50 to 100 years turn to operations in less economically to recover after logging. At the same The Russian authorities are taking attractive areas that are associated with time, it takes two to 10 years to build and steps to improve the investment higher transportation costs resulting in commission a woodworking plant under attractiveness of the forest sector. For higher prices of finished products. an investment project that will start to instance, subsidies are available to partly pay in four to eight years. This means Inefficient re-forestation practices and compensate companies for loan interest. that companies need a stable regulatory unsustainable logging observed in Russia Like other exporters of non-commodity environment to run investment projects. for many years have led to a decline in goods, forest sector companies are However, the legislative framework commercial forest resources. Currently, also entitled to transportation cost regulating the forest sector is revised more commercially valuable conifers subsidies. annually. A national forest sector policy are being replaced with broadleaved is needed, along with amendments to species, birch and aspen. The authorities the Forestry Code, to improve regulatory are looking for solutions, introducing a certainty in the longer term and reduce temporary ban on veneer exports in 2019 regulatory risk. and considering a complete ban on raw

32 | Russian Forest Sector Overview 2018-19 timber exports. However, more efficient Higher industry risks increase returns less sensitive to macroeconomic volatility measures to mitigate shortages of forest required by investors, as evidenced by an as opposed to boards that are used in resources could be the promotion of analysis of expected and actual returns construction. intensive15 forest exploitation practices, across economic sectors against beta. It is rather difficult to predict how global robust control to prevent illegal logging The beta value in the oil & gas and metals trends might impact the forest sector, and a transparent system to track wood sectors ranges from 1.3 to 1.5, according but there are ways of mitigating risks, reserves. to Aswath Damodaran. These sectors are including changes in the global market highly cyclical. The beta value for power environment. For instance, it is possible 4. External volatility and utilities companies stands between to account for some trends using The Russian forest sector is highly 0.6 and 0.8 (Aswath Damodaran's data) various indicators. At the same time, the oriented toward exports, which as the sectors are more stable and less diversification of investment portfolios contributes to its exposure to the dependent on economic cycles. remains the most common approach to mitigating risks. changing external environment. The beta value for companies in the forest Investors’ risks associated with external sector exceeds 1.0. This means that volatility can be measured using the beta returns can dramatically decline during coefficient that determines the degree economic recession. Investments in the of systematic risk as opposed to asset- forest sector are risky even in developed specific risk and shows how changes in economies. However, the degree of an asset’s returns correlate with changes market risk can obviously depend on the in the market’s returns. If an asset has a industry. For instance, the biofuel industry beta of more than 1.0, this indicates that that produces feedstock for electricity is 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

Russian Forest Sector Overview 2018-19 | 33 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.

Government support mechanisms that may have the greatest impact on the forest Respondents cited tax benefits and sector in the next five to seven years changes in customs regulations among the initiatives that are stimulating forest sector projects most in 2019. Restrictions on exports of roundwood and 78% other raw materials 77% At the same time, the percentage of companies applying tax benefits dropped 72% Tax benefits for projects in the forest sector in 2019 despite the recognition of their 77% important role for project activities. This is probably due to the complicated Financial support of projects in the 61% forest sector 59% process of applying for tax benefits as well as business concerns about possible 56% disputes with the tax authorities. Financing of construction of forest roads 68% Forest sector companies need to study Special Investment Contracts, incentives for projects 50% available tax benefits to apply them on in advanced development zones and other designated support mechanisms 41% a larger scale and rule out any disputes with the tax authorities. Increased spending on forestry education and 33% scientific research 32% Priority Investment Projects and Special Investment Contracts are the most State procurement contracts for forest products, including 28% incentives for construction projects using innovative popular government initiatives among materials based on timber 32% investors. However, a big number of companies use none of the available 22% Import substitution regulations for the forest sector 27% instruments. Possible reasons may include non-compliance with eligibility 22% criteria, which is unlikely given the Financial support for the seed plantation industry 36% abundance of tax benefits and the eligibility scope, as well as low awareness 22% Simplification of lease procedures for forest land and a poor understanding of how the 18% 2018 company can apply available tax benefits. 2019 17% It is feasible to study all available tax Amendments to customs regulations 18% benefits and potential reform areas, including the development of a regulatory

Source: EY and ASPPI Survey

34 | Russian Forest Sector Overview 2018-19 framework for Special Investment Given the recent proposal by the A shortage of internal resources that are Contract 2.0, to determine how they can Russian Ministry of Finance to introduce needed to technically address the issue is be best applied to a specific company or an environmental tax by amending usually a key barrier. project. the Tax Code (for details see below), However, it is feasible to consider such steps are being taken to harmonize According to the survey, tax regulations initiatives as they can deliver significant environmental regulations with tax laws. are not at the top of the agenda of the value and give the company leverage in An overwhelming majority of respondents Russian forest sector. Companies are negotiations with the tax authorities. surveyed in 2019 said that they had more worried about the distribution of opportunities to improve their tax forest resources and environmental laws. efficiency.

Government support mechanisms used by the forest sector in 2018-19 Availability of opportunities to improve tax efficiency in 2019

67% Federal and regional subsidies 74% Yes 62% 67% Special tax regimes 42% No 19% We don’t know, we have 20% 19% Support of development institutions never thought about it 32%

Source: EY and ASPPI Survey 33% Other 2018 16% 2019

Source: EY and ASPPI Survey

Government incentives that forest sector companies Key regulatory challenges for Russia’s forest sector currently use or plan to use to reduce their tax burden in 2019 (as of 2019)

Priority Investment Project 37% Allocation of forest resources 55%

Special Investment Contract 37% Environmental regulations 55%

None, because we cannot obtain Construction standards and 32% 36% access to any operational principles

Advanced development zone 26% Import/export duty 36%

Regional Investment Contract 11% Tax legislation 14% None, because we do not understand what mechanisms are 11% Other 5% efficient

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

Russian Forest Sector Overview 2018-19 | 35 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 The finance ministry proposes replacing and recycling fees paid by producers charges for negative environmental and importers of vehicles, including impact with an environmental tax to trailers and self-propelled vehicles, will be Reform of non-tax payments be imposed on legal entities and sole incorporated into a single recycling fee In January 2019, Russia’s Ministry of entrepreneurs for environmental damage applicable to an extended list of taxpayers Finance published for public discussion caused by their operations in Russia, and taxable items. Different recycling fee a draft of amendments to Parts 1 and 2 including on its continental shelf, in the rates will apply to goods and packaging of the Tax Code introducing the following exclusive economic zone or in the Russian subject to recycling after the loss of their federal payments: part of the seabed of the Caspian Sea. consumer properties, and to trailers and self-propelled vehicles. • Environmental tax This tax will be charged on emissions of air and water pollutants from stationary Following a discussion on the draft • Recycling fee sources, discharges of pollutants into amendments to the Tax Code with the • Federal road fee water sources and the disposal of business community, the authors added • Tax on public communication network production and consumption waste. a provision allowing companies to recycle operators Fixed rates will apply to different types of waste using their own resources, as they negative impact, depending on the type are currently allowed to do. Companies plus one local tax: of pollutant. that recycle goods and packaging on their • Hotel fee own will be eligible for a tax deduction Environmental fees currently paid by of no more than the product of all sales companies that produce or import in the 12-month fee period and the consumer products, including packaging, applicable recycling quota in this period. but do not recycle waste from their use,

36 | Russian Forest Sector Overview 2018-19 The entry into force date is still under Court practice on the classification of The lower court, based on an expert consideration. The draft law, if adopted in movable property as immovable opinion, took sides with the tax 2019, will enter into force on 1 January authorities that maintained that the fixed Pursuant to amendments to the Russian 2020.16 Taxpayers failing to pay new assets in question should be subject to Tax Code made by Federal Law No. 302- taxes fully or partly will be subject to a tax as they are not intended to function FZ of 3 August 2018, movable property fine equal to 10% of the unpaid amount separately from the primary asset (the ceased to be taxable as of 1 January from 1 January 2020 through shop) and cannot be removed or replaced 2019. Currently, taxpayers face an 31 December 2029. without prejudice to the building’s increased risk of their movable property designated use. The appeals court upheld We recommend keeping a close eye on being reclassified as immovable. the lower court, adding the following: the evolution of the regulatory framework When seeking to prove their case pertaining to charges for negative • The argument that equipment can be in disputes over the classification environmental impact and environmental dismantled and sold does not negate the of property, the tax authorities cite tax. It is important to note that new lower court’s conclusion. attributes of immovable property and articles of Russia’s Administrative indivisible items as set out in civil laws • The taxpayer’s argument that there is Offenses Code applying to producers and such an inseparability of an item from no registered title to the fixed assets is importers of goods and packaging took land, the impossibility to move an rejected. The absence of registration effect on 17 June 2019, including Article item without causing disproportionate does not disprove the fact that the 8.5.1 on violations of the procedure for damage to its designated use17 or the assets in question constitute an submitting reports and Article 8.41.1 on impossibility of dividing an item in kind integrated indivisible item. the failure by producers and importers without destroying or damaging it or of goods using external providers of • The accounting method used for the modifying its designated use18, and recycling services to pay the required fee fixed asset does not automatically as established through court practice, in a timely manner. Thus, the failure to classify this asset as movable or including attributes such as technological pay the environmental fee is currently immovable property. A fixed asset connection. punished by a fine of RUB 5,000 to RUB recognized in accounting as several 7,000 for officials and a fine equal to One of the most illustrative cases inventory items may constitute a single triple the amount of the unpaid fee, but considered in the last two years was a immovable item. no less than RUB 500,000, for legal case against Timber Mill No. 2519 CJSC The Federal Arbitration Court of the entities. that was denied tax benefits for movable Northwest District supported the above property20 and ordered to pay additional findings and rejected the taxpayer’s tax amounts with respect to this property claims. (a wood pellet line, cross transfers and automated anti-fire system) reclassified The case was subsequently heard by the by the tax authorities as immovable. Supreme Court.

16 Excluding the hotel fee that will be introduced on 1 January 2022 17 Article 130 of Russia’s Civil Code 18 Article 133 of Russia’s Civil Code 19 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 hearing 20 Article 381.25 of the Russian Tax Code

Russian Forest Sector Overview 2018-19 | 37 The Supreme Court ruled the following: • An analysis of individual cases should To avoid the assessment of additional tax not depend on expert opinions amounts due to the above and minimize • Tax laws must contain clear and or specific requirements for item overall tax risks, we recommend the precise criteria for movable property installation and operation – for example, following: items that have attributes allowing on climate conditions requiring that the their reclassification for property tax • Using a uniform documented approach equipment be housed in a building to purposes. Tax rules must be formally to accounting for such fixed assets so ensure its normal operation. well-defined, meaning that they must that they are recognized according to be sufficiently precise to be properly • Nevertheless, the court upheld the the same standards or classifications understood and applied. tax authorities’ right during a tax • Adopting uniform rules for the audit to check for signs that an item • The taxation of corporate assets is made assignment of available groups or of immovable property (a building or definite by means of formal accounting types of fixed assets to OKOF codes, structure) can be treated in accounting criteria for treating a taxpayer’s depreciation groups and useful lives to separately to avoid assets tax. property (movable and immovable) as perform a comprehensive functional fixed assets Based on these arguments and analysis of available fixed assets conclusions, the Supreme Court reversed • The Russian Classifier of Fixed Assets • Using OKOF codes in assigning a fixed the appealed part of the court decisions (OKOF) is the principal classification asset to movable or immovable property and sent the case back to the lower court applied to fixed assets for accounting for a new hearing.21 • Preparing a defense case for assets purposes. that may lead to a dispute with the tax Despite the positive outcome of this case • In accordance with the OKOF, as it was authorities so that the company could for the taxpayer, it is yet early to speak when the fixed assets were recognized effectively support its position based on of any fundamental change in the tax in accounting, the assets in question specifications, accounting policies and authorities’ approach to the classification were intended to support the production expert opinions. of property as movable. In particular, the of finished products, rather than Supreme Court’s ruling has introduced EY can provide comprehensive support to building operations, and should thus the ‘designated use of an item’ as a new taxpayers in the matters described above. be treated like fixed assets such as tax criterion, suggesting that a decision machines and equipment. should be made whether the designated Special Investment Contract 2.0 • The fact that equipment is installed in a use of an immovable property item specially constructed building, including in question (e.g., a building) is a use In August 2019, Russia published a the fact that subsequent dismantling that supports its normal operations or federal law25 that is part of a package of and moving the equipment would entail a manufacturing process. Since this laws introducing significant amendments additional costs and partial liquidation of criterion requires judgment, taxpayers to the regulatory framework for Special the building, does not in itself mean that and tax authorities may take diametrically Investment Contracts. This law outlines the equipment is a building accessory. opposite positions. changes in tax benefits available to investors under such contracts. • The expert opinions are essentially an Property uses are also often an issue in assessment of the economic feasibility disputes with the tax authorities over New eligibility criteria for profits tax of dismantling the equipment if it is the useful life of fixed assets as well as benefits are the following: subsequently decided to move the codes under OKOF and the Classification • Investors must account separately for facility. of Fixed Assets by Amortization Group. income/expenses attributable to the Such disputes also arise in connection • In other words, these conclusions investment project that is implemented with a functional analysis performed by concern matters that are not relevant under the Special Investment Contract the tax authorities to revise the OKOF to the case and are inadmissible as and income/expenses attributable to code, classification or useful life of a fixed evidence, since they do not prove that other activities. asset. Both courts and tax authorities the assets acquired by the taxpayer build their cases on designated uses of Previously, Special Investment were wrongly classified as equipment fixed assets,22 industry regulations,23 Contracts entitled investors to a that can be accounted for as separate specifications or the manufacturer’s reduced profits tax rate only when inventory items. recommendations regarding the asset in revenue from contract-related activities question.24 exceeded 90% of their total revenue.

21 As of the date of this Report, the date of a new hearing was not yet known 22 Resolution of the Federal Arbitration Court of Volga-Vyatka District of 18 February 2013 in Case No. А29-4831/2012 23 Determination of the Supreme Court of the Russian Federation No. 304-KG18-11694 of 10 August 2018 in Case No. А67-4196/2017 24 Determination of the Supreme Court of the Russian Federation No. 304-KG17-14299 of 13 October 2017 in Case No. А27-26491/2015 25 Federal Law No. 269-FZ “On Amendments to Parts One and Two of the Tax Code of the Russian Federation” of 2 August 2019

38 | Russian Forest Sector Overview 2018-19 This threshold was lifted under the new International tax laws The MLI will apply simultaneously with rules, with investors only required to existing tax treaties, meaning that account for financial results under the taxpayers will be required to compare Special Investment Contract separately MLI ratification the contents of the applicable tax treaty to apply a reduced rate to income from In April 2019, the Federation Council, with the contents of the MLI and positions related activities. the upper house of the Federal Assembly taken by both jurisdictions that are parties to this tax treaty. • Reduced profits tax rates under Special of Russia, approved a law ratifying the Investment Contracts will now be Multilateral Convention to Implement The MLI will considerably tighten granted for the entire project duration. Tax Treaty Related Measures to Prevent eligibility requirements for benefits Base Erosion and Profit Shifting, known under tax treaties, introducing the Previously, they were available to internationally as the Multilateral principal purpose test, a requirement any investor only until 2025. Under 26 Instrument (MLI). that a taxpayer should hold a minimum the new rules, tax benefits will be amount of shares or interest in a Russian granted until the reporting/tax period The objective of the MLI is to allow company to apply a reduced tax rate to in which the Special Investment governments to modify existing tax dividends, and other limitations. Contract terminates, but not beyond treaties in an efficient manner to address the reporting period in which total the intentional transfer of income to The MLI will take effect on the first day of income and tax benefits granted under jurisdictions where it is exempt from tax the month following the three calendar the Contract exceed 50% of capital or subject to reduced tax rates, causing months from the date the instrument of expenditures for the investment significant tax revenue losses. ratification is deposited. Russia deposited project. MLI signatories are required to adopt a its instrument of ratification for the list of tax treaties that the MLI will cover Multilateral BEPS Convention on 18 June and determine exceptions for optional 2019. Thus, the MLI will take effect for provisions and how they will comply with Russia on 1 October 2019. agreed minimum standards.

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

Russian Forest Sector Overview 2018-19 | 39 The effective date of the MLI differs from We recommend companies with • Exemptions will apply if the tax liability its entry-into-force date. For withholding operations in the EU to adopt procedures arose before 1 January 2019 and the tax, the new rules will start to apply from for monitoring compliance with the respective asset (property) is reported 1 January 2020, covering the tax treaties new rules that are aimed at deterring in the return, with the exception of a that have been ratified by the other state. aggressive tax planning practices. CFC’s profits. For other taxes, the new rules will start to • Taxpayers filing notifications of apply no earlier than 1 January 2021. Third stage in Russia’s capital amnesty participation in a foreign company or The coming implementation of the program a CFC notification, along with a special MLI suggests that companies with tax return, will not be deemed to be in The State Duma, the lower chamber international presence should take a violation of the deadlines. of the Federal Assembly of Russia, has close look at their operational policies, passed a package of laws27 launching a Exemptions may apply to a CFC only if including: third stage for the voluntary declaration it is registered as a Russian legal entity • Checking their international transactions of assets under the capital amnesty after its redomiciliation and simultaneous for compliance with the principal program. The stage will last until status conversion to international purpose test to ensure that their 29 February 2020. company. principal purpose is not treaty abuse, Under the capital amnesty program, and with other criteria set out in the MLI Russian citizens are invited to voluntarily Changes in Switzerland’s tax laws • Introducing controls to monitor declare their assets abroad such In a referendum held on 19 May 2019, compliance with the MLI as accounts, real estate, securities Swiss voters adopted the Federal Act on or controlled foreign companies EY has developed a proprietary tool to Tax Reform and AHV Financing (TRAF). (hereinafter, the “CFC”). As previously, assess the impact of the MLI on tax treaty The amendments will take effect at the taxpayers submitting such “special provisions. This tool is freely available at federal level on 1 January 2020. In most returns” will be exempt from certain https://mli.ey.com/match. cantons, they will also take effect in criminal, administrative or tax sanctions, 2020. provided that certain conditions are met, Mandatory disclosures but controlling persons will no longer be The new rules will terminate tax Europe exempt from tax on the CFC’s profits.28 privileges on 1 January 2020 for holding The list of assets that should be reported companies, trading companies, principal In May 2018, the Council of the European has remained the same. companies and Swiss-based finance Union formally adopted Council Directive branches of foreign companies. (EU) 2018/822 introducing a new Key changes under the capital amnesty mandatory disclosure regime. The new program are the following: This means that companies with regime provides for mandatory automatic operations in Switzerland need to • Taxpayers may declare foreign accounts exchange of information in the field of consider other opportunities for the opened before 1 January 2019. taxation in relation to reportable cross- optimization of their tax burden if Accounts closed as of the special border arrangements. These rules require they want to continue operations in return date are also covered by the intermediaries such as tax advisors, Switzerland. program, provided that they were banks, lawyers and other providers of closed no earlier than 1 January 2019. similar services and, as the case may be, Exemptions are provided only if the taxpayers to report potentially aggressive taxpayer has transferred all cash from tax arrangements to the tax authorities in such foreign accounts to Russian banks. the EU member countries.

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

40 | Russian Forest Sector Overview 2018-19 Forest resources

Russia is home to one of the world’s Countries with the largest wood Countries with the highest timber largest wood reserves. Its forest land reserves in 2018, % of the world’s wood harvesting volumes in 2018, million totaled around 1,185 million hectares reserves cubic meters in 2017, with 67% of it covered with growing stock. Despite its vast reserves, Russia 21% US 439 Russia ranks only fifth globally in timber harvesting. Factors behind low timber Brazil 13% India 354 harvesting volumes include extensive forest exploitation practices that result in Canada 8% China 329 the depletion of forest resources. US 8% Brazil 257 Currently, Russia is seeing a gradual China 5% Russia 236 shift to intensive forest exploitation practices as resource scarcity has DR Congo 4% Canada 152 become an industry-wide concern.29 Australia 4% Indonesia 118 Artificial reforestation programs were implemented in a total area of 172,000 Indonesia 2% Ethiopia 114 hectares in 2018 compared with natural reforestation in a total area of 751,000 Sudan 2% DR Congo 89 hectares. The area under artificial India 2% Nigeria 76 reforestation declined by 2.3% in 2018 compared with a year before. Other 32% According to the LesPromInform magazine, forest users planted trees on Source: Lesonline Source: FAOSTAT 120,000 hectares of land, or 70% of all land covered by artificial reforestation programs, in 2018.

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

Russian Forest Sector Overview 2018-19 | 41 Wildfires also make a substantial At the same time, the wildland fire wildfire management responsibilities contribution to forest depletion, management service Avialesokhrana has to a federal-level agency. If it happens, damaging 7.4 million hectares of Russia’s been allowed to conduct artificial rain considerable public funds may be forest land in 2018, double the 2017 operations, which helped prevent massive earmarked for such operations. level. The hot and dry weather was wildfires in Yakutia. There is also a debate a key cause of the 2018 wildfires.30 about the possibility of transferring

Wildfires in Russia Reforestation programs in Russia, thousand hectares

17 7,408 962 940 863 872 840 2% 2% 803 2% 2% 2% 18% 18% 12 2% 12 21% 22% 21% 11 11 23%

3,191 3,282 2 ,749 2,508 80% 80% 77% 76% 75% 77%

2014 2015 2016 2017 2018 2013 2014 2015 2016 2017 2018

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

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

Russia’s wood reserves by region

Far East Federal Siberian Federal Northwestern Federal Indicator Ural Federal District District District District Forest land, thousand hectares 505,864 373,061 118,323 115,242 Land covered by forest vegetation, 294,941 276,625 88,546 69,425 thousand hectares 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 18% 28% 44% 16% allowable cut

* 2017 data

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

Southern Federal Northwestern Federal Indicator Volga Federal District Central Federal District District District Forest land, thousand hectares 41,290 24,665 3,793 2,212 Land covered by forest vegetation, 37,857 22,637 2,955 1,701 thousand hectares 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 42% 38% 9% 34% allowable cut

* 2017 data

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

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

42 | Russian Forest Sector Overview 2018-19 Conclusion

Russia’s forest sector demonstrated Improved financial results in 2018, the support for specific projects and the record-high performance levels in 2018, development of strategic initiatives and construction of forest roads are the most with considerable growth observed in government support have increased the efficient support mechanisms, according most sector industries. Companies are forest sector’s investment appeal. This to the survey. At the same time, forest also optimistic about growth prospects, is evidenced by our survey findings, with infrastructure development, including counting on key growth enablers. more than 50% of respondents expecting the construction of forest roads, will be Domestic and international demand for increased investment inflows into the a low priority in 2019, as expected by Russian forest products is strong, which forest sector in 2019 and 25% noting respondents. is attributable to their superior consumer “considerable” improvements in the To achieve targets set under Russia’s properties, environmental sustainability investment climate. Forest Sector Strategy to 2030 and the and relatively low costs. Government support for the forest sector sustainable growth of the forest sector, it Priorities for forest sector companies is significant and includes restrictions on is crucial to take further steps to increase in 2019 include capacity additions, the raw timber exports, investment incentives resources available to companies, expansion of geographical presence under Priority Investment Projects, stimulate value-added production, and operational excellence that will also Regional Investment Contracts and improve the investment appeal of the be driven by the closure of inefficient Special Investment Contracts, and the sector and enhance the regulatory plants. Limited access to capital and low development of Russia’s Export Center, framework and government support liquidity of investments are key risks to with more than half of respondents mechanisms. capacity expansion projects. According to using government support, especially the survey, access to debt has worsened Priority Investment Project and Special compared with a year earlier, while debt Investment Contract benefits31 (37% is a key source of financing for new of respondents). Restrictions on raw projects, along with equity. timber exports, tax benefits, financial

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

Russian Forest Sector Overview 2018-19 | 43 Contacts

Ksenia Baginian Igor Prutov Partner, CIS Industrial Partner, CIS Forest Products Leader Sector Leader Tel.: +7 (495) 755 9884 Tel.: +7 (916) 825 2309 [email protected] [email protected]

Andrei Sulin Denis Mekhedov Partner, CIS Metals & Mining Senior Manager, Russian Forest and Industrial Products Sector Advisory Services Tax & Law Leader Tel.: +7 (903) 784 3474 Tel.: +7 (495) 755 9743 [email protected] [email protected]

Sergei Malkov Yelena Smirnova Management Board Member Russian Export Center, Leader of the Association of Specialists of the Forest Sector Exports Project of the Pulp and Paper Industry Tel.: +7 (965) 196 5548 Tel.: +7 (925) 000 1011 [email protected] [email protected]

44 | Russian Forest Sector Overview 2018-19

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About EY About the Association of Specialists of the Pulp and Paper Industry EY is a global leader in assurance, tax, transaction and advisory The Association of Specialists of Pulp and Paper Industry is a union services. The insights and quality services we deliver help build of industry experts with voluntary membership created to represent trust and confidence in the capital markets and in economies and protect professional interests involving the promotion of the pulp the world over. We develop outstanding leaders who team to and paper industry and the forest sector in the Russian Federation. deliver on our promises to all of our stakeholders. In so doing, The association currently has around 300 members working in we play a critical role in building a better working world for our the Russian forest sector and pulp and paper industry. people, for our clients and for our communities. The association’s mission is to unite professionals and enhance the EY works together with companies across the CIS and assists image of the sector. The Association of Specialists of the Pulp and them in realizing their business goals. 5,500 professionals work Paper Industry is a nonprofit organization. at 19 CIS offices (in Moscow, Ekaterinburg, Kazan, Krasnodar, Novosibirsk, Rostov-on-Don, St. Petersburg, Togliatti, The chief objectives of the Association of Specialists of the Pulp Vladivostok, Almaty, Atyrau, Nur-Sultan, Baku, Bishkek, Kyiv, and Paper Industry are to support and develop the domestic forest Minsk, Tashkent, Tbilisi, Yerevan). sector, including the wood-processing, pulp-and-paper and forest chemical industries, promote important industry initiatives and EY refers to the global organization, and may refer to one or projects, make the sector more competitive, facilitate the exchange more, of the member firms of Ernst & Young Global Limited, of information and experience between industry professionals, each of which is a separate legal entity. Ernst & Young Global represent the sector’s interests in interaction with state and other Limited, a UK company limited by guarantee, does not provide agencies, promote cooperation between companies in the sector, services to clients. For more information about our organization, and organize and participate in industry exhibitions, seminars and please visit ey.com. conferences in Russia and abroad.

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