OREANDA-NEWS. December 5, 2011. This month we maintain our focus on costs. As we pointed out in previous reports (Remain Cautious as Costs Take Centre Stage on 17 Feb and our latest report Russian Steel - Not Stainless on 2 Nov) costs will continue to negatively influence steelmakers’ performances in the short to medium term. Margin pressure is increasingly evident if we examine the 3Q11 financials recently reported by Evraz and NLMK. We believe the financial performance of the remaining sector peers will demonstrate the same margin dynamics. Russian steelmakers boast a reasonably high degree of vertical integration vs their global peers, which provides some margin protection. Moreover, should market conditions worsen, steelmakers could opt to cut output, which could eventually bring down raw material costs. However, raw materials currently account for just 45-65% of steel company costs. The rest are labour, transport, energy, services, SG&A, etc., which are less elastic to falling steel output. During the 2008 crisis, steel prices suffered a sharp decline in 4Q08 while company costs continued to rise. It took the sector nearly a year (4Q08-3Q09) to arrest the margin decline and bring the average sector EBITDA margin back above 10%. The downward move in steel prices we have seen so far in 2H11 looks seasonal in our view and steelmakers can still maintain reasonable margins. However, this also means that steel output remains high and, in turn, costs are still elevated. Should the situation on steel markets deteriorate, it could be difficult for producers to bring their costs under control quickly. In these circumstances we would expect six-to-twelve months of unimpressive financial performance from sector companies.