* Devaluation would give competitive boost
* But financial turmoil would increase financing risks
* Russian competitors fret about Ukrainian imports
* Barriers to entry to Russia-led Customs Union
By Alessandra Prentice and Douglas Busvine
MOSCOW, Dec 5 (Reuters) - Ukraine's choice of closer tieswith Moscow, spurning a trade pact with the EU, could rub itsstruggling steelmakers up against Russia's own beleagueredmetals firms, who will resist Kiev's attempts to export its wayout of trouble.
Since President Viktor Yanukovich pulled out of the dealwith the European Union, a key market for the steel industry,the former Soviet country of 46 million has been in turmoil,with mass protests in the capital and markets hammered by fearsof currency devaluation or sovereign bond default.
The protests will make it harder for Yanukovich to acceptPresident Vladimir Putin's invitation to join a regional CustomsUnion and the advantages that would bring to its exporters.
Russian steelmakers are also unlikely to feel warmly towardsthe political rapprochement.
"Steelmakers in Russia certainly see Ukrainian competitionas a threat," said Sergey Donskoy, an industry analyst atSociete Generale in Moscow.
Ukraine produced 33 million tonnes of raw steel in 2012 -down 10 million from its 2007 peak - and exported a total of 24million tonnes of steel mill products, accounting for 28 percentof the country's entire exports.
Russian output, 70 million tonnes last year, has been morestable. The former Soviet Union has the biggest steel surplus ofany region and, with global demand depressed, freer tradebetween the neighbours would only intensify competition.
Russian steelmakers have aggressively lobbied theirgovernment to implement measures to defend domestic producersfrom Ukrainian imports, which exceeded 3 million tonnes lastyear.
In July, Russia scrapped duty-free quotas on Ukrainian steelpipes, while last month it launched an anti-dumping probe intosteel rod imports from Ukraine into the Customs Union that alsoincludes Belarus and Kazakhstan.
"The lack of prospects for domestic demand growth as well asthe huge amount of spare capacity will cause Ukrainian firms toboost exports, including to the Customs Union," said arepresentative for Russia's No.2 steel firm Severstal.
Ukraine is likely to account for around 65 percent of totalRussian steel imports this year, the representative said.
"We see a significant rise in imports of construction steeland coated steel. Of course, this affects the growth of thedomestic metals industry," he said.
"Such a huge rise in supply volumes can only happen with aserious fall in price ... We're fighting against unfair importssuch as the Ukrainian supplies." Severstal estimates thatUkrainian wire rods are being sold into the Customs Union atprices 12.6 percent lower than charged on other markets.
Indebted Russian metals and mining firms - including Mechel and Evraz - recently petitioned theirgovernment for financial help so they can restructure and regaincompetitiveness.
Ukraine is running wide external deficits, with a currentaccount shortfall of 7 percent of gross domestic product,reflecting the fact that it pays a high price for Russian gasimports, while prices for steel exports are depressed.
This has drained the Ukrainian central bank's reserves toaround $20 billion - just 2-1/2 months of import cover -fuelling speculation that a devaluation of the hryvnia currency may be in the offing.
Devaluation would give its steel exporters a boost to theircompetitiveness, but metals traders say they would struggle tocapitalise on it as the financial turmoil would make it harderto raise trade financing from banks typically used to completesteel purchases.
"A depreciation of the currency is absolutely possible,"said a senior executive at a European steel trading firm withstrong ties to Ukraine.
"Depreciation of the currency, defaulting on the bonds areall issues which affect the steel industry's ability to borrowbut ultimately makes them more competitive."
Global steel prices have recovered from athree-year low hit in June, but the rise has since stalled inEurope, while prices in Asia softened in November.
Players whose costs are chiefly denominated in the localcurrency would benefit from a cheaper hryvnia, such asLondon-listed iron ore miner Ferrexpo, said BorisKrasnojenov, a sector analyst at Renaissance Capital in Moscow.
Ferrexpo has said, however, that a hryvnia-denominated taxcredit that it holds, now worth $300 million, would also take ahit if the currency was devalued.
Ukraine's largest steelmaker, Metinvest, controlsabout 50 percent of Ukraine's steel market, while the biggestforeign player is ArcelorMittal, the world's largeststeelmaker, which has 12 percent. Both firms' Ukrainianoperations are vertically integrated, meaning they supply muchof their own scrap, iron ore and coking coal rather than havingto buy inputs on the market at dollar prices.
If Ukraine did join the Customs Union, that would give itssteelmakers greater market access but would also increasepressure for cross-border consolidation to achieve economies ofscale and upgrade their outdated facilities.
Metinvest, with production of 12.5 million tonnes in 2012,ranks behind Russian producers Evraz (15.9 million), Severstal(15.1 million), NLMK (14.9 million) and MMK (13 million). All are dwarfed by ArcelorMittal's 93.6 milliontonnes. Severstal's main owner and CEO, Alexei Mordashov, hasspoken approvingly of consolidation but given no hints as to whowould make a potential partner.
"If Ukraine throws its lot in with Russia, there wouldprobably be a round of consolidation," said a fund manager basedin Moscow. "But Yanukovich, politically, can't justify thisright now."
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