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Goldminers play Russian roulette - DANCES WITH BEARS
By John Helmer - Asia Times Online

Золотодобытчики разыгрывают российскую карту - ТАНЦЫ С МЕДВЕДЯМИ

Со времени распада Советского Союза, не было лучших времен для золотодобычи в России, чем сейчас. Но похоже, что российские золотодобытчики намерены не позволить воспользоваться открывающимися возможностями иностранцам.

Мировые цены на золото в обозримом будущем будут колебаться в пределах $US 330-400 за унцию, ориентируясь на валютные рынки и колебания $US. Пока неувереное положение $US будет сохраняться, золото будет привлекательной "зоной безопасности" для инвесторов, разочарованно смотрящих на падение акций на фондовых рынках и испытывающих недостаток иных альтернативных активов.

В тоже самое время, ведущие западные золотодобытчики быстро вырабатывают "экономически подготовленные" запасы (mineable reserves). Связанно это, главным образом, с недостаточными расходами на разведочные работы за последние пять лет. Так Barrick Gold Corporation, третий в мире производитель золота, недавно предупредил, что его gold reserves будут истощены в течении десятилетия, если не увеличить вложения в новые геологоразведочные работы. Однако если вложения в разведку и начнутся увеличиваться уже в этом году, отдача от них не будет скорой и пройдет достаточно много времени до в ввода в эксплуатацию новых объектов.

In the meantime, the world's central banks have agreed to cap annual sales of gold out of their massive stocks to 400 metric tons, and producers have all but liquidated their hedgebooks - their forward commitments to sell new gold at predetermined prices. Nothing but global demand stands in the way of rising gold prices - and most industry experts project demand will comfortably outstrip supply for the next five years.

Russia and China remain the largest unexploited regions for goldmining in the mining world. But compared to China, Russia has two immediate advantages. Much of the country's gold reserves have already been identified; and at a current cash cost of production of between $120 and $150 per troy ounce, Russian production can be managed on one of the lowest - and most profitable - cost bases in the world. In theory then, with low geological risk and manageable economic risk, Russian gold should be attracting a rush of mining capital to stimulate production.

Indeed, with mine output of gold rising by more than 12 percent per annum, and Russia challenging Indonesia for fourth place on the world producers' table, the pace of development here is moving much faster than in the world at large, where total mine output is falling, and will continue to fall for the foreseeable future.

There's one catch - the Russian goldmining sector has been a disaster zone for foreign investors, many of whom have lost their entire investment, as well as their mining licenses. These include Pan American Silver (Canada), Star Mining (Australia), Johannesburg Consolidated Industries (JCI) (South Africa), and most recently Troy Resources (Australia).

It is worth noting that most major international goldminers, including Rio Tinto, BHP, Anglo American (AngloGold), Normandy, Goldfields, Barrick and Placer Dome have conducted exploration, project studies, drilling and other investment work, only to decide against proceeding with Russian projects.

For example, Anglo American considered Nezhdaninskoye (Sakha republic) and several other deposits, but decided against proceeding. Placer Dome assessed the Ozernovskoye (Kamchatka) deposit, and decided not to go further. Barrick has maintained a Moscow office for several years, and is conducting minor exploratory activities, but for the time being, has withdrawn from active pursuit of proven deposits like Sukhoi Log, near the Chinese border.

Kinross has fared better, and for longer than most foreign mining investors, in part because it took up-front management fees for itself, at the same time as it paid off the project's international creditors. Kinross thus did much better than the Russian shareholders and the Russian lender to the project - the federal Finance Ministry through the Magadan regional government - who received next to nothing. As a result, Kinross has been facing regional court and other challenges to its management of the near-depleted Kubaka deposit, with claims of more than $60 million from the Russian shareholders in the venture company, Omolon. A settlement of $45 million was proposed by Kinross last November, in the week before the assassination of Magadan governor Valentin Tsvetkov; this was double Kinross's original offer, but still less than the Russian claims.

In parallel, in the Sakha republic, a challenge has been mounted by the regional government, in alliance with commercial interests, to remove London-based Celtic Resources as operator of the Nezhdaninskoye goldmine, and dilute Celtic's stake in the project to a minority of around 20 percent.

An overview of the sector's potential must start with the negative record, and the reasons for the distrust of Russian mining partners which the record reveals. But there is a recent, positive story to be considered also: Bema Gold's Julietta mine; High River Gold's stake in Buryatzoloto; Highland Gold's acquisition of the Mnogovershinnoye deposit; and the Peter Hambro group's operations at Pokrovsky Rudnik all indicate rising production, rising profitability, and at least for the time being, solid tenure. It is too early to make a confident conclusion on whether these positives are likely to outweigh the negatives in the gold sector's short and medium-term future.

For one thing, the level of concentration in the sector is still low compared to other Russian metal and mining industries. At the end of the year 2000, the government in Moscow counted 566 mining companies licensed to explore for and produce gold, scattered over 26 of Russia's federal regions. Out of this total, 389 (69 percent) produced just 11 percent of the annual goldmine output, while 78 (14 percent) produced 74 percent. Another way of describing this is to note that the top five gold producers in 2001 accounted for just 30 percent of the gold mined; producers with output of more than 1 metric ton produced just 46 percent of the aggregate output. Yet another way of gauging the concentration of the sector is to note that in 2001, 56 commercial banks contracted with miners to supply 130 tons of gold; in 2002, 48 of the banks contracted for 178 tons.

In a rising gold price environment, the relative smallness of the individual producers makes it likely that Russian entrepreneurs will see the arbitrage opportunities in consolidations of the smaller mining units, or in takeovers of the mid-size to larger ones. The capital required for exploration and proving deposits, and for the switch from alluvial mining to hard-rock operations, has been a deterrent to this process until now for Russian mining companies, and also for Russian banks, which demand high rates of interest, substantial discounts in the price of gold accepted for loan repayment, and six to 12-month cycles of financing.

If a foreign investor introduces this capital, then he risks lowering the deterrence, and raising the profitability of a raid on his license. In these circumstances, the selection of a small Russian partner is no guarantee of security of tenure, if and when a significant deposit is found, and the likelihood of a raid grows. This has been the experience of Troy Resources, an Australian junior which had its license to the Chita region deposit of Taseyevskoye revoked more than a year ago. Picking a bigger Russian partner, capable of riding out the consolidation process, may offer more security of tenure in both the short and long term, but such a partner is unlikely to grant a foreign investor the management control he may insist on.

Most Russian gold producers are so small, their annual profit amounts to less than the price of a Western-made bulldozer. As noted already, there are hundreds of them. Like the fauna of their regions, they migrate with the seasons and the depletion of their pickings. They have a unique culture of their own, and like prospectors in North America, they don't make easily manageable partners of established mining companies. The traditional prospectors are loosely organized in units known as artels, which collectively form the Association of Starately, headed by Victor Tarakanovsky. He claims his membership produces just over half of the sector's output each year. The association says it ranks its member artels in terms of the size of their annual gold production, but does not keep systematic data on the size of their exploration territories, or their spending on exploration and non-production activities. Some of this spending is done in conjunction with larger enterprises, the so-called zolotos, with which the artels are united in various forms of partnership.

It is worth noting that the active commercial banks in the gold sector have developed the view that the risk of Russian mining ventures differs considerably from one region to another. This in turn compounds the trend towards accelerating growth in some regions - Krasnoyarsk, Khabarovsk, Amur, Khakassia, Buryatia, Sverdlovsk and Magadan - and declining production in other regions, such as Sakha and Chukotka. Concern about Sakha has accentuated among Russian banks recently, following the accession of the new republic president Vyacheslav Shtirov, formerly the chief executive of diamond-miner Alrosa, and his decision to put Alrosa Invest - a unit linked to Shtirov and indirectly to Alrosa - in overall charge of state stakes in the Sakha gold-mining companies, and the deposits they are working. Alrosa Invest is leading the attack on Celtic at Nezhdaninskoye.

According to data of the Russian Union of Gold Producers, in 2002 Russia produced a total of 170.9 tonnes of gold, up by 11 percent year on year. Out of that aggregate, gold production from ore and alluvial mining amounted to 158.6 tonnes, a gain of 12 percent compared to the year before. According to Valery Braiko, head of the gold producers union, last year's performance was the best by the local goldminers since the collapse of the Soviet Union. Most of the increase, however, was concentrated in Krasnoyarsk, where the country's leading miner Polyus entered an acquisition agreement with Norilsk Nickel that will combine their resources, and shift the requirement for capital spending to sustain output on to Norilsk Nickel's balance-sheet. Magadan also showed a significant increase, along with Khabarovsk, where Mnogovershinnoye (MNV), a property controlled by Roman Abramovich and his associates, was transferred for a London listing to Highland Gold, a venture managed by Fleming Family & Partners.

That London listing late last year was curious, because it generated considerable positive publicity for the Western investors involved, but little information about the Russian deposit, its development history, or its vulnerability to a raid. As late as last October, six months after Highland claimed to have acquired the controlling interest in the deposit, the Khabarovsk regional government issued an ambiguous statement claiming there had been no sale of the deposit, and that its shareholders had not changed. Debt recovery claims, and settlement of the ownership of related mine property, held by the Khabarovsk administration, were pending at the time.

Asked to say what the Khabarovsk region plans to do with mine-related property at the deposit, the local official in charge of mining, Gennady Pocherevin said, "Some of the property that is used by MNV is regional property. But the governor [Viktor Ishayev] has signed a resolution that this property should be offered for sale through a tender. We expect that MNV will buy it." However, there is growing evidence that governor Ishayev is in no hurry to see that happen.

Industry sources caution that for the time being projects like Polyus's Olympiada deposit, and Highland Gold's MNV do not require large-scale investment to assure rising output, and rising profits. But they also note that Olympiada's grades are forecast to fall sharply, while the costs of the mine will rise inexorably. Highland Gold's other deposits, Darasun and new deposits in the Chita region, will also require much more investment than has been invested to date, and payback will be slower than their Russian owners like to demand.

Local miners point out that, as has been the case with the Russian oil industry, almost all of the recent gains in production have come from deposits that were discovered and proven in the Soviet period. Unlike the oil sector, however, Russian goldminers, large and small alike, have been pocketing their profits, and investing for payback just one season at a time. This makes the future for capital intensive projects, like the still unexploited Sukhoi Log deposit in Irkutsk region, extremely doubtful, despite the interest which Polyus and Polymetal of St Petersburg are publicly showing in bidding for it.

According to Braiko, "The main problem of the industry remains one of finding new gold reserves to replace those that have been mined. Over the past five years that gold production in Russia was on the increase, the level of the mineral reserves base continuously deteriorated. The companies worked on deposits that were discovered in Soviet years, and no new deposits were found. The problem became worse after the government abolished its payments on restoration of the mineral reserves base, which were used for financing state geological research. Geological exploration has become a business to be financed by the mining companies with their own resources."

This then is the fork in the road for Russian goldmining. In the next five years, the local miners see no need for foreign mining expertise, finance, or management to sustain the current momentum of rising output, or to pay for the consolidation of mining firms that is bound to occur. It remains to be seen whether the accommodation shown toward junior foreign miners like Bema Gold and Highland Gold will last so long. On the other hand, the billion-dollar investments required for projects like Sukhoi Log, and slow payback on spending for geological exploration, are conditions that favor the reentry into Russia of the global miners. While many Russian miners say that will only come over their dead bodies, the experience of the oil sector suggests that some of them will only be too happy to play dead, and sell out.