Russian gold mining wins from financial crisis

Worried financial investors are fleeing to gold as a safe haven. Prices are now due to hit $1000 in the year Russia auctions the world’s second largest gold deposit. But Russia’s biggest gold producer is stricken by a corporate dispute that saw $1bn worth of stock go to an unknown buyer this week.

“The price for gold is currently at $860. We believe the price will reach $1000 by the end of the year,” says Trust investment bank’s Dmitry Sergeev. “Under conditions of financial instability, gold will be used as a hedging instrument, and this will increase demand,” Sergeev explains.

“We expect the price of gold to rise in these financial conditions because it is a safe haven for investors,” agrees Alfa’s Maxim Semenovykh.

But this latest price surge is just the icing on the cake for gold. In 2006 gold prices grew by 23% and reached a record US$730 per ounce. Gold prices increased by 25% in 11M 2007 and climbed to a 27-year high of US$830.

“Structural price drivers are falling production in main producer country South Africa. South African deposits are increasingly exhausted and metal content in ore is falling. South African production will continue to decrease,” explains Troika Dialog’s Mikhail Stiskin.

“Demand has been boosted by growing demand for jewellery products on emerging markets – Russia, China, India, Brasil and Turkey,” he adds. The fall in the dollar and political tension in the Middle East are also contributing.

And Russia will benefit from the price development: Russia is one of the four richest countries in the world by total gold reserves, with 3000 tonnes, compared to South Africa’s 6000, Australia’s 5000, Peru’s 3500.

A whole log of gold

What is more, the giant Sukhoi Log gold field in Irkutsk region, the world’s second largest deposit, is up for sale in 2008.

A reassessment concluded last autumn sensationally doubled the reserves to 1,920 tonnes of gold. Russian state agency Rosnedra calculated that gold sales over the field’s life would total $30bn and that state revenues from mining of this Eurasia’s biggest gold deposit would run to more than $2.5 billion. The future mine should be capable of producing 30-50 tonnes of gold from 12m tonnes of ore per year.

And in 2008, all this will be – apparently – be up for sale.

“The tender for Sukhoi Log will take place, we think, in the second half of 2008, after the presidential elections, this is more or less the unstated official position,” says Sergeev.

Other gold analysts agree that the tender will be in the second half of 2008, and about who the favourite is:

“The mostly candidate is Polyus Gold, around which the consolidation of the gold sector could take place,” says Sergeev. “Polyus Gold has a deposit adjacent to the location, and thus all the infrastructure at hand, and also Polyus Gold participated in the revaluation of Sukhoio Log reserves.”

Polyus Gold, by far Russia’s largest producer, with 1215 koz oz output in 2006 compared to next best Peter Hambro with 261 k oz, ranks among the world’s top ten gold producers.

“Polyus Gold is the most probable candidate,” agrees Semenovykh, “but there are other possibilities like Severstal or Alrosa, maybe someone else. Highland Gold issued 40% of shares in favour of Abramovich so they now have the financial resources for such a project. It will be a very competitive tender, so the price is completely unpredictable.”

Nevertheless, foreign investors are more or less excluded from the bidding, because the scale of the Sukhoi Log deposit means it has been put on the government’s restricted strategic list.

Moreover, in September 2007, the Russian Natural Resources Ministry announced it was going to hold a tender for the licence instead of an auction.

“There is a fine difference between auction and tender. Sukhoi Log is a strategic deposit, and in my opinion, it was a political decision to hold a tender, perhaps to additionally restrict access of foreign investors,” says Sergeev. “Investors can only participate through minority holdings in Russian companies mining the deposit. There is a possibility that Baring Gold as minority and Millhouse will jointly submit a bid for the licence.”

Another reason for holding a tender with investment commitments is the scale of investment which will be required. “Mining of Sukhoi Log will cost $1.6bn investment and it will take 2-3 years before gold can start to land on the market,” says Sergeev.

Polyus Gold – The plot thickens

Polyus Gold might be the favourites to take charge of the Sukhoi Log tender – but it is far from clear who will be in charge of the company itself.

“We’ve just seen about $1bn of Polyus gold stock changing hands”, says Renaissance Capital’s Yury Vlasov. “That’s about 10% of Polyus market capitalisation.”

A splurge of OTC deals in Polyus Gold shares took place from Friday 18th January to Tuesday January 22, at the same time as the Russian stock market plummeted.

“There are various explanations,” says Vlasov. “With the market plummeting down, there were of course margin calls to blame.”

“But the size of the transactions indicated it has to do with the EGM meeting called for mid-February, where there will be another clash between Mikhail Prokhorov’s Onexim Group and Vladimir Potanin’s Interros. So in all probability it was Potanin beefing up his stock in preparation for the EGM.”

The context is bitter divorce proceedings between Polyus Gold’s parents, metal tycoons Mikhail Prokhorov and Vladimir Potanin, after French police caught Prokhorov indulging in après-ski activities with young girls in Courchevel in December 2006.

Their custody tug of war over joint metals assets, such as copper giant Norilsk, spilled over to Polyus Gold in 2007. Prokhorov appointed his own man Evgenyi Ivanov as CEO in October. In December, the new board decided to carve out greenfield Polyus projects into a subsidiary, Polyus Exploration, to be subsequently floated.

Potanin protested this decision January 17, forcing an EGM to be called for mid-February. The next day the buying started. Potanin needs around an extra 3% to achieve a blocking stake in Polyus Gold.

“If the dispute between Potanin and Prokhorov continues, it will have a negative effect on implementation of large projects such as Natalka,” believes Alfa’s Semenovykh. “It will not effect operation of current activities, but the future plans.” The Natalka deposit, for which Polyus already holds the licence, is Russia’s second largest.

More worryingly, because the dispute has now crystalised around the proposed spin-off of greenfield sites into a separate entity, it could directly call into question ownership of the Sukhoi Log licence: “A potential asset split between Interros and Oneksim, including a possible transfer of part of Polyus Gold’s licenses to a subsidiary, Polyus Exploration, (asset spinoff) would create additional risks,” reads a Trust bank research comment.

M&A to support production increase

Evidently stricken by gold fever on seeing prices move towards the $1000 mark, two Russian oligarchs bought themselves gold companies for Christmas 2007. In December, Alexei Mordashov of Severstal completed acquisition of 81% of Celtic Resources, while Evraz owner Roman Abramovich announced acquisition of a 25% stake in Highland Gold, with a view to acquiring 40%.

There is, however, still plenty of room for consolidation in the sector.

“The top 3 – Polyus Gold, Peter Hambro and Polymetal – produce only 36% of total gold production in Russia,” explains Sergeev. “By way of contrast, the three largest gold producers in the Republic of South Africa produce 85% of total gold production.”

“We expect Severstal to continue activity in buying licences. Alliance Group is bidding for a stake in Polyus Gold being sold by KM Invest. Millhouse has already bought 40% of Highland Gold. Peter Hambro will probably continue to be independent. But the point is that the sector is very under-consolidated and Severstal is planning an IPO of its gold assets within five years,” says Sergeev.

A research note from Unicredit bank agrees that “Severstal and Abramovich are far from done with consolidating their new gold businesses.” Unicredit mention as acquisition targets further Russian/CIS gold juniors such as European Minerals and Uzbekistan’s Oxus Gold.

“I think some smaller players will definitely be acquired by majors,” says Alfa’s Semyonovykh. “It’s hard to predict huge deals, though. There’s probably enough oligarchs in the sector already.”

This overdue consolidation could prompt an upturn in stagnating production, believes Sergeev. Russian gold production fell in 2006 by 2.9% yo-y to 147.6 tonnes, and Sergeev expects that in 2007 total gold production in Russia might have decrease by another 2% to 161 tonnes. But he is bullish about 2008:

“Thanks to the arrival of large companies, increased investment, the high gold prices, and ongoing consolidation, I expect 2008 to be a turnaround year for the gold-mining sector in Russia.”

Tracing the rise of Medvedev’s network – Russia’s “civiliki”

Graham Stack for business new europe

Dmitry Medvedev, Russian President Vladimir Putin’s endorsed successor, is likely to ask a slew of old university friends round to the Kremlin when he moves in later this year. Not to party, but to work. Much as Putin has relied on a string of friends from St Petersburg formerly with the KGB, the so-called siloviki, Medvedev has hauled up into high positions a network of friends and colleagues from the St Petersburg State University civil law department: the “civiliki,” as it were.

“Relations between state and business are like a seesaw – they tip to one side and then to another. There was a time when the state had lost influence over business to the extent that it practically handed out indulgences for non-payment of taxes. Now we are in tougher times. Perhaps the seesaw has even tipped too far in the other direction, and it is time to re-determine the correct balance between business interests and state authority.”

When the chairman of Russia’s Supreme Arbitration Court, 42-year old Anton Ivanov, interviewed by business daily Vedomosti on December 25, came out with the above statement, Russian political observers took notice: only two weeks before, Ivanov’s friend and colleague of 25 years standing, Deputy Prime Minister Dmitry Medvedev, had been picked by Putin to succeed him as president. The presidential elections are due on March 2.

Medvedev and Ivanov studied together at what was then Leningrad University’s faculty of law from 1982-1987. Following graduation, both went on write PhDs and teach at the faculty in the civil law department. Their PhD supervisor was none other than law professor Anatoly Sobchak, leader of St Petersburg’s surging pro-democracy movement, elected mayor of Petersburg in 1990, and Putin’s boss until 1996.

Medvedev and Ivanov’s professional partnership extended to co-authoring, together with other faculty members, an acclaimed civil law textbook that’s still widely used in Russia, and also jointly founding a legal consultancy in St Petersburg in the early 1990s.

At every stage of Medvedev’s subsequent rise to the top since then, Ivanov has followed him at a short distance. And not only Ivanov. From Medvedev and Ivanov’s class of ‘87, a cluster of names such as Konstantin Chuichenko, Valeriya Adamova, Vladimir Allisov, Ilya Eliseev, Mikhail Krotov and Nikolai Vinnichenko have accompanied Medvedev and Ivanov’s dizzying rise.

Just as during Putin’s presidency saw the previously obscure siloviki members such as aide Igor Sechin and state arms trader Sergei Chemezov rise to become national figures, in the same way some of the above names are likely to figure large in the still-nascent art of “Medvedevology.”

First stop: Gazprom

Dmitry Medvedev was named head of the supervisory board of Gazprom in June 2000, immediately after Putin’s inauguration as president. The civiliki were quick to follow him to Gazprom.

In July 2004, Anton Ivanov was appointed first deputy head of Gazprom Media, Gazprom’s structure for managing its media assets which had been expropriated from exiled media oligarch Vladimir Gusinsky.

A number of his former classmates had already been installed at Gazprom.

Konstantin Chuichenko, class of ‘87, had in March 2001 become head of Gazprom’s legal department, and in 2002, he became a member of the Gazprom management board and chairman of the supervisory board of Gazprom Media. As of 2004, Chuichenko has been a managing director of the controversial gas trader RosUkrEnergo, the murky intermediary for Russia’s sales to Ukraine of Turkmen gas that was at the centre of the “gas wars” scandal in 2006.

Valeriya Adamova, also class of ‘87, became vice-president of the legal department of the Gazprom chemicals affiliate Sibur in April 2003. Adamova played an active role in helping Gazprom to reclaim assets transferred to Sibur under the 1990’s management. Vladimir Alisov, again class of ‘87, was head of the legal department of Gazprom’s newly-created subsidiary, Gazpromregiongaz, which handles gas distribution in Russia.

One year after Ivanov’s move to Gazprom, Ilya Eliseev, Medvedev and Ivanov’s former classmate, faculty colleague and co-author, was appointed deputy chairman of the management board of Gazprombank, Russia’s third largest. Finally in April 2005, Mikhail Krotov, class of ‘85 this time, former faculty colleague and co-author, succeeded Ivanov as deputy general director of Gazprom Media. Putin had chosen Ivanov to chair the Supreme Arbitration Court, Russia’s highest commercial court.

Civiliki go to court

Ivanov became chairman of the Supreme Arbitration Court in 2005 despite his never having worked before as a judge. He was tasked with launching a systematic reform of the commercial court system – and quickly built up a public profile thanks to frequent media appearances.

Ivanov appointed as his deputy, Elena Valyavina, a university classmate and then faculty colleague, who in the 1990s worked under Ivanov in the St Petersburg city justice department. Adamova moved from her post at Sibur in 2005 to become deputy chairman of the very important Moscow Arbitration Court in 2005.

Nikolai Vinnichenko, class of ‘87, a friend of Medvedev and Ivanov, had risen through the state prosecutor’s office to become state prosecutor for Petersburg in 2003. In October 2004, he was appointed director of the Federal Service of Court Bailiffs.

Vinnichenko’s long-standing deputy in St Petersburg prosecutor’s department, Aleksandr Konovalov, a 1992 graduate of the St Petersburg law faculty, and then faculty colleague of Medvedev and Ivanov, moved to become chief state prosecutor for Bashkiria in 2005, and in the same year was promoted to the post of presidential representative for the Volga region.

Finally, in November 2005, Medvedev’s faculty colleague and co-author Mikhail Krotov moved from Gazprom Media to become the presidential representative to the Constitutional Court.

Civiliki at the Kremlin gates?

How quickly Medvedev will promote his own people to important posts will only become clear if he wins the presidential election and after he is inaugurated as president in May.

It’s also too early to say how the civiliki might impact on the country’s politics. But it would be wrong to expect fundamental democratic impulses from them. Not only are legal scholars inclined to favour technocratic solutions over the cut and thrust of democratic politics, but more importantly at Gazprom Media the civiliki were implicated in the effective de-privatisation of formerly independent TV station NTV, and it was after Anton Ivanov’s move to the Supreme Arbitration Court that the crippling tax claims against Mikhail Khodorkovsky’s now-bankrupt oil company Yukos were enforced.

For the civiliki to tilt the seesaw back towards society, they will first have to discard a lot of ballast.