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By John Helmer in Moscow

The Udokan copper contest has been won, but by whom?

In April, Mineweb reported that Russia’s biggest copper contest was going to be a very private affair.

Even if there are just two, possibly three contenders — we said at the time — predicting who will win over the next 90 days of the contest may prove to be more frustrating than it looks:

This week, the decision to award Russia’s largest unmined copper deposit to a duo, Metalloinvest and Russian Technologies, which has never mined copper, confirmed, after the contest had stretched to six months, just how private — and how unclear the prospects for the project continue to be.

Metalloinvest is an unlisted private conglomerate, with two steel mills and two iron-ore mines, which has been having trouble getting a valuation and an underwriter to list its shares on the London Stock Exchange. It is owned in three stakes, whose magnitudes have never been publicly confirmed or verified, by Alisher Usmanov (with about 50%); Andrei Skoch (30%); and Vasily Anisimov (20%).

The history of each man’s asset position has been controversial, and is best left unpublished. What is clear is that copper-mining has not been their line. This is in stark contrast to the other contestants in the bidding for Udokan — the Urals Mining and Metallurgical Company (UMMC), Russia’s second copper miner and refiner, owned by Iskander Makhmudov; and Norilsk Nickel, which entered the bidding through separate initiatives of controlling shareholder, Vladimir Potanin, and his onetime partner, now rival, Mikhail Prokhorov.

Another bid, by a unit of the Basic Element holding owned by Oleg Deripaska, also said it was competing, only to withdraw when it learned it had been passed over. A holding company announcement claimed that it was “economically inexpedient to participate in the tender independently.” Most of this phrase is correct, but it was politics, not economics, which excluded Deripaska in the end.

In Russian mine licensing law and regulation, it is required that deposits owned by the state should be auctioned publicly and competitively, and that the award should go to the highest bidder. While bidders may conceal themselves by multiple nominee identities, the competing prices are usually made publicly known. In this case, after more than a decade of deliberation and dickering, the state decided to reserve its power to make an in camera review of the bids, and to issue an award without making clear what price has been paid for the mining right, and what investment obligations have been incurred.

In March, the state conglomerate Russian Technologies, headed by Sergei Chemezov — built on the base of Rosoboronexport, the state arms export monopoly — tried to persuade the government to conduct a major auction of the Verkhnekamsoye potash deposits in the Urals (3.8 billion tonnes of reserves) in this in camera mode. Chemezov was turned down, and the decision was taken at the time to take the assets to public auction. The outcome was a very costly bidding contest ($2.4 billion in toto) — and an expensive victory for Chemezov’s partner, Silvinit, which was pushed to commit $1.5 billion for the mine rights it wanted.

This time Chemezov has won both rounds, decisively. He also appears to have avoided the obligation to make a big down-payment. That is the first point of political significance. The head of the mine licensing authority Rosnedra, Anatoly Ledovskih, is reported as saying the Udokan licence award requires an initial payment of Rb4.5 billion ($176 million), and a total of Rb15 billion ($588 million).

The second political point is that Chemezov defeated Makhmudov’s partner, Vladimir Yakunin, head of another rich state corporation, Russian Railways, and once considered a contender to succeed Vladimir Putin as president. However, Yakunin has not been the intimate of the Putin circle as was publicly speculated, and he dropped out of the running in the presidential race early on. There has been speculation that President Dmitry Medvedev will replace him at the rail company; and that Putin won’t mind. Rail company sources say they have heard nothing yet.

Makhmudov, whose central Russian copper mines are running out of ore to feed his smelters, and who needs Udokan more than Norilsk Nickel, is one of several metal oligarchs, who were given their start in business by Mikhail Chernoy (Michael Cherney) in the early 1990s. Makhmudov, an Arabic speaking veteran of the Soviet Ministry of Foreign Trade, told Mineweb that in the early 1990s, when he was in a Chernoy partner, he opted for copper, when aluminium went to Deripaska. Part of the tale can be found in court papers filed in Chernoy’s UK High Court case against Deripaska.
Makhmudov also took, and still runs, a group of domestic coal-mining companies. A bid to convert his coal position into a takeover of the Severstal steelmills failed, not least of all because Makhmudov lacked the Kremlin clout of his rivals. To win Udokan, Makhmudov calculated that he needed an influential ally. Yakunin turned out to be an unfortunate choice.

The third point of political significance in the Udokan award is that Deripaska has suffered his second major defeat in as many months. As Mineweb has reported in detail, Deripaska’s nine-month bid to take over Norilsk Nickel from Potanin, and merge it with United Company Rusal, was rejected several weeks ago by Putin and his deputy in charge of resource concessions and metals, Igor Sechin. Once that had become apparent in the marketplace, it was rumoured that Deripaska was staying in the Udokan race, in order to receive a consolation prize. The reasoning was that Deripaska would agree to concede on Norilsk Nickel, if he were given Udokan instead.

This not only turns out to be untrue. Twice now, Deripaska appears to have failed to demonstrate that he has the oxygen Russian oligarchs require to breathe — that is, clout with Sechin. The implication for Deripaska and Rusal is serious, especially in London. There Deripaska faces the possibility that, if his pending appeal against a High Court ruling in favour of Chernoy is rejected, he faces what amounts to a trial of his methods in acquiring the Rusal and Basic Element assets, and a ruling in favour of Chernoy’s claim for shares or compensation, worth more than $6 billion.

With the price of commodity aluminium falling, and resource company shares declining sharply in value, Deripaska’s standing internationally shrinks in proportion. His borrowing capacity declines concomitantly. The overhang of his buyout obligations to his shareholding partners in Rusal, and of the enormous debt Rusal is carrying, grows heavier, and heavier. If he is now perceived as lacking the necessary political support of the Kremlin, then one of the key undertakings the underwriters of last year’s Rusal London listing bid demanded — a letter of support from the Kremlin — would be forfeit. All the cards foretelling Deripaska’s future appear to have passed into Chernoy’s hand.

But what of the fourth point in the Udokan affair — the much reported political influence of Usmanov?
On the eve of Tuesday’s Udokan announcement, Usmanov was granted an audience with President Medvedev. Fully televised, this was one of the rare solo appearances Usmanov has been granted at the Kremlin. The presidential release suggests he and the President talked of Metalloinvest’s plans to expand iron-ore output at the Lebedinsky and Mikhailovsky mines — two of the three largest in Russia — and also of Usmanov’s problems in London. According to the Kremlin statement, “Dmitry Medvedev has taken an interest in whether Alisher Usmanov and his partners face any complexities in the placment of investments in other countries.”

The statement also winds up with a pat on Usmanov’s back for the creation of a fund for “the support of the suffering people of South Ossetia”. The fund, with a target of Rb1 billion ($40 million), is described as Usmanov’s initiative, but others are intended to contribute.

Before the Udokan award, Usmanov had been designated by then President Putin to assist Potanin in the latter’s scheme to resolve his shareholding conflict with Prokhorov, and ward off the takeover attempt by Deripaska. Mineweb reported in February, when the terms of the Potanin-Usmanov arrangement followed Potanin’s meeting with Putin, that the plan was for a cross-shareholding arrangement between Potanin’s Interros holding and Usmanov’s Gallagher group that would be the precursor for a merger of Metalloinvest assets with Norilsk Nickel.

Subsequently, Usmanov couldn’t get Potanin to accept his valuation of Metalloinvest, and they began to dicker. Usmanov said he would prefer an IPO in London to fix Metalloinvest’s value. Further reinforcement of their intention to combine against Deripaska was called for. Again, Potanin met Putin, and on May 29, a public statement was issued by Interros to the effect that “considering the high potential for the growth of Norilsk Nickel value, Gallagher company expressed its intention to acquire up to 10% in this company. In its turn Interros considers the possibility to buy 25% plus one share in Metalloinvest holding and intends to file an appropriate request to Russian antitrust authorities.”

It is not clear whether Gallagher has accumulated anything like a 10% stake in Norilsk Nickel. If it has, there is likely to be far less cash in the Metalloinvest till to meet the the investment terms which the award of the Udokan project require. A release by Metallonvest reports that the total will exceed Rb100 billion ($3.9 billion). Metalloinvest does not have that kind of cash. Together with Russian Technologies, it is far from certain that, in present market conditions for copper mining projects, Usmanov adds to the international bankability of the project. Their combination, however, should assure at least $1 billion in funding from state banks, Sberbank and VTB.

But there are signs that Chemezov doesn’t have, and doesn’t intend to put up the cash required to secure a half-share in the project. The Metalloinvest release reports that “the underwriting share of Rostechnologii will make not less than 25%. The parties agreed that the participation of other stakeholders in the project will not be excluded.”

After years of debate, foreign copper miners from outside Russia — notably, Kazakhmys, the Chinese and Chileans, BHP Billiton, and Rio Tinto — have shown interest in Udokan, and in taking an equity and development financing stake in return for offtake. The Russian government reaction has been to exclude foreign participation, and curtail future exports. until and unless Russia’s expanding domestic demand for copper centrate is fully satisfied. The reference to other stakeholders probably does not refer to foreigners.

The terms of the licence award, disclosed this week by Metalloinvest, call for considerable copper-mining experience. The terms include completion of feasibility studies within 18 months; reserve confirmation within 60 months; startup of a mine plan with annual capacity of 12 million tonnes of ore within 60 months; achievement of design capacity of 36 million tonnes of ore output within 84 months; and within the same period, construction of a smelter at the town of Yasnogorsk to turn out 474,000 tonnes of cathode copper, and 62.7 million tonnes of copper wire rod per annum.

The timing is tight. According to the project schedule reported in the Metalloinvest announcement, “the construction of the hydrometallurgical complex on the Udokan copper field will start in 2010. The first section of the mining and metallurgical complex with the production capacity of 150 thousand tones of cathodic copper (12 mln tones of the concentrate) per year will be put into operation as soon as in 2014. The design capacity is expected to be reached in 2016.” The cost of power, roads, rail links, seismic protection, and other infrastructure appear to be allocated to the state.

The obvious candidate to help accomplish all this, and to become third stakeholder, is Potanin, and for a mine operating partner, Norilsk Nickel. And so who wins is a harder question to answer than who loses.

What has been awarded is this: Russian studies indicated a year ago that Udokan’s mineable ore reserves break down into sulfides 43%, mixed 40%, and oxides 17%. Official reserves, according to the Russian classification, amount to 1,310.8 million tonnes of ore, 19.7 million tonnes of copper (average grade 1.51%) and 11,900 tonnes of silver (average grade 9.6 g/t). International studies, which include BHP and Bateman, estimate Udokan reserves at 27 million tonnes of copper.
At the current copper price, the project resource is worth at least $135 billion, plus another $4 billion for the silver.

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