iHub Mining Sector Entrance Lobby

[Frank Pembleton]

A-Z of mining in Russia; part 1

By: James Wade
Posted: 2002/12/23 Mon 11:41 ZE2 / © Mineweb 1997-2003

I decided to present this paper as result of several questions from Russian miners at the last meeting of the Mining Advisory Council. It is directed towards Russian companies seeking financing from foreign sources.

I don’t recall who made this quotation “Money goes where it is wanted and stays where it is well treated” but it is certainly true for the international mining industry. Attracting capital to explore for, develop and operate new mines or to renew or expand existing mines is a difficult task in the best of circumstances. Experience to date in Russia has not been good. The money has not been well treated even though it appears to be wanted. As a result very little foreign funding has come to or is coming into Russia for exploration, development or expansion.

BACKGROUND

The past several years have been dreadful for the international mining industry. Metals prices have been at historic lows, the economy has faltered during the past 2 ½ years and the stock market has sunk. One of the results has been that the traditional sources of risk capital for exploration projects has pretty much dried up. In the past, the majority of risk money for exploration was raised in Canada with some also raised in Europe. This has changed dramatically. It is now very difficult to find any money from Canadian sources. The perception of Russia is however slowly changing and there is now a bit of money that can be raised. London could be a place to start looking for funding for a good and well conceived project. It is however, a buyers market and the terms of any financings that are completed are usually quite stiff.

There are many countries in the world with a history of mining projects that have progressed successfully to commercial production. Some of these include Peru, Chile, Argentina, Australia, Canada, Brazil and Mexico to name just a few. Russia is competing with these countries for finances.

It is important to also remember that there is no project so good that an exploration company or a mining company can’t walk away from it. If the investor believes that the business terms are not proper or that he is not being properly treated, he can and often will walk away, as painful as that might be at the time. That does not suggest that he won’t try to stay, it means that walking is a very real option, even if it is a difficult option.

The track record of foreign investment in Russian mining projects to date is not good. We need not discus the details of Star Resources at Sukhoi Log, Pan American Silver at Dukat, Archangel Diamonds at the Grib Pipe in the Verkhotina field and now Celtic Resources at the Nezhdaninskoye project in Yakutsk. These highly publicized incidents have made foreign investors very leery of Russia. Miners are not afraid of risk, that is inherent in the business, but they do expect a level playing field and fair treatment. I just showed a client an interesting project in Yakutia and they declined to go to there because of the treatment of Celtic Resources. News travels fast and opinions are formed quickly.

There are of course some success stories such as Bema Gold and the Julietta mine, High River Gold and its 51% interest in Buryatzoloto, Kinross Gold and the Kubaka mine and now Harmony Gold and its purchase of an interest in Mnogovershinoe. Russia needs more of these good stories and fewer of the bad stories if it is to successfully compete for scarce resource financing funds in a very dynamic and competitive marketplace.

Let’s consider the two types of financing required by the Russian mining industry, risk capital for exploration and equity/debt financing for development of new mines or renewal or expansion of existing mines.

RISK CAPITAL

Normally one thinks of risk capital as the capital required to finance some sort of exploration program and/or a feasibility study to secure bank financing to build a project and finally the equity component of a project financing. The following are a few of the many questions one must consider:

· What will the funds be used for?
Develop a focused business plan with a realistic strategy. Be specific in stating use of funds.

· How much is required?
Be realistic in estimating the amount of funding required. Often the amount is substantially underestimated.

· Where to get it, large companies or small companies?
The source of funding will depend to some extent on the size of deposit. A large company will not look at a small deposit and some deposits are too large for small companies. Some small and medium size companies however have the ability to raise finances. Satisfy yourself that the company with whom you are talking can raise the required capital if, at the time you meet, it does not have all the finances required. Generally get the financing where you can. Often the smaller companies are more venturesome than larger ones.

· How to get financing and what is the cost?
This is the tough part. Offer a deal that the investor can accept. Be prepared to give up both a controlling interest in the project and operations management. This is always a sensitive topic and the subject of detailed negotiations. Obtain strong commitments from the investors for doing this.

· What are foreign investors looking for?
It is important to understand what the foreign investor looks for and present the information that satisfies that. Some of the topics are:

· An experienced and acceptable management team?
A management team that is experienced in getting things done in the region, knows its way around Moscow and knows how to solve the Russian problems. It would be a benefit if it also knew how to operate a mining company.

· Reserves & grade
Western companies are accustomed to receiving reserves information about a deposit stated in XX million of tonnes at an average grade of YY% Cu or ZZ grams Au per tonne of ore, not BBB tonnes of contained metal. Provide the information in an acceptable manner.

· Clear title
All foreign companies are concerned about clear ownership to the deposit. Provide the comfort that you have clear ownership. Show the documentation and explain how you received the license.

· Good partner
They are seeking a good partner. Demonstrate that you are a good partner. That means prove that you know your way around in the region and Moscow, that you are honest, have integrity, are fair and will do what you commit to do. Hold up your end of the deal. Above all be honorable and honest. If you don’t know something or can’t do something, say it.

PROJECT CAPITAL

Project capital is the capital required to build a project, whether it be expanding an existing operation or building a new one. The following are a few of the many questions one must consider:

· What will the funds be used for?
Be clear in stating the use of funds. That means a detailed cost description of topics such as mining development, mining equipment, mill equipment, mill construction, tailing pond construction, infrastructure development, first fill, working capital, over run allowance and contingency. Don’t withhold anything.

· Where to get project financing?
A good place to start is with the international financing agencies such as IFC, part of the World bank and EBRD. Those agencies could take on the role as syndicate leader to obtain a bank consortium to provide the financing. Many banks have a successful history of working with both. I have had successful experience with IFC. They will require all your documentation. You could also go to commercial banks such as Standard Bank, ABN Amro or others who have a track record and are experienced in Russia.

· How to get it?
Submit an application to IFC or EBRD or go directly to a commercial lender such as Standard Bank, ABN Amro or others. Develop a relationship early if you know you will be seeking project financing. Make the application complete and supported by all documentation you have. They will ask for additional information and materials if you do not provide them.

· What is needed?
The bankers require a lot of information. Don’t hold anything back. Present the information in a manner acceptable to them. Some of this is:

· Reserves-tonnes & grade
A reserves estimate performed by a western engineering company describing the reserves in XX tonnes of ore at YY grade. The grade could be %Cu, %Zn, Grams Au/ tonne, etc. It must be to internationally acceptable standards.

· OVOS
An OVOS (Environmental Report) performed by an acceptable western company and satisfying the guidelines of the World Bank and Russian standards.

· ÒÝÎ
It will be necessary to provide a Bankable Feasibility Study (ÒÝÎ) prepared by an acceptable western engineering company. This will describe the project in detail and provide a financial model which includes a debt service model.

· Legal due diligence
A substantial amount of legal due diligence will be required. This will include such topics as the corporate history of the company, a review of its legal records to confirm that the charter documentation and all directors resolutions are in order, a review of the title to the license, background on the ownership of the company and much more. Clear title is probably the biggest concern.
· Technical due diligence
A technical due diligence review will be required by the lenders. Sometimes different lenders of a consortium will have different engineering firms or consultants performing due diligence so it is quite possible that there could be 2 or more groups of engineers reviewing the data. The firms that did the reserves estimate, ÒÝÎ or OVOS will not be qualified to provide this due diligence as they would have a conflict. They will be required to answer questions from the due diligence teams.

· Financing costs and who pays
You pay! Securing project financing is expensive. There is no guaranty that one will be successful in obtaining credits. All of the costs of the ÒÝÎ, OVOS, legal due diligence, technical due diligence, travel, accommodation, and legal costs for drafting agreements will be paid by the borrower. How much does all of this cost? Perhaps 8-12% of the project loan required. Thus for a $50 million loan it could cost $4-$6 million. This is even before you have any assurance that you will secure a loan. It is up front, out of your pocket risk money! Additionally, when a loan has been approved, there will be a syndication fee of ~1% of the loan amount desired, a bank commitment fee which could be ~1% of the amount of the loan, a standby fee of ~½% of the unused funds, an interest rate of perhaps LIBOR + 3-5% or more and then the costs associated with monitoring the loan by consultants to the lenders. The fees may vary with the size of the loan and are negotiable.

· D/E ratios
It is not possible to secure 100% project debt financing. It is necessary that project financing have an equity component and a debt component. The D/E (debt to equity) ratio is usually about 6:4. that means that if the capital required to construct the project is $50 million you could expect to obtain a $30 million loan but would need to have $20 million of equity. The flow of funds to construct the project will first be the owners cost ($20 million) after which the loan advances will be made. Repayment is first to the lenders, interest plus principal. After the debt is repaid the owners can receive dividends or profits from the operation.


CONCLUSION

Securing partners and project financing is a difficult and expensive task anywhere in the world. Russia is competing for funds with many other countries which have successful track records. The history to date in Russia is not good and that is affecting the desire of companies to come here or lenders to lend to projects here.

It is important to remember:

“Money goes where it is wanted and stays where it is well treated.”

(James Wade is Director of Moscow based GNK Consultants and can be reached at: [e-mail], web site www.gnk.ru )
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