Editorial: Russia tightening its grip on natural resources (October 30, 2006)

Foreign investors of time and money in Russia’s mining sector would do well to keep a close eye on the increasingly bullying stance the Russian government is taking towards foreign oil companies, because the power games the Kremlin is now playing with Big Oil will likely soon be replayed even more skillfully with foreign mining and mineral exploration companies.

In September, Russia’s Natural Resources Ministry all of a sudden turned treehugger and withdrew a key environmental permit for the US$22-billion Sakhalin II liquefied natural-gas project in Russia’s Far East, a massive effort being led by Royal Dutch Shell under a production-sharing agreement struck in 1994.

This was quickly followed up by the ministry announcing plans to probe other oil production-sharing agreements such as the one at the Kharyaga project in northern Siberia, implemented by France’s Total, and at the Kovykta gas project in eastern Siberia, developed by the Anglo-Russian joint venture TNK-BP.

Most observers see these moves as little more than the Russian government reasserting state control over the country’s oil and gas reserves at a time of high prices in order to gain lucrative profits for itself and the country’s favoured oligarchs.

In late October, Russian Natural Resources Minister Yury Trutnev said that the agency for mineral resources and oil and gas companies will be given six months to update its licensing agreements, and warned that licences might be revoked should companies violate legislation or the provisions of agreements on mineral-deposit use. His ministry added that less serious cases would more likely result in economic sanctions rather than licence revocations.

Meanwhile, Russia’s Industry and Energy Ministry has just submitted amendments to the government that identify seven industries that should be classified as “strategic” and therefore have foreign ownership limited to 50%.

These industries are resource extraction, nuclear energy, aerospace, space, armaments and military equipment, production of special equipment, and activities involving existing monopolies.

Of crucial importance to oil and mining companies, it’s proposed that the size threshold of what is deemed a “strategic” oil or gas field be substantially lowered, a move that will bring 30 more oil fields and 40 more gas fields into the strategic category.

For mineral deposits, it’s proposed that the threshold be cut to 500,000 tonnes of contained copper from 10 million tonnes, and to 50 tonnes contained gold (1.6 million oz.) from 700 tonnes (22.5 million oz.).

That might put a company like Canada’s Bema Gold offside with its 75% ownership in the spectacular Kupol gold mine development in Russia’s Far East, where Bema’s attributable indicated resource is pegged at 3.1 million oz. gold and 40 million oz. silver.

Don’t count out Bema yet, though: Bema says it’s grandfathered in at Kupol and the 50-tonne threshold may be just a bargaining chip. For sure, the company has shown with the successful development and operation of the smaller-scale Julietta gold mine in Russia’s Far East that it has the right stuff to survive and thrive in that country’s harsh business climate.

Interestingly, it seems that the foreign majors have had a better inkling of the potential for a 50%-ownership cap on large mineral deposits: In their respective exploration alliances with Russia’s Norilsk Nickel struck earlier this year, both BHP Billiton and Rio Tinto limited their exposure to 50%; and Barrick Gold’s 20%-owned affiliate Highland Gold has just sold half its stake in the Novoshirokinsky polymetallic deposit near China to Kazzinc for US$36 million in order to jointly develop the project.

Meanwhile, it looks like gold really will have growing strategic interest to the Russian government, with the country’s central bank recently stating that it would like grow its gold reserves to 10% from 3% of total reserves, a move that would soak up much of the world’s mine supply.

Thanks to income from booming oil and gas exports, the Russian government’s total reserves are growing at a rate of US$12 billion per month and now rank as the world’s fourth-largest at US$267 billion, and are reportedly comprised mostly of U.S. dollars and euros, plus some pound sterling.

In another pro-gold change, the Russian Trading System, Russia’s premier stock market, began trading gold, oil, and oil products in rubles in June as part of a broader plan by the government to at long last make the ruble fully convertible.

In all, it looks like the Russian government is bent on regaining dominance over its domestic oil and gas and mining industries, and anyone in its way better be careful or else suffer the consequences.