Centerra fighting to set the right example with Boroo (September 22, 2006)

When looking at the economics of Centerra Gold‘s (CG-T) Boroo gold mine in Mongolia, it’s hard to find much to quibble with.

The mine will turn out roughly 275,000 oz. of gold for 2006 with total cash costs in the US$210 to US$215 per oz range. Over the course of its seven-year mine life Boroo should pour over one million ounces of gold with total production costs being held down by a favourable tax structure.

But the strength of the tax scheme is at the same time the project’s Achilles heel, as the stability agreement it is born from has drawn public ire.

The agreement lets Centerra off from paying income tax during its first three years of operation, and for the following three years it requires it to pay just half of the official amount. Those three years begin in Mach of 2007 and will see the company pay income tax at a rate of 15%.

And while such a tax scheme looks great from an investors perspective, for the Mongolian public and a couple of the country’s parliamentarians — the project has become the symbol for unfair exploitation of Mongolian resources by western corporations.

A fact disputed by Boroo’s president Paul Korpi, who in an interview with MonInfo over the summer, pointed out that Boroo’s tax contributions amounted to roughly $9 million in 2005 when things such as land payment fees, social insurance fees, VAT and royalties are taken into account.

Those numbers either weren’t known about or weren’t good enough for the some 100 protesters who were bussed to the mine from Ulaanbaatar. Their protest resulted in the mine being put on care and maintenance for roughly 40 hours with some production being lost. While the protest was dealt with in relatively short order, tensions remain.

On the hour long drive back from Boroo to Ulaanbaatar, Igor Kovarsky, Boroo’s vice president of government affairs and corporate development, says that in March of this year, in an effort to be good corporate citizens Centerra management told the government it was willing to contribute more to the country’s coffers.

One government official floated the idea of having the company make a sizable donation towards the construction of a new health-care facility in Ulaanbaatar. And while Kovarsky says Centerra was open to the idea, it has yet to receive any formal proposals for the project.

In addition to the protests, there is widespread speculation in the business community that Centerra’s getting too good of a deal on its stability agreement, was an impetus behind the implementation of the revised and heavy handed mineral law.

The revised mineral law includes the infamous 68% windfall tax on gold and copper production after prices for the metals reach a certain threshold, and a strategic deposit stipulation which could see the government earn into projects to the tune of 34% or 50% depending on where funding for a given project came from.

While it’s impossible to know whether Boroo’s stability agreement played into the drafting of the new laws, it’s clear that Centerra has received a lot of bad press for an agreement that it didn’t even negotiate.

The Australian-based exploration company — AGR — negotiated the original agreement back in 1998. What’s more, there has been little public outcry against the government officials who were at the table when the deal was signed.

Centerra has taken the brunt of the criticism for doing nothing more than making an astute business move.

It acquired the cash strapped AGR for US$12 million in cash and a US$4.8 million promissory note for additional properties, including Gatsuurt, and US$3 million of exploration funding. AGR also got roughly 4 million common shares of Centerra at an IPO price of $15.50 per share.

Also lost in the controversy is the fact that in Boroo, Centerra has the distinction of setting up the first hard rock gold mine in Mongolia. An accomplishment made possible in part due to the expertise and capital that come with having Cameco (CCO-T, CCJ-T) behind you.

Currently Cameco is a 53% stakeholder in Centerra, but the company was born as a spin-off of what was formerly Cameco’s gold division. The two companies share inter-company advances as well as expertise.

Boroo is situated 110 km. northwest of Ulaanbaatar, and unlike many other mining projects in the remote and still underdeveloped country, it benefits from being near good infrastructure. The drive from the Ulaanbaatar is smooth by Mongolian standards, as the mine sits just off of the all-weather, fully paved Ulaanbaatar-Irkutsh highway. In addition the mine has easy access to the Trans-Mongolian railway.

The mill — which was built for US$75 million and went into commercial produciton in March of 2004 — is currently being fed by two open pits (Pit 5 and Pit 3) and is expected to process more than 13.4 million tonnes of ore and more than one million oz. of gold over the course of its mine life.

Pit 5 will be mined-out by the end of this year and has had an average grade of 4.5 grams gold per tonne. Pit 3, which encompass the former Pit 2, is averaging 3.5 grams gold per tonne, but that number will drop down to between 2.5 and 3 grams gold after this year. The pit will be mined out in 2010.

It is anticipated that another pit, Pit 6 will carry the production at the mine through 2011.

While those numbers aren’t huge on the global stage, by Mongolian standards they are significant. The mine has thus far accounted for a 45% increase in Mongolian gold production, and employs some 500 bodies — 90% of which are Mongolian nationals.

Although 2005 was a banner year for the mine — it exceeded its targets for tonnes mined, tonnes milled, gold ounces produced, and cash cost came in at a very low US$183 per oz. — there’s been a downturn in production for 2006.

For the six months ending June 30 the mine poured roughly 130,000 oz of gold, compared with the roughly 147,000 oz. it poured for the same period in 2005. Gold recovery for the first six months of the year was down to 87.6%, compared with 92.4% for all of 2005. The reduction in recovery is a result of the processing of more transitional ore as opposed to the oxide ore that was previously mined.

Kovarsky says he expects the recovery rate to go back up over 90% once pit five is mined out by the end of this year.

On the plus side, lower production was offset by a higher average realized price. For the first six months gold from Boroo was sold for an average of US$587 compared with US$418 for the same period last year. The second quarter of this year was particularly strong at an average price of US$640 an oz.

The higher price of gold lifted revenue to US$43.1 million in the second quarter, compared with US$33.2 million for the same period last year.

As for sustaining capital, the company says 90% of its projected US$7.5 million capital expenditure cost for the year will be sustaining capital costs — most of that being incurred in the first half of the year.

And while exploration at the site continues around the peripheries of the pits — Centerra managed to add roughly 350,000 oz. to its reserves and another year of mine life in 2005 — most of the replacement ounces for the mill were slated to come from the Gatsuurt project.

However, with revision of the mineral laws making the economics of new projects less attractive Centerra has suspended operations at the site and it admits that discussions with the government towards another stability agreement for Gatsuurt could be slow going.

Gatsuurt has a reserve of roughly 9 million tonnes grading 3.4 grams gold for 986,000, and a resource of 5.5 million tonnes grading 3.1 grams gold for 565,000 oz. of gold.

Centerra finished a feasibility study for the project back in late 2005. That study estimated a US$75 million investment over three years to develop the deposit. Those figures include the capital cost needed to modify Boroo for the processing of Gatsuurt’s ore.

In the meantime, the company continues to do an exemplary job with Boroo. All of the public attention and scrutiny has resulted in the mine being run with a sharp eye for every detail.

The land reclamation projects is clicking along on time, with the use of local farmers to re-seed land, and the tailings pond is clean enough to have birds and frogs co-mingle along its shores.

The mine also recently hosted a group of environmentally related NGO groups who, Kovarsky says, were both surprised and impressed with how environmentally conscious operations were being run.

When such visits are combined with more information being given to the general public about how business is being done on site, and with the following through on high visibility community projects like the proposed medical centre, Centerra should be able to put the controversies of the past behind it. That way Mongolia’s first hard rock mine will stand out as a positive example for all others to follow.