Centerra fighting to set the right example with Boroo (October 16, 2006)

SITE VISIT

Ulaanbaatar, Mongolia — It’s hard to quibble with the economics of Centerra Gold’s (CG-T, CAGDF-O) Boroo gold mine in Mongolia.

The mine will turn out roughly 275,000 oz. gold in 2006 with total cash costs in the US$210- to US$215-per-oz. range. Over the course of its 7-year life, Boroo should pour over 1 million oz. gold with a favourable tax structure keeping total production costs low.

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.

Under the agreement, Centerra pays no income tax during its first three years of operation, and just half the standard amount for each of the following three years. That second period begins in March 2007 and will see the company pay income tax at a rate of 15%.

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

Boroo’s president, Paul Korpi, challenged this characterization in an interview with Mongolian news website MonInfo over the summer, pointing out that Boroo’s tax contributions amounted to roughly $9 million in 2005 when land payment fees, social insurance fees, value added tax and royalties are taken into account.

However, the roughly 100 protesters who were bussed to the mine from Ulaanbaatar for a demonstration in July either didn’t know about those numbers or didn’t feel they were good enough. Their protest caused the mine to be 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 governmental affairs and corporate development, said that in March, in an effort to be a good corporate citizen, 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 said Centerra was open to the idea, it has yet to receive any formal proposals for the project.

In addition to the protests, widespread speculation in the business community that Centerra is getting too good a deal with its stability agreement was one of the reasons for the implementation of the revised and heavy-handed mineral law.

The revised 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 that 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 not clear whether Boroo’s stability agreement played into the drafting of the new laws, it’s true that Centerra has received a lot of bad press for an agreement that it didn’t even negotiate.

Australian exploration company AGR negotiated the original agreement 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.

The company acquired the cash-strapped AGR for US$12 million in cash and a US$4.8-million promissory note for additional properties, including the Gatsuurt project, 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 came with having Cameco (CCO-T, CCJ-N) behind it.

Cameco currently holds a 53% interest in Centerra, but the company was born as a spinoff 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 underdeveloped country, it benefits from being near good infrastructure. The drive from Ulaanbaatar is smooth by Mongolian standards, as the mine sits just off 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 production in March 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 1 million oz. gold over the course of its 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 encompasses the former Pit 2, is currently averaging 3.5 grams gold per tonne, but will drop 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 about 500 workers — 90% of whom are Mongolians nationals.

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

For the six months ended June 30, the mine poured roughly 130,000 oz. gold, compared with the roughly 147,000 oz. produced in the same period of 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 reduced 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 5 is mined out at 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 per oz. compared with US$418 per oz. for the same period last year. The second quarter of this year was particularly strong at an average price of US$640 per 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 capital spending of US$7.5 million 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 edges 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 expected to come from the Gatsuurt project.

Gatsuurt

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

Centerra finished a feasibility study for the project 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 to process Gatsuurt ore.

In the meantime, the company continues to do an exemplary job with Boroo. All of the publ
ic attention and scrutiny has ensured that the mine is run with a sharp eye for every detail.

The land reclamation project is clicking along on schedule, with the help 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 number of environmental NGO groups who, Kovarsky says, were both surprised and impressed that the operations were being run with a high degree of environmental consciousness.

When such visits are combined with more information being given to the general public about how the site is being operated, and by following through on high-visibility community projects such as 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.