Mining policy, Venezuelan style (November 17, 2008)

Falling oil prices and the global credit crisis are fuelling Venezuela’s descent towards the lowest rungs on the ladder of investor confidence.

With oil revenue shrinking and its currency falling, the country is talking of nationalizing its largest gold deposits as part of a plan to bolster its national reserves with bullion.

The story began to unfurl in early November, when Minister of Mines Rodolfo Sanz said the country would mine the Las Cristinas project under state administration. The pronouncement threw the status of Toronto-based Crystallex International (KRY-T, KRY-x)– which has been trying to get Las Cristinas into production for years — into serious doubt, yet again.

Crystallex won a contract to mine the massive deposit back in 2002, but has been unable to get started because of a lack of an environmental permit.

News of the Crystallex rebuke was followed just a day later by word that the project would, in part, be handed over to Vancouver-based, but Russian-controlled Rusoro Mining (RML-V, RMLFF-o).

Sanz reportedly told a Russian delegation that Las Cristinas would be mined in a 50-50 joint venture between the state and Rusoro.

The plot thickened further when, a few days later, Sanz backed off the remarks and told Dow Jones Newswires that the ministry hadn’t thought about where the mine might end up.

The convoluted tale is unfolding in an environment in which Venezuelan President Hugo Chavez is not only nationalizing key industries but also strengthening ties with Russia, China and Iran.

Since 2005, Venezuela has bought some US$4 billion worth of weapons from Russia and is currently working on a deal with the country to buy tanks, armoured vehicles and war planes. On Nov. 8, it announced it would form a joint bank with Russia with US$4 billion in capital.

But such investments are becoming increasingly draining on a country whose economy relies so heavily on oil. As crude prices threaten to drop below US$60 per barrel, the government could find itself in financial straits as it used a US$60- per-barrel price forecast in its 2009 federal budget.

Beyond weapons and banks, Venezuela is also racking up a hefty nationalization bill. Chavez’s moves to nationalize portions of the telecom and steel industries, as well as oil, are projected to cost the government roughly US$14 billion.

Rather than carving out a cohesive strategy to deal with such financial strain, however, Venezuela is pursing two seemingly contradictory approaches.

On one hand, it is trying to coax Western oil companies back on to its soil to help develop its massive Orinoco heavy oil deposit.

While the deposit is one of the largest and lowest cost in the world, Western investors are understandably nervous about the latest government offers to bid on Orinoco, given that Chavez has already renegotiated 30 past oil contracts. Two companies, Exxon Mobil (XOM-n) and ConocoPhillips (COP-n),refused to accept renegotiated terms and are currently tied up in international courts.

Regardless, Crystallex would love to have the government take the same welcoming tone with it as it has with oil companies.

As it stands, however, Rusoro is the lone North American-listed miner feeling any love from Caracas. The company is said to enjoy favoured status in the country due to its Russian element — it is headed by well-connected Russian entrepreneur Vladimir Agapov and his son, Andre Agapov.

Still, a spokesperson for Rusoro, Ross Gatensbury, says the company was as surprised as anyone by the initial report linking Rusoro to Las Cristinas, and dismissed the idea as a rumour.

What is readily apparent is that Rusoro has managed to increase its presence in the country by leaps and bounds at a time when other foreign investors are heading for the exits.

Rusoro made its first big move in October 2007, when it bought Gold Fields’ (GFI-N, GOF-l) Choco 10 gold mine — slated to produce 120,000 oz. gold this year.

Its next move was to acquire Hecla Mining’s (HL-n) Venezuelan assets — chief among them being the Isidora mine, which hosts proven and probable reserves of 185,085 oz. gold.

The same deal saw Rusoro acquire the La Camorra mill, even though it said that it expected it to go under state control by next year. The company says it is currently trying to negotiate a joint venture with the government for the mill.

In 2007, the La Camorra unit produced 87,490 oz. gold at an average total cash cost of US$537 per oz.

But if Hecla is happy to get out of a deteriorating political situation, it isn’t letting on. A spokesperson for the company steered away from political comment, saying instead that its decision to sell had to do with a new corporate focus on its Greens Creek project in Alaska. Hecla sold the Venezuelan asset at a loss of roughly $12 million.

But it hasn’t been all smooth sailing for Rusoro, either. The company’s acquisition streak was upset by Spokane, Wash.-based Gold Reserve (GRZ-T, GRZ-x).

While Rusoro’s Gatensbury denies Rusoro ever made an official offer for Gold Reserve, a letter sent from Rusoro in August clearly laid out its intentions.

“Rusoro is prepared to offer to acquire 100 per cent of Gold Reserve shares through a business combination by which Gold Reserve shareholders would receive two Rusoro shares for each Gold Reserve share,” a letter addressed to Gold Reserve’s board of directors reads.

The letter says that if Gold Reserve made its contents public, the proposal would become null and void.

Gold Reserve’s president Doug Belanger refused to play along.

Knowing the letter classified as material information, Gold Reserve released it to the public anyway.

No doubt the decision was made easier by Belanger’s estimation that the proposal was “naive, ill-conceived and an insult.”

Gold Reserve controls the Brisas project, which abuts Las Cristinas and hosts proven and probable reserves of 10.2 million oz. gold and 1.3 billion lbs. copper — representing far more ounces in the ground than Rusoro has at present.

Additionally, Rusoro’s uninspiring financial statements — the company reported a net loss of roughly US$54 million for the first six months of the year — made determining Rusoro’s real value a difficult task, Belanger says — a key consideration as the proposal was an all-share offer.

And while some may believe the Rusoro overture was a last chance for Gold Reserve to get out of Venezuela with something to show for it, Belanger is taking a steadier approach.

“We’ve been in Venezuela for almost seventeen years, so we do have patience. That said, we can’t wait forever,” he says. “What we’re saying to the government is it is their right to do whatever it is they want to do, but they are subject to consequences.”

Belanger says such consequences would take the shape of appropriate compensation for Brisas.

He points out that despite market reservations about Chavez, the Venezuelan government has compensated companies for projects it has nationalized.

Belanger says deals struck with the oil and steel industry show companies settling for 1.5 to 2.5 times their investment in a project. Gold Reserve has put roughly US$200 million into Brisas.

And if compensation doesn’t pan out, following Exxon Mobil and ConocoPhillips to the international courts would be the next step.

While doubts always arise as to whether international courts have any teeth when dealing with countries like Venezuela, a recent Dutch court ruling in favour of Exxon shows they just might. That ruling froze some US$12 billion of Venezuela’s global assets. A verdict is pending in Exxon’s case against the government.

As for Crystallex, while its days appear numbered, it has faced such dark clouds before, only to be offered new rays of light by government officials.

The company says it hasn’t received any word about a cancellation of its mining contract.

Maison Placement analyst John Ing is also taking the latest news in stride.

“Rome was built a lot faster than Crystallex,” Ing quips. “But any news that comes from Venezuela has to be taken with a grain of salt,” he adds. “It tends to be clarified later on by the government or the company.”

As a case in point, he offers that many of the initial reports regarding Sanz’s comments claimed the government was taking over Las Cristinas. But as those familiar with the story already know, the government has long been the owner of the project, with Crystallex being contracted to mine the deposit along with state mining firm CVG.

Still, such finer details failed to assure the market. It signalled it was taking the news seriously by slashing Crystallex shares by 28% or 13 to 33 on roughly 3.75 million shares traded.

Such harsh reactions come with operating in politically risky areas, Ing says.

“Whether you’re Crystallex, Centerra Gold or Ivanhoe Mines, it’s a fact of life,” he says. “While logic would put these projects into production quickly when metal prices were high, there are always other factors. Mining is not a sure thing.”