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Tuesday, August 22, 2006

Uzbekistan: Westerners out, Russians in?


US miner Newmont says it has lost control of its gold-producing joint venture in Uzbekistan, following the imposition of a US$48m bill for back taxes and fines. The Uzbek government seems determined to oust Newmont, and other foreign investors could follow in due course. Although the state is motivated partly by a desire to revoke tax concessions granted in the 1990s, there is a discernible political push to replace Western companies in Uzbekistan with Russian ones.

Newmont, the world’s second-largest gold producer, announced on August 11th that it was under criminal investigation in Uzbekistan and had lost day-to-day control over the Zarafshan-Newmont joint venture, which produces gold from the Muruntau open pit mine. Its expatriate employees in Uzbekistan have been put on leave. Following the imposition of two bills for back tax and penalties relating to 2002-05, totalling US$48m, Newmont has been prevented from exporting its share of gold output from Muruntau. The company also says that some of its assets have been seized by the government, and that the European Bank for Reconstruction and Development (EBRD) has frozen one of the company’s offshore accounts. Newmont admitted in July that it was looking to sell its 50% stake in the joint venture, as relations with the government have deteriorated.

Going for gold

The Zarafshan-Newmont joint venture is a sizeable gold producer in Uzbekistan, although its share has declined in recent years and currently accounts for less than 10% of national output. In 2002 it produced 16m tonnes, but output fell to just over 12m tonnes in 2004 and 7.7m tonnes in 2005. Before the latest troubles, the company forecast 2006 output at 7.5m tonnes. Total gold output in Uzbekistan is 80m-85m tonnes annually.

Newmont established the joint venture in 1992 with the Navoi Ore Mining and Metallurgical Plant (NGMK) to recover gold from tailings at the Muruntau mine. It has 220m tonnes of off-balance ore with an average grading of 1.4 grams per tonne for gold. Newmont values its stake at US$94m.

Although Newmont’s investment is not particularly large by the standards of foreign investment in east-central Europe and the former Soviet Union, the company is a major investor by Uzbek standards. Until last year, Newmont ranked alongside British American Tobacco (BAT) and South Korea’s Daewoo as one of the three largest foreign investors in Uzbekistan. Since then, Daewoo has quit the country. Newmont’s ouster would thus signal a dramatic worsening in the standing of foreign investors in Uzbekistan.

Carat and stick

In common with several other foreign investors in Uzbekistan, the Newmont-Zarafshan joint venture has enjoyed generous tax breaks by government decree. In March 2006, the government told Newmont it wished to renegotiate or eliminate Decree 151, which protected the venture from changes in tax laws and provided other financial and operational benefits. In June the government scrapped all indefinite tax concessions and insisted it would henceforth only grant concessions for a definite period.

The immediate motive for this appears to have been to boost the government’s financial position, which is believed to be less sound than the headline numbers would suggest. In the case of Zarafshan-Newmont the government cited the rising price of gold. At the time the joint venture was formed, gold was worth around US$220/troy ounce, whereas in mid-2006 the average world price was nearly three times as high.

Newmont was then taken to court, on the basis that the revocation of Decree 151 was to be applied retrospectively. It was billed US$37m for back taxes and fines for the period 2002-04, and a further US$11m for 2005. Newmont refuses to accept court rulings, although it has already lost one appeal. Its prospects for victory appear slim to non-existent, and it is difficult to envisage any outcome other than Newmont selling its interest in the joint venture.

Anxious onlookers

Assuming that Newmont is eventually forced out, the focus of the authorities could switch to the other companies affected by the revocation of indefinite tax exemptions. These include fellow gold producer Amantaytau Goldfields (an Uzbek-UK joint venture) and the SamKocAuto (Uzbek-Turkish) automobile venture.

Already the Amantaytau-Goldfields venture, which is operated by Oxus Resources, has lost some of its tax privileges. The company says it has not been affected by the Newmont-Zarafshan dispute and adds that it is “sympathetic” to the government’s desire to increase revenue from the mining sector at a time of high metal prices—and so is open to renegotiating its tax arrangements. Whether this conciliatory tone will be sufficient to spare Oxus from the likely fate of Newmont is uncertain. It may be to Oxus’s advantage that the Amantaytau-Goldfields venture is smaller than Newmont-Zarafshan.

Turning back to Russia

Although the government’s shifting stance on tax concessions seems to have been triggered by financial concerns, in particular the desire to get a greater share of the wealth from record-high metals prices, it is difficult not to take note of a broader political undercurrent.

In the wake of the crackdown against protestors in Andizhan in May 2005, when several hundred protestors were reportedly killed, Uzbekistan’s relations with Western states soured. This culminated in the government’s decision to request that the US military vacate its military base in the country, which helped to support operations in Afghanistan. Since that time, Western investors report that they have faced greater hostility in their dealings with state representatives.

Simultaneously, President Islam Karimov has made clear that he would like to see greater Russian investment in the country. Russia, in contrast with Western states, supported Mr Karimov’s handling of the Andizhan protests. It has since developed a closer political and military relationship with Uzbekistan, which throughout the 1990s sought to keep Russia at arm’s length.

In the case of the Newmont-Zarafshan venture, there has been considerable speculation that the US investor will be replaced by Russian gold producer Polyus, the subsidiary of Vladimir Potanin’s Interros holding. At first sight, this appears an odd move for Polyus: Newmont-Zarafshan is a small-scale producer by the standards of the Russian company. Indeed, Polyus has denied an interest in the joint venture, citing its attendant “risks”. It has, however, admitted a keen interest in projects in Uzbekistan. The particular attraction of Newmont-Zarafshan for Polyus lies in the relationship it would thereby establish with NGMK, which accounts for three-quarters of Uzbekistan’s gold output and is also a major producer of uranium. Uranium—often located close to gold deposits—is perhaps Interros’s main interest in Uzbekistan. Russia is aiming to increase its output of nuclear power and plans to build 40 nuclear reactors in the next 20 years; as a result, the need for additional supplies of uranium is likely to grow.

Western investment: the trickle dries up

Whether or not Interros becomes involved in Newmont-Zarafshan, it is clear that the Uzbek government is more interested now in Russian than Western investment. This is not only a matter of politics: it is also easier for the Uzbek government to sign contracts with Russian firms, which are less encumbered by environmental concerns and shareholder-imposed restrictions on business operations than their Western counterparts. The business culture of many Russian firms is also a better fit for Uzbekistan’s state-dominated environment. Added to the difficulties of gaining access to foreign exchange, weak judicial and legal frameworks, and the government’s disinclination to offer majority control to investors, the shifting political winds in Tashkent seem certain to ensure that Uzbekistan receives little or no Western investment while Mr Karimov remains in power.

Source: ViewsWire Eastern Europe

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