NEW POLITICAL RISKS ARISE WITH THE NEXT GENERATION OF METALS MINING IN KAZAKHSTAN

Kazakhstan is well known for its mineral riches. The country is a top producer of uranium, chrome and zinc, along with several other metals. Reputation sings in Kazakhstan – the successful mining companies operating in the country, mostly on legacy Soviet mines, know that strong relations with both the local and national governments via intensive and expensive social projects lead to investment security and new opportunities. However, as the next generation of mining companies – smaller exploration and development companies such as Frontier Mining Ltd. – begins to break ground on undeveloped or underdeveloped fields, new political risks emerge. What will the Kazakh government expect of them?

BACKGROUND: Obtaining the so-called social “license to operate” in Kazakhstan rests largely on reputation. Two of the largest operations in the country – Kazakhmys and Kazzinc (majority-owned by privately held Glencore) – have been operating in the country since the mid-1990s. After a trial period of a few years, Kazakhmys was able to expand its copper operations and Kazzinc its lead and zinc operations to a point in which both companies now have close to a virtual monopoly over production of their respective minerals in the country.

Since the early 2000s, the mining junior Frontier Mining Ltd. (FML: AIM) has been elbowing its way onto the Kazakh scene. It now has 50 percent ownership of an estimated 2.8 million ton copper resource in northwest Kazakhstan (which will likely soon become 100 percent ownership) and 100 percent ownership of an estimated 1 million ounces gold resource in the northeast region of the country. Frontier hopes to have Benkala, the copper resource, in production by late 2011, while Koskuduk, the gold resource under their Naimanjal License, has a recently downgraded estimate of 6,000 ounces (from 10,000) of gold production for 2010.

The successful mining companies in Kazakhstan to date have recognized that a positive reputation relies on supporting social projects at both the local and national level. At times these endeavors bear little resemblance to traditional community engagement strategies used by mining companies. Take, for instance, Kazzinc, which locally funds the Kazzinc-Torpedo ice hockey team (the ‘backbone’ of Kazakhstan’s Olympic team) and on the national level, contributes to the Astana cycling team (of Lance Armstrong and Alberto Contador fame). In 2009 they received the ‘Best Social Project’ award from a corporate social responsibility competition sponsored by the Kazakh government for setting up a foster care and adoption network in the country. Kazakhmys, one of the largest employers in Kazakhstan, recently announced that it will finance the national library in Astana – a US$ 130 million facility located in the nation’s capital, hundreds of miles away from their main operations. Locally, they support several nursery schools, orphanages, and trade schools, among other initiatives.

But these two companies – along with the other mining stars of Kazakhstan, such as ArcelorMittal and ENRC – share something in common that Frontier Mining does not: traditional metals mining operations in Kazakhstan since independence have primarily been extensions of legacy mines from the Soviet era (and in some cases date back to the Russian Empire). Lead has been developed in East Kazakhstan (where Kazzinc is located) since 1784, and in 1912 it was one of the largest mining operations in the Russian Empire. In the 1980s, the region supplied 60 percent of the lead and 50 percent of the zinc to the entire USSR. Because of this deep history, a host of issues that mining companies typically deal with in South America and Africa – specifically related to the considerable social and environmental disruption associated with mining, for example land resettlement – are bridges that the mining forefathers of Kazzinc and Kazakhmys crossed decades ago during the Soviet Union or Russian Empire.

IMPLICATIONS: This is not the case for Frontier Mining. Frontier’s name is significant in more ways than one. Its growing gold and soon-to-be copper operations in previously undeveloped (or underdeveloped) fields in Kazakhstan represent a new social engagement frontier for mining in the country: what will the local and national governments of Kazakhstan expect of Frontier? How will it be different from companies like Kazakhmys and Kazzinc? And how will these expectations evolve over time? These are critical questions not only for Frontier but for the community of political risk analysts that are expected to understand and predict these issues for investors.

So far, Frontier is only in its infant stages of crafting a social responsibility strategy for the communities in which it operates. A recent technical review by the engineering consultancy Wardell Armstrong International of the company’s Benkala copper project in northwest Kazakhstan specifically points out the lack of a formal social engagement plan as well as the company’s apathy toward the Equator Principles, which are social and environmental requirements agreed upon by the world’s largest investment banks for investment in projects with capital costs of US$ 10 million or more, something Frontier will likely want to make itself eligible for in the coming years. According to the report, as of June 2010, ‘there was no Environmental and Social Management System (ESMS) in place for operations,’ nor was there ‘any formal policy pertaining to the social development of community engagement.’ In fairness to Frontier, the company is equally in its infant stages of mining development. After all, the company has a market capitalization of roughly US$ 90 million (compare to Kazakhmys, which spent close to that amount on social projects in Kazakhstan alone in 2009).

Frontier must recognize that as the company grows, so will its expectations from the Kazakh government, particularly with regard to social engagement. In recent correspondence with Frontier, they indicated that they have embraced the conclusions of the Wardell Armstrong International report and are currently developing a social and environmental engagement plan. In fact, according to CFO George Cole, public meetings were held in early September of this year for the Benkala project. He believes that all sites will likely implement a plan in the near future that will be specifically aimed at complying with the Equator Principles, and that in the interim, Frontier Mining continues to operate under complete compliance with Kazakh legislation.

Of course, there is nothing in the Equator Principles, or in Kazakh legislation, about hockey teams or 130 million dollar libraries, and while political risk analysts will be watching Frontier to see how the company navigates itself through the social infrastructure of Kazakhstan, there will also be considerable focus on the Kazakh government to see how it responds in turn. At this point in the country’s history, most of the fully developed Soviet era legacy mines have been doled out, and so a new chapter begins in which companies like Frontier attempt to develop previously undeveloped or underdeveloped deposits.

The President of Kazakhstan, Nursultan Nazarbayev, has high hopes for the future of the metals mining industry in Kazakhstan (he has called for significant increases in output as well as processing and finishing), but the country will need to think critically about a strategy for staying attractive to mining companies as old deposits meet their life expectancy and new deposits are discovered. The closures of legacy mines in the coming decades have the potential for significant social unrest.  And in the near term, the government will have an additional public relations hurdle to jump if it proceeds with plans for a possible minerals export tax to begin in 2011.

CONCLUSIONS: If history is any indicator, Frontier’s reputation with the local and national government of Kazakhstan will play a large role in determining whether its current successes will be fleeting or enduring. How that reputation will play out via a social engagement plan remains unclear. The junior exploration and development companies are nowhere near the size of a Kazakhmys or a Kazzinc and yet in many ways, they will be faced with greater risks of social unrest. As Frontier outlines and executes a strategy for integrating its presence into the social fabric of the country, other junior exploration and development firms keen on Kazakhstan, as well as associated political risk analysts, will be watching to see what works, and what does not.

AUTHOR’S BIO: J. Edward Conway (jc555@st-andrews.ac.uk) is a postgraduate researcher at the Institute for Middle East, Central Asia and Caucasus Studies (MECACS) at the University of St Andrews in Scotland. He is a former analyst for the U.S. Department of Defense.