In recent years, London has been the preferred option for Russia/CIS companies in search of capital, which means that, either through ordinary shares or depositary receipts, it's now possible to gain access to dozens of companies with primary assets in the former Soviet states, whether they're global energy heavyweights such as Lukoil, established ventures such as Petropavlovsk, or prospective home-grown entities such as Chaarat Gold. However, there are major risks involved with backing these ventures and investors need to tread cautiously.
A major concern is the prospect that these companies could be disproportionately affected by Europe's ongoing economic woes, which means 2012 could be an unnerving time for anyone with a stake in the Russia/CIS region. From midway through 2008 to the following February, Russia's RTS index lost a staggering four-fifths of its value - the decline was more than double that of the major European indices.
The collapse of the oil price was obviously a major factor given the index's heavy weighting towards energy stocks, but the Russian economy was also forced to contend with an accelerated flight of capital at a time when external finance had all but dried up. As export earnings from energy and metals went into sharp decline, Moscow had to draw heavily on the nation's foreign capital reserves in order to meet state expenditure, while purchasing power shrank as the ruble depreciated by 35 per cent against the dollar.
Who's the boss?
It's not only the volatility of the market that is a problem for investors. A frequent source of chargrin for fund managers targeting the region is opaque business practices and insular corporate culture. There is also frustration that attempts by institutional shareholders to exert external pressure for corporate reform are often stymied by the comparatively low levels of free-floating shares. Indeed, two companies - precious metals producer Polymetal Intl., and Evraz, an integrated steelmaking and mining company, part-owned by Roman Abramovich - were added to the UK's FTSE 100 index at the tail-end of last year, with respective free-floats of 51 and 28 per cent. Many have questioned whether it is appropriate that companies with this type of corporate profile should be included in the UK's benchmark index.
The issue of lax corporate governance still provides a major disincentive for investment in the region. Alas, two decades after the dissolution of the Soviet Union, the notion of political patronage dies hard. Though many of the larger listed entities are at pains to extol the virtues of a new-found corporate 'glasnost', the reassurances don't always tally with the deeds. One of the most heavily criticised companies in this regard is Eurasian Natural Resources Corp (ENRC). While ENRC undoubtedly boasts some world-class assets, much has been made of the undue influence wielded by a triumvirate of CIS oligarchs, who, along with fellow FTSE 100 constituent, Kazakhmys, control the bulk of the shares.
Growth plays
Nevertheless, if you want to avoid residual political influence, you could always consider some independent growth plays in the region. One such company, Kryso Resources, has just received the mining licence that will allow it to forge ahead with the development of the multi-million ounce Pakrut gold project in Tajikistan. The plan submitted by Kryso involves an initial annual processing capacity of 660,000 tonnes, rising to 1.32m tonnes from 2017, by which time it is expected that Pakrut will be producing in the region of 50,000 ounces of gold per year, with estimated operating costs of $377 (£240) per ounce - low by industry standards - which gives more play should the gold price falter this year.
Another Aim-traded entity, Max Petroleum, is trying to unlock riches within oil fields located in Western Kazakhstan, which lay close to the massive Kashagan, Karachaganak and Tengiz fields that hold 36bn barrels of oil between them. Another route into growth opportunities in the CIS states is provided by Tethys Petroleum, the only independent oil and gas operator with projects in all three Central Asian republics of Kazakhstan, Tajikistan and Uzbekistan.
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| Max Petroleum's short-term objective is to commercialise its low-risk 'post-salt' inventory, while pursuing potentially transformational 'pre-salt' prospects in western Kazakhstan, which, in geological terms, are similar in nature to the huge discoveries made in Brazil's Santos basin by BG Group and others. While its drilling programme in these 'pre-salt' reservoirs is highly prospective in nature, the potential upside is commensurate. Max recently added three new prospects to its drillable prospect inventory with a combined mean potential oil resource of 26m barrels, while a proven and probable reserves update will be published in February, with more data on EMBA B 'pre-salt' prospect a month later. One to watch. |
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| It's curious that while the board of ENRC might charitably be described as having been in a 'state of flux' at certain points over the past 12 months, the company has actually made significant progress from an operational perspective. And after a long-running legal dispute, ENRC has just agreed to pay Canadian copper miner First Quantum Resources $1.25bn for the Kolwezi copper tailings project in central Africa's Congo, which might signal ENRC's determination to restore a somewhat tarnished public image. |
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Admittedly, the Russian economy is now better insulated against any global economic reversal because of lower internal rates of inflation and credit growth, together with a more flexible exchange rate mechanism. And Russia's state budget has recently returned to a surplus. However, it's probable that valuations for Russian/CIS companies could unravel again if European industry hits the skids. So, if you've been actively considering a foray into these markets, it would be wise to keep your powder dry till the likely effect of the European downturn on energy prices becomes apparent.
