Want to gamble? Go mining in the far eastern Russian province of Magadan. The contrasting fortunes of the Julietta gold mine project and the Dukat silver mine in the region provide an object lesson in the possibilities and problems of projects in Russia.

The possibilities all lie with Julietta. Having closed its project financing last month (see Project Finance, August 2000, page 6), it is now looking to start production in the second half of 2001 with operating costs of $75 an ounce.

Dukat, the world's third largest silver deposit, has the problems: it is mired deeper than ever before in a complicated ownership dispute and the dominant partner in the joint venture company, Pan American Silver of Canada, has admitted it may have to walk away if a complex ownership dispute is not resolved.

Clive Johnson, chief executive officer of Bema Mining, the Canadian company that owns 89% of the Julietta project company, says the breaks on VAT and other taxes afforded by Magadan's special economic zone were one of the greatest advantages for the project, whose total production over its lifespan is estimated at 113,000 oz.

Johnson says the Mineral Base Replenishment Duty, which is charged at 7.8% and is a major cost for Russian mine projects, has been reduced after negotiations to a single $1.7 million payment. ?We were able to settle on a lower payment because Julietta was discovered very late in the Soviet period. We estimate our operating costs will be $75 per ounce, or $93 per ounce including taxes and royalties.?

Standard Bank London and HypoVereinsbank put together the final $30 million in finance for the Julietta project company, Omsukchansk Mining & Geological Company, in July. The project also had $10 million from the IFC.

Another crucial element for Julietta has been an agreement with the Central Bank, now in the final stages of negotiation, allowing revenues to be paid into dollar-denominated offshore accounts. Johnson says that here the trail had been blazed by Kinross Gold Corporation of Canada, the major partner at the nearby Kubaka mine: ?in this respect, as in many others, the fact they had broken ground made it much easier for us?.

There could be no sharper contrast to the Julietta success story than that provided by Serebro Dukat, a project company which owns a 20-year concession to rehabilitate a Magadan mine projected to produce 16 million oz of silver and 33,000 oz of gold in concentrate annually for 15 years. A previous mine on the site closed in 1996 due to lack of working capital and smelting equipment.

Serebro Dukat received a $105 million debt-and-equity IFC-led financing package, with participation from Standard Bank and HypoVereinsbank, in November last year. Since then it has been embroiled in a series of endless legal disputes with Kaskol, a newly-formed Russian company that has bought some of the mine's assets, including the ore-processing mill building, at auction.

Serebro Dukat has tried to challenge the auction results in court and failed. A related legal dispute concerns a leasing agreement on the mill, under which Serebro Dukat was to buy it for $9 million minus monthly lease payments: Serebro Dukat argues that the sale of the mill building to Kaskol nullified the leasing agreement. On 18 August the Magadan region arbitration court again rejected an application from Serebro Dukat on this issue.

On 2 August Kaskol lodged a counter-claim for damages, stating that since starting work on the site last year, Serebro Dukat has done $10 million worth of damage. Pan American Silver says that due diligence done at the site will clearly establish that they had nothing to work with but a broken-down building.

Industry observers say that the cases are merely battles in a war for control over the mine. And whereas Kaskol, formed shortly before last November's auction by flamboyant Moscow businessman Sergei Nedoroslev, seemed an unlikely competitor, earlier this year it formed an alliance with Polimetall of St Petersburg, a financial group.

Magadan governor Valentin Tsvetkov, who has won admiration from foreign investors for his role in creating a business-friendly environment and establishing the special economic zone, has become impatient with the Dukat dispute. In June he threatened Serebro Dukat that he would attempt to get its mining licence withdrawn if production did not start production by the third quarter of 2001 as its terms require.

Kaskol says that if Serebro Dukat runs out of time and has to surrender the licence, it will bid for it ? and is also ready to negotiate in the meantime. The two sides have held talks but failed to reach agreement.

Rosie Moore, at Pan American Silver, says the company is pursuing a number of different possible solutions to the Dukat problems. Firstly, it has attempted to assert its rights through the Russian courts, ?which has been the least fruitful approach?. Secondly, talks have been held not only with Kaskol and Polimetall, but also with governor Tsvetkov, and through Canadian prime minister Jean Chretien the issue was raised with the Russian government. But the politicians argue this is essentially a business dispute.

Thirdly, Pan American is negotiating with the IFC the possibility of raising another $25 million to finance the construction of a new mill ? and, while the response has been ?sympathetic?, no new money has been agreed. Fourth, Moore says, ?we have talked to some large Russian natural resources companies who are considering earning an interest in the mill?.

Moore added: ?We are a small company; we do not exercise the clout that BP does. We lost 40% of our share price in August 1998 after the Russian crash, so we are not getting anything for Dukat now. We have nothing to lose by pressing on and trying to reach a solution. But if we had no other option, we would write it off.?

Pan American's travails have highlighted the difficulties presented to mining projects by Russia's unpredictable judicial system. But lawyers familiar with Russian mining point out that, on top of this, the legislation itself is far from perfect.

Levon Kocharyan, partner at Macleod Dixon's Moscow office and chairman of the Russian Precious Metals Council, says export duties imposed in early 1999 (5% on gold and 6.5% on silver concentrate) are ?a significant problem?. The Central Bank added to the problem by discounting the prices it was prepared to pay on the domestic market once the duties were imposed.

A more serious issue is the state's right of first refusal on sales of precious metals, or rather, the way it is exercised. The state exercises this right through the federal precious metals agency, Gokhran, and its regional affiliates. The federal Gokhran buys gold at London fixing prices ?1%; regional Gokhran prices are between London fixing ?2% and ?5%

While most of Russia's gold producers, the small artels, are content for banks to buy their gold and handle the administrative, legal and business complexities of export, the foreign-partnered joint venture projects would probably rather export their own production, Kocharyan says. But a draft presidential decree to permit direct export has been ?stuck in the presidential administration for three years already, and there is no saying when it will come out?.

Kocharyan says that serious problems remain with the legal status of mine licences, despite amendments to the subsoil law enacted in January this year. ?Firstly, grounds for termination of licences are too broad, and courts are frequently asked to determine what are the ?essential terms' of a licence.

?Secondly, there is no concept in the legislation of preferential rights to property located at a mine.

?Thirdly, there is no clear limitation period in the subsoil legislation. Even if a mineral licence was issued back in the 1950s it is still open to legal challenge.?

Aleksandr Barmin of Allen & Overy in Moscow says the subsoil law amendments ?may provide a partial solution? to the critical issue of transfer of licences that has dogged Russian projects for some years.

The old subsoil law allowed for licence transfer only in the case of corporate ?reorganisation?, a tricky and limited legal concept. The ministry of natural resources' Instruction No. 65 of May 1995 famously hoped to get round this problem by permitting transfer of licences to a third party ? and more than 4,000 licences were issued under it, only for the courts to find in a series of cases that the instruction was not legally valid.

The subsoil law amendments that came into force in January provide for licence transfer to a subsidiary ?at the time of transfer? ? which implies that a licence-holder may be able to transfer the licence to the subsidiary in which it then sells its share. The amendments also provide for licence transfer in the case of ?acquisition by a legal entity of all assets of a bankrupt enterprise?.

It remains to be seen whether the future holds a string of Julietta-type successes or Dukat-style difficulties. Probably there will be both. In the two years since the Russian financial crash, native companies such as Polimetall have grown stronger and more confident: no doubt they will be ready to compete fiercely for position in the country's natural resources industries. Perhaps the varied experience in the Magadan shows that, while most ? if not all ? tax and legal problems are ultimately soluble, the selection of local business partners will be at least as important as either for future projects.