No sooner was the Dukat silver mine in Russia's Far East proclaimed one of the country's first post-crisis successes than a bizarre ownership dispute threatened to transform it into another legal and political quagmire. But the project's main backer, the IFC, is confident of meeting the challenge.

An IFC-led financing package for Dukat, the first new Western investment in a mining project since the August 1998 market meltdown, was finalised on November 3. It comprises $60 million debt and $45 million equity to Serebro Dukat, a Russian company 90% owned by Pan American Silver of Canada, which has a 20-year concession to rehabilitate a mine in Magadan region, closed in 1996 due to lack of working capital and smelting facilities.

But when some of the mine's assets, including the ore processing mill building, were auctioned on November 30, Serebro Dukat was outbid by Kaskol, a month-old Russian company that had previously shown no interest in the project. Kaskol bid $12 million, topping Serebro Dukat's offer of $8.5 million, and by December 31, made payment in accordance with the terms of the auction.

The aim of the bid by Kaskol, which is linked to Titan Aviation, the Moscow tea importer Moskovsky Chai and several small trading companies, is not immediately clear. Kaskol chairman, Sergei Nedoroslev, has said in newspaper interviews that he plans to mill, concentrate and refine silver ore in Russia instead of exporting it, thereby cutting costs - although industry sources say it is next to impossible to produce refined ore in Russia.
Other serious obstacles to Kaskol's plan are that Serebro Dukat retains the mining licence, without which the mill is useless, and a very strong leasing agreement on the mill, which survives any change of ownership. Kaskol, which shuns publicity, has not said how it might resolve these problems.

Dukat is projected to produce 16 million oz of silver and 33,000 oz of gold in concentrate annually for 15 years. The financing kicked in after exports of silver concentrate from the mine were authorised by presidential decree on October 14.

Pan American and its partners, Western Pinnacle Mining and Geometall Plus - who have a good relationship with Magadan governor Valentin Tsvetkov -  believe the dispute with Kaskol could delay, but not stop, the project. After Kaskol confirmed it had made payment for the mill, Pan American announced that it may seek to overturn the auction legally. It is also commissioning a study for a new mill. Ross Beaty, Pan American chairman, says: "Kaskol's action is frustrating, but we believe it will not prevent us from successfully developing Dukat as soon as possible."

Waldemar Maj, senior investment officer at IFC, says the Dukat investment, the corporation's first in Russian mining, is a landmark - despite the mill dispute. The $60 million debt financing includes $15 million each in loans from the IFC itself and the Export Development Corporation of Canada, and a $30 million IFC loan syndicated to Bayerische Hypo Vereinsbank, Standard Bank and FMO of the Netherlands. There is also a $10 million standby facility.

Maj says: "Of course the perception of Russia is not improved by disputes such as this. But, even if Pan American has to build its own mill, the project will go ahead. The business environment in Magadan remains a friendly one."

According to Maj, Russian mining projects remain prime targets for Western lending. "The IFC will continue to look at export-oriented projects. We are keen to work with those that have modern, Western-style management and good cost management." He adds that mining projects  "on which the Russian tax burden, 10% royalties plus profit tax is high but predictable, are usually more stable than larger oil projects."

It is not only the IFC that is moving forward with Russian mining projects. Standard Bank and Hypo Vereinsbank  - the most active players in the sector, from which Barclays and NM Rothschilds effectively withdrew after August 1998's financial meltdown - last month finally went ahead with a $25 million project loan for the Julietta gold mine in Magadan.

The loan went through, together with a $5 million convertible debenture available for construct cost overrun protection. The remainder of the projected cost of mine construction, $38.5 million, will be raised either by extending the loan or by equity funding from Bema, the Canadian miner with a controlling 79% stake in the mine's owner, Omsukchansk Mining & Geological Company.

Engineering and procurement is scheduled for January-April next year; on-site construction and mine development to June 2001 and full production thereafter.

Julietta is expected to produce 113,000 oz of gold equivalent at operating costs of $93 per oz. Ken Booth, vice-president for corporate development at Bema, says: "We are absolutely positive about working in Magadan. There is good regional government, a highly skilled workforce, great potential resources and a gold refinery that is to be commissioned shortly."

Those sentiments about Magadan are shared by Kinross Gold Corporation of Canada, the major partner at the nearby Kubaka mine, which has been in commercial production since June 1997. Kubaka - whose other owners are four local miners, the Russian Credit Bank and the Association of Native Peoples of the Severo-Evensk District East - has produced 1.2 million oz of gold equivalent in its first two-and-a-half years.

Gordon McCreary, vice-president of corporate development at Kinross, says: "Despite the lack of flexibility in sales implied by the state's right of first refusal, and despite the continually weak gold price over the period of operation, the mine has been a success. That is testimony to the robust nature of the ore body and shows that mining in Magadan pays off."

Kubaka has blazed the trail for others in two key respects. First, it has reminded lenders that there is such a thing as a performing loan in Russia: $50 million of the $130 million debt financing the project received from the EBRD and OPIC has been repaid and on November 24 the remaining portion of these loans became non-recourse to Kinross. Russian domestic loans from ABN Amro for capital cost overruns and working capital, which totalled about $30 million, are also being serviced promptly.

Second, Kubaka has shown that hiccups in the sale of gold and repatriation of proceeds can be overcome. Gokhran, Russia's state precious metals agency, has right of first refusal on all gold production, at a fixing-related price, and Omolon has permission to convert the proceeds and pay them into legally constituted offshore accounts.

From June 1997 until September 1998, when the financial meltdown caught up with it, Gokhran bought all Kubaka's output. From then until March 1999, Kubaka's gold was exported. Gokhran took up its option again until September 1999; then the gold was sold to Russian banks. Although Kinross will not comment, an authoritative market source says: "Each time that Gokhran was unable to take up the option and the question of export came up, bureaucratic obstacles suddenly went up. Kinross threatened to just stop production and walk away, and the obstacles disappeared again."

Kubaka, Julietta - and hopefully Dukat - should increase lender confidence in Magadan. Mines in production elsewhere in Russia include two in the Buryat Republic operated by Buryatzoloto, which are expected to produce 100,000 oz of gold in 1999 at costs including taxes of under $180 per oz. Don Whalen, spokesman for High River Gold of Canada, the project's largest shareholder, claims: "It's going great. There are a number of investment options that could be taken up if the gold price rises, which would increase production to between 200,000 oz and 250,000 oz per year." Buryatzoloto, like Kubaka, proved a good bet for the multilaterals. A $10 million loan extended by the EBRD in November 1996 to build a carbon-in-pulp plant has been repaid.

The Pokrovsky mine in the Amur region, in which Zoloto Mining of the UK has a controlling interest, produced its first gold in 1999. Zoloto is working to a scaled-down development plan after it was unable to raise equity capital to match the $52.3 million the IFC had been prepared to put in to a more ambitious project. The IFC now has no commitment to Pokrovsky.

Precious and non-ferrous mining projects in Russia are likely to be limited to medium-sized projects such as those mentioned, and Norilsk Nickel's operations. The vast array of smaller mines are too sensitive to world prices, cost fluctuations and the rouble rate, to attract finance. Nikolai Menshikov of Lanta bank of Moscow, which specialises in gold mine financing, told a recent Gold Fields Minerals Services conference in London: "We consider the small projects a special risk group that are unable to provide adequate security."

As for future large-scale projects, banks' credit committees will not even think about them until they know the outcome of next summer's presidential election. So, for now, export-based projects with strong Western sponsors remain the only game in town.