COMMENT: Eurasia region to power ahead

By bne IntelliNews September 30, 2009

Eurasia Capital<br -

Often regarded as being on the edge of the world, Eurasia's rich treasure of minerals is moving the region towards the centre of economic gravity. The region is poised to receive substantial investments from resource-hungry foreign investors. Reading down the list of Eurasian countries, nearly all of them have important news to announce. Kazakhstan is the largest economy in the region and has been benefiting from continuous investments into its oil and gas industry. However, the biggest are yet to come, including huge projects like Kashagan, Karachaganak and Tengiz (see box "World Class Resources"). Despite an acute banking crisis, the country should rebound strongly on the back of a revival in commodity prices and economic recovery in the near future.

Azerbaijan is another success story, weathering the current crisis exceptionally well thanks to the continued strong growth of its oil industry and the large foreign currency reserves it built up in the boom years. The recent reserve audit of the Turkmenistan's South Yolotan super giant natural gas deposit catapulted this Caspian country into the global league with the world's fourth largest gas reserves (after Russia, Iran and Qatar). And the Southern energy corridor from Caspian to Europe could soon transform Azerbaijan and Turkmenistan into major gas exporters. Developments have been even more dramatic in resource-abundant Mongolia, where a Parliament decision to allow the government to kick off the massive Oyu Tolgoi copper-gold deposit, a Canadian Ivanhoe Mines' flagship project, was front-page business news in the international investment capitals.

The region has already attracted billions of dollars from China to help these countries overcome the economic crisis and develop their natural resources, and the Eurasian region is already seeing growing rivalry between global majors and national companies from Russia, China, India, Japan and South Korea hoping to secure access to the region's mineral wealth.

Local equity markets offer strong upside potential

Kazakhstan has the best-developed equity market in the region, which was already attracting the attention of international portfolio investors in 2006. Having lost over 70% of its value in 2008, the Kazakh market has rebounded strongly this year, albeit with most of the recent gains concentrated on several resource blue chips. Despite strong run-ups in share prices, companies like Eurasian Natural Resources Corporation and Kazakhmys still represent good value and trade at a significant discount to emerging market peers. ENRC's intention to acquire Central African Mining & Exploration Company (CAMEC) for $955m highlights the resumption of the expansion strategies of major Kazakh companies that will involve acquiring overseas assets and building international operations.

Local equity markets in Azerbaijan, Mongolia and Uzbekistan are still in their infancy and have suffered from the recent flight of foreign investors, poor liquidity and corporate governance issues. These three countries have one of lowest ratios of market capitalization/GDP among emerging markets (see chart). However, with the development of their huge natural resources and the evolution of the capital markets, shares in these markets represent substantial upside potential for an intrepid portfolio investor.

Mongolia - the Saudi Arabia of mining?

Blessed with an abundance of mineral resources, Mongolia has all the ingredients to become a prosperous nation. However, investment has been stymied by inconsistent legislation and the inability of the government to strike terms with potential investors. The uncertainties found more clarity at the end of August when the parliament approved several laws that will allow the government in the next month or so to sign a deal with Ivanhoe Mines and Rio Tinto to develop Oyu Tolgoi, the world's largest untouched copper-gold deposit.

The Oyu Tolgoi mine holds as much as 36m tonnes of copper and 1,200 tonnes of gold and will require $4bn to develop over the next five years. Annual output is expected top 450,000 tonnes of copper with 330,000 ounces of gold. The Mongolian government expects to earn $30bn in tax revenue over 30 years from this mine alone.

In addition, the nation sports another 6,000 known mineral deposits, including reserves of coal, gold, uranium, iron ore, silver, nickel, zinc and molybdenum. Mark Mobius of Franklin Templeton has recently referred to Mongolia as the "Saudi Arabia of mining." With GDP of only $5bn and the value of its 100+ locally listed companies less than $500m, Mongolia has huge economic potential if the government manages to develop effectively its massive mining resources.

M&A activity on the rise

The oil, gas and mining sectors in Eurasia have seen an uptick in mergers and acquisitions over the past two years and this trend is expected to accelerate. China, Russia, Japan and South Korea have emerged as the major acquirers in the region, seeking access to oil and gas assets that will secure their future supplies at the currently attractive prices. The crisis has only increased the opportunities for cash-rich companies and energy-hungry national oil companies (NOCs) to expand their resource bases at attractive prices.

While global M&A volumes in the oil and gas sector were down 29% on year in terms of value, in Eurasia the volumes were up by 62% over the same period. Likewise, the volume of global mining sector deals were down in 2008, but up in Eurasia last year. Among the most significant deals struck was the acquisition of Kazakhstan's PetroKazakhstan by China National Petroleum Corporation (CNPC) for $4.2bn, Italian Eni's 100% acquisition of Turkmen-based Burren Energy for $3.45bn and Russian Lukoil's 100% acquisition of Uzbekistan's SoyuzNefteGas for $580m. Currently, CNPC is in the middle of closing a deal to buy a 50% stake in Kazakhstan's MangistauMunaiGas for $3.3bn, while Russia's Mechel Steel Group just acquired 95.7% in Oriel Resources for $1.34bn. Going forward, M&A activity in the region is set to increase as China's strong demand spurs interest in securing resource assets,

European countries attempt to ensure security of energy supplies and diversify gas transportation routes, and as the global economy recovers. We expect that Eurasian countries will continue to sell off state assets to attract investment and sustain economic growth.

Russia and China in Eurasia

The Eurasia region has moved into the centre of Russia and China's geopolitical and economic crosshairs in recent years as the major energy and mining companies from these two emerging global powers have made multi-billion-dollar acquisitions.

The Chinese government offered Kazakhstan a $10bn loan during the crisis, which should allow the country to cement its position in Kazakhstan's energy sector. CNPC, Sinopec and CITIC are involved in developing and operating oil deposits in Kazakhstan, with about 20m tonnes of oil produced with the participation of Chinese companies. ENRC, the producer of ferroalloys and iron ore in Kazakhstan, is planning to build a $910m railway to export commodities to China.

In Turkmenistan, China is providing a $3bn loan to develop the "super giant" South Yolotan gasfield. China is also investing over $1bn in power and infrastructure projects in Tajikistan. A $650m hydroelectric power station is planned to be built in Tajikistan, which potentially could export electricity to China. Russia has a strong intent to maintain its competitive advantage in Central Asia in the face of growing competition from both the West and China. Russia provides a monopoly exit for gas exports from Turkmenistan (50bn cubic metres per year) and Uzbekistan (12bn cm/year).

Kyrgyzstan is another country with abundant hydropower resources eager to attract Chinese interest, where it hopes to sell electricity. In the midst of the global crisis, China offered a $1.5bn loan to Mongolia for infrastructure development and support of its financial sector. China, Mongolia's largest trading partner, buys over 64% of all Mongolian exports, as well as all of its coal and copper exports. Shenhua Group, China's biggest coal producer, is bidding for the development of world class Tavan Tolgoi coking coal deposit there.

Russia has a strong intent to maintain its competitive advantage in Central

Asia in the face of growing competition from both the West and China. Russia provides a monopoly exit for gas exports from Turkmenistan (50bn cubic metres per year) and Uzbekistan (12bn cm/year).

Despite Russia's strategy of maintaining its dominant position over gas supplies, Central Asian countries are expected to establish alternative export routes. China signed deals with Turkmenistan, Uzbekistan and Kazakhstan to build a Central Asia - China gas pipeline, while the EU is strongly backing Nabucco, a gas pipeline which would allow gas from the Caspian region and Middle East to be delivered to Europe bypassing Russia. Nevertheless, Russia's big state energy companies like Gazprom, Rosneft and Rosatom are expected to play significant roles in the Eurasia region. Recently, Mongolia established a joint venture with Russian nuclear firm Rosatom to develop its Dornod uranium deposit. Turkmenistan has signed with Russia's Itera to jointly develop an offshore gasfield in the Caspian Sea. Azerbaijan signed a contract with Gazprom to provide 0.5bn cm/y of gas through the Baku-Novosibirsk pipeline.

Caspian region - a new key player in the global energy market

Gas-rich nations Azerbaijan, Kazakhstan and Turkmenistan have become a major focus for European countries' attempt to ensure gas supplies. The EU and US-backed Southern energy corridor is counting on Azerbaijan and Turkmenistan as major sources of future gas supply. Azerbaijan has expressed interest in the Nabucco pipeline project to diversify gas export routes as the country is poised to boost its gas output from the Shan Deniz gasfield. Turkmenistan also is actively considering alternative export options to reduce its dependence on Russia's Gazprom, especially since a dispute with the Russian company over who was at fault for a blast on a gas pipeline in the country.

China, in its quest for new energy supplies, is building a $7.3bn Central Asia- China gas pipeline that is designed to deliver up to 40bn cm of gas annually from Turkmenistan through Uzbekistan and Kazakhstan to China. The pipeline is to be completed by the end of 2009. China pledged to support developing South Yolotan gas deposit in Turkmenistan. In order to meet its natural gas supply commitments to Russia, China and Iran, Turkmenistan may need at least $5bn per year of investments over the next decade. The country has been opening up its hydrocarbon sector and many global majors are hovering, waiting to enter the lucrative market.

Eurasia is expected to resume its strong growth in coming years, which should benefit different asset classes like local currencies, public equities and property. Investors with long-term views should seek exposure to the resource rich Eurasia markets.

Alisher Ali Djumanov is CEO of Eurasia Capital and Sardorbek Koshnazarov is Head of Research

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